Stephen Law filed a chapter 7 petition in California. His only valuable asset was his home, which he scheduled at a value of $363,348. Washington Mutual Bank held a lien against the home to secure a loan in the amount of $156,929. Law asserted a homestead exemption under California law of $75,000. In order to prevent the bankruptcy trustee from selling his home, Law fabricated a second lien against his home which consumed his entire equity, and obtained the cooperation of a Chinese national named Lili Lin to assert that she was actually owed money by the debtor. The bankruptcy trustee brought an adversary proceeding to avoid the lien, an action which Law and Lin vigorously opposed. In what some might call a poor financial decision, the bankruptcy trustee incurred $500,000 in legal fees overcoming Law’s fraudulent misrepresentations regarding his $363,000 home. The bankruptcy court approved a surcharge of the debtor’s $75,000 homestead exemption to pay a portion of the trustee’s legal fees, a holding which was affirmed by the Ninth Circuit BAP and the Ninth Circuit.
The Supreme Court reversed in its opinion in Law v. Siegel, 2014 WL 813702 (March 4, 2014). The Supreme Court held that neither 11 U.S.C. § 105(a) nor the bankruptcy court’s inherent powers provided a basis for a bankruptcy court to contravene the express language of § 522 of the Bankruptcy Code allowing debtors to claim exemptions in certain assets. In addressing § 105(a), the Court stated “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. . . But in exercising those statutory and inherent powers, a bankruptcy court may not contravene specific statutory provisions,” and that “It is hornbook law that § 105(a) ‘does not allow the bankruptcy court to override explicit mandates of other sections of the Bankruptcy Code.’” (citing 2 Collier on Bankruptcy ¶ 105.01, p. 105-6 (16th ed. 2013). Consequently, because § 105(a) confers on bankruptcy courts the authority to “carry out” the provisions of the Bankruptcy Code, “it is quite impossible to do that by taking action that the Code prohibits.”
The Court also rejected the trustee’s argument that the surcharge did not contravene § 522 of the Code. The trustee argued that a bankruptcy court has equitable power to deny an exemption in response to a debtor’s misconduct. The Court first held that the trustee’s failure to object to the debtor’s homestead objection within the time required by the Code prevented him from challenging the exemption through seeking a surcharge. In addition, the Court held that the plain language of § 522 prevented the surcharge. Section 522(b) provides that the debtor may exempt property, and the Court interpreted this provision as vesting the debtor, not the bankruptcy court, with the discretion on whether the exemption can be claimed. Section 522 contains various bases on which an exemption can be limited or disallowed, some of which relate to misconduct by the debtor. The Court held that § 522’s “meticulous—not to say mind-numbingly detailed” list of restrictions and limitations on a debtor’s right to assert an exemption “confirms that courts are not authorized to create additional exceptions.” Consequently, the debtor’s misconduct in fabricating a lien was not grounds to deny his exemption.
Finally, the Court held that its prior decision in Marrama v. Citizens Bank, 549 U.S. 365 (2007) did not require a different result. The Court explained its decision in Marrama as one where a chapter 7 debtor could be denied his statutory right to convert his bankruptcy case to a chapter 13 proceeding because his bad faith conduct prevented him from qualifying for relief under chapter 13, and should not be read as providing bankruptcy courts with an equitable right to take action which contravenes the express provisions of the Bankruptcy Code.