Cases Related to Bankruptcy

Close-up of a bankruptcy petition


Chemerinsky: What these 3 decisions tell us about SCOTUS inconsistency

By Erwin Chemerinsky

Sep 2, 2014, 08:30 am CDT

The justices on the Supreme Court often vocally disagree as to how federal statutes should be interpreted. Justice Antonin Scalia, for example, frequently expresses the view that the focus should be on the text itself and eschews any consideration of legislative history. By contrast, Justice Stephen G. Breyer stresses that a statute should be interpreted to carry out the purpose of the legislature that adopted it. What is striking, though, is that the Supreme Court is completely inconsistent, even in unanimous decisions, sometimes taking a textualist approach and sometimes a purposivist approach.

The three decisions about bankruptcy law from October Term 2013 are striking illustrations of this. All three rulings were unanimous, but the court’s approach to the bankruptcy statute could not have been more different.

Law v. Siegel involved the issue of whether a bankruptcy judge may sanction a dishonest debtor by denying an exemption provided in the statute. Under Section 522(d) of the Bankruptcy Code debtors may exempt certain property from liquidation and distribution during the bankruptcy, including a homestead exemption in California of up to $75,000.

Stephen Law filed for bankruptcy under Chapter 7 in 2004. He said that his house was valued at $363,348, but that there were two liens on it: a note and deed of trust for $147,156.52 in favor of Washington Mutual Bank, and a second note and deed of trust for $156,929.04 in favor of “Lin’s Mortgage & Associates.” Law thus represented that there was no equity in the house that could be recovered for his other creditors because the total of the two liens exceeded the house’s nonexempt value.

The trustee in bankruptcy, Alfred Siegel, did extensive work and established that the latter lien was entirely fictional. In 2009, the bankruptcy court concluded that “no person Lili Lin ever made a loan to [Law]” and that “the loan was a fiction, meant to preserve [Law’s] equity in his residence beyond what he was entitled to exempt.” The bankruptcy court concluded that Siegel had incurred more than $500,000 in attorney fees in establishing this fraud. The bankruptcy court held that Law should be denied his $75,000 homestead exemption with these funds going instead to help compensate Siegel for his fees. The Bankruptcy Appellate Panel and the 9th U.S. Circuit Court of Appeals affirmed.

The Supreme Court, in an opinion by Justice Scalia, unanimously reversed. The court emphasized the text of the statute, concluding that Section 522 “entitled Law to exempt $75,000 of equity in his home from the bankruptcy estate.” The court declared that the “bankruptcy court violated Section 522’s express terms when it ordered the $75,000 protected by Law’s homestead exemption be made available to pay Siegel’s attorney’s fees.”

This explicit emphasis on the text of the Bankruptcy Code is puzzling because in Marrama v. Citizens Bank, decided in 2007, the court held that bankruptcy judges had the inherent power to deal with fraudulent debtors, including the ability to deny them the ability convert from a liquidation under Chapter 7 to a reorganization under Chapter 13. Justice John Paul Stevens, writing for the court in a 5-4 decision, said that a bankruptcy judge could deny this conversion as a sanction for bad faith. The Supreme Court emphasized the importance of courts having the power to deal with fraudulent conduct. Justice Samuel A. Alito Jr. wrote the dissent, joined by Chief Justice John G. Roberts Jr. and Justices Scalia and Clarence Thomas, and emphasized that the text of the law gave debtors an “absolute right” to convert proceedings from Chapter 7 to Chapter 13.

In Law v. Siegel, Justice Scalia attempted to distinguish Marrama by saying that case did not provide bankruptcy courts the ability to “contravene express provisions of the code.” But in Marrama the court did exactly that in allowing the bankruptcy court to deny the dishonest debtor of the statutorily granted right to convert from Chapter 7 to Chapter 13.

Law v. Siegel’s emphasis on the text is also at odds with its approach in Clark v. Rameker, decided last term. Clark also involved the ability of a debtor in a Chapter 7 proceeding to claim an exemption. Section 522(b)(3)(c) creates an exemption and allows debtors to protect “retirement funds to the extent those funds are in a fund or account that is exempt from taxation.” This includes Individual Retirement Accounts (IRAs). The issue in Clark was whether this included an inherited IRA. Heidi Heffron-Clark had an IRA, and when she died it was left to her daughter. When her daughter filed for bankruptcy under Chapter 7 she attempted to exempt the IRA, which was worth about $300,000.

