Law v. Siegel, 134 S.Ct. 1188 (March 4, 2014)
The surcharge of a homestead exemption.` In Law v. Siegel, Debtor Mr. Law filed bankruptcy in California in 2004. He listed as have a first mortgage with Washington Mutual and a second mortgage with another entity. The second mortgage took up what would be the equity in the real property. After much litigation it was found that the second mortgage was not valid and fraudulent. The real property did in fact have substantial equity and the second mortgage was a sham. The Bankruptcy Court eventually determined that “the loan was fabricated by Debtor in an attempt to preserve equity in his residence and defeat the collection efforts of his judgment creditors.” In re Law, 401 B.R. 447, 449 (Bankr. C.D. Cal. 2009). The debtor took a homestead exemption in the property.
The trial judge then “surcharged” the exemption for the amount of money the bankruptcy estate spent litigating the matter. The trial court allowed the surcharge and on appeal the 9th Circuit found in favor of the trustee.
The matter went to the Supreme Court and the Court found in favor of the debtor under 11 USC 522 (k):
(k) Property that the debtor exempts under this section is not liable for payment of any administrative expense except—
(1) the aliquot share of the costs and expenses of avoiding a transfer of property that the debtor exempts under subsection (g) of this section, or of recovery of such property, that is attributable to the value of the portion of such property exempted in relation to the value of the property recovered; and
(2) any costs and expenses of avoiding a transfer under subsection (f) or (h) of this section, or of recovery of property under subsection (i)(1) of this section, that the debtor has not paid.
The Supreme Court found that the “plain meaning” of the statute said that “administrative expenses” cannot be paid by exempted property. Even though the Trial court found bad faith, the estate was not entitled to surcharge the exemption.
Practice Pointer: While the debtor won this round, debtors ultimately lost since now chapter 7 trustees will be more aggressive to gain assets least they fall into a Law v. Siegel scenario.