Court Can't Deny Debtor's Exemptions Due to Bad Faith

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By Diane Davis

Dec. 4 — A bankruptcy court lacked authority to deny a debtor her claimed exemptions on account of her bad faith concealment of her inheritance, a district court in North Carolina held Dec. 1.

Judge Graham C. Mullen of the U.S. District Court for the Western District of North Carolina agreed with the bankruptcy court that neither North Carolina law nor federal law provided a basis to deny debtor Tracy Layne Caillaud's exemptions.

Under Chapter 7 bankruptcy in which the debtor's nonexempt assets are liquidated and the proceeds are distributed to creditors, certain types of assets, or exempt property, may be retained by the debtor post-bankruptcy under Bankruptcy Code Section 522(b)(1). The debtor can choose to forgo federal exemptions in order to claim particular exemptions that are available under state law.

No Power to Deny Exemptions

The court looked to Law v. Siegel, 134 S. Ct. 1188 (2014) (26 BBLR 311, 3/6/14), in which the U.S. Supreme Court held that the bankruptcy court didn't have the power to equitably surcharge administrative expenses against a debtor's claimed exemptions on the grounds that the debtor had engaged in fraudulent or bad faith conduct. According to the court, under Siegel, the court's broad powers to “sanction abusive litigation practices” doesn't include the authority to “contravene specific statutory provisions” in the Bankruptcy Code.

Nearly all of the courts to interpret Siegel have held that it denies bankruptcy courts the power to deny claims for exemptions on bad faith grounds, the court said.

Trustee's Other Recourses

The court also found that the bankruptcy court didn't abuse its discretion in denying the Chapter 7 trustee's request for a new trial.

The trustee isn't without recourse under the circumstances, the court said. The debtor's conduct may warrant revocation of her discharge and other penalties, the court said.

Debtor's Inheritance

The debtor filed for Chapter 7 bankruptcy. Shortly thereafter, her father died intestate and she and her two siblings were his sole heirs.

The debtor signed a sworn Application for Letter of Administration attesting that her father's home had a value of $189,000. Subsequently, her father's home sold for $275,000, and after they paid off her father's debts, the siblings were left with net sale proceeds of $28,225. The debtor failed to disclose this information to the Chapter 7 trustee, who learned of the sale during a property records search.

Failure to Disclose

The trustee contacted the debtor's attorney, who informed him that the siblings received approximately $20,000, and that the debtor had received $6,000. The trustee then demanded that the debtor turn over the $6,000.

The debtor admitted that her share of her father's estate was closer to $16,000, but claimed that she couldn't turn over these funds and asked for a payment plan. The trustee refused to allow the payment plan.

The debtor then argued that she had $4,980 in available exemptions under North Carolina law and that she should be permitted to use those to offset a portion of the proceeds from her father's estate.

The trustee objected and asked the bankruptcy court to deny the motion, arguing that the debtor's bad faith concealment and disposal of the funds from the sale were grounds for denying her motion.

Foreclosed by Siegel

The bankruptcy court held that the trustee's argument was foreclosed by Siegel. Under Siegel, the bankruptcy court said it had no equitable power to deny the debtor the exemptions that she claimed unless North Carolina law explicitly authorized such action.

Looking at North Carolina law, the bankruptcy court concluded that no provision empowered it to deny exemptions on grounds of bad faith.

The trustee also filed a motion for a new trial, joined by the bankruptcy administrator in the case.

The bankruptcy court denied the motion for a new trial, concluding that nearly every court to consider Siegel had followed the relevant dicta, and that the Bankruptcy Code governs in the event of a conflict between the Code and the Bankruptcy Rules.

Trustee's Argument Waived

The district court agreed with the bankruptcy court's determination that it was not free to disregard the Supreme Court's pronouncements in Siegel — even if it was only dicta.

The trustee only located one case in which a bankruptcy court disregarded Siegel‘s dicta and held that it had the equitable power to deny or disallow an exemption on the basis of the debtor's bad faith conduct, the court said. According to the court, no other court has followed the rationale advocated by the trustee.

The court found that the trustee's argument that the debtor failed to comply with rules regarding amending her exemptions is waived because the trustee failed to raise it before the bankruptcy court.

John W. Taylor, John W. Taylor, P.C., Charlotte, N.C.; Linda Wright Simpson, U.S. Bankruptcy Administrator, Charlotte, N.C., represented themselves as appellants; Appellee/debtor Tracy Layne Caillaud, Charlotte, N.C., represented herself.

To contact the reporter on this story: Diane Davis in Washington at

To contact the editor responsible for this story: Jay Horowitz at

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