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Bankruptcy exemptions and fraud, part 2: Supreme Court ruling

In the first part of this post, we began discussing the importance of bankruptcy exemptions.

As we noted, exemptions may be available under state law for certain types of property. As a result, even in a Chapter 7 bankruptcy, a person who files for bankruptcy may be able to keep certain types of property - rather than having it taken by the bankruptcy trustee so that the proceeds from a sale can go to creditors.

In this part of the post, we will discuss the result of a recent U.S. Supreme Court case in which a person who sought to make use of the homestead exemption under his state's law was accused of placing a fraudulent lien on the property.

The debtor apparently placed this fraudulent lien in order to keep money from creditors.

The debtor went to elaborate lengths to create and defend this lien. This included devising an identity for a fictitious lien holder and aggressively filing questionable pleadings in that lien holder's name.

As a result of these dubious tactics, the bankruptcy trustee ended up having to spend more than $200,000 in legal fees in order to show that the lien in question was false.

The trustee then asserted that, because the debtor had engaged in such an elaborate lie, a surcharge would be imposed on the debtor. The surcharge was on the proceeds from sale of the residence, which would otherwise have been exempt from creditors under the homestead exemption.

A federal appeals court found that this tactic by the trustee was permissible. But the U.S. Supreme Court reversed in a unanimous decision.

The Supreme Court held that such surcharges are counter to the plain language of the bankruptcy code. That language, the Court said, does not grant bankruptcy courts the authority to use property covered by a bankruptcy exemption to cover administrative expenses -- even in a case where the debtor has engaged in fraudulent conduct.

Source: SCOTUSblog, "Opinion analysis: Justices stick with Bankruptcy Code text, rejecting Ninth Circuit's creative punishment of lying bankrupty," Ronald Mann, March 4, 2014

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