In re: Ian Nehemiah Gray and Cynthia Jackson Gray

• Court: United States Bankruptcy Appellate Panel for the Ninth Circuit
• Decided: December 9, 2014
• Docket: AZ-13-1502-JuKiD
• Status: Published

Opinion

FILED 1 ORDERED PUBLISHED DEC 09 2014

2 SUSAN M. SPRAUL, CLERK U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT 3 UNITED STATES BANKRUPTCY APPELLATE PANEL 4 OF THE NINTH CIRCUIT 5 6 In re: ) BAP No. AZ-13-1502-JuKiD ) 7 IAN NEHEMIAH GRAY and CYNTHIA ) Bk. No. 3:13-bk-8071-MCW JACKSON GRAY, ) 8 ) Debtors. ) 9 ______________________________) ) 10 IAN NEHEMIAH GRAY; CYNTHIA ) JACKSON GRAY, ) 11 ) Appellants, ) 12 v. ) O P I N I O N ) 13 LAWRENCE J. WARFIELD, ) Chapter 7 Trustee, ) 14 ) Appellee. ) 15 ______________________________) 16 Argued and Submitted on November 20, 2014 17 at Phoenix, Arizona 18 Filed - December 9, 2014 19 Appeal from the United States Bankruptcy Court for the District of Arizona 20 Honorable Randolph J. Haines, Chief Bankruptcy Judge, Presiding 21 ________________________ 22 Appearances: Kenneth L. Neeley, Esq. for appellants Ian Nehemiah Gray and Cynthia Jackson Gray; 23 Terry A. Dake, Esq. for Lawrence J. Warfield, Chapter 7 Trustee. 24 ________________________ 25 Before: JURY, KIRSCHER, and DUNN, Bankruptcy Judges. 26 27 28 1 JURY, Bankruptcy Judge: 2 3 Chapter 7 debtors1 Ian and Cynthia Gray appeal from the 4 bankruptcy court’s order sustaining the chapter 7 trustee’s 5 objection to an amended exemption on the grounds of bad faith. 6 Because the Supreme Court in Law v. Siegel, 134 S. Ct. 1188 7 (2014), determined that bankruptcy courts have no discretion 8 either to disallow amended exemptions or to deny leave to amend 9 exemptions based on equitable grounds not specified in the 10 Bankruptcy Code, we VACATE and REMAND. 11 I. FACTS 12 Ian and Cynthia Gray (Debtors) filed their chapter 7 13 petition and schedules on May 14, 2013. The schedules did not 14 list as an asset or claim as exempt any prepaid rent. At the 15 § 341(a) meeting of creditors on June 24, 2013, the chapter 7 16 trustee (Trustee) questioned Debtors about the payment of 17 $2,707.00 made to their landlord on March 11, 2013. Debtors 18 testified that the payment was a prepayment of rent for April, 19 May, and June of 2013. On July 8, 2013, Trustee demanded 20 turnover of $900.00 for the prepayment of the post-petition rent 21 due for June 2013 (the June Prepaid Rent). Debtors responded by 22 amending schedules B and C to respectively list as an asset and 23 claim an exemption (the Amended Exemption) in the June Prepaid 24 Rent. Because Debtors did not claim a homestead exemption, they 25 26 1 Unless otherwise indicated, all chapter and section 27 references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and “Rule” references are to the Federal Rules of Bankruptcy 28 Procedure.

