National Consumer Bankruptcy Rights Center

Protecting The Rights Of Consumer Debtors In Bankruptcy

Exemptions

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Tenth Circuit to Decide Dispute Over Child Tax Credit Exemption in Bankruptcy

Facts

The Tenth Circuit is reviewing a case that centers on Colorado’s bankruptcy exemption statute, which allows debtors to exempt the “full amount” of tax refunds attributed to the Child Tax Credit (CTC). The debtor, Jose L. Garcia-Morales, filed for Chapter 7 bankruptcy in 2021 and claimed an exemption for his $1,800 CTC, which resulted in a $1,455 tax refund.

The Chapter 7 trustee, Robertson Cohen, objected, arguing that the refund was only partially exempt and sought to retain $914.40 for the bankruptcy estate using a pro-rata allocation method. The bankruptcy court, and later the district court, sided with Garcia-Morales, finding that the entire refund was exempt under the plain meaning of the statute. The trustee has appealed to the Tenth Circuit.

Issues on Appeal

The case raises significant questions about how bankruptcy exemptions should be applied:

  1. Interpretation of “Attributed To”: Does Colorado’s statute require a pro-rata allocation of tax refunds based on the contribution of different sources, such as wage withholdings and the Child Tax Credit? Or does it exempt the entire refund if the CTC is a “but-for” cause?
  2. Public Policy Goals: How should bankruptcy courts balance the legislative intent of providing debtors with a financial “fresh start” against trustees’ duty to maximize estate value for creditors?
  3. National Implications: Could this case set a precedent for how other courts interpret similar exemption statutes, particularly in states that allow for federal tax credit exemptions?

Amici Brief

The National Consumer Bankruptcy Rights Center (NCBRC) and the National Association of Consumer Bankruptcy Attorneys (NACBA) filed an amici curiae brief supporting the debtor. The key arguments include:

  • Fresh Start Policy: Bankruptcy exemptions, such as those for tax credits, are designed to shield essential assets and ensure families can maintain a minimal standard of living. Denying full exemptions for public assistance benefits like the CTC undermines this purpose.
  • Role of the CTC: The CTC is a critical part of the social safety net, aimed at reducing child poverty and supporting working families. Exempting it in full aligns with public policy and ensures its intended benefits reach families in need.
  • Trustee Incentives: Current compensation structures incentivize Chapter 7 trustees to pursue minor assets, often at a net loss to creditors. In this case, litigation costs would likely consume most of the funds the trustee seeks to recover.

Conclusion

This appeal has far-reaching implications for bankruptcy law, particularly regarding the treatment of public assistance benefits. If the Tenth Circuit affirms the lower courts’ decisions, it would bolster protections for vulnerable families by ensuring tax credit exemptions are interpreted broadly. Conversely, a reversal could encourage more aggressive challenges to exemptions, reducing the effectiveness of safety-net programs in bankruptcy.

A decision is expected later this year. Oral arguments have yet to be scheduled.

Garcia-Morales Amici Brief

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The 9th Circuit Holds A Homestead Exemption Is Limited to Statutory Cap in a Chapter 11 to 7 Conversion

The Ninth Circuit held that the failure to object to a claimed homestead exemption within the 30-day period does not allow the debtor to exempt more than the statutory limit when the case originated as a Chapter 11 bankruptcy and included conflicting representations regarding the exemptions.

Facts

Monte and Rosana Masingale filed for Chapter 11 bankruptcy in 2015, claiming a homestead exemption of “100% of FMV” (fair market value) for their residence. No party in interest objected within the 30-day window. The case was later converted to Chapter 7, and the Masingales sought to sell the home and retain all proceeds, despite the statutory cap on the homestead exemption.

Analysis

The court’s legal analysis focused on whether the initial lack of objection to the homestead exemption claim allowed the Masingales to exempt more than the statutory limit. The court distinguished this case from Taylor v. Freeland & Kronz and Schwab v. Reilly, which involved different circumstances and did not originate in Chapter 11.

