Now That We Found Assets, What Are We Going To Do With Them?

Bryan Cave Leighton Paisner
“You can make me walk the plank – but please, don’t let the law render a claim for wartime losses as property of my bankruptcy estate!” **

My most recent post surveyed situations in which a debtor might lose assets, or see their value drop to zero, during a bankruptcy case. This article addresses the opposite circumstance: how might a debtor’s estate gain new assets after a bankruptcy filing?

First, the basics. In general, the bankruptcy estate consists of “all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. § 541(a)(1). Two provisions capture certain general categories of assets that materialize post-petition: proceeds, products, offspring, rents, or profits from property of the estate, and interests in property acquired by the estate. Id. § 541(a)(6), (7). Thus, a typical Chapter 7 estate does not include post-petition assets, other than the proceeds of property sold by the trustee. Because a debtor in Chapter 11, 12, or 13 ordinarily continues to generate income, the bankruptcy estate expands to include a variety of post-petition assets. The bullets below discuss the treatment of post-petition assets that might be unexpected or unpredictable at the outset of a bankruptcy case.

  • Bonuses. Post-petition salaries and wages are straightforward: they belong to the bankruptcy estate in Chapters 11, 12, and 13, but not in Chapter 7. See 11 U.S.C. §§ 541(a)(6), 1115(a)(2), 1207(a)(2), 1306(a)(2). A post-petition bonus that is based on pre-petition services presents a more challenging question. One important fact is whether the debtor had a contractual right to receive the bonus. Compare In re Klein-Swanson, 488 B.R. 628, 633 (B.A.P. 8th Cir. 2013) (because employer had “absolute discretion” whether to award bonuses, debtor had “nothing more than a hope or expectation” on petition date), with In re Booth, 260 B.R. 281, 284 (B.A.P. 6th Cir. 2001) (debtor had contingent interest on petition date in profit-sharing payment from employer, where only conditions were employer’s generation of profits and debtor’s employment through end of year).
  • Gifts. A gift to a Chapter 11, 12, or 13 debtor appears, at first blush, to be “an interest in property that the estate acquires” and thus property of the estate under Section 541(a)(7). But problems quickly surface. What if the debtor doesn’t want the gift because it’s PCB-soaked real estate?[1] What if the donor wouldn’t have made the gift if she were aware of the bankruptcy or had understood its legal significance; is the debtor nevertheless required to distribute the gift to creditors under the best-interests test? What if the only purpose of the gift is to permit the debtor to sell the property free and clear of liens under Section 363(f) or to strip off a wholly unsecured lien under Section 1322(b)(2), neither of which the original owner of the property could accomplish outside of bankruptcy? To avoid these absurd outcomes, some courts have limited the reach of Section 541(a)(7) to “property interests that are themselves traceable to ‘property of the estate’ or generated in the normal course of the debtor’s business.” In re TMT Procurement Corp., 764 F.3d 512, 524 (5th Cir. 2014); see also In re Gallucci, 931 F.2d 738, 744 (11th Cir. 1991) (gift to Chapter 7 trustee of real estate “unrelated to the debtor and the bankruptcy estate” did not cause it to become estate property).
  • Government awards. What’s more American than going broke and starting fresh? If your answer is “asking the government for a bailout,” you’re awfully cynical but not necessarily wrong. Complications abound when government relief comes years or even decades after the loss in question. For example, the 5th Circuit held that crop-disaster payments awarded to a farmer on account of pre-petition crop years were not property of his Chapter 7 bankruptcy estate because Congress didn’t enact the relief statute until after the debtor filed his petition. See In re Burgess, 438 F.3d 493, 499 (5th Cir. 2006) (en banc). But seven judges joined a spirited dissent, citing cases dating back to the early 1800s. See id. at 508 (Jones, C.J., dissenting). Those older cases involve some of the wildest fact patterns in American bankruptcy jurisprudence. See Comegys v. Vasse, 26 U.S. (1 Pet.) 193 (1828) (where debtor paid insurance claims on vessels captured by Spain before 1802 bankruptcy and received compensation from federal government in 1824 under treaty with Spain, award was property of bankruptcy estate); Milnor v. Metz, 41 U.S. (16 Pet.) 221 (1842) (where debtor had an “unusually laborious” year as gauger for the port of Philadelphia, additional compensation awarded to him by Congress four years later was property of his assignee under an intervening assignment for the benefit of creditors); Williams v. Heard, 140 U.S. 529 (1891) (steamship operator’s claim for compensation for war-risk insurance premiums during “the war of the Rebellion,” ultimately resolved by 1871 U.S.-Great Britain treaty, 1872 arbitration award, 1874 and 1882 Acts of Congress, and 1886 award by court of commissioners, belonged to estate created by 1875 bankruptcy filing).[2]
  • Inheritance. Section 541(a)(5)(A) of the Bankruptcy Code provides that an interest in property that the debtor acquires or becomes entitled to acquire “by bequest, devise, or inheritance” within 180 days after a bankruptcy filing is property of the estate. But what if the debtor disclaims the inheritance in an attempt to pass it to his or her descendants instead of to creditors? This was a plausible strategy under the Bankruptcy Act of 1898. See In re Detlefsen, 610 F.2d 512, 520 (8th Cir. 1979). Under the Bankruptcy Code, however, courts generally conclude that both the inheritance and the right to disclaim it become property of the estate, to be preserved for the benefit of creditors. See, e.g., In re Scott, 385 B.R. 709, 711-12 (Bankr. D. Neb. 2008).[3]
  • Legal fees. When a lawyer-debtor is retained pre-petition and collects a contingency fee post-petition, a portion of the fee attributable to pre-petition services belongs to the bankruptcy estate. See Turner v. Avery, 947 F.2d 772, 774 (5th Cir. 1991). In addition, trustees for bankrupt law firms once found success with claims that a firm’s estate owns the profits that would be generated in the future on matters for which the firm charged hourly rates. This “unfinished business” theory was largely put to rest by state-court determinations that a failed firm has no property interest in future profits. See In re Thelen LLP, 762 F.3d 157 (2d Cir. 2014); In re Heller Ehrman LLP, 716 F. App’x 693 (9th Cir. 2018).
  • Life insurance. As with an inheritance, a debtor’s recovery as a beneficiary of a life insurance policy or a death benefit plan within 180 days after a bankruptcy filing becomes property of the estate. 11 U.S.C. § 541(a)(5)(C).
  • Lottery winnings. A post-petition lottery win yields property of the estate under the reorganization chapters. See In re Cook, 148 B.R. 273, 277 (Bankr. W.D. Mich. 1992) (Chapter 12); In re Koonce, 54 B.R. 643, 645 (Bankr. D.S.C. 1985) (Chapter 13).[4]
  • Tax refunds. Tax refunds are different from most of the other types of property discussed here, because their timing is predictable and their amount can be estimated. Yet they still present challenges for courts, debtors, and creditors. The leading case on the estate’s power to capture cash received post-petition involved a tax refund. In Segal v. Rochelle, 382 U.S. 375 (1966), the debtors suffered losses during the pre-petition portion of the year in which they filed their bankruptcy petitions, and their trustee carried the losses back to obtain refunds of taxes from earlier years. The Supreme Court held that the refunds were “sufficiently rooted in the pre-bankruptcy past” to qualify as estate property. Id. at 380. While this phrase has been quoted frequently, the courts have struggled with issues such as how to divide a refund between debtor and non-debtor spouses. See In re Spina, 416 B.R. 92, 96-97 (Bankr. E.D.N.Y. 2009) (summarizing three approaches and adopting a fourth). Similar problems arise when a corporate group files a single tax return on behalf of both healthy and bankrupt affiliates. See Rodriguez v. FDIC, 140 S. Ct. 713, 718 (2020) (rejecting federal common law allocation rule and directing courts to apply state law).
  • Treasure trove. The possibility that a debtor will discover treasure post-petition appears to be largely theoretical, as reported decisions about property discovered underground tend to involve hazardous substances rather than valuable ones. But what should we make of one court’s statement that a debtor wouldn’t be able to pay his student loans unless he “finds a gold mine or a treasure trove in the backyard”? In re Carnduff, 367 B.R. 120, 130 (B.A.P. 9th Cir. 2007). As with so many other types of property, much depends on what rights the debtor has in the treasure and when those rights arise. For example, if the debtor owned the real estate in the backyard pre-petition, he also might have had an interest in treasure buried in the yard, even if he had not yet discovered the treasure. See generally United States v. Shivers, 96 F.3d 120 (5th Cir. 1996) (under federal common law, abandoned property embedded in soil belongs to owner of soil). On the other hand, if the debtor first obtained an interest in the treasure upon finding it post-petition, he would have a strong argument that the treasure belonged to him and not to his Chapter 7 trustee. See generally Hurley v. City of Niagara Falls, 289 N.Y.S.2d 889 (App. Div. 1968) (under New York law, finder obtains title after period in which police attempt to locate original owner).

