Category Archives: Creditor Exemptions

October 27, 2015

Creditors May Collect Debts From Funds Distributed to a Debtor From His/Her Exempt Retirement Account Under Tenth Circuit Ruling that Distributed Funds are not Exempt

In a case of first impression, the Tenth Circuit has held that a resident of Colorado may not assert an exemption under Colo. Rev. Stat. § 13-54-102(1)(s) for funds distributed from an exempt pension or retirement plan.  In re Gordon, 791 F.3d 1182 (10th Cir. 2015).  In Gordon the debtors received a lump sum distribution of $16,700 from an exempt 401(k) plan prior to filing bankruptcy.  They deposited the funds into a savings account, where the funds remained segregated from all other funds the debtors had received from other sources.  The debtors used these funds to pay their living expenses prior to filing bankruptcy, and on the petition date had $2,051 remaining.  They asserted an exemption in these remaining funds.  The trustee objected to the claim of exemption, contending the exemption does not apply to funds after their distribution from the exempt retirement account.  The bankruptcy denied the exemption, and the Tenth Circuit agreed with the bankruptcy court’s holding.

The court concluded the language of the statute was clear in allowing an exemption only for funds that are within the exempt retirement account, noting the statute provides an exemption for “property, including funds, held in or payable from any pension or retirement plan or deferred compensation plan.”  Colo. Rev. Stat. § 13-54-102(1)(s).  Noting that Colorado courts have not addressed the question whether the exemption applies to funds which have been distributed, the Tenth Circuit stated that it “must ascertain and give effect to the intent of the legislature, and that task begins with the language of the statute itself.”  The court concluded that the statutory exemption applies only to funds that are actually in the exempt plan.  Although the court agreed with the debtors that Colorado liberally interprets statutes granting exemptions, the court stated that “even a liberal construction must find support in the statutory text,” and determined that such support was lacking in the statute at hand.  The fact that the Colorado legislature had provided an exemption in other statutes for distributed funds but did not do so in the pension and retirement account statute also supported its reasoning.  For example, the court noted that Colorado law provides for an exemption for proceeds of life insurance policies, Colo. Rev. Stat. § 13-54-102(1)(l)(I)(B), as well as for all money received as a pension arising out of service as a member of the armed forces of the U.S., Colo. Rev. Stat. § 13-54-102(h). 

The court concluded that creditors are prohibited by the statute from going after the plan itself, but once the funds in the plan are distributed to the debtor, the creditor is free to execute. 

March 17, 2015

Ninth Circuit BAP Holds Law v. Siegel Precludes Barring a Debtor’s Amendment of Exemptions on Grounds of Bad Faith or Equity

In its opinion in Gray v. Warfield (In re Gray), 523 B.R. 170 (9th Cir. BAP 2014), the Ninth Circuit BAP held that the U.S. Supreme Court’s decision in Law v. Siegel, 134 S. Ct. 1188 (2014) precludes a bankruptcy court from denying a debtor’s amendment of his claim of exemption on equitable grounds.

Prior to filing bankruptcy, the Grays prepaid three months of rent on their residence, but did not list the prepaid rent as an asset in their schedules.  At the 341 meeting the trustee questioned their payment of $2707 to their landlord, at which time the debtors disclosed they had prepaid several months rent, including rent for the first two months after their bankruptcy filing.  Following the 341 meeting, the debtors amended their schedules to disclose the prepaid rent and also to assert an exemption in it, an exemption allowed by applicable state law.  The trustee filed an objection to the amended exemption, contending the debtors’ failure to list the asset initially constituted equitable grounds for denying the exemption, arguing the debtors acted in bad faith in failing to disclose the asset in the first place.  The bankruptcy court sustained the objection, and the debtors appealed. 

On appeal the BAP analyzed the question in light of the U.S. Supreme Court’s opinion in Law v. Siegel.  The BAP noted two pre-Law v. Siegel opinions which held that a debtor could be denied the right to amend his exemption schedule if the debtor’s failure to initially disclose the asset was done in bad faith:  (1) the Ninth Circuit’s opinion in Martinson v. Michael (In re Michael), 163 F.3d 526, 529 (9th Cir. 1998 (“Whether the [debtors] could amend their schedules post-petition is separate from the question whether the exemption was allowable.”); (2) Doan v. Hudgins (In re Doan), 672 F.2d 831, 833 (11th Cir. 1982).  The BAP initially concluded that the distinction noted by the Ninth Circuit in Michael is meaningless—denying a debtor the right to amend an exemption schedule on equitable grounds has the identical effect of disallowing the exemption. 