The court noted that the Masingales, as Chapter 11 debtors-in-possession, owed fiduciary duties to their creditors. During the Chapter 11 proceedings, they made representations in their Disclosure Statement and Chapter 11 Plan that they were not claiming above-limit exemptions or that such exemptions would only be allowed after creditors were fully paid. These representations indicated that the homestead exemption would be limited to the statutory cap, contrary to their Schedule C notation of “100% of FMV.”

The court reasoned that these conflicting representations within the 30-day objection period affected whether the “100% of FMV” notation created a clear and objectionable exemption. The court emphasized that the fiduciary duties and specific statements made in Chapter 11 documents provided context that negated the need for an early objection based solely on the Schedule C notation. Therefore, the initial failure to object did not permit the Masingales to claim an exemption above the statutory limit.

Tips

  1. Clarify Exemption Claims: Ensure that exemption claims are clear and consistent across all bankruptcy documents to avoid disputes and objections.
  2. Understand Fiduciary Duties: Recognize that debtors-in-possession in Chapter 11 have fiduciary duties to creditors, and their representations can impact exemption claims.
  3. Timely Objections: While objections to facially invalid exemptions should be timely, consider the entire context and any additional representations made by the debtor within the objection period.

NCBRC filed an amicus brief in support of the Debtors and provided a moot court to Debtors’ counsel to prepare for oral arguments.

Masingale 9th Circuit Opinion

NACBA-NCBRC Amicus Brief in Support of Appellee

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The 9th Circuit Reviews Whether Res Judicata Applies to Exemptions

The 9th Circuit Court in Nance v Warfield is considering whether to overrule the District Court of Nevada which held that the bankruptcy court erred in overruling the trustee’s res judicata-based objection to the debtor’s federal exemptions in the property and RV. The court also concluded that the bankruptcy court exceeded its authority by sua sponte granting an exemption for the RV under the federal wildcard exemption.

Facts

Lawrence Warfield, the trustee of Johnie Lee Nance’s bankruptcy estate, objected to Nance’s claimed exemptions for his property and RV under Arizona law. After the court sustained the trustee’s objections, Nance amended his schedule to claim exemptions under Washington law, and the trustee again objected. When those objections were sustained, Nance amended his schedule to claim federal exemptions. The bankruptcy court overruled the trustee’s objections to these federal exemptions and sua sponte granted an exemption for the RV under the federal wildcard exemption.

Analysis

The district court analyzed the applicability of res judicata to the debtor’s successive exemption claims. It noted that claim preclusion, a form of res judicata, bars litigation of claims that were or could have been raised in a prior action. The court applied the three-part test for claim preclusion: identity of claims, final judgment on the merits, and identity or privity between parties. The court found that the debtor’s claims for exemptions in the property and RV, regardless of the legal framework (Arizona, Washington, or federal law), arose from the same nucleus of operative facts and involved the same property. Therefore, the claims were identical.

The court also determined that the previous rulings sustaining the trustee’s objections constituted final judgments on the merits, satisfying the second criterion. Finally, the parties involved in the objections were identical, fulfilling the third requirement for claim preclusion. Consequently, the court concluded that the bankruptcy court erred in overruling the trustee’s objections based on res judicata.

Additionally, the court addressed the bankruptcy court’s sua sponte action to grant an exemption for the RV under the federal wildcard exemption. The court emphasized the principle of party presentation, which requires courts to decide only the questions presented by the parties. The court found that the bankruptcy court exceeded its authority by granting an exemption that the debtor had not claimed, noting that the debtor, represented by counsel, could have asserted the exemption but did not. Therefore, the court held that the bankruptcy court’s action was improper and reversed its decision.

NCBRC and NACBA filed an amicus brief in support of the Debtor/Appellant.

Warfield v Nance Amici Brief NACBA-NCBRC

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State Law Does Not Create Exemption in Trust

A state statute protecting a trust from judgment creditors is not an exemption statute for bankruptcy purposes where it was not designated as such and it did not provide unequivocal protection against all forms of collection. In re Morris, No. 21-30468 (Bankr. N.D. Ill. Jan. 13, 2023).

