Law v. Siegel – SCOTUS Limits the Application of 11 U.S.C. § 105

An important issue that is often addressed in Chapter 7 bankruptcy cases is whether the debtor asserts a “homestead” exemption to attempt to protect their home equity from becoming property of the bankruptcy estate. Recently, an intriguing decision was handed down by the United States Supreme Court. The important message gleaned from the court was that 11 U.S.C. § 105 cannot be invoked while disregarding other express provisions of the Bankruptcy Code.

In the case of Law v. Siegel, 188 L. Ed. 2d 146 (U.S. 2014), decided on March 4, 2014, the debtor, Stephen Law, essentially tried to keep money away from his creditors by asserting two fictional liens on his home. The Trustee claimed that in order to expose the false liens on the property, he incurred approximately $465,000 of legal fees charged to the estate. Therefore, the Trustee asserted that the Bankruptcy Court for the Central District of California should permit him to “surcharge” the debtor’s homestead exemption in order to offset the Trustee’s costs. When the decision was appealed to the Appellate Panel for the Ninth Circuit, the court held that the Trustee could collect litigation expenses out of the proceeds of the sale of the debtor’s home. However, the United States Supreme Court reversed this decision, consequently reshaping the conversation on this issue.

In a rare unanimous decision, the court held that when a debtor creates fictional liens to prevent a Chapter 7 Trustee from selling his home based on an asserted homestead exemption, the Trustee cannot sell the property to use those funds to pay administrative litigation expenses, even despite the debtor’s completely fraudulent conduct. The decision truly came down to the court’s interpretation of the breadth of 11 U.S.C. § 105, which is often used to assert “catch-all” authority by the bankruptcy bar. In the decision, written by Justice Scalia, the court clarified the reach of § 105, clarifying that although the statutory language includes that the court can “issue any order . . . that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code],” this does not permit the court to contravene specific statutory provisions. Specifically, in this case, 11 U.S.C. § 522(k) sets out that exempt assets are “not liable for the payment of any administrative expense.” Furthermore, while Chapter 7 debtors are not required to assert a homestead exemption, when they elect to do so, this election must be honored, even when a debtor acts in a completely fraudulent manner.

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