Stephen Law, the chapter 7 debtor in this case, attempted to shield the equity in his home by claiming that the property was subject to a fictional lien. Indeed, Law went to great lengths to establish the validity of the false mortgage, including recording a forged deed of trust and filing forged pleadings in the name of the fictional lienholder. In order to combat and reveal Law's fraudulent conduct, the chapter 7 trustee, Alfred H. Siegel, incurred over $500,000.00 in legal fees. Acknowledging the impropriety of Law's conduct in this case, the bankruptcy court granted Siegel's motion requesting to surcharge Law's $75,000.00 homestead exemption to pay for a portion of these fees. On appeal, the Ninth Circuit Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals affirmed, both courts citing Ninth Circuit precedent authorizing bankruptcy courts to use their equitable powers to compensate the bankruptcy estate in exceptional circumstances of debtor misconduct.
Justice Scalia began his discussion by acknowledging the powers of bankruptcy courts to issue orders necessary to carry out the provisions of the Bankruptcy Code and to sanction litigation misconduct. He cautioned, however, "in exercising those statutory and inherent powers, a bankruptcy court may not contravene specific statutory provisions.
Section 522(k) of the Bankruptcy Code provides that "[p]roperty that the debtor exempts under this section is not liable for payment of any administrative expense except" under specific circumstances not relevant in the context of debtor misconduct. Finding that Siegel's legal fees were "indubitably an administrative expense," Justice Scalia found that the surcharge of Law's homestead exemption ordered by the bankruptcy court in this case was squarely prohibited by section 522(k).
The Court recognized that this ruling "may produce inequitable results for trustees and creditors in other cases," but reiterated, "it is not for courts to alter the balance struck by statute." The Court did not fail to mention, though, the other courses of action available to punish debtor misconduct, including denial of discharge and sanctions under Federal Rule of Bankruptcy Procedure 9011.