Carlos J. Cuevas

Justice Scalia had a profound impact on the development of American law, and he especially had a significant impact on the development of bankruptcy law.  Although Justice Scalia did not write many decisions, his methodology of textualism or strict statutory construction has permeated the Supreme Court’s bankruptcy decisions.  Justice Scalia’s emphasis on strict statutory construction has been the dominant mode of analysis in the Supreme Court’s bankruptcy decisions. E.g., Patterson v. Shumate, 504 U.S. 753 (1992); Toibb v. Radloff, 501 U.S. 177 (1991); United States v. Ron Pair Enterprises, Inc., 489 U.S. 235 (1989).  Justice Scalia’s methodology of strict statutory construction has been embraced by all of the justices of the court, and therefore, a significant portion of the Supreme Court bankruptcy decisions have been unanimous. E.g., Law v. Siegel, 571 U.S. 415 (2014); Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1 (2000); Nobelman v. American Sav. Bank, 508 U.S. 324 (1993). Justice Scalia’s opinions in Law v. Siegel, 571 U.S. 415 (2014) provides significant insight as to why strict statutory construction is the dominant mode of analysis for bankruptcy issues by the federal courts.

In Law v. Siegel, 571 U.S. 415 (2014) the court had to determine whether a bankruptcy court could utilize Bankruptcy Code Section 105(a) to surcharge a debtor’s exempt assets to pay for administrative expenses incurred as the result of a debtor’s misconduct. In Law, the Debtor listed a second mortgage in his schedules, which resulted in there being no equity in his residence. The Chapter 7 trustee conducted an investigation as to the validity of the second mortgage.  The Chapter 7 trustee concluded that the second mortgage was fraudulent. The Chapter 7 trustee commenced an adversary proceeding to avoid the second mortgage.  The holder of the second mortgage litigated the validity of the second mortgage and the sale of the residence for over five years.  The bankruptcy court concluded that the alleged second mortgage was a fiction meant to preserve the debtor’s equity beyond the exemption that he was entitled to assert. The assertion of the fraudulent second mortgage was a fraud on the court and the creditors. The bankruptcy court determined that the Chapter 7 trustee had incurred over $500,000.00 in legal fees in litigating the validity of the fraudulent second mortgage. The bankruptcy court granted the Chapter 7 trustee’s motion to surcharge the entirety of the debtor’s homestead exemption to enable the Chapter 7 trustee to defray his legal fees. The Bankruptcy Appellate Panel for the Ninth Circuit affirmed the bankruptcy court.  The Ninth Circuit Court of Appeals affirmed the Bankruptcy Appellate Panel for the Ninth Circuit.

The Supreme Court reversed the Ninth Circuit Court of Appeals.  The lower courts had misconstrued Bankruptcy Code Section 105(a) in direct contravention of Bankruptcy Code Section 522.  Justice Scalia made the following comments concerning the limitations of Bankruptcy Code Section 105(a):

It is hornbook law that § 105(a) “does not allow the bankruptcy court to override explicit mandates of other sections of the Bankruptcy Code.” 2 Collier on Bankruptcy ¶ 105.01[2], p. 105–6 (16th ed. 2013). Section 105(a) confers authority to “carry out” the provisions of the code, but it is quite impossible to do that by taking action that the code prohibits. That is simply an application of the axiom that a statute’s general permission to take actions of a certain type must yield to a specific prohibition found elsewhere. See Morton v. Mancari, 417 U.S. 535, 550–551, 94 S.Ct. 2474, 41 L.Ed.2d 290 (1974); D. Ginsberg & Sons, Inc. v. Popkin, 285 U.S. 204, 206–208, 52 S.Ct. 322, 76 L.Ed. 704 (1932). Courts’ inherent sanctioning powers are likewise subordinate to valid statutory directives and prohibitions. Degen v. United States, 517 U.S. 820, 823, 116 S.Ct. 1777, 135 L.Ed.2d 102 (1996); Chambers v. NASCO, Inc., 501 U.S. 32, 47, 111 S.Ct. 2123, 115 L.Ed.2d 27 (1991). We have long held that “whatever equitable powers remain in the bankruptcy courts must and can only be exercised within the confines of” the bankruptcy code. (Footnote omitted). Id. at 421.

