9th Cir: Here’s who gets Asset Appreciation in Converted Bankruptcy

Fighting over home appreciation in a converted bankruptcy

9th Cir: Here’s who gets Asset Appreciation in Converted Bankruptcy

Ninth Circuit rules home appreciation which accrued between Chapter 13 confirmation and conversion to Chapter 7 can be administered to repay debts, creating split from 10th Circuit

It’s not uncommon for a debtor in Chapter 13 bankruptcy to need to convert to Chapter 7 if debtor has a job loss or health problems.  In a rising real estate market, homes can appreciate between confirmation and conversion. To whom does the appreciation in equity belong? This is where debtors and Chapter 7 trustees fight fiercely over the home and its new equity.

Summary

In Castleman v. Burman (In re Castleman), 2023 WL 483486 (9th Cir. July 28, 2023), the Ninth Circuit Court of Appeals ruled that appreciation in home equity after Chapter 13 confirmation is property of the estate and does not belong to the debtors in a case which converted to Chapter 7. Opinion here.

Facts

Debtors John Felix Castleman, Sr. and Kimberly Kay Castleman filed a Chapter 13 bankruptcy in Washington in 2019. Debtors disclosed a home valued at $500,000 encumbered by a mortgage of $375,000 and protected with a maximum $125,000 homestead exemption, resulting in no remaining equity for the estate’s liquidation analysis.

However, after the case was confirmed and about two years into the payments, Debtor contracted Parkinson’s Disease. Debtors exercised their right to convert to Chapter 7. However, by this time, their residence had appreciated in value approximately $200,000. The Chapter 7 trustee filed a motion to sell the home, and debtor’s objected, citing 11 USC 348(f)(1)(A). The trustee did not assert it was a bad faith conversion subject to Section 348(f)(2). The bankruptcy court and district court concluded that the Debtors’ home, including postconfirmation appreciation, was property of the estate, per Section 348(f). The Ninth Circuit Court of Appeals affirmed.

Reasoning

Section 348(f)

As always, we start with the relevant statute. Section 348 of the Bankruptcy Code describes the applicable law regarding a converted case. In relevant part, it states:

(1) Except as provided in paragraph (2), when a case under chapter 13 of this title is converted to a case under another chapter under this title— (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;

The house was property of the estate at the time of filing. The appreciation of home equity totaling $200,000 did not exist at the time of filing. The question then becomes, “is the asset appreciation property of the estate, or is it separate, after-acquired property beyond the trustee’s reach?”

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Property of the Estate

Section 541 of the Bankruptcy Code

The 9th Circuit Court of Appeals attempted to determine if the appreciation in equity was property of the estate. In doing so, the 9th Circuit combed through the Bankruptcy Code for a definition of the term of art “property of the estate.”

See also  Bankruptcy Conversion and Exemption Objection Deadlines

It reviewed Section 541, the key section of the Code for property of the estate. In its definition, Congress said at Section (a)(6) that the estate includes “[p]roceeds, product, offspring, rents, or profits of or from property of the estate, except such as are earnings from services performed by an individual debtor after the commencement of the case.”

The Ninth Circuit then found that it has already decided that “appreciation [i]nures to the bankruptcy estate, not the debtor.” Schwaber v. Reed (In re Reed), 940 F.2d 1317, 1323 (9th Cir 1991).  It had recently affirmed Schwaber when it ruled “proceeds, product, offspring, rents, or profits” which become part of the estate under § 541(a)(6) “include[] the appreciation in value of a debtor’s home.”  Wilson v. Rigby, 909 F. 3d 306, 309 (9th Cir, 2018).

The majority in the Ninth Circuit Court of Appeals then noted that ambiguity in the Code’s text would justify looking at legislative intent. However, the 9th Circuit then said that the text is not ambiguous, and with that, avoided getting into the legislative history. The dissent reached a different conclusion.

But what about Section 1327

The Ninth Circuit then addressed whether the Section 1327(b) language that “confirmation of the plan vests all of the property of the estate in the debtor” means that appreciation then goes to Debtor as well.  However, it then dispelled this approach by concluding that it did not make sense since there was no explicit cross-reference in Section 541 to Section 1327.  Further, it considered that if Congress intended Section 348(f) to exclude any increase in equity of an estate, it could have amended § 348(f) further to make this result clear. Lacking this language, the Court concluded that it must not have been the Congressional legislative intent.

