United States: Law v. Siegel: The End Of Equitable Disallowance?

The question of whether a bankruptcy court may "equitably disallow" a creditor's claim-that is, direct that a creditor shall receive no distribution out of a bankruptcy estate on account of an otherwise valid claim-has long divided the courts. Section 510(c) of the Bankruptcy Code grants the bankruptcy courts the authority to "equitably subordinate" a claim-in essence, provide that a creditor holding an otherwise valid claim, but who has engaged in wrongful conduct that has harmed the bankruptcy estate, will not be paid until other valid creditors are paid in full. But there is no express statutory provision providing for "equitable disallowance." If anything, the Bankruptcy Code says the opposite, providing that a court "shall allow" a creditor's claim unless one of a number of specified conditions-not including the creditor's inequitable conduct-are met. 11 U.S.C. § 502(b).1 For this reason, courts have held, applying ordinary principles of statutory construction, that there is simply no such thing as "equitable disallowance" under the Bankruptcy Code.2

Other courts, however, have held that bankruptcy courts do have the authority to "equitably disallow" a claim.3  Those courts have typically relied on language in the Supreme Court's decision in Pepper v. Litton, 308 U.S. 295 (1939), which, while using the terms "disallowance" and "subordination" interchangeably, at least suggested that the "disallowance" of a claim might be an appropriate exercise of the court's equitable authority. Because the equitable authority of the bankruptcy court is now codified in Section 105(a) of the Bankruptcy Code, these courts have generally looked to that provision as the statutory authority for the remedy of equitable disallowance.4

The Supreme Court decision earlier this week in Law v. Siegel, No. 12-5196 (U.S. Mar. 4, 2014), which concluded that Section 105(a) provides no authority to exercise a remedy that is not included in the Bankruptcy Code's enumeration of  statutory remedies-and is therefore implicitly excluded-may well put an end to that debate.5

Law was an individual debtor chapter 7 case. The debtor claimed that his house, which he said was worth approximately $365,000, was subject to two liens, each of approximately $150,000, such that debt secured by the house came to approximately $300,000. In addition, Law was entitled to "exempt" from his estate up to $75,000 in value in his homestead. As a result, there appeared to be no non-exempt value in the debtor's home that would become part of the bankruptcy estate. One of the two liens, however, was entirely fictitious, an artifice of the debtor's intended to deceive the chapter 7 trustee into believing that there was no non-exempt value in the debtor's house.

The chapter 7 trustee incurred more than $500,000 in legal fees in discovering and proving the debtor's fraud. The question the case presented is whether the $75,000 exemption could be "surcharged"-in effect, disallowed so that the estate could recover the funds-on account of the debtor's inequitable (indeed, overtly fraudulent) conduct. 

The lower courts all held that the exemption was subject to this "surcharge," finding that Section 105(a) of the Bankruptcy Code supported that authority in exceptional circumstances where the debtor engages in "inequitable or fraudulent conduct." The Supreme Court unanimously reversed. In an opinion by Justice Scalia, the Court held that the Code itself sets forth the circumstances in which otherwise exempt property is available to the trustee to distribute to creditors, and that the "Code's meticulous . . . enumeration of exemptions and exceptions to those exemptions confirms that courts are not authorized to create additional exemptions." Law v. Siegel, slip op. at 9. Indeed, in the context of exemptions, the Code goes even farther (in language that is perhaps analogous to the command of Section 502(b) that a court shall allow a creditor's claim unless specified conditions are met), stating expressly that exempt property is "not liable for payment of any administrative expense."  11 U.S.C. § 522(k).

The Court summarily rejected the argument that Section 105(a) was the source of relevant authority to take action prohibited by the text of the Code. "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."  Law, slip op. at 5. 

