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Decision in Schwab Is an Irritating Nonevent

posted by Bob Lawless

The Supreme Court handed down its decision in Schwab v. Reilly today. Schwab looks like a technical case only of interest to bankruptcy specialists because it requires the parsing of specific language in section 522(l) of the Bankruptcy Code and rule 4003(b) of the Federal Rules of Bankruptcy Procedure. In fact, Schwab is of great practical importance and could have had an effect on almost every one of the more than 1.6 million bankruptcy cases that consumers will file this year.

Schwab revolves around how debtors may claim their bankruptcy exemptions--the property that bankruptcy law allows the debtor to keep and is part of the fresh start the bankruptcy system is supposed to give debtors. Exemptions are important in most every consumer bankruptcy case (including chapter 13 where they determine the amount debtors must pay in the chapter 13 plan). For nonspecialists, here is some background on the case. If you're familiar with Schwab and the Bankruptcy Code and rules, you might want to skip the next two paragraphs.

Glossing over a lot of detail, it is sufficient to understand that the Bankruptcy Code gives the debtors what basically amounts to a shopping list and says the debtor can pick items they own off the shopping list to keep after a chapter 7 bankruptcy case. (Because a chapter 13 plan must pay creditors at least as much as they would receive in chapter 7, in chapter 13 exemptions play a role in determining how much the debtor must pay.) Often exempt items are limited in dollar amounts but not always. For example, the federal statute allows a debtor to keep a motor vehicle not to exceed $3,255 in value but all professionally prescribed health aids regardless of value. The federal list of exemptions lists twelve different items, and in many cases, the bankruptcy exemptions that a debtor can keep are determined by state law. My favorite exemption case involves whether a broken riding lawn mower in someone's front yard could count as "furniture."

In Schwab, the debtor had claimed an exemption of $10,718 in business equipment and had listed that amount as the value of the equipment. Her bankruptcy trustee objected after an appraiser told him the equipment was worth at least $17,000. The trustee moved to auction the business equipment and pay the debtor $10,718 in cash from the proceeds of the sale. The debtor responded by pointing out the trustee had missed the thirty-day deadline for objection to exemptions in Federal Rule of Bankruptcy Procedure 4003(b). The trustee responded that he was not objecting to the exemption just its valuation, and the deadline did not apply. The bankruptcy court, district court, and court of appeals all held for the debtor. In a 6-3 vote, the Supreme Court reversed.

I have a lot of reactions to the Schwab decision, but I wanted to focus on just two points. First, it turns out to be pretty much a nonevent for everyone but the debtor in this case. The Supreme Court spent much of its decision discussing whether the bankruptcy trustee should have interpreted the debtor's exemption claim as being in the thing itself or just the value of the exemption in the thing. (My previous post on this case discussed this very point.) Where the debtor wrote "exemption in asset = $10,718, value of asset = $10,718," should the trustee have interpreted this as a claim to the actual equipment or just $10,718 in value from the equipment? Regardless of how that language should have been interpreted, the Court lays out a road map for future cases. The Court says that, in the future, if the debtor wants to claim the thing itself rather than just the value of the exemption, just write something like "exemption in asset = $10,718, value of asset = $10,718 (100% of fair market value)."

Well-informed attorneys will simply fill out the bankruptcy schedules to satisfy the Court's magic formula (and I understand some attorneys already followed this practice). The Court's approach in Schwab and other decisions, however, does raise the bar on being well-informed, and it raises huge issues for pro se debtors as the dissent notes. To know the rule, one must look at not only the Bankruptcy Code and the Federal Rules of Bankruptcy Procedure, but also one must look through case law. OK, how hard is that? Actually, as a theoretical matter, pretty hard. On any issue, the search is essentially to prove a negative--that no provision of the relevant authority contains a contrary directive. The Bankruptcy Code and Federal Rules of Bankruptcy Procedure are relatively self-contained as compared to the vast body of case law. I'm not saying the Court is wrong to set a clear rule in Schwab. I'm glad it did set a clear rule, and CLEs and other professional materials will take care of seeing that attorneys are well informed on what the Court directs. I'm just saying let's not to be too sanguine about courts plugging holes in statutory schemes.

My second reaction to Schwab surely stems from signing an amicus brief on what turned out to be the losing side. The decision is irritatingly illogical, and its reasoning is in internal conflict. The Court dismisses the debtor's arguments about how the trustee should have understood her claim of exemptions by saying this understanding defies the plain words of the Bankruptcy Code, and the statute has to be the final arbiter. I also think the Court is just plain silly where it tries to parse the difference in meaning between "property" and "interest," but that is beside the point. If the Bankruptcy Code trumps whatever intent the debtor had in the way she claimed her exemptions in this case, then it also should trump whatever intent a future debtor has when writing "100% FMV" next to the claim of the exemption. Yet, the Court clearly says that is all debtors have to write to get the result the debtor in Schwab wanted. The Court shouldn't be able to have it both ways, but I did not get a vote.

Comments

The Supreme Court looked at how exemptions have worked historically, and what exemptions are intended to do.

In instances where the debtor(s) want to try to get more than they are entitled to under the statute - and that is what this case was all about - they put the burden exactly where it should be: On the debtors.

This case had nothing to do with the core purpose of most dollar-denominated exemptions - to provide the debtor a fresh start. And the Supreme Court recognized that it was dealing with an attempt to get a "free pass" in Reilly, not the intended fresh start.

