On an issue where the courts are widely divided, Chief Bankruptcy Judge Brian T. Fenimore of Kansas City, Mo., adopted the so-called estate-replenishment theory to conclude that appreciation in a home sold after confirmation of a chapter 13 plan belongs to creditors.

Judge Fenimore’s January 17 opinion is an admirable summary of the pros and cons of the five competing theories to decide whether post-confirmation proceeds are or are not property of the chapter 13 estate.

The Post-Confirmation Sale

A couple filed a chapter 13 petition owning a home they listed as having a value of $140,000. The home was subject to a mortgage of almost $125,000. The exemption was $15,000. Evidently, there were no objections to the homestead exemption or any disagreement about the value of the home.

The debtors’ income was below median, but they elected to confirm a five-year plan. The debtors paid the mortgage through the trustee, while unsecured creditors were to receive nothing. The plan revested estate property in the debtors on confirmation.

More than three years after filing but before the end of the five-year term of the plan, the debtors filed a motion to sell the home for $210,000. The court approved the sale, which generated net proceeds of about $73,000. The mortgage payoff apparently left nothing else to pay under the plan.

The debtors filed a motion to retain the net proceeds from the sale. The chapter 13 trustee objected, asking Judge Fenimore to rule that the debtors must turn over enough to pay 100% of unsecured creditors’ claims.

The debtors took the position that the home and its proceeds were not estate property because Section 1327(b) revested the home and the proceeds in them on confirmation.

The Competing Code Sections

Judge Fenimore saw a “conflict” among Sections 541, 1306 and 1327.

The home itself was estate property on filing under Section 541(a), and proceeds of estate property become estate property under Section 541(a)(6).

Section 1306(a)(1) says that property of the estate in chapter 13 includes property of the type in Section 541 “that the debtor acquires” after filing but before the case is closed.

Section 1327(b) provides that “the confirmation of a plan vests all of the property of the estate in the debtor,” unless the plan or the confirmation order provides otherwise.

On one hand, Judge Fenimore said that Sections 541 and 1306 “appear to capture” property for the estate that the debtor owned before and after confirmation. Those two sections taken in isolation would seem to take sale proceeds into the estate.

On the other hand, Judge Fenimore said that “§ 1327 arguably alters the estate’s interest in property at the moment the court confirms the debtor’s chapter 13 plan.”

“Some courts,” Judge Fenimore said, believe that Section 1327 takes property out of the estate and into the control of the debtor after confirmation.

Implications for Chapter 13 Cases

Judge Fenimore pointed out several instances where the resolution of the conflict affects chapter 13 debtors. First, the applicability of the automatic stay could turn on whether property remained under the umbrella of estate property. Second, the ability to assert an administrative claim for preservation of estate property could depend on which statute applies.

Third, resolution of the ambiguity controls the outcome in a case like that before Judge Fenimore. He exhaustively analyzed the five approaches to reconcile Sections 1306 and 1327.

The Five Approaches

Under the estate-termination approach, estate property is taken out of the estate and revests in the debtor on confirmation. The Eighth Circuit, he said, had rejected that approach.

The estate-preservation theory means that property acquired after confirmation becomes estate property. Judge Fenimore rejected the theory for “not recognizing the import” of Section 1327.

The conditional-vesting approach means that property is both estate property and property of the debtor until completion of the plan. Judge Fenimore said that the approach creates “uncertainty.” He rejected the theory for having the “same flaws” as estate preservation.

The estate-transformation approach posits that the estate includes the income and property required to effectuate the plan. Judge Fenimore rejected the idea as having no textual basis.

Judge Fenimore adopted the estate-replenishment approach, which, he said, “reconciles” Sections 1306 and 1327.

The replenishment theory works like this: Property acquired after confirmation is not subject to Section 1327(b) because it was not in existence on confirmation. After confirmation, Section 1306(a) takes after-acquired property into the estate.

Despite what he called “flaws” and “valid critiques,” Judge Fenimore said that “the estate replenishment approach best reconciles § 1306 and § 1327.”

Applying the Facts to the Replenishment Theory

Applying the replenishment theory to the proceeds from a sale after confirmation, Judge Fenimore held that sale proceeds were estate property because they were “distinct from the property sold to produce them” and were “of the kind” specified in Section 541.

Judge Fenimore said that courts “disagree about whether proceeds from the sale of vested property are distinct from the property sold.” Some courts, he said, believe that proceeds are distinct, while others hold that “the proceeds from the later sale of that property cannot become property of the estate” because “the debtor owns vested property outright.”

Judge Fenimore conceded that unrealized appreciation cannot be divorced from property and thus remain vested in the debtor. By contrast, he said that “treating proceeds as separate property logically results from the differences between sale proceeds and unrealized appreciation.” He deduced that cash proceeds are “entirely separate from the underlying property.”

Judge Fenimore therefore held that proceeds were “a separate, distinct form of property” that “could not have vested” in the debtors on confirmation. Since the proceeds were “of the kind” specified in Section 541, he ruled that the proceeds became estate property.

Even if the proceeds were estate property, the debtors argued that they could retain the proceeds because their three-year commitment period had ended. In sum, Judge Fenimore said that the three-year period did not apply because the debtors had elected to have a five-year plan.

Postscript

Although Judge Fenimore held that the sale proceeds were estate property earmarked for creditors, he did not tell the debtors how much to turn over, because the record was insufficient.

In the days following his January 17 opinion, the debtors and the trustee settled, allowing the debtors to retain some $62,700 while turning over about $10,300 to the trustee.

In negotiating the settlement, the debtors may have said they were entitled to a credit for interest or principal they paid to the lender after filing. The $10,300 may have reflected the amount in unsecured claims.

Note: Siding with what he called the “slight minority,” Judge Fenimore recently held that the appreciation in the value of a homestead during a chapter 13 case belongs to the chapter 7 estate when the case converts. In re Goetz, 20-41493, 2022 BL 404129, 2022 Bankr. Lexis 3188 (Bankr. W.D. Mo. Nov. 10, 2022). To read ABI’s report, click here. The decision in Goetz is on appeal to the Bankruptcy Appellate Panel for the Eighth Circuit.

Observations

One cannot understate the importance of the issue and the eventual outcome of the split among the courts, which has begun reaching the circuits. Debtors who are unable to retain proceeds may be unable to buy another home or one equivalent to the one they are selling in chapter 13.

If proceeds belong to creditors, some debtors may be effectively precluded from selling their homes until the chapter 13 case is over. In some situations, selling a home isn’t discretionary, because the debtor may need to move for a new job.

The issue is similar to when a chapter 13 debtor sells a home in a case converted to chapter 7.

There are a pair of arguments that the debtors did not raise in the litigation before Judge Fenimore that might persuade another court to rule differently.

First, debtors can argue that creditors are not entitled to proceeds from an exempt homestead if there was no objection to the exemption and the deadline for exemption was more than one year earlier. For a decision appearing to mean that an effort to glom sale proceeds would be a collateral attack on an exemption that was final, see Masingale v. Muding (In re Masingale), 644 B.R. 530 (B.A.P. 9th Cir. Nov. 2, 2022). To read ABI’s report, click here.

Second, debtors could get more mileage from Section 541(a)(6), which says, “Proceeds . . . of or from property of the estate” become estate property.

In a chapter 13 case where estate property has revested on confirmation, the words “of the estate” could be read to mean that proceeds do not become estate property because the proceeds were not derived from estate property that revested on confirmation. Section 1306(a) would not bring proceeds into the estate because the proceeds were arguably not “of the kind specified” in Section 541.

Courts need to develop a uniform rule, given that some chapter 13 plans do not revest property in the debtor to retain the applicability of the automatic stay. The outcome also should be uniform whether or not the case converts to chapter 7.