The BAP then looked to well-settled case law to the effect that a claimed exemption is presumptively valid, and also that Fed. R. Bankr. Proc. 1009(a) gives a debtor the right to amend any schedule “as a matter of course at any time before the case is closed” without court approval.  The court also noted that, prior to Law v. Siegel, courts had crafted judicially created exceptions to limit the right to amend on a showing of either the debtor’s bad faith or prejudice to creditors. 

The BAP concluded that Law v. Siegel changed the landscape, and that courts no longer may deny a debtor’s right to amend his claims of exemption on findings of bad faith or other equitable grounds:  “The Supreme Court’s definitive position that the Bankruptcy Code does not grant bankruptcy courts ‘a general, equitable power . . . to deny exemptions based on a debtor’s bad-faith conduct’ is clearly irreconcilable with the use of judicially created remedies either to bar amendments or to disallow amended exemptions.” 

However, the BAP noted the Supreme Court in Law v. Siegel, recognizes that exemptions created under state law are governed in their allowance by state law.  Consequently, the BAP remanded the case to the bankruptcy court to determine if applicable state law provided equitable grounds for denial of the exemption.

May 13, 2014

Tenth Circuit BAP Holds a Debtor may Exempt as “Tools of the Trade” Assets Used by the Debtor in a Side Business

In addition to their full-time jobs, many individuals have their own “side businesses” which generate some income but not enough to enable them to give up their “day job.”  Many of these side businesses require assets in order for the individual to deliver the goods or services to his customers.  When that individual has to file for bankruptcy, may he or she claim a “tools of the trade” exemption in the assets used in the side business?  The Tenth Circuit Bankruptcy Appellate Panel in held a debtor may assert such an exemption in appropriate circumstances, in its decision in Larson v. Sharp (In re Sharp), 2014 WL 1400073 (10th Cir. BAP April 11, 2014).

In Sharp, the debtor was employed full time in his proverbial “day job.”  However, his dream was to become an outdoor outfitter and guide and to spend his retirement years in that occupation, and in his effort to fulfill his dream the debtor started a part-time outdoor outfitting business, Aspen Place Outfitters.  The debtor attended trade shows, and used his vacation time from his main job to provide outfitting and guide services for his customers.  The debtor had acquired various assets (firearms, boats, a camper, an ATV, utility and horse trailers and fishing poles) which he used in his outfitting business and which he owned on the date he filed bankruptcy.  The debtor’s outfitting business generated some income but not enough to enable him to quit his full time job. Although the debtor’s side business was growing, it had not yet generated a net profit by the time the debtor filed bankruptcy.

The debtor asserted an exemption to his outfitting company assets as tools of the trade, under Colorado Rev. State § 13-54-102(1)(i), which allows an exemption in the “stock in trade, supplies, fixtures, maps, machines, tools, electronics, equipment, books, and business materials of any debtor used and kept for the purpose of carrying on any gainful occupation in the aggregate value of twenty thousand dollars.”  The trustee objected to the claim of the exemption, contending the Colorado statute’s use of the term “gainful occupation” requires the occupation to generate a net profit as of the petition date in order for a debtor to assert the exemption.  Consequently, the BAP’s analysis was focused on the term “gainful” in the statute. 

The court began its analysis by noting that the Constitution of the State of Colorado requires its exemption laws to be liberally construed.  See Beneficial Fin. Co. of Colo. V. Schmuhl, 713 P.2d 1294, 1298 (Colo. 1986).  The court also noted that the purpose of the exemption is to preserve to the debtor his means of support.  Taking these concepts in hand, the BAP next agreed with the bankruptcy court’s conclusion that the term “gainful” as used in the exemption statute, is ambiguous.  The bankruptcy court had found that the debtor’s outfitting business was “an entrepreneurial business that may become viable in the near future.”  The BAP agreed that this conclusion was supported by the record, and then went on to determine whether this finding supported the bankruptcy court’s conclusion that the side business was, therefore, a “gainful occupation” of the debtor.

