In its first bankruptcy decision of 2014 (October Term, 2013),
the U.S. Supreme Court held on March 4, 2014, in Law v.
Siegel, No. 12-5196 (Mar. 4, 2014) (available at http://www.supremecourt.gov/opinions/13pdf/12-5196_8mjp.pdf),
that a bankruptcy court cannot impose a surcharge on exempt
property due to a chapter 7 debtor's misconduct, acknowledging
that the Supreme Court's decision may create "inequitable
results" for trustees and creditors.
In reversing a ruling by the Ninth Circuit Court of Appeals,
Law v. Siegel (In re Law), 2011 BL 148411 (9th Cir. June
6, 2011), cert. granted, 133 S. Ct. 2824 (2013), the
Supreme Court concluded that the bankruptcy court overstepped the
bounds of its statutory authority (under section 105(a) of the
Bankruptcy Code) and inherent authority when it imposed a $75,000
surcharge on the debtor, who engaged in litigation misconduct by
falsely claiming, in an effort to defraud creditors, that his
California homestead was encumbered by a lien securing a $168,000
purchase money loan provided by a personal friend. Litigation
concerning the fabricated lien and the debtor's "egregious
misconduct" caused the bankruptcy estate to incur $450,000 in
legal fees and related expenses.
Writing for a unanimous Court, Justice Antonin Scalia reasoned
that "[a] bankruptcy court may not exercise its authority to
'carry out' the provisions of the Code, or its
'inherent power . . . to sanction abusive litigation
practices,' by taking action prohibited elsewhere in the
Code."
According to Justice Scalia, the bankruptcy court's surcharge
contravened section 522 of the Bankruptcy Code, which gave the
debtor the right to use California's "homestead
exemption" to exempt $75,000 of equity in his home from the
bankruptcy estate.
Justice Scalia acknowledged that the Supreme Court's ruling
may cause bankruptcy trustees and creditors to shoulder greater
costs in fighting allegedly fraudulent claims. However, he wrote,
"it is not for courts to alter the balance struck by the
statute." Moreover, he explained, ample authority remains to
address debtor misconduct, including denial of discharge under
section 727(a); sanctions for bad-faith litigation conduct under
Rule 9011 of the Federal Rules of Bankruptcy Procedure, section
105(a), or a bankruptcy court's inherent powers; enforcement of
monetary sanctions through the procedures set forth in section
727(b) for collecting money judgments; and possible prosecution for
bankruptcy crimes under 18 U.S.C. § 152.
On March 25, 2014, the Supreme Court ruled in U.S. v. Quality
Stores, Inc., No. 12-1408, 2014 BL 80719 (Mar. 25, 2014),
available at http://www.supremecourt.gov/opinions/13pdf/12-1408_6468.pdf,
that severance payments made to employees who were involuntarily
terminated prior to and during an agricultural retailer's
chapter 11 case pursuant to plans which did not tie payments to the
receipt of state unemployment insurance are taxable under the
Federal Insurance Contributions Act ("FICA").
Prior to filing for bankruptcy and continuing afterward pursuant
to a court-approved bonus plan, Quality Stores, Inc.
("Quality") paid more than $10 million in severance pay,
for which it made the required contributions under FICA. Quality
later sought a refund of the tax payments, claiming that the
severance pay should be exempt from FICA taxes.
After the Internal Revenue Service ("IRS") failed to
respond to the refund request, Quality asked the bankruptcy court
to rule on the issue. The IRS argued that the severance pay met the
definition of "wages" for FICA purposes. Quality
countered that the payments were made after employment ended and
therefore should not be considered wages for work.
The bankruptcy court, a district court, and the Sixth Circuit
Court of Appeals all ruled in Quality's favor. See Quality
Stores, Inc. v. United States (In re Quality Stores, Inc.),
383 B.R. 67 (Bankr. W.D. Mich. 2008), aff'd, 424 B.R.
237 (W.D. Mich. 2010), aff'd, 693 F.3d 605 (6th Cir.
2012). Other circuits, however, have concluded that at least some
severance payments do constitute wages subject to FICA tax. See
CSX Corp. v. United States, 518 F.3d 1328 (D.C. Cir. 2008);
University of Pittsburgh v. United States, 507 F.3d 165
(3d Cir. 2007); North Dakota State Univ. v. United States,
255 F.3d 599 (8th Cir. 2001).
The Supreme Court reversed the Sixth Circuit's ruling in
Quality Stores. Writing for a unanimous court (with
Justice Kagan taking no part in the consideration or decision),
Justice Kennedy explained that: (i) "[a]s a matter of plain
meaning," severance payments fit the definition of
"wages" under FICA because "[t]hey are a form of
remuneration made only to employees in consideration for
employment"; and (ii) the provisions of the Internal Revenue
Code (see 15 U.S.C. §§ 3401(a) and 3402(o))
governing income-tax withholding do not limit the meaning of
"wages" for FICA purposes.
The ruling may have a significant impact on the future
implementation of severance-pay plans for companies undergoing
restructuring in or outside bankruptcy.
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