Below, Anthony Dick of Stanford Law School previews Schwab v. Reilly, one of three cases to be heard by the Supreme Court on Tuesday, November 3. Check the Schwab v. Reilly (08-538) SCOTUSwiki page for additional updates.

Section 522 of the Bankruptcy Code permits debtors to claim certain exemptions, thereby retaining some assets free from the claims of creditors in bankruptcy.  The Code also requires a party in interest (e.g., a creditor) to object to a claimed exemption within thirty days after the creditors' meeting; once the thirty-day period has passed, any objections to the exemption are deemed waived, and the property claimed is fully exempt.

This case arises out of the bankruptcy of respondent Nadejda Reilly, who owned and operated a small catering business.  Reilly claimed an exemption of $10,718 for her kitchen equipment and listed the estimated market value of the equipment at the same amount, $10,718. (The $10,718 exemption was within the total amount authorized by the combination of two exemptions established in Section 522 of the Code:  subsection (d)(6)'s exemption for  "tools of the trade" and subsection (d)(5)'s "wildcard exemption," which allows a certain dollar amount to be allocated to any asset of the debtor's choice.)   Reilly has explained that she attaches an "extraordinary sentimental value" to the equipment because her parents bought it for her as a gift, at great personal sacrifice to them.

Petitioner William Schwab was appointed as the Chapter 7 Trustee in Reilly's bankruptcy.  Because he "suspected, but did not know, that Reilly's kitchen equipment might be worth more than $10,718," he sought an appraisal of the equipment before Reilly claimed her exemption. Although the appraiser estimated the equipment's value at roughly $17,000, Schwab did not object within the 30-day period to the exemption. Instead, he sought to sell the cooking equipment at auction and planned to give the exempt amount of $10,718 in cash to Reilly and distribute the remaining amount to Reilly's creditors.

Reilly objected to this plan and filed two motions: one to dismiss her bankruptcy petition, and "“ subsequently "“ another to prevent the liquidation of her cooking equipment. The bankruptcy court denied the first motion but granted the second, keeping Reilly's bankruptcy alive but blocking the sale of her equipment in which she claimed an exemption. Schwab appealed to the district court, which affirmed. He then appealed to the Third Circuit, which also affirmed.

The Third Circuit relied on Taylor v. Freeland & Kronz, in which a debtor improperly claimed the proceeds of a pending lawsuit as exempt, and listed the value of the proceeds as "unknown." In that case, the Court held that the trustee's failure to timely object waived any claim to the lawsuit proceeds, effectively granting the debtor a full exemption for that particular asset.  In the panel's view, Taylor means that "where the debtor signals her intention to exempt certain property in its entirety by listing an identical entry for the property's value and the amount of the exemption, the trustee must object . . . lest the property be rendered fully exempt."

This is the central issue that the Court will now take up in Schwab v. Reilly: by claiming an exemption in her kitchen equipment for the same dollar amount as its estimated value, did Reilly signal her intent to exempt the equipment fully, thereby requiring Schwab either to object or to acquiesce in the full exemption for the equipment?

Petitioner Schwab claims that the Third Circuit misread Taylor and applied a new rule that is both incorrect and unworkable.  In Taylor, he contends, the claimed exemption"”for an unknown amount of proceeds from a pending lawsuit"”was objectionable on its face.  Because the debtor in that case clearly intended to exempt the entire proceeds from the pending lawsuit, without limiting the claimed exemption to any dollar amount, the trustee was on notice that the exemption was impermissible and should have objected to it.  By contrast, in this case Reilly's claimed exemption of $10,718 was unobjectionable on its face because it was within the dollar amount she was authorized to claim as exempt.  Schwab reasonably interpreted Reilly's claimed exemption as being limited to the dollar amount she specified.  There was no indication that Reilly intended to claim an impermissibly high exemption, nor did Schwab think that the exemption could qualify her for an exemption of higher value than she actually specified.  Thus, Schwab reasonably viewed (and continues to view) Reilly's claimed exemption of $10,718 as unobjectionable.  But his failure to object to that exemption does not preclude him from arguing that the exemption should be limited to the dollar amount Reilly specified.

Schwab further argues that the Third Circuit's rule would be unworkable because most trustees lack the time or resources to investigate the estimated values for property claimed as exempt.  The rule would thus give debtors an incentive to undervalue assets and claim their full amount as exemptions: if the trustee did not object, then the debtor in bankruptcy would receive a windfall by insulating the entirety of the improperly undervalued assets from the claims of creditors.  A better rule would be to require the debtor to make a clear statement when he or she intends to claim the entire value of an asset, so that trustees are not surprised when debtors later get to keep assets with values that exceed their original estimates.

Respondent Reilly argues that when she listed the estimated value of her cooking equipment as $10,718 and then claimed an exemption in the same amount, she "unambiguously indicated her intent to claim the equipment as exempt in its entirety." Put another way, because she claimed an exemption for the full value of the property, she did not intend her exemption to cover only a partial interest in the property worth $10,718.  Her clear intent to keep the actual property, rather than exempting only a partial monetary interest in the property after it was auctioned off, is further reflected in the facts that she needed the cooking equipment to pursue her livelihood and regarded it as having special sentimental value.  Because Schwab did not timely object to the property being claimed as fully exempt, he cannot now lodge this objection.  To hold otherwise, according to Reilly, would be to create a major loophole and thereby eviscerate the concern for finality that is at the heart of the thirty-day objection period.

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