Inforuptcy Blog Archives December 2014

Property of the Estate Under 11 U.S.C. § 541

Posted by Zev Shechtman, Esq. on December 16, 2014

Guest Post By Zev Shechtman, Esq.
Danning, Gill, Diamond & Kollitz, LLP
www.dgdk.com

INTRODUCTION
Sophisticated investors may look to bankruptcy for deals in distressed assets.  By definition, such buyers are trying to buy “property of the estate” from chapter 7 or 11 trustees or chapter 11 debtors in possession.  An investor with knowledge of the scope of property of the estate under the Bankruptcy Code, and who understands the schedules which list estate assets and liabilities, can better evaluate where there may be opportunities to realize value while avoiding bankruptcy’s pitfalls.  

STATUTORY FRAMEWORK
The Bankruptcy Code (title 11 of the United States Code) defines what is and what is not property of the estate.  Pursuant to Section 541 of the Bankruptcy Code, property of the estate includes a broad range of tangible and intangible assets, including “all legal or equitable interests” of the debtor in property as of the commencement of the bankruptcy case.[1]

Property of the estate also includes, among other assets: community property interests of the debtor’s spouse; property recovered by a trustee or debtor in possession; certain property the debtor becomes entitled to within 180 days after the petition filing, such as property acquired by inheritance; proceeds and profits (unless for personal services); and other property acquired by the estate after the petition date.[2]  While the Bankruptcy Code defines property of the estate, it is state law that generally dictates what substantive rights the estate has in property.[3]   

SCHEDULES
Property of the estate, which the debtor must list on the debtor’s schedules (filed with or shortly after the petition), may include interests in real property, which are listed on the debtor’s Schedule A.  Property of the estate may also include all manner of personal property, listed on Schedule B, such as: automobiles, equipment, furniture and inventory, cash, bank accounts, stocks, bonds, loans receivable, accounts receivable, licenses, insurance policies and intellectual property.  

Other intangible assets may include corporate goodwill as well as contingent assets, including tax refunds, rights to royalties, or the recovery on a lawsuit.  Virtually every fathomable type and manner of interest which the debtor has when the debtor files for bankruptcy is in all likelihood property of the estate.[4]

A debtor’s assets, as reflected on Schedules A and B, may be of substantial value, but the analysis cannot be complete without reviewing Schedule D, and Schedule C if the debtor is an individual.  Schedule D lists all secured claims against the debtor’s property, which may equal or exceed the value of the property, thereby limiting or eliminating value.  Schedule C  lists exemptions available to individuals, which, when proper, allocate some or all of the equity in certain property to the debtor, thereby reducing the equity available to the estate.

THE ROLE OF A TRUSTEE OR DEBTOR IN POSSESSION
It is the duty of a chapter 7 trustee to liquidate the property of the estate “as expeditiously as is compatible with the best interests of parties in interest.”[5]  In other words, when economically feasible, chapter 7 trustees will sell estates’ assets.  Chapter 11 trustees and chapter 11 debtors in possession are also generally required to utilize estates’ assets in a manner that is beneficial to creditors.  While that does not necessarily require a sale of assets, sales of chapter 11 debtors’ assets, in whole or in part, are common.  

SALE OF A COMPANY OR ALL ITS ASSETS
It is not unusual for an entire company or substantially all of its assets to be sold.  An order of the bankruptcy court defining the buyer’s rights and fixing liabilities of the company going forward can be of great value to a buyer.  While avoiding successor liability is not always possible outside of bankruptcy,[6] a bankruptcy court order can often eliminate successor liability.[7]   

LIMITATIONS ON ESTATE PROPERTY
Disputes often arise in bankruptcy cases regarding whether or not property is property of the estate such that the trustee can sell such assets free and clear of any party’s interest.  A common issue arises when a married couple in a community property state takes title to property as joint tenants rather than as community property, and even though the source of purchase money was community funds.[8]  In such a scenario, if a debtor wife files for chapter 7 protection, she is likely to claim that only her half of the property is property of the estate, while the other half is asserted as the husband’s separate property.  This will impact the economic feasibility of a sale, even if the characterization of the property as joint tenancy is subject to attack, because litigation is expensive.