Under the literal terms of the statute, this should have been an easy case. The law creates an exemption for “retirement funds” that are “exempt from taxation.” An inherited IRA fits within this definition. But the Supreme Court, in an opinion by Justice Sonia Sotomayor, rejected this view and held that an inherited individual retirement account does not qualify as “retirement funds” within the meaning of the bankruptcy exemption.

Justice Sotomayor stressed that inherited retirement accounts do not fit within the purpose of the exemption and that they are different from retirement funds that a person saves for himself or herself. Under the statute, additional funds cannot be placed in an inherited account. Also, an inherited account may be spent without penalty and, in fact, must be spent within five years. These are persuasive reasons why inherited retirement accounts are different, but nothing in the statutory language draws this distinction.

The final bankruptcy case of the term, Executive Benefits Insurance Agency v. Arkison, also turned on a question of statutory interpretation. The Bankruptcy Act adopted in 1984 draws a basic distinction between “core” claims, which arise from the bankruptcy itself, and “non-core claims,” which augment or diminish the bankruptcy estate. Under the act, bankruptcy courts can issue final judgments over core claims, but may do so as to non-core claims only with consent of the parties.

In the 2011 decision Stern v. Marshall, the Supreme Court held that even as to core claims under the act, a bankruptcy court cannot issue a final judgment as to a state law claim unless it stems from the bankruptcy itself. In other words, Stern v. Marshall creates a third category of claims: there are core claims where the bankruptcy court case issue a final judgment, there are non-core claims where the bankruptcy court can issue a final judgment with the consent of the parties, and then there are Stern claims which are core claims, but under the Supreme Court’s decision the bankruptcy court cannot issue a final judgment. The court in Executive Benefits said that Stern claims are those “designated for final adjudication in the bankruptcy court as a statutory matter, but prohibited from proceeding in that way as a constitutional matter.”

The statute says nothing about this latter category because they were not envisioned. But the Supreme Court unanimously ruled that they should be treated the same as non-core claims under the act. Justice Thomas, writing for the court, emphasized the severability provision in the act. But the severability provision says that if a provision of the law is declared unconstitutional, the rest of the statute should remain in effect. That does not speak to how to deal with a type of claim not addressed in the statute at all. It is not possible to reconcile the court’s approach with its emphasis on textualism in cases such as Law v. Siegel.

In Executive Benefits, the court did not decide the question presented of whether the bankruptcy court can issue a final judgment over state law claims with consent of the parties. On July 1, the court granted review in another case for next term, Wellness International Network Ltd. v. Shariff, which again raises the question of whether bankruptcy courts can issue final judgments over state law claims with consent of the parties.

In conclusion, the three bankruptcy decisions from last term—Law v. Siegel, Clark v. Rameker and Executive Benefits v. Arkison—will have great practical significance. All come to reasonable conclusions. But they are markedly inconsistent in their approach to interpreting the bankruptcy act and to statutory interpretation more generally.

Erwin Chemerinsky, Dean and Distinguished Professor of Law, and Raymond Pryke Professor of First Amendment Law at the University of California, Irvine School of Law, is one of the nation’s top experts in constitutional law, federal practice, civil rights and civil liberties, and appellate litigation. He is the author of seven books, the latest being The Conservative Assault on the Constitution (Simon & Schuster, 2010). His casebook, Constitutional Law, is one of the most widely read law textbooks in the country. Chemerinsky has also written nearly 200 law review articles in journals such as the Harvard Law Review, Michigan Law Review, Northwestern Law Review, University of Pennsylvania Law Review, Stanford Law Review and Yale Law Journal. He frequently argues appellate cases, including matters before the U.S. Supreme Court and the U.S. Court of Appeal, and regularly serves as a commentator on legal issues for national and local media. He holds a J.D. from Harvard Law School and a B.S. from Northwestern University.