Schwab v. Reilly (08-538)

Oral argument: Nov. 3, 2009

Appealed from: United States Court of Appeals for the Third Circuit (July 21, 2008)

BANKRUPTCY, CHAPTER 7, SCHEDULE C, EXEMPTIONS, “IN KIND” EXEMPTION

In 2005, Nadejda Reilly filed a Chapter 7 bankruptcy petition. On the petition she listed her business property as an exemption, demonstrating her intent to retain the entire property by declaring the property’s exemption amount to be equal to her estimation of the asset’s value. The bankruptcy trustee assigned to the case, William Schwab, did not object to Reilly’s exemption but later determined the business property had a higher value than Reilly’s estimation and sought to sell the property to recoup the difference. Reilly argued that Schwab’s failure to object within the thirty-day statutory period rendered the property exempt. Schwab countered that Reilly’s exemption was limited to the specific amount claimed and did not serve to fully exempt the property from distribution. Schwab also argued that the objection deadline applied only to the type of property claimed as exempt, not to the value. The United States Court of Appeals, Third Circuit disagreed, holding that Schwab was on notice that Reilly intended to fully exempt the property and failure to object in time rendered the property exempt. The U.S. Supreme Court’s decision will determine whether a debtor in a Chapter 7 proceeding successfully claimed a full exemption in an asset by declaring that the exemption value equals the asset’s value, and whether the thirty-day objection period applies.

·      [Question(s) presented]

·      [Issue(s)]

·      [Facts]

·      [Discussion]

·      [Analysis]

Questions presented

1. When a debtor claims an exemption using a specific dollar amount that is equal to the value placed on the asset by the debtor, is the exemption limited to the specific amount claimed, or do the numbers being equal operate to "fully exempt" the asset, regardless of its true value? 

2. When a debtor claims an exemption using a specific dollar amount that is equal to the value placed on the asset by the debtor, must a trustee who wishes to sell the asset object to the exemptions within the thirty day period of Rule 4003, even though the amount claimed as exempt and the type of property are within the exemption statute?

top

Issues

Whether a debtor undergoing Chapter 7 Bankruptcy proceedings has successfully claimed an “in kind” exemption in an asset by declaring that he or she would like to claim a monetary amount that equals his or her estimation of the asset’s value .

top

Facts

In a Chapter 7 filing, a debtor is allowed to claim certain items exempt from creditor collection. See 11 U.S.C. § 522. The claimed exemption at issue in this case deals with two types of exemptions. The first type allows a debtor to exempt certain types of property, but only allows the debtor to retain up to a certain statutorily defined monetary amount on the asset. See 11 U.S.C. § 522(d). The second type of exemption allows a debtor to claim an “in kind” exemption, which is not subjected to any monetary caps and allows a debtor to keep the entire property in tact. See id.

Respondent, Nadejda Reilly (“Reilly”), a cook with a one-person catering business, filed a Chapter 7 bankruptcy petition on April 21, 2005. See Schwab v. Reilly, 534 F.3d 173, 174 (3d Cir. 2008). Under Schedule B in the petition, which asks for a list of all the debtor’s personal property, Reilly put down “business equipment” and valued the equipment at $10,718. See id. On her Schedule C, which allows a debtor to claim certain property exempt from the bankruptcy, Reilly again listed “business equipment” also valued at $10,718, under the debtor’s tools of trade exemption. See id.

The bankruptcy trustee assigned to the case, Petitioner, William Schwab (“Schwab”) did not object to the exemption taken by Reilly on her Schedule C within the thirty-day timeframe required by the Federal Rule of Bankruptcy Procedure. See Schwab, 534 F.3d at 174. After the deadline passed, Schwab appraised Reilly’s business equipment and determined that it actually had a value of $17,200. See id. Schwab then filed a motion seeking to sell the business equipment, in order to recover the difference between the $10,718 exemption and the $17,200 value, based on the argument that Reilly did not file the equipment as an “in kind” exemption and therefore was only entitled up to $10,718. See id. In response, Reilly filed an answer claiming that the equipment was fully exempt, based on the argument that Schwab needed to and did not file a timely objection. See id. 

