United States: When Considering When To Object To A Debtor’s Claimed Exemptions, Banks Should Keep Recent Second Circuit Decision In Mind

Chapter 11 bankruptcy proceedings, unlike their counterparts under Chapter 7, do not typically involve liquidation of the debtor's estate and distribution of the proceeds to the creditors. Rather, in the great majority of cases under Chapter 11 the debtor remains in possession of its assets and, after a period of stabilization and restructuring, proposes a plan of reorganization whereby it agrees to pay its debts within a prescribed period. This type of bankruptcy has traditionally been utilized by businesses, as opposed to individual debtors. It is only within the past ten years that the Supreme Court has confirmed that individuals who are not conducting a business may take advantage of the opportunity for reorganization afforded by Chapter 11.⁶ However, while Chapter 11 contemplates the reorganization of the debtor's affairs, such attempts are often unsuccessful and the proceedings must accordingly be converted to Chapter 7 liquidations. A certain number of these converted cases, albeit a small percentage, will therefore involve individual debtors, who are the only debtors permitted to exempt certain property from the estate pursuant to the Bankruptcy Code. The issue of whether the deadline for objecting to such exemptions is extended by conversion is thus raised in these cases. Unfortunately, Congress has ostensibly failed to anticipate the question of whether conversion extends the period in which to object to exemptions claimed by the debtor under these circumstances.

The Bell court concluded that the only legitimate statutory interpretation of the Bankruptcy Code compels the disallowance of a second thirty-day period. Rule 4003(b) provides that objections must be filed "within 30 days after the conclusion of the meeting of creditors held pursuant to Rule 2003(a),"⁷ which in turn requires that a creditors meeting be held between twenty and forty days after the order for relief. Because conversion to Chapter 7 requires that a second meeting of creditors be convened, many courts have held that objections must be filed within thirty days of the conclusion of the second creditors meeting in order to be considered timely. Indeed, the statutory language has typically been deemed ambiguous at best. Nonetheless, the Bell court dismissed this argument as having only "superficial appeal,"⁸ adopting instead an alternative interpretation. In Bell, the court reasoned that, even though conversion requires a second meeting of creditors, this meeting cannot be a meeting of creditors pursuant to Rule 2003(a) as mandated by the Bankruptcy Code. Rule 2003(a) states that the meeting of creditors must be held within forty days of the "order for relief." Because section 348(a) of the Bankruptcy Code states that conversion does not change the date of the order for relief,⁹ the court concluded that the phrase "order for relief" must refer to the initial filing of the bankruptcy petition.

The Bell trustee argued that conversion of a bankruptcy proceeding from Chapter 11 to Chapter 7 also constitutes an "order for relief" pursuant to section 348(a) of the Bankruptcy Code. Therefore, the trustee took the position that so long as the second meeting of creditors was held within forty days of conversion (the "order for relief") and objections were filed within thirty days of the conclusion of this second meeting, the applicable timing requirements had been satisfied. The Bell court, unpersuaded by this line of reasoning, instead employed the statutory construction maxim expressio unius est exclusio alterius¹⁰in order to reach its conclusion. Because it is expressly stated in Rule 1019(2) that conversion extends certain enumerated deadlines,¹¹ the Bell court concluded that Congress would presumably have included the deadline for challenging exemptions in the Bankruptcy Code had it wanted such deadline to be extended upon conversion.

Another argument for disallowing a second thirty-day period, as espoused by the Bell court, is that permitting objections to claimed exemptions that went unchallenged during the Chapter 11 case will abridge the substantive property rights of the debtor. The act of filing for bankruptcy creates an "estate", the property of which is separate and distinct from the debtor's personal property from that point onward. Thus, according to the court, once property becomes "exempt" by virtue of the fact that the debtor claimed it as such and no one filed a timely objection during the Chapter 11 case, that property is permanently removed from the estate. It is thus, the court reasoned, forevermore the debtor's personal property and it cannot subsequently be "recaptured" by conversion of the case to a Chapter 7 liquidation. To hold otherwise would, in the court's view, allow a rule that was intended merely to govern procedure to curtail the substantive exemption rights of the debtor as granted by Congress in the Bankruptcy Code.

