Whose Property Is It At Conversion?

Twenty years in, it’s still undecided.

We have no uniform rule on what happens to equity in an asset, built up during a Chapter 13 plan, when the case converts to Chapter 7.

Amazingly, nearly 20 years after subsection (f) was added to 348, courts are split on how it works. But another court has just weighed in.

Given the propensity for Chapter 13 cases to crater, you need to know where your court stands on this critical issue.

The facts

The prototypical fact pattern has a encumbered car at the start of the plan. Over the course of a couple of years, the debt is paid down, creating equity not present at the commencement of the case.

Section 348(f) tells us:

1) Except as provided in paragraph (2), when a case under chapter 13 of this title is converted to a case under another chapter under this title—

(A) 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;

In our example, the car was property of the estate when the case was filed, and it still in the possession of the debtor at conversion. The secured creditor got the payments provided for, presumably as did the unsecured creditors.

Who gets the equity created during the plan when it becomes a Chapter 7? The courts are split.

Equity to the debtor

Judge Funk of the Middle District of Florida recently sided with the courts holding that the post petition, pre conversion equity belonged to the debtor not the estate. Robinson, 472 B.R.854.

The legislative history, he wrote, demonstrates a Congressional intent to encourage debtors to reorganize rather than liquidate. To expose the equity built up during the plan to the Chapter 7 trustee would create a disincentive to choose Chapter 13.

Equity to the estate

A scary example of the other line of cases is John, 352 B.R. 895, where the debtors’ Chapter 13 plan was driven by the best interests of creditors test.

They’d paid some $42,000 into the plan before conversion, and the court held that they must surrender the property to the Chapter 7 trustee, notwithstanding the sums paid already to creditors during the plan.

As the court in John pointed out, the debtors could have sought a hardship discharge rather than convert.

Keep your eyes peeled.

Image courtesy of Gerait.