by A Bankruptcy Appellate Panel for the Tenth Circuit found that appreciation in value of the debtors’ homestead while in chapter 13 belongs to the debtors upon conversion to chapter 7. Rodriguez v. Barrera (In re Barrera), No. 20-3 (B.A.P. 10th Cir. Oct. 10, 2020) (unpublished).
When the debtors filed for bankruptcy, their homestead was valued at $396,606, encumbered by two liens totaling $336,209. They claimed their $75,000 homestead exemption leaving no equity for the bankruptcy estate. During the course of their chapter 13 bankruptcy, they sold the homestead for $520,000. They then converted to chapter 7. The trustee sought turnover of the sale proceeds in excess of the debtors’ exemption. The bankruptcy court denied the trustee’s motion, holding that the value of the property consisted of the value it had on the original petition date.
On appeal, the BAP for the Tenth Circuit began with section 348(f)(1)(A), which provides that when a case is converted from chapter 13 to chapter 7, property of the chapter 7 estate consists 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.”
The trustee argued that section 541(a)(6) provides that “proceeds” of estate property are property of the estate and that the term includes appreciation. The trustee also cited In re Hayes, No. 15-20727-MER (Bankr. D. Colo. Mar. 28, 2019), for the proposition that section 348(f)(1)(A) is not ambiguous, clearly allowing for capture of appreciation in property held by the estate on the petition date. The Hayes court found that “postpetition accrual of equity through appreciation in . . . value is not itself a separate interest in property which could be excluded from post-conversion estate property.”
The panel disagreed. It found that the fact that two sister bankruptcy courts—Hayes and the Barrera court—came to opposite conclusions concerning the interpretation of section 348(f)(1)(A), demonstrated the inherent ambiguity in the provision. The panel therefore turned to legislative history for guidance noting that, in enacting section 348(f) in 1994, Congress explicitly overruled Matter of Lybrook, 951 F.2d 136 (7th Cir. 1991), which held that property inherited during the course of the debtor’s chapter 13 case, entered the estate under section 1306(a)(1) and remained part of the estate upon conversion, and adopted the reasoning of In re Bobroff, 766 F.2d 797 (3d Cir. 1985).
In Bobroff, the debtor originally filed in chapter 7 and later converted to chapter 13. While in chapter 13 he acquired several causes of action in tort. He then reconverted to chapter 7, and the trustee sought to acquire the causes of action for the bankruptcy estate. The Third Circuit held that the causes of action were not part of the bankruptcy estate, but it did so on the basis that the debtor’s conversion to chapter 13 was void ab initio and, therefore, section 1306(a) never became applicable. The Hayes court reasoned that a contrary finding would discourage a debtor from voluntarily filing under chapter 13 because of the potential loss of after-acquired property upon conversion to chapter 7. Significantly, the Barrera panel was persuaded that Congress relied on the policy concerns in Bobroff rather than on the unique facts of that case.
Applying that reasoning to the case before it, the panel found that including the post-petition appreciation of a debtor’s homestead under these circumstances would discourage debtors from attempting chapter 13 for fear of being penalized if they later convert to chapter 7. Having concluded that Congress enacted section 348(f)(1)(A) to further the policy goal of not disincentivizing debtors from attempting chapter 13, the panel found that the bankruptcy court’s decision harmonized with that intent.
The panel was further convinced of its finding by the language of section 348(f)(2), which provides that if a debtor is found to have converted from chapter 13 to another chapter in bad faith, the property of the new estate would consist of the property of the estate as of the date of conversion. That section, designed to punish bad faith conversion, would lose its teeth if courts included post-petition appreciation in conversions under section 348(f)(1). The panel cited as an example, paydown cases where a debtor’s equity increases as a result of payments made toward his real property during the chapter 13 case, reasoning that a debtor would be punished for converting if the increased equity was included in the converted chapter 7 case.
The trustee differentiated paydown cases, where the increase in equity was a result of the debtor’s efforts, from cases in which the equity increases because of appreciation. But the court found that the difference was insignificant because the real disincentive was in the possibility that the chapter 7 trustee would sell the homestead to capture the increased value. Further, the trustee’s argument would have the practical effect of requiring a court determine whether the increase in value of a debtor’s homestead was due to his own efforts—i.e. improvements to the property itself—or merely to market forces as the parties agreed was the case here.
The panel concluded that “neither § 348(f) nor § 541(a) clearly delineate a debtor’s interest in the postpetition appreciation of a homestead. Interpreting congressional intent as incentivizing chapter 13 repayment and following the guidance of many other courts that have reviewed this issue, we hold any postpetition appreciation in the value of the debtor’s prepetition property—including postpetition appreciation of a homestead—belongs to the debtor and does not become property of the estate upon conversion to chapter 7.”