-2- 1 were permitted to claim as exempt “prepaid rent, including 2 security deposits . . . not exceeding the lesser of one thousand 3 dollars or one and one-half months’ rent.” Ariz. Rev. Stat. 4 Ann. § 33-1126(C).2 5 On July 9, 2013, Trustee filed an objection to the Amended 6 Exemption and argued that Debtors’ initial failure to disclose 7 the asset constituted grounds for the denial of the exemption. 8 Debtors filed their response on July 10, 2013, arguing that 9 under Rule 1009(a) amendments to their schedules should be 10 allowed as a matter of course because Debtors’ failure to 11 disclose did not amount to bad faith and Trustee failed to show 12 prejudice to creditors. 13 After oral arguments from both parties, the bankruptcy 14 court issued its order sustaining the objection on September 16, 15 2013. Without holding an evidentiary hearing, the bankruptcy 16 court disallowed the Amended Exemption because Debtors acted in 17 bad faith and intentionally concealed the June Prepaid Rent. 18 Debtors filed a timely notice of appeal. 19 II. JURISDICTION 20 The bankruptcy court had jurisdiction over this proceeding 21 under 28 U.S.C. §§ 1334 and 157(b)(2)(A) and (B). We have 22 jurisdiction under 28 U.S.C. § 158. 23 III. ISSUE 24 1. Whether the bankruptcy court has discretion either to 25 disallow the Amended Exemption or to deny leave to amend an 26 27 2 This reflects a prior version of Ariz. Rev. Stat. Ann. § 33-1126(C), effective from July 20, 2011 to September 12, 28 2013.

-3- 1 exemption based on a finding of bad faith; and 2 2. Whether the bankruptcy court abused its discretion in 3 deciding not to conduct an evidentiary hearing. 4 IV. STANDARD OF REVIEW 5 Questions of law are subject to de novo review. United 6 States v. Lang, 149 F.3d 1044, 1046 (9th Cir. 1998). Questions 7 of fact are reviewed under the clearly erroneous standard. 8 Pullman-Standard v. Swint, 456 U.S. 273, 287 (1982). 9 The bankruptcy court’s decision not to conduct an 10 evidentiary hearing is reviewed for abuse of discretion. 11 Khachikyan v. Hahn (In re Khachikyan), 335 B.R. 121, 128 (9th 12 Cir. BAP 2005). 13 The bankruptcy court abuses its discretion when it applies 14 the incorrect legal rule or when its application of the law to 15 the facts is: (1) illogical; (2) implausible; or (3) without 16 support in inferences that may be drawn from the facts in the 17 record. United States v. Hinkson, 585 F.3d 1247, 1263 (9th Cir. 18 2009) (en banc). 19 V. DISCUSSION 20 A. The Ninth Circuit Standard Before Law v. Siegel. 21 The briefs before the Panel and the pleadings filed with 22 the bankruptcy court identify two issues: whether the Amended 23 Exemption is allowed under § 522 and whether Debtors may amend 24 under Rule 1009(a) to claim the June Prepaid Rent as exempt. 25 Martinson v. Michael (In re Michael), 163 F.3d 526, 529 (9th 26 Cir. 1998) (“Whether the [debtors] could amend their schedules 27 post-petition is separate from the question whether the 28 exemption was allowable.”). Trustee relied on the asserted bad

-4- 1 faith of the Debtors to disallow the Amended Exemption of the 2 June Prepaid Rent under either theory. 3 The distinction is substantively meaningless: denying leave 4 to amend the exemption of property has the identical effect as 5 disallowing an amended exemption. In fact, even before the 6 Supreme Court in Law v. Siegel made the distinction 7 insignificant, Ninth Circuit case law had evolved such that the 8 judge-made exceptions used to bar amendments under Rule 1009(a) 9 were also used as grounds to disallow amended exemptions. 10 A claimed exemption is presumptively valid. Gonzalez v. 11 Davis (In re Davis), 323 B.R. 732, 743 (9th Cir. BAP 2005). 12 Rule 1009(a) gives debtors the right to amend any list, 13 schedule, or statement “as a matter of course at any time before 14 the case is closed” and without court approval. Michael, 163 15 F.3d at 529. The right to amend includes the right to amend the 16 list of exempt property. Goswami v. MTC Distrib. (In re 17 Goswami), 304 B.R. 386, 393 (9th Cir. BAP 2003). 18 Notwithstanding the unqualified and permissive language of 19 Rule 1009(a), courts used judicially created exceptions to limit 20 the right to amend without analyzing whether courts had the 21 statutory authority to do so. The Eleventh Circuit in Doan v. 22 Hudgins (In re Doan), 672 F.2d 831, 833 (11th Cir. 1982), first 23 recognized that bankruptcy courts had discretion to deny leave 24 to amend on a showing of either debtor’s bad faith or prejudice 25 to creditors based on its reading of Rule 1103 (incorporated in 26 27 3 Rule 110 stated that “(a) voluntary petition, schedule or statement of affairs may be amended as a matter of course at any 28 (continued...)

