On March 4, 2014, the U.S. Supreme Court issued an opinion dealing with whether a bankruptcy court can seize exempt assets from a person who has committed fraud during the course of a Chapter 7 bankruptcy case. The decision has important implications for future bankruptcy cases.

Fraudulent lien claimed in Chapter 7 case

The case stems from a Chapter 7 bankruptcy case. When the man filed the bankruptcy petition, he listed his home as his only major asset, valued at over $363,000. He claimed that there were two liens on the home, which far exceeded the value of the house that was not covered by the state's $75,000 homestead exemption. As such, the man argued that there was no equity in the home to give to creditors.

After some investigation, the trustee discovered that one of the liens on the house, held by "Lin's Mortgage & Associates" for over $156,000, was fraudulent. The trustee spoke with a woman named Lili Lin, who told him that the bankruptcy filer had on multiple occasions tried to involve her in scams dealing with transactions involving a deed of trust. The trustee found that the bankruptcy filer had forged documents to create the lien. The trustee ultimately incurred over $500,000 in legal fees while the bankruptcy filer and the trustee fought about the avoidance of the deed and the trustee's sale of the house.

The bankruptcy court issued an order allowing the trustee to "surcharge" all of the $75,000 the bankruptcy filer received from the sale of his home under the homestead exemption to help offset the trustee's legal fees. The court noted that the Section 105 of the Bankruptcy Code allowed the court to "issue any order ... that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]," and reasoned that this section gave the court the authority to take the $75,000. The appellate court later affirmed the lower court's order.

Impermissible bankruptcy court order

The U.S. Supreme Court reversed the decision of the lower courts, however. The Supreme Court said that Section 105 cannot be used to directly contradict another provision of the Bankruptcy Code. The Court said that Section 522(k) explicitly forbids using exempt assets to pay administrative expenses. By admitting the $75,000 was exempt and then ordering it seized as a "surcharge," the lower court's order directly violated the Bankruptcy Code. The Court noted that the Bankruptcy Code is meticulous in detailing exemptions, and reasoned from it "that courts are not authorized to create additional exemptions." It also means that a court cannot withhold an exemption whenever it deems it appropriate.

The Court pointed out that there was other recourse for courts to punish fraud in bankruptcy cases. Federal law allows for criminal prosecution of those who commit fraud when filing bankruptcy.

Speak with an attorney

While some people may try to cheat while filing bankruptcy, many others inadvertently create problems for themselves while trying to file bankruptcy on their own. Some of those problems can even lead to a person's bankruptcy petition being dismissed and losing the possibility to re-file. Bankruptcy laws are complicated, and it is easy for people to get confused by them. If you are considering bankruptcy, seek the assistance of a skilled bankruptcy attorney who can help you proceed properly.