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PROBATE, DEATH and BANKRUPTCY
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9th Cir. B.A.P. held that a bankruptcy estate’s interest in a trust is limited to whatever rights are held by an individual at the time the bankruptcy is filed.
The Dead (and Their Bankruptcy Estate) Cannot Hold Property Under Recent Ninth Circuit Bankruptcy Appellate Panel Decision
I recently had the pleasure of working with my colleagues Benny Roshan and Jillian Berk on an appeal before the Ninth Circuit Bankruptcy Appellate Panel (B.A.P), which tested the ever-evolving intersection between bankruptcy law and probate and trust law.
In re Rens, __ B.R. __ , No. AP 19-90067-LA, 2021 WL 5049829 (B.A.P. 9th Cir. Oct. 29, 2021) is a case about Robert Duane Rens – an 83 year old retiree who filed a chapter 7 bankruptcy. When Mr. Rens filed for bankruptcy, his income sources included distributions of net income from an irrevocable trust established by his deceased parents.
The trust, which became the central focus of Mr. Rens’s bankruptcy, held a one-half interest in a business and industrial park ground lease. Under the trust, beneficiaries received regular distributions from rent, and in 2035 the property would be distributed outright to the then-beneficiaries in equal shares. Under the trust terms, if Mr. Rens dies before 2035, his issue become entitled to his share and would receive his share of the net income and eventually the principal. The chapter 7 trustee commenced litigation to determine the extent of the bankruptcy estate’s interest in the trust. The bankruptcy court ultimately ruled not only that Mr. Rens turn over 25% of his income from the trust, but that his bankruptcy estate would also continue to collect 25% of the income and 25% of the trust principal after his death. See Davis v. Sparhawk, Adversary No. 19-90067-LA (Bankr. S.D. Cal. May 7, 2020). The trustee of the trust appealed. Mr. Rens’ children, who had never been notified of the bankruptcy court’s proceedings, intervened in the appeal upon learning of the bankruptcy court’s ruling. Greenberg Glusker represented Mr. Rens’s children as intervenors in the appeal and sought to reverse the bankruptcy court’s decision.
The appeal is a cutting-edge interpretation of Carmack v. Reynolds, 2 Cal. 5th 844, 849 (2017). In Carmack, the California Supreme Court determined that a bankruptcy estate could reach 25% of future distributions under a spendthrift trust. What Carmack did not address, however, is what happens after the bankrupt debtor dies. The bankruptcy court in Rens interpreted the trust provisions and found that the bankruptcy estate continued to hold that 25% trust interest post-mortem. Greenberg Glusker argued on behalf of the intervenors that this was an incorrect application of California trust law and would essentially create a form of “zombie” trust interests held by the formerly living, which creditors could inevitably seize upon.
In a published opinion, the B.A.P. agreed and reversed the bankruptcy court’s ruling, holding that a bankruptcy estate’s interest in a trust is limited to whatever rights are held by an individual at the time the bankruptcy is filed. At the time he commenced his bankruptcy, Mr. Rens held only a contingent interest in the trust. His interest was contingent upon distributions being made under the trust, contingent upon the property vesting in 2035, and, of course, contingent upon him being alive to realize those distributions. As such, the bankruptcy estate could not reach any interests after Mr. Rens’s death.
An appeal to the Ninth Circuit has been filed, so please stay tuned for updates.
*In its opinion, the B.A.P. incorrectly identifies intervenors as “intervening appellees” when they should be identified as “intervening appellants” due to the intervenors’ alignment with the positions of the appellant.
Fed. R. Bankr. P. 1016 states:
“Death or incompetency of the debtor shall not abate a liquidation case under chapter 7 of the Code. In such event the estate shall be administered and the case concluded in the same manner, so far as possible, as though the death or incompetency had not occurred. If a reorganization, family farmer’s debt adjustment, or individual’s debt adjustment case is pending under chapter 11, chapter 12, or chapter 13, the case may be dismissed; or if further administration is possible and in the best interest of the parties, the case may proceed and be concluded in the same manner, so far as possible, as though the death or incompetency had not occurred.”
Possible options:
- Dismissal
- Hardship discharge if the debtor had completed a significant portion of the repayment plan
- Continuation of the case with another party such as a spouse, heir, or surviving family member making plan payments. This is usually done where there is a strong interest in preserving property like a home that was included in a plan.
- Conversion to Chapter 7
Alexandra R. Byrne, Continuation of Chapter 13 Postmortem: Why Courts Should Allow Deceased Debtors’
Cases to Continue Post Plan Confirmation, 37 EMORY BANKR. DEV. J. 427 (2021).
ABSTRACT
A lack of direct guidance from Rule 1016 of the Federal Rules of Bankruptcy Procedure has created inconsistency among bankruptcy courts regarding whether to continue a chapter 13 case if the debtor dies post plan confirmation but before discharge. Rule 1016 allows a deceased debtor’s chapter 13 case to continue if “further administration is possible” and it is “in the best interests of the parties.” Although dismissal is appropriate if the debtor dies before plan confirmation, continuation after plan confirmation is possible and benefits all parties.
The benefits of continuation post plan confirmation stem from the certainty under federal bankruptcy law regarding what pre-petition creditors will receive and allows beneficiaries and post-petition creditors to have access to the decedent’s assets in probate, rather than all three parties fighting over the decedent’s assets in probate. Continuation of the bankruptcy case results in creditors receiving their expected distribution amount under the confirmed payment plan (through continued plan payments made by the decedent’s beneficiaries) or unsecured creditors receiving at least as much as they would have received under chapter 7 (through conversion to chapter 7). A hardship discharge may also be warranted if the decedent’s unsecured creditors have already received at least as much as they would have under chapter 7. Courts should permit continuation of the bankruptcy case and ultimately award a discharge if a chapter 13 debtor dies post plan confirmation because it will create uniformity among bankruptcy courts, equitable treatment among chapter 13 and chapter 7 debtors, and more certainty to both the decedent’s beneficiaries and her creditors.
