Bankruptcy exemptions are very important. They reflect one of the humane elements of bankruptcy: the fact that filing bankruptcy does not have to mean giving up all of your personal possessions.

Though bankruptcy filings are made under federal law, bankruptcy exemptions involve state law and vary by state. Claiming bankruptcy exemptions therefore involves both state and federal law.

In this two-part post, we will discuss a newly decided U.S. Supreme Court case that clarified the use of exemptions in a Chapter 7 bankruptcy.

The name of the case is Law v. Siegel. It concerned a man from California who filed for Chapter 7 bankruptcy. Chapter 7 is often thought of as a “liquidation” bankruptcy, in contrast to a “reorganization” bankruptcy under Chapter 13.

Even in a Chapter 7 bankruptcy, however, exemptions under state law still apply. And so, in Law v. Siegel, the man who filed for Chapter 7 sought to claim a homestead exemption under California law.

Under that exemption, a person filing for bankruptcy is allowed to keep up to $75,000 of the proceeds from the sale of a residence.

The case was made more complicated, though, by an issue concerning liens on the house. The man filing for bankruptcy contended there were two liens on the house and that those liens were greater than the nonexempt value of the house.

If that were the case, there would be no nonexempt proceeds left from the house to be applied to other creditors.

But the bankruptcy trustee asserted that one of the liens on the house was fraudulent. Ultimately, this led to the issue of whether the trustee was permitted to place a “surcharge” on the money from the homestead exemption because of the alleged fraud.

In part two of this post, we will discuss how the Supreme Court resolved the case.

Source: SCOTUSblog, “Opinion analysis: Justices stick with Bankruptcy Code text, rejecting Ninth Circuit’s creative punishment of lying bankrupt,” Fonald Mann, March 4, 2014