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ESTOPPEL TO THE RESCUE: OBJECTIONS TO EXEMPTIONS ON THE BASIS OF BAD FAITH MAY SURVIVE LAW V. SIEGEL IN CALIFORNIA

On March 4, 2014, the Supreme Court of the United States struck down the Ninth Circuit's imposition of an equitable surcharge on the basis of bad faith against a debtor's exempt property in Law v. Siegel, 134 S.Ct. 1188 (2014). The Supreme Court held that the general equitable powers of Bankruptcy Code Section 105(a) did not provide authority for judge-made exemptions to explicit mandates of the Bankruptcy Code. The Supreme Court emphasized that "federal law provides no authority for bankruptcy courts to deny an exemption on a ground not specified in the Code," and that any basis for denial of a state law exemption must arise under state law. Id. at 1197-98. As a result of Law v. Siegel, a growing number of cases have held that bankruptcy courts lack the authority to disallow a debtor's claimed homestead exemption based on Section 105(a), whether indirectly by denying leave to amend, or directly by disallowing the exemption; therefore, effectively rendering an objection to claimed exemptions on the basis of bad faith a nullity.

All hope is not lost, however, given the recent decision of the Bankruptcy Court for the Central District of California in In re Lua, 529 B.R. 766 (Bankr. C.D. Cal. 2015). The court in Lua applied California state law to determine whether the debtor's claimed homestead exemption may be disallowed on equitable grounds and ultimately found that an amended homestead exemption could be disallowed under the doctrine of equitable estoppel. In Lua, the court reasoned that California courts have long recognized that equitable estoppel applies to homestead exemptions. Moreover, the concept of equitable estoppel is codified in California Evidence Code Section 623 and California Code of Civil Procedure 583.140. In order to invoke equitable estoppel under California law, a party must show: (a) a representation or concealment of material facts; (b) made with knowledge, actual or virtual, of the facts; (c) to a party ignorant, actually and permissibly, of the truth; (d) with the intention, actual or virtual, that the ignorant party act on it; and (e) that the party was induced to act on it.

In Lua, the debtor's schedule A listed a 30% interest in residential real property, describing the property as her husband's prior to marriage. The debtor exempted $75,000.00 of the equity in the property on her schedule C pursuant to Cal. Code Civ. Pro. Section 704.730(a)(1). At the debtor's meeting of creditors, the debtor testified that she did not have a prenuptial agreement with her husband and that earnings were used to pay all of the mortgage payments on the property. Approximately three months after the initial schedules were filed, the debtor filed amended schedules and indicated that she had no interest in the property other than "such community interest as may exist for the purposes of a divorce action." The debtor removed her claim of exemption in the property from her amended schedule C, and asserted exemptions in personal property assets instead. The trustee then determined that the property could be monetized and took action to move forward with administering the property. Three years after the case was filed, and two years and nine months after the amended schedules were filed, after the trustee investigated the property, initiated litigation to establish the estate's interest in the property, obtained orders for turnover of the property, employed a real estate broker to market the property, and reached a settlement with the husband to sell the property and pay creditors in full, the debtor again amended her schedules A and C to state that the debtor had a community interest in the property and exempt $100,000.00 of the equity in the property under Cal. Code Civ. Pro. Section 704.730.

Applying California equitable estoppel factors to the debtor's actions in Lua, the court found that: (a) not claiming a homestead exemption was a material fact because the value of the homestead exemption significantly affected the amount of equity available to pay administrative expenses and creditors of the estate; (b) the debtor acted with knowledge because she knew of her right to claim a homestead exemption and in fact did claim a homestead exemption in her initial schedules; (c) the trustee was ignorant to the truth as she had no knowledge or indication that the debtor would amend her schedules; (d) the debtor acted with intent given her failure to oppose any of the trustee's acts moving forward with the sale until the eleventh hour; and (e) the trustee was induced to act on behalf of all creditors by relying on the debtor's representation that she was not going to claim a homestead exemption.

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