From The Top In Brief - March/April 2014

In its first bankruptcy decision of 2014 (October Term, 2013), the U.S. Supreme Court held on March 4, 2014, in Law v. Siegel, No. 12-5196 (Mar. 4, 2014) (available at http://www.supremecourt.gov/opinions/13pdf/12-5196_8mjp.pdf), that a bankruptcy court cannot impose a surcharge on exempt property due to a chapter 7 debtor's misconduct, acknowledging that the Supreme Court's decision may create "inequitable results" for trustees and creditors. In reversing a ruling by the Ninth Circuit Court of Appeals, Law v. Siegel (In re Law), 2011 BL 148411 (9th Cir. June 6, 2011), cert. granted, 133 S. Ct. 2824 (2013), the Supreme Court concluded that the bankruptcy court overstepped the bounds of its statutory authority (under section 105(a) of the Bankruptcy Code) and inherent authority when it imposed a $75,000 surcharge on the debtor, who engaged in litigation misconduct by falsely claiming, in an effort to defraud creditors, that his California homestead was encumbered by a lien securing a $168,000 purchase money loan provided by a personal friend. Litigation concerning the fabricated lien and the debtor's "egregious misconduct" caused the bankruptcy estate to incur $450,000 in legal fees and related expenses. Writing for a unanimous Court, Justice Antonin Scalia reasoned that "[a] bankruptcy court may not exercise its authority to 'carry out' the provisions of the Code, or its 'inherent power . . . to sanction abusive litigation practices,' by taking action prohibited elsewhere in the Code." According to Justice Scalia, the bankruptcy court's surcharge contravened section 522 of the Bankruptcy Code, which gave the debtor the right to use California's "homestead exemption" to exempt $75,000 of equity in his home from the bankruptcy estate. Justice Scalia acknowledged that the Supreme Court's ruling may cause bankruptcy trustees and creditors to shoulder greater costs in fighting allegedly fraudulent claims. However, he wrote, "it is not for courts to alter the balance struck by the statute." Moreover, he explained, ample authority remains to address debtor misconduct, including denial of discharge under section 727(a); sanctions for bad-faith litigation conduct under Rule 9011 of the Federal Rules of Bankruptcy Procedure, section 105(a), or a bankruptcy court's inherent powers; enforcement of monetary sanctions through the procedures set forth in section 727(b) for collecting money judgments; and possible prosecution for bankruptcy crimes under 18...