The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:
The Ninth Circuit Court of Appeals (Ninth Circuit) recently held that post-petition, pre-conversion appreciation in value of an asset belongs to the chapter 7 bankruptcy estate, not the debtors, following conversion from chapter 13 in good faith. As the lengthy dissent pointed out, this ruling created a circuit split with a decision from the Tenth Circuit, Rodriguez c. Barrera (In re Barrera), 22 F. 4th 1217 (10th Cir. 2022). Castleman v. Burman (In re Castleman), 75 F. 4th 1052 (9th Cir. July 28, 2023).
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Debtors John and Kimberly Castleman filed a chapter 13 bankruptcy, listing as an asset their home (the “Residence”) valued at $500,000, with a mortgage balance of $375,000 and a homestead exemption of about $125,000. After they performed under a confirmed plan for 20 months, a job loss and the onset of Parkinson’s Disease prevented the couple from making their plan payments and they converted the case to a chapter 7. In the interim, the value of the Residence had increased by $200,000 based on appreciation.
The chapter 7 trustee (the Trustee) filed a motion to sell the Residence to recover this new excess equity for the creditors. The Castlemans objected, arguing the appreciation belonged to them. The bankruptcy court ruled in favor of the Trustee, concluding the equity belonged to the estate, allowing the sale to proceed. The district court affirmed. The Castlemans appealed to the Ninth Circuit which also affirmed.
The Ninth Circuit recognized that courts are “heavily divided on this question.” However, it concluded that the plain language of Section 348(f)(1)(A) of the Bankruptcy Code and the circuit’s previous interpretation of Section 541(a) attributed the increased equity to the estate.
Section 348(f) defines what property becomes estate property upon conversion from a chapter 13 to a chapter 7: “(1) Except as provided in paragraph (2), when a case under chapter 13…is converted to a case under another chapter… — (A) property of the estate in the converted case shall consist of property of the estate, as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion.” (emphasis in original). Paragraph (2) defines estate property if debtors convert in bad faith, not an issue here.
Despite the fact that section 348(f) did not define “property,” the Ninth Circuit ruled the statute was not ambiguous and conducted a plain meaning analysis. It determined that “property of the estate” was a term of art in the Bankruptcy Code and looked at other provisions for its definition. It began by looking at the definition for chapter 7 set forth in section 541(a)(1), which creates an estate of all legal and equitable interests of the debtor on the commencement date, and then the complimentary subparagraph, section 541(a)(6), which adds “proceeds, product, offspring, rents, or profits” from such property to the estate. The Ninth Circuit then referred to circuit authority which had concluded that in a chapter 7 post-petition appreciation was part of the original scheduled asset and therefore was estate property. It then opined that the logic in those cases applied equally in a converted case.
The Ninth circuit rejected the reasoning of cases which had consulted legislative history to reach a contrary conclusion based on the distinction provided in such history between the purpose of a chapter 13 versus a chapter 7. It also declined to follow the analysis in Barrera from the Tenth Circuit, which ruled that, under section 1327(b), property of the estate had revested in the debtors upon confirmation, meaning that post confirmation appreciation was the debtors’, not the estate’s. Therefore, the Ninth Circuit’s plain language approach resulted in the appreciation accruing to the estate’s benefit.
The dissent, which was longer than the majority, argued that the majority’s decision essentially punished the Castlemans for filing a chapter 13 to make a good faith effort to pay something back to their creditors, rather than discharging all their debt in a chapter 7. After all, if they had filed chapter 7 in the first place, the case would have ended in 4-5 months and the property appreciation would not be an issue. Accordingly, the result of the decision was to disincentivize debtors from filing chapter 13s. The dissent found fault with the majority applying comparable reasoning to a converted chapter 13 as to an initially filed chapter 7 and noted that section 1327(b) ended the concept of property of the estate upon confirmation, the linchpin to the Barrera decision. Finally, it concluded the language was ambiguous; it consulted the legislative history which supported its preferred ruling that the appreciation belonged to the debtors.
Along with many others, I have followed this issue through the conflicting rulings for the past several years. Although the Ninth Circuit cites authority for the proposition that just because many courts disagree about what a statute means does not necessarily mean it is ambiguous, it is hard for me to believe that a strict textual analysis without consulting legislative history and paying keen attention to the statute’s object and structure as a whole is the correct approach. As noted by the dissent, a chapter 13 is a voluntary effort by debtors to pay some of their future income to their creditors rather than just discharging their unsecured debt. If they risk losing their homes if their efforts to pay are thwarted and they convert to a chapter 7, fewer debtors will be counseled by their attorneys to even try. This outcome appears to be inconsistent with the legislature’s purpose in creating chapter 13s and, on the whole, will not be in the best interest of creditors and debtors alike.
This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.). Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.