Michigan Bankruptcy Blog

Sixth Circuit Reverses Bankruptcy Court Decision to Disallow Chapter 7 Debtor's Amendment to Exemptions

While Chapter 7 bankruptcy offers individuals a fresh start and discharge from many debts, it doesn't come without a price. Property of the debtor becomes property of the estate and is used to pay creditors.

But not all of it. Section 522 of the Bankruptcy Code lists exemptions that debtors can use to exempt property - up to a certain dollar amount in value - from the estate. The purpose of exemptions is to ensure that the individual debtor is able to maintain a basic standard of living post-bankruptcy. But because there are very few assets available for creditor recovery beyond exempt property in many bankruptcy cases, the propriety of a debtor's claimed exemptions is an issue that is oft-litigated.

Such was the case in an appeal to the U.S. Court of Appeals for the Sixth Circuit (the "Sixth Circuit") arising from a Chapter 7 bankruptcy case that was filed in the U.S. Bankruptcy Court for the Eastern District of Michigan.

Background

Debtor Latoyna Westry filed for Chapter 7 and claimed an exemption under 11 U.S.C. § 522(d)(5) of an "unknown amount" for a workers' compensation claim. The exemption was limited to approximately $10,000. She subsequently settled the claim - 16 months later - for $25,000. She then filed an amended schedule in which she claimed two new exemptions: $25,000 under 11 U.S.C. § 522(d)(10)(C), the "[f]ull amount" under 11 U.S.C. § 522(d)(11)(E) and $10,555 under 11 U.S.C. § 522(d)(5) "if any amount not used from exemptions noted above."

The Chapter 7 trustee objected, arguing that it would be prejudicial to allow the amendment because of its "late date," but otherwise conceded that Westry was entitled to the claimed exemptions under the Bankruptcy Code.

The bankruptcy court ruled in favor of the trustee, ruling that it was "improper" for the debtor not to have claimed the additional available exemptions from the start. The debtor appealed to the district court, which affirmed the bankruptcy court ruling. The debtor then appealed the district court decision to the Sixth Circuit.

The Appeal

The debtor argued on appeal that the bankruptcy court exceeded its authority to deny her claimed exemptions because, according to Sixth Circuit precedent, only bad faith and fraudulent concealment are grounds to deny a debtor the right to amend schedules before the close of a case. In other words, there is no exception for "prejudice."

The Sixth Circuit noted that there was no dispute that the debtor's failure to claim additional exemptions in her original schedules was not the result of "intentional misconduct such as bad faith or fraud." Thus, it limited its analysis to whether the bankruptcy court had the discretion to deny the debtor's attempted amendment due to prejudice.

The Sixth Circuit reversed the lower court ruling. It focused its analysis on the Supreme Court decision (a decision handed down after the bankruptcy court ruling, but before that of the district court) in Law v. Siegel (a case we analyzed in detail here).

In the Law opinion, Justice Scalia, writing for the unanimous Court, concluded that the bankruptcy court order at issue - which surcharged an exemption to help pay the trustee’s legal fees - violated the Bankruptcy Code's exemption rules. Specifically, the Court stated that "whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of the Bankruptcy Code."

The Court further noted that the Bankruptcy Code's "meticulous…enumeration of exemptions and exceptions to those exemptions confirms that courts are not authorized to create additional exceptions...[F]ederal law provides no authority for bankruptcy courts to deny an exemption on a ground not specified in the Code." Finally, the Court rejected the notion that the Bankruptcy Code creates "a general, equitable power in bankruptcy courts to deny exemptions based on a debtor's bad-faith conduct."

While acknowledging that Law was not directly on point, the Sixth Circuit stated that "Law strongly suggests that the bankruptcy court exceeded its authority when it disallowed Westry's amendment, which asserted proper exemptions within the time period allowed for amendment." However, despite analyzing Law's impact, the Sixth Circuit declined to determine the "exact perimeters" of the bankruptcy court's discretion to disallow the amended exemption claim based on prejudice. Instead it concluded that there was no adequate showing of prejudice in the first instance.

The trustee argued that prejudice was due to "the extremely late timing of the amendment," that creditors would be prejudiced because "the estate has administered the case for so long prior to the amendment," and that allowing the amendment would impair her diligent administration of the estate. The Sixth Circuit noted, however, that there was no record to support these allegations of prejudice, and the decision was reversed and remanded to the bankruptcy court.

Categories: 6th Circuit Court of Appeals, Chapter 7