Texas Bankruptcy Courts Split Over Application of Schwab v. Reilly

The Supreme Court's decision in Schwab v. Reilly, 130 S.Ct. 2652 (2010) last term provoked a lot of concern about the finality of exemptions. Under Taylor v. Freeland & Kronz, 503 U.S. 638 (1992), a trustee's failure to timely object to an exemption, even a frivolous one, meant that the asset left the estate. However, in Schwab v. Reilly, the Supreme Court held that an exemption of a specific dollar amount in value of property exempted only the value claimed but not the asset itself, allowing a trustee to sell the asset if the value ultimately exceeded the amount of the debtor's exemption.

I have written about Schwab v. Reilly and its consequences here and here.

Now Texas Bankruptcy Judges are struggling with whether Schwab permits, or even dictates, that a debtor may claim 100% of fair market value, forcing the trustee to object within 30 days. Judge Michael Lynn and Judge Craig Gargotta have held that claiming 100% of FMV is permissible, In re Moore, 442 B.R. 865 (Bankr. N.D. Tex. 2010), In re Dominguez-Ortega, No. 10-61416 (Bankr. W.D. Tex. 5/17/11), while Judge Robert Jones has ruled the opposite way, In re Salazar, 2011 Bankr. LEXIS 1117 (Bankr. N.D. Tex. 2011).

Because Judge Gargotta's opinion is the latest word, I will start with his ruling in this post. The transcript is not yet available online. I will be happy to provide a copy to anyone who requests it.

The Permissible Approach

In the Dominguez-Ortega case, the court was faced with objections filed by the chapter 7 and chapter 13 trustees in six cases in which the debtors claimed 100% of FMV. Relying upon the Moore decision and scholarly articles from the American Bankruptcy Institute, Judge Gargotta denied the objections. He stated:

As everyone knows, in Schwab v. Reilly, the Supreme Court unequivocally says at least two things--it may say other things in addition to that.

One, that one hundred percent of fair market value on Schedule C is permissible and correct.

And second, that the trustee may not be bound by the 30 day objection period under Federal Rule of Bankruptcy Procedure 4003(b).

Transcript, pp. 6-7. He went on to adopt the reasoning of Judge Lynn of the Northern District. He stated:

(T)he judges in the (Fort Worth) division had the following observations.

First of all, fair market value of one hundred percent is the correct methodology. It puts the trustee on notice to object within 30 days. Then there can be an evidentiary hearing . . . regarding whether or not that's a fair objection.

For purposes of the proceedings here in Waco, I agree with that. I think that's exactly what the Supreme Court requires.

Second as to the discussion that we had on the record day about whether or not debtors may use a numeric amount for the interest they claim as an aid, they are free to do that, but they are not required to do that. And I will leave it up to them as to whether or not they want to do that.

Transcript, pp. 8-9.

Judge Gargotta acknowledged that his ruling would result in more work for the trustees and the court, but stated that his mandate was to follow the Supreme Court.

Now, what is the consequence to the Court? Well, the consequence to the Court is, in those situations where the trustee thinks that . . . when (the debtors) use the designation of one hundred percent of fair market value, that it may exceed the amount of the interest in an asset, the trustee is going to have to object, and I'll have to conduct a hearing on it and we'll . . . figure out how that plays out.

I recognize that, ultimately, it may increase the litigation in this Court. But, by the same token, I'm of the opinion, and I think it's unequivocally clear that what debtors are doing in that consequence is precisely what the Supreme Court ordered, and I'm not going to alter their methodology in terms of claiming it.

I apologize to both Mr. Hendren and Mr. Studensky if it increases their workload. That is not my intent. Rather, I am complying with what the Supreme Court commands.

Transcript, p. 10.

The Impermissible Approach

Writing in Salazar, Judge Robert Jones agreed that if a debtor claimed 100% of fair market value and no party objected, that "the debtor effectively reclaims the property." 2011 Bankr. LEXIS 1117 at *15. However, he disagreed with Judge Lynn about what to do if there was a timely objection. His conclusion was that an objection to 100% of fair market value was a facially valid objection and that the debtor would be required to amend his exemption to state a specific dollar amount.

