Steven Law ("Debtor") ran on financially hard times and filed for Chapter 7 bankruptcy in 2004. The Court appointed Alfred Siegel as the Bankruptcy Trustee ("BKT") to oversee the case and to marshal the Debtor's assets.
Debtor filed a bankruptcy schedule that listed the value of his California home at $363,348 and claimed the $75,000 nominal protection of California's homestead exemption. Debtor also reported that there were two voluntary liens on his home: (1) for $147,156 to Washington Mutual Bank, and (2) for $156,929 to Lin's Mortgage & Associates. Thus, Debtor claimed, there was no equity left in his home for creditors.
Probably to the Debtor's surprise, the BKT did not just blindly accept the Debtor's schedules, but started to investigate who or what Lin's Mortgage & Associates actually was and what they actually did. The BKT's investigation turned up that the Debtor himself had filed a Deed of Trust reflecting a lien to "Lili Lin". The BKT then filed an adversary lawsuit to challenge the Deed of Trust to Lili Lin as fraudulent.
Nothing to write home about so far, cases of bogus and liens and suspicious Deeds of Trust make up the daily routine of bankruptcy lawyers and trustees. But strap yourself in, because here is where the case gets weird.
Lili Lin of Artesia, California, responded to the BKT adversary lawsuit. She said that she was an old acquaintance of the Debtor, who testified that the Debtor had repeatedly tried to involve her in various "sham transactions" to protect his home equity with bogus Deeds of Trust, but she had refused. For her part, she wanted nothing to do with the case, and entered into a stipulated judgment whereby she totally disclaimed any interest in the Debtor's house.
Well, that doesn't happen everyday, but the case even gets weirder, much weirder.
About as quick as Lili Lin turned on the Debtor and disclaimed any interest in the house, a second "Lili Lin" showed up to contest the adversary proceeding! This Lili Lin #2 spoke no English, and was apparently resident in China, but she made a claim on the house and litigated the case for the next five years, thwarting the BKT's attempts to sell avoid the Deed of Trust or sell the house for its equity.
By 2009, the Bankruptcy Court had enough of this charade, and entered an Order that basically said that the claim of Lili Lin #2 was bogus, and that her loan was nothing more than a fiction to protect the Debtor's equity in his home. But even beyond that, the Court held that the Debtor had submitted false evidence to the Court to try to convince it that the Lili Lin #2 loan was bona fide, causing the BKT to expend more than $500,000 in attorney's fees to overcome the Debtor's fraudulent misrepresentations.
Therefore -- and this is where our legal issue arises -- the Bankruptcy Court allowed the BKT to "surcharge" the Debtor's otherwise-exempt $75,000 homestead amount to help defray the legal fees that the Lili Lin #2 bogus loan had caused.
In the Ninth Circuit, appeals from bankruptcy judges are direct to the Bankruptcy Appellate Panel ("BAP") of that court, which affirmed -- though noting a split among the U.S. Circuit Courts of Appeals as to whether the surcharging of exempt assets was permissible. A further appeal of the BAP's ruling to the full Ninth Circuit was likewise affirmed.
Apparently because of the split between the Circuits, the U.S. Supreme Court granted the Debtor's Writ of Certiorari, and the Court in a unanimous opinion by Justice Scalia ruled on this case, which is remarkable in itself since bankruptcy issues of this nature only very rarely are found in the nation's highest court, and particularly one where the amount in controversy was only $75,000 -- a pittance compared to most disputes that land in the big white building behind the Capitol.
Antonin Scalia, Associate Justice of the Supreme Court of the United States (Photo credit:... [+]
Justice Scalia's opinion was pretty straightforward, and was basically that Congress had set forth the exemptions that debtors are entitled to under Section 522 of the Bankruptcy Code (Title 11), Congress had not seen fitten to carve out an exception for debtor misconduct, and thus the surcharging of an exempt asset is impermissible. After reviewing the complex scheme of exemptions and exceptions under Section 522, Justice Scalia concluded:
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.
Justice Scalia considered the BKT's argument that other precedent allowed Trustee's to seek relief where the Debtor acted in bad faith, but then distinguished that authority which dealt with the conversion of cases from a debtor-friendly reorganization under Chapter 13 to the creditor-friendly proceedings under Chapter 7.
The Court was also sympathetic that these case could force Bankruptcy Trustees to "shoulder a heavy burden" from egregious debtor misconduct, but that was a problem for Congress to solve by amending Section 522, and not by the Court carving out a judicial exception to detailed legislation. But this was not to say that debtors who engage in this sort of conduct would necessarily get away with it:
Our decision today does not denude bankruptcy courts of the essential "authority to respond to debtor misconduct with meaningful sanctions." [] There is ample authority to deny the dishonest debtor a discharge. [] 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." [] The court may also possess further sanctioning authority under either sec. 105(a) or its inherent powers. [] 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. [] Fraudulent conduct in a bankruptcy case may also subject a debtor to criminal prosecution under 18 U.S.C. sec. 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.
And on that final note, the U.S. Supreme Court reversed the Ninth Circuit and remanded the case, such that the Debtor would be entitled to his $75,000 homestead despite his misconduct. Now, for some kibitzing from the peanut gallery:
ANALYSIS
At first glance, this case is good for those who engage in aggressive post-claim planning (which is nothing like legitimate pre-claim asset protection planning) and might have been concerned that their shenanigans as to the debtor's non-exempt assets might lead to a surcharge of the debtor's exempt assets. For example, if after a judgment the debtor transferred all her assets to a new offshore trust, but kept an IRA in the U.S., the IRA was (before this decision) potentially exposed to being surcharged in bankruptcy. Those concerns have for the moment evaporated.
But this silver cloud has a dark lining, and it is in Justice Scalia telling us that Bankruptcy Trustees may need to get more aggressive in going after a misbehaving debtor, including seeking post-petition (non-dischargeable) sanctions and making criminal referrals for bankruptcy fraud to the U.S. attorney. So once again, we start to see those situations where the assets are protected, but the person of the debtor may be subject to greater exposure.
Justice Scalia also tells us that this issue is simply one of legislative drafting -- it does not present constitutional issues that Congress could not navigate around. Don't be surprised if the powerful Banking Lobby, the American Bankruptcy Institute, and the American Bar Association's Bankruptcy Law Section starts to work on Congress for a legislative fix that would specifically allow the surcharging of assets for egregious debtor misconduct, similar to how Congress enacted Bankruptcy Code section 548(e) to effectively neuter transfers to self-settled trusts (a/k/a "asset protection trusts") made within 10 years of the bankruptcy filing.
For the moment, however, the concept of "surcharging" in bankruptcy is one of those things that were, although of course this decision has no impact whatsoever on the states whose courts or judgment enforcement laws allow such surcharging, i.e., in a particular state surcharging may still be available outside of bankruptcy. Check your local laws.
But the best way to avoid surcharging is for a person to simply do things the right way, well ahead of the time they become a debtor, and then as a debtor avoid misconduct altogether -- which is what good planning is all about.
And you don't need a nine folks in black robes to tell you that.
CITE AS
Law v. Siegel, ___ U.S. ___, ___ S.Ct. ____, 2014 WL 813702 (Mar. 4, 2014). Full Opinion at http://goo.gl/o8kQL3
This article at http://onforb.es/1g4td5q and http://goo.gl/Y09Fa7
