U.S Supreme Court: Bankruptcy courts cannot surcharge exempt property

Posted on Mar 04, 2014

In the March 4, 2014 U.S. Supreme Court case of Law v. Siegel, the Court ruled that a bankruptcy court may not use Bankruptcy Code Sec. 105(a) or it's inherent powers to sanction abusive litigation practices by taking action which conflicts with another part of the Code.

In this case, the Supreme Court ruled that the bankruptcy court cannot surcharge the debtor's California homestead exemption claim of $75000 to pay Trustee's attorney's fees for the debtor's fraudulent conduct.

Law filed bankruptcy, and claimed the equity in his home as exempt. But he had been crooked about it. After Siegel the trustee objected, the bankruptcy court ruled that Law had invented a fake mortgage, to account for about $150,000 of debt, so that he could claim the remaining $75,000 of equity as exempt under California law and keep his house without having the trustee sell it to pay creditors.

Litigating all of this mess cost $500,000, and the trustee won. The bankruptcy court held, and the district and circuit courts affirmed, that the debtor's homestead equity could be taken from him to help pay the litigation costs, since he had lied about the fake mortgage and started all the litigation to begin with.

The Supreme Court said no. While bankruptcy courts have power to sanction parties for misconduct, they do not have the power to take away something that is explicitly given to a debtor by another section of the Bankruptcy Code (exemptions), which is federal law. Not only that, but the trustee would have had to object to exemptions within 30 days, which he did not do.

The Court went on to hold that there were other ways for the court to punish the debtor for his misbehavior, including sanctions, denial of discharge, and even criminal penalties.

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