Did Segal Survive Butner in Defining Property of the Estate?

Following the Fifth and Seventh Circuits, Bankruptcy Judge Thomas L. Perkins of Peoria, Ill., joined those courts believing that Segal v. Rochelle, 382 U.S. 375 (1966), no longer determines whether an asset is estate property.

Interpreting the former Bankruptcy Act, the Supreme Court ruled in Segal that a tax-loss carryback refund was estate property because it was “sufficiently rooted in the pre-bankruptcy past and so little entangled with the bankrupts’ ability to make an unencumbered fresh start that it should be regarded as ‘property’ under §70a(5).” Id. at 380.

In 1979, in a case also decided under the former Bankruptcy Act, the Supreme Court handed down Butner v. U.S., 440 U.S. 48 (1979), again defining property interests. The high court was resolving a circuit split to decide whether state or federal law determines whether a security interest in property extends to rents and profits. Without citing Segal or referring to the “sufficiently rooted” standard, the Supreme Court held, “Unless some federal interest requires a different result, . . . [p]roperty interests are created and defined by state law.”

Around the time the Court was deciding Butner, Congress adopted new bankruptcy laws. In Section 541(a), the Bankruptcy Code gave an expansive definition to estate property, which includes “all legal and equitable interests of the debtor in property as of the commencement of the case.”

The legislative history to Section 541(a) does not mention “sufficiently rooted” but says that the result in Segal “is followed.”

The Bonus Case

Judge Perkins was tasked with identifying a definition of estate property in a case involving an annual bonus.

The debtor had the same employer for several years and was eligible for an annual bonus. The debtor had been awarded a bonus every year. The bonus was entirely discretionary, and the employer had the right to terminate the program at any time.

The chapter 7 trustee contended that a pro rata portion of the bonus should be estate property. Because the filing date was in August, the parties stipulated that 62.7% was “rooted in the prebankruptcy past.”

Ruling that none of the bonus was estate property, Judge Perkins explained in his May 9 opinion why he would not decide the question “through application of the ‘sufficiently rooted’ test.” Instead, Judge Perkins said that the debtor “did not have a prepetition property interest in the bonus as a matter of Illinois law.”

The Erosion of Segal

Judge Perkins said there is uncertainty when an asset has its origin “in the prepetition time frame” but is “subject to the postpetition occurrence of one or more contingencies.” He examined post-Butner caselaw to settle on the proper standard.

But first, Judge Perkins distinguished Segal on the facts. There, the right to a refund was “a property interest in existence on the petition date,” he said. According to Judge Perkins, Segal “dealt not with an expectance but, rather, with a property interest subject to a contingency.”

“There is little doubt,” Judge Perkins said, that “the second part of Segal’s test, whether the property interest is so entangled with the debtor’s fresh start that it should be excluded from the estate, is no longer a relevant factor.” He then proceeded to parse whether “sufficiently rooted” is alive and well after Butner.

Judge Perkins cited the Fifth Circuit for holding that “sufficiently rooted” did not survive the adoption of Section 541. In re Burgess, 438 F.3d 493, 498-99 (5th Cir. 2006).

Closer to home, Judge Perkins said the Seventh Circuit “has expressed skepticism about the usefulness of the ‘sufficiently rooted’ test even in the context of tax refunds,” citing In re Meyers, 616 F.3d 626, 628 (7th Cir. 2010). In Meyers, the appeals court apportioned a postpetition refund between the debtor and the estate.

Without mentioning Segal, the Seventh Circuit held, according to Judge Perkins, that “a prepetition property interest becomes property of the estate only to the extent that the debtor had a right to enforce the interest as of the petition date.”

Casting doubt on the longevity of Segal, Judge Perkins pointed out that Butner neither cited Segal nor referred to “sufficiently rooted.” The notion in Segal that principles of federal bankruptcy law prevail over state law, he said, “contradicts Butner’s holding that state law should determine the nature and extent of a debtor’s property interests for property of the estate purposes.”

Perhaps because he was bound by Seventh Circuit precedent, Judge Perkins held that “Segal should not be interpreted as setting forth a federal standard to be layered on to the property of the estate analysis under Section 541, where property interests arising under state law are at issue.”

Restating the standard to suit the facts of the case, Judge Perkins said that an asset is not estate property “without regard to whether the interest may be said to be ‘rooted’ in the debtor’s pre-bankruptcy past,” when “state law provides that a potential property interest of a debtor was merely an expectancy as of the petition date.”

Finding abundant Illinois precedent, Judge Perkins ruled that none of the bonus was estate property because a bonus under a discretionary program “is a mere expectancy” in which the debtor had no property interest on the filing date.

Observations

Segal is not at odds with the result reached by Judge Perkins. Property under Segal does not fall into the estate simply from being “rooted” in the prebankruptcy past. It must be “sufficiently” rooted.

A discretionary bonus not earned until paid is not “sufficiently” rooted in the prebankruptcy era, in this writer’s view.

Segal’s use of “sufficiently” implies the bankruptcy court’s use of equitable powers, rather than the slavish adherence to a bright-line formulation. Segal’s invocation of equitable powers is a principle that should not have changed with the adoption of the Bankruptcy Code, because bankruptcy courts fundamentally remain courts of equity, however much some courts may limit equitable powers in an attempt to divine the plain meaning of the statute.

Butner was decided only 13 years after Segal. The Supreme Court ordinarily does not overrule its own authority sub silentio, especially when both cases dealt with the former Bankruptcy Act.

The fact is, Butner and Segal confronted entirely different questions. Butner turned on whether a property interest existed, whereas Segal was deciding when the property interest arose. It is therefore not surprising that the Supreme Court developed different tests and saw no reason for citing Segal in Butner.

In addition, Butner can be harmonized with Segal by viewing state law as a guidepost for deciding whether property is sufficiently rooted in the prebankruptcy era.

Disclosure: The Rochelle in Segal v. Rochelle was this writer’s father. He was the trustee and argued the case in the Supreme Court as his own lawyer.