In a unanimous decision, the Supreme Court struck down the Ninth Circuit’s imposition of an equitable surcharge against a debtor’s exempt property in Law v. Siegel, No. 12-5196 (3/4/14) [an enhanced version of this opinion is available to lexis.com subscribers]. The opinion can be found here. The opinion by Justice Scalia represents a limitation on the equitable powers of bankruptcy courts to override statutory protections, even when a debtor has behaved badly. The case is a counterpoint to Marrama v. Citizen’s Bank, 127 S.Ct. 1105 (2007) [enhanced version] which had read an equitable good faith requirement into the absolute right to convert a case.
Debtor Law filed for chapter 7 protection in California which has a limited homestead exemption. He claimed a $75,000 homestead exemption and also claimed that the property was encumbered by a first lien to Washington Mutual and a second lien in favor of “Lin’s Mortgage & Associates.” Had the liens been valid, there would have been no equity for the estate. It turned out that the Lin lien was made up. However, it took the trustee a lot of litigation to reach that result. The Trustee spent over $500,000 trying to get to the bottom of the dispute, which involved a Lili Lin of Artesia, California who denied loaning the Debtor any money and a Lili Lin of China who most likely did not exist.
When the Trustee ultimately sold the home, he sought to surcharge the Debtor’s $75,000 exemption with the costs of avoiding the fraudulent lien. The Bankruptcy Court allowed the surcharge and was affirmed by the BAP and the Ninth Circuit. Mr. Law submitted a pro se petition to the Supreme Court which granted cert. I have previously written about the improbable grant of cert here.
Justice Scalia’s ruling is encapsulated in the first paragraphs of his analysis:
A bankruptcy court has statutory authority to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of” the Bankruptcy Code. 11 U. S. C. §105(a). And it may also possess “inherent power . . . to sanction ‘abusive litigation practices.’ ” (citation omitted). But in exercising those statutory and inherent powers, a bankruptcy court may not contravene specific statutory provisions.
It is hornbook law that §105(a) “does not allow the bankruptcy court to override explicit mandates of other sections of the Bankruptcy Code.” (citation omitted). Section 105(a) confers authority to “carry out” the provisions of the Code, but it is quite impossible to do that by taking action that the Code prohibits. That is simply an application of the axiom that a statute’s general permission to take actions of a certain type must yield to a specific prohibition found elsewhere. (citations omitted). Courts’ inherent sanctioning powers are likewise subordinate to valid statutory directives and prohibitions. (citation omitted).
We have long held that “whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of” the Bankruptcy Code. (citations omitted).
Opinion, pp. 5-6.
11 U.S.C. §522(k) expressly states that exempt property is not liable for any administrative expense except for costs incurred in allowing the debtor to avoid a transfer of exempt property. Thus, the case posed a clear conflict between the statutory language of the Code and the Bankruptcy Court’s desire to punish a wrongdoer.
Justice Scalia easily brushed off the arguments made by the Trustee and the United States (appearing as amicus curiae).
The Trustee contended that his fees were not really administrative expenses, a contention that Justice Scalia promptly rejected.
The Trustee and the United States argued that section 522 does not expressly prohibit denying an exemption based on bad conduct. The U.S. argued that section 522 “neither gives debtors an absolute right to retain exempt property nor limits a court’s authority to impose an equitable surcharge on such property.”
Justice Scalia made the easy conclusion that the Trustee had waived his right to challenge the exemption by failing to object. He went on to state that:
(E)ven assuming the Bankruptcy Court could have revisited Law’s entitlement to the exemption, §522 does not give courts discretion to grant or withhold exemptions based on whatever considerations they deem appropriate. Rather, the statute exhaustively specifies the criteria that will render property exempt. See §522(b), (d). Siegel insists that because §522(b) says that the debtor “may exempt” certain property, rather than that he “shall be entitled” to do so, the court retains discretion to grant or deny exemptions even when the statutory criteria are met. But the subject of “may exempt” in §522(b) is the debtor, not the court, so it is the debtor in whom the statute vests discretion. A debtor need not invoke an exemption to which the statute entitles him; but if he does, the court may not refuse to honor the exemption absent a valid statutory basis for doing so.
Moreover, §522 sets forth a number of carefully calibrated exceptions and limitations, some of which relate to the debtor’s misconduct. For example, §522(c) makes exempt property liable for certain kinds of prepetition debts, including debts arising from tax fraud, fraud in connection with student loans, and other specified types of wrongdoing. Section 522(o) prevents a debtor from claiming a homestead exemption to the extent he acquired the homestead with nonexempt property in the previous 10 years “with the intent to hinder, delay, or defraud a creditor.” And §522(q) caps a debtor’s homestead exemption at approximately $150,000 (but does not eliminate it entirely) where the debtor has been convicted of a felony that shows “that the filing of the case was an abuse of the provisions of ” the Code, or where the debtor owes a debt arising from specified wrongful acts—such as securities fraud, civil violations of the Racketeer Influenced and Corrupt Organizations Act, or “any criminal act, intentional tort, or willful or reckless misconduct that caused serious physical injury or death to another individual in the preceding 5 years.” §522(q) and note following §522. The Code’s meticulous—not to say mind-numbingly detailed—enumeration of exemptions and exceptions to those exemptions confirms that courts are not authorized to create additional exceptions. (citation omitted)(emphasis added).
Opinion, pp. 8-9.
