THE CHAPTER 7 AND CHAPTER 13 BANKRUPTCY ESTATE & INHERITANCE
The filing of a Chapter 7 or Chapter 13 bankruptcy triggers the creation of a legal construct known as the Bankruptcy Estate.
As with its better-known cousin, the Probate Estate, the Bankruptcy Estate can be conceived of as an imaginary house containing all of the property of the individual filing the Chapter 7 or Chapter 13 (even including actual houses).
What property of the debtor is or is not included in the Bankruptcy Estate when the Chapter 7 or Chapter 13 is filed is the subject of much litigation.
However, very generally speaking, the Bankruptcy Estate contains everything that the debtor owns in full or in part as of the date of the bankruptcy’s filing, including a claim for property or cash (i.e., unpaid but earned wages, the proceeds from a lawsuit, the portion of a tax refund earned as of the date of filing, the winnings from a lottery ticket purchased before filing for bankruptcy, etc.)
The Bankruptcy Estate can also contain or come to contain assets transferred by the debtor fraudulently within as many six years (in Michigan) prior to the filing of the bankruptcy and money paid to creditors preferentially over other creditors as long as one year prior to the filing of the bankruptcy.
As with claims to payment or property that have not yet resolved, the Bankruptcy Estate also reaches into the future in specific circumstances.
One of these circumstances is the right to an inheritance or bequest.
INHERITANCES & BEQUESTS AS PROPERTY OF THE BANKRUPTCY ESTATE
The rule in the Federal Bankruptcy Code concerning the inclusion of monies or property received after the filing of a Chapter 7 or Chapter 13 case is that any inheritance, bequest, or devise or payment from a death benefit plan received within 180 days (6 months) of the filing of the bankruptcy case is included within the Bankruptcy Estate.
This does not mean that only inheritances received within 180 days of the Chapter 7 or Chapter 13 bankruptcy case enter the Bankruptcy Estate.
Case-law in the Eastern District of Michigan and the Sixth Circuit Court of Appeals, in which Michigan rests, has made it clear that what need occur within 180 days of the bankruptcy filing-date is merely the event triggering the right to the inheritance, bequest, devise, or death benefit plan receipt.
In other words, it is Uncle Charlie’s mysterious death in the jungles of Borneo within 180 days of your Chapter 7 or Chapter 13 filing-date that causes anything he is leaving you in his will to enter your Bankruptcy Estate—not your receipt by international courier of the wooden box containing the cursed gold monkey’s head.
Thus, one cannot with any accuracy time a bankruptcy filing to avoid this occurrence.
The next question is whether the funds or property received fall into the range of inheritances, bequests, or devises considered by the Bankruptcy Code provision above.
In a recent decision by Judge Applebaum in the Northern Division of the Eastern District of Michigan Bankruptcy Court, the Court found that a post-filing receipt of funds from the debtor’s deceased mother’s IRA was not an “inheritance, bequest, or devise” under Michigan law and therefore did not enter the Bankruptcy Estate.
Judge Applebaum reasoned that the debtor’s beneficiary interest in her mother’s IRA was a matter of contract and not of testament, or provision of a death-based benefit.
The Chapter 7 Trustee’s Motion to Compel Turnover of funds received post-filing by the debtor from her deceased mother’s IRA was therefore denied. To read the Opinion click here: Applebaum Opinion Denying Trustee’s Motion to Compel Turnover of Funds Related to The Estate of Carol J. Fournier
INHERITANCES IN CHAPTER 7 VS. CHAPTER 13 BANKRUPTCY
The action of the Chapter 7 bankruptcy Trustee in that case is illustrative of what can (and will) happen in a Chapter 7 bankruptcy when an inheritance is received post-filing.
A Chapter 7 Trustee will always demand turnover of the funds or property, unless you can amend your bankruptcy petition schedules to disclose and exempt the to-be-received cash or property.
Why is this necessary?
In a Chapter 7 bankruptcy, assets of the debtor are seized by the Chapter 7 Trustee assigned to the case upon filing in order that they may be liquidated to generate a pool of money for the debtor’s creditors, who otherwise receive nothing from the Chapter 7 process.
This only happens if the debtor is unable to fully exempt, or protect, his or her assets with the exemptions available under the Bankruptcy Code or, alternatively in Michigan, a state statute.
Exemptions are simply statutory language allowing a debtor in bankruptcy to remove certain types of assets up to certain dollar value caps from the Bankruptcy Estate.
