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Schwab v. Reilly -- The Amicus Brief

posted by Bob Lawless

Last week, I agreed to join an amicus brief in the pending U.S. Supreme Court case of Schwab v. Reilly. This case will not receive a lot of medial attention, but it could have a big practical effect on the approximately 1.5 million bankruptcy cases that it looks like the U.S. will be experiencing each year. The amicus brief was filed on behalf of the National Association of Consumer Bankruptcy Attorneys (NACBA) and four law professors (Ken Klee of UCLA, Richard Lieb of St. John's, Michael D. Sousa of Denver, and myself).

The amicus brief supports a debtor, Nadejda Reilly, who claimed an exemption in her bankruptcy for tools of the trade, namely kitchen equipment for her restaurant. On the schedule where she was to claim her exemptions, Reilly listed the value of the equipment as $10,718 and claimed an exemption in the equipment of the same amount, combining the federal $1,850 tools-of-the-trade exemption with $8,868 of her federal "wild-card exemption." More than 30 days after the meeting of creditors, the trustee filed a motion to sell the equipment because, based on an appraisal, he believed it to be worth more than $17,000.

Nobody disputes that the equipment is eligible for the exemption. Rather, the question is whether the trustee procedurally defaulted by not acting more promptly. Federal Rule of Bankruptcy Procedure (FRBP) 4003(b) requires that any objection to an exemption be made within 30 days after the meeting of creditors, and section 522(l) of the Bankruptcy Code states that absent an exemption, the property claimed on the list of exemptions "is exempt." Despite these clear rules, my initial instinct was that the trustee should win. The more I thought about the case, however, the more I became convinced the debtor is right.

My initial mistake was to make a distinction only a lawyer would make, namely that there is a distinction between the value of the thing and the thing itself. Thus--and this is exactly the trustee's position--Reilly's exemption is vindicated by selling the property and giving her the amount of her exemption, namely $10,718. Lawyers often like to talk about value as if it was some objective measuring stick, albeit a measuring stick with a lot of uncertainty but still objective. Of course, that conception is wrong. For example, there is plenty of literature to show that Reilly likely would value the equipment much higher, simply because she currently owns it (the endowment effect), than anyone else. Slapping a value on the asset is to make a bunch of normative judgments about the asset. Granted, the law makes normative judgments all over the place, but we should not pretend that we are not making normative judgments when we use the language of valuation.

Once I got beyond the idea that this case is merely about a dispute over the value of the asset in question, it became much easier for me. Debtors usually claim exemptions to protect the thing claimed in the exemption. That is certainly true here as Reilly said she wanted to dismiss the bankruptcy case rather than turn over the equipment to the trustee. I don't like the idea of the creditors--represented by the trustee--to lose a recovery simply because a deadline passed, but some deadline has to be set. Otherwise, bankruptcy debtors always would be at risk of losing a claimed exemption long after a bankruptcy case passed.

Imagine this conversation as a bankruptcy lawyer: "You know that car you protected in your bankruptcy last year? The trustee now wants to sell it because it's market value is higher." There has to be a deadline. The rules committee might have picked a year or seven days or a three months. Any choice of a deadline is arbitrary. The rules committee chose thirty days. The statute cuts off any further objections past that date. End of analysis.

For the debtor to lose, I think the Supreme Court would have to make the technical distinction between value and the thing itself. That is a lawyer's distinction, not a plain and ordinary interpretation of the statutory scheme. In addition to all the usual reasons to prefer the plain and ordinary meaning, this meaning is also the one that best effectuates the purpose of the bankruptcy law.


My bankruptcy software program lets me type in additional law comments on Schedule C. Aware of this issue percolating in the courts, I'm now starting to assert that the "entire value is exempt," or is "exempt up to $____", the statutory limit, if I've listed the asset at a level below the statuory limit. It's like suing in state court and bankruptcy court simultaneously to discharge student loan debts a few years ago, when there was an Eleventh Amendment issue about those cases before the Supreme Court. I did that at least once.

If the debtor wins, the law should be changed, or, at the very least, the official forms should be fixed in a manner that requires a distinction between a dollar value exemption and an attempt to exempt the entire asset.

Chapter 7 trustees - for a ridiculously low $60 per case fee for no asset cases - are being put into a position of having to file objections to exemptions, or be the loser in a cheap game of "gotcha". How many debtor's lawyers would file anything for some portion of a $60 flat fee?

I'm all for debtors fully exercising their exemption rights - but in a straight forward, everybody-gets-notice-of-what's-actually-happening manner. Not on the Chapter 7 Trustee's bond.

There is also a typo in your post -

"section 522(l) of the Bankruptcy Code states that absent an exemption, the property claimed on the list of exemptions "is exempt." "

It should be "absent an OBJECTION".

I disagree with your analysis. This is a question of value. There is no basis for a trustee to challenge a debtor's assertion of an exemption of $X in a particular asset. If the trustee believes the asset is worth less than the exemption, the trustee does not administer the asset and the debtor keeps it. If the asset has value in excess of the exemption and costs of sale, the trustee sells it and pays off the exemption claim. The debtor is not at risk of losing the exemption.

Rather than suggesting that trustees should file objections in every case that involves and in kind objection, the proper action would be for debtor's counsel (who charges between $500 and $3000 per case around here) to file a motion to compel the trustee to abandon the asset in question under 554(b).

