Inheritances Received During Bankruptcy
Inheritances Received by Chapter 13 Debtors after Confirmation and after the Filing of the Case: Exactly Whose Money Is It?
Experienced debtor’s counsel understand the difficulty in managing clients through a three- to five-year Chapter 13 process. Life continues for debtors, of course, even after confirmation, and situations arise for debtors that do not always have a clear answer in the Bankruptcy Code. One such situation with particularly significant consequences is the Chapter 13 debtor’s postpetition receipt of an unexpected inheritance during his or her case.
The debtor’s obligations under those circumstances are relatively straightforward if the death that triggers the right to the inheritance occurs within 180 days of bankruptcy. Section 541(a) brings the inheritance within the definition of property of the estate, including
11 U.S.C. § 541(a)(5)(A) (Westlaw current through P.L. 113‑13 approved 6‑3‑13).
Further, Federal Rule of Bankruptcy Procedure 1007 requires that the debtor file a supplemental schedule disclosing any § 541(a)(5) assets acquired postpetition “within 14 days after the information comes to the debtor’s knowledge or within such further time the court may allow.” Fed. R. Bankr. P. 1007(h). If an inheritance is acquired within 180 days of bankruptcy, the best-interests-of-creditors test would be implicated and may require a change to the debtor’s plan. See In re Pittman, No. 08-08662-8-RDD, 2010 WL 2206919 (Bankr. E.D.N.C. May 27, 2010) (concluding that debtor’s refusal to modify plan to account for inheritance acquired within 180 days of the bankruptcy was ground for dismissal pursuant to trustee’s motion). The consequences of failing properly to address such an inheritance may be dire for the debtor. See In re Knupp, 461 B.R. 351 (Bankr. W.D. Va. 2011) (debtor’s failure to disclose inheritance received postpetition resulted in the revocation of the discharge).
More difficult questions may arise out of the Chapter 13 debtor’s receipt of an inheritance postconfirmation and after the first 180 days following the filing of a case. For purposes of this article, such an inheritance is referred to as a “Postconf/180 Inheritance.” In addition to § 541 detailed above, two other sections of the Bankruptcy Code are particularly relevant in the Postconf/180 Inheritance analysis: §§ 1306 and 1327.
The definition of property of the estate in a Chapter 13 case is broader than § 541’s definition of property of the estate. Pursuant to 11 U.S.C. § 1306, property of the estate in a Chapter 13 case includes the following, in addition to the property specified in § 541:
11 U.S.C. § 1306(a)(1). Section 1327 returns some property of the estate to the debtor upon confirmation of the plan: “Except as otherwise provided in the plan or the order confirming the plan, the confirmation of a plan vests all of the property of the estate in the debtor.” Id. § 1327(b). Unless the plan or confirmation order states otherwise, “the property vesting in the debtor under subsection (b) of this section is free and clear of any claim or interest of any creditor provided for by the plan,” id. § 1327(c), and the debtor shall remain in possession of all property of the estate under § 1306(b).
PROPERTY OF THE ESTATE?
Once the inheritance issue is raised, courts have utilized varying approaches to decide how the inheritance impacts the debtor’s case. Is the asset property of the Chapter 13 bankruptcy estate?
In In re Carroll, No. 09‑01177‑8‑JRL, 2012 WL 5960077 (Bankr. E.D.N.C. Nov. 28, 2012) (slip copy), appeal granted, No. 13-1024 (4th Cir. filed Jan. 4, 2013), the debtor, having received a Postconf/180 Inheritance, argued that § 1306(a) brings in property from § 541 but does nothing to supersede or eliminate the 180-day time limitation mandated by the specific subsection, § 541(a)(5). In other words, the debtor asserted that § 1306(a) recognizes that all of the provisions found in § 541 control in Chapter 13 cases, including those clauses that include property within the estate as well as those clauses that exclude property from the estate.
The Chapter 13 Trustee urged reading § 541 together with § 1306(a). Section 1306(a) expands only the time restrictions set by § 541and brings into the bankruptcy estate property of the type defined in § 541(a), such as an inheritance, regardless of when that property was received, so long as it was received during the case. Judge Leonard found that the Trustee’s position was consistent with the majority of cases that have considered the issue. He held that an inheritance acquired after the 180-day period of § 541(a) is brought in to the property of the estate in a Chapter 13 case under § 1306(a)(1). See In re Zeitchic, No. 09-05821, 2011 WL 5909279 (Bankr. E.D.N.C. Sept. 23, 2011). The issue ultimately will be resolved by the U.S. Court of Appeals for the Fourth Circuit.
