Bankruptcy Law Roundup

Sharp Thinking

No. 111     Perspectives on Developments in the Law from The Sharp Law Firm, P.C.      March 2014

Exempt Assets Can’t Be Surcharged Due To Debtor Misconduct

            A bankruptcy court may not order that a debtor’s exempt assets be used to pay administrative expenses incurred as a result of the debtor’s misconduct, the U.S. Supreme Court has held.

            In Law v. Siegel, 571 U.S. __, 2014 WL 813702 (March 4, 2014), the bankruptcy court had found that the debtor had caused a fraudulent lien to be put against his home, giving the impression there was no non-exempt equity therein.  It also believed that the debtor had authored and forged court papers from the putative creditor contesting the trustee’s attempt to have the lien declared fraudulent.  The bankruptcy court determined it was appropriate to surcharge the entirety of the $75,000 California home exemption because of the expense which had been caused to the bankruptcy trustee.

            The Court ruled that the bankruptcy court’s surcharge was unauthorized because it “contravened a specific provision of the [Bankruptcy] Code.”  It reasoned that 11 U.S.C. § 522(b)(3)(A) and state law incorporated therein gave the debtor a $75,000 exemption in the home, and that § 522(k) said the exemption was “not liable for payment of any administrative expense.”  The trustee’s attorney’s fees were an administrative expense, and ordering that they be paid from exempt assets thus violated § 522(k).

            Citing 11 U.S.C. § 105(a) and prior case law, the court said a bankruptcy court has “statutory authority to ‘issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of’ the Bankruptcy Code” and “may also possess ‘inherent power . . . to sanction “‘abusive litigation practices”’”, but “in exercising those statutory and inherent powers, a bankruptcy court may not contravene specific statutory provisions.”  “The Code’s meticulous – not to say mind-numbingly detailed – enumeration of exemptions and exceptions to those exemptions confirms that courts are not authorized to create additional exemptions,” it said.

Sanctions For False-Statement Counseling Affirmed

            Sanctions may be awarded for counseling a client to make a false or incomplete statement in a bankruptcy filing even if the client ultimately does not do so, a U.S. District Court judge in Missouri has held.  The court said 11 U.S.C. § 562(a)(2) “is directed toward improper advice or counseling” and “the success of the bad counseling would seem to be a matter that at most goes to punishment.  The misconduct is complete when it occurs, although a document filing is essential to the offense.”  In re Clink, 497 B.R. 44 (W.D. Mo. 2013).

Bankruptcy Courts Must Implement Code As Written  

            Bankruptcy courts must “implement the Bankruptcy Code as written, rather than make changes that they see as improvements,” the Seventh Circuit Court of Appeals has twice intoned already this year.

            In In re New Energy Corp., 739 F.3d 1077 (7th Cir. 2014), the court made the admonition in refusing to find that the Code permitted a prospective competitor at a bankruptcy sale to protest alleged collusion at that sale.  Then in In re Equipment Acquisition Resources, Inc., 742 F.3d 743 (7th Cir. 2014), the court reiterated New Energy on that point in finding that 11 U.S.C. § 544(b) (unlike 11 U.S.C. § 544(a)) requires “the actual existence of an unsecured creditor that could have brought the state-law action itself” in order for the bankruptcy trustee or debtor-in-possession to avoid a transfer under state fraudulent transfer law.  On the latter point, the court acknowledged it was the first Circuit Court of Appeals to so rule and that its ruling was contrary to the great weight of lower court authority.

Automatic Stay Doesn’t Require Dismissal Of Citation

            Because dismissal of a supplementary proceeding would result in loss of the lien priority obtained upon service of a citation to discover assets, a judgment creditor is not required to dismiss those proceedings in order to comply with the automatic stay in bankruptcy, a bankruptcy judge in Chicago has held.  Calling dismissal a “drastic step,” the court in In re Tires N Tracks, Inc., 498 B.R. 201 (Bankr. N.D. Ill. 2013), said the creditor could allow the proceeding to remain pending as long as it did not take any step in the citation court to enforce its lien.  It did not address the effect of the automatic freeze which a citation typically effects (735 ILCS 5/2-1402(f)(1)).

Charitable Gifts Over 15% Are Avoidable In Toto, Court Says

            When bankrupts-to-be give more than 15% of their gross annual income (GAI) in pre-petition contributions to a charity, the entire transfer – and not just the amount exceeding 15% of GAI – may be recovered on behalf of the bankruptcy estate, the 10th Circuit U.S. Court of Appeals has ruled.

            In a case interpreting the Bankruptcy Code as amended by the Religious Liberty & Charitable Donation Protection Act of 1998 (Pub. L. 105-183), the court said the statutory language was unambiguous in providing that a transfer of a charitable contribution to a qualified religious or charitable entity or organization is not avoidable in any case in which “the amount of that contribution does not exceed 15 percent of the gross annual income of the debtor for the year in which the transfer of the contribution is made”.  It accepted the bankruptcy trustee’s logic that “the converse must also be true – if the ‘transfer’ exceeds 15% of GAI, then the ‘transfer’ – meaning the entire transfer – is subject to avoidance.”  In re McGough, 737 F.3d 1268 (10th Cir. 2013).

7th Circuit Addresses Constructive Trusts in Bankruptcy

            The Seventh Circuit Court of Appeals has issued an instructive decision on handling constructive trust claims in bankruptcy.

            In In re Mississippi Valley Livestock, Inc., __ F.3d __, 2014 WL      949969 (7th Cir. 2014), the putative creditor entrusted his animals to the debtor for resale.  Shortly before filing bankruptcy, the debtor paid to the creditor nearly $900,000 representing completed sales.  The trustee attempted to recover those funds as preferential transfers.  Finding that the parties’ relationship constituted a bailment, the court found that the proceeds were never a part of the estate.  Moreover, it said, “When a restitution claim is made against a bankruptcy estate, the key question to ask is whether the estate – not the now-defunct debtor – would be unjustly enriched by keeping the claimant’s property.”

                                       – John T. Hundley,, 618-242-0246