Court Opinion

ID: 4192957
Source: CourtListenerOpinion
Date Created: 2017-08-03 17:03:31.202187+00
Date Added: 2024-06-11T14:40:24.460044
License: Public Domain

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
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 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.

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 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.

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 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

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 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.”

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 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.
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