The BAP noted that “virtually all dictionary definitions” of the work “gainful” list “profitable” as a synonym.  The BAP then stated that the Bankruptcy Code’s fresh start policy is served only when there is some element of profitability to the trade for which the debtor seeks to exempt his tools.  Consequently, the BAP concluded the term “gainful occupation” under Colorado’s exemption statute requires some aspect of profitability to the business.  However, the BAP held that the business in question need to actually be generating a profit at the time of the debtor’s bankruptcy.  Rather, the court held that a gainful occupation consists of two elements: a business (1) which is conducted with continuity and regularity and (2) which has a profit motive, meaning an expectation or anticipation of profit in the future. 

Taking the facts indicating that the debtor’s side business was on a trend toward profitability, with the debtor devoting regular efforts to the business, the BAP concluded the debtor could assert an exemption in the assets associated with his side business as tools of his trade.

March 5, 2014

SCOTUS Tells the Ninth Circuit to Follow the Law: Section 105(a) Is Not a Means to Contravene Other Provisions of the Bankruptcy Code

Stephen Law filed a chapter 7 petition in California.  His only valuable asset was his home, which he scheduled at a value of $363,348.  Washington Mutual Bank held a lien against the home to secure a loan in the amount of $156,929.  Law asserted a homestead exemption under California law of $75,000.  In order to prevent the bankruptcy trustee from selling his home, Law fabricated a second lien against his home which consumed his entire equity, and obtained the cooperation of a Chinese national named Lili Lin to assert that she was actually owed money by the debtor.  The bankruptcy trustee brought an adversary proceeding to avoid the lien, an action which Law and Lin vigorously opposed.  In what some might call a poor financial decision, the bankruptcy trustee incurred $500,000 in legal fees overcoming Law’s fraudulent misrepresentations regarding his $363,000 home.  The bankruptcy court approved a surcharge of the debtor’s $75,000 homestead exemption to pay a portion of the trustee’s legal fees, a holding which was affirmed by the Ninth Circuit BAP and the Ninth Circuit.

The Supreme Court reversed in its opinion in Law v. Siegel, 2014 WL 813702 (March 4, 2014).  The Supreme Court held that neither 11 U.S.C. § 105(a) nor the bankruptcy court’s inherent powers provided a basis for a bankruptcy court to contravene the express language of § 522 of the Bankruptcy Code allowing debtors to claim exemptions in certain assets. In addressing § 105(a), the Court stated  “A bankruptcy court has statutory authority to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of” the Bankruptcy Code. . . But in exercising those statutory and inherent powers, a bankruptcy court may not contravene specific statutory provisions,” and that “It is hornbook law that § 105(a) ‘does not allow the bankruptcy court to override explicit mandates of other sections of the Bankruptcy Code.’” (citing 2 Collier on Bankruptcy ¶ 105.01[2], p. 105-6 (16th ed. 2013).  Consequently, because § 105(a) confers on bankruptcy courts the authority to “carry out” the provisions of the Bankruptcy Code, “it is quite impossible to do that by taking action that the Code prohibits.” 

The Court also rejected the trustee’s argument that the surcharge did not contravene § 522 of the Code.  The trustee argued that a bankruptcy court has equitable power to deny an exemption in response to a debtor’s misconduct.  The Court first held that the trustee’s failure to object to the debtor’s homestead objection within the time required by the Code prevented him from challenging the exemption through seeking a surcharge.  In addition, the Court held that the plain language of § 522 prevented the surcharge.  Section 522(b) provides that the debtor may exempt property, and the Court interpreted this provision as vesting the debtor, not the bankruptcy court, with the discretion on whether the exemption can be claimed.  Section 522 contains various bases on which an exemption can be limited or disallowed, some of which relate to misconduct by the debtor.  The Court held that § 522’s “meticulous—not to say mind-numbingly detailed” list of restrictions and limitations on a debtor’s right to assert an exemption “confirms that courts are not authorized to create additional exceptions.”  Consequently, the debtor’s misconduct in fabricating a lien was not grounds to deny his exemption.

Finally, the Court held that its prior decision in Marrama v. Citizens Bank, 549 U.S. 365 (2007) did not require a different result.  The Court explained its decision in Marrama as one where a chapter 7 debtor could be denied his statutory right to convert his bankruptcy case to a chapter 13 proceeding because his bad faith conduct prevented him from qualifying for relief under chapter 13, and should not be read as providing bankruptcy courts with an equitable right to take action which contravenes the express provisions of the Bankruptcy Code.