If they are not within the Bankruptcy Estate, they are not subject to seizure and liquidation by the Chapter 7 Trustee.
This is true of, say, an automobile that a debtor may own on the date of the Chapter 7 filing. It is just as true of a car bequeathed to a debtor by a parent who passes away after the case is filed.
If, in that automobile example, the debtor had no idea that the parent would become deceased when he or she filed the case, the debtor could still amend his or her petition schedules to list the car, assign it an accurate fair-market value, and then apply the statutory “automobile exemption” to it in order to protect it from seizure by the Chapter 7 Trustee.
If the debtor has already used up the available automobile exemption, the inherited car will be seized and liquidated.
If, further, the debtor did know that his or her parent was in bad shape at the time of Chapter 7 filing and did not disclose in his or her petition the possible vehicle inheritance, the Chapter 7 Trustee might object to the debtor’s amended exemptions and obtain the vehicle after litigation over the objection.
Honest disclosure is always the key to a successful outcome in bankruptcy.
When the property or cash received by a debtor post-filing is truly within the scope of the Bankruptcy Code provision sweeping it into the Bankruptcy Estate, it is difficult to do anything in a Chapter 7 other than to amend exemptions and/or negotiate in various ways with the Chapter 7 Trustee.
While it is possible to convert to Chapter 13 bankruptcy in such a situation, it must be accomplished by motion and with an opportunity to respond and object by the Chapter 7 Trustee. There is never a guarantee of an easy slide into Chapter 13 where a Chapter 7 Trustee stands to recover property.
Why would a debtor want to convert to Chapter 13 post-filing?
In a Chapter 13 bankruptcy, assets are never seized and liquidated by a Trustee because the debtor, in that process, is making monthly payments over a period of time from 3 to 5 years in order to repay something to his or her creditors already.
Assets must still be disclosed, valued, and, where possible, exempted, but the downside to failing to exempt them is not the loss of the asset but an increase in the amount of money that a debtor is required to repay through the Chapter 13 process to his or her unsecured creditors.
The most that can be repaid to unsecured creditors in a Chapter 13 is 100% of what is owed, logically. Therefore, if a debtor inherits a castle in Scotland worth $20 million but only owed $20,000 in debt, in a Chapter 13, the debtor must merely amend his or her Chapter 13 Payment Plan to provide that the creditors are paid a sufficient amount per month that, over a maximum of 60 months, they are paid $20,000 (plus a small amount of interest). The castle stays put.
A Chapter 7 Trustee will want that castle, however, and will fight any attempt to convert to 13. (It is important to note that Chapter 7 Trustee are compensated for their efforts by way of a percentage of the money that they distribute to creditors. They are always self-interested actors.)
Thus, if you have not yet filed your bankruptcy case and suspect that there is a reasonable chance that you will inherit a $20 million Scottish castle but are not sure when, you may want to discuss filing a Chapter 13 from the outset with your bankruptcy lawyer.
This may be the better form of bankruptcy to file in such a situation, if for no other reason than that a Chapter 13 may be voluntarily dismissed by a debtor with nearly absolute flexibility.
A Chapter 7 bankruptcy case cannot be voluntarily dismissed by a debtor. Again, a motion must be filed, and, if there is significant value to the case for the Chapter 7 Trustee, it will be opposed.
INHERITANCE AND BANKRUPTCY: THE BOTTOM LINE
If you have an elderly relative whom you know has accounted for you in his or her estate planning and who is not faring well—a situation which, by the way, must be explicitly disclosed in your bankruptcy petition—it may be best to discuss waiting to file your bankruptcy with an experienced bankruptcy attorney.
However, if you cannot wait to file because you are facing garnishment, foreclosure, or other dire collections activity, the conversation you will have with your bankruptcy lawyer is what your options within the Michigan bankruptcy process may be when you are likely to receive an inheritance in the short-term.
This is just one of the reasons to consult with and retain an experienced Michigan bankruptcy attorney to assist you with your Chapter 7 or Chapter 13.
Attorney Walter Metzen has represented thousands of consumers in Chapter 7 and Chapter 13 bankruptcy cases in Michigan. A Board Certified Bankruptcy Expert, Attorney Metzen has successfully represented debtors in bankruptcy for over 28 years.
The Law Offices of Walter A. Metzen & Associates offers free consultations for those interested in the bankruptcy process and is experienced in determining and advising as to the best course of action when filing a Chapter 7 or Chapter 13 bankruptcy in Michigan.