Pro Bono Spotlight: Katzen & Schuricht aim to preserve important bankruptcy law principle

Can you please provide a summary of the issue that caused you to get involved?

David Katzen (DK): In Wolfe v. Jacobson (In re Jacobson), 2012 U.S. App. LEXIS 8103 (9th Cir. Apr. 23, 2012), the Ninth Circuit Court of Appeals held that bankruptcy debtors who successfully asserted a homestead exemption nevertheless lost the protected layer of value (here, $150,000), because a judgment creditor forced a postpetition execution sale of the house, and the debtors failed to reinvest their share of the proceeds in a new dwelling within six months.  The court effectively reasoned that whenever a California exemption is allowed in a bankruptcy case, the debtor’s right to postpetition proceeds from the exempt value is subject to California’s time-limited protection of proceeds.

Why was this issue important?

DK: Although the circumstances in Jacobson weren’t commonplace, postpetition sales of exempt property are hardly unusual.  The ruling could jeopardize bankruptcy debtors’ ability to retain ostensibly exempt proceeds from a sale by a bankruptcy trustee, by a secured party, or by the debtors themselves.  As an example of the mischief wrought, the trustee in an unrelated case—who had sold an older couple’s high-equity home, realizing several hundred thousand dollars for the estate but giving the debtors their $175,000 exempt share—has now reportedly demanded that they return that cash in reliance on the Jacobson holding; we’re told these debtors hadn’t even tried to reinvest in another house, because they need the cash for ongoing subsistence and medical expenses.  As a matter of logic, the problem of a lapsing proceeds exemption could also arise from the postpetition sale of a vehicle, of exempt “tools,” or of household or personal items.

What caused you to step in and provide pro bono work when you did?

DK: In our view, the Ninth Circuit’s ruling is unsound both because it conflicts with prior circuit precedent and because it mistakenly “imports” state law to determine not merely what can be claimed as exempt in bankruptcy but also the effect of an allowed bankruptcy exemption.  If exempt value is understood as “withdrawn” from the bankruptcy estate, as the weight of authority indicates, then there is no basis for proceeds from this reclaimed value to somehow be pulled back into the estate.  Further, with limited exceptions, Bankruptcy Code § 522(c) provides that exempt property is “not liable” for prepetition debts either “during or after” the bankruptcy case.  Thus, we think the value of exemptions allowed in bankruptcy is permanently allocated to the debtor’s “fresh start,” as a matter of federal law.  Finally, it is perverse to use a California interval-limited proceeds shield—which is almost certainly designed to help debtors who have no other refuge—as a sword to cut off their rights under bankruptcy law.  The Ninth Circuit’s opinion did not address any of these points.

To avert the harm to bankruptcy law and debtors posed by the opinion, the Jacobsons had to seek rehearing promptly—when we first learned of the decision on May 2 (only because Marlene Weinstein spotted it in the Daily Journal that day and called it to our attention), the deadline to file a petition was a scant five days off.  However, the Jacobsons had no funds, and their appellate counsel did not expect to soldier on uncompensated.  Fortunately, with that lawyer’s cooperation, the debtors authorized Katzen & Schuricht to petition for rehearing.  K&S undertook the project on a pro bono basis, because we feared that the initial ruling could be quite destructive, and our stepping in immediately appeared to be the best (if not the only plausible) way to restore equilibrium and preserve important principles of bankruptcy law.

What work did you provide?

DK: Within the short time available, K&S conducted legal research, drafted a petition for rehearing, then filed it with the Ninth Circuit Court of Appeals.

What do you hope your efforts will achieve?

DK: Ideally, the Ninth Circuit will grant rehearing, vacate its initial opinion, and issue a new decision holding that allowance of the Jacobsons’ homestead exemption removed the exempt layer of value from their bankruptcy estate and that—notwithstanding California’s circumscribed window for reinvestment—Bankruptcy Code § 522(c) generally immunizes identifiable postpetition proceeds from any exempt property interest against collection on prepetition debts forever.

When do you expect to hear the results of your efforts?

DK: On May 10, the Ninth Circuit directed the trustee, who prevailed in the court’s first opinion, to file a response to our petition for rehearing within 21 days.  We assume the court will consider that submission and whether further oral argument is warranted, and then either set a date for another round of argument or just rule on the briefs.  Though we cannot say for sure, we suspect that a favorable disposition would be forthcoming within the next six months.  (An adverse outcome might be a lot quicker, but we’re in no rush!)

What would you say to other attorneys who are considering providing pro bono work?

DK: Every once in a while, there’s a chance to participate in potential “impact litigation” where the lawyer’s commitment of resources is reasonably circumscribed, rather than open-ended.  If the cause is right, this is an ideal context for a pro bono undertaking.

David Katzen practices with Katzen & Schuricht in Walnut Creek and has concentrated on representing parties in the insolvency context for over 30 years.  He is recognized by the State Bar of California Board of Legal Specialization as a Certified Specialist in Bankruptcy Law and is also Board Certified in Business Bankruptcy Law by the American Board of Certification.