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Winning While Losing in the Supreme Court - Schwab v. Reilly

posted by Henry Sommer
A few weeks ago, Bob Lawless called the Supreme Court’s decision in Schwab v. Reilly  a non-event.  Some commenters expressed the view that it was a victory for trustees.  I have to disagree. I think it settled a very important issue that has been splitting courts and trustee practice for many years.  While technically a win for the trustee in the case, the opinion really represents a victory for debtors.
The court’s ruling turned on the narrow issue of whether the trustee reasonably could interpret the debtor’s schedules as exempting only an interest of a specific dollar amount in her kitchen equipment, rather than all of the equipment.  The debtor in her schedules listed the same amount for the property in the columns labeled “Value of Claimed Exemption” and “Current Market Value of Property without Deducting Exemptions.”  The court accepted the trustee’s argument that it was reasonable for him to infer from this that the debtor only intended to exempt an interest in the equipment worth the amount listed, rather than her entire interest in the equipment.  Therefore, the court held, the trustee did not have to object to that exemption, which on its face exempted no greater amount than the statute permitted. In so doing, the majority rejected the conclusion of the courts below and the three dissenting justices that by listing the same amount in both columns the debtor manifested an intent to exempt the entire property.

If that were all the court had held, I’d agree the case was not significant. However, by ruling in this narrow manner –  focused on how this particular debtor’s schedules could be interpreted by the trustee – the court also addressed the main concern raised by the National Association of Consumer Bankruptcy Attorneys (NACBA), which filed an amicus brief.  NACBA’s concern was that if trustees did not have to adhere to the objection deadline they could wait for months before acting and the question of whether property is exempt would remain in limbo.  The court set forth a very simple solution to this problem: The debtor need only make absolutely clear the debtor’s intent to exempt the entire asset by listing the exempt value as “full fair market value (FMV)” or “100% of FMV.” (Slip Opinion at 20-21).  Then the trustee will know that she must object within the time set by Rule 4003 or else the entire asset will be exempted.  Thus, the court rejected the argument often made by trustees that debtors cannot exempt the debtor’s entire interest in property “in kind” if there is a dollar limit on the exemption. It specifically provided a way to do exactly that.

This result should not present any problem for debtors represented by competent counsel, who should use the suggested language whenever there is any doubt about whether an exempted asset is within the amount of exemption allowed (assuming, of course, that there is a good faith argument the asset can be completely exempted.)  Some attorneys may want to include this language for every asset exempted. Unfortunately, as Bob suggested, pro se debtors such as Ms. Reilly are not likely to know they should do this. Amendments to Schedule C of Official Form 6 to provide an easy way to do this, perhaps with a box to be checked, would help standardize the process for all involved.

The Supreme Court’s decision also should resolve the problem raised by cases like In re Chappell, (pending in the 9th Circuit, in which NACBA also filed an amicus brief) where the trustee attempts to keep a case open waiting for an asset like a debtor’s home to increase in value beyond the exemption amount.  (This practice, not such a big problem after the housing bust, also runs up against the language in section 522(a) that property should be valued as of the petition date for exemption purposes.) If the debtor clearly indicates an intent to exempt the entire asset, the trustee must file a timely objection, based on the value at the outset of the case, or the entire asset will be exempt.

I also have to disagree with those who have stated that the decision will result in a new flood of exemption objections by trustees who want to keep their options open. The result in Reilly has been the law in some places for years, and trustees do not file numerous exemption objections that are not pursued.  They just have to evaluate property more promptly and decide within the exemption objection deadline (which can be extended in a couple of ways) whether they seriously believe an asset can be liquidated for an amount sufficiently above the exemption amount to produce a meaningful distribution to creditors. The prompt determination of whether property is exempt that should result is exactly what the statute and rules intended all along.
       

Comments

The values declared in Schedule A (real estate) and B (other property) should rarely if ever be anything other than full fair market value. Debtor's counsel can and should explicitly so state on Schedule C, and also state that an exemption claim in that amount, or of the equity net of encumbrances derived therefrom, claims the asset fully exempt.

