Bankruptcy? Now What?

Bankruptcy? Now What?

Personal Injury Exemptions – A Primer

More frequently now, we see clients in our personal injury practices whose cases are complicated by extreme financial distress. The injuries themselves are stressful, but layering on a failed business or loss of a job due to the current state of economic affairs makes things much more difficult. Financial distress is corrosive – it interferes with an individual’s physical health, damages familial relationships, and complicates the resolution of claims.

If a bankruptcy case is filed, that filing can have significant effects on potential settlements. The Bankruptcy Code and State Law provide exemptions for bodily injury claims and/or settlements.

This article will describe those exemptions and provide a practical analytical framework to use in practice when these issues come to you.

When an individual files a bankruptcy case, several legal consequences flow from it immediately on filing.

First, the filing of the petition operates as a stay of any act which attempts to recover a claim against the individual (now “debtor”) which arose before the filing. This stay is very broad, and is liberally construed to protect the debtor, and to give full effect to the provisions of the code.

Second, an estate is created, which consists of all property in which the debtor has an interest. This bankruptcy estate is administered by a trustee appointed by the Bankruptcy Court.

Third, a panel trustee is appointed to administer the estate. The trustee “stands in the shoes” of the debtor on the date of filing as a matter of legal fiction and fact. Administration, in its most basic sense, is simply the orderly liquidation of debtor’s non-exempt assets, and payment of the proceeds to creditors of the debtor pro-rata, according to an order of priorities contained in the code.

Exempt Property

Historically, the purpose of exemption laws has been to allow people to retain those items of property essential to daily life. In the bankruptcy context, that purpose is joined with the “fresh start”, which is a major concept for individual debtors. These basic necessities may be chosen by the debtors from the possessions or interests they have acquired, prior to filing.

Both Minnesota law and the Bankruptcy Code provide debtors with the ability to exempt property from the bankruptcy estate. If property is exempted, the trustee in bankruptcy has no interest in it and the debtor retains his interest in the property. Exemptions are provided for by 11 U.S.C. §522. Section 522(b)(3) permits a debtor in Minnesota to make a choice between the Federal exemption system, and the State’s exemption system. There are significant differences.

M.S.A. §550.37(22)

This section provides that a “right of action” for injuries to the person of the debtor or of a relative, whether or not resulting in death, is not “liable to attachment, garnishment or sale on any final process, issued from any Court”.

This is the state exemption law applicable to personal injury claims. If the debtor chooses the state exemption system, this statute will allow the debtor to retain his right of action, free from any claim by the trustee in bankruptcy. State law will be referred to in interpreting the statute.

The statute exempts rights of action for bodily injury. Case law makes it clear that to qualify under this section, the claim or right of action must flow from an actual physical, bodily injury. A claim for pain and suffering alone will not suffice. In re Marshall, 208 B.R. 690 Bkrtcy. D. Minn. 1997. Nor will a defamation claim. In re Crawford, 208 B.R. 924, Bkrtcy. D. Minn. 1994.

The exemption, however, is of the right of action. If the action or claim has been settled, the cash proceeds are not exempt.

In re Procter, 186 B.R. 466 Bkrtcy. D. Minn. 1995, surveyed the precedents at that time, and addressed the issue as follows:

The term “rights of action”, is defined as “the right to bring suit; a legal right to maintain an action, growing out of a given transaction or state of facts and based thereon.” “Rights of action” within the meaning of Minn. Stat. § 550.37, subd. 22, pertains to remedy and relief through judicial proceedings as opposed to “cause of action: which refers to particular facts which give a person a right to judicial relief. This court has consistently construed “rights of action” as referring only to pending or future claims. And has noted that only disputed or contingent claims would likely fall “within the ambit” of the statute.

See also In re Carlson, 40 B.R. 746, 750, holding that settlement proceeds at issue in that case were exempt as “rights of action” only because payment had not been made and releases had not been signed at the time of the filing of the petition.

Thus once again, we learn that timing is everything. A creditor or trustee cannot attach the right of action, but once the case is settled, the cash can be garnished and may become property of the bankruptcy estate.

This also applies to structured settlements. In Christians v. Dulas, 95 F.3d 703, C.A. 8 1996, the Eighth Circuit Court of Appeals, overruling both the Bankruptcy Court and the U.S. District Court, District of Minnesota found that a structured settlement annuity was not exempt under M.S. 550.37(22). The Court said that the exemption could not be allowed where the defendant in the action had been released, and had no continuing obligation to the plaintiff-debtor. In Dulas, the only entity with an obligation to the debtor, was the guarantor of the annuity contract – leaving the debtor with a potential breach of contract action, not a bodily injury right of action. The annuity was thus not exempt. This rule remains the same today.

Note, however, that if the defendant had merely agreed to pay sums of money over time, and had not been released, the result may have been the opposite.

11 U.S.C. 522(d)(11)(D)

The Federal exemption system contains an exemption for payments on account of personal bodily injury, not to exceed $20,200. The statute reads as follows:

(11) The debtor’s right to receive, or property that is traceable to-

(D) a payment, not to exceed $20,200. on account of personal bodily injury, not including pain and suffering or compensation for actual pecuniary loss, of the debtor or an individual of whom the debtor is a dependent

This exemption is simpler than our state’s “right of action” exemption, but notice it is limited more than monetarily. The statute does not provide an exemption for money received for pain and suffering, nor for wage losses or property damage. Thus, when settling a claim for money within this exemption, there should be no breakdown of the general amount. Compensation for bodily injury is again the key.

Two other parts of 522(d) may apply to cases we are familiar with.

Section 522(d)(11)(B) provides an exemption for:

a payment on account of the wrongful death of an individual of whom the debtor was a dependent, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor.

Section 522(d)(11)(E) provides an exemption for:

(E) a payment in compensation of loss of future earnings of the debtor or an individual of whom the debtor is or was a dependent, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor.

Note the language “reasonably necessary for the support of the debtor and any dependent of the debtor”. The use of this language mandates a fact based inquiry into what is reasonably necessary to support the debtor and his or her dependents. This inquiry is generally made in the context of a hearing in Bankruptcy Court on an objection to the claim of exemption. The evidence would focus on reasonable, necessary support and should result in a fact specific order which may sustain or overrule the objection in whole or in part. It is likely, however, that in perhaps a majority of cases the use of the Minnesota exemption would be more beneficial.

Conclusion

Exemption analysis, is an applied art. The decision about which exemption system to elect is complicated. The asset mix, the debtor’s employment status, the state of the debtor’s residence (and how long she has lived in that state) all play important parts in this analysis.

Exemption planning is still available, but has been impacted by the passage of the BAPCPA amendments to the code which went into effect in late 2005. It is important that our clients are advised of their exemptions and the extent of those exemptions if the level of financial distress is such that they may be forced to file for bankruptcy protection.

And, as noted above, timing is important. If your settlement is finalized and the defendant(s) released, you may inadvertently expose the proceeds to loss to creditors or a bankruptcy trustee, an unhappy result in most circumstances. A referral to a competent bankruptcy practitioner for a complete review of your client’s situation may be valuable in avoiding unintended consequences.

For more information please contact James P. Ryan.

This article was published in Minnesota Trial – Journal of the Minnesota Association for Justice (Summer 2009).

DISCLAIMER:

This information has been prepared for general information purposes only. This information is not legal advice. Legal advice is dependant upon the specific circumstances of each situation. Laws not only vary from jurisdiction to jurisdiction, but also change frequently within a given jurisdiction. Therefore, this information cannot replace the advice of competent legal counsel in your state.