A debtor may also claim property as exempt from property of the estate.  The Bankruptcy Code allows each state to decide whether the federal scheme of exemptions applies, or the state’s own exemption scheme.  California’s exemption statutes, for example, currently provide for a homestead exemption of between $75,000 and $175,000 in real property.[9]  Generally (but there are exceptions), if the equity in the real property does not exceed the homestead exemption, a trustee will not attempt to sell it.  One commonly litigated issue with respect to homestead exemptions is whether the real property should be characterized as the debtor’s “homestead”—e.g., whether the debtor resided in the property at the time of the bankruptcy filing.[10]

CLAIMS OF THE ESTATE
Certain assets are less obvious than an interest in real property.  For example, assume that prior to filing for bankruptcy a corporate debtor has a financial dispute with another party in a joint venture arising from that party’s breach of contract or misappropriation of funds.  That claim, whether or not a lawsuit was filed before bankruptcy, is property of the estate.  As such, only the trustee or debtor in possession may pursue such a claim.  The trustee or debtor in possession may choose to sue the other party or may settle with that party for money which will be used to pay creditors.  Alternatively, the trustee may sell the asset.[11]  In another case, an individual debtor might have been injured in an accident before filing for bankruptcy, but had not yet filed a personal injury lawsuit at the time of the bankruptcy filing.  The contingent right to recover damages for such injury is property of the estate, and therefore may be pursued or sold by a trustee or debtor in possession.[12]  

THE DEBTOR CANNOT OPT PROPERTY OUT OF THE ESTATE
A debtor cannot exclude such contingent assets from a bankruptcy case by, for example, failing to schedule such assets in the bankruptcy schedules.  In such event, a trustee will re-open the case, even years after the fact, to administer the asset and use its proceeds to pay creditors—worse yet, if the debtor is an individual, the debtor can lose his or her right to a discharge for failing to list the asset.  Even if the trustee does not reopen a case to administer unscheduled assets (such as legal claims), the failure of the debtor (individual or corporate) to list such assets can result in a waiver of the claims, meaning that the debtor cannot assert that the claims even exist.

TRUSTS AND PROPERTY OF THE ESTATE
There are certain provisions of the Bankruptcy Code dealing with a debtor’s interest in trusts.  A debtor may be the beneficiary of a trust, in which case such trust is generally property of the estate.  However, a trust with valid restrictions on the use of the proceeds, such as a spendthrift trust, may be inaccessible (in whole or in part) to the estate.[13]  A debtor may also be a trustee for the benefit of others, such as an ERISA trust, in which case the estate may have no beneficial interest in the asset.[14]  

CONCLUSION
The bankruptcy courts are constantly adjudicating what is and what is not property of the estate.  Many thousands of federal court decisions from the bankruptcy court level all the way up to the Supreme Court of the United States (and quite a few state courts) have analyzed the issue.  Above is just a brief sketch of some of the issues that commonly arise.  Just as there are innumerable types of property, and relationships between parties relating to property, issues relating to property of the estate continue to arise in interesting variations.  The informed buyer must remain aware of the possibilities, and problems, so as to be better prepared for opportunities to realize value.  

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[1] 11 U.S.C. § 541(a)(1).

[2] 11 U.S.C. § 541(a)(2)-(7).

[3] Butner v. United States, 440 U.S. 48 (1979).

[4] In addition to Schedules A, B, C and D discussed herein, there are also Schedules: E and F (priority and nonpriority unsecured claims); G (executory contracts); H (codebtors); I (income of individual); and J (expenses of individual).  All debtors must also file a Statement of Financial Affairs providing required information regarding, among other things, transfers from the debtor, historical income, business interests, former addresses, among various other questions.  

[5] 11 U.S.C. § 704(a)(1).

[6] See, e.g., Ray v. Alad Corp., 19 Cal. 3d 22 (1977) (tort liability); Teed v. Thomas & Betts Power Solutions, L.L.C., 711 F.3d 763, 764 (7th Cir. 2013) (federal employment law liability).

[7] See, e.g.,  Myers v. United States, 297 B.R. 774, 786 (S.D. Cal. 2003) (finding no successor liability for buyer of assets “free and clear” of claims pursuant to 11 U.S.C. § 363).

[8] This discussion is limited to only a few topics, but there are many other interesting issues that affect property of the estate.

