Even in Egregious Circumstances, Sanctions Cannot be Imposed in Contravention of a Statute

Law v. Siegel, ___ U.S. ___ (2014).  Outrageous behavior of a litigant deserves to be punished.  That is why provisions such as Federal Rule of Civil Procedure 11 and a comparable bankruptcy rule, Federal Rule of Bankruptcy Procedure 9011, among other remedies, permit a court to impose sanctions on wrondoing litigants.  However, as this bankruptcy law opinion by Justice Scalia makes clear, courts have no power to impose sanctions using a mechanism whose application contravenes a statute.

Law, the debtor, had misrepresented that his residence, a portion of whose value is exempted by section 522 of the Bankruptcy Code, from being included in the bankruptcy estate that may be distributed to creditors, was subject to two mortgage liens.  As Justice Scalia colorfully recounted, the Bankruptcy Court found that one of those liens was in fact non-existent, and that Law had perpetrated an elaborate scheme to fabricate the lien in an effort to induce the bankruptcy trustee, Siegel, not to pursue the non-exempt portion of the residence’s value for inclusion in the estate.  Siegel incurred hundreds of thousands of dollars in legal expenses to expose Law’s fraud.  Since Law had no other assets, Siegel then sought to surcharge the homestead exemption for some of the attorneys’ fees that Siegel had incurred.  The lower courts allowed that, with the Ninth Circuit approving because that result was “calculated to compensate the estate for the actual monetary costs imposed by the debtor’s misconduct, and was warranted to protect the integrity of the bankruptcy process.”  The Supreme Court, however, unanimously reversed those rulings.

Section 522 of the Bankruptcy Code expressly granted the homestead exemption, and that exemption made the exempt value “not liable for payment of any administrative expense.”  The attorneys’ fees that the trustee sought were “administrative expenses,” as Justice Scalia demonstrated by “a short march through a few statutory cross-references.”  Neither the Bankruptcy Court’s sanction power conferred by section 105(a) of the Bankrutpcy Code nor the court’s inherent power to impose sanctions permit a court to override the statutory command of section 522. 

Siegel offered some arguments in an effort to get around what seemed to be the plain import of section 522.  Justice Scalia swatted away each of those contentions with a close analysis of the Code.

The Court acknowledged that its result meant that the trustee had to shoulder the burden caused by Law’s fabrications, and that the Court’s ruling might produce “inequitable results for trustees and creditors in other cases.”  Those types of considerations likely underlay the lower courts’ rulings tha required Law to pay for his own wrongdoing.  But “Congress balanced the difficult choices that exemption limits impose on debtors with the economic harm that exemptions visit on creditors.”  The courts are not free to alter that balance.  There are other ways to deter debtor misconduct.  These include denying a discharge in bankruptcy, imposing sanctions under Bankruptcy Rule 9011 or the court’s inherent powers, or even a potential criminal prosecution.  But a bankruptcy court cannot “contravene express provisions of the Bankruptcy Code by ordering that the debtor’s exempt property be used to pay debts and expenses for which that property is not liable under the Code.”