Chapter 7 Trustee Who Does Not Object to “Arguably” Inapplicable Claim of Exemption Does Not Forfeit Right to Later Argue that Exemption Does Not Apply

Sometimes it is better for the trustee not to object to an “arguably” inapplicable claim of exemption. That’s one of the takeaways from the Sixth Circuit’s recent decision in Biondo v. Gold, Lange, Majoros & Smalarz P.C. (In re Biondo) [1].

In Biondo, a chapter 7 debtor listed an “auto accident” claim in her schedules with an unknown value. She sought an exemption for the claim under 11 U.S.C. § 522(d)(11)(D). The trustee did not raise a timely objection to the debtor’s exemption. Rather, the trustee pursued the claim for the benefit of the estate. The trustee was able to obtain two settlements related to the claim: The first settlement covered the debtor’s “medical expenses, attorney’s fees, ‘lost wages,’ and all ‘other forms of economic or non-economic loss.’” The second settlement simply covered the debtor’s “pain and suffering.” [2]

The debtor moved for an order compelling the trustee to abandon a portion of the settlement proceeds. The debtor argued that the settlement proceeds were exempt under § 522(d)(11)(D), and that the trustee forfeited his objection to the exemption by failing to timely raise it earlier in the case. The trustee opposed the debtor’s motion, arguing that the proceeds were not exempt because the second settlement only covered “pain and suffering” — which is clearly not protected under the statute — and the second settlement made no mention of bodily injuries.

The debtor and the trustee settled. But when the trustee’s counsel later filed an application for compensation, the debtor objected. The debtor contended that the trustee’s counsel should not receive compensation for time spent opposing the debtor’s motion to abandon. Specifically, the debtor argued that the trustee’s counsel raised groundless legal arguments such that his services did not benefit the estate.

The bankruptcy court disagreed with the debtor and granted the trustee’s fee request. The debtor appealed to the district court, which dismissed the appeal as equitably moot. On further appeal, the U.S. Court of Appeals for the Sixth Circuit was confronted with two issues: (1) whether the trustee’s counsel had reasonable arguments that the settlements fell outside of § 522(d)(11)(D); and (2) even if he did, whether the trustee forfeited these arguments by failing to object to the debtor’s exemption. The court sided with the trustee on both issues.

First, the court held that the trustee’s counsel had reasonable arguments related to the settlements. Section 522(d)(11)(D) of the Bankruptcy Code allows a debtor to exempt “a payment, not to exceed [$27,900], on account of personal bodily injury, not including pain and suffering or compensation for actual pecuniary loss, of the debtor or an individual of whom the debtor is a dependent[.]” [3] The court stated that courts “typically read [§ 522(d)(11)(D)] to exclude payments for medical bills too.” [4] The court held that the trustee’s arguments were not groundless because (1) every dollar of the second settlement only covered “pain and suffering,” and (2) the first settlement was subject to “attack” because it covered medical bills and made no mention of bodily injuries. [5]

Second, the court ruled in favor of the trustee on the forfeiture issue. The court explained that (1) a trustee forfeits objections to exemptions if he fails to raise them on time, (2) the “clock begins” when a debtor “claims” an exemption, (3) “many cases” hold that a debtor “claims” an exemption when she “unambiguously identifies a particular property as exempt,” and (4) when construing claims, the court must presume that a debtor acts “lawfully and with knowledge of the law.” [6]

The court held that because the two settlements dealt with harms beyond bodily injuries, the debtor “at least arguably” never exempted them, and therefore nothing was forfeited. The court explained its decision with a hypothetical:

Suppose a debtor claims a $1,000 exemption under 11 U.S.C. § 522(d)(3), which covers “household furnishings,” in “the contents of [his] bedroom.” And suppose that the debtor’s bedroom contains a bed, a chair, and a safe full of cash. Has the debtor claimed an exemption in his safe? Surely not. In context, “bedroom contents” means “bedroom contents that fall within § 522(d)(3),” including the bed and chair but not the safe. The same holds true today. [The debtor’s] claim for $23,675 plausibly covered such settlement proceeds as might fall within § 522(d)(11)(D), not anything broader. [7]

The court’s decision was also driven by policy considerations:

Trustees rarely know the details of Chapter 7 debtors’ assets from the start, and the Bankruptcy Rules do not give them much time to dig before the time for objections expires. That makes it crucial that trustees be able to determine precisely whether a listed asset is validly exempt simply by reading a debtor’s schedules. Reading [the debtor’s] claim broadly, however, would frustrate that objective. It would punish [the trustee] for not knowing the unknowable — that [the debtor’s] recoveries from her nascent auto accident case would not include $23,675 in damages for personal bodily injury. We recognize that [the debtor] had competing interests in claiming her exemptions promptly, but it is hard to see why that interest justifies exemptions falling outside the Bankruptcy Code’s boundaries. [8]

The decision in Biondo has several important takeaways for consumer bankruptcy practitioners:

1. Debtors have an obligation to identify their assets and claims of exemption unambiguously to allow a trustee to be able to determine quickly whether a listed asset is validly exempt simply by reading the debtor’s schedules; [9]
2. Although courts typically construe exemption statutes liberally in favor of debtors because exemptions further the Bankruptcy Code’s fresh-start policy [10], a liberal reading of exemption statutes does not allow a court to enlarge a statute or strain its meaning [11], and a court will not construe a debtor’s claim of exemption broadly; [12]
3. An “arguably” inapplicable claim of exemption might not even require an objection from the trustee. In Biondo, the court rejected the debtor’s argument that the trustee should have raised a “prophylactic” objection to the exemption at the outset of the case, reasoning that (a) the fact that the trustee could have raised such an objection did not obligate him to do so, and (b) “prophylactic objections can slow down bankruptcies and waste judicial resources”; [13] and
4. A trustee who does not object to an arguably inapplicable claim of exemption may not forfeit his or her right to raise arguments about the propriety of the exemption later in this case. Of course, this approach is not without risk, because a trustee loses his or her right to object to a properly claimed exemption when no timely objection is raised [14].