In his chapter 7 bankruptcy schedules, the debtor listed an interest as a potential beneficiary in a trust that did not have a spendthrift provision. The debtor claimed an exemption for the interest under Illinois law, 735 ILCS 5/2-1403 (1999), which provides:

Judgment debtor as beneficiary of trust. No court, except as otherwise provided in this Section, shall order the satisfaction of a judgment out of any property held in trust for the judgment debtor if such trust has, in good faith, been created by, or the fund so held in trust has proceeded from, a person other than the judgment debtor. . . .

The trustee objected, arguing that the statute did not create a bankruptcy exemption.

Illinois is an opt-out state, so the court looked to state law to determine whether the trust interest would be exempt even though, unlike other specified exemptions like retirement plans and worker’s compensation awards, the statute at issue here did not create an explicit exemption. The court found that exemptions under the state laws are not limited to those so designated. Rather, “exempt property is any property that the legislature has identified and declared to be free from liability to processes such as seizure and sale, or attachment to satisfy debts.” The essential characteristic of an exemption “is simply whether the provision unequivocally protects the identified property against all forms of collection.”

In this case, the statute the debtor relied on was limited to protecting a debtor’s interest in a trust from judgment creditors. But the court found the chapter 7 trustee was merely gathering estate assets under section 541. He was not a judgment creditor nor was he attempting to collect on a judgment. The court quoted from In re Gutterridge, 2013 WL 395140 (Bankr. C.D. Ill., Jan. 31, 2013), discussing the same state statute, that “once a bankruptcy petition is filed, the Illinois statute in this case cannot apply to create an exemption to a trust that is otherwise simply an asset of the bankruptcy estate.”

The court noted that the grantors could have placed the trust out of reach under section 541(c)(2) by including a spendthrift provision. But the trust in this case did not do so.

The court rejected the debtor’s argument that because certain forms of collection such as levy, garnishment and attachment, all involve a judgment the state statute essentially applies to all collection actions. The court found no support for the argument in the language of the statute. Had the legislature intended to create an exemption, it could have done so.

The court concluded that the narrow language of the Illinois statute was not an “unequivocal” protection of the trust for bankruptcy exemption purposes. It sustained the trustee’s objection.

Morris Bankr SD Ill Jan 2023

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The Ninth Circuit Reviews Whether an Exemption of “100% of FMV” Protects the Entire Value of the Property Including any Post-Petition Appreciation

UPDATE: The Ninth Circuit has since decided this case. Click here to read our article discussing their ruling.

The Ninth Circuit Court of Appeals is considering whether an exemption of “100% of FMV” protects all the equity in the property, over and above the allowable exemption, and any appreciation in value post-petition.  The Ninth Circuit Bankruptcy Appellate Panel reversed the bankruptcy court and found that an exemption claim of “100% of FMV” included the entire value of the property, not the allowable exemption. Further, the court held that this exemption claim included any post-petition appreciation because there was no objection to the exemption.  Masingale v. Munding, 644 B.R. 530 (B.A.P. 9th Cir. 2022).  The BAP held:

“Monte L. Masingale and Rosana D. Masingale filed a chapter 11 bankruptcy petition and claimed a “100% of FMV [fair market value]” exemption in their homestead. No one objected. Years later, the bankruptcy court converted the case to chapter 7. Mrs. Masingale and the chapter 7 trustee disputed the amount of the homestead exemption to which Mrs. Masingale was entitled: the chapter 7 trustee argued that she was bound by the statutory limit under § 522(d)(1), but Mrs. Masingale contended that she was entitled to the entire fair market value of the property, because no one had objected to the claimed homestead exemption. The bankruptcy court agreed with the chapter 7 trustee and approved his request to sell the property, limiting the homestead exemption to $45,950.

“Mrs. Masingale appeals, arguing that the bankruptcy court erred in determining the amount of the homestead exemption. We agree with Mrs. Masingale. We REVERSE the portions of the order on appeal that determine the amount of the homestead exemption and REMAND. We publish to explain the effect of a “100% of FMV” exemption claim and to reiterate that parties must timely object to any improper exemption claim, no matter how frivolous. …

“As a matter of first impression, we hold that the Masingales’ claim of an exemption equal to “100% of FMV” includes postpetition appreciation and becomes incontestable if there is no timely objection. The snapshot rule is one of the limits on a debtor’s entitlement to exemptions. Taylor holds that, if no one objects, the debtor can get the benefit of exemptions to which the debtor is not entitled. In other words, in order to get the benefit of the snapshot rule, a trustee or party in interest must object to an exemption claim that contradicts that rule.”