Justice Scalia also distinguished Marrama on the basis that it invoked a specific statutory condition (namely that the debtor could only convert if he was eligible to be a debtor under chapter 13) and that the Court was not so much overriding the statute as compressing multiple hearings into one. He wrote:
True, the Court in Marrama also opined that the Bankruptcy Court’s refusal to convert the case was authorized under §105(a) and might have been authorized under the court’s inherent powers. Id., at 375–376. But even that dictum does not support Siegel’s position. In Marrama, the Court reasoned that if the case had been converted to Chapter 13, §1307(c) would have required it to be either dismissed or reconverted to Chapter 7 in light of the debtor’s bad faith. Therefore, the Court suggested, even if the Bankruptcy Court’s refusal to convert the case had not been expressly authorized by §706(d), that action could have been justified as a way of providing a “prompt, rather than a delayed, ruling on [the debtor’s] unmeritorious attempt to qualify” under §1307(c). Id., at 376. At most, Marrama’s dictum suggests that in some circumstances a bankruptcy court may be authorized to dispense with futile procedural niceties in order to reach more expeditiously an end result required by the Code. Marrama most certainly did not endorse, even in dictum, the view that equitable considerations permit a bankruptcy court to contravene express provisions of the Code.
Opinion, pp. 10-11.
Finally, Justice Scalia wrote that notwithstanding the burden to the Trustee, there were other avenues available to him under the Code and the Rules.
We acknowledge that our ruling forces Siegel to shoulder a heavy financial burden resulting from Law’s egregious misconduct, and that it may produce inequitable results for trustees and creditors in other cases. We have recognized, however, that in crafting the provisions of §522, “Congress balanced the difficult choices that exemption limits impose on debtors with the economic harm that exemptions visit on creditors.” (citation omitted). The same can be said of the limits imposed on recovery of administrative expenses by trustees. For the reasons we have explained, it is not for courts to alter the balance struck by the statute. (citation omitted).
* * *
Our decision today does not denude bankruptcy courts of the essential “authority to respond to debtor misconduct with meaningful sanctions.” Brief for United States as Amicus Curiae 17. There is ample authority to deny the dishonest debtor a discharge. See §727(a)(2)–(6). (That sanction lacks bite here, since by reason of a postpetition settlement between Siegel and Law’s major creditor, Law has no debts left to discharge; but that will not often be the case.) In addition, Federal Rule of Bankruptcy Procedure 9011—bankruptcy’s analogue to Civil Rule 11—authorizes the court to impose sanctions for bad-faith litigation conduct, which may include “an order directing payment. . . of some or all of the reasonable attorneys’ fees and other expenses incurred as a direct result of the violation.” Fed. Rule Bkrtcy. Proc. 9011(c)(2). The court may also possess further sanctioning authority under either §105(a) or its inherent powers. (citation omitted). And because it arises postpetition, a bankruptcy court’s monetary sanction survives the bankruptcy case and is thereafter enforceable through the normal procedures for collecting money judgments. See §727(b). Fraudulent conduct in a bankruptcy case may also subject a debtor to criminal prosecution under 18 U. S. C. §152, which carries a maximum penalty of five years’ imprisonment.
But whatever other sanctions a bankruptcy court may impose on a dishonest debtor, it may not contravene express provisions of the Bankruptcy Code by ordering that the debtor’s exempt property be used to pay debts and expenses for which that property is not liable under the Code.
Opinion, pp. 11-12.
What It Means
The way I read the opinion, Mr. Law gets to keep his $75,000 in exempt property, but is subject to sanctions under Rule 9011 and criminal prosecution under 18 U. S. C. §152. The Trustee and the U.S. Attorney will no doubt figure this out so that Mr. Law’s victory may ultimately be hollow.
Law v. Siegel reflects the tension between the fact that Bankruptcy Courts are nominally courts of equity but that they are subject to an often “mind-numbingly detailed” statutory scheme. Any time there is a conflict between section 105 and another section, section 105 should lose out (especially if Justice Scalia is writing the opinion). On the other hand, the statutory scheme and rules often creates alternative pathways to the desired result. Here, the appropriate pathway was to allow the Debtor to keep his $75,000 in exempt property while imposing $500,000 in sanctions against him. Mr. Law’s reward for having brought this abuse of equitable powers to the Supreme Court’s attention is that he may ultimately face a much more severe penalty.
The Supreme Court’s decision in Law v. Siegel restores order to the bankruptcy universe. Bankruptcy judges remain empowered to address misconduct in their courts. However, they must do it using the tools granted by Congress in the Code and by the Supreme Court in the Bankruptcy Rules. Justice Scalia has given the lower courts a reasonably low-key scolding that while the ends do not justify the means, if you look hard enough there is a legitimate means for every legitimate end.
On a more mundane note, the opinion contains a lot of good language about exemptions and equity which can be profitably quoted in a number of contexts.
Fifth Circuit practitioners may recognize that this case is reminiscent of In re Niland, 825 F.2d 801 (5th Cir. 1987) [enhanced version]. In that case, Mr. Niland (who was a former Dallas Cowboy), obtained a loan on a condominium by claiming that it wasn’t his homestead. The Bankruptcy Court granted a constructive trust against the property after voiding the invalid lien. The Fifth Circuit reversed, finding that the Debtor could not be estopped from claiming his valid homestead rights. However, he went to jail for two years for fraud.
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