Sixth Circuit Affirms Bankruptcy Court Order Allowing Amended Exemptions Following Re-Opening of Case

In a Chapter 7 bankruptcy case, a debtor is required to file a schedule listing all of the debtor’s property. This includes cash, hard assets such as furniture and cars, as well as intangibles such as causes of action or potential causes of action. The Bankruptcy Code allows debtors to “exempt” certain types of property from the estate, enabling them to retain exempted assets post-bankruptcy.

In a recent opinion, the U.S. Court of Appeals for the Sixth Circuit analyzed the limits of a bankruptcy court’s authority to disallow claimed exemptions. 

In the case of Baker v. Ellman[1]the debtors filed for Chapter 13 bankruptcy, and the case was subsequently converted to Chapter 7. The debtors failed to disclose an interest in a cause of action related to the foreclosure of their home in their bankruptcy schedules. They received a discharge of their debts and the bankruptcy case was closed.

After the case was closed, the debtors filed a lawsuit in Michigan state court against their former lender who foreclosed on a home they owned before the debtors filed for bankruptcy relief. The litigation lasted over four years, but the debtors never sought to reopen their bankruptcy case to amend their schedules and disclose the cause of action. The Chapter 7 trustee in their case learned of the cause of action and moved to reopen the case, claiming that the cause of action was property of the estate. The case was reopened.

The debtors then filed an amended schedule listing the cause of action. They valued the cause of action at $3 million. Each debtor also claimed a “wildcard” exemption (which allows a debtor to protect property that does not fall into one of the other exemption categories) of $5,300 in the cause of action.

The trustee objected to the amended exemptions, arguing among things that the exemptions should not be allowed because of the debtors’ past failure to disclose the cause of action and the debtors' acts of bad faith.

The bankruptcy court rejected the trustee’s arguments and allowed the exemptions. The bankruptcy court relied upon the U.S. Supreme Court’s 2014 Law v. Siegel[2] decision, holding that the decision precludes a bankruptcy court from using its equitable powers to deny an exemption as a sanction for debtor misconduct. Further, the bankruptcy court ruled that the trustee’s objection was untimely and thus waived. The trustee appealed to the U.S. district court which affirmed the bankruptcy court’s order. The trustee then appealed to the Sixth Circuit.

On appeal to the Sixth Circuit the trustee argued that the bankruptcy court was within its power, notwithstanding Siegel, to deny the exemptions because in this case, unlike in Siegel, the exemptions were claimed after the case had been re-opened. The trustee asserted that the bankruptcy court improperly extended Siegel “so as to abrogate all existing limitations on the right of a debtor to make an amended claim of exemption in a re-opened case.”

The trustee sought to distinguish Siegel based on the difference between an open and a re-opened case because the Sixth Circuit previously held (prior to Siegel), in the case of Lucius v. McLemore[3], that “courts may refuse to allow an amendment where the debtor has acted in bad faith or where property has been concealed.”

The Sixth Circuit ruled against the trustee, holding that the open case versus re-opened case was a distinction without a difference in this context. It explained that, despite assertions that relevant language in Siegel is mere dicta and thus non-binding, that lower courts are obligated to follow Supreme Court dicta. While the Sixth Circuit acknowledged the trustee’s argument that Siegel “did not involve an amended claim of exemption made after the case had been closed,” it noted that the trustee failed to explain why this distinction is critical. The Sixth Circuit also affirmed the lower court’s ruling that the trustee waived his objection by failing to timely file it.