It's not just a question of "subjective" or "idiosyncratic" value. It's also a question of liquidation vs. replacement value (this comes up all the time in insurance law). On the face, the debtor wanted to hang onto tools of her trade (apparently) so she could pursue that trade in future. If the trustee sold her tools he would realize less than it would cost to replace them (even if comparable used tools were available, they would sell for more than the debtor's tools could have brought, because of (a) middleman's margin, and (b) sales tax). So selling off the tools and giving the debtor cash would have the same effect as fining the debtor a significant chunk of her exemption (say 25%), with the added bonus of disabling her from her livelihood (since she wouldn't have her tools!). That would defeat the purpose of the exemptions Congress legislated.

Of course some debtor might try to defraud creditors by undervaluing tools, but the trustee should detect problems like that within the time allotted or apply to the Court for appropriate remedies. If the difference in appraisals were modest the Court could resolve the matter by ordering the debtor to surrender some of her tools (she could choose the least critical or easiest to replace) until the Court was satisfied that the ones she retained were not worth more-- liquidation value-- than her exemption. Under such a regime the debtor would get the full value of her exemption and the creditors would lose no more than that amount (since no party can extract more cash than liquidation value).

But, if Congress (or in most cases, the state legislatures) had wanted an unlimited tool of trade exemption, they could have provided one.

They did not - and never have for tools of the trade. At least not in any state exemption scheme I've ever seen.

When Congress enacted the Code in whatever time period during the process you want to look at - 1977 to 1979 - exemption statutes typically had two kinds of exemptions, dollar value limited exemptions, and exemptions of the entire item.

In Florida, for example, you can exempt your homestead, regardless of value. In Indiana, you can only exempt a dollar amount.

You can exempt a bible, a wedding and engagement ring, pets, medically prescribed health aids in Virginia - regardless of value. But you only get $2,000 on a motor vehicle, and $10,000 on tools of the trade.

This is a common feature of exemption statutes throughout the U.S.

The argument that exemptions of dollar amounts is somehow not understandable to debtors, or not fair to them, ignores the long history of a clear distinction between items that are fully exempt, and items in which only a dollar value exemption is permitted. And bankruptcy law is not intended (with the exception of the proof of claims process) to be navigated by debtors on their own, without an attorney.

I don't understand the argument that debtors aren't getting what Congress of the legislature intended. When property with a dollar value exemption are sold by a Chapter 7 Trustee, the Chapter 7 estate doesn't get a dime until the debtor's full exemption - the exact amount the legislature (or Congress) stated in the exemption statute - is paid to the debtor.

The argument that the debtor doesn't realize full replacement value of the tools of the trade is one that should be directed to the state legislatures and Congress. If they were too stupid to understand that equipment sometimes costs more to buy than it can be liquidated for, then they can fix the problem by increasing the dollar value of the exemption.

The Supreme Court held that Congress makes law knowing the status of the law at the time the new legislation is passed. Goodyear Atomic Corp. v. Miller, 486 U.S. 174, 184-185 (1988); Cannon v. University of Chicago, 441 U.S. 677, 696-697 (1979) And, the Supreme Court “will not read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure.” Cohen v. de la Cruz, 523 U.S. 213, 221 (1998); Pennsylvania Dep’t of Pub. Welfare v. Davenport, 495 U.S. 552, 563 (1990)).

There is a long history of this distinction - between exemption of the item and exemption of a dollar value. I just don't see any indication that Congress intended to change that long-standing distinction, and make the claims objection process into a game where the Chapter 7 trustee - who has the least knowledge of the actual value of the goods he or she has never seen - has to file protective objections.

Looking at this from all points of view, I am failing to see ANY possible argument here, The value of the items in question have no bearing on the question before the Court at all. And it is not a matter of making the debtor whole or not. The only questions to be answered is if (FRBP) 4003(b) and section 522(l) of the Bankruptcy Code were corretly followed or not. In this case, they were not followed at all. I don't see how you could even raise the question concerning the value to the U.S. Supreme Court.

I have the greatest respect for Dick Lieb, Ken Klee and Bob Lawless. But I am having a hard time with this one.

Let's say a given exemption statute sets the maximum value for a motor vehicle at $25,000. The debtor might have a Toyota Camry, or the debtor might have a Mercedes CLK 430. Assuming both are unencumbered (just for the sake of discussion), doesn't the dollar limitation simply indicate a legislative intention that Camrys should be exempt, but Mercedes convertibles should not be? The trustee will surely sell the Mercedes, and give the debtor a check for $25,000 and the send-off "Here, go buy a Camry."

Isn't that the real point of dollar caps?

Are we really just concerned about trustees who might want to keep cases open in order to engage in "exemption arbitrage" -- wait to see if one or more exempt assets might appreciate in value during the case above the value claimed as exempt, then sell the asset to recoup that excess value? Wouldn't the solution for that problem be either legislative or a function of rulemaking (setting limits, for example, on how long and under what circumstances a case can remain open)?

I agree in great part with Veracitor and offer further analysis on point.
Time restrictions, as all of the Code, are there for a reason to streamline the case load. Allowing post time complaints on thousand dollar issues cost the system tens of thousands. Such is why appeals are 10 days - Regardless.
Intentional fraud - if that be the reason - is a whole different issue and has itself as remedy.
The greater evil here is the argument of value as the reason to thwart the exemption. Once a party files for any exemption - that becomes the Trustee's priority and 30 days is plenty of time to ascertain the value of items via common sense or phone calls (ebay) etc. A stymie or halt of the exemption cannot be permitted to transpire - merely because some appraiser says such "may" bring higher value. An actual cash bid - within the 30 days - must be the requisite in order for the Court to void the exemption.
Or simply anyone can say to the Trustee - I believe this is worth more - then utilize the Courts for retribution - such as in a divorcee v he/her case stipulating the other party will give more Now!

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