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Bankruptcy Court Cannot Use Section 105 to Contravene Other Bankruptcy Code Provisions Says The Supreme Court

Law v. Siegel, 2014 WL 813702, 571 U.S. ___ (2014)

Justice Scalia delivered the Opinion issued by the Supreme Court in Law v. Siegel, which reversed the decision of the Ninth Circuit allowing a Chapter 7 trustee to surcharge a debtor’s homestead exemption pursuant to Section 105 of the Bankruptcy Code despite clear contrary authority of Section 522(k).  During his Chapter 7 proceeding, Steven Law (the “Debtor“) elected to claim a homestead exemption under California state law.  Pursuant to the express language of Section 522(k) of the Bankruptcy Code, the property subject to the exemption was to be free from liability “for payment or any administrative expense.”

Nevertheless, the Bankruptcy Court permitted the Chapter 7 trustee to surcharge the entire homestead exemption to defray the trustee’s legal fees incurred in overcoming the Debtor’s fraudulent misrepresentations related to fictitious liens manufactured by the Debtor to create equity in his property and thus, avoid its sale.  The Bankruptcy Appellate Panel and the Ninth Circuit both affirmed the decision, holding it within the Court’s inherent powers to protect the integrity of the bankruptcy process when faced with debtor misconduct.

The Supreme Court was fast and direct with its reversal.  As the Court has previously held, a bankruptcy court possesses the statutory and inherent authority to carry out the Bankruptcy Code and sanction abusive practices.  However, it cannot exercise such powers if doing so overrides or contradicts specific provisions of the Bankruptcy Code.  In Law, the Supreme Court held that the trustee’s surcharge was an administrative expense, and thus, the Bankruptcy Court violated Section 522(k)’s express terms when it allowed the Debtor’s exemption to be reduced to pay it.  The Supreme Court acknowledged the “inequitable” result in light of the debtor’s “egregious misconduct,” but stated that “it is not for the courts to alter the balance struck by [Congress].”  While there exists ample authority to sanction dishonest debtors, the sanctions a bankruptcy court may impose “may not contravene express provisions of the Bankruptcy Code.”