By: Elizabeth H. Shumejda
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
Broadly construing section 105(a) of the Bankruptcy Code (the “Code”), the First Circuit, in Malley v. Agin, upheld a surcharge against the value of an otherwise exempt asset as an appropriate remedy for a chapter 7 debtor’s fraudulent concealment of assets.[1] The debtor intentionally failed to disclose $25,000 in assets, which violated his specific disclosure obligations under section 521 of the Code, as well as his general obligation to be forthright and honest with the court.[2] The bankruptcy court sanctioned the debtor by denying the debtor’s discharge pursuant to section 727 of the Code.[3] In addition, the bankruptcy court used its general equitable powers under section 105(a) to surcharge the concealed amount, plus the cost of untangling the fraud, against the value of an otherwise exempt asset—a truck used in the debtor’s business.[4] On direct appeal to the First Circuit, the debtor challenged the bankruptcy court’s surcharge order on the grounds that it exceeded the court’s equitable power under section 105(a).[5]
The First Circuit upheld the bankruptcy court’s surcharge order as a proper exercise of its discretionary powers under section 105(a), which grants bankruptcy courts the power to issue any order that is “necessary or appropriate to carry out the provisions” of the Code.[6] Specifically, the First Circuit upheld the surcharge as “an appropriate and necessary way to vindicate” key provisions of the Code, specifically section 521, requiring full and honest disclosure by a debtor of its assets.[7] Although the Code enumerates certain remedies for debtor misconduct, such as denial of discharge, the First Circuit reasoned that these enumerated remedies did not effectively redress the debtor’s fraudulent concealment of assets.[8] While denying the debtor’s discharge would punish the debtor, the surcharge order was necessary to restore the value of the property wrongfully concealed by the debtor to the estate, thus adding something “to the pot for listed creditors, who would otherwise bear the brunt of the fraud.”[9] Therefore, the First Circuit concluded that the surcharge order issued pursuant to section 105(a) was necessary “both to protect the integrity of the bankruptcy process and to ensure that a debtor exempts an amount no greater than … the Bankruptcy Code [permits].”[10]
To date, only three circuit courts have explicitly addressed the extent of a bankruptcy court’s discretion and authority under section 105(a) in the context of surcharge orders.[11] In Malley v. Agin, the First Circuit joined the Ninth Circuit in adopting a broad interpretation of section 105(a). Both circuits have held that section 105(a) provides a bankruptcy court with the authority to craft an equitable remedy in furtherance of the underlying intent and purpose of a specific provision of the Code.[12] In so doing, the First Circuit rejected the rationale of In re Scrivner. In that case, the Tenth Circuit took a restrictive view of section 105(a) and held that bankruptcy courts may not create remedies—such as surcharge—that are not specifically identified in the Code as a remedy for debtor misconduct.[13] In contrast, the First Circuit noted that the Supreme Court recently adopted an expansive interpretation of section 105(a) in Marrama v. Citizens Bank of Massachusetts that appears to support the result in this case.[14] These decisions illustrate the fundamental disagreement over the meaning of section 105(a) and how much discretion it affords the bankruptcy courts.
[1] 693 F.3d 28 (1st Cir. 2012).
[2] See 11 U.S.C. § 521 (2006) (requiring honest disclosure by debtor of non-exempt assets); Malley, 693 F.3d at 29.
[3] See 11 U.S.C. § 727(a)(2) (“The court shall grant the debtor a discharge, unless … the debtor, with intent to hinder, delay, or defraud a creditor … has transferred, removed, destroyed, mutilated, or concealed … property of the estate”); Malley, 693 F.3d at 29.
[4] See 11 U.S.C. § 522 (regulating determination of legitimate exemptions for debtor’s benefit); Malley, 693 F.3d at 29.
[5] See Malley, 693 F.3d at 28. The debtor claims that the court is limited to issuing orders that carry out specific “provisions” of the Code. Id. at 29. The debtor relied on 11 U.S.C § 522(c), which provides that, absent a dismissal of the case, property exempted under that section is not liable during or after the case for any pre-petition debt of the debtor. Id. The First Circuit found this argument unpersuasive, reasoning that if it were to continue to recognize that a debtor’s asset were exempt under this section, it would amount to “fraud on creditors by giving the debtor a greater exemption in fact that the code entitles him to claim in law.” Id.
[6] See id. at 30; 11 U.S.C. § 105(a) (“The court may issue any order . . . that is necessary or appropriate to carry out the provisions of this title. No provision of this title . . . shall be construed to preclude the court from . . . taking any action or making any determination necessary or appropriate . . . to prevent an abuse of process.”).
[7] “We naturally suppose that Congress intended bankruptcy courts to be able to enforce the ‘provisions’ requiring honest disclosure on the part of the debtor, see § 521, and placing limits on exemption claims, see § 522.” Malley, 693 F.3d at 29.
[8] See id. at 30.
[9] See id.
[10] See id. (citing Latman v. Burdette, 366 F.3d 774, 786 (9th Cir. 2004)). “There could not be a clearer example of foiling abuse of process than a surcharge order mitigating the effect of fraud in retaining non-exempt assets.” Id.
[11] See id.; Scrivner v. Mashburn (In re Scrivner), 535 F.3d 1258 (10th Cir. 2008); Latman, 366 F.3d at 786.
[12] The Code establishes an equitable distribution scheme that divides property between a debtor and his creditors according to the Code’s two overarching policies: to provide a fresh start for the honest but unfortunate debtor and to provide for the fair and equitable distribution of non-exempt property to creditors. See Latman, 366 F.3d at 786 (concluding that debtor’s fraudulent concealment of non-exempt assets is an exceptional circumstance in which surcharge order is necessary). “If § 105(a) was not meant to empower a court to issue an order like the one before us, it is hard to see what use Congress had in mind for it.” Malley, 693 F.3d at 30.
[13] In re Scrivner, 535 F.3d at 1264 (concluding that statutory enumeration excludes what is left out).
[14] See Malley, 693 F.3d at 30 (citing to Marrama v. Citizens Bank of Mass., 549 U.S. 365, 374–75 (2007) (applying section 105(a) in holding that a chapter 7 debtor who fraudulently concealed assets did not have an absolute right to convert his case to one under chapter 13)).
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