He explained his reasoning as follows:

The Court will set forth its reasons for the approach it adopts. First, the Court fails to see the necessity of a hearing under the circumstances as presented. The debtors' exemption claims are limited to an interest in the property. The value of the property itself is relevant only to the extent that there is sufficient value to support the amount of the exemptible interest. If, as suggested by the Supreme Court, the debtor is trying to exempt the property in-kind rather than an interest in property, such goal may still be thwarted if, for example, the property subsequently appreciates in value. This is the very issue confronted by the Ninth Circuit in In re Gebhart, 621 F.3d 1206 (9th Cir. 2010). There the debtors made an exemption claim to the equity in their house, which amount was well within the amount they were allowed under § 522(d)(1). The trustee did not object; like the trustee in Schwab, the trustee in Gebhart had no reason to object. During the pendency of the bankruptcy case, the house appreciated in value. Two years later, after the debtors had defaulted on their mortgage payments and the mortgage company moved for stay relief, the trustee sought approval to sell the house to recover the value of the house that then well exceeded the exemption claim. The Ninth Circuit, consistent with Schwab, emphasized that the debtors' allowable exemptions did not permit the exemption of the house itself, but rather the specific dollar amount of their interest in the house.

2011 Bankr. LEXIS 1117 at *17-18. The Court went on to state

The Supreme Court in Schwab predicted such claims would likely draw objections. Claiming "100% of FMV" is the debtors' way of stating that they wish to keep the asset in-kind. While this is their desire, the Court must construe that such claim has the legal effect of claiming an interest in the property up to an amount that is determined by the fair market value of the property in-kind. Accordingly, if the trustee wishes to preserve for the estate any excess value--value over the amount of the statutory limit that may exist either at the time the exemption is claimed, as was the case in Schwab, or any excess value that may exist as a result of an anticipated appreciation in the property, as happened in Gebhart--the trustee must object to the exemption claim itself. That is precisely what has been done here. The trustees' objections are facially valid. The objections do not otherwise contest the exemption claims. The Court certainly concedes that, given the items against which the exemptions were made and the claimed values of the items in-kind, it is highly unlikely that any of the items would ever achieve a value that would exceed the statutory limit for the exemption. Regardless, the Court recognizes the trustees' right to preserve this eventuality for the estates.

2011 Bankr. LEXIS 1117 at *25-26.

Reconciling the Cases

Moore, Salazar and Dominguez-Ortega all agree that if a debtor claims 100% of fair market value and no party objects, that the debtor gets to keep the property. However, where they split is in allocating the burden of proof. Under Fed.R.Bankr. P. 4003(c), the objecting party has the burden of proof on an objection to exemptions. Moore and Dominguez-Ortega require the trustee to meet the burden of proof with evidence. On the other hand, Salazar holds that the objection should be sustained as a matter of law and that the debtor has the burden of proof to state what the value of the property is. Even then, the debtor has no security. If the value of the property increases beyond the exempt amount, the trustee may sell it out from underneath the debtor.

I have mixed feelings about these opinions. Moore and Dominguez-Ortega bring order to the force by restoring the status quo under Taylor v. Freeland & Kronz. On the other hand, Salazar is more faithful to the Supreme Court's reasoning that an exemption attaches to a dollar amount rather than the thing itself. However, that is a horrible result. It allows trustees to sleep on their rights and leave estates open in the hope that an asset may appreciate. As a practical matter, it is much better to require the trustee to put up or shut up in an evidentiary hearing. This will ensure that the trustee only objects when there is a genuine basis for doing so and gives all parties certainty in dealing with assets claimed as exempt.

Post-Script

I typically do not blog about oral rulings. I chose to do so in this case because it was a very definitive ruling from one of my local judges. However, I do want to acknowledge that all of the Texas bankruptcy judges that I appear in front of put a lot of thought and hard work into their oral rulings. In most cases, the oral rulings are equivalent in force to a written opinion, just delivered in a more informal manner. In this case, it was refreshing to hear the directness of the Court’s comments.

Finally, I apologize to Judge Robert Nelms. In his ruling, Judge Gargotta referred to rulings by Judge Michael Lynn and Judge Robert Nelms. I could only find Judge Lynn's opinion. When Judge Gargotta refers to the Fort Worth judges, he is referring to both Judge Lynn and Judge Nelms.