[1] A debtor can’t simply abandon environmentally contaminated property. Midlantic Nat’l Bank v. New Jersey Dep’t of Envt’l Protection, 474 U.S. 494 (1986). So must the debtor clean it up, even though the debtor had no involvement in polluting it?

[2] The craziest of the 19th-century cases involved claims for compensation for French naval activities during the Quasi-War, which ended in 1800. Congress didn’t authorize claimants to seek relief in the Court of Claims until 1885 and didn’t appropriate funds until 1891, at which point it was apparently easiest to state expressly in the legislation that funds should be paid to the original parties’ next of kin and not to any assignees in bankruptcy. See Blagge v. Balch, 162 U.S. 439 (1896).

[3] Pre-petition disclaimers remain fair game and generally cannot be avoided as fraudulent transfers. See In re Simpson, 36 F.3d 450 (5th Cir. 1994) (upholding Homer Simpson’s disclaimer of inheritance from his father one day before he filed Chapter 7 petition) [Editor’s note – the party involved here really was named Homer Simpson – we looked it up!].

[4] Some debtors have argued that post-petition annuity payments on account of a pre-petition lottery win are not property of the estate because they are comparable to a spendthrift trust. This is not an advisable tactic. See In re Brown, 86 B.R. 944, 948 (N.D. Ind. 1988) (“You won big in the Arizona lottery. You lose here!”).

** Photo credit: Getty Images

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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