In re Castleman
In re Castleman, (US District Court W.D. Wash. July 1, 2022), appeal to District Court from Bankruptcy Court, DC case no. 21-00829: US District Court Affirms that when a Chapter 13 Debtor’s bankruptcy case is converted from Chapter 13 to Chapter 7, that appreciation in the value of debtor’s residence/real property from when the Chapter 13 case was filed, onward, belongs to the Chapter 7 bankruptcy estate, not to the debtor; whereas if the debtor had remained in Chapter 13, the appreciation in the value of the residence/real property, during the Chapter 13 case, belongs to the Chapter 13 bankruptcy estate, which the debtor (not a Trustee) controls. Result: Conversion from Ch13 to Ch7 can result in debtor’s real property being sold by Chapter 7 Trustee, whereas if debtor had remained in Chapter 13, that would not have happened.
Detail:
On an issue where the courts are split, the US district Court, in In re Castleman holds that the debtors lose the post-petition appreciation in the value of estate property when a chapter 13 case converts to chapter 7.
Who gets the appreciation in a home when a chapter 13 case converts to chapter 7 after confirmation? Does the debtor keep the appreciation, or does it belong to the chapter 7 trustee? It’s one of the hottest topics in chapter 13 these days. The courts are split.
Having confirmed a plan, the debtors were in chapter 13 for about 18 months before converting to chapter 7. In chapter 13, they had scheduled their home as being worth $500,000 at filing. With a $500,000 valuation, there was no equity in the property on the filing date in view of a $375,000 mortgage and the debtor’s claimed homestead exemption of $125,000.
After conversion, the chapter 7 trustee alleged that the property was worth $700,000 and filed a motion for authority to sell the home. The debtors argued that the valuation at conversion didn’t matter because appreciation during chapter 13 was theirs.
Bankruptcy Judge Marc Barreca of Seattle Washington disagreed with the debtors and held that post-petition, pre-conversion appreciation belonged to the chapter 7 estate. In re Castleman, 631 B.R. 914 (Bankr. W.D. Wash. June 4, 2021).
The debtors appealed, but District Judge John H. Chun affirmed in a seven-page opinion on July 1.
Judge Chun looked primarily at Sections 541(a)(1) and (a)(6). The former defines the estate broadly to include all legal and equitable interests in property as of the filing date. Subsection (a)(6) brings proceeds, rents and profits into the estate, except earnings by an individual for services performed after filing.
Judge Chun also examined Section 348(f)(1)(A). When a chapter 13 case converts to a case under another chapter, it provides 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.”
However, Judge Chun said that Section 348(f)(1)(A) does not address whether the increase in equity of a pre-petition asset qualifies as a separate, after-acquired property interest — as with after-acquired wages — or whether it is inseparable from the asset itself. Put another way, § 348(f)(1)(A) does not indicate whether “property of the estate, as of the date of filing of the petition,” refers to property as it existed at the time of filing, with all its attributes, including equity interests.
For not addressing the question directly, the debtor contended that the statute was ambiguous. Judge Chun still found the answer within the four corners of the statute in view of the Ninth Circuit’s decision in Wilson v. Rigby, 909 F.3d 306 (9th Cir. 2018). Over a vigorous dissent, the Ninth Circuit, in Wilson v. Rigby, held that Sections 541(a)(1) and (a)(6), read together, lead to the conclusion that post-petition appreciation in the value of a home belongs to the chapter 7 trustee. See detailed discussion of Wilson v. Rigby, below.
However, Wilson was not entirely on point because the 2018 precedent dealt with a case in chapter 7 from the outset, not one converted from chapter 13.
Judge Chun worked from the proposition that a chapter 7 debtor keeps property acquired after filing. Therefore, he said, the question is whether appreciation is “a separate, after-acquired property interest” belonging to the debtor.
By having held in Wilson “that appreciation inures to the estate under 541(a)(6),” Judge Chun inferred that the Ninth Circuit “has necessarily found that increased equity in a pre-petition asset cannot be a separate, after-acquired property interest.”
“This logic,” Judge Chun said, “applies with equal force in a conversion case.”
Although Section 348(f)(1)(A) might seem ambiguous initially, Judge Chun concluded that “it is unambiguous when considered in the context of the Code as a whole and under the Ninth Circuit’s holding in Wilson.”
Judge Chun upheld Bankruptcy Judge Barreca and allowed the trustee to sell the home and retain appreciation for the estate, after covering the debtors’ homestead exemption. He permitted the debtors to file a motion for payment of an administrative expense for mortgage payments the debtors made after filing.