-5- 1 present Rule 1009(a)). Likewise, the Ninth Circuit adopted the 2 equitable exceptions set forth in Doan without citing a specific 3 statutory provision in the Bankruptcy Code. Michael, 163 F.3d 4 at 529. 5 Bankruptcy courts subsequently used the same equitable 6 considerations as grounds to disallow amended exemptions. In 7 Magallanes v. Williams (In re Magallanes), 96 B.R. 253 (9th Cir. 8 BAP 1988), the bankruptcy court sustained the chapter 7 9 trustee’s objection to amended exemptions claimed in a converted 10 chapter 7 case. In adopting the test articulated in Doan, the 11 Panel found that bankruptcy courts do not have discretion to 12 disallow amended exemptions unless the amendment either was done 13 in bad faith or caused prejudice to third parties. Id. at 256; 14 Arnold v. Gill (In re Arnold), 252 B.R. 778, 784 (9th Cir. BAP 15 2000). 16 Therefore, prior to Law v. Siegel, Ninth Circuit cases had 17 used the bad faith of debtors both to deny leave to amend 18 exemptions and to disallow an amended exemption. The bankruptcy 19 court here relied on this precedent to disallow the Amended 20 Exemption. 21 B. The Supreme Court in Law v. Siegel Discredited the Use of 22 Equitable Principles to Disallow Exemptions Under Federal Law. 23 In Law v. Siegel, 134 S. Ct. 1188 (2014), the Supreme Court 24 held that the bankruptcy court exceeded both its statutory 25 authority and inherent powers when it ordered that the funds 26 protected by the debtor’s homestead exemption be surcharged to 27 3 (...continued) 28 time before the case is closed.”

-6- 1 pay administrative expenses. In the bankruptcy proceeding, the 2 debtor had created and perpetuated a false trust deed against 3 his home to protect any equity from administration by the 4 chapter 7 trustee. Id. at 1193. Eventually the chapter 7 5 trustee invalidated the trust deed, and the bankruptcy court 6 granted the chapter 7 trustee’s motion to surcharge the debtor’s 7 homestead exemption to offset the very high administrative costs 8 incurred in overcoming the debtor’s fraudulent 9 misrepresentations. Id. 10 The Supreme Court ruled that the debtor was entitled to 11 exempt the equity in his home under § 522 and California 12 exemption law, and the exempted funds were deemed “not liable 13 for payment of any administrative expense” under § 522(k). Id. 14 at 1195. Because the attorney’s fees incurred by the chapter 7 15 trustee qualified as an administrative expense, the bankruptcy 16 court’s surcharge violated the express terms of § 522. Id. 17 Albeit in dicta, the Supreme Court found no equitable power 18 in the bankruptcy court to deny an exemption as a remedy to 19 debtor’s bad faith conduct, Id. at 1196-97, and in so 20 doing, implies that the judge-made exceptions of Michael do not 21 survive Law v. Siegel. 22 The Supreme Court discerned no practical difference between 23 disallowing an exemption and denying the debtor the right to 24 amend an exemption: the Bankruptcy Code does not grant 25 bankruptcy courts the “authority to disallow an exemption (or to 26 bar a debtor from amending his schedules to claim an exemption, 27 which is much the same thing)” based on a debtor’s misconduct. 28 Id. at 1196. The Supreme Court explicitly rejected the chapter

