Debtors selling houses during a chapter 13 continues to cause conceptual problems for the courts. A recent decision, In re Marsh, from Judge Fenimore in Kansas City is an example. (Hat tip to Bill Rochelle for flagging this decision in his DailyWire column from the American Bankruptcy Institute ($). If you are a bankruptcy lawyer and don't get this column in your inbox each morning, you are missing out.) Judge Fennimore's opinion is a good point of departure to discuss why I don't think these conceptual problems are as difficult as lawyers make it out to be.
In the case at hand, the debtors scheduled the value of their home at $140,000. Between the $125,000 mortgage and a $15,000 homestead exemption, there was no value for unsecured creditors. The debtor confirmed a plan that provided for payment of the mortgage through the trustee, known as a "conduit plan." Although the debtor was below-median income and qualified for a three-year plan, the debtor opted to do a five-year plan, presumably to make it easier to cure the mortgage arrearage. The plan specified that unsecured creditors were to receive no distribution.
Forty-three months into the case the debtors filed a motion to sell the home for $210,000, which the court approved and which generated about $78,000 in cash after payment of the mortgage and fees. The debtor filed a "motion to retain" the cash. The chapter 13 trustee resisted, noting the cash would pay unsecured creditors in full.
The opinion focuses on the issue presented by the parties. Is the $78,000 in cash property of the estate? Judge Fenimore succinctly lays out the competing "theories" in a way that will make a great resource for anyone who has issue land on their desk. I agree with Judge Fenimore's conclusion that the cash is property of the estate. Yes, yes . . . the house may or may not have revested with the debtors which may or may not have the effect of terminating the estate's interest in the house. Section 1306(a), however, says the estate includes any property the debtor acquires before the closing of the case. Whatever else it is, the $78,000 is property the debtor has acquired.
Whether the cash is property of the estate is beside the point, and this is where the confusion seems to lay. In a chapter 13, of course, there is no requirement that the debtor turn over estate property to the trustee for liquidation and distribution to creditors. Often the whole point of a chapter 13 is for the debtor to retain estate property. In a chapter 13, the debtor must pay the value of nonexempt equity into the plan under the "best interest" test of section 1325(a)(4), requiring a creditor to receive under the chapter 13 plan at least as much as they would in a chapter 7. Moreover, that section specifies "value" is determined as of the date of the plan. If the trustee or unsecured creditors wanted to argue the house was worth more than the $140,000 the debtor valued it at, the time to do that was at confirmation. That train has sailed. The plan has been confirmed, and there are no grounds to revoke confirmation.
The procedurally proper move here is plan modification. On this I recommend Judge Fenimore's discussion on the last two pages of the opinion where he rules that he can't rule because the right issue has not been put before him. In this case, the debtors filed a "motion to retain," which, if I can loosely paraphrase Judge Fenimore, is "not a thing." Because the debtors' plan proposed monthly payments to pay a mortgage which is now paid in full through the sale, the debtors should move to modify the plan to eliminate those payments "to take account of any payment of [the mortgage] other than under the plan." Bankr. Code ยง 1329(a)(3). The trustee can file his own motion to modify the plan, although even under the loose guidance of section 1329 it is not clear what would justify plan modification to make payment to unsecured creditors. The debtor's obligation is to pay "disposable income," and a one-time sale of property does not generate "income" as that term is commonly used. If it did, then a debtor could not sell property during a chapter 13 because the proceeds would then be grounds for plan modification and distribution to creditors.
In his opinion, Judge Fenimore alludes to the idea that some might consider allowing the debtors to walk away with $78,000 cash to be unsavory. Why? The postpetition world is part of the debtor's fresh start. If postpetition value has arisen, that should belong to the debtor. It is no more or less unsavory than any bankrupt debtor keeping postpetition value. This "fresh start" policy is at the heart of the Bankruptcy Code's second chance. Some might argue those rules should be changed, although not me and, I would suspect, not Judge Fenimore. Unless Congress changes the rules, it is not a court's place to change them in the name of the court's personal sense of what is or is not an "unsavory" result.
Equally unsavory is the "heads I win, tails you lose" nature implied in the trustee's position. Tf the trustee thinks an asset will generate value for unsecured creditors, the time to raise that objection is at plan confirmation. The trustee should not get a free option to sit around and see what happens, raising an objection if things work out in the trustee's favor but otherwise just letting it go.
Chapter 13 debtors are going to continue to sell houses and generate proceeds that raise these issues. Rather than fumbling around with ethereal concepts about the nature of estate property, let me humbly suggest these other tools are already in place to deal with the issues.
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