The Supreme Court’s Decision Guides Debtor Exemptions

Posted by David Falvey on Monday, December 2nd, 2013 - 2,863 views

Lost Appreciation in Chapter 7 bankruptcy

In the United States Supreme Court case of Schwab v. Reilly, 130 S. Ct. 2652 (2010), the Court turned the bankruptcy world’s understanding of debtor exemptions on its head.

The Court held that when a debtor ascribes a dollar value to property of the bankruptcy estate and claims an interest in the property up to that dollar amount, the debtor is expressing only an interest in the property.

The property remains in the bankruptcy estate during the life of the case (unless abandoned by the trustee). This remains true even after the exemptions are “approved” or the trustee fails to file a timely objection to claimed exemptions.

When a dollar amount in the debtor’s property is claimed exempt, the property is only exempted to that amount.

This means that even if the debtor accurately values the property at the time the bankruptcy case is filed, the debtor loses his interest in any appreciation in the property during the case.

The trustee may leave the estate open for months or years to capture the appreciation for the bankruptcy estate.

Let’s use the gold watch as an example

For example, suppose you own a gold watch. The watch is scheduled in your bankruptcy case with a fair market value (FMV) of $1,000, and you use a state law exemption for jewelry capped at $1,000 to protect it.

A year later, after gold prices have escalated, the trustee can have the watch appraised at $3,000. The watch may be taken and sold by the trustee but only your $1,000 exemptible interest is returned to you after the watch is sold.

The decision in Schwab also makes it clear that when you claim an exemption interest in property of a bankruptcy estate, the property itself stays in the bankruptcy estate.

Consequently, it would be in your best interest as a debtor to have the trustee abandon his or her interest in the property as early as possible.

In the above situation, there may also be fairness arguments available to the debtor, as one writer argues that the trustee should not reach the appreciation of real property if the trustee is not paying the mortgage or the property taxes.

Chapter 7 trustee objections to exemptions

Since one purpose of the federal bankruptcy laws is to provide the debtor with a fresh start, the Bankruptcy Code and Federal Bankruptcy Rules limit the time period for creditors and the bankruptcy trustee to file objections to the debtor’s claimed exemptions.

Section 522(l) of the Bankruptcy Code states “unless a party in interest objects, the property claimed as exempt on such list is exempt.” Rule 4003(b) requires the trustee (or other interested party) to object to the debtor’s exemption claim within 30 days after the meeting of creditors is concluded.

Unfortunately, the United States Supreme Court chose to ignore the plain language of Rule 4003(b) in the case of Schwab v. Reilly, 130 S. Ct. 2652 (2010).

The Supreme Court held in Schwab that when a debtor claims a statutorily permissible dollar value interest in his exempt property, the trustee has no duty to object within the 30-day objection deadline.

The Court empowered Chapter 7 bankruptcy trustees to object to the value of a debtor’s claimed property exemption at any point during a bankruptcy proceeding when the claimed dollar value is unobjectionable on its face.

The Court stated that under Rule 4003(b) the trustee has the duty to object to (1) an incorrect description of the debtor’s property; (2) an inapplicable or incorrect bankruptcy exemptions; and 3) an incorrect value of the claimed exemption.

However, the trustee is not obligated to evaluate the debtor’s value estimate of the property and file an objection within the 30 day period described in Rule 4003(b).

Here’s an example

For instance, suppose the debtor has a gold watch. The watch is scheduled in the bankruptcy case with a fair market value of $1,000, and the debtor uses a state law exemption for jewelry capped at $1,000 to protect it.

Later, the trustee has the watch appraised at $3,000. The watch may be taken and sold by the trustee. The trustee, by not objecting within the 30 day period to the debtor’s claim of $1,000 (which is within the statutory limits) has lost his right ability object to that exemption.

However, according to the Schwab decision, the trustee has not lost the ability to sell the property and realize the value in excess of the debtor’s exemption claim.

But this “protection” only extends to those values that are within the statutory limits. For instance, the Supreme Court upheld its prior ruling in Taylor v. Freeland & Kronz, 503 U.S. 638 (1992), and stated that should the debtor list the property’s value as “unknown,” the trustee has a duty to object within 30 days.

A claim of exemption for an “unknown” property value is not within the statutory limits and is objectionable on its face.

The Schwab Court also stated that a debtor may indicate an intent to fully exempt an asset without risking trustee confusion.

For example, the Court stated that by claiming an exemption of “full market value (FMV)” or “100% of FMV” on Schedule C, a debtor could clearly indicate that he is exempting the full value of his property (and not just a partial, exemptible interest in the property). This compels the trustee’s obligation to object within 30 days or lose the entire asset from the bankruptcy estate.

Bankruptcy courts and trustees have reacted to the Schwab ruling differently. In most cases, a debtor claiming an exemption of “full market value” or “100% of FMV” triggers a trustee objection and a hearing in bankruptcy court to determine the value of the property.

In other cases, trustees are continuing the meeting of creditors in order to avoid starting the 30 day clock while seeking to determine a FMV and applicable exemption amount.

The courts also differ on who has the burden of proof when a debtor claims a 100% FMV exemption. Some courts have required the trustee to prove that the fair market value of the asset exceeds the allowed amount of the exemption but every case is different.