In a case of first impression among the circuits, the Ninth Circuit held that misrepresentations made by individuals in chapter 11 about the value of a home will allow a later chapter 7 trustee to revisit the allowance of a homestead exemption to which no timely objection had been filed.

The Ninth Circuit’s July 26 decision analyzes the two prominent Supreme Court decisions regarding the finality of exemptions, Taylor v. Freeland & Kronz, 503 U.S. 638 (1992), and Schwab v. Reilly, 560 U.S. 770 (2010). The opinion by Circuit Judge Daniel A. Bress explains why the snippet from Schwab about claiming “100% of FMV” will not exempt the entire value of an asset when debtors in chapter 11 made misrepresentations in violation of their fiduciary duties to creditors.

The opinion is a rare example of the survival of equity to obviate an inequitable result that seemed mandated by Supreme Court authority.

The Exemption Claim of 100% of FMV

A husband and wife filed a chapter 11 petition in 2015. They claimed a federal homestead exemption that, at the time, was limited to some $46,000. They scheduled the home as being worth $165,430 and subject to a mortgage of some $131,000.

In their schedules, they stated the value of the homestead exemption as “100% of FMV.” Assuming the claimed value of the home was $165,000, the entire home was indeed exempt.

There were no objections to the homestead exemption claim by the deadline following the meeting of creditors, but other facts carried the day when the case went to the Ninth Circuit.

In their chapter 11 disclosure statement and plan, the debtors made a pair of fatal representations. For the home, they stated that they were not retaining an exemption of more than the $46,000 allowed by the Bankruptcy Code. If the debtors did not make all payments called for in the plan, the plan said that the value of an asset in excess of the exemption would belong to creditors.

In 2018, more than a year after confirmation, the case converted to chapter 7 on motion of the U.S. Trustee for failure to file financial reports. Having a buyer willing to pay $400,000, the debtors filed a motion in 2021 to compel abandonment of the home. The trustee objected to abandonment and filed a motion to sell.

The bankruptcy court denied the motion to compel abandonment, granted the trustee’s motion to sell and ruled that the debtors were only entitled to retain $46,000. Ultimately, the home sold for $422,000, leaving more than $220,000 in escrow to abide a final determination of whether the debtors were entitled to exempt all net proceeds.

The debtors appealed, and the Ninth Circuit Bankruptcy Appellate Panel reversed. In re Masingale, 644 B.R. 530 (B.A.P. 9th Cir. 2022). To read ABI’s report, click here. Citing Section 522(l), Bankruptcy Rule 1019(2)(B)(i) and Taylor, the BAP said that “the property claimed as exempt on such list is exempt” unless “a party in interest objects.”

As to the amount of the exemption, the BAP cited Schwab for the idea that claiming 100% of fair market value, or FMV, put parties in interest on notice that the debtors intended to claim the full value of the property as exempt.

Despite deciding that the debtors were entitled to retain the entire $220,000, the BAP indicated that it was uncomfortable with a result that allowed debtors to improperly claim an exemption above the statutory cap.

The trustee appealed to the Ninth Circuit and won.

Taylor and Schwab

Judge Bress stated the question as being “whether the debtors successfully exempted an above-limit interest, so that the statutory cap for the homestead exemption no longer applies.”

In Taylor, the debtor claimed an exemption in a discrimination claim for an unknown amount. There was no objection. When the debtor eventually settled for $110,000, the trustee claimed that the proceeds were estate property.

Judge Bress cited Taylor for holding “that the trustee’s failure to object to the claimed exemption within the 30-day timeframe prevented the trustee from challenging the validity of the exemption.”

In Schwab, the debtor had claimed an exemption in personal property said to be worth about $11,000. The debtor claimed that the $11,000 exemption was within the limits of the Bankruptcy Code by combining tools of the trade with the wildcard exemption. There was no objection to the objection claim, but it later turned out that the personal property was actually worth some $17,000.

Deciding Schwab, the Supreme Court distinguished Taylor and allowed the trustee to retain the excess by observing that the debtor in Taylor had not claimed that the assets had a value within the dollar amounts permitted by the Code.

In what likely was dicta, the Court in Schwab said that the debtor would have kept everything had she claimed “100% of FMV.” The Court said that a claim of this sort would have encouraged the trustee to object.

Schedule 106C

In the case before the Ninth Circuit, the debtors had filed their schedules before the amendment in 2015 to Schedule 106C. With regard to the amount of an exemption, the schedule today requires the debtor to claim a specific dollar amount or check a box saying “100% of fair market value, up to any applicable statutory limit.”

Because the amendment was not in effect at the time, Judge Bress said, “we must consider the implications of a debtor claiming a ‘100% of FMV’ exemption on a Schedule C without checking a box that limits the value to the applicable statutory limit.”

Representations Count

Judge Bress said that the debtors “made critical representations within the 30-day objection period,” indicating “that they were not claiming an above-limit homestead exemption, or that they would not be entitled to such an exemption until the creditors were paid in full.” Those representations “were not mere legalese,” he said. They were made “to convince creditors” to proceed with the plan.

As chapter 11 debtors in possession, Judge Bress said that the debtors had fiduciary obligations to their creditors. “Under these circumstances, we do not think it correct to apply Taylor’s rule of decision,” he said.

Judge Bress saw “further support” in Taylor, where the debtor had said that the value of the asset was unknown. Indicating that equity sometimes still has a role to play in bankruptcy, he said,

[P]recedent does not suggest that we should endorse what happened here: debtors saying one thing about the homestead exemption on their Schedule C, saying something contradictory in their Disclosure Statement and proposed Chapter 11 Plan, and then capitalizing on the lack of any objection within the 30-day period.

“Even though Taylor allows debtors to secure above-limit exemptions that lack any colorable basis,” Judge Bress said, “it does not justify the far greater inequity” shown in the case on appeal.”

Judge Bress reversed and limited the debtors’ exemption to the $46,000 statutory cap.

Observations

In this writer’s view, finality is particularly critical with regard to exemptions, so that debtors can go about their lives without looking over their shoulders. The opinion seems to mean that Supreme Court authority should not be interpreted to encourage baseless exemption claims. Schedule 106C does just that by forcing debtors to take a position on the value of exempt assets. Whether Schedule 106C alters substantive rights after Schwab is another question.

The outcome seems to result from application of the doctrine of judicial estoppel, a term that the decision does not employ. It might have been preferable if the opinion had decided whether the holding was a proper invocation of Ninth Circuit rules about judicial estoppel. Chances are, the debtors’ misrepresentations hit the bid to apply judicial estoppel.

The decision is a notable reincarnation of equity during an era when equitable powers of bankruptcy courts have been eroding. It remains to be seen whether courts will invoke equity to improve a debtor’s outcome rather than to improve the recovery for creditors.