The case is tentatively set for oral argument in early December 2023.

Appellant Trustee Munding Brief

Appellee Masingale Brief

NCBRC Amicus Brief In Support of Appellee – Masingale

Appellant Trustee Munding Reply Brief

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“Sham” Carve-Out Agreement Rejected

Calling the agreement a “sham,” the district court affirmed the bankruptcy court’s denial of a carve-out agreement between the chapter 7 trustee and the state and federal tax creditors. The court found the agreement would adhere to no one’s benefit but their own. The court also upheld the bankruptcy court’s finding that the debtor’s homestead exemption applied to section 724(b). Summerlin v. Turnage (In re Turnage), No. 22-122 (W.D. N.C. March 14, 2023).

The 72-year-old widowed debtor living on Social Security income and help from her son, filed for chapter 7 bankruptcy. She claimed an exemption of $55,000 in her home which she valued at $124,510.00. Her secured debts at the time of her petition totaled $231,788.29, and consisted of a mortgage on her home and both federal and state tax debts.

The chapter 7 trustee valued the debtor’s home at between $175,000 and $180,000. He objected to her exemption as inapplicable to her tax liens under North Carolina law. He then entered into a carve-out agreement with the debtor’s tax creditors under which he would receive $30,000 for his expenses and “[t]he IRS and NCDOR each get 60% of their secured tax liens. The remaining 40% carved out of the tax liens (approximately $38,000 after payment of the Trustee’s expenses) would be used to pay priority unsecured claims in full and the remainder would be disbursed pro rata among the general unsecured creditors.” He moved the court for authority to sell the property so he could carry out this distribution plan.

The bankruptcy court denied the motion to sell and overruled the objection to the debtor’s exemption. The trustee appealed to the district court.

The court found the appeal turned on application of section 724(b). In addition to establishing the order of distribution where tax liens are involved, that section provides that after the first mortgage is paid off, claimants holding certain types of priority claims may substitute in for the tax lien to the extent of the tax lien. The court noted that the only priority claim that would be available to substitute in for the tax lien would be the trustee’s own compensation, related primarily to the sale of the debtor’s home.

Notably, section 724(b) makes no provision for exemptions. Because North Carolina opted out of the federal exemptions, the court turned to state law to determine how the debtor’s homestead exemption would fare under a section 724(b) distribution scheme. It found state law emphasizes a liberal construction of exemption laws, favoring their application.

The court was unpersuaded by the trustee’s argument that permitting the debtor to take her homestead exemption would impinge on the tax liens. The court differentiated between the homestead exemption’s applicability to proceeds from sale of the home and its applicability to the tax liens themselves. It found that “once the tax agencies agree to the carve-out they cannot direct the allocation of the value created by such carve-out.”

Finally, the court noted with distaste that the carve-out benefited only the trustee and the tax agencies. It stated: “for her ‘fresh start,’ the Debtor, a 72- year-old widow with no meaningful source of income, loses her home and gets no more than a check for about $2,000. The minimal benefit to the other general unsecured creditors does not obscure the reality of this agreement.”

The court affirmed the Bankruptcy Court’s decision that the Debtor’s homestead exemption applies to section 724(b) and its denial of the Motion to Sell.

Turnage WD NC March 2023

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Trustee Entitled to Attorney’s Fees for Exemption Dispute

Where the debtor’s original exemption claim was for bodily injury, the trustee had a reasonable argument that the actual post-petition settlements of her personal injury case, which specified that they were for non-bodily injury damages, did not fall under that exemption. Because the trustee’s objection related to the post-settlement exemption claim, it was timely. Biondo v. Gold, Lange, Majoros & Smalarz, P.C., No. 22-1666 (6th Cir. Feb. 8, 2023).

