Wildcard Exemption Covered a Prepetition Malpractice Claim

Section 522(g) does not bar an individual debtor from claiming a wildcard exemption over a prepetition malpractice suit against the debtor’s own attorney, according to Bankruptcy Judge Scott W. Dales of Grand Rapids, Mich.

Before bankruptcy, a creditor garnished the debtor’s bank account and took about $6,000. Allegedly aware of the transfer, the debtor’s bankruptcy counsel did not file the chapter 7 petition within 90 days to preserve the ability of the trustee to recover the transfer as a preference under Section 547.

Were the preference claim preserved, the debtor could have exercised his rights under Section 522(g) by using his wildcard exemption to cover the $6,000 once it was recovered by the trustee.

The trustee uncovered the potential malpractice claim against the debtor’s counsel at the Section 541 meeting. Subsequently, the trustee filed a negligence suit against the debtor’s counsel. The debtor then amended his schedules to claim an exemption covering the negligence suit.

The trustee objected to the exemption claim but lost when Judge Dales handed down his decision on December 7.

“Notwithstanding sections 550 and 551 of this title,” Section 522(g) provides that “the debtor may exempt . . . property that a trustee recovers under Section  . . . 550 . . . , to the extent that the debtor could have exempted such property . . . if such property had not been transferred, if — (1)(a) such transfer was not a voluntary transfer . . . by the debtor; and (B) the debtor did not conceal such property . . . .”

In substance, the trustee tried to turn Section 522(g) on its head by contending that it limits rather than expands a debtor’s ability to exempt assets of the estate. Evidently, the trustee contended that a lawsuit must fall within Section 522(g) before the proceeds can be exempt. Judge Dales did not buy the argument.

The trustee’s theories are difficult to fathom. Suffice it to say that the trustee contended that the debtor’s counsel concealed a cause of action transferred by the debtor. Judge Dales rejected the argument, saying there was no transfer by the debtor, thus making Section 522(g) inapplicable.

Blocked on that score, the trustee contended that the transfer of the cause of action occurred when the debtor filed bankruptcy, allegedly transferring the potential lawsuit to the trustee. Again, Judge Dales did not agree.

Judge Dales explained that the “transfer” referred to in Section 522(g) is a prepetition transfer necessitating the use of avoiding powers, not the transfer that occurs on the filing of a petition.

The trustee argued that Section 522(g) applies to all property of the estate under Section 541(a)(1), not only to property that the trustee recovers by using the chapter 5 avoiding powers. Judge Dales dismissed that argument as well. If it were true, he said, “there never would be any eligible property within the estate for the debtor to exempt.”

Judge Dales allowed the debtor to exempt the malpractice claim because the debtor could invoke the exemption under Section 522(b) and (d)(5) without “implicating Section 522(g) in any way.”