Henry is right that what the Court did here makes a great deal of sense. At the end of the day, what this area of the law needed was a clear rule so that both debtors and trustees knew what they need to do to protect their rights. I was surprised by Bob's earlier suggestion that the decision was "irritatingly illogical." The logic of the opinion is exactly what Henry's post describes (and which we argued on behalf of the trustee) -- that it was reasonable to assume that the debtor intended to make a lawful claim of a valid exemption, rather than assume that the debtor intended to claim an exemption that would have no lawful basis. While I find Bob to be a consistently thoughtful voice on issues of bankruptcy law, his failure to engage with that reasoning, while attacking the majority opinion as illogical, seemed to me to be rather off note.

If a debtor wants to claim that an asset is exempt no matter what the value, this opinion tells a debtor exactly how to do that (though in fairness, it will be the unusual case in which a debtor has a good faith basis to claim that an asset is fully exempt regardless of the market value), and a trustee knows exactly how and when to respond. Trustees will not be permitted -- as they never should have been -- to drag out the process in the hopes that the asset will appreciate in the meantime.

At the end of the day, the winner here is clarity and the rule of law. This is an example of the Supreme Court functioning exactly as it should on a narrow but important area of bankruptcy law -- adding clarity and demonstrating to all parties how they may enforce and protect the rights afforded to them under the Bankruptcy Code. Henry is clearly right that in this respect, it is a win for all.

Henry, I still think of Schwab as a nonevent but more in a jurisprudential sense. In most bankruptcy cases, the Court's decision will generally create one or more substantive rules that shift the balance of power between debtors and creditors. That did not happen here, but it could have. Consider what might have happened with a decision where the Court left open most any valuation decision on an exemption claim. I completely agree with you, however, that Schwab provides consumer bankruptcy attorneys with an important tool to protect a debtor's claim of exemption in an asset.

Craig, my characterization of "illogical" goes to two specific portions of the Court's opinion rather than its outcome. The Court's opinion reaches the result you argued, but it does not use the very pragmatic reasoning you outline in your comment. The opinion is essentially a paean to formalism. First, the Court makes this very silly distinction between the words "interest" and "property" in section 522. Second, the Court parses the language of section 522 to say that the words on this particular debtor's Schedule C contravened what the statute allowed. But, the Court does not engage the question of whether it's own solution of "100% FMV" fits the statutory language. That strikes me as inconsistent. The result may be clear, but how the Court got there was not.

Like most Thomas decisions, Schwab is hard to read, harder to understand, cramped, illogical, non-common sensical, and motivated by an anti-human animus.

Assume Debtor is a plumber. Here’s the result of Schwab –

(a) In Schedule C, Debtor lists his speedboat as a “tool of the trade.” In fact, Debtor uses speedboat for fun, not plumbing. Trustee must object within Rule 4003 period.

(b) In Schedule C, Debtor lists plumbing tools as “tools of the trade.” Debtor lists exempt value of tools as “unknown.” Trustee must object within Rule 4003 period.

(c) In Schedule C, Debtor lists plumbing tools as “tools of the trade.” Debtor lists exempt value of tools as $3,000 (exceeding allowed amount of exemption). Trustee must object within Rule 4003 period.

(d) In Schedule C, Debtor lists plumbing tools as “tools of the trade.” Debtor lists exempt value of tools as $2,025 (exact amount of exemption). Trustee has unlimited time to object.

What possible result is there for a different result in (d)?

Thomas’s cramped, crabby reading ignores the obvious purpose the Code’s use of “interest” – if the property’s worth less than the “interest” that can be exempted, the debtor can keep it. If it’s worth more, the debtor must pay the trustee the difference, or the trustee can sell it. That’s why 522(d) uses the phrase “interest in property” - not to create arbitrary rules for when 4003 does and doesn’t apply.

And how about this language: “[If there’s no timely objection,] title to the asset will remain with the estate pursuant to 541, and the debtor will be guaranteed a payment in the dollar amount of the exemption.” That’s not what the Code says – the Code says that exempt property is exempt from property of the estate. Even if exempt property is an “interest in property” – the debtor’s “interest” is title to the property, so long as its value is less than the allowed $$ amount.

But – Henry may be right. Thomas seems to say that if the debtor lists the exempt value as “full FMV” or “100% of FMV,” the trustee must object within the 4003 period. If so, Schwab is probably a non-event. But beware – Thomas’s opinion does not state explicitly that this is a safe harbor.

In the meantime, can we get a conforming update to bankruptcy software?

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  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless (rlawless@illinois.edu) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.

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