Bankruptcy Exemptions and “The Price is Right”

Bankruptcy exemptions are a privilege belonging to individual debtors in bankruptcy cases. An exemption permits a debtor to shield property that a trustee might otherwise take to pay creditors. Most, but not all exemptions are subject to dollar limits (e.g., a debtor may exempt $3,450 in one motor vehicle, 11 U.S.C. § 522(d)(2)). Under the Federal exemption scheme, a debtor also has a “wildcard exemption” of $1,150, that can be amplified by the unused portion of the debtor’s homestead exemption up to $10,825. The wildcard exemption can be applied to protect any interest of a debtor in property.

Often, debtors face difficult valuation questions for certain assets. What is the value of a one-third interest in a nascent business? How much is a gas lease worth when the lessee has not begun production and the debtor does not know when she will receive royalties or how much those royalties will be?

In 2010, the United States Supreme Court decided that a debtor’s exemption is limited to the dollar amount scheduled (even when the scheduled value and the value of the exemption are equal). Schwab v. Reilly, 130 S. Ct. 265 (2010). Thus, in the context of a gas lease, if production begins after a case is commenced and the debtor exempted $1.00 of her interest under the lease, she could find the royalties in excess of $1.00 are subject to claims by her creditors or a bankruptcy trustee. The Schwab case involved a debtor that understated the value of an asset but argued that, since the exempted value was equal to the scheduled value, the asset was no longer within the reach of the debtor’s creditors. The Court disagreed and limited the value of the exemption to the amount the debtor actually claimed exempt. The United States Court of Appeals for the Third Circuit recently ruled that Schwab was not limited to cases in which debtors purposefully understated the value of assets in order to protect more property than envisioned by the exemptions scheme. In re Orton, No. 11-4157 (3d Cir. Jul. 20, 2012). Rather, debtors are stuck with the value of their claimed exemptions. Therefore, even when a debtor puts a good faith estimate on the value of the asset and exempts the property up to that value, future appreciation (think of the gas well that starts producing after the debtor claims exemptions) in excess of the claimed exemption inures to the benefit of the debtor’s creditors.

Debtors and their bankruptcy lawyers are now forced to play a game of “The Price is Right” with assets. The Schwab and Orton decisions mean that, more than ever, it is important to develop a well-considered bankruptcy strategy with your bankruptcy lawyer.

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