Desperate times call for desperate measures. It is not surprising then that a less than scrupulous debtor might be less than candid when disclosing assets and liabilities to a bankruptcy court. But what happens if an individual debtor is discovered to have concealed assets – possibly fraudulently or in bad faith – and then seeks to exercise his or her statutory right under the Bankruptcy Code to exempt all or a portion of the discovered assets from being available to satisfy creditors? Can a bankruptcy court in that circumstance look to the bad acts of the debtor as a basis to take away the otherwise legitimate right to exempt property in a bankruptcy case? In the Sixth Circuit, the answer is no.
On July 2, the Sixth Circuit issued its opinion in Ellmann v. Baker, Case No. 14-2149, in which a chapter 7 trustee sought to re-open a bankruptcy case after discovering that the debtors failed to disclose their interest in litigation involving their former residence. Once the case was re-opened, the debtors amended their schedules of assets and liabilities to include their interest in the former residence and related litigation as exempt property under section 522 of the Bankruptcy Code unavailable for distribution to creditors. The trustee objected to the amendments arguing that the debtors should not be permitted to exempt the property given their failure to previously disclose their interest in the property during the bankruptcy, which the trustee characterized as fraudulent or otherwise a result of bad faith. The bankruptcy and district courts agreed with the trustee. On appeal, however, the Sixth Circuit reversed the lower courts.
According to the Sixth Circuit, this was really an open and shut issue given the Supreme Court’s decision in Law v. Siegel, 134 S. Ct. 1188 (2014). In Siegel, the Supreme Court explained in dicta that section 522 was very detailed about when the exemptions can and cannot be invoked, and there is no prohibition against applying exemptions where the debtor has acted fraudulently or in bad faith. As such, a bankruptcy court does not have the power to deny a claimed exemption under those circumstances. Although some courts have characterized these statements by the Supreme Court as “mere dictum,” the Sixth Circuit explained that “lower courts are obligated to follow Supreme Court dicta, particularly where there is not substantial reason for disregarding it, such as age or subsequent statements undermining its rationale.” The Sixth Circuit in Baker clarified that the Supreme Court’s Siegel opinion effectively overruled a prior Sixth Circuit opinion (Lucius v. McLemore, 741 F.2d 125 (6th Cir. 1984), which came out the other way on this issue.
Needless to say, this opinion is not a license for a debtor to hide assets. However, there is no longer any question as to a bankruptcy court’s ability to deny exemptions based on fraud or bad faith, at least in the Sixth Circuit.