Federal Judiciary

Does the debtor call the shots?

By Akin Gump Supreme Court Practice Group

The Supreme Court, taking on a new case on debtors’ rights, agreed on Monday to decide whether an individual or firm can keep away from creditors her property that turns out to be worth more than the debtor thought when trying to protect it in bankruptcy. In a case involving a Pennsylvania woman who ran a catering business by herself, a trustee is urging the Court to rule that creditors are entitled to the amount that an item’s value exceeds what the debtor claimed, even if the trustee did not dispute that claim. 

The new case — Schwab, Trustee, v. Reilly (08-538) – requires the Justices to interpret their 1992 ruling in Taylor v. Freeland & Kronz. In that decision, the Court ruled that a bankruptcy trustee loses the chance to contest the value of an asset the debtor wants to keep if the trustee does not object within 30 days.

The Schwab case, raising issues that have divided lower courts, seeks clarification of whether the debtor gets to keep the full value of property, even after underestimating it with a specific dollar claim, and whether the trustee has to object within 30 days or lose the right to claim the excess value for creditors.  The Court granted review of those two issues, but declined to hear a claim that the Third Circuit Court acted unconstitutionally in supposedly creating “new trustee duties” and authorizing ”unlimited ’in kind’ exemptions” of a debtor’s property.

The case involves Nadejda Reilly, a cook who ran a catering business in northeast Pennsylvania.  She filed for bankruptcy under Chapter 7 in 2005.  Her parents had bought the utensils and other cooking equipment she had used, and she said it thus had “sentimental value” for her.  She claimed it as exempt from distribution to creditors — $1,850 as the value of the items as tools of her trade plus $8,868 as miscellaneous property she wanted to retain — a total of $10,718.

The bankruptcy trustee, William G. Schwab, did not object within the 30 days allowed by law.  The trustee insisted that no objection was necessary, because he was not objecting to Reilly keeping the value as she had claimed it.  An appraisal showed that the property was actually worth $17,200, so the trustee asked the bankruptcy judge for permission to sell the property, leaving Reilly with what she had claimed, but distributing the rest to creditors.

The courts ruled that the property was fully exempt, because that is what Reilly intended to claim, even though she underestimated its value.  Because the trustee did not object within 30 days, Reilly was entitled to keep the property at its full value, the courts held.   The Third Circuit Court ruled that the result was controlled by the Supreme Court’s Taylor decision.

Taking the case on to the Supreme Court, Trustee Schwab argued that the 30-day objection rule only applies to the dollar amount that a debtor claims for supposedly exempt property.  If the Third Circuit approach stands, the petition contended, trustees will have to object to again exemption properly claimed by a debtor, or else seek a court-ordered extension of time to object, thus adding new burdens on managing bankrupts’ estates,

“The importance and breadth of the issue and the number of times it arises are reflected in the number and variety of recent lower court decisions of all levels on this case,” Schwab asserted.  His petition also argued that the bankruptcy law speaks in terms of dollar values of exempted property, not of an “in kind” valuation that the debtor intends to claim even while not claiming it specifically.

 The petition was supported by the National Association of Bankruptcy Trustees, contending that debtors should be held to the dollar claims that they enter on their exempt schedules of property.

The case will be heard and decided in the Court Term starting Oct. 5.

Full post as published by SCOTUSBLOG on April 27, 2009 (boomark / email).