The U.S. Supreme Court ruled against the trustee in a Chapter 7 case who had obtained a bankruptcy court’s leave to pay attorney’s fees, incurred as a result of fraud by the debtor, from the debtor’s exempt assets. Law v. Siegel, No. 12-5196, slip op. (Sup. Ct., Mar. 4, 2014). While a court may impose other sanctions on a debtor for fraud and other misconduct, the court held that use of exempt assets in such a situation exceeds a bankruptcy court’s discretionary authority under 11 U.S.C. § 105(a).
The debtor filed a Chapter 7 bankruptcy petition in 2004. He listed a house with a value of $363,348 as his only asset, and claimed the $75,000 of that value was exempt under California law. Cal. Civ. Proc. Code § 704.730(a)(1). He also identified two liens encumbering the house held by Washington Mutual Bank for $147,156.52 and Lin’s Mortgage and Associates for $156,929.04. Since the sum of the two liens exceeded the claimed value of the house, the debtor alleged that the house had no equity.
The trustee filed an adversary proceeding several months later, claiming that the second lien was fraudulent. An individual named Lili Lin, who claimed to be the beneficiary of the deed of trust to Lin’s Mortgage and Associates, tied the case up in litigation for about five years. The bankruptcy court ruled in 2009 that the loan from Lin was a “fiction” meant to enable the debtor to keep the house. Law, slip op. at 3. It further found that the trustee had incurred over $500,000 in attorney’s fees, and it granted the trustee’s motion to “surcharge” the debtor’s $75,000 exemption to put towards those fees. Id. at 4. Continue reading