Surcharging Exempt Assets

Palm Beach County Bar Association Bulletin, February 2008

Not all exempt assets can be kept from the hands of the chapter 7 bankruptcy trustee. Although there is no Eleventh Circuit Court of Appeals case on point, courts around the country, including a Middle District of Florida Bankruptcy Court, have considered whether a trustee should be permitted to surcharge exempt assets.

In In re Mazon, 368 B.R. 906 (Bankr. M.D. Fla. 2007), the debtors failed to disclose in their bankruptcy schedules non exempt assets valued at approximately $615,000.00. Further, after filing bankruptcy, the debtors dissipated those assets, therefore keeping them out of the trustee’s reach. Upon learning of the debtors’ misconduct, the chapter 7 trustee filed a motion to surcharge the debtors’ exempt assets, including their homestead property. The court agreed with the trustee that the debtors’ failed to schedule and turnover estate assets and therefore the trustee could equitably surcharge the debtors’ statutorily exempt property. The court, however, would not allow the surcharge to extend to the debtors’ constitutionally protected homestead property

The Mazon court did not surcharge the homestead property because none of the dissipated estate assets could be traced into the debtor’s homestead. The court found that in Florida, courts must separately consider whether a trustee is entitled to surcharge a debtor’s homestead exempt property, as opposed to statutorily exempt property, as a debtor’s homestead exemption enjoys a special place in the hierarchy of rights given to Florida citizens. Id. at 911, citing, Havoco of America, Ltd. vs. Hill, 790 So.2d 1018 (Fla. 2001). The court further pointed to the case of In re Chauncey, 454 F.3d 1292 (11th Cir. 2006) which reaffirmed that an equitable lien may only be imposed under Florida Law when money used to obtain an interest in the homestead property is obtained by fraud or egregious conduct. Id. at 912. In Mazon, the debtors lawfully obtained the money and property they failed to disclose and turnover.

Other cases throughout the country have addressed the ability of a chapter 7 trustee to surcharge exempt assets. For example, in Latman vs. Burdette, 366 F.3d 774 (9th Cir. 2004), just days before the filing of their bankruptcy petition, the debtors sold a car and a boat for $8,500.00. However, the debtors only scheduled cash on hand in the amount of $1,500.00 and were unable to account for the $7,000.00 balance. Accordingly, the trustee moved to surcharge the debtors’ exempt assets. The Ninth Circuit Court of Appeals upheld the trustee’s ability to equitably surcharge exempt assets because it was reasonably necessary to protect the integrity of the bankruptcy process and insured that a debtor did not exempt an amount greater than permitted by the Bankruptcy Code. Id. at 786. The Latman court stated that a surcharge of exempt assets does not hinge on a concealment of assets. It requires misconduct that would cause “fraud on the bankruptcy court and the debtor’s creditors.” Id. at 785.

In another Ninth Circuit Court of Appeals case, Onubah v. Zamora, 375 B.R. 549 (9th Cir. BAP 2007), the appellate court upheld the bankruptcy court’s decision to allow a chapter 7 trustee to surcharge a debtor’s exempt assets. In Onubah, the debtor did not conceal any assets. However, the debtor frustrated the trustee’s attempts to administer non-exempt proceeds generated upon the sale of the debtor’s residence by refusing to give up possession of the residence and by converting his case to a chapter 11, even though he had no ability to fund a plan. Id. The court found that the surcharge was necessary to compensate the estate for the actual damage inflicted by Onubah’s misconduct. Id. at 556.

Other courts have held likewise. See for example, Scrivener vs. Mashburn, 370 B.R. 346 (10th Cir. BAP 2007) wherein the bankruptcy court allowed a surcharge on exempt assets based upon the debtor’s failure to turnover non-exempt royalties that were property of the estate; and In re Karl, 313 B.R. 827 (Bankr. W.D. Mo. 2004) in which the bankruptcy court surcharged an exempt asset because of the debtor’s failure to turn over to the estate a non-exempt truck.

In summary, honest and straightforward debtors should not fear that their exempt assets will be surcharged. However, if debtors conceal and dissipate assets or participate in misconduct which damages the estate, they are putting their exempt assets at risk as a result of the chapter 7 trustee’s ability to surcharge exempt assets.