THE BANKRUPTCY CORNER – New Holding for Debtors

Law v. Siegel (In re Law), No 12-5176, 571 U.S. _(March 41 , 2014).

This United States Supreme Court decision provided Chapter 7 debtors (and presumably Chapter 13 debtors) with judicial cover for pre-petition misconduct, holding the bankruptcy courts cannot surcharge the Debtor’s homestead exemption as a result of pre-petition misconduct. The Debtor in the Law case owned a homestead consisting of California real estate; the debtor misrepresented the homestead’s fair market value and overstated in his bankruptcy schedules the amount of the actual multiple secured lien claims. The combination of the overstated secured lien claims and the Debtor’s homestead exemption indicated there was no equity in his real estate. Neither the Chapter 7 Trustee, nor any creditors, filed objections to Debtor’s homestead exemption claim. The Debtor’s house was sold for almost twice the scheduled value, and it was subsequently determined that the $168,000 scheduled second mortgage was non-existent.

The bankruptcy court sustained the Chapter 7 Trustee’s request to surcharge the Debtor’s homestead exemption for the Trustee’s costs and expenses and payment of claims. Referencing 11 U.S.C. section 522(k), the Supreme Court held that the bankruptcy court’s powers under 11 U.S.C. section 105(a) do not extend to surcharging the Debtor’s homestead exemption for pre-petition misconduct, finding that the surcharge would contravene the provisions of section 522(k). The Law case seems to provide broad protection of the Debtor’s homestead exemption against a surcharge for fraudulent misconduct, but this protection may be short-lived based on Bankruptcy Rule 4003. Note, the Chapter 7 Trustee is authorized under Bankruptcy Rule 4003 to file an objection to Debtor’s exemption up to one year after the case is closed if the claim of exemption was fraudulently asserted.