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:
Answering a question that has been addressed by multiple bankruptcy courts with mixed results, the Bankruptcy Court for the Western District of Missouri (the Court) ruled that when debtors sell real property they own when a chapter 13 is filed, the proceeds from the sale are new property that replenishes the chapter 13 estate and may be available for distribution to creditors. In re Marsh, 647 B.R. 725 (Bankr. W.D. Mo. 2023).
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Christopher and Nicole Marsh (Debtors) filed chapter 13 in 2018. They owned their residence (the Residence), valued at $140,000 and subject to a $125,000 mortgage lien. Debtors exempted the remaining equity in the Residence. The Court confirmed their chapter 13 plan later that year, which made payments to the mortgage creditor but paid zero percent to the general unsecured claims. Under the terms of the plans and Bankruptcy Code § 1327, the property of the estate revested in Debtors upon confirmation.
In April 2022, Debtors filed a motion to sell the Residence which would result in net proceeds of about $78,000. The chapter 13 trustee (Trustee) did not object and the Court approved the sale. After closing Debtors filed a motion to retain the net proceeds from the sale, which they intended to use to purchase a new residence. Trustee opposed the motion, asserting that Debtors were required to remit to Trustee funds sufficient to pay 100% of the allowed unsecured claims. In the briefs filed in the motion, Debtors asserted that since the Residence had revested in them, the proceeds were not property of the estate, whereas Trustee argued to the contrary that such funds were property of the estate. The Court agreed with Trustee, concluding that the proceeds were after-acquired property, swept into the estate by Bankruptcy Code § 1306, because they were distinct property from the Residence, which had departed the estate upon revesting. As discussed below, this did not end the Court’s inquiry, as appropriate disposition of the funds required modification of the plan and a further hearing.
The Court noted that the dispute before it arose from a conflict between the provisions of Bankruptcy Code §§ 541 and 1306, which define property of the estate in a chapter 13, and Bankruptcy Code § 1327, which removes property from the estate by revesting at the time of plan confirmation. Section 541 broadly defines property of the estate as “all legal or equitable interests of the debtor in property as of the commencement of the case.” In a chapter 13, § 1306 adds to the estate property “that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted…whichever occurs first.” In contrast, § 1327(b) removes property from the estate upon confirmation by providing that “the confirmation of a plan vests all of the property of the estate in the debtor.” Reconciling these statutes has led to five different approaches, which the Court reviewed.
The “estate termination approach” rules that the estate ends upon the revesting of the property in the debtor and therefore after-acquired property belongs to the debtor. This approach had been rejected by Eighth Circuit precedent, so the Court did not address it further. Under the “estate preservation approach” the estate continues after confirmation, retains all pre-confirmation property, and also includes any property the debtor acquires after confirmation. Courts adopting this approach conclude that § 1327’s revesting provisions affect only the debtor’s right to possession of the property and never removes it from the estate. The Court rejected this approach as not adequately reconciling §1306 and § 1327, because it makes the vesting provision meaningless.
The “conditional vesting approach” interprets the conflicting statutes to make the property simultaneously property of the estate and the debtor. The debtor’s complete vesting, however, is conditional on plan completion. The Court dismissed that approach as not giving proper meaning and consequence to the vesting language in § 1327 and creating future uncertainty. The fourth approach, “estate transformation,” provides that the “estate consists of the property and future earnings of the debtor dedicated to fulfillment of the Chapter 13 plan.” (citations omitted.) The Court concluded that this approach was not supported by the plain language of the Code “nor the practicalities of chapter 13.”
Finally, the Court analyzed and adopted the “estate replenishment approach,” under which pre-confirmation property becomes property of the debtor upon confirmation but post-confirmation new acquisitions are property of (i.e., replenish) the estate. It concluded that this approach reconciled §§ 1306 and 1327 and ruled that “any property the debtor acquires after confirmation ‘is not subject to § 1327(b) because it was not in existence at confirmation.’ (citation omitted).” Once the Court adopted this approach it had to determine whether the proceeds from the sale were distinct property from the Residence owned on the petition date. It concluded the property proceeds were different property because proceeds of property are treated separately from the original property in § 541((a)(6) and therefore qualify as after-acquired property. Because the proceeds were distinct, Debtors did not own them on the petition date and they did not revest in Debtors upon confirmation.
Debtors had argued that because they acquired the proceeds after their mandatory three-year commitment period set forth in § 1325(b)(1), they did not qualify as after-acquired property. The Court denied this argument because § 1325(b)(1) was only in play during the initial plan confirmation. It had no bearing on a modification later, as is happening here, because § 1325(b) was not incorporated into §1329 which controls modifications
Despite making these rulings in favor of Trustee, the Court was unable to rule on the motion to retain because Debtor’s confirmed plan required ongoing payments to the mortgage, which were no longer necessary after the sale of the Residence. The Court therefore continued the hearing for Debtors to file a modified plan, after which it could address the modification’s compliance with § 1329’s requirements and its effect on their right to retain some portion of the proceeds.
As this case illustrates, bankruptcy courts, with limited appellate input, have answered the question posed here using five different methodologies. This has led to uncertainty for practitioners, making it difficult for them to advise their clients whether a sale of property in a pending chapter 13 will be in their best interest. This dilemma begs for precedent from appellate review. I hope that once this case has a final ruling, an appeal will follow, because it provides a comprehensive review of the conflicting approaches and an analysis of their strengths and weaknesses, which will assist the appellate court in understanding the conflicts.
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.