Before filing for Chapter 7 bankruptcy, the debtor was in a car accident. In her bankruptcy filings, she listed the personal injury claim with an unknown value. She claimed an exemption in potential recovery, tracking the text of section 522(d)(11)(D), for “payment[s]” she received “on account of personal bodily injury, not including pain and suffering or compensation for actual pecuniary loss.”

The trustee did not object to the exemption. He hired a law firm to litigate the debtor’s claims against the driver of the other vehicle and the debtor’s insurance company. The insurance company settled for $48,500 specifically covering “medical expenses, attorney’s fees, ‘lost wages,’ and all ‘other forms of economic or non-economic loss.’” The driver of the other car settled for $70,000, covering “pain and suffering.”

The debtor moved to compel the trustee to turn over $23,675 from the settlement recovery arguing that the funds were exempt under section 522(d)(11)(D). She and the trustee settled the exemption claim, and the trustee moved to recover $2,880 in attorney’s fees he incurred in litigating the motion to compel. The debtor objected, arguing that the attorney’s services did not fulfill the requirement under section 330(a)(1)(A) that they be either reasonably likely to benefit the estate or necessary to the administration of the case. The bankruptcy court granted the trustee’s request for fees, and the district dismissed the appeal as equitably moot.

The debtor appealed to the Sixth Circuit.

The court began with the parameters of section 522(d)(11)(D)’s exemption, finding that while funds resulting from personal bodily injury are exempt, the exemption does not include “payments for pain and suffering and pecuniary losses.” The exemption is also typically interpreted to exclude payments for medical bills. Here, the two settlements specified that they were for damages other than personal bodily injury. For that reason, the circuit court found the trustee’s objection to the exemption was reasonable and for the benefit of the estate.

The debtor argued that the trustee forfeited his opportunity to object to the exemption because he failed to do so when she filed the exemption claim in her original bankruptcy schedules.

Under section 522(l), in the absence of a timely objection, an exemption is automatically allowed. Citing Mercer v. Monzack, 53 F.3d 1 (1st Cir. 1995), the court found that “exemptions should be unambiguous and should be read to conform with the law.” The debtor must therefore unambiguously identify a particular property as exempt before the clock begins to run.

Here, the debtor’s claimed exemption related only to recovery for bodily injury, as contemplated by section 522(d)(11)(D). It was not until the actual settlements were reached that the debtor at least arguably attempted to apply the exemption to non-bodily injury recovery. The trustee’s post-settlement objection was related to the debtor’s recovery based on medical expenses and other pecuniary losses, as well as pain and suffering. Because the actual funds the debtor sought to exempt differed from the description in her claimed exemption, the court found her original exemption claim did not trigger section 522(l)’s clock and the trustee’s objection was not time-barred. While the trustee could have lodged a prophylactic objection to the debtor’s exemption from the outset, he was not obligated to do so.

Because the district court’s finding that the appeal was equitably moot was not jurisdictional, the circuit court declined to address that issue.

The court affirmed.

Biondo 6th Cir Feb 2023

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Good Faith in Failure to Disclose Lawsuit

Where the debtor failed to amend her schedules before her case was closed, she forfeited the right to do so as a matter of course, but based on the facts and circumstances in this case, the debtor’s neglect was excusable. The court allowed her to reopen her case to claim an exemption in a personal injury settlement. In re Wantz, No. 18-2851 (Bankr. W.D. Mich. Jan. 5, 2023).

Prior to filing her chapter 7 petition, the debtor contacted a personal injury attorney who was representing other women suing the manufacturer of an implanted medical device to explore the possibility of filing a lawsuit. The attorney told the debtor via email that because she had not had the device removed, she would be unlikely to prevail in a lawsuit. When she filed for bankruptcy, the debtor did not disclose this potential cause of action in her bankruptcy. Shortly before receiving her discharge, she signed an Attorney Employment Contract with the personal injury attorney. That agreement stated only that the attorney would investigate her potential claim.

She received her discharge in October, 2018, and her case was closed in November, 2018. In 2020, the debtor received two emails from her personal injury attorney suggesting, but not directly stating, that a case had been filed on her behalf. In March, 2021, the debtor sought medical advice with respect to the device and, upon learning that it was the cause of her pain, had it removed. Her medical expenses were $7,000. At around the same time, the debtor learned that her personal injury case had settled and that she would net $6,500.