January 28, 2013

Utah Supreme Court Holds that the Utah Consumer Credit Code does not Create a Bankruptcy Exemption on Earnings

In connection with an appeal in the bankruptcy proceedings of Dr. Douglas Reinhart, the United States Court of Appeals for the Tenth Circuit certified the following question to the Utah Supreme Court:  “Does Utah Code Ann. sec. 70C-7-103 create an exemption in bankruptcy, or does it only limit a judgment creditor’s garnishment remedy outside bankruptcy?”

In its opinion in Gladwell v. Reinhart, 723 Utah Adv. Rep. 66 (Utah 2012), the Utah Supreme Court
concluded that section 103 does not create an exemption in bankruptcy, and is expressly limited to a judgment creditor’s garnishment remedy outside of bankruptcy.

At the time he filed bankruptcy, Dr. Reinhart was owed unpaid salary by his professional corporation. 
He asserted an exemption to those monies under both the federal Consumer Credit Protection Act, 15 U.S.C. sec. 1673, and section 103 of the Utah Consumer Credit Code.  The trustee objected to the claim of exemption, contending that the asserted federal exemption was precluded by the United States Supreme Court’s decision in Kokoszka v. Belford, 417 U.S.C 642 (1974) and that the provisions
of section 103 of the Utah Consumer Credit Code apply only outside the bankruptcy context.  The bankruptcy court denied the trustee’s objection and allowed the exemption.  The United States District Court for the District of Utah summarily affirmed.  The United States Court of Appeals for the Tenth Circuit reversed as to the exemption claimed under federal law, agreeing that the Supreme Court’s decision in Kokoszka precluded the federal exemption. Gladwell v. Reinhart, 416 F. App’x, 761, 763 (10th Cir. 2011). The Tenth Circuit certified the question as to the state exemption to
the Utah Supreme Court.

The Utah Supreme Court began its analysis by noting that Utah has opted out of the federal exemption scheme for purposes of determining what exemptions Utah residents may claim in bankruptcy cases.  The court then noted that exemptions for Utah debtors are generally located in the state’s Exemptions Act, but that additional exemptions are located outside the Exemptions Act.  As an example, the court that Utah Code sec. 35A-3-112 provides for an exemption allowable generally and in bankruptcy for public assistance monies. 

In determining whether section 103 of the Utah Consumer Credit Code provides a general exemption allowable in a bankruptcy case the court began with the plain language of the statute:

                “(2) the maximum part of the aggregate disposable earnings of an individual for any
pay period which is subjected to garnishment to enforce payment of a judgment arising from a consumer credit agreement may not exceed the lesser of: (a) 25% of his disposable earnings for that pay period; or (b) the amount by which his disposable earnings for that pay period exceed 30 hours per week multiplied by the federal minimum hourly wage prescribed by Section 6(a)(1) of the Fair Labor Standards Act of 1938, 29 U.S.C. Section 206(a)(1), in effect at the time the
earnings are payable.”

The court viewed the plain language of the statute as restricting its application to those instances where a judgment creditor seeks to garnish wages to enforce a judgment arising from a consumer credit agreement.  The court concluded that this plain language did not provide a general exemption for purposes of bankruptcy proceedings.  The plain language indicated it was not intended to apply outside of the context of a garnishment to enforce a judgment arising from a consumer credit agreement.

The court buttressed its conclusion by noting that, at the time the Utah Consumer Credit Code was enacted in 1969, the Utah Exemptions Act already contained a general exemption of “half a debtor’s earnings rendered at any time within thirty days next preceding the levy of execution or attachment
by garnishment or otherwise.” The two statutes co-existed for a number of years, leading the court to conclude that the protections in section 103 of the Utah Consumer Credit Code applied in circumstances relating to enforcement of judgments arising from consumer credit agreements, whereas the Utah Exemptions Act had a broader protection for wages from judgment creditor actions.  This co-existence indicated a legislative intent for a more limited application of section 103 of the Consumer Credit Code.  In 1981, the Utah legislature repealed the earnings exemption in the Exemptions Act, but did not amend the Consumer Credit Code to expand its application. 

The totality of these circumstances lead the court to conclude that the legislature did not intend section 103 to provide a general exemption for unpaid earnings under Utah law in a bankruptcy case.