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Embezzlement Judgment Does Not Prevent Debtor From Exempting Proceeds of Civil Lawsuit Against Creditor

seier+seier [CC BY 2.0 (https://creativecommons.org/licenses/by/2.0/)], via FlickrA U.S. magistrate judge in California ruled on a very unusual set of circumstances in a bankruptcy case, Thomas v. Bostwick, No. 13-cv-02544, order (N.D. Cal., Aug, 29, 2014). A creditor had filed a lien against the possible proceeds of a lawsuit filed by the debtor against the creditor. The creditor was the debtor’s former employer, and the two had been involved in both civil and criminal legal proceedings for some time. The debtor had claimed the proceeds of the lawsuit as exempt property in his bankruptcy petition. Regardless of the parties’ prior history, the court agreed that the lawsuit proceeds were exempt.

In 2009, the creditor obtained a $19.8 million civil judgment against the debtor for embezzlement, as well as an order for criminal restitution of about $8.8 million. The creditor later liquidated its employee profit-sharing plans and transferred over $21,000 from the debtor’s account to itself, as partial payment of the debtor’s judgment debts. The debtor filed suit against the creditor for alleged breach of fiduciary duty, claiming that the profit-sharing plan included provisions against alienation mandated by the Employee Retirement Income Security Act (ERISA), 29 U.S.C. § 1001 et seq., and that the creditor wrongfully ignored those provisions. The lawsuit was still pending when the debtor filed for bankruptcy in 2012.

The debtor filed an amended Schedule C in June 2012, identifying exempt personal property, including the potential proceeds of the lawsuit against the creditor “for converting pension plan accounts.” Thomas, order at 2. At some point, the creditor filed a notice of lien on the proceeds of the debtor’s lawsuit against it, but it did not object to the debtor’s Schedule C.

The creditor filed an adversary proceeding in August 2012, asking the court to rule that the embezzlement judgment and the restitution order were non-dischargeable debts under 11 U.S.C. §§ 523(a)(2)(A), (4), (6), and (7), which deal with matters like fraud and embezzlement. The debtor did not dispute that the debts were not dischargeable, but he objected to the creditor’s application of the profit-sharing plan funds towards the debt.

The bankruptcy court declined to rule on the issue beyond simply finding that the debts were not dischargeable. After the bankruptcy court closed the adversary proceeding, the debtor filed the present case against the creditor in district court under ERISA. The court applied bankruptcy law in ruling on his motion to quash the notice of lien.

A debtor in a bankruptcy case may claim certain personal property as exempt from the bankruptcy estate, meaning that the property may not be used to satisfy debts incurred before the debtor filed for bankruptcy. 11 U.S.C. § 522(c). A party in interest must object to a claimed exemption within 30 days of the creditor meeting or an amendment by the debtor to the claimed exemptions, whichever happens later. The U.S. Supreme Court has held that failure to object within that time period results in the property being exempted, regardless of whether the law specifically allows an exemption. Thomas, order at 3-4, citing Taylor v. Freeland & Kronz, 503 U.S. 638, 643-44 (1992). Since the creditor did not object, the lawsuit proceeds are exempt from the judgment debts, which pre-date the debtor’s bankruptcy.

Personal bankruptcy attorney Devin Sawdayi has represented individuals and families in Chapter 7 and Chapter 13 bankruptcy cases in the Los Angeles area since 1997. To schedule a free and confidential consultation with a skilled and experienced advocate, contact us today online or at (310) 475-9399.

More Blog Posts:

Supreme Court Rules Bankruptcy Trustee Cannot Use Exempt Assets to Pay Expenses, Even If Caused by Debtor Misconduct, Los Angeles Bankruptcy Lawyer Blawg, May 31, 2014

Court Converts Bankruptcy Case from Chapter 13 to Chapter 7 Based on Finding that Debtor Withheld Information, Los Angeles Bankruptcy Lawyer Blawg, January 27, 2014

Bankruptcy Court Denies Chapter 13 Debtor’s Request for Turnover of Garnished Wages, Los Angeles Bankruptcy Lawyer Blawg, October 15, 2013

Photo credit: seier+seier [CC BY 2.0], via Flickr.