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Tallman Dissent

Leaving Debtor Worse Off than Filing a 7

In his dissent, Circuit Judge Richard C. Tallman pointed out the logic of filing Chapter 13 bankruptcy is to preserve a home or other asset. He then cited recent Ninth Circuit authority which points out that “if all assets acquired after filing of the Chapter 13 petition were available to creditors after conversion, the debtor would be ‘in a worse position than if the petition had been filed in Chapter 7 initially.'” Castleman dissent, citing In re Brown, 953 F. 3d 617, 620 (9th Cir 2020).

In Brown, Debtors filed Chapter 13, which later was converted to Chapter 7 with an increased value of the property of the estate which the 9th Circuit concluded was all indeed property of the estate. That, however, is where the parallels end. In Brown, there was an inheritance, which is a completely distinct asset, and not appreciation of one existing at the time of filing. Further, Debtor in Brown transferred his share of the inheritance to family members without trustee approval.  Finally, the conversion to Chapter 7 was at the motion of the Chapter 13 trustee as a sanction against debtor. The bankruptcy court and BAP concluded that because the transfers were in bad faith to avoid creditors, they should be property of the converted estate, which the 9th Circuit affirmed.

Distinguishing Schwaber v Reed and Wilson v Rigby, both Chapter 7 filings

Next, Judge Tallman in the Castleman dissent, distinguished Schwaber v Reed and Wilson v Rigby from the instant case, in a break from the majority. The distinguishing factor, writes the dissent, is that in both Reed and Wilson were filed as Chapter 7 cases.  Here, the Castlemans filed Chapter 13, whose purpose is different, and even its treatment in Section 348 is different, as Subsection (f).

See also  Inheritance, Bankruptcy and Chapter 13

Further, the estate in a Chapter 7 is short-lived, unlike in Chapter 13, where debtor retains all property and that confirmation vests all of the property of the estate in the debtor unless the plan or a court order says otherwise. Citing the recent BAP case of Black v Leavitt, “the revesting provision of the confirmed plan means that the debtor owns the property outright and that the debtor is entitled to any postpetition appreciation.” In re Black, 609 B.R. 518, 521, 529 (9th Cir BAP, 2019).  Judge Tallman urges that Black should be followed, and not undone.

Legislative Intent of the 1994 Bankruptcy Reform Act

Lastly, Judge Tallman in the Castleman dissent, pointed out that in 1994, Congress specifically added Section 348(f) to the Bankruptcy Code. This was done to resolve a circuit split about what property should be included in a Chapter 7 estate upon conversion from Chapter 13.  He then cited a legislative House Report which gave the exact example of home appreciation in a Chapter 13, which said if it goes to the Chapter 7 trustee, it would provide a disincentive to file Chapter 13.  Citing H.R. REP. NO. 103-835, at 57 (1994).

While the majority summarily concluded there was no ambiguity in the text, the dissent pointed out that the Tenth Circuit Court of Appeals has reached the opposite result on this issue: “The automatic vesting provision of § 1327(b) supports our conclusion that the proceeds from the sale of the Debtors’ house are not included in the Chapter 7 estate. Under § 541(a)(6), only proceeds “of or from property of the estate” become property of the bankruptcy estate. In a typical Chapter 13 case, this provision is operative only before confirmation of the Chapter 13 plan because confirmation “vests all of the property of the estate in the debtor.” Id. § 1327(b). Thus, proceeds generated from the debtor’s property after confirmation do not become property of the estate as the underlying property no longer belongs to the estate.” In re Barrera, 22 F. 4th 1217, 1223 (10th Cir 2022)

The dissent concludes, with the 9th Circuit directly opposing the 10th Circuit, a new circuit split has developed. Because a new court split has emerged on the interpretation of newly-enacted Section 348(f) — which itself was intend to resolve a court split — further legislative action is needed.

Author’s Comment

The Castleman result appears to be a case where the majority in 9th Circuit got it wrong. It both followed situations which are different — its Chapter 7 rulings in Reed and Wilson, and fraudulent transfer holding in Brown — and ignored a situation which is the same: the 10th Circuit ruling in Barrera.

The dissent in Castleman seems to be more consistent in following the plain text of Sections 1327(b) and 348(f).

Ironically, the mere fact that the the 9th Circuit itself was split shows that the meaning of the code isn’t “unambiguous.” Not only is the Ninth Circuit Court of Appeals split amongst itself, but its direct variance with the opposite result by the 10th Circuit in Barrera reveals a circuit split which makes the law very ambiguous in the other circuits.

The situation, then, calls for Congress to clarify again what it attempted to clarify with the enactment of Section 348(f) in 1994: that home appreciation in a Chapter 13 bankruptcy after confirmation is intended to belong to the debtors, and not the bankruptcy estate.