Surcharge of Exempt Assets - Failure to Disclose and Dissipation of ...

On May 11, 2007, the court in In re Mazon, ___ B.R. ___, 2007 WL 1437370 (Bkrtcy.M.D.Fla.)(Williamson, J.) issued its decision on an issue on which [t]here is no Eleventh Circuit Court of Appeals case or any Florida case - either bankruptcy court or district court..." But the court noted that other courts around the country have had the occasion to consider the issue - the issue being whether a trustee should be permitted to surcharge exempt property in exceptional circumstances such as where there has been a material failure to disclose estate assets that are subsequently dissipated. The court concluded that pursuant to its authority under section 105 and its inherent powers, it may equitably surcharge statutorily exempt property where the debtor has failed to schedule and turn over estate assets, but could not equitably surcharge an exempt Florida homestead unless the estate assets can be traced into the acquisition of an interest in the homestead.

The court noted that the only explicit reference to a right to surcharge in the bankruptcy code is found in section 506(c), but that this section is limited to a trustee's right to recover the reasonable and necessary costs and expenses of preserving or disposing of property securing a claim to the extent that the secured claimant has benefits. Section 506(c) states that "[t]trustee may recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving, or disposing of, such property to the extent of any benefit to the holder of such claim."

The court noted that although the bankruptcy code does not explicitly provide for the remedy of surcharge against a debtor's exemptions, that bankruptcy judges have broad authority to prevent abuse of process pursuant to section 105 which authority was recently reaffirmed by the Supreme Court in Marrama v. Citizens Bank of Massachusetts, ___ U.S. ___ (2007). Furthermore as noted in Marrama, even if section 105(a) had not been enacted, every federal court possesses the inherent power to sanction abusive litigation practices which may provide an adequate justification for a remedy when faced with a debtor's active misconduct to take advantage of the bankruptcy systems for improper purposes as occurred in Marrama and has occurred in the case before the court. The court also noted that the Supreme Court has also recognized that bankruptcy courts have long relied upon their inherent equitable powers in passing on and preventing "a wide range of problems arising out of the administration of bankruptcy estates." Pepper v. Litton, , 308 U.S. 295 (1939). Accordingly, the court surcharged the assets that the debtors had claimed as exempt under Florida statutory exemptions. These assets included the debtors' 401k retirement accounts and the cash value of a life insurance policy.

The court found though that Florida law does not permit or authorize a surcharge against the debtors' constitutionally allowed homestead exemption. The court based its decision on Havoco of America, Ltd. v. Hill, 790 So. 2d 1018 (Fla.2001) in which the Florida Supreme Court at the request of the Eleventh Circuit Court of Appeals considered whether a debtor is entitled to Florida's homestead exemption when the debtor acquired the homestead using non-exempt funds with the specific intent to hinder, delay, or defraud creditors. The Florida Supreme Court answered the certified question in the affirmative and held that so long as the funds being used to pay down a mortgage or buy the homestead were not acquired by fraud or under egregious circumstances, the homestead exemption cannot be denied. The court in Havaco noted that article X, section 4 of the Florida Constitution expressly only provides for three narrow exceptions to the homestead exemption.

The court stated that the Trustee was essentially asking the court to impose an equitable lien against the debtors' homestead as a means to collect on the obligation of the debtors to turn over estate property. The court cited to In re Chauncey, 454 F.3d 1292 (11th Cir.2206) where the Eleventh Circuit Court of Appeals reaffirmed that an equitable lien may be imposed under Florida law only when money used to obtain an interest in the homestead property is obtained by fraud or egregious conduct. The focus then would be on how the money is obtained and no upon how is is used. Money lawfully obtained that is thereafter improperly used does not support the imposition of an equitable lien against homestead property. Under the facts of this case, the court held that an equitable lien or surcharge against the homestead were not appropriate as the money and property were not diverted to acquire the interest in the homestead.