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Monday, November 02, 2009

A Final Word About Finality

Due to some unexpected illnesses in the family, this post comes a few days later than I expected.  In any case, thanks to Dan and Prawfs for having me.  I'll close out my visit with a few final words about finality in bankruptcy.

This week, the Supreme Court will hear oral arguments in Schwab v. Reilly.  This case is the direct result of the Court's 1992 opinion in Taylor v. Freeland & Kronz, which concluded that a claimed exemption becomes final once the 30-day period for objections passes.  In that case, the debtor claimed the exemption value as "unknown," which both the debtor and trustee admittedly understood to mean that the debtor was claiming the entire asset as exempt regardless of its ultimate value.  Thus, the clear language of Bankruptcy Rule 4003 required an objection within the 30-day period.

In the time since Taylor, the lower courts have struggled to outline consistent standards for interpreting a debtor's intent when she lists an exemption in the same amount as the value of the property.  Schwab is a long overdue case that should clear up this confusion.  More after the jump.

One line of cases assumes that a debtor is effectively exempting the entire asset, regardless of its ultimate value.  These cases often argue, as did the Third Circuit in Schwab, that Taylor requires the conclusion that listing the value of the asset and the exemption as the same amount necessarily infers that the debtor intends to exempt the entire asset regardless of the asset's real value.  This is a curious conclusion because that question was not before the court in Taylor; indeed, as noted, the parties agreed that they understood the debtor in that case intended to exempt the entire asset regardless of its value.  Thus, the Court had no reason to consider whether, as a matter of law, this is the necessary conclusion to be drawn when the debtor lists the values in this way.

Another series of cases refuses to assume that the debtor intends to exempt the entire asset without a clearer expression of that intention in Schedule C (the exemption schedule).  Under this approach, the debtor receives only the value of the exemption as listed (i.e., if the debtor lists the exemption value as $1, the debtor gets $1 out of the proceeds of the sale of the property).  Of course, if the debtor makes an unequivocal declaration in the schedule (I am exempting the entire property regardless of its ultimate value), she is likely to draw an objection.  In short, there is nothing in Schedule C that precludes debtors from stating a clear intent to keep the entire property; they just choose not to do so because it will virtually ensure that the trustee will object.

Thus, debtors may lowball their estimated values on the property to fall at or below the relevant exemption cap(s), claim their allowed exemptions in an equal amount, and hope for the best (the trustee won't object and the court will assume the asset is exempt in its entirety).  This puts trustees in a difficult position.  Should they assume that any time a debtor lists an exemption as the same dollar value as the estimated value of the exempt property that the debtor is trying to exempt more than the relevant exemption provision allows?  Under the approach taken by the Third Circuit, they must, even if the claimed listed exemption value falls under the applicable cap(s). 

As a practical matter, this will not only invite but require objections in nearly all consumer bankruptcy cases until the trustee can figure out whether the debtor is trying to play "gotcha" or is claiming a legitimate exemption up to the value of the asset.  Defenders of this approach stress the need for finality in consumer bankruptcies, but this approach will certainly delay finality by requiring objections to avoid default across a number of cases where there would not have ultimately been a dispute.  Nothing in the language of the Code or the Bankruptcy Rules makes a debtor's estimates of value binding, but this approach, by implication, does exactly that in the absence of a timely objection.  Thus, trustees will be forced to object precisely because valuations are inherently uncertain, especially early in a case.

Indeed, unlike Taylor, the parties in Schwab v. Reilly all clearly understood that the exemption amount was appropriate and that the trustee intended to sell the property from, at the latest, the 341 meeting of creditors, and pay the exemption amount to the debtor after the sale.  Only after the 30-day period elapsed did the debtor assert, for the first time, that the manner in which the exemption was scheduled (listing both values in the same amount) exempted the entire asset.  This is a classic "gotcha" case; placing the burden on the trustee to assume the subjective intent of the debtor from the manner in which the schedule was filled out.  The debtor here would not have been prejudiced in any way by the sale of the property; they would have merely received exactly what the Code entitles them to receive under the circumstances and what the trustee told them they would get at the meeting of creditors.  The debtor here only hoped for finality as a result of confusion, created by the debtor's own choices in filling out the schedule, and bankruptcy law should not reward this sort of gamesmanship.

Posted by S. Todd Brown on November 2, 2009 at 11:07 AM | Permalink

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