Three weeks later, the debtor moved to reopen her bankruptcy to add the settlement to her schedules and claim it as exempt. The trustee objected to the exemption arguing that it was untimely.

Rule 1009(a) provides that a debtor may amend a bankruptcy schedule as a matter of course any time before the case is closed. The question here was whether that automatic right to amend is reignited when a closed case is reopened. The debtor lobbied for the court to find that once a case is reopened the debtor’s right to amend her schedules is “as a matter of course,” as it would be under Rule 1009(a) and that any other conclusion would violate the holding in Law v. Siegel, 571 U.S. 415 (2014).

The court found the debtor’s interpretation of that case was overbroad. Law prohibited a court from surcharging a debtor’s exemptions based on equitable considerations and in contravention of Code provisions. Law did not deal with timeliness of an amendment to the schedule of exemptions. The court here found that because Rule 1009(a) specifically applies to a debtor’s right to amend prior to her case being closed, the obverse is not true. A debtor may not amend her schedules as a matter of course after the case is closed even if it is later reopened.

The court turned next to the impact of Rule 9006, which provides that, with certain specified exceptions, a court may extend a deadline after that deadline has expired upon a showing of excusable neglect. The debtor argued that Rule 9006 was inapplicable because that rule applies only when the act in question “is required or allowed to be done at or within a specified period by these rules.” The debtor argued that because the time for amending schedules is not circumscribed by a specific period but is tied to the non-specific point at which the case is closed, amendments are not subject to Rule 9006’s requirement of a finding of excusable neglect.

The court disagreed with the debtor and with the cases, such as Mendoza v. Montoya (In re Mendoza), 595 B.R. 849 (B.A.P. 10th Cir. 2019), supporting her position. It found that Rule 1009(a)’s requirement that an amendment be filed before the case is closed is sufficiently specific to bring it under the auspices of Rule 9006.

The court turned to whether the debtor had shown excusable neglect, finding that the inquiry was equitable in nature and involved consideration of all relevant circumstances.

The court agreed with the trustee that the debtor’s failure to disclose the lawsuit during her bankruptcy deprived the trustee of the opportunity to litigate the claim for the benefit of the estate. But the court found that prejudice to the trustee and creditors was not significant in light of the fact that the debtor could have claimed an exemption under 522(c) for the settlement at any time during her bankruptcy. The court was unwilling to agree that the trustee would likely have obtained a better outcome from the litigation had she been involved.

As to the length of the delay—three years between filing her petition and reopening her case—the court found the debtor was unaware of several salient facts that would have alerted her to the necessity of disclosing the claim. First, the debtor did not know the cause of her pain was due to the device; second she did not know her attorney had moved past the investigation stage and filed a claim on her behalf; and third, the debtor lacked the sophistication to untangle the conflicting information she had received from her personal injury lawyer. The court noted that the debtor’s personal injury case involved many plaintiffs and that the debtor did not have a relationship with her attorney, but dealt with him from a distance. The court concluded that the debtor acted in good faith.

With the final observation that the debtor’s ultimate recovery did not even meet her medical bills based on the injury, the court found the debtor was entitled to amend her schedules to claim the exemption.

Wantz Bankr. WD Mich Jan 2023

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Post-Petition Fee Agreement a No-Go

A fee agreement that purports to attach an attorney’s lien on the debtor’s as exempt personal property is unenforceable under section 526(a) where state law allows such liens only on non-exempt property or on exempt personal property for specified exceptions, not including attorney’s fees. In re Turner, No. 22-41570 (Bankr. D. Minn. Dec. 2, 2022). [Read more…] about Post-Petition Fee Agreement a No-Go

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Exemption Amount in Lien Avoidance Action

For purposes of lien avoidance under section 522(f), the debtor was able to claim a homestead exemption in the amount of the California exemption in effect at the time of his bankruptcy petition, despite California law that fixed the exemption amount at the time of lien creation. Barclay v. Boskoski (In re Boskoski), No. 22-55098 (9th Cir. Nov. 14, 2022). [Read more…] about Exemption Amount in Lien Avoidance Action