Statutory construction aside, the disquieting result of Bell is that the Chapter 7 trustee, appointed upon conversion of the Chapter 11 case but more than thirty days after the close of the initial meeting of creditors, will never have the chance to object to the debtor's claimed exemptions and will therefore play an attenuated role in the bankruptcy process. Rather, the onus will now fall upon the creditors themselves to challenge exemptions during the early phases of the Chapter 11 case, at which point in time there may be no indication of whether such case will ultimately be converted to a liquidation under Chapter 7. Because the goal of Chapter 11 is to foster the reorganization of the debtor, with distributions to be funded through future earnings and the liquidation of non-essential assets, Chapter 11 creditors have traditionally taken a restrained approach to objecting to claimed exemptions. Moreover, because the value of the claimed exemptions may represent a small fraction of the amount hoped to be realized through a plan, there may be little incentive to challenge exemptions where liquidation is not imminent. Indeed, many creditors, unrepresented by counsel and with limited knowledge of their rights under the Bankruptcy Code, may not even be aware that they are empowered to influence the proceeding in this way. Moreover, the cost of prosecuting such objections may seem prohibitive to most individual creditors, particularly in the early stages of a case when the benefits to be derived from attempting to bring such assets into the estate may be largely speculative.

The potential for abuse by individual debtors resulting from this holding is evident where a savvy debtor may file initially under Chapter 11 in order to claim frivolous, or, at the least, questionable exemptions in the hopes that no creditor will make a timely objection. The Bell court addressed this concern by noting that individuals who file under Chapter 11 and then convert to Chapter 7 constitute a small percentage of the total number of bankruptcies in this jurisdiction.¹² While the court also noted that a dishonest creditor may face sanctions and perhaps even criminal penalties pursuant to the Bankruptcy Code for fraudulent conduct, whether these provisions will have a pronounced deterrent effect is questionable. That an impermissible exemption was claimed with an actual intent to defraud is an allegation requiring a standard of proof that will be difficult to satisfy except in the most egregious situations.

If the United States Supreme Court does grant certiorari in a future case in order to end the now larger split among the courts with respect to this issue, recent decisions of the Court indicate that it may adopt the reasoning employed in Bell. While the Court has been willing to broaden the ability of creditors to assert claims in recent years,¹³ the closely-related case of Taylor v. Freeland & Kronz¹⁴ suggests that the Court may favor strict adherence to an early deadline for objecting to exemptions in the interests of providing closure for the debtor. In Taylor, the Court denied relief to creditors where the trustee had failed to object to a claimed exemption within the thirty-day period. All agreed that the debtor had had no possible legal basis for exempting all of the proceeds of a six-figure lawsuit settlement from the estate. Nonetheless, the Court would not countenance an untimely objection.

The Taylor Court refused to imply any requirement of good faith on the part of the debtor, leaving that task to Congress should it choose to amend the Bankruptcy Code in this regard. The Court observed: "Deadlines may lead to unwelcome results, but they prompt parties to act and they produce finality."¹⁵ It would seem irrefutable that the outcome of Taylor violated the spirit of the bankruptcy exemption provisions in allowing the debtor to discharge $23,000 in debts to various creditors while keeping $110,000 for herself. Nonetheless, the Court chose to promote the practical goals of consistency and predictability in this area of the law, even though its decision produced a patently inequitable result. As Justice Stevens opined in dissent: "It is a mistake to adopt a ‘strict letter' approach . . . when justice requires a more searching inquiry."¹⁶

The practical significance of Bell remains that it is now incumbent upon attorneys who represent creditors in the Second Circuit to advise their clients of the exigencies involved in challenging claimed exemptions. Unless and until the highest court in the land declares otherwise or Congress revises the Bankruptcy Code, creditors must view the opportunity to contest exemptions claimed by the individual Chapter 11 debtor as the only opportunity to preserve such assets for the estate should the case ultimately be converted to a Chapter 7 liquidation. Failure to do so may leave creditors in the unfortunate position of attempting to recover property that should by all accounts have remained within the bankruptcy estate, yet finding themselves wholly without redress.

Henry Condell is partner and head of the bankruptcy department at Garden City’s Jaspan Schlesinger Hoffman LLP. Christine Lindwall, an associate of the firm, assisted with the preparation of this article.

1. 225 F.3d. 203 (2d. Cir. 2000). This Court of Appeals decision reversed the judgment of the United States Court for the District of Vermont (J. Garvan, C.J.), which had held that conversion of a case from Chapter 11 to Chapter 7 does extend the deadline for objecting to claimed exemptions. In re Bell No. 1:98CV111, slip op (Bankr. D. Vt. June 13, 1996). In so holding, the District Court affirmed an order of the United States Bankruptcy Court for the District of Vermont (Francis G. Conrad, Bankr. J.).

