Lawyers typically stand in awe of courts’ “inherent power” – we understand that compliance with courts’ whims as well as their directives, and unambiguous candor, are essential if we are to escape the broad range of sanctions that courts have at their disposal. In Law v. Siegel,[1] however, a unanimous Supreme Court ruled this month that courts’ inherent power to sanction is subject to important limits: Courts cannot impose sanctions that contravene the Bankruptcy Code’s express provisions, no matter how just or appropriate the sanctions may seem.
Background
Chapter 7 debtor Stephen Law was determined to keep his house in Hacienda Heights, California. Under § 522(b)(3)(A) of the Bankruptcy Code and applicable state law, Mr. Law was entitled to claim $75,000 of his house’s $363,348 in value as exempt from the reach of his creditors. Further, under § 522(k) of the Bankruptcy Code, Mr. Law’s $75,000 was “not liable for payment of any administrative expense.” That was not enough for Mr. Law, however: he asserted that all of the remaining value of his house was subject to a note and deed of trust for $147,156.52 in favor of Washington Mutual Bank, and a second note and deed of trust for $156,929.04 in favor of Lin's Mortgage & Associates (“Lin’s”). As a result, Mr. Law maintained, he had no equity in his house that his creditors could seize. If there really had been a note in favor of Lin’s, he would have been right.
Alfred H. Seigel, the skeptical trustee of Mr. Law’s estate, commenced an adversary proceeding contending that the lien in favor of Lin’s was fraudulent. Two different individuals claiming to be Lili Lin responded to Siegel’s complaint – one denied that she had ever loaned Mr. Law money, and the other engaged the trustee in a costly five-year litigation concerning the validity of the lien despite purportedly living in China and speaking no English.
Ultimately, the bankruptcy court determined that the loan to Lin “was a fiction” and that Law himself had “authored, signed and filed some or all of [Lin’s] papers.” [2] Further, the court found that Siegel “had incurred more than $500,000 in attorney’s fees overcoming Law’s fraudulent misrepresentations.”[3] As a result, the bankruptcy court “granted Siegel's motion to ‘surcharge’ the entirety of Law's $75,000 homestead exemption, making those funds available to defray Siegel's attorney's fees.”[4]
On appeal, the Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals both affirmed. In Latman v. Burdette,[5] the Ninth Circuit had previously recognized a bankruptcy court’s power to “equitably surcharge a debtor’s statutory exemptions” in exceptional circumstances such as “when a debtor engages in inequitable or fraudulent conduct.”[6] In Law v. Siegel, the Ninth Circuit adhered to that ruling despite the Tenth Circuit’s disagreement.
Analysis
The Supreme Court reversed. In a unanimous opinion by Justice Scalia, the Court recognized bankruptcy courts’ statutory authority under 11 U.S.C. § 105(a) “to issue any order, process or judgment that is necessary or appropriate to carry out the provisions of the Bankruptcy Code” as well as their “inherent power . . . to sanction ‘abusive litigation practices.’”[7] Bankruptcy courts may not, however, “contravene specific statutory provisions.” [8] The Supreme Court then concluded that the bankruptcy court’s “surcharge” violated § 522(k) of the Bankruptcy Code, demonstrating by “a short march through a few statutory cross-references” that Siegel’s attorney’s fees “were indubitably an administrative expense” for which the “surcharge” made Mr. Law’s exempt property liable.[9]
The Supreme Court also sidestepped the trustee’s argument that the surcharge did not contravene § 522 because that section merely authorizes – and does not require – the bankruptcy courts to exempt certain property. The Court found the argument inapplicable because Mr. Law’s property had already become irrevocably exempt at the time the surcharge was granted. Further, because the Bankruptcy Code includes a “mind-numbingly detailed” specification of the grounds on which exemption may be denied, courts “are not authorized to create additional exceptions” – though when state law provides the basis for exemption, state law limitations on that exemption may apply.[10] Finally, the Supreme Court stated that its decision “does not denude bankruptcy courts” of the authority to respond to debtor misconduct. [11] Bankruptcy Courts can sanction debtors in many ways short of “contraven[ing] express provisions of the Bankruptcy Code.” [12]
Implications
The Supreme Court’s decision in Law v. Siegel elevates form over substance: the bankruptcy court could have sanctioned Mr. Law in an equivalent amount without expressly stating that he was being held liable for an administrative expense, and the court likely could have found a different way to grant equivalent compensation to the trustee. However, the Supreme Court’s elevation of form over substance is arguably its key point: the law is the law, which bankruptcy courts must not circumvent for the sake of equity, in the exercise of “inherent powers,” or based on a subjective view of the Bankruptcy Code’s implications. Further, as the Supreme Court emphasized by dramatically restricting bankruptcy courts’ jurisdiction in Stern v. Marshall, 132 S. Ct. 56 (2011), the Supreme Court sees bankruptcy courts as intended solely to implement the Bankruptcy Code, and grants them very little latitude to go beyond that task. Going forward, Law v. Siegel cautions trustees and bankruptcy counsel to be careful what they wish for, because if the text of the Bankruptcy Code appears to be a bar, then irrespective of the justice of their request, they are not likely to get it.
[1] Law v. Siegel, No.12-5196, 2014 U.S. Lexis 1784 (U.S. March 4, 2014).
[2] Id. at *8 (quoting In re Law, 401 B.R. 447, 453 (Bankr. C.D. Cal. 2009)).
[3] Id. at *9.
[4] Id.
[5] 366 F.3d 774 (2004).
[6] Law v. Siegel at *9 (quoting In re Law, BAP No. CC-09-1077-PaMkH, 2009 Bankr. LEXIS 4542, 2009 WL 7751415 (Oct. 22, 2009) (per curiam).
[7] Id. at *10 (quoting Marrama v. Citizens Bank of Mass., 549 U. S. 365, 375-376 (2007)).
[8] Id.
[9] Id. at *12.
[10] See id. at *17-18.
[11] See id. at *21.
[12] See id. at *22.