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Banking & Finance Law Report

Law v. Siegel, __ U.S. ___, 134 S.CT. 1188 (2014): The Supreme Court Addresses the Scope of the “All Writs” Provision in the Bankruptcy Code

Posted in Bankruptcy

The Bankruptcy Code has approximately 275 different sections. The number of its subsections and subparagraphs is well into the thousands. It is impossible to select the “most significant” provision in the Bankruptcy Code, but among the candidates for that title is certainly § 105 of the Code.

Section 105(a) of the Bankruptcy Code provides in part that “The court may issue any order, process, or judgment that is necessary to carry out the provisions of this title.” The importance of this “all writs” provision is obvious. It specifically authorizes bankruptcy courts to make the rest of the Bankruptcy Code effective, even if Congress has not specifically included in the other provision of the Code any directive that puts those provisions into motion. When the Bankruptcy Code addresses an issue, § 105 (a) is available to ensure that the issue can be resolved and the solution implemented.

The Supreme Court recently took on the task on determining the limits of the reach of § 105(a) in the case of Law v. Siegel. In Siegel, Stephen Law filed for Chapter 7 bankruptcy in 2004. Among the listed assets in the case was Law’s house in California. Law valued the house at approximately $350,000, and he claimed $75,000 of that amount as exempt under the California homestead exemption. The debtor’s schedules also stated that the house was subject to two mortgages. The first mortgage was identified as being held by Washington Mutual Bank and was in the amount of nearly $150,000. The second mortgage was also in the approximate amount of $150,000 and was listed as being held by “Lin’s Mortgage & Associates.” If these two mortgages were enforceable, they would have rendered the property of no value to the bankruptcy estate and the trustee. Rather, the debtor would likely have retained the property by asserting his homestead exemption and making a new deal with the lenders to reaffirm or otherwise pay their claims.

The trustee apparently had some concerns, particularly about the second mortgage allegedly held by Lin Mortgage. He brought an adversary proceeding against that entity. The underlying debt secured by that mortgage was supposedly owed to “Lili Lin” who also was named as a defendant in the trustee’s action. Interestingly, two persons claiming to be Lili Lin responded to the lawsuit. The first was a former acquaintance of the debtor’s, and she disclaimed any interest in the property and denied that she had made any loan to the debtor. The second “Lili” claimed to live in China and to speak no English. Nonetheless, the second Lili vigorously litigated the matter and defended the claimed second mortgage. The Bankruptcy Court eventually determined that “the loan was fabricated by Debtor in an attempt to preserve equity in his residence and defeat the collection efforts of his judgment creditors.” In re Law, 401 B.R. 447, 449 (Bankr. C.D. Cal. 2009). Given this finding, the bankruptcy judge also concluded that the debtor had caused the trustee to incur hundreds of thousands of dollars of attorney fees and that the debtor’s $75,000 exempt interest in the homestead should be surcharged to defray the trustee’s attorney’s fees. Whether the bankruptcy court had the authority to surcharge the debtor’s exemption in this manner was the question presented to the Supreme Court.

In a unanimous opinion authored by Justice Scalia, the Court concluded that the courts have no authority under § 105 of the Bankruptcy Code to surcharge otherwise exempt property for costs incurred by the trustee even when the debtor has engaged in fraudulent actions to protect his interest in the property. The Court, citing the Collier treatise, noted that § 105 does not permit courts to override specific mandates contained in the Bankruptcy Code. It stated that the section authorizes courts to “carry out” the provisions of the Bankruptcy Code, and given that authorization, the section certainly cannot be used to take action otherwise prohibited by the Code. In particular, the Court analyzed the exemption statute, § 522, to determine whether any specific provisions of that section would operate to prohibit the use of § 105(a) to surcharge the debtor’s otherwise exempt property.

Section 522(k) provides that exempt property is not liable for any administrative expense in the case other than the costs and expenses incurred in avoiding transfers that recover property that the debtor can thereafter exempt under subsections (g), (h), and(i) of § 522. Those exceptions simply recognize that if the estate incurs costs that result in exempt property becoming available to the debtor, the debtor must pay for the benefit he or she is receiving. Without the effort of the trustee in those matters, the debtor would not have had any property to claim as exempt. Importantly, if the exempt property is available to the debtor without the trustee recovering that property, then § 522(k) makes that exempt property unavailable for the payment of administrative expenses such as the trustee’s attorney fees.

The Court specifically rejected arguments based on the bankruptcy court’s inherent power to deny exemptions based on the bad faith conduct of the debtor. The language of § 105 (a), in the words of the Supreme Court, however, “admits no such power.” The Court also held that its earlier decision of Marrama v. Citizens Bank of Massachusetts, 549 U.S. 365 (2007), offered no support for the trustee. That case had recognized the power of the courts to refuse to convert a case from Chapter 7 to Chapter 13 based on the debtor’s bad faith even in the absence of specific authority to do so in the Code. The Court in Law v. Siegel was faced not with a court taking action in the absence of authority to do so (as in Marrama), but rather a court acting in the face of another provision (§ 522(k)) that directly addresses the matter.

The Supreme Court concluded its opinion by noting that it was aware of the financial burdens that its decision puts on trustees. Nonetheless, the allocation of those costs is made by Congress through the language of the Code, and any change in that allocation must come from Congress. Additionally, the Court noted that the trustee has other actions available against debtors who engage in bad faith conduct in the course of the case. Specifically, the Court indicated that the lower courts could sanction the debtor for the wrongful behavior under Bankruptcy Rule 9011. That Rule would allow the lower court to issue an order directing the debtor to pay the trustee’s attorney’s fees, and that award would survive the entry of a discharge for the debtor because it would be a postpetition claim against the debtor.

The Supreme Court has issued a number of decisions over the years in which the Court was required to interpret provisions of the Bankruptcy Code. Many of these cases were consumer bankruptcy cases. While the cases featured consumer debtors, it is important to note that the interpretation of the Code applies in both consumer and business bankruptcy cases. The key point is that the power of the courts under § 105(a) is subject to the remaining provisions of the Bankruptcy Code. When the Code includes specific direction, it is inappropriate to use § 105 to override that Congressional decision. This provides parties in bankruptcy cases with more confidence that their actions will be governed by the applicable provisions of the Code and will not be governed instead by the less predictable applications of a particular judge’s views. Of course, if the Code is silent or incomplete as to any particular matter, §105 will continue to provide the authority to the courts to enter such orders as they see fit to “carry out the provisions” of the Bankruptcy Code.