(Reprinted with permission. Bankruptcy Law Network September 2011)

By Wendell Sherk, Missouri Bankruptcy Attorney

Sometimes a strategy causes more harm than good.  Many long-accepted Missouri bankruptcy exemptions have become uncertain or been lost due to one such case.  This is the story of how one strategy blew up to create dangerous uncertainty for consumers.

Bankruptcy exemptions dictate what stuff is protected from a bankruptcy trustee.  As allowed by federal law, Missouri has “opted out” and require debtors to use only its bankruptcy exemptions when they file.

In most places, the “opt out” is a simple law.  And Missouri’s “opt out” simply says a debtor can protect “any property that is exempt from attachment and execution under the law of the state of Missouri…”

This language seems simple and caused no trouble for over 25 years when it came to Missouri bankruptcy exemptions.  But some felt that “exempt from attachment and execution” meant any property that could not be attacked via the exact technical process of “attachment and execution.”

Specifically, income tax refunds not yet received because a creditor cannot “attach” a tax refund in Missouri — even though some creditors could get at them in other ways.

The reading, if it prevailed, would benefit consumers when determining their bankruptcy exemptions.  But the strategy would allow attorneys to file cases in Missouri without any concern about large tax refunds coming in soon.  That in turn would streamline bankruptcy practice and avoid a major exemption issue we all deal with each Winter and Spring.

It would also take a regular source of assets away, frustrating bankruptcy trustees and creditors alike.

Ultimately the question reached the federal Eighth Circuit Court of Appeals in In re Benn in 2007.  The circuit concluded that the bankruptcy exemptions could not be used to protect tax refunds under the “opt out” law, Sec. 513.427 RSMo.

In essence, the circuit reasoned that the words “from attachment and execution” should not be read separately from the word “exemption.”  Reading it as a whole, it implied that the “opt out” law requires a separate Missouri law that would protect the property.  Essentially, “exempt” was crucial while “attachment and execution” was not.

This was actually the prevailing wisdom concerning bankruptcy exemptions.  Unfortunately, the Benn court went on to reach additional conclusions — which seems to be dicta — that played havoc in consumer Missouri bankruptcy cases ever since.  It is not clear the implications of the additional Benn comments were intended, though.  For example, Benn says

[The opt out law] does not create an exemption for tax refunds, and no other Missouri statute or non-bankruptcy federal exemption statute permits a debtor to exempt tax refunds from the bankruptcy estate.

Missouri does provide “wildcards” (e.g. 513.430.1(3) RSMo.) which are bankruptcy exemptions for any property the consumer chooses and has always been allowed for refunds.  Yet a literal reading of this Benn dictum means the Missouri wildcards have been struck down (at least as used for refunds).

It’s clear Benn did not really intend to disallow exemption wildcards.  And no bankruptcy court has so ruled as yet.  But a strict obedience to every phrase in Benn would result in no exemption for any tax refund in the future.  And some courts have gone some way down this road in following other Benn dicta, as we will see in the next installment.

Wendell J. Sherk is an attorney in St. Louis, practicing primarily in consumer bankruptcy and debtor representation. He graduated from Washington University in 1986 and Washington University School of Law in 1989. He is a principal of the firm Sherk & Swope, LLC as well as a member of the National Association of Consumer Bankruptcy Attorneys, American Bankruptcy Institute, and The Missouri Bar. He contributes to the bankruptcylawnetwork.com blog and his e-mail is: [email protected].