The Bankruptcy Court for the Middle District of Pennsylvania agreed with Reilly and denied Schwab’s motion to sell the business equipment, stating that Schwab needed to object and the property was fully exempt because the deadline had expired. See Schwab, 534 F.3d at 174. The District Court for the Middle District of Pennsylvania denied Schwab’s appeal, finding that Reilly demonstrated her intent that the entire business property be fully exempt when she listed the $10,718 amount for both the value of the asset and the amount of the exemption. See id. The United States Court of Appeals, Third Circuit affirmed the district court’s decision, holding that Schwab was on notice when Reilly demonstrated her intent to fully exempt the property by claiming an identical number for the property value and the exemption value. See id. at 178. The court decided that Taylor v. Freeland applied so that Schwab’s failure to object in time meant Schwab forfeited any right he had to challenge the exemption. See Taylor v. Freeland at 642. The United States Supreme Court granted certiorari on April 27, 2009. See Schwab v. Reilly, No. 08-538 (U.S. 2008).

top

Discussion

Schwab v. Reilly will determine a procedural point of the Bankruptcy code, which may hugely affect some of the million Chapter 7 bankruptcy cases filed each year. See United States Courts Bankruptcy Statistics. The Supreme Court will decide whether a debtor can successfully claim a full exemption on an asset by equating the exempt amount with the asset’s value, and whether the trustee who wishes to sell that asset must object to the exemption within 30 days even if the listing is otherwise proper. See Schwab v. Reilly, No. 08-538 (U.S. 2008). With the increasing amount of Chapter 7 filings, efficiency and finality in the bankruptcy proceedings has become a paramount issue for both debtors and trustees. The decision in this case will determine which party will shoulder the burden for the sake of speedy and inexpensive determinations in Chapter 7 proceedings: the trustee, who must make premature complex property valuations creating a holdup in the early stages of bankruptcy, or the debtor, who must delay any certainty on the status of their property and thus affect how they structure their post-bankruptcy affairs.

Chapter 7 trustees handle a heavy caseload. According to Petitioner William Schwab, trustees average approximately 700 cases each year. See Brief for Petitioner, William G. Schwab at 33. The National Association of Bankruptcy Trustees (“NABT”) argue that part of the reason why trustees can handle such a high volume of cases is through the adoption of standard forms. See Brief of Amici Curiae the National Association of Bankruptcy Trustees (“NABT”) in Support of Petitioner at 4. According to NABT, a decision in favor of Respondent, Nadejda Reilly, would require trustees to analyze these forms in such a way as to determine the subjective intent of the debtor, thus completely undermining any efficiency the standard form is designed to achieve. See id. at 12. In support of this argument, the United States argues that Reilly’s interpretation would require a trustee to value property claimed as exempt at the beginning of the bankruptcy process, giving the trustee only 50–70 days to value the property, which is often an insufficient amount of time to conduct appraisals. See Brief of Amici Curiae the United States in Support of Petitioner at 23-24. The United States contends that this would force trustees in certain cases to prematurely bind themselves to the valuations they make at the early stages of bankruptcy when information is the most lacking. See Brief for Petitioner at 32.

In response to Schwab’s efficiency argument, the National Association of Consumer Bankruptcy Attorneys (“NACBA”) argues that if Schwab’s interpretation of the code applies, trustees will frequently challenge a debtor’s valuation after an extended time lapse. See Brief of Amici Curiae the National Association of Consumer Bankruptcy Attorneys, et al. (“NACBA”) in Support of Respondent at 4. NACBA contends that this passage of time will exacerbate the already difficult task of valuation that debtors face, and as valuation contests become more common, the objection hearings will deplete the debtor’s already limited resources. See id. In addition, NACBA points out that the policy behind allowing a Chapter 7 debtor to claim property exemptions serves to give debtors a “fresh start” by allowing a debtor to exempt certain items that help debtors regain their status as productive members of society. See Brief of NACBA at 1, 7. With this policy in mind, Reilly argues that Schwab’s interpretation would defeat the idea of a fresh start since debtors would not be certain whether the claimed property is exempted until after the case has ended, which is often years after the case is filed. See Brief for Respondent, Nadejda Reilly, at 57. Thus, Reilly contends, debtors will be unable to restructure their affairs to allow for post-bankruptcy planning, denying them the foundation to land on their feet and harming their future prospects. See id.

