State Exemption Need Not Specify that it Applies in Bankruptcy

Posted by NCBRC - December 31, 2019

Reversing the courts below, the Seventh Circuit found that unpaid vacation wages that were exempt under state law were also exempt under bankruptcy law notwithstanding the lack of explicit reference to bankruptcy in the state statute. In re Burciaga, No. 19-2246 (7th Cir. Dec. 13, 2019).

The debtor filed for bankruptcy shortly after losing his job and at a time that his employer owed him $24,000 in unused vacation pay. The debtor sought to exempt 85% of the unpaid vacation time under an Illinois law which allows creditors to reach only 15% of unpaid wages. It was undisputed that Illinois law treats vacation time as wages. The trustee objected to the exemption arguing that there was no suggestion that the state legislature intended the exemption to apply in the federal bankruptcy context. The bankruptcy court sustained the objection, and the district court, agreeing with the trustee’s position, affirmed.

On appeal, the Seventh Circuit described the district court’s reasoning that “Illinois did not ‘intend’ to exempt vacation pay from creditors’ claims in bankruptcy, as exemplified by the fact that the state’s statutes do not specifically mention bankruptcy law,” as unfortunate. The court noted that section 522(b)(2) and (3)(A) applies state law in bankruptcy without regard to what state legislatures may have intended with respect to the issue. In the bankruptcy context when state exemptions are applicable, the court need only determine whether an asset would be exempt under state law. It is the operation of federal law that renders the exemption applicable in bankruptcy.

The court held that, because state law exempts unpaid wages, including vacation pay, that exemption carries over to the bankruptcy context. That is true notwithstanding hypothetical inequities such as the possibility of a debtor with large unpaid severance pay at the time of bankruptcy benefiting from the exemption to withhold vast amounts from creditors, or the fact that the exemption applies only to unpaid wages, thereby rendering timing of bankruptcy filing crucial to how much creditors are able to receive. The circuit court found that bankruptcy is clear that exemptions are established at the time of the petition and it is Congress’s role, not the role of the courts, to change it. “[T]he Bankruptcy Code is what it is and cannot be overridden in the name of equity.”

The court noted that its holding contradicted its earlier holding in Wienco, Inc. v. Scene Three,

Inc., 29 F.3d 329 (7th Cir. 1994), but found that Wienco dealt with a slightly different exemption statute which was clarified after the decision became final. Therefore, Wienco was not applicable.

The court reversed.

Burciaga 7th Cir Dec 2019


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