Supreme Court to Decide Bankruptcy Surcharge Case

The United States Supreme Court recently agreed to review a bankruptcy case from the Ninth Circuit Court of Appeals. The case is Law v. Siegel (In re Law), 435 Fed. Appx. 697 (9th Cir. 2011), and it involves payment of a Chapter 7 trustee’s fees and costs from the proceeds of a debtor’s exempt property. This case  is remarkable for several reasons: (1) the Supreme Court reviews very few bankruptcy cases each year; (2) the case was appealed by the debtor pro se; and (3) the U.S. solicitor general recommended against reviewing the case.

The surface issue in Law is the ability of a bankruptcy court to impose a surcharge on exempt property for debtor misconduct. The debtor in Law claimed that his homestead was subject to two liens which consumed all of its nonexempt value. The trustee objected to the second lien, which the bankruptcy court found bogus and avoided the lien. After the property was sold, the bankruptcy trustee sought to “surcharge” the debtor’s homestead exemption to recover some of his litigation expenses. The bankruptcy court surcharged the debtor’s exemption by $75,000. The Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals affirmed the lower court’s decision.

The Ninth and First circuits hold that bankruptcy courts have the power to impose an “equitable surcharge” on otherwise exempted property under Section 105 of the Bankruptcy Code. The Tenth Circuit has ruled otherwise, creating a split of authority in the Circuit Courts.

The second issue is more weighty: how should Section 105 of the Bankruptcy Code be interpreted. Section 105 gives courts the power to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of” the Bankruptcy Code. Courts have come to different conclusions on the parameters of Section 105. In the context of Law, Section 105 was used to set aside the debtor’s statutory exemptions in order to “protect the integrity of the bankruptcy process,” as the BAP court reasoned in Law. On the one hand Courts should be able to remedy manifest injustice and punish a dishonest debtor. On the other hand, Congress has laid out exemption statutes that each bankruptcy court must follow.

For the bankruptcy world, Law v. Siegel is very compelling. It will be interesting to read the briefs and the ultimate decision from the U.S. Supreme Court. Law also highlights how important it is to have experienced counsel guiding you through the bankruptcy process.