A chapter 13 debtor ties the score in the top half of the ninth inning in a game against the trustee. In the bottom half of the ninth inning, the trustee loads the bases with two outs. The batter for the trustee hits a long fly ball. Will it be caught to end the inning and win the game for the debtor, or will it go over the fence, with the trustee beating the debtor on a walkoff homer?
The case involves an inheritance the debtor received almost three years after confirming a chapter 13 plan. Will the debtor get to keep the inheritance or not?
Former Bankruptcy Judge Keith Lundin, the author of the treatise Lundin on Chapter 13, predicts that the debtor will win the game, perhaps in extra innings (that is to say, on appeal or after converting the case from chapter 13 to chapter 7).
The Inheritance
The debtor confirmed a 36-month chapter 13 plan with nothing for unsecured creditors on their $25,000 in claims. The debtor paid $140 a month over the life of the plan, for a total of $5,040.
In the 31st month of the plan, the debtor received a $72,000 inheritance on the death of her mother. After completing payments in the 37th month of the plan, the debtor informed the trustee about the inheritance and amended her schedules.
The debtor still had a wildcard exemption that could be applied to the inheritance. After the exemption, the trustee calculated that the $58,000 net was estate property.
The chapter 13 trustee insisted that the debtor either pay 100% of filed claims or modify her plan to pay 100%. After the debtor declined, the chapter 13 trustee filed a motion asking Bankruptcy Judge Mary Jo Heston of Tacoma, Wash., to modify the plan under Section 1329(a) by increasing payments and extending the life of the plan.
The Seven Questions
In her May 18 opinion, Judge Heston marched through a string of questions to decide whether the debtor could keep the entire inheritance or part of it. First, she tackled the issue of whether the inheritance was property of the chapter 13 estate.
Two statutory provisions come into play. Section 541(a)(5) tells us that an inheritance becomes property of the estate if the debtor “acquires” the inheritance within 180 days of the filing date. In this case, the debtor acquired the inheritance long after the 180-day period.
“[I]n addition to the property specified in section 541,” Section 1306(a)(1) provides that estate property in chapter 13 includes “all property of the kind specified in such section that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first.”
Judge Heston refined the first question by asking “whether § 1306 extends the time frame under which inheritances become property of a chapter 13 bankruptcy estate beyond 180 days or whether § 541 sets a fixed time frame for the receipt of an inheritance under any chapter of the Code.”
Courts differ on the answer. Judge Heston elected to follow the majority of courts, citing the Fourth Circuit and the Ninth Circuit Bankruptcy Appellate Panel. See Carroll v. Logan, 735 F.3d 147, 152 (4th Cir. 2013) (holding that Section 1306 extends time frame set by Section 541 beyond 180 days in chapter 13 cases), and Dale v. Maney (In re Dale), 505 B.R. 8, 13 (B.A.P. 9th Cir. 2014) (same).
Judge Heston found the BAP to be most persuasive and held that the post-petition inheritance became property of the estate under Section 1306(a)(1). In other words, Section 1306(a)(1) overrules or modifies the 180-day limitation in Section 541(a)(5).
Second, Judge Heston analyzed Section 1329 and decided that the trustee had the ability to modify the plan. Pointing to the debtor’s delay in notifying the trustee about receipt of the inheritance, she next concluded that equitable estoppel barred the debtor from relying on Section 1329(a) by claiming that the trustee could not modify the plan, since she had already made the last payment under her plan.
Fourth, Judge Heston asked whether a modified plan would satisfy the best interests test in Section 1325(a)(4). “[A]s of the effective date of the plan,” the section requires that distributions be not less than what unsecured creditors would receive in chapter 7. But what’s the effective date? Is it the date of confirmation of the original plan or the confirmation date of the amended plan?
Although she found no controlling authority, Judge Heston said that “most courts” believe that the “effective date” refers to the modified plan, meaning that the liquidation analysis must be “reapplied” when the plan is modified. She said that “the majority approach ensures that the plan as modified accurately reflects what creditors might hope to receive in a chapter 7 liquidation if the debtor were to convert the case to chapter 7 today.”
For the fifth question, Judge Heston asked “whether the value of the non-exempt portion of the inheritance is included in a hypothetical liquidation, known as the best interest of the creditors test.”
Again, two sections were in competition. Section 1306 brings post-petition property into the estate, but what about Section 348(f)(1)(A)? When a case is converted from chapter 13, Section 348(f)(1)(A) says that “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.” If conversion was in bad faith, subsection (f)(2) says that “the property of the estate in the converted case shall consist of the property of the estate as of the date of conversion.”
