In re Castleman, 2021 WL 2309994 (Bankr. W. D WA. 2021)

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:

A recent Bankruptcy Court decision from the Western District of Washington (the “Court”) disagreed with a 2007 case from the Ninth Circuit Bankruptcy Appellate Panel (BAP) and a 2021 case by the Bankruptcy Court of the District of Idaho when it ruled that when a case is converted from a chapter 13 to a chapter 7 case, the property of the Chapter 7 estate included the appreciation in the market value of property owned by the debtor on the original petition date. In re Castleman, 2021 WL 2309994 (Bankr. W. D WA. 2021).

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FACTS

In June 2019 debtors John and Kimberly Castleman filed a chapter 13 case, listing as an asset the real property located at 5857 Everson Goshen Road, Bellingham, WA, (the “Property”) with a value of $500,000. They claimed a homestead exemption in the property which exempted the available equity after taking into account the secured debt. The court confirmed the debtors’ chapter 13 plan in September 2019. In February 2021, the debtors’ case converted to Chapter 7.

The Chapter 7 trustee asserted that the value of the Property at the time of conversion was $700,000, creating substantial nonexempt equity. By way of motion he sought a judicial declaration that the increase in value inured to the benefit of the Chapter 7 estate and a ruling that he could sell the property for the benefit of creditors. After acknowledging that the proper procedural path for the trustee would have been to file an adversary proceeding, but perceiving no error in handling the issue as a contested matter since no evidentiary facts were disputed by the parties, the Court ruled in favor of the trustee. It recognized two conflicting approaches to answering the question posed. The Court followed the cases which ruled that the appreciation in value of an asset owned on the petition date belonged to the estate, not the debtors, when a Chapter 13 was converted to a Chapter 7.

REASONING

The Court acknowledged the two different approaches to determining who owned the appreciation, denominated by it as the “Cofer Approach” and the “Goins Approach.” These approaches turned on whether section 348(f)(1) of the Bankruptcy Code, amended by the 1994 Amendments, was ambiguous, bringing the legislative history into play, or was unambiguous such that only the words of the statute controlled.

Section 348(f)(1) provides:

(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;

(B) valuations of property and of allowed secured claims in the chapter 13 case shall apply only in a case converted to a case under chapter 11 or 12, but not in a case converted to a case under chapter 7, with allowed secured claims . . . reduced to the extent that they have been paid in accordance with the chapter 13 plan . . . 

Under the Cofer Approach (In re Cofer, 625 B.R. 194, 202 (Bankr. D. Idaho 2021), the courts have held that section 348(f)(1) is ambiguous and therefore relied on the legislative history to the 1994 Amendments. These courts, including the BAP in In re Lynch, 363 B.R. 101, 107 (9th Cir. BAP 2007), ruled that the legislative history showed the amendment was intended to favor the debtors by awarding the postpetition appreciation to them.

Under the Goins Approach ((n re Goins, 539 B.R. 510, 516 (Bankr. E.D. Va. 2015), the courts have ruled that section 348(f)(1) is not the least big ambiguous and therefore they must rely on the plain meaning of the language as conclusive, without consulting the legislative history.

To resolve the dispute for itself, the Court looked both to the plain meaning and the legislative history to decide whether they were in conflict. It concluded they were not because the concern of the legislature addressed in the history was not addressed at all by the amendments. The amendments addressed solely how to characterize property acquired by the debtors while the Chapter 13 was pending—the statute by its words excludes that property from the Chapter 7 estate—not an increase in the value of existing property caused either by debt reduction under the confirmed plan or by appreciation. When considering that increased equity, the words of the statute are not ambiguous. The crux of the Court’s ruling was its observation that “the equity attributable to the post-petition appreciation of the property is not separate, after-acquired property . . . [but] is inseparable from the real estate, which was always property of the estate under Section 541(a).”

AUTHOR’S COMMENTS

First, I admire the Court for taking on the BAP decision. Although BAP rulings are persuasive and followed most of the time by the majority of the bankruptcy courts in the Ninth Circuit, they are not binding precedent and ripe for disagreement. Here, the Court found the BAP’s reasoning was driven by the policies demonstrated in the legislative history more than what the actual amendment accomplished.

Second, I agree that appreciation of property is not a separate asset, but rather is part and parcel of what was owned by the debtors on the petition date. To the extent that the subject property remains in the possession or control of the debtors when the case is converted, the language of section 548(f)(1)(A) dictates that the property with that appreciation becomes property of the Chapter 7 estate.

This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D.CA, ret.) a member of the ad hoc group. 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.