2. Fed. R. Bankr. P. 4003(b). Rule 4003(b) provides in pertinent part: "The trustee or any creditor may file objections to the list of property claimed as exempt within 30 days after the conclusion of the meeting of creditors held pursuant to Rule 2003(a) . . . unless, within such period, further time is granted by the court." This Rule has been amended, effective December 1, 2000, to permit the court to grant a timely request for an extension of the 30-day period for cause without actually having to rule on the request within that period. Further, under the Rule as amended any party in interest, not just the trustee or the creditor, may file an objection or request an extension of time in which to do so.

3. See 11 U.S.C. § 522. Section 522 states in pertinent part: "The debtor shall file a list of property that the debtor claims as exempt under subsection (b) of this section . . . Unless a party in interest objects, the property claimed as exempt on such list is exempt."

4. See In re Wolf, 244 B.R. 754 (Bankr. E.D. Mich. 2000); In re de Kleinman, 172 B.R. 764 (Bankr. S.D.N.Y. 1994); In re Bergen, 163 B.R. 377 (Bankr. M.D. Fla. 1994); In re Havanec, 175 B.R. 920 (Bankr. N.D. Ohio 1994); In re Leydet, 150 B.R. 641 (Bankr. E.D. Va. 1993)(holding that conversion results in a second thirty-day period in which to object to claimed exemptions); But see In re Halbert, 146 B.R. 185 (Bankr. W.D. Tex. 1992)(holding that conversion does not result in a second-thirty day period in which to object to claimed exemptions).

5. The author has been informed that the trustee will not seek certiorari in this case.

6. Toibb v. Radloff, 501 U.S. 157 (1991)(interpreting the plain language of the Bankruptcy Code to permit individual debtors who are not in business to file under Chapter 11).

7. Fed. R. Bankr. P. 2003(a). Rule 2003(a) provides in pertinent part: "In a chapter 7 liquidation or a chapter 11 reorganization case, the United States trustee shall call a meeting of creditors to be held no fewer than 20 and no more than 40 days after the order for relief."

8. Bell v. Bell, 225 F.3d. 203, 211(2d. Cir. 2000).

9. 11 U.S.C. § 348(a). This section states in pertinent part: "Conversion of a case from a case under one chapter of this title to a case under another chapter of this title constitutes an order for relief under the chapter to which the case is converted, but . . . does not effect a change in the date of . . . the order for relief."

10. The expression of one thing implies the exclusion of another thing. "When the legislature expressly mentioned one thing in a statute, we can assume that it intended to exclude other things (e.g., if the statute says "teachers" must register, the implication is that police officers do not have to register under this statute)." WEST'S LEGAL THESAURUS/DICTIONARY (Special Deluxe ed. 1986).

11. Fed. R. Bankr. P. 1019(2). Rule 1019 provides in pertinent part: "When a chapter 11, chapter 12 or chapter 13 case has been converted or reconverted to a chapter 7 case . . . A new time period for filing claims, a complaint objecting to discharge, or a complaint to obtain a determination of dischargeability of any debt shall commence pursuant to Rules 3002, 4004, or 4007 . . . "

12. The court cited statistical data indicating that 85,377 bankruptcy petitions were filed in the Second Circuit between September 30, 1998 and September 30, 1999. Of those bankruptcies, 827 (less than 1% ) were filed under Chapter 11 and 101 of those (less than 0.12%) were filed by individuals not conducting a business. The number of cases wherein an individual debtor files under Chapter 11 and then converts to Chapter 7 will necessarily be an even smaller subcategory of this group. Bell, 225 F.3d. 203, 220 (2d. Cir. 2000) (citing 1999 Judicial Business of the United States Courts: Annual Report of the Director 271 tbl. F-2).

13. Pioneer Inv. Serv's Co. v. Brunswick Assoc's Ltd. Partnership, 507 U.S. 380 (1993)(permitting the late filing of a proof of claim by a creditor because the attorney's inadvertent failure to file on time could be considered "excusable neglect" within the meaning of Rule 9006(b) in light of all of the relevant surrounding circumstances).

14. 503 U.S. 638 (1992).

15. Id. at 644.

16. Id. at 652 (quoting Bailey v. Glover, 88 U.S. 342, 347 (1875).