Chapter 13 Debtors Need to Know Whether They Lose Appreciation When They Sell a Home–Rochelle’s Daily Wire, American Bankruptcy Institute
In re Robinson, 18-31989 (Bankr. E.D. Va., March 17, 2023)
According to Bill Rochelle (ABI’s Editor-at-Large), Congress desperately needs to amend the Bankruptcy Code and decide whether chapter 13 debtors are allowed to retain post-petition appreciation in the value of their homes.
Courts today are divided. In the worst case, the debtor may be compelled to turn the appreciation over to the trustee, not leaving enough for the debtor to purchase a new home in today’s inflated market.
The case ABI reported today led to a bad result for the debtor, in part because the lack of clarity in the law left counsel unable to give sound advice.
Home Destroyed by Fire
The debtor filed a chapter 13 petition owning a home she valued at about $42,000, subject to a $15,000 mortgage. She claimed a $10,000 exemption under Virginia law.
Bankruptcy Judge Keith L. Phillips of Richmond confirmed the plan after the trustee withdrew an objection based on the value of the home. The 60-month plan called for payments of $840 a month.
Although not mentioned in the opinion, the confirmation order revested estate property in the debtor.
The plan would pay off the mortgage on the home and the lien on a car. Unsecured creditors would receive 24%, better than the 23% liquidation value calculated by the debtor.
Twenty months after confirmation, a fire burned the home to the ground. The debtor filed an insurance claim and received some $82,500 from the insurer. The insurer sent another $8,500 to the lender, paying off the mortgage.
Seventeen months after receiving the insurance proceeds, the debtor consented to conversion of the case to chapter 7 after the chapter 13 trustee moved to dismiss for failure to make payments. By that time, unsecured creditors had received 15% of their claims, and the debtor was still holding $11,000 from the insurance proceeds.
While in chapter 13, the debtor did not amend her schedules to disclose the insurance proceeds. However, the debtor or her counsel on two occasions before conversion told the trustee about the fire and inquired about the disposition of some of the proceeds. Evidently, neither the debtor nor counsel disclosed the amount of the proceeds.
After conversion, the debtor filed new schedules disclosing the fire loss and giving a $5,000 value for the uninhabitable property. The new schedules did not disclose receipt of insurance proceeds.
The chapter 7 trustee learned about the insurance and found that the debtor still held $5,000 when he filed the motion to dismiss, according to the March 17 opinion by Judge Phillips. Alongside the motion to dismiss the chapter 7 case, the trustee wanted a two-year bar to refiling.
Finding the debtor’s testimony to be credible, Judge Phillips said that the debtor had spent the insurance proceeds on personal expenses but not on luxuries.
Dismissal with Prejudice and a Bar to Refiling
Had the chapter 13 trustee or creditors known about the insurance proceeds, Judge Phillips said that someone “likely” would have moved to modify the plan and direct some or all of the proceeds to creditors.
According to Judge Phillips, another judge in the district said last year that debtors have a duty of cooperation with the trustee under Section 521(a)(3) and Rule 4002(a)(4), even though “the Bankruptcy Code and Federal Rules of Bankruptcy Procedure may not explicitly require the amendment of a debtor’s schedules when an asset becomes property of a chapter 13 estate pursuant to § 1306(a).”
From the Code and the Rules, Judge Phillips concluded that a chapter 13 debtor had a duty to disclose a substantial and unanticipated change in the debtor’s financial condition. Even if amending the chapter 13 schedules was not “technically required,” he held that “their receipt required accurate and timely disclosure to the Chapter 13 Trustee.”
The debtor argued that the proceeds were not estate property and that there was no duty to disclose. Citing authorities, Judge Phillips went on to hold that the “Proceeds of the policy insuring the [home] were property of the Debtor’s chapter 13 estate that the Debtor could use only with court approval.” Without disclosure, he said that “the Chapter 13 Trustee and her creditors were not afforded the opportunity to seek a plan modification.”
Based on the “totality of the circumstances,” Judge Phillips held that the debtor had not acted in good faith, giving rise to dismissal for “cause” under Section 707(a). While a two-year bar to filing was “excessive,” he dismissed with prejudice and instituted a one-year bar to refiling.
Observations
Courts disagree about creditors’ entitlement to increments in a debtor’s assets during the course of a chapter 13 case. Some believe that creditors are entitled to boosted plan payments, while others believe that increased payments are due only if the debtor’s earned income has increased.
Likewise, Section 548(f)(1)(A) does not say who gets appreciation in property between the chapter 13 filing date and the date of conversion to chapter 7.
It’s no surprise that chapter 13 debtors’ counsel are in a quandary about actions to take when a home is sold or a debtor seeks to sell other property that has appreciated in value.
The sanctions imposed by Judge Phillips are not surprising given the debtor’s partial and perhaps misleading disclosures about the insurance. However, the sanctions imposed on the debtor raise a question under Taggart v. Lorenzen, 139 S. Ct. 1795, 1799 (2019), where the Supreme Court held that a court “may impose civil contempt sanctions [for violating the discharge injunction] when there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful under the discharge order.” To read ABI’s report, click here. The Taggart rule has been expanded to cover violations of the automatic stay.
Through Taggart, creditors are protected from contempt except when stay or discharge violations are beyond cavil. Should the same standard be applied before courts impose sanctions on debtors?
In the instant case, Judge Phillips said that the Code and Rules “may not explicitly require the amendment of a debtor’s schedules when an asset becomes property of a chapter 13 estate pursuant to § 1306(a).” With respect, it is also not absolutely clear that proceeds from a home are estate property after confirmation.
When there is no clear answer to a question, should Taggart protect debtors to the same extent it protects creditors?