Naturally, the trustee contended that Section 1306 brought the inheritance into the estate. Judge Heston disagreed, handing the debtor an apparent victory under Section 348(f)(1)(A).
Judge Heston followed In re Taylor, 631 B.R. 346 (Bankr. D. Kan. 2021). She described the opinion by Bankruptcy Judge Dale L. Somers of Topeka, Kan., to mean that “the hypothetical chapter 7 estate does not include [the recovery on a post-petition personal injury claim] pursuant to § 348(f).” Taylor appears to mean that chapter 13 debtors retain post-petition inheritances, lottery winnings and other windfalls that have no connection to pre-petition assets. To read ABI’s report on Taylor, click here.
If Section 1306 were to control, Judge Heston said that “liquidation value would be subject to constant upwards and downwards adjustments during the pendency of the case to account for any postconfirmation asset or liability acquired.” She also said that the adoption of Section 348(f) in 1994 “expressly overruled In re Lybrook, 951 F.2d 136 (7th Cir. 1991),” and removed a disincentive for filing in chapter 13.
Saying there were unresolved facts to govern whether conversion to chapter 7 would be in bad faith, Judge Heston identified a sixth question but did not decide whether Section 348(f)(2) would bring the inheritance into the estate.
Yogi Berra Precedent
At this point, the score was tied, or the debtor might have had a leg up, because Judge Heston’s ruling on Section 348(f)(1)(A) meant that the inheritance would not be included in the new liquidation analysis absent bad faith. But as Yogi Berra allegedly said, “It ain’t over ’til it’s over.”
On the penultimate page of her opinion, Judge Heston raised a seventh issue and dropped a bombshell when she said, without statutory authority:
In determining whether modification is warranted, the Court may in its discretion consider whether a debtor experienced a substantial and unanticipated change in her financial condition. In re Mattson, 468 B.R. 361, 370 (B.A.P. 9th Cir. 2012).
Citing the Fourth Circuit’s Carrroll opinion, Judge Heston found, “as a matter of its discretion, that the inheritance is a significant improvement in the Debtors’ financial condition that warrants increasing the distribution to unsecured creditors.” She therefore directed the debtor to “propose a modified plan that increases the distribution to unsecured creditors that meets the good faith requirements of § 1325(a)(3).”
Commentary
Former Bankruptcy Judge Lundin told ABI that “post-confirmation change in assets/income is probably the hottest topic going in the chapter 13 world, because post-petition assets and income are badly managed by the Code.”
Judge Lundin said that Judge Heston “correctly excluded the inheritance from the best-interests-of-creditors test analysis because of Section 348(f).” But then, he said, the opinion “jumps to ‘unforeseen, changed circumstances’ to allow a section 1329 modification without telling us what provision of Section 1329 captures the inheritance.”
Judge Lundin said that “1325(b) doesn’t apply at modification after confirmation under section 1329. So where is the hook? Is the inheritance ‘future income’ of some sort?”
Judge Lundin answered his own question by saying that “it can’t be the projected disposable income test in Section 1325(b) because an inheritance is not a substitute for wages or salary.” He cited the Ninth Circuit for having “rejected the notion that liquidation of an asset produces income for Section 1329 modification purposes.”
“Once the inheritance is excluded from the asset calculation in Section 1325(a)(4),” Judge Lundin said, “it doesn’t come back in through the income door.”
Judge Lundin’s analysis suggests that the debtor might succeed on appeal. To do so, she could modify her plan to satisfy Judge Heston and then appeal, asking the trustee to hold her extra payments pending appeal.
Or, the debtor might covert her case to chapter 7 as of right under Section 1307(b), if she were confident that conversion would not be in bad faith under Section 348(f)(2). Were she to convert, Judge Lundin said that the “debtor would keep the entire inheritance on a good faith conversion to chapter 7.”
A chapter 13 debtor ties the score in the top half of the ninth inning in a game against the trustee. In the bottom half of the ninth inning, the trustee loads the bases with two outs. The batter for the trustee hits a long fly ball. Will it be caught to end the inning and win the game for the debtor, or will it go over the fence, with the trustee beating the debtor on a walkoff homer?
The case involves an inheritance the debtor received almost three years after confirming a chapter 13 plan. Will the debtor get to keep the inheritance or not?
Former Bankruptcy Judge Keith Lundin, the author of the treatise Lundin on Chapter 13, predicts that the debtor will win the game, perhaps in extra innings (that is to say, on appeal or after converting the case from chapter 13 to chapter 7).