Professor Kenneth Klee analyzes the March 4, 2014 Supreme Court ruling in Law v. Siegel which held that a bankruptcy court exceeds its authority when it permits a surcharge on a debtor's otherwise exempt assets to pay administrative expenses incurred as a result of a chapter 7 debtor's misconduct.
In a unanimous opinion authored by Justice Scalia, the Court held that a bankruptcy court exceeds its authority when it surcharges a debtor's otherwise exempt assets to pay administrative expenses incurred as a result of the debtor's misconduct. Law v. Siegel, 571 U.S. __, 2014 U.S. LEXIS 1784, at *11 (March 4, 2014) [an enhanced version of this opinion is available to lexis.com subscribers]. The Court emphasized that a bankruptcy court may not exercise its statutory and inherent equitable powers in contravention of specific provisions of the Bankruptcy Code. Id. Accordingly, on the facts presented in Law, the Court held that the bankruptcy court's equitable powers did not provide a basis to surcharge the debtor's homestead exemption because section 522(k) expressly provides that a debtor's exempt assets are "not liable for payment of any administrative expense." 11 U.S.C. § 522(k) [an annotated version of this statute is available to lexis.com subscribers]. Of course any sanction for postpetition behavior would not be a prepetition debt, but could only be an administrative expense. See, e.g., Reading Co. v. Brown, 391 U.S. 471 (1968) [enhanced version]. Legal Background: The filing of a bankruptcy petition creates a bankruptcy estate, which is comprised of, inter alia, "all legal or equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C. § 541(a)(1) [annotated version]. An individual debtor, however, may elect to "exempt" certain property from the estate. See 11 U.S.C. § 522. Subject to certain limited exceptions, exempt property "is not liable" for the payment of "any [prepetition] debt of the debtor" or "any administrative expense." 11 U.S.C. § 522(c), (k). Unless applicable state law provides otherwise, a debtor may choose to claim eitherthe exemptions enumerated in section 522(d) or the exemptions available under applicable state or local law. See 11 U.S.C. § 522(b)(3)(A). Nearly every state provides for a "homestead exemption" that protects a portion of the equity in the debtor's residence. Law, 2014 U.S. LEXIS 1784, at *6. For example, California law (the applicable state law in Law) generally provides for a homestead exemption of $75,000. See Cal. Civ. Proc. Code § 704.730(a)(1). There is no provision in the Bankruptcy Code that expressly permits a bankruptcy court to surcharge otherwise exempt property on the basis of a debtor's misconduct in the bankruptcy case. Nevertheless, several circuits have determined that surcharge of otherwise exempt property is permissible when it would compensate the bankruptcy estate for the debtor's wrongful withholding or concealment of non-exempt property. See, e.g., Malley v. Agin, 693 F.3d 28, 29 (1st Cir. 2012) [enhanced version].; Latman v. Burdette, 366 F.3d 774, 786 (9th Cir. 2004) [enhanced version]. But see In re Scrivner, 535 F.3d 1258, 1262-63 (10th Cir. 2008) (no "equitable surcharge" in the absence of a specific Bankruptcy Code provision authorizing surcharge) [enhanced version]. The courts that permitted surcharge have relied on, inter alia, section 105(a), which provides that 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) [annotated version], as well as the "inherent power" of courts to sanction abusive litigation practices. The Supreme Court granted certiorari in Law to resolve the question "whether a bankruptcy court ... may order that a debtor's exempt assets be used to pay administrative expenses incurred as a result of the debtor's misconduct." Law, 2014 U.S. LEXIS 1784, at *5. [footnotes omitted]
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