The surcharge violated bankruptcy code sections 522(b)(3)(A) and (k). The surcharge violated the express language of bankruptcy code section 522(k) that contains express limitations on when an exempt property is subject for the payment of an administrative expense.

The court also rejected the argument that the bankruptcy court had the authority to deny the debtor exercise of his homestead exemption because of his egregious conduct. The express language of bankruptcy code section 522 does not authorize a bankruptcy court to summarily deny a debtor the exercise of a statutory exemption based on whatever considerations it deems appropriate. Bankruptcy code section 522 contains a number of subsections that are intended to penalize a debtor for misconduct and that are also intended to prevent the misuse of exemptions. Thus, the bankruptcy code’s meticulous enumeration of exemptions and exceptions to those exemptions confirms that courts are not authorized to create additional exceptions.

The court was dissuaded that its decision would invite debtor misconduct.  To the contrary, the bankruptcy code and related statutes provided various potent remedies to address debtor misconduct.  Justice Scalia stated:

There is ample authority to deny the dishonest debtor a discharge. See § 727(a)(2)-(6). (That sanction lacks bite here, since by reason of a post-petition settlement between Siegel and Law’s major creditor, Law has no debts left to discharge; but that will not often be the case.) In addition, Federal Rule of Bankruptcy Procedure 9011—bankruptcy’s analogue to Civil Rule 11—authorizes the court to impose sanctions for bad-faith litigation conduct, which may include “an order directing payment … of some or all of the reasonable attorneys’ fees and other expenses incurred as a direct result of the violation.” Fed. Rule Bkrtcy. Proc. 9011(c)(2). The court may also possess further sanctioning authority under either § 105(a) or its inherent powers. Cf. Chambers, 501 U.S., at 45–49, 111 S.Ct. 2123. And because it arises post-petition, a bankruptcy court’s monetary sanction survives the bankruptcy case and is thereafter enforceable through the normal procedures for collecting money judgments. See § 727(b). Fraudulent conduct in a bankruptcy case may also subject a debtor to criminal prosecution under 18 U.S.C. § 152, which carries a maximum penalty of five years’ imprisonment. Id. at 427.

The Bankruptcy Code did not expressly authorize a bankruptcy court to surcharge a debtor’s exempt property to redress a debtor’s fraudulent conduct that has damaged the estate. Under these circumstances, the bankruptcy court exceeded its authority by directing that the debtor’s property be surcharged.

The Law decision is consequential for its mode of analysis.  Justice Scalia provided an in-depth analysis as to how the bankruptcy code should be interpreted.  The first part of the decision discusses the restrictions upon the employment of bankruptcy code section 105(a).  A bankruptcy court is prohibited from utilizing bankruptcy code section 105(a) to override an express section of the bankruptcy code.  When Congress has enacted specific legislation to address a specific issue it is a usurpation of Congressional authority for a bankruptcy court to disregard the express text of a bankruptcy code section to craft an equitable solution.

Justice Scalia also recognized that the bankruptcy code is a complex statute.  Congress has sought to address the major debtor-creditor insolvency issues in a comprehensive statute: the bankruptcy code. By demanding strict adherence to the text of the bankruptcy code predictability and efficiency are promoted, which are fundamental to commercial law.  The bankruptcy code is a significant component of commercial law because it nationally regulates insolvency proceedings. The purpose of having a national statute, the bankruptcy code, governing insolvency proceedings is eviscerated when a bankruptcy court disregards the express language of the bankruptcy code and supplants the bankruptcy code with its own conception of justice. The uniform commercial code and the bankruptcy code enable commercial lawyers throughout the United States to plan commercial transactions throughout the United States.

Justice Scalia also recognized the need to punish debtor misconduct.  Justice Scalia recognized that a bankruptcy court has a panoply of tools to punish debtor misconduct, and thus, it was unnecessary for a bankruptcy court to devise its own remedy that was not authorized by the bankruptcy code.  The denial of a debtor’s discharge, the imposition of monetary sanctions and criminal prosecution are devices that are available to a bankruptcy court to address egregious misconduct committed by a debtor during the course of a bankruptcy case.

As the preceding discussion establishes, Justice Scalia has made a substantial contribution to the development of bankruptcy law.  Justice Scalia’s strict statutory construction is the dominant mode of interpreting the Bankruptcy Code.

Carlos Cuevas is a bankruptcy attorney in New York.