Both parties claim that their opponent’s interpretation of the code will create perverse incentives. Schwab argues that a decision in favor of Reilly would induce debtors to game the system by undervaluing their personal property. See Brief for Petitioner at 35. Schwab claims that under the Third Circuit’s ruling, any debtors will be able to exempt property from bankruptcy simply by equating the value of the exempt property to the undervalued assets. See id. In contrast, the NACBA counters that a ruling in favor of Schwab would in fact create perverse incentives for trustees. See Brief of NACBA at 4. NACBA argues that if the thirty-day deadline is ignored, trustees can wait to object to exemptions in order to take advantage of any increase in market value and claim that the higher property valuation is the correct one. See id. This would have the effect, NACBA contends, of allowing trustees to demand, at any time, that the debtor hand over the property claimed as exempt, rendering debtors constantly in doubt as to the status of their belongings. See id.

The Supreme Court decision will determine the balance between the bankruptcy trustee’s interest in an efficient Chapter 7 proceeding and the debtor’s interest in finalizing his or her exempt property status in order to embark on a fresh start.

top

Analysis 

Chapter  7 bankruptcy allows debtors to make two varieties of exemptions: “in kind” exemptions, which allow the debtor to retain the physical asset and prevent the asset’s liquidation, and other exemptions, where the debtor only retains a limited, statutorily defined monetary interest in the value of the asset. See Brief for Petitioner, William Schwab at 7–8. Once a debtor files the appropriate schedules to claim these exemptions, parties of interest must file an objection to the list within 30 days following the creditor’s meeting. See Federal Rules of Bankruptcy Procedure 4003(a)-(b). If no one objects, the property interest that the debtor claims under § 522 becomes exempt. See 11 U.S.C. 522(l). In Taylor v. Freeland & Kronz, the Supreme Court held that if the trustee does not file a timely objection to a defective exemption, he or she surrenders the right to challenge the exemption at all. See Taylor v. Freeland at 642. The Court further held that a debtor claims an in kind exemption by listing both the value of the asset and the value of her exemption as “unknown.” See id. at 642. It is, however, unclear whether the Court’s holding in Taylor governs a situation where the trustee accepts the debtor’s exemptions generally but seeks to oppose the debtor’s estimated value of his or her property. In Schwab v. Reilly, the Court will determine whether a trustee’s disagreement over a debtor’s estimated valuation of her property triggers the 30-day duty to oppose and, if so, whether a debtor claiming an equal monetary exemption to her estimated value provides adequate notice to ultimately entitle the debtor to an in kind exemption if the trustee fails to oppose.

Does a trustee’s disagreement with a debtor’s estimated valuation of property trigger the trustee’s duty to oppose within the statutory 30-day timeframe?

Petitioner William Schwab (“Schwab”) argues that the 30-day opposition window functions only to compel opposition to the debtor’s “List of Property Exempted.” Schwab first points to the text of Federal Rule of Bankruptcy Procedure 4003(b) (“Rule 4003(b)”), which plainly outlines that there is a 30-day deadline for objecting to the list of property claimed as exempt. See Brief for Petitioner at 20 (emphasis added). Schwab further points to § 522, which specifically makes reference to the fact that the property claimed as an exemption on the debtor’s list is exempt. Schwab therefore argues that neither the statute nor the Bankruptcy rules set any deadline for claiming an opposition to anything other than the debtor’s list of property. See id. at 20–21. Schwab then argues that Rule 4003(b)’s opposition window is consequently inapplicable here because he does not object to the debtor’s list of exempted property. See id. at 21. Schwab argues that there is no reason to grant these items an “in kind” exemption when Respondent Nadejda Reilly (“Reilly”) has failed to clearly indicate that this is the type of exemption she was seeking: her failure to do so, Schwab contends, deprived him of the notice he requires in order to find a proper reason to object to her exemption. See id.

In response, Reilly argues that exemptions system is a significant element of the “fresh start” that Chapter 7 Bankruptcy grants a debtor. See Brief of Respondent, Nadejda Reilly at 21. Reilly argues that § 522(l) unambiguous in its requirements that the debtor file a listing of property that he or she considers exempt and provides a clear deadline for the trustee to object. Further, Reilly points out that the statute does not distinguish between different types of objections, and Schwab’s disagreement with Reilly’s valuation of her kitchen equipment squarely falls into the basic statutory definition of an objection. See id. at 24. Ultimately, Reilly points to the rule’s purpose, which is to set a firm deadline. See id. at 25. Reilly contends that failure to meet this deadline forfeits the privileges granted by a timely objection, thereby thwarting the rule’s underlying rationale. See id. at 26–27.

