Validity of Surcharge on Debtor’s Home Debated at U.S. Supreme Court

Validity of Surcharge on Debtor’s Home Debated at U.S. Supreme Court

 WASHINGTON, D.C. — (Mealey’s) The U.S. Supreme Court heard oral arguments Jan. 13 in a case in which a Chapter 7 debtor argues that the Ninth Circuit U.S. Court of Appeals wrongly affirmed a ruling in which a bankruptcy court levied a surcharge on his residential property as punishment to “deter improper conduct” (Stephen Law v. Alfred Siegel, No. 12-5196, Chapter 7, U.S. Sup.).


In 2004, Stephen Law filed for Chapter 7 bankruptcy in the U.S. Bankruptcy Court for the Central District of California and sought a homestead exemption for his home property valued at $363,348.

The Chapter 7 trustee, Alfred Siegel, did not object to the homestead exemption, but two years later, he moved to surcharge Law's homestead exemption $75,000.

The Bankruptcy Court granted the surcharge, but the U.S. Bankruptcy Appellate Panel (BAP) for the Ninth Circuit reversed the surcharge order, concluding that it was “not warranted.”

The trustee appealed to the Ninth Circuit, which reversed the BAP's ruling and determined that the surcharge was proper. Law appealed to the Supreme Court.

11 U.S. Code Section 522

At oral argument, Law’s attorney, Matthew S. Hellman, contended that Congress has “expressly prohibited” what the Bankruptcy Court decided in this case. Hellman said that 11 U.S. Code Section 522(k) specifies that a debtor’s exempt property, his homestead, his pension and his wedding ring are “not liable for the payment of ‘any administrative expense.’”

Moreover, Hellman maintained that the Bankruptcy Court was not free to override that express and specific prohibition in the name of equity, a point that “has been clear for at least 80 years.” Hellman said that Congress made its “judgment” in 11 U.S. Code Section 522(k) that debtors and their dependents — even dishonest debtors — ought not be deprived of their exempt property such that they would emerge from bankruptcy as “wards of the State.”

Justice Samuel A. Alito Jr. said he was “somewhat taken aback” by Hellman’s reference to “ward of the state” and said, “What we're talking about is whether your client gets $75,000. Do you think everybody who doesn't have $75,000 is a ward of the State?”

Ward Of State

Hellman said that in the case at hand, all of Law’s creditors have been paid off and the trustee has already received “approximately $280,000,” so “we’re just talking about literally, literally, the last $75,000, and all of it, that would be going to the trustee.”

Siegel’s attorney Neil K. Katyal of Hogan Lovells in Washington argued that the facts explain why the Bankruptcy Court “exercised its discretion appropriately” under 11 U.S. Code Section 105(a) and the longstanding inherent power of the court.

“Mr. Law committed a massive fraud on that court with the fake mortgage and fake documents,” Katyal said. Law “lied repeatedly to the court, and then lied about his lies, all in an attempt to retain nonexempt property and equity in his home in contravention of the code.”

Authority ‘Ample’

Katyal contended further that 11 U.S. Code Section 105 “was made for a case like this” and provides “ample authority” for what the Bankruptcy Court did.

However Justice Sonia Sotomayor questioned how a party could legitimately make any claims to the exempt property in this case. She went on to say that the Bankruptcy Code limits access to the exemption “to specified frauds”; namely, frauds that result in conviction.

“So if the code doesn’t permit full recovery for fraud, why should a court be permitted to do it?” Justice Sotomayor asked.

Katyal said that the provision of the Bankruptcy Code to which Sotomayor was referring was not in effect at the time the instant bankruptcy was being conducted.

Surcharge ‘Necessary’

Sarah E. Harrington, assistant to the U.S. solicitor general, who had argued that the case should not have been granted certiorari, said the surcharge order was “necessary and appropriate” to enforce the Bankruptcy Code because Law “flouted” his obligations and made it “impossible” to carry out the provision of the Bankruptcy Code without surcharging him in some way.

Harrington added that the Bankruptcy Court could have imposed a sanction, which would have been prepetition debt and would not have been discharged. If the Bankruptcy Court had ordered Law to pay the money “on pain of contempt,” it could have enforced the order notwithstanding any state law provision that would have exempted the property after the bankruptcy, she said.


Law is represented by Hellman of Jenner & Block in Washington. The trustee is represented by David Seror of Ezra Brutzkus Gubner in Woodland Hills, Calif.

Siegel is represented by Katyal of Hogan Lovells in Washington, D.C.

The solicitor general is represented by Acting Assistant Attorney General Stuart F. Delery, Deputy Solicitor General Malcolm L. Stewart, Michael S. Raab, Anne Murphy and Harrington of the U.S. Department of Justice. All are in Washington. 

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