The Court went on to observe that a number of lower courts have suggested that bankruptcy courts have a "general equitable power . . . to deny exemptions based on a debtor's bad-faith conduct." Id. at 9. Such a power, if it existed, would be highly analogous to the authority to disallow a creditor's otherwise valid claims on account of the creditor's bad faith conduct. But the Supreme Court made clear that there is no such power. "For the reasons we have given, the Bankruptcy Code admits no such power. . . .  [F]ederal law provides no authority for bankruptcy courts to deny an exemption on a ground not specified in the Code." Id. at 9-10.

This reasoning is likely to sound the death knell for the remedy of "equitable disallowance." As the Court said, "whatever other sanctions a bankruptcy court may impose on a dishonest debtor, it may not contravene the express provisions of the Bankruptcy Code by ordering that the debtor's exempt property be used to pay debts and expenses for which that property is not liable under the Code." Id. at 12. Because essentially the same thing can be said of the power to "equitably disallow" the claim of a dishonest creditor-which claims the Code says may be equitably subordinated without any mention of equitable disallowance-the reasoning of Law strongly supports the conclusion that equitable disallowance simply does not exist under the Bankruptcy Code.

Moreover, while it is the unusual case in which the question of "equitable disallowance" is significant-after all, the statutory remedy of equitable subordination will typically be sufficient to leave a creditor without any economic recovery except in cases in which all other valid creditors receive payment in full-the approach taken by the unanimous Court to the statutory question is highly instructive. Many bankruptcy appeals involve circumstances in which a bankruptcy court's judgment about sound bankruptcy policy may be difficult to square with the clear command of the Bankruptcy Code. Law v. Siegel makes clear that in such circumstances, where Congress has addressed the issue, the language of the Code must prevail.

1See Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 549 U.S. 443, 450 (2007) (if a claim is valid under non-bankruptcy law, "the court 'shall allow' the claim 'except to the extent that' the claim implicates any of the nine exceptions enumerated in § 502(b)").

2 See, e.g., Harbinger Capital Partners LLC v. Ergen (In re LightSquared, Inc.), --- B.R. ---, 2013 WL 6140717 (Bankr. S.D.N.Y. Nov. 21, 2013); In re Mobile Steel Co., 563 F.2d 692, 699 (5th Cir. 1977) (noting "equitable considerations can justify only the subordination of claims, not their disallowance").

3 See, e.g., Adelphia Recovery Trust v. Bank of America, 390 B.R. 64 (S.D.N.Y. 2008) (affirming bankruptcy court's denial of motion to dismiss claim for equitable disallowance); In re Adelphia Communications Corp., 365 B.R. 24 (Bankr. S.D.N.Y. 2007) (denying motion to dismiss and concluding that equitable disallowance is permissible); In re Washington Mutual, Inc., 461 B.R. 200 (Bankr. D. Del. 2011) (denying motion to dismiss and concluding that bankruptcy court has the authority to disallow claim on equitable grounds), vacated upon settlement of parties, 2012 WL 1563880 (Bankr. D. Del. Feb. 24, 2012).

4 See, e.g., Adelphia Recovery Trust v. Bank of America, 390 B.R. at 74 n.13. The district court in Adelphia ultimately held that the litigation trust's equitable disallowance claims were barred by the plan's payment of claims in full, and the Second Circuit affirmed. See Adelphia Recovery Trust v. Bank of America, N.A., 390 B.R. 80 (S.D.N.Y. 2008), aff'd 379 Fed. App'x 10 (2d Cir. 2010).

5 WilmerHale represented the National Association of Consumer Bankruptcy Attorneys as amicus curiae in Law v. Siegel, filing a brief that argued (as the Court concluded) that the general authority provided in Section 105(a) of the Bankruptcy Code could not override the clear statutory language. The firm also represented a number of financial institutions as defendants in the Adelphia litigation cited above, arguing that the Bankruptcy Code does not provide for the remedy of equitable disallowance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Herrick, Feinstein LLP
Herrick, Feinstein LLP
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Herrick, Feinstein LLP
Herrick, Feinstein LLP
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions