Trustee’s Valuation of Unresolved Pre-Petition Cause of Action Rejected

A bankruptcy court rejected a chapter 13 trustee’s valuation of the debtor’s pre-petition cause of action and found that an estimated value of the state court case should not be included in the plan distributions but that the plan may be modified if the debtor obtains a money judgment during the commitment period. In re Morales, No. 12-7296 (Bankr. P.R. July 2, 2015).

In her petition, Teresita Morales disclosed that she was a member in a class action lawsuit seeking contractual and tort damages in the amount of $264,283, based on the claim that the mortgage deed she executed in certain property was not properly recorded. In accordance with a court order, the debtor changed the listed value of the claim from “unknown” to $132,142. In her plan, the debtor proposed to distribute the lawsuit proceeds only if she obtained them during the applicable commitment period.

The trustee argued that under section 541 the cause of action was part of the bankruptcy estate, and under section 1325(a)(4)’s “best interest of creditors test” the liquidation value of the cause of action must be calculated for distribution to unsecured creditors. In valuing the cause of action, the trustee applied a formula whereby the amount sought in the complaint was multiplied by the likelihood of success and came up with the figure of $90,140.32.

The court walked through the relevant Code sections noting that section 1325(a)(4) provides that a plan must distribute to creditors at least what they would receive in a hypothetical chapter 7 liquidation case. Recognizing that calculating the liquidation value was not an exact science the court was satisfied with Ms. Morales’ valuation of the claim as half of what she demanded in the state court complaint.

The court turned to the stickier issue of how the unliquidated cause of action affects the debtor’s obligation to creditors in her current plan. The court rejected the trustee’s argument that distributions should include the speculative valuation of the claim without regard to when it is concluded. Rather, the court resolved the issue by requiring that the debtor supply status updates as to the state court action every four months through the life of the plan. If the case is resolved in the debtor’s favor she is to modify her plan under section 1329 to include the income. On the other hand, “if the local court dismisses Debtor’s cause of action, rules against the Debtor, or the cause of action is not resolved by month 59 of the plan commitment period, a modification of the confirmed plan shall then promptly follow to remove the approximate value of the cause of action from the plan.”

Morales Bankr PR opinion