Debtors get the benefit of rising real estate values..or do they?

triple deckerWhen you own a home, file a bankruptcy case, and then watch real estate prices rise, who gets the benefit of the new-found value in the property?

Traditionally, the rule has been the debtor benefits and gets to keep all the new equity that might accumulate after the date of filing, with the trustee and creditors unable to touch it.

However, that doesn’t mean an aggressive trustee would never try to change the rules. That’s what happened in Massachusetts in the Garajau case (click here for the text of the opinion), where the Chapter 13 trustee attempted to modify the debtor’s plan in order to attach post-petition equity.

Naturally, there was a twist in the case: before the bankruptcy, the debtor’s neighbor had erected a fence across her driveway, preventing her from parking in her own yard. This spawned a lawsuit which was still pending when the bankruptcy case was filed.

Although the driveway lawsuit was eventually settled in the debtor’s favor, the Chapter 13 trustee used it a lever to try to get at the increasing equity in the property.

First, the trustee tried to get an order to force the debtor to modify her plan to pay out an additional $76,000 to creditors based on the home’s increased value.

No dice, said Boston bankruptcy judge Frank J. Bailey: there is nothing in section 1329 of the bankruptcy code that allows a trustee to force a debtor to modify a properly confirmed plan.

However, the code does allow other parties, including a trustee, to propose a modified plan after confirmation, so that was the trustee’s second gambit. Fortunately for this debtor, the judge ruled that the trustee’s proposal would create an unfeasible plan, since there was