Bankruptcy Court’s Equitable Powers Not Unlimited

Lest we forget, the U.S. Supreme Court recently reminds us that Bankruptcy Courts, unlike other federal courts, are courts of equity and law; however, while bankruptcy judges have a great deal of discretion to carry out the philosophy and purpose of the Bankruptcy Code, that power is constrained.

In Law v. Siegel, the Supreme Court examined whether a bankruptcy court exceeded its authority under section 105(a) of the Bankruptcy Code and its inherent powers by authorizing the chapter 7 trustee to “surcharge” the debtor’s homestead exemption to defray litigation costs incurred in an adversary proceeding brought against the debtor. Section 105(a) permits a bankruptcy court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions” of the Bankruptcy Code.

The debtor listed his house as exempt and encumbered by two liens and, therefore, represented that there was no non-exempt value in the house and it was of no economic benefit to the bankruptcy estate. The trustee objected, alleging that one of the asserted liens was a sham, won, and, in doing so, incurred over $500,000 in legal fees. The trustee moved to surcharge the homestead exemption to pay these fees. The bankruptcy court permitted the surcharge and was affirmed on appeal. However, the Supreme Court was not so inclined to permit the surcharge.

Justice Scalia, writing for a unanimous Supreme Court, reinforced that “in exercising [its authority under section 105] and inherent powers, a bankruptcy court may not contravene specific statutory provisions.” In the context of exemptions, the Bankruptcy Code plainly states that exempt property “is not liable” for the payment of “any administrative expense” (see 11 U.S.C. § 522(k)). The Court held that the bankruptcy court’s surcharging the debtor’s exemption ran afoul of the prohibition stated in section 522(k), as the trustee’s attorney’s fees were “indubitably an administrative expense.” The Court also observed that the “carefully calibrated exceptions and limitations” to the exemption statute are further proof that the courts do not have discretion to disturb a debtor’s exemption based on other equitable considerations.

The decision acts as a reminder that a bankruptcy court’s discretionary authority to act is not unlimited, particularly when constitutes taking action which is prohibited by the Bankruptcy Code. In so holding, the Supreme Court, revisited its decision in Marrama v. Citizens Bank (2007). In Marrama, the Supreme Court held that a bankruptcy court had inherent equitable powers that did not depend on section 105(a) and rejected the argument that a bankruptcy court’s equitable powers were confined by specific provisions of the Bankruptcy Code. While Law does not directly overrule Marrama, it recharacterizes Marrama’s equity analysis, labeling it as mere “dictum” and holds that a bankruptcy court’s inherent non-section 105 equitable power are limited to those which it “may also possess” (emphasis supplied).

What lesson is learned from all of this? Bankruptcy court’s have neither the inherent nor statutory equitable power to contravene specific provisions of the Bankruptcy Code. Bankruptcy Courts, non-Article III courts, are once again reminded of their place and that section 105(a) is not a broad mandate of equitable authority for the purpose of seeking or providing relief that contravenes the letter of the Bankruptcy Code.