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Bankruptcy court not authorized to deny exemptions based on debtor’s bad faith

A bankruptcy court did not have the authority to deny exemptions based on a Chapter 7 debtor’s failure to disclose assets at the time of filing. Applying the Supreme Court’s 2014 decision in Law v. Siegel, 571 U.S. 415 (2014), the Eighth Circuit Bankruptcy Appellate Panel held that exemptions and amendments may not be disallowed on grounds not specified in the Bankruptcy Code, including a debtor’s bad faith or prejudice to creditors.

The debtor disclosed a bank account during the meeting of creditors that had not been disclosed on the schedules the debtor filed with his petition. The debtor amended his schedules a week later to add the account and claim it as exempt. The trustee later discovered additional assets that had not been disclosed by the debtor. The debtor again amended his schedules to add the assets and claim them as exempt. The trustee objected to the debtor’s second amended claim of exemptions, arguing the amendments should be disallowed on the grounds of bad faith and prejudice to creditors. Relying on Law v. Siegel, the bankruptcy court overruled the trustee’s objection.

Law v. Siegel. In Law v. Siegel, the Supreme Court held that a bankruptcy court could not order a debtor’s exempt property surcharged with administrative expenses incurred as a result of the debtor’s bad conduct. Although the bankruptcy court had inherent powers to curb abusive practices, the surcharge contravened a section of the Code that entitled the debtor to exempt his property from administrative expenses. In dicta, Justice Scalia went on to explain that federal law also did not authorize a bankruptcy court to deny a debtor’s claim of exemptions on grounds not specified in the Code.

Amendments permitted liberally prior to Law. Bankruptcy Rule 1009 provides that a debtor may amend exemptions as of right at any time until the case is closed. Prior to Law, the two recognized exceptions to Rule 1009 were bad faith on the part of the debtor and prejudice to creditors. Courts uniformly denied exemption claims in cases where a debtor fraudulently concealed assets. However, bad faith and prejudice to creditors are not grounds specified in the Code to deny exemption claims, and many courts, applying the dicta in Law, now hold that bankruptcy courts lack the power to disallow exemptions on the grounds of the debtor’s fraud or bad faith.

No authority to deny exemptions. The question facing the BAP in this case was whether to follow the Supreme Court’s dicta in Law and uphold the bankruptcy court’s ruling or apply Eighth Circuit precedent recognizing a bankruptcy court’s equitable powers to deny exemptions based on debtor misconduct. The BAP found itself bound by Law, noting that “not all dicta are created equal,” and adding that the Supreme Court’s “unambiguous” statements of law could not be ignored: a bankruptcy court is not authorized to deny exemptions based on non-statutory grounds such as a debtor’s bad faith.

Belew v. Rucker (In re Belew), No. 18-6007, 2018 Bankr. LEXIS 2717 (B.A.P. 8th Cir. Sep. 6, 2018)