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Argument recap: Justices find little sympathy for lying bankrupt

My preview suggested that Monday’s argument in Law v. Siegel would present the Justices a straightforward choice between providing a routine application of the Bankruptcy Code’s text to reverse the Ninth Circuit, on the one hand, or responding to a visceral distaste for the misconduct of a bankrupt, on the other.  The argument suggests that most of the Justices are coming down pretty hard on the latter side, though it is not at all clear what they will manage to say about the statute to justify that outcome.

The case involves a bankrupt (Law) who tried to keep money from his creditors when he filed for bankruptcy by claiming that his home was subject to a fictional lien.  Because of Law’s taste for litigation, the trustee in the bankruptcy proceeding (Siegel) spent several hundred thousand dollars proving that Law’s claim was wholly fabricated. Unfortunately for the trustee, his costs are an administrative expense, payable out of the assets of the estate, and the principal asset in the estate is Law’s $75,000 share of the proceeds of the sale of his house – his homestead exemption.

Although the Code states explicitly that exempt property cannot be used to pay administrative expenses, the Ninth Circuit held that it was appropriate to “surcharge” Law’s exemption to pay those expenses, relying on the general grant in Section 105 of power to issue orders “appropriate to carry out” the provisions of the Code.

Matthew Hellman for the debtor started his argument in a pedestrian manner, summarizing the policy behind exemptions, ensuring that debtors can leave the bankruptcy process with sufficient assets to keep them from becoming “wards of the State.”  Though Hellman doubtless was thinking of (and hoping to conjure) Dickensian images of debtors’ prisons and workhouses, he struck a raw nerve with Justice Alito, who was by his own account “taken aback” by the suggestion that somebody with $75,000 would be a ward of the State.  When Hellman emphasized that this was “his last $75,000,” Justice Alito asked if Hellman knew the median net worth of a household in the United States.  When Hellman professed ignorance, Justice Alito explained that the median is below $75,000, “[s]o the question here is not whether he’s going to be a ward of the State. The question is whether he’s going to be above the median in his assets.”

And it didn’t get any better.  When Justice Alito paused to take a breath, Justice Ginsburg started to pound Hellman for his statement that “every penny – all of Mr. Law’s creditors in this case have been paid off.”  What about the trustee and the money he spent? When Law started to explain (accurately) that the consumer bankruptcy system works on the premise that trustees will make cost-effective decisions about how to pursue funds for the estate, Justice Alito scoffingly interjected – “What was the trustee supposed to do? * * * I better stop, because otherwise I’m going to be working free.”

Finally turning the argument to the law, Justice Sotomayor entered the fray to suggest that she found it hard to believe that the inherent power of courts was not sufficient to remedy such blatantly abusive conduct. Law then started to explain his doctrinal view that the sanctioning power has not traditionally been used to circumvent specific grants of authority in the Code.  As the discussion made clear the implications of Law’s position, Justice Kennedy asked with some incredulity if Hellman really meant to suggest that the trustee had no way of getting paid: “There is nothing the bankruptcy trustee can do to make the bankruptcy estate whole?”

Hellman’s next tack was to summarize the structure of the Bankruptcy Code’s penalties, suggesting that Law already had gotten the Code’s worst sanction – a denial of discharge that is “essentially the death penalty” for debtors (possibly a quotation of the preview of the argument on this blog).

At that point, Justice Breyer tried to throw Hellman a lifeline, suggesting that Hellman’s position resembled the traditional exemption for retirement funds (presumably a topic familiar to the Justices from the recently granted Rameker case). Hellman quickly embraced that suggestion and tried to weave back to his argument, but Justice Sotomayor was having none of that.  She wanted to know whether Law could just keep the money free and clear forever.  When Hellman explained that under California law he had to reinvest the money in a home within six months, she seemed unimpressed, doubting that the law could be the same in “every other State.”

When the Chief Justice weighed in to suggest that the problem with this case is that the “terrible sanction [Hellman describes] doesn’t mean a thing to him, does it,” vote counters in the courtroom would have concluded that a majority of the Justices were set strongly against Law. Probing Hellman carefully, he seemed outraged by the possibility that the trustee’s firm would be stuck with bearing the costs of uncovering Law’s fraud while Law would take $75,000 from the bankruptcy.

At that point, the rest of the argument (including the appearances by Neal Katyal for the trustee Siegel and Sarah Harrington for the Solicitor General) became a lengthy effort, spearheaded for the most part by Justice Kagan, to figure out some way to read the Bankruptcy Code to reach the result so many of the Justices plainly favor.  There is strong precedent for this; in the 2007 decision in Marrama v. Citizens Bank of Massachusetts, the Court dealt with a similar problem and offered a highly creative (not to say fabricated) reading of the statute to justify the conclusion that would prevent a debtor from converting his Chapter 7 case to Chapter 13 in bad faith.  Interestingly enough (given the comments of Alito and the Chief Justice on Monday), Justice Alito wrote the “plain language” dissent from that decision, joined by the Chief Justice and Justices Scalia and Thomas. In this argument, only Justice Breyer seemed to have any sympathy for Hellman’s presentation.

When the Justices retreat to consider this case in Conference, there is of course every possibility that they will find themselves so constrained by the relatively plain language of the Bankruptcy Code that they will rule in favor of Law despite their abhorrence of the outcome.  But I wouldn’t bet on it.

Cases: Law v. Siegel

Recommended Citation: Ronald Mann, Argument recap: Justices find little sympathy for lying bankrupt, SCOTUSblog (Jan. 15, 2014, 12:28 PM),