Of course the language of the Bankruptcy Code leaves room for different interpretations of what is property of the estate, but the legislative history suggests that a Postconf/180 Inheritance should be excluded from the estate in a Chapter 13 context. With the apparent intent not to penalize Chapter 13 debtors for attempting and failing at a reorganization, Congress amended § 348 in the Bankruptcy Reform Act of 1994 to make clear that property of the estate in a case converted in good faith from Chapter 13 to Chapter 7 is “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.” 11 U.S.C. § 348. If such a provision would exclude a Postconf/180 Inheritance from property of the estate in a good-faith conversion to Chapter 7, it is difficult to reconcile why that same property would be appropriated to benefit creditors in a Chapter 13 plan. Keith M. Lundin & William H. Brown, Chapter 13 Bankruptcy § 237.1, at ¶ 12 (4th ed. 2000 & Supp. 2006).
Considering, by analogy, how the issue of postpetition wages are addressed in § 1306, the structure of the section itself also arguably offers support that a Postconf/180 Inheritance may be excluded from property of the estate in a Chapter 13. In that section, Congress addressed the exclusion of postpetition wages found in § 541(a)(6) by specifically bringing them back into the Chapter 13 estate through § 1306(a)(2), which includes “earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first.” 11 U.S.C. § 1306(a)(2). Had Congress intended to eliminate the inheritance limitations of § 541(a)(5) in a Chapter 13, it could have done so explicitly the same way it did for postpetition wages.
DUTY TO DISCLOSE?
Another issue presented by the several sections of the Bankruptcy Code and corresponding Bankruptcy Rule provisions is whether the debtor is under any duty to disclose a Postconf/180 Inheritance. Upon the filing of the bankruptcy petition, the initial forms required to be filed by the debtor are dictated, in part, by Rule 1007(b), including the filing of a list of assets of the debtor. Thereafter, Rule 1007(h) addresses postpetition assets but speaks only of assets specifically acquired within 180 days of filing and that fall within the umbrella of § 541(a)(5), that is, property acquired “(A) by bequest, devise, or inheritance; (B) as a result of a property settlement agreement with the debtor’s spouse, or of an interlocutory or final divorce decree; or (C) as a beneficiary of a life insurance policy or of a death benefit plan.” 11 U.S.C. § 541(a)(5).
Despite the lack of specific direction in the Bankruptcy Code, cases have found an ongoing duty of the debtor to disclose a Postconf/180 Inheritance or other change in financial circumstances by amending his or her schedules. For example, in addressing a Postconf/180 Inheritance, the court in In re Euerle, 70 B.R. 72 (Bankr. D.N.H. 1987), concluded that the debtor was obligated to advise the trustee and also to file a supplemental schedule listing the additional asset under Rule 1007(h) because the inheritance was property of the estate under §§ 541(a)(5) and 1306(a)(1). Likewise, after first finding that the debtor’s postconfirmation claim for underinsured motorist benefits was property of the estate, the court in In re Waldron, 536 F.3d 1239 (11th Cir. 2008), determined that the Chapter 13 debtor had an ongoing duty to disclose any changes in his financial circumstances.
In contrast, the court in In re Walsh, No. 07-60774, 2011 WL 2621018 (Bankr. S.D. Ga. June 15, 2011), specifically distinguished the Waldron, 536 F.3d 1239, case from post-180 day inheritance cases because Waldron dealt with a § 541(a)(1) asset, the underinsured motorist benefits, that is not restrained by the 180 day limitation and not a § 541(a)(5) asset, like an inheritance. In a different case dealing with a debtor who converted from Chapter 13 to Chapter 7 and who failed to disclose a postconfirmation inheritance received over 180 days after the petition, the court in In re Doetsch, No. 04-63998, 2007 WL 2702645 (Bankr. N.D.N.Y. Sept. 12, 2007), was not persuaded by the argument of the trustee that the nondisclosure amounted to bad faith and required the inclusion of the inheritance in property of the converted Chapter 7 estate.
Disclosure requirements may also be mandated by local rules or the terms of a confirmation order. Nonetheless, despite the lack of clear statutory requirements to compel disclosure, the safest course for the debtor will be to err on the side of disclosure to avoid subsequent actions to deny him or her a discharge and to be in a stronger position to argue against potential motions to expand the scope of property of the estate or to modify the plan.
WHAT IS THE IMPACT?