-7- 1 7 trustee’s argument that Doan and other like cases reflect a 2 general, equitable power in the bankruptcy courts. Id. Since 3 the Ninth Circuit in Michael adopted the exceptions of bad faith 4 and prejudice articulated in Doan, the effective abrogation of 5 Doan necessarily extends to the use of these equitable grounds 6 in Michael. In re Arellano, 517 B.R. 228, 232 (Bankr. S.D. Cal. 7 2014) (finding that at least as to the bad faith and prejudice 8 exceptions, Michael is effectively abrogated). 9 Supreme Court dicta is not to be taken lightly, and we must 10 consider the rationale behind the holding, if sufficiently 11 persuasive. Cnty. of Allegheny v. Am. Civil Liberties Union 12 Greater Pittsburgh Chapter, 492 U.S. 573, 668 (1989) (Kennedy, 13 J., concurring in judgment in part and dissenting in part) (“As 14 a general rule, the principle of stare decisis directs us to 15 adhere not only to the holdings of our prior cases, but also 16 their explications of the governing rules of law.”). The 17 Supreme Court’s definitive position that the Bankruptcy Code 18 does not grant bankruptcy courts “a general, equitable 19 power . . . to deny exemptions based on a debtor’s bad-faith 20 conduct” is clearly irreconcilable with the use of judicially 21 created remedies either to bar amendments or to disallow amended 22 exemptions. Law, 134 S. Ct. at 1196; Miller v. Gammie, 335 F.3d 23 889, 893 (9th Cir. 2003) (holding prior circuit authority is 24 effectively overruled where its reasoning or theory is clearly 25 irreconcilable with the reasoning or theory of a higher 26 authority). 27 Courts have long recognized that without the judge-made 28 exceptions of Michael, bankruptcy courts have no discretion to

-8- 1 disallow amended exemptions. Magallanes, 96 B.R. at 256; 2 Arnold, 252 B.R. at 784. Had debtor’s entitlement to the 3 exemption been at issue in Law v. Siegel, the Supreme Court 4 dicta leaves no room to doubt how it would have ruled: “§ 522 5 does not give courts discretion to grant or withhold exemptions 6 based on whatever considerations they deem appropriate.” Law, 7 134 S. Ct. at 1196. The Supreme Court noted that sole 8 discretion to invoke an exemption vests in the debtor, not the 9 bankruptcy court, and observed that the bankruptcy court “may 10 not refuse to honor the exemption absent a valid statutory basis 11 for doing so.” Id. 12 Here, but for the allegation of bad faith, the Amended 13 Exemption is presumptively valid. Arizona opted out of the 14 federal exemptions provided by the Bankruptcy Code. Ariz. Rev. 15 Stat. Ann. § 33-1133(B). Debtors are entitled to exempt the 16 $900.00 of prepaid rent under Ariz. Rev. Stat. Ann. 17 § 33-1126(C). Moreover, Trustee did not challenge the legal 18 sufficiency of the Amended Exemption. 19 Thus, Law v. Siegel mandates the conclusion that the 20 bankruptcy court is without federal authority to disallow the 21 Amended Exemption or to deny leave to amend exemptions based on 22 Debtors’ bad faith. Law v. Siegel does recognize that when a 23 debtor claims an exemption created under state law, the scope of 24 the exemption is determined under state law which “may provide 25 that certain types of debtor misconduct warrant denial of the 26 exemption.” Law, 134 S.Ct. at 1196-97. It does not appear that 27 Arizona exemption law was considered in determining whether the 28 Amended Exemption could be disallowed based on the Debtors’

-9- 1 conduct. Accordingly, the matter is remanded to give the 2 bankruptcy court the opportunity to determine whether under 3 Arizona law equitable considerations may be used to disallow 4 exemptions. 5 C. The Issue of Whether the Bankruptcy Court Abused Its 6 Discretion by Not Holding an Evidentiary Hearing Is Moot. 7 Because under federal law the bankruptcy court has neither 8 the discretion to disallow amended exemptions nor deny leave to 9 amend based on equitable grounds not specified in the Bankruptcy 10 Code, we need not address this issue. 11 VI. CONCLUSION 12 For the reasons stated above, we VACATE and REMAND for 13 further proceedings consistent with this opinion. 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

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