Evaporating Equity: Charting a Course Through the Confusion of Chapter 13

When a debtor’s assets appreciate after filing a chapter 13 petition, historically that appreciation has inured to the debtor and not to the estate [1]. That norm is gradually evaporating, as courts are beginning to hold that post-petition appreciation belongs to creditors [2]. The ambiguity in chapter 13 of the Bankruptcy Code is responsible for shifting appreciation from debtors to creditors.

This ambiguity arrived at the forefront of the bankruptcy bar’s attention through two cases that dealt with post-petition, pre-conversion increases in home values. Although these cases deal with post-petition appreciation in the context of conversion, they underscore the vast differences in how the bench approaches property of the estate in chapter 13.

In early 2022, debtors could keep post-petition, pre-conversion appreciation [3]. In re Barrera featured a home that initially had no equity available for creditors [4]. The home appreciated, and the debtors sold it, netting $140,251 [5]. Two weeks after the sale, the debtors converted to chapter 7 [6]. The court began its analysis with § 348(f)(1), which stated that the property of the estate on the date of the petition was the property that entered the converted estate.

Turning to § 541(a), property of the estate is any property in which the debtor has a legal right [7]. However, the court continued, at confirmation the home vested in the debtor, permanently removing the home and its future proceeds from the estate [8]. Thus, the sale proceeds from the home belonged exclusively to the debtor [9]. The court cabined its analysis to whether the post-petition, pre-conversion proceeds of the sale inured to the debtor or to the estate, and not whether the post-petition, pre-conversion equity inured to the debtor [10].

The Ninth Circuit was quick to disagree with Barrera. In Matter of Castleman [11], The Ninth Circuit held that post-petition, pre-conversion equity inured to the estate and not to the debtor [12].

Like the Barrera court, the Ninth Circuit started with § 348(f)(1) [13]. The majority claimed that if Congress intended post-petition, pre-conversion appreciation to remain in the hands of the debtor, Congress would have made a cross-reference to § 1327(b) [14].

Judge Tallman disagreed and dissented by distinguishing the chapter 13 estate from the chapter 7 estate: The debtor gets to keep her property in exchange for dedicating disposable income to a plan to repay creditors [15]. According to Judge Tallman, § 348(f)(1) must be read in light of the entire Code, and he cited In re Black for the proposition that § 1327(b) revested the property in the debtor, meaning that the debtor would be entitled to any post-petition appreciation [16].

Did the Castleman decision create a circuit split? The Barrera court was particularly careful to note that its holding did not pertain to unliquidated appreciation in a home. But the dissent in Castleman and the Barrera opinion both lean on § 1327(b) in conjunction with § 348(f) to give post-petition, pre-conversion appreciation to debtors.

Barrera and Castleman illustrate fundamentally different approaches to handling estate property in chapter 13. The foundation of this dispute stems from courts’ various understandings of how the Code classifies property of the estate throughout the lifespan of a chapter 13 plan. Although the Castleman and Barrera courts turn on the issue of conversion, the answer to solving the post-petition, pre-conversion conundrum runs deeper than § 348(f). The issue lies in how to determine property of the chapter 13 estate under Code §§ 1306 and 1327.

The Code is fantastically ambiguous on property of the estate in chapter 13. Section 1306 commands that the chapter 13 estate include all property acquired after the case begins until the case is terminated or converted, while § 1327(b) states that all property vests in the debtor at confirmation unless otherwise stated. Further complicating the state of the chapter 13 estate, § 1327(c) decrees that the debtor controls the property free and clear of any interest provided for in the plan.

In response to these conflicting Code sections, courts have developed five frameworks to administer estate property in chapter 13 [17]. These approaches include the estate-termination approach [18], estate-preservation approach [19], conditional-vesting approach [20], estate-transformation approach[21] and estate-replenishment approach [22].

Although the estate-replenishment approach enjoys some popularity [23], there seems to be no clear consensus on how to apply it. In 2023, Judge Fenimore in Missouri and Judge Randon in Michigan both concurred that the estate-replenishment theory was the correct way to read §§ 1306 and 1327, but both judges came to different outcomes based on the facts of their individual cases.

Both cases featured debtors that confirmed chapter 13 plans, sold their homes, and moved the court to retain the proceeds of the sales [24]. Both courts recognized the tension between §§ 1306 and 1327 [25]. The two courts differed on how they classified the proceeds. Judge Fenimore posited that the sales proceeds are a separate asset, and because they came into being after the case commenced, the proceeds replenished the estate and inured to the creditors[26]. Judge Randon disagreed, claiming that the proceeds were inseparable from the underlying estate, and therefore they did not replenish the estate and remained in the hands of the debtor [27].

The Marsh court grounded its reasoning in the fact that the proceeds did not exist at the start of the case, so they could not have vested in the debtor at plan confirmation under § 1327 [28]. The Elassal court relied on the policy rationale of chapter 13, namely that the debtor gets to keep her property in exchange for devoting all future income to the chapter 13 plan [29].

The Bankruptcy Code is not clear on how courts should treat post-petition appreciation. Due to the ambiguity in §§ 1306 and 1327, courts have been left to guess at how to best distribute property. Hopefully, courts can coalesce around one analytical viewpoint or Congress can eliminate the ambiguity. While some debtors may fare better in the current confusion, other debtors may see more of their equity evaporate.