Nadejda Reilly never thought her kitchen equipment would become part of a federal case that eventually made its way to the Supreme Court. Her bankruptcy attorney in central Pennsylvania assured her that her property would be exempt and never be at risk. He scheduled its value at just over $10,000 and claimed that entire amount exempt. The trustee did not pay much attention. When he found out that the equipment was worth almost twice as much, he figured that he could sell the equipment for fair-market value, pay the amount that the debtor claimed as exempt and administer the balance as part of a small bankruptcy estate, but it did not work out that way.
William Schwab, the trustee, did not object to the debtor’s exemption within 30 days after the conclusion of the debtor’s meeting of creditors pursuant to § 341 of the Bankruptcy Code as required by Bankruptcy Rule 4003(b). Reilly listed the fair-market value on Schedule B as $10,718 and exempted the full value on her Schedule C using the tools of the trade exemption under § 522(d)(6) of $1,850 and a miscellaneous exemption of $8,868, all within statutory limits. After obtaining an appraisal that the equipment could be sold for as much as $17,200, Schwab filed a motion to sell, which was denied by the bankruptcy court because Schwab had not timely objected to the debtor’s exemptions.
Reilly contended that in exempting the full value of the property on Schedule C, she manifested her intent to claim the property as fully exempt. The bankruptcy court and all reviewing courts, including the Third Circuit Court of Appeals, agreed and held that the debtor had asserted that the property was fully exempt. Since the trustee did not timely object, he could not sell the collateral. Schwab v. Reilly, U.S. ___ (2010) (slip op. at 4-5).
The Supreme Court reversed, holding that Schwab had no obligation to object to Reilly’s objections. They were “facially valid” since they did not exceed the exemption amounts debtor was permitted to assert under § 522(d) of the Code. Id at 17-18. An exemption in property is an interest up to a certain dollar amount as indicated by § 522(d) or the relevant state statute, and not in the property itself.
Implications from the Debtor’s Perspective
For debtors, the holding in Schwab v. Reilly makes exemption planning to protect property in full difficult. Debtors face uncertainty if trustees are not required to object within 30 days of the 341 meeting for facially valid exemptions. A trustee may determine months—or even years—later that the property is worth more than the exemption, seek court permission to sell it and pay the debtor their exemption. Some assets may appreciate in value in which the trustee would benefit from the appreciation. In such cases, it might well be to the benefit of debtors to move to compel the trustee to abandon any interest in such property.
The Court’s ruling suggests that requiring a trustee to object within 30 days would be too burdensome given the caseloads of most trustees. However, objecting to exemptions within 30 days does not put an additional duty on the trustee as they have an existing duty to value property for the benefit of creditors. Schwab v. Reilly, 560 U.S. ___ (2010) (Ginsburg, J. dissenting) (slip op. at 12). Additionally, Rule 4003(b) allows a trustee to ask the court to extend the objection period for cause. Id at 13. The trustee could also postpone the conclusion of the meeting of creditors under Rule 2003(e) so that the 30-day deadline does not start running. Id. Finally, if there is a dispute as to valuation, the trustee could ask for a hearing under Rule 4003(c). Id.
Nonetheless, the Court’s opinion does clarify how debtors can claim exemptions in a way that waves a “warning flag” to the trustee that they intend to exempt the full fair-market value of the property. Debtors could simply list the exempt value as either “full fair-market value (FMV)” or “100 percent of FMV,” which makes it abundantly clear to the trustee that the debtor intends to fully protect the property at issue. Schwab v. Reilly, 560 U.S. ___ (2010) (slip op. at 20-21).
Structuring an exemption this way will likely prompt an objection from the trustee within 30 days of the creditor’s meeting. If the trustee does not timely object to the exemption, or the objection is overruled, the debtor will be able to retain the property in kind. If a trustee’s objection is sustained, the debtor could amend Schedule C and receive the cash value of their exemption upon liquidation. As the Court elaborated, “[e]ither result will facilitate the expeditious and final disposition of assets, and thus enable the debtor (and the debtor’s creditors) to achieve a fresh start.” Id at 22.
Such a declaration on Schedule C also eliminates a trustee’s concern that requiring objections to “facially valid” exemptions within 30 days “‘would give debtors a perverse incentive to game the system by undervaluing their assets.’” Schwab v. Reilly, 560 U.S. ___ (2010) (Ginsburg, J. dissenting) (slip op. at 15) (citing Brief for Petitioner 35; see Brief for United States as Amicus Curiae 27). The Court’s ruling outlines a clear path for debtors and their attorneys in completing Schedule C that is a better result than resorting to exemption strategies that would be abusive at best and perjury at worst.
While debtors’ attorneys can structure exemptions in a manner that the Court outlined, pro se debtors who simply follow the instructions attached to Schedule C would not consider listing the exemption as “full FMV” or “100 percent of FMV” as the instructions indicate to “state the dollar value of the claimed exemption in the space provided.” Id at 15 (emphasis in original). Even so, an update to the instructions to the schedules could alleviate this problem given the Court’s instructions on how to list the value of the claimed exemption.
Implications from the Trustee’s Perspective
A trustee must liquidate non-exempt assets for the benefit of creditors as quickly as possible consistent with the best interests of the estate and then make distributions and close the estate as soon as practicable. Bankruptcy Code § 704. Since chapter 7 trustees receive compensation of only $60 per case, a trustee must be able to make a prompt determination as to whether there are assets to administer. It is impractical for a trustee to have to object in every case to exemptions in kind so as to preserve the ability to administer assets for which value is not yet known. Assertion of exemptions of assets as 100 percent exempt where a statute does not permit such an exemption may be a way to “wave a flag” at the trustee—but is it a red flag of warning or a red flag of provocation? Trustees would want debtors to claim assets to be 100 percent exempt when appropriate—for example, as in the case of personal clothing which, in many states, is 100 percent exempt. However, trustees would not want debtors to follow Reilly’s example and claim exemptions in kind for property worth more than the scheduled amount of the exemption.
Conclusion
Schwab v. Reilly represents the fifth in a series of recent consumer bankruptcy cases decided by the Supreme Court including Milavetz,Gallop & Milavetz v. United States, 559 US ____ (2010); Hamilton v. Lanning, 560 US ____ (2010); United Student Aid Funds v. Espinosa 559 US ___ (2010); and Marrama v. Citizens Bank of Massachusetts 549 U.S. 365(2007). From the detailed understanding that the Court evidenced in Schwab v. Reilly, it seems that the Court is becoming increasingly familiar with the day-to-day intricacies of consumer bankruptcy practice. Consumer bankruptcy attorneys can look forward to an increasingly practical and pragmatic approach toward the Bankruptcy Code as more cases come to its attention. The next such case will likely be Ransom v. MBNA America Bank (09-907, cert granted April 19, 2010) addressing whether, in calculating the debtor’s “projected disposable income” during the plan period, a bankruptcy court may allow an ownership cost deduction for vehicles only if the debtor is actually making payments on the vehicles. Consumer bankruptcy attorneys will await further guidance from the Court in interpreting plain language of the less than clear Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).