U.S. Supreme Court Reins In Bankruptcy Court Authority Under § 105(a)

On March 4, 2014, the United States Supreme Court issued its decision in Law v. Siegel, 571 U.S. __ (Mar. 4, 2014) and held that the bankruptcy court exceeded its authority under section 105(a) of the Bankruptcy Code and its inherent powers by authorizing the chapter 7 trustee to "surcharge" the debtor's homestead exemption to defray litigation costs incurred in an adversary proceeding brought against the debtor. At play was a bankruptcy court's authority to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions" of the Bankruptcy Code. 11 U.S.C. § 105. The result turned on a very simple proposition: "it is quite impossible to [carry out the provisions of the Code] by taking action that the Code prohibits."

The debtor in Law listed his house on his bankruptcy schedules, claiming a homestead exemption in the amount of $75,000 under Cal. Civ. Proc. Code § 704.730(a)(1). The debtor represented that the house was encumbered by two liens: a note and deed of trust for $147,156.52 in favor of Washington Mutual Bank, and a second note and deed of trust for $156,929.04 in favor of "Lin's Mortgage & Associates." Based on these representations, the debtor made it appear as if there was no nonexempt value in the house that the trustee could realize for the benefit of the estate. The trustee, however, initiated an adversary proceeding against the debtor, alleging that the lien in favor of "Lin's Mortgage & Associates" was a sham. After expending over $500,000 in legal fees, the trustee was successful in proving that the debtor fabricated the second "loan" to defraud his creditors and the court. The United States Bankruptcy Court for the Central District of California granted the trustee's motion to "surcharge" the debtor's claimed homestead exemption to help pay for some of the trustee's legal fees; the Bankruptcy Appellate Panel of the Ninth Circuit and the Ninth Circuit affirmed.

Justice Scalia, writing for a unanimous Court, reinforced that "in exercising [its authority under section 105] and inherent powers, a bankruptcy court may not contravene specific statutory provisions." In the context of exemptions, the Code plainly states that exempt property "is not liable" for the payment of "any administrative expense." See 11 U.S.C. § 522(k). The Court held that the bankruptcy court's surcharging the debtor's exemption ran afoul of the prohibition stated in section 522(k), as the trustee's attorney's fees were...