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A debtor could increase the value of a pre-petition personal injury claim by $100,000 nearly two years after filing his Chapter 7 case, despite allegations that the debtor engaged in bad faith by originally listing the claim as having no value, a U.S. Bankruptcy Court judge has decided.

The trustee argued that although bankruptcy rules generally permit a debtor to amend a schedule “as a matter of course,” bankruptcy courts have authority to deny “bad faith” amendments under precedent from the 1st U.S. Circuit Court of Appeals.

But Judge Christopher J. Panos concluded that, under dicta in a 2014 decision by the U.S. Supreme Court, Law v. Siegel, debtors are permitted to amend their exemptions despite allegations of bad faith in undervaluing a claim.

“While it is hard to square Siegel’s conclusion with the frequently cited refrain underlying bankruptcy protection that it is the ‘honest, but unfortunate debtor’ that may obtain the protections and benefits of filing, this Court is constrained by the Supreme Court’s dicta on the issue of exemption amendments and bad faith conduct,” Panos wrote.

The 15-page decision is In Re: Hoover, John E., Lawyers Weekly No. 04-037-17. The full text of the ruling can be found at here.

Supreme Court leads the way

The debtor’s attorney, David G. Baker of Boston, said rather than breaking new ground, Hoover reaffirms fundamental principles.

“It reaffirms that bankruptcy judges are bound by Supreme Court precedent and that debtors have a right to amend their schedules at any time, certainly at least with respect to exemptions,” Baker said.

While disappointed with the result, the trustee in the case, Jonathan R. Goldsmith, said it is important that Panos recognized bankruptcy trustees faced with similar circumstances have other options to pursue, including objecting to discharge.

“There are other avenues that we can utilize to deal with debtors who act in bad faith and/or fraudulently in claiming exemptions,” Goldsmith said.

The Springfield lawyer added that those “other avenues” are often more costly and time-consuming. For that reason, Goldsmith said he hopes Congress will eventually close what he sees as a “loophole” in the process by which debtors seek relief under the Bankruptcy Code.

Boston bankruptcy attorney Alison M. Kinchla said Hoover is consistent with a string of decisions issued across the country in the wake of Siegel.

“It applied the Supreme Court’s holding that a court has to honor all claimed exemptions, even in the face of a debtor’s bad acts, unless there’s a specific statutory basis for not allowing the exemption,” Kinchla said. “Here, there was no statutory basis for disallowing the exemption.”

For Boston’s Lynne F. Riley, the judge in Hoover “got it right” in concluding that Siegelabrogated exceptions to Rule 1009’s liberal amendment scheme previously recognized in the 1st Circuit for bad faith amendments.

“Here, Rule 1009 implements other express [Bankruptcy Code] provisions regarding exemptions, and advances code policy that exemptions are fundamental in bankruptcy,” Riley said.

John C. La Liberte agreed that Panos reached the correct result based on Siegel. The Boston practitioner pointed out that Hoover is also consistent with the liberal rule of allowing amendments to complaints followed by federal and state courts generally.

“If you file a complaint, there’s a permissive standard typically applied to amendments,” La Liberte said. “If an opposing party cannot show meaningful prejudice, most courts will allow the amendment.”

Allegations of bad faith

The debtor filed for Chapter 11 protection in 2014. In his schedule of assets, he included his interest in a personal injury claim he valued at $0 arising from a February 2012 automobile accident. The debtor correspondingly asserted a state-law exemption in the claim in the amount of $0.

The case was later converted to Chapter 7. Over the debtor’s objection, the trustee retained the debtor’s former personal injury attorney, Robert F. Casey Jr., as special counsel to handle the auto accident claim on behalf of the bankruptcy estate.

Casey filed a complaint in Worcester Superior Court and negotiated a $15,500 settlement with the insurer for the defendant in the state court action. Most of the proposed settlement would have gone toward the payment of attorneys’ fees and settlement of a lien held by the debtor’s health care insurer.

The trustee filed a motion in the debtor’s bankruptcy case for approval of the settlement, but the debtor objected, asserting the settlement was unreasonable given the severity of his injuries and the $100,000 policy limit in the defendant’s liability policy.

The trustee argued that the settlement was fair in light of the fact that the debtor had refused to be evacuated for medical treatment at the time of the accident, the insurer’s rejection of mediation, and the need to pay a $2,000 Personal Injury Protection offset.

The trustee also complained that the debtor failed to cooperate with attorney Casey in the state court action, going so far as to refuse to execute a medical release when requested to do so.

In response to the trustee’s motion to approve settlement and nearly two years after filing his petition, the debtor moved to amend his bankruptcy schedules to increase the value of his personal injury claim from $0 to $100,000 and assert federal exemptions with respect to that claim in excess of $34,000, the maximum amount available.

In explaining his change of position, the debtor stated that he originally listed the personal injury claim as having no value because Casey had expressed pessimism in obtaining any recovery at the time he represented the debtor.

The trustee objected to the amendment, asserting that the debtor’s claim that Casey had been pessimistic about recovery was “false, misleading and constitutes an attempt by the Debtor to perpetrate fraud on the Court.”

Amendment allowed

Bankruptcy Rule 1009(a) states that a “schedule … may be amended by the debtor as a matter of course at any time before the case is closed.”

The trustee argued that the 1st Circuit has recognized exceptions to the liberal rule allowing amendments in cases involving bad faith.

The debtor countered that those precedents are no longer valid in the wake of Siegel. In that case, the Supreme Court recognized in dicta that a debtor is vested with the discretion to invoke an exemption, further stating courts “may not refuse to honor an exemption absent a valid statutory basis for doing so.”

The trustee contended Siegel was distinguishable because in that case the trustee sought to surcharge a valid exemption, while in Hoover he was challenging the very propriety of the debtor’s claimed exemptions based on bad faith.

But Judge Panos found the Supreme Court’s decision on point, noting that Judge Melvin S. Hoffman had given Siegel a similarly broad reading in a 2015 Massachusetts bankruptcy case, In Re: Mateer, Robert Jr.

“In this instance, the Siegel dicta provides clear guidance concerning the limits of bankruptcy courts to use their §105 powers to address debtor fraud in the exemption context and this guidance has been recognized by the United States Court of Appeals for the First Circuit,” the judge wrote. “Application of Siegel, therefore, requires this Court allow the Amendment Motion, as the Court is limited in its authority to deny the Debtor leave to amend his exemptions whether there was bad faith conduct or not.”

In arguing that bankruptcy courts retained the authority to deny “bad faith” amendments post-Siegel, the trustee pointed to Bankruptcy Rule 4003(b)(2). The rule provides that a trustee “may file an objection to a claim of exemption at any time prior to one year after the closing of the case if the debtor fraudulently asserted the claim of exemption.”

The trustee cited a 2014 bankruptcy decision from the Eastern District of Michigan, In re Woolner, for the proposition that Siegel is non-binding dicta and that Rule 4003(b)(2) provides courts the authority to sustain an objection to a fraudulently asserted exemption.

But Panos characterized Woolner as representing the “decidedly minority view.” In finding that Rule 4003(b)(2) did not apply, the judge wrote that the trustee “is not asserting that the exemption claim itself was fictitious, or that the exemption was not legitimately available. Further, the Trustee does not cite a post-Siegel case, other than Woolner, as standing for the proposition that a debtor asserting an exemption by conduct that is generally fraudulent to his creditors is a basis to deny such an exemption under Rule 4003(b)(2).”

The judge pointed out that other avenues remain available to trustees and creditors to address fraudulently claimed exemptions, despite the prohibition of Siegel and the inapplicability of Rule 4003(b)(2) to exemptions resulting from bad faith conduct.

“As recognized by the Siegel Court, a bankruptcy court’s authority under [Bankruptcy] Rule 9011 to sanction a debtor and ‘further sanctioning authority under either §105(a) or its inherent powers’ may address improper conduct by a debtor,” Panos wrote.

The Bankruptcy Code provides additional remedies to trustees, he added, including the denial of discharge, dismissal of a case or, if the fraud relates to the transfer of an asset, avoidance of the transfer and recovery of the asset.

In Re: Hoover, John E.

THE ISSUE: Could a debtor increase the value of a pre-petition personal injury claim by $100,000 nearly two years after filing his Chapter 7 case, despite allegations by the trustee that the debtor engaged in bad faith by originally listing the claim as having no value?

DECISION: Yes (U.S. Bankruptcy Court)

LAWYERS: David G. Baker, Boston (debtor)

Jonathan R. Goldsmith of Goldsmith, Katz & Argenio, Springfield (trustee)

Originally published in Massachusetts Lawyers Weekly, July 27, 2017