There is no problem with debtors who are pro se, except to the extent they want to put one over on the trustee and claim more than Congress - or in most cases, the state legislature - were willing to allow in balancing the rights of creditors against a debtor's legitimate post-bankruptcy needs. Reilly was (and is) to get every dollar that was clearly claimed as exempt.

Sorry, no crocodile tears for the loss of a non-existent right to list exemptions ambiguously and lull a $60 a case Chapter 7 trustees (who could be personally liable for the loss to the estate) into not objecting to unclear claims of exemption.

The appellate court ruling was nonsensical, did not take into account the purpose and two century history of exemptions, and improperly placed the burden of mind reading on the Chapter 7 trustee instead of putting the burden of written clarity on the debtors when they want to over-reach in claiming exemptions beyond what the statutes allow.

I also liked the footnote 3 comments on the irrelevancy of the extraordinary sentimental value the debtor placed on the business equipment....

In Reilly, the property was a bunch of used catering equipment. The debtor put the value at $10,718, while the trustee put it at $17,000. The nature and amounts of the debtor's other exemptions do not suggest the debtor was trying to game the system. In fact, the debtor hand wrote a list of the 31 pieces of catering equipment with the original purchase price and her estimate of their current value. In any event, as the dissent notes, there are many consequences for a debtor who makes a false claim of exemptions (including an extension of the deadline to object). This case was a dispute about the value of a bunch of stuff that the trustee wanted to resolve by auctioning off the equipment well after the deadline for objections had passed.

As a Trustee serving within the Third Circuit, I am relieved to learn that the rules are what I always believed them to be -- value in excess of a claimed exemption is property of the Estate. If you improperly claim an exemption of 100% (which the Code allows in only the rarest of circumstances), at least i KNOW I need to object. The odd "value matching exemption" trap was unworkable and created stupid objections that even the Debtor bar didn't intend (like objecting to a personal injury exemption because the lawyer didn't want to opine as to the REAL value of the claim, so put it at the statutory maximum). The bankruptcy system depends upon everyone doing his or her job with diligence and suffer the consequences for failure to do so.

I have already added to my standard Schedule C language the "magic words" from Schwab. I have long had explicit "claimed fully exempt" language citing Taylor v. Kronz. This has never led to or come into play in a Schwab-type situation -- but I want to be as well-positioned as possible if it ever does.

We know from the debtor's own pleadings that the trustee notified her of his intention to sell the equipment no later than during the meeting of creditors. The debtor did not suggest at this time, nor could she without drawing a certain (and certainly successful) objection, that she was claiming a right to exempt the entire property regardless of its actual value. Instead, she filed a motion to dismiss her case a week later. The trustee's response to this motion, filed around a week later, expressly noted that he had already retained an auctioneer and was preparing to sell the property. The motion to dismiss was not decided for more than a month, during which time the trustee finalized arrangements to auction the property (in spite of the risk that the case would be dismissed and his time and energy would be for nothing) and filed a motion to sell. Not surprisingly, only after this motion was filed did the debtor argue that her schedules demonstrated an intent to exempt the asset in full in spite of the statutory cap.

In short, this is not a case like Taylor, where the trustee changed his mind about pursuing the estate's rights to property as the case went on because he realized the asset was more valuable than he initially thought. Maybe she did not intend to game the system at the outset, but she certainly did attempt to exploit an ambiguity that she could have easily clarified but, for obvious reasons, chose not to. And though I seriously doubt these facts would warrant an extension under 4003(b)(2) or the evidence is sufficient to establish an abuse of the bankruptcy process, the decision does not strike me as an inequitable outcome for this debtor.

One thing the Court did in Schwab troubles me terribly -- the Court allowed the Trustee to sell ALL of the property and just write the Debtor a check for her dollar amount of exemption claim. Why not allow the Debtor to "cherry pick" the things she wanted to keep up to the allowed exemption amount, and just let the Trustee sell whatever she didn't pull aside? Given the Court's discussion of "interest" vs. "actual property," we now find ourselves in the peculiar situation that the Trustee can sell all property -- even when there's no NON-EXEMPT value -- and hand the Debtor a check. As a practical matter, I realize this will never happen if there's truly NOTHING for the estate to gain, but it certainly seems to me to be a slippery slope that can produce some pretty terrible results.

As a proud grad of the University of Illinois and a trustee for nearly 30 years, I was very disappointed when you took the debtor's side of this argument, but I am very pleased that the SC vindicated the trustee's position and practice.


I am not an attorney or a bankruptcy professional. The problem, as I see it, and a problem I had some years ago is that the discrepancy between fair market value (sale at auction) and the trustee's perception of fair market value can be very large. The trustee asked the court for a dead line extension and, predictably, passed the problem on to his usual experts who had no experience with assets of this sort. Long and short, it took a year to receive a ruling to the effect that the asset had no market value. The small business by that time was past recovery.

It should be noted that this could easily be resolved legislatively: simply set an explicit deadline for the trustee to challenge the debtor's stated value for the purpose of determining if there is value above exemptions. It could be the same as for other exemption objections, or not. It could be extendable as are most deadlines, or not. And of course, deception or bad faith by the debtor would as always be a separate matter.

http://wislawjournal.com/article.cfm/2010/07/05/Supreme-Court-decision-may-benefit-debtors

Although the debtor technically lost, the decision "is a positive one for debtors generally," explained Henry Sommer, a Philadelphia attorney and former president of the National Association of Consumer Bankruptcy Attorneys, because the court provided language that a debtor can use if he or she intends to exempt the full value of an asset.

"Lawyers [just] have to be very aware and use the 'magic words' provided by the Court if a debtor wants an asset to be fully exempt," Sommer said.

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