• Does the Bankruptcy Court have the Authority to Surcharge Exemptions?
  • November 3, 2014 | Author: Keri Ebeck
  • Law Firm: Weltman, Weinberg & Reis Co., L.P.A. - Pittsburgh Office
  • Law v. Siegel: The facts of the case are that Mr. Law (Debtor) filed for Chapter 7 bankruptcy protection. He valued his home in California at $363,348 and claimed a $75,000 homestead exemption, as well as listed two mortgage liens on the property in question: (1) to Washington Mutual Bank for $147,156.52; and (2) to Lin's Mortgage & Associates for $156,929.04. Due to the alleged amount of the mortgages on Mr. Law's property and the claimed homestead exemption, there appeared to be no equity for the Bankruptcy Estate. It was determined through an adversary brought by the Chapter 7 Trustee that the alleged second mortgage to Lin's Mortgage & Associates was fraudulent and did not exist except in the mind of Mr. Law. The adversary litigation to determine such was extensive, lengthy and cost approximately $500,000 in attorney fees for the Trustee. The bankruptcy court ruled that the debtor's homestead exemption of $75,000 could be surcharged, making those funds available to pay a portion of the Trustee's legal fees incurred.

    The legal issue in question and up on a Writ of Certiorari (meaning to ask the Court to review the lower courts decision) to the U.S. Supreme Court was the surcharge of legal fees by the Bankruptcy Court, and its direct contradiction of a specific provision in the Bankruptcy Code, specifically §522(k). Under §522(k), homestead exemptions are not liable for administrative expenses of the bankruptcy estate and cannot be used for that purpose. As the legal fees incurred by the Chapter 7 Trustee are administrative expenses under §522, the Bankruptcy Court did not have the authority under §105(a) to surcharge the debtor's homestead exemption as it directly contravened §522(k). Under §105(a), the bankruptcy court may issue any order, process or judgment that is necessary or appropriate to carry out the provisions of bankruptcy code. The question was whether §105(a) as previously explained allowed the Court to "surcharge" (meaning to charge the debtor's homestead exemption for the trustee's incurred attorney fees.) The Supreme Court stated that "the Bankruptcy Court thus violated §522's express terms when it ordered that the $75,000 protected by Law's homestead exemption be made available to pay Siegel's attorney's fees, an administrative expense. In doing so, the court exceeded the limits of its authority under §105(a) and its inherent powers." 1

    The Supreme Court went on to state that its decision did not prevent the Chapter 7 Trustee or Bankruptcy Court from seeking other sanctions imposable against the debtor, such as denial of discharge, sanctions for bad-faith litigation and reimbursement of attorney fees as a result of the debtor's fraud upon the Court in this matter. Additionally, because any sanctions awarded against the debtor would be post-petition, it would not be subject to the debtor's discharge (should he receive one). Furthermore, the Court acknowledged that "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." 2

    Although under §522(b), the debtor's homestead exemption is his, and his only to claim, "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." 3 In this case, the Bankruptcy Court did not have a valid statutory basis to impair the exemption; rather it directly contradicted another statute under the Bankruptcy Code. The Bankruptcy Court could not order the exemption to pay the Trustee's fees, but did provide the Bankruptcy Estate and Trustee with other options within the Court's discretion to sanction the debtor's fraudulent conduct in this case. Overall, the Supreme Court case ruling places limitations on §105(a) and that bankruptcy courts should not be expanding this section, especially when it specifically contradicts another section under the Bankruptcy Code.

    1 Law v. Siegal, 134 S.Ct. 1188 (2014).
    2 Id.
    3 Id.