Arguably the debtor’s receipt of a Postconf/180 Inheritance does not alter the terms of a confirmed plan, and the debtor may rely on res judicata and the binding effect of the plan under § 1327. Some courts, however, have held that a debtor under such circumstances is compelled to modify the plan because of the change in value of property of the estate. In re Zeitchic, No. 09‑05821‑8‑JRL, 2011 WL 5909279, at *1 (Bankr. E.D.N.C. Sept. 23, 2011) (denying the trustee’s motion to dismiss the debtor’s case for the debtor’s failure to propose a modified plan to include an inheritance, provided that the debtor file such a plan.).
Chapter 13 Trustees have advocated modification of the plan on the theory that the Postconf/180 Inheritance requires increased plan funding based on the best-interests-of-creditors test. The court in In re Nott, 269 B.R. 250 (Bankr. M.D. Fla. 2000), reasoned that the inheritance should be included in determining the amount that unsecured creditors would receive in a hypothetical Chapter 7 case when applying the best-interests-of-creditors test under § 1325(a)(4) to any modified plan proposed in the case. See also In re Moran, No. 08-60201-RLJ-13, 2012 WL 4464492 (Bankr. N.D. Tex. Sept. 25, 2102) (best-interests-of-creditors test measured as of the effective date of modified plan; includes postconfirmation inheritance).
Similarly, when faced with the Chapter 13 Trustee’s motion to modify the plan to include payment of the Postconf/180 Inheritance, the court in In re Tinney, No. 07‑42020‑JJR13, 2012 WL 2742457 (Bankr. N.D. Ala. July 9, 2012), concluded that the inheritance was property of the estate and constituted a sufficient change in circumstances to warrant plan modification. As the court reasoned, “[t]he benefits of chapter 13 come with a price tag, and as we see in the instant case, some risk.” Id. at *3. The court explained that the “privilege of retaining encumbered assets and imposing a payment plan” on creditors requires that the debtor, in exchange, commit postpetition wages and property during the plan. Id.
Other courts have determined that whether an inheritance is property of the estate is not relevant to a trustee’s motion to modify the debtor’s plan and have concluded that the plan modification may be mandated by other factors. The inheritance itself creates a substantial and unanticipated change in financial circumstances that justifies modification of the plan. In re DelConte, No. 07-30583, 2012 WL 1739788 (Bankr. E.D. Va. May 15, 2012); see also Ch. 13 Prac. & Proc. § 11B:3 (Westlaw database updated May 2013); 5A Bankr. Serv. L. Ed. § 50:788 (Westlaw database updated July 2013) (collecting cases).
Absent from some cases considering whether a Postconf/180 Inheritance should be included in the best-interests-of-creditors test for postconfirmation plan modifications is an explanation of why such a test would not be utilized in the context of a converted Chapter 7 case. Does consideration of the best-interests-of-creditors test in the context of a postconfirmation modification require that a court examine the impact of a conversion to a Chapter 7 case to satisfy the hypothetical liquidation required by § 1325(a)(4)? In a case converted to Chapter 7, the hypothetical liquidation test would clearly exclude a Postconf/180 Inheritance unless there was evidence of bad faith.
To the extent a party argues a Postconf/180 Inheritance is income that compels a plan modification under § 1329 and an increase in plan funding to satisfy the disposable income test requirements of § 1325(b), Hon. Keith Lundin noted in his treatise the awkwardness of the application of the disposable income test in such a context since it is triggered only upon objection by the “trustee or the holder of an allowed unsecured claim.” Keith M. Lundin & William H. Brown, Chapter 13 Bankruptcy § 255.1, at ¶ 7 (4th ed. 2000 & Supp. 2006). If the party moving under § 1329 for plan modification to include the inheritance is the trustee or an unsecured creditor, is the disposable income test even implicated? If it does apply, is an inheritance “projected” as required by § 1325(b) if it has already been received? Is it appropriate to reconsider what is projected disposable income when that analysis was previously completed at the original plan confirmation and no inheritance was projected at that time?
The varied approaches taken by the courts with respect to Postconf/180 Inheritances, the unexpected nature of the windfall, and competing policy considerations all combine to complicate the challenges such an event creates in the context of executing the Chapter 13 plan. Determining the impact of these considerations on a particular debtor’s case will depend largely on the facts of each case. With so much at stake, likely the best approach for debtors and their counsel will be to disclose the inheritance and try to negotiate a mutually satisfactory resolution among the parties while preserving their arguments should the issues ultimately come before the court.
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