• Kentucky Supreme Court Rules that Federal Bankruptcy Exemption Scheme is not available to Non-Bankruptcy Debtors in Kentucky
  • August 20, 2009 | Author: Ellen Sharp
  • Law Firm: Frost Brown Todd LLC - Office
  • Until a recent decision overturning the Court of Appeals of Kentucky was handed down by the Kentucky Supreme Court, there was authority in this Commonwealth for the proposition that a non-bankruptcy debtor could benefit from the Federal bankruptcy exemption scheme, which is much more liberal than the exemption scheme provided by state law.

    In late June, the Kentucky Supreme Court recently handed down a decision on exemptions available for a non-bankruptcy debtor under Kentucky law in a case that has been closely monitored by banks around the Commonwealth. The case, styled MPM Financial Group, Inc. v. Morton, developed out of a garnishment issued by MPM Financial Group, Inc. (“MPM”) on a judgment it had obtained in the Fayette Circuit Court against Michael P. Morton (“Morton”). In order to execute upon its judgment, MPM issued a writ of garnishment (non-wage) on UNUM Provident, which was at that time making payments to Morton on a private disability insurance policy (the “Garnishment Order”). Morton brought a challenge to the Garnishment Order in Fayette Circuit Court, alleging that his disability payments were exempt from garnishment pursuant to both KRS 427.150 and KRS 427.170.

    KRS 427.150 is the Kentucky exemption scheme, which includes, under subsection (2)(d), an exemption for “compensation of the loss of future earnings.” The Fayette Circuit Court ultimately found the Morton’s disability payments did not constitute compensation for the loss of future earnings, and ruled that KRS 417.150 did not provide Morton with an exemption from the Garnishment Order; however, the court found that KRS 427.170 (described in more detail below) provided Morton an exemption for the entire amount of his disability payments, as 11 U.S.C. § 522(d)(10)(C) provides an exemption for the debtor’s “right to receive a disability, illness, or unemployment benefit.”

    MPM appealed, claiming that KRS 427.170 was not intended to provide non-bankruptcy debtors with access to the federal exemption scheme. The Kentucky Bankers Association filed an amicus brief in support of MPM’s position, but incredibly, the Court of Appeals ruled in favor of Morton, finding that KRS 427.170 authorizes a non-bankruptcy debtor to claim the exemptions provided by 11 U.S.C. 522(d).

    On June 25, 2009, the Kentucky Supreme Court reversed, holding that KRS 427.170 does not provide non-bankruptcy debtors with the benefits of federal bankruptcy exemptions. The Court found that KRS 427.170 was ambiguous on its face, so to make its determination, the Court examined the legislative history of the statute and applied customary Kentucky rules of statutory construction.

    First, and of apparent significance to the Court, KRS 427.170 was originally enacted in 1980 as a response to the 1978 revision of the Bankruptcy Code, which included in 11 U.S.C. § 522(b) a provision that a bankruptcy debtor could choose between the federal exemption scheme and his resident state’s exemption scheme, unless that state had “opted-out” of the federal scheme. Accordingly, KRS 427.170 was initially enacted as an “opt-out” statute, which provided that a debtor in Kentucky is not authorized to elect the Federal exemptions contained in Section 522 of the Bankruptcy Code. In 2005, after Congress’ substantial revisions to the Bankruptcy Code commonly known as Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), the Kentucky General Assembly revised KRS 427.170 apparently to “opt-in” to the federal scheme, simply by deleting the word “not” from the statute and re-titling it “Federal Bankruptcy Code Exemptions Applicable in Kentucky.”

    The Kentucky Supreme Court found that since the initial purpose of KRS 427.170 was clearly to prevent a bankruptcy debtor from benefiting from the exemption scheme of 11 U.S.C. § 522(d), then it clearly made sense that the revised version of 427.170 should only benefit a bankruptcy debtor. The Court further found that since KRS 427.170 and KRS 427.150 were enacted at the same time, both statutes must be given effect if possible. Since 11 U.S.C. 522(d) contains all of the exemptions provided in KRS 427.150, the Court found that interpreting 427.170 to apply to non-bankruptcy debtors would render 427.150 meaningless. Accordingly, and further based on examination of available transcripts of legislative debate surrounding the revisions to 427.170, the Supreme Court held that 427.170 does not make the federal exemption scheme of 11 U.S.C. §522 available to non-bankruptcy debtors.

    The Court’s decision is a victory for judgment creditors in Kentucky pursuing collection outside of bankruptcy. The federal exemption scheme is generally perceived to be more liberal than the Kentucky scheme, so restriction of its application to bankruptcy debtors will leave more assets available for judgment creditors in Kentucky. The Court’s opinion, while not final at this time, is available at 2009 WL 1819485.