[9] Cal. Code. Civ. Proc. § 704.730.  California offers two sets of exemptions which may be elected by the debtor.  Debtors who own real property with equity typically elect to use the “704 series” of exemptions.

[10] For example, a debtor’s vacation home typically would not be subject to a homestead exemption.

[11] It may be appropriate, in some circumstances, to treat a compromise as a sale, or a sale as a compromise.  

[12] There may be an exemption for such a personal injury claim.  Cal. Code Civ. Proc. § 704.140.  Whether or not the claim is exempt is something that a trustee will evaluate before deciding to pursue or sell the claim.  

[13] 11 U.S.C. § 541(c)(2).

[14] 11 U.S.C. § 541(d).

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The 363 Bankruptcy Sale Procedure – Broken Down and Simplified

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The 363 Bankruptcy Sale Procedure – Broken Down and Simplified

Posted by Yosina M. Lissebeck, Esq. on December 2, 2014

Guest Post By Yosina M. Lissebeck, Esq.
Lissebeck Law
www.lissebecklaw.com

Bankruptcy Code § 363 authorizes a debtor-in-possession or Trustee, to sell property of the estate other than in the ordinary course of business. A proposed sale of estate property will be approved if it is in the best interests of the estate, based on the facts and history of the case.[1] Before the Court can approve such a proposed sale, the Court must find that there is a valid business justification for the sale.[2] In addition to a sufficient business reason for the sale, the Court must find (1) the sale is in the best interest of the estate; (2) is fair and reasonable; (3) the assets to be sold were adequately marketed; and (4) was negotiated in good faith; and (5) that the buyer is proceeding in good faith; and (6) the sale is an “arms-length” transaction.[3] Lastly, the Court must find that the debtor-in-possession gave adequate and reasonable notice of the sale.[4]

In most circumstances, the DIP/Trustee will sell any and all assets of the estate that have equity available to pay creditors. Equity is determined by looking at the value of the asset, deducting any claim of exemption the debtor may have, and usually deducting something for the costs of the sale. The DIP/Trustee will then market the property to be sold. If the property is real property or IP, the bankruptcy estate may hire a broker to assist with the sale. If the property is personal property, the DIP/Trustee may reach out to parties he knows are interested in purchasing those types of assets, or may list it on various websites – including Inforuptcy. If you are interested in purchasing an asset, it is always best to reach out to the DIP/Trustee and find out what the Estate’s intent is in selling it. 

There are various types of sales that can take place, but the two most typical are a private sale, and a sale subject to overbid. A private sale is a sale between just the Estate and the purchaser. A sale subject to overbid is a sale between the Estate and the purchaser; but a third party can come into the process and state that it is willing to purchase the asset for more than the sale price, and then there will be bidding between the parties, like at an auction. Once an offer is obtained, the DIP/Trustee will negotiate and ensure that the relevant information, type of sale, and language is in the purchase agreement or sale documents. All agreements are subject to Bankruptcy Court approval.

Thus, once the parties agree to the terms, the DIP/Trustee will file a motion, with supporting documents including the agreement itself, obtain a hearing date, and serve these documents on all creditors and parties in interest. It usually takes 30 days from the date the motion is filed, before the matter is heard by the Court. If no party objects to the sale, and the Court determines that the factors above have been satisfied, it will approve the sale. An Order will be submitted by the DIP/Trustee and entered by the Court, usually within the week. The Order is deemed final 14 days after entry. If there was an escrow, it can close; otherwise any and all appropriate transfer documents can be exchanged. 

Now of course, as the title of this blog states: this is “broken down and simplified.” That means there may be factual circumstances, local bankruptcy court preferences, and procedural requirements that may differ. Thus, it is always best to contact a bankruptcy practitioner to answer any questions or assist you with the sale process.

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[1] In re American West Airlines, 166 B.R. 908, 912 (Bankr. D. Ariz. 1994), citing In re Lionel Corp., 722 F.2d 1063, 1071 (2nd Cir. 1983).

[2] See, e.g., In re 240 North Brand Partners, Ltd., 200 B.R. 653, 659 (9th Cir. BAP 1996).

[3] In re Wilde Horse Enterprises, Inc., 136 B.R. 830, 842 (Bankr. C.D. Cal. 1991).

[4] Ibid.

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