On the other hand, the United States, in support of Schwab, argues that the Trustee can only object to the property claimed rather than to the value of the property. See Brief of Amicus Curiae the United States at 12. The United States argues that § 522(l) does not specify precise procedures surrounding claims of exemptions and corresponding objections; instead, the only specifications are that the list must (a) describe the asset, (b) provide the legal authority under which the debtor claims an exemption, and (c) contain the actual value of the claimed exemption. See id. at 14. The United States contends that the trustee only needs these three pieces of information to assess the validity of the debtor’s claims, and therefore, these are the three grounds on which the trustee must be compelled to oppose the debtor’s listing with 30 days. See id. Because Schwab’s disagreement does not fall under one of the three grounds for an objection that must be made within 30 days, the United States holds that he has no basis for objection. See id. at 16.

Reilly in turn argues that Congress could have explicitly limited the property exemption based on how the debtor indicates the exemption on the listing if it had wanted to; however, because it did not, Reilly contends that the exemption should not be limited to the declared value. See id. at 39. Further, Reilly argues that if Rule 4003(a) requires the debtor to state the value of the asset that he or she claims as exempt, it only makes sense to apply the same rule to objections that would relate to these same exemptions. See id. at 41.

Reilly further argues that the history of exemptions has evolved to favor prompt determination of the fate of the bankrupt debtor’s estate. See id. at 42–43. Reilly contends that, historically, bankruptcy law has treated the debtor’s list of exemptions as presumptively valid, but it has also always required “prompt, efficient, and comprehensive determination of a debtor’s exemption entitlement.” See id. a 52–53. Therefore, Reilly argues that excusing the trustee from having to promptly object to the debtor’s valuation runs afoul the statute’s larger purpose. See id. 

Does the ambiguity in a debtor’s listing of exemptions entitle the debtor to an “in kind” exemption to the property?

Although Schwab concedes that all of the property that Reilly listed on her list of exemptions is properly exempt, he argues that Reilly’s form did not indicate that she was claiming an in kind exemption simply by stating the same number in both columns indicated “Amount Exempted” and “Value of Property.” See Brief for Petitioner at 22–23. Both Schwab and the United States argue that when a debtor claims an exemption, the presumption is that he or she is claiming an exemption only up to the limit allowed by law. See id. at 23; see Brief of United States at 25–26. Reilly in turn argues that, by indicating that she wanted to retain an exemption that was the full amount of her valued estimation of the asset, she clearly signaled her intent to retain an in kind exemption in the property. See Brief for Respondent at 31.

The United States argues further that if Reilly wanted to claim an indefinite interest in the value of the kitchen equipment, she could have written “unknown,” “to be determined,” or “100% of value,” because these are terms that Courts read as “‘red flags’” that should put a trustee on notice, thereby triggering the 30-day duty to oppose. See Brief of United States at 19–20. Reilly in response argues that if writing something as ambiguous as “unknown” would serve to provide the trustee with notice of her action, as the court found in Taylor, then by that standard her own actions should be construed as providing ample notice. See id. at 36.

Schwab reads Taylor as clearly inapplicable because it compels an objection where the debtor’s claimed exemption is clearly improper. See Brief for Petitioner at 26. In fact, Schwab points out that the schedule that Taylor’s plaintiff filled out in 1984 did not even contain a column for the debtor’s valuation of the property. See id. at 28–29. 

Schwab further contends that even if Reilly’s listing is only ambiguous, such ambiguity should be construed against her both because she drafted the list and because the consequences for the estate of granting Reilly an in kind exemption would be unduly harsh. See Brief for Petitioner at 24. In response, Reilly argues that, in the event that there is some ambiguity as to her actions, any ambiguity should be construed against the trustee because the trustee’s position inhibits the Bankruptcy Code’s “fresh start” policy by depriving her of the tools that she would need to regain her livelihood. See Brief for Respondent at 31.

top

Conclusion

In Schwab v. Reilly, the U.S. Supreme Court will decide if a Chapter 7 debtor’s list of exemptions that includes an exemption in the same amount of the estimated valuation of the asset requires a trustee to object to the exemption within the statutory 30-day timeframe. The decision in this case will impact the strategy that parties in bankruptcy will employ in liquidating the estate by determining whether trustees must first make premature property valuations or whether debtors must face uncertainty regarding the fate of their assets which they seek to exempt.

top

Authors

Prepared by: Lilian Balasanian and Tamilia Chiu

Edited by: Lara Haddad

Additional Sources

·      Wex: Law about Bankruptcy

·      United States Bankruptcy Code

·      Federal Rules of Bankruptcy Procedure

top

Edited by: