Laura B. Bartell, the Peripatetic Debtor: Choice of Law and Choice of Exemptions

• Jurisdiction: United States,Federal
• Publication year: 2011
• Citation: Vol. 22 No. 2

THE PERIPATETIC DEBTOR:

CHOICE OF LAW AND CHOICE OF EXEMPTIONS

Laura B. Bartell^*

We live in a mobile society. Every year, more than fourteen million U.S. residents move.¹Of these, about nineteen percent migrate to a different state, up from only sixteen percent in 1994.²When a citizen of one state moves to another, he or she becomes subject to the laws of the new state to the same extent as one who has resided in the new jurisdiction all of his or her life. This general principle, however, is not necessarily applicable to the new state's exemptions laws if the relocating person becomes a debtor in bankruptcy. Under Sec. 522(b)(3)(A) of the U.S. Bankruptcy Code ("Code"), if the debtor has not been domiciled in the same state for the 730 days immediately preceding the filing date of the bankruptcy petition, the new state's exemption laws may not apply to the debtor.³Instead, Congress has directed the applicable exemptions for those recently relocated debtors who may or must be governed by state (as opposed to federal) exemptions⁴are the exemptions established by the law of their former domicile rather than their new one.⁵

But what happens when the state whose exemption laws apply according to the Code either (1) embraces choice of law principles that would make its exemption laws inapplicable to the foreign debtor or (2) has substantive limitations in its exemption laws that preclude the foreign debtor from taking advantage of them (a situation that has been described as "functionally restrictive substantive rules"⁶)? Did Congress intend to allow a state to reject application of its exemptions to the foreign debtor?

In Part I of this Article I will explore at the development of the exemption provision in federal bankruptcy law and the policy underlying the federal/state law dichotomy. In Part II, I will review traditional choice of law doctrine with respect to the selection of applicable law in inter-state disputes. Part III examines the efforts of federal bankruptcy courts to handle the choice of law problems created by Sec. 522(b)(3) of the Code and suggests that applying general choice of law principles would steer them towards interpreting federal bankruptcy law, rather than state law, to resolve the issues. In the final Part, I discuss how the language of Sec. 522(b) supports the conclusion that Congress intended to incorporate state exemption laws without any substantive limitations on their applicability. I further suggest Congress has failed to resolve the issue adequately in the 2005 amendments to the Code,⁷even if

Congress intended to ignore traditional choice of law principles that would permit it to override limitations on the applicability of that state law.

I. CONGRESSIONAL TREATMENT OF EXEMPTIONS

Excluding some property from the reach of creditors historically has been justified on two principal grounds.⁸First, it has been seen as a way of ensuring the debtor had property necessary to continue to be a productive member of society, i.e., financial rehabilitation.⁹Therefore, early exemption laws protected tools of the trade (those tools and implements necessary for carrying on a trade or business).¹⁰As the economy expanded, exemptions came to represent a broader humanitarian goal of protecting debtors and their dependents from destitution.¹¹Of course, there was an economic justification for this goal as well. Those residents who were completely without resources would require financial assistance from the state.¹²By preventing creditors from taking all available property from the debtor, exemptions shifted the cost of maintaining the debtor from the state onto the creditors.¹³

The earliest U.S. bankruptcy laws, the Acts of 1800¹⁴and 1841,¹⁵contained their own lists of limited uniform bankruptcy exemptions. State law exemptions were not recognized.¹⁶The Act of 1867,¹⁷which was repealed in

1878, also included federal exemptions for apparel of the bankrupt, his wife, and children, as well as household and kitchen furniture and other articles and necessaries not exceeding $500 in value.¹⁸The Act of 1867, however, took a new approach allowing the bankrupt to exempt any other property specified under the state exemption laws of the bankrupt's domicile at the time of the commencement of bankruptcy proceedings in an amount not exceeding the amount allowed under those laws as in effect in 1864.¹⁹

The first permanent U.S. bankruptcy law, the Bankruptcy Act of 1898, went even further, eliminating federal exemptions entirely.²⁰Instead, section 6 of the Act explicitly stated:

This Act shall not affect the allowance to bankrupts of the exemptions which are prescribed by the State laws in force at the time of the filing of the petition in the State wherein they have had their domicile for the six months or the greater portion thereof immediately preceding the filing of the petition.²¹

The approach was controversial. In Hanover National Bank v. Moyses,²²the U.S. Supreme Court rejected the contention that, in failing to provide uniform federal exemptions, Congress had acted beyond its power to enact a "uniform" system of bankruptcy law under the Bankruptcy Clause to the U.S.

Constitution ("Bankruptcy Clause").²³The Court concluded creditors were not harmed because they "contracted with reference to the rights of the parties thereto under existing [state] exemption laws,"²⁴and the uniformity required by the Constitution was "geographical, and not personal."²⁵Thus, the decision of Congress to incorporate state exemption law was found constitutionally permissible because it uniformly gave all creditors access to exactly that property they could have reached outside of bankruptcy.²⁶When the Act was amended in 1938, section 6 was amended only slightly and did not change the deference to state law.²⁷

Many commentators criticized the incorporation of state exemption laws into the federal bankruptcy case,²⁸noting state law exemptions were not enacted with bankruptcy liquidation in mind;²⁹were in many cases so antiquated as to conflict with the fresh start policy of federal bankruptcy laws;³⁰and were nonuniform, providing dramatically different treatment of debtors who lived in different states but were similar in all other respects.³¹

Their arguments proved persuasive to the Commission on the Bankruptcy

Laws of the United States ("Commission"), which recommended in its 1973

Report that uniform federal bankruptcy exemptions be adopted.³²As the

Commission stated, "[b]y eliminating the reference to nonbankruptcy law much litigation and considerable inequity due to state procedural requirements are avoided. Questions as to the applicable law, its scope, and whether a law provides an exemption within the meaning of section 6 of the Act are mooted."³³

An alternative approach advocated by the National Conference of Bankruptcy Judges became the basis of a bankruptcy bill in the House of Representatives.³⁴The bill provided federal exemptions, but would have allowed debtors to elect either the federal exemptions or those provided by the state of the debtor's domicile.³⁵

The law as enacted rejected the Commission's approach, which proved politically unpalatable, and adopted a last minute compromise³⁶between the exemption scheme proposed by the National Conference of Bankruptcy Judges (endorsed by the House³⁷) and the limitation to state exemption law contained in the Bankruptcy Act (proposed by the Senate³⁸). Although Congress included federal exemptions in the new Code and provided the debtor the option to elect the federal exemptions or the applicable state exemptions as the House bill had provided, Congress inserted a new provision consistent with the

Senate bill that permitted each state to enact a law making the federal exemptions unavailable to its residents.³⁹As a result, under current

Sec. 522(b)(2) of the Code, the debtor has a choice between federal and state exemptions unless the applicable state law "specifically does not so authorize"⁴⁰the so-called "opt-out" provision.⁴¹The opt-out provision has attracted substantial academic criticism,⁴²and uniform federal exemptions were proposed once again by the Commission in its 1997 Report.⁴³However, the political realities that doomed the same proposal when made by the Commission on the Bankruptcy Laws of the United States in 1973 killed the

1997 proposal as well;⁴⁴the opt-out provision remained in the 2005 amendments to the Code.⁴⁵

Because the opt-out clause was drafted quickly,⁴⁶it provides no guidance on the scope of the state's power to regulate with respect to exemptions when the state has exercised its right to confine its residents to those exemptions. The language of the statute does not tell us what Congress meant when it provided that exempt property is "any property that is exempt under . . . State or local law that is applicable on the date of the filing of the petition."⁴⁷To interpret this phrase (and the issue is one of statutory interpretation), we must look to general choice of law principles for guidance.

II. CHOICE OF LAW PRINCIPLES

There are many situations in modern life when the facts giving rise to litigation could lead to the application of the laws of more than one jurisdiction. The constitutional constraints on the applicability of a particular state's laws are limited. The state whose substantive law is applied to the dispute "must have a significant contact or significant aggregation of contacts, creating state interests, such that choice of its law is neither arbitrary nor fundamentally unfair."⁴⁸

For a debtor who has moved within the 730 days prior to bankruptcy, either the state in which he or she is currently residing or the state from which he or she moved could be seen as having the requisite state interest in applying its exemption laws to the debtor's bankruptcy. The state in which the debtor is newly settled has an interest in ensuring its residents retain the property specified in its exemption statutes as they emerge from bankruptcy so they...