Concealed Assets and Exemptions

In a post last week, I reported on the 9th Circuit BAP’s recent decision, In re Onubah, 2007 WL 2701336 (Bankr. App. 9th Cir. August 31, 2007), which surcharged the Debtor’s allowed homestead and household goods exemptions in the amount of the attorney fees and other costs incurred by the trustee as a result of the Debtor’s legal and extra-legal obstruction of the sale of his home.

In the Onubah opinion, the Court tries to explain why the result, which amounts in part to an award of the Trustee’s attorney fees against the debtor, did not violate the “American Rule” that the parties to litigation bear their own fees:

[T]he American Rule has three exceptions: (1) when a litigant preserves or recovers a fund for the benefit of others; (2) when a losing party acts in bad faith; and (3) in a civil contempt action for disobedience of a court order. Perry v. O'Donnell, 759 F.2d 702, 704 (9th Cir.1985). . . . Even a charitable view of Onubah's conduct in this case would characterize it as being undertaken in “bad faith” and as an abuse of the bankruptcy process. This implicates the second exception to the American Rule.

The Onubah decision is tantalizingly close to Ninth Circuit authority for the proposition that an exemption can be denied in its entirety for bad faith conduct in relation to the exempt asset. The paradigm case is one in which the debtor, intending to conceal an asset from the trustee, fails to list it on the schedules. After the trustee discovers the asset and spends time and money preparing to liquidate it, the Debtor seeks to amend Schedule C to claim the asset exempt. The Tenth Circuit has recently ruled that such an amendment will not be allowed. See, In re Ford, 492 F.3d 1148 (10th Cir. 2007), following In re Grogan, 300 B.R. 804 (Bankr. D. Utah 2003).

A debtor’s attorney could argue that denial of an exemption for bad faith conduct is already addressed by Bankruptcy Code section 522(g), which forbids the taking of an exemption in property recovered by the trustee using the avoiding powers, if the avoided transfer was voluntary. The argument would be that if Congress had wanted to deny exemptions as punishment for unsuccessfully attempting to conceal an asset from the trustee, it could have said so expressly in section 522. A debtor’s attorney in the 9th Circuit might also argue that denying an exemption for bad faith conduct, as opposed to carefully surcharging the exemption by the amount of the fees and costs occasioned by the debtor’s bad faith conduct, amounts to withholding an exemption to punish the debtor, which is forbidden by Latman v. Burdette, 366 F.3d 774 (9th Cir. 2004)

The key distinction supporting the result in Ford may be that in the concealed asset cases the debtor must seek to amend Schedule C, and that the allowance of an amendment is within the discretion of the Court.

The Tenth Circuit’s ruling in Ford is welcome. It imposes serious additional, real consequences on the debtor for concealing an asset. The loss of an exempt asset by an otherwise “judgment proof” debtor has more real-life impact than even a denial of the bankruptcy discharge. The loss of an exemption also may benefit creditors in dollars and cents, immediately.