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Supreme Court protects statutory exemptions in Chapter 7

In all bankruptcy districts, including in Arkansas, the debtor is given statutory exemptions to retain certain property in a bankruptcy. The Chapter 7 trustee has the obligation to sell the debtor's property that is not exempt, and to distribute the proceeds to the creditors. In most consumer bankruptcies, however, the exemptions are sufficient to allow debtors to retain their basic furnishings, belongings and other specified property.

With respect to residential real estate, the federal exemptions provide for $20,200 per person of equity in the home. That equals an exemption of $40,400 for a married couple. If they have a home worth $200,000 and a mortgage of $170,000, then $30,000 of the $40,400 exemption amount would be available to apply to the $30,000 in equity that they have in the home.

That means that there would be nothing left from a sale of the home for its $200,000 market value, after paying the bank and applying the exemption. Therefore, debtors can retain their homes in Chapter 7 if they are current on their mortgage, and if they do not have more equity than is allowed by the Bankruptcy Code. However, a problem sometimes arises when filers try to undervalue their home's worth or overstate the amount that they owe on the mortgage.

That is called bad faith. If bad faith is proved, courts usually refuse to allow the filers to get the value of their real estate exemption. This would in effect mean that the trustee would not have to honor the $40,400 exemption if she or her tried to sell the property.

The U.S. Supreme Court recently ruled that the Chapter 7 trustee and the Bankruptcy Court must honor the statutory exemption and cannot surcharge it away because of bad faith by the debtor. The Court held that the statutory exemption could only be dishonored if the federal statute itself provided for dispensing with the exemption in the case of fraud or bad faith. But there was no wording to that effect, and the Bankruptcy Code's real estate exemption had to be enforced. This holding will apply to Arkansas bankruptcies as well as in all other states.

Source: jurist.org, "Bankruptcy Courts Are No Longer Courts of Equity", May 1, 2015

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