Chapter 13 Debtor Can’t Keep Postpetition Appreciation in Value of Stock Options

Splitting with the First Circuit, the Ninth Circuit Bankruptcy Appellate Panel held in late December that a chapter 13 debtor may retain the post-petition increase in value of a nonexempt asset.

Last week, the same BAP held that creditors are entitled to recover the value of stock options granted to the debtor after confirmation of a chapter 13 plan.

Are the two opinions reconcilable? Read more and decide for yourself. By the way, both BAP opinions were written by Bankruptcy Judge Robert J. Faris.

The Prior BAP Opinion

In the appeal decided by the BAP in December, the debtor owned nonexempt rental real estate that he scheduled with a value of $44,000. The debtor confirmed a chapter 13 plan calling for payments of $250 a month for 59 months. In addition, the plan called for the debtor to sell the real property and pay an additional $45,000 to unsecured creditors.

More than three years after confirmation, the bankruptcy court approved the sale of the property for $107,000. The chapter 13 trustee proposed an amended plan where creditors would receive not only the promised $45,000 but also an additional $50,700, representing the remainder of the net proceeds of the sale after deduction for the costs of sale.

The bankruptcy court approved the amended plan over the debtor’s objection. The debtor appealed to the BAP and won.

In his December 31 opinion, Judge Faris said that the “chapter 13 deal” allows a debtor to retain all prepetition property, such as money and real estate, in exchange for committing all postpetition disposable income to the payment of unsecured creditors’ claims.

The prior case is Black v. Leavitt (In re Black), 609 B.R. 518 (B.A.P. 9th Cir. 2019). To read ABI’s report on Black, click here.

The New Case: Similar or Not?

The debtor confirmed a five-year chapter 13 plan where unsecured creditors would receive 1% of their claims. At filing, the debtor was earning $60,000 a year as a software developer.

After confirmation, the debtor landed a job as the chief executive of a startup, from which he began receiving stock options. The company received a buyout offer paying the debtor $3.8 million for his options. In the fifth year of the plan, the debtor notified the trustee about his potential receipt of the $3.8 million.

At the behest of the trustee and over opposition from the debtor, the bankruptcy judge approved a modification of the plan requiring the debtor to turn over $200,000 of the proceeds from the options, enough to pay unsecured creditors in full.

The debtor appealed and lost in an opinion by Judge Faris on April 17.

Judge Faris first tackled the question of whether the bankruptcy judge abused his discretion by confirming the amended plan. He explained that Section 1329(a) allows modification after confirmation but does not prescribe when an amendment is proper.

The BAP and the Ninth Circuit have held that an unexpected increase in income can justify an increase in plan payments. “In other words,” Judge Faris said, “confirmation does not shield increases in the debtor’s postconfirmation income from the reach of the chapter 13 trustee or creditors.”

Judge Faris therefore held that the bankruptcy judge did not abuse his discretion in approving the plan amendment.

The Objection Based on Termination of the Estate

The debtor argued that the options were beyond the reach of creditors because the estate terminated when confirmation revested estate assets in him, citing Section 1327(b). Since the options and their proceeds were postpetition property that were not part of the estate, the debtor reasoned that he was entitled to retain the fruits of his postpetition labor.

Judge Faris agreed, up to a point. He agreed that the Ninth Circuit BAP concurs with the notion that the estate terminates when assets revest in the debtor on confirmation. However, he went on to say, “Nothing in the Code provides that plan payments may only be funded by estate property.”

For example, Judge Faris said that a court may approve a plan modification to increase payments based on a postpetition increase in the creditor’s income, “whether or not the additional income is property of the estate.”

Finally, Judge Faris tackled the job of harmonizing the case at hand with Black. After all, Black allowed the debtor to retain the postpetition appreciation in value of a nonexempt, capital asset. So, why couldn’t the debtor retain the appreciation in the value of stock options, which likely had little or no value when issued?

In Black, Judge Faris said, the home that rose in value was an asset of the estate on the filing date and on the date of confirmation. The case on appeal, he said, “is solely concerned with postconfirmation wages.” [Emphasis in original.]

The debtor’s theory, according to Judge Faris, “would effectively nullify Section 1329.” Courts have interpreted that section, he said, as allowing creditors to “modify a plan to increase plan payments based on a debtor’s unexpected postconfirmation increase in income.”

Judge Faris therefore upheld the amendment to the plan because “the stock options were postconfirmation income that [the debtor] earned as part of his compensation package.”

Observations

The two BAP cases seem to evidence a bias in favor of debtors who own capital assets. In Black, the BAP sought to avoid constantly revaluing a debtor’s assets throughout the life of a chapter 13 plan.                                                                                                             

The unrealized appreciation in the value of capital assets can shortchange creditors as much as or perhaps more than a debtor’s increased income. Why strip a wage earner of his or her increased income when an owner of capital assets retains appreciation?

Perhaps Black was wrongly decided and the First Circuit was correct. Or perhaps the result in Black is entirely a consequence of the plan that gave creditors a fixed dollar amount when the asset was sold. Maybe Black must be confined to situations where the debtor and creditors struck a deal as part of confirmation.

Here’s an argument the debtor should have made: The proper value of the options was not $3.8 million but the minimal value of the options at the time they were granted.

Looking at the valuation at the time of issuance would allow the debtor to retain the appreciation in value and make the result more in line with Black.

Consider this hypothetical: Suppose a debtor manages to save $500 in the first two years during a chapter 11 plan and buys stock that rises in value to $5,000 before the end of the term of the plan. Are the creditors entitled to the $5,000? Does it matter whether the debtor sells the stock before making the final plan payment? Is the debtor obligated to inform the trustee periodically about the value of capital assets?

In other words, does chapter 13 discourage a debtor from attempting to improve his or her circumstances?

Before the 2005 amendments, honest debtors received discharges and kept everything they earned later. Now, bankruptcy indentures chapter 13 debtors to their creditors for five years. Some courts don’t even allow debtors to provide for their retirements by making IRA contributions during the life of the plan. We’ve come a long way from the notion of bankruptcy as a fresh start. These days, it’s a slow start.

Perhaps the economic agony being visited upon the country today will prompt Congress to rethink the concept of bankruptcy. People are losing everything, through no fault of their own. Why tie them down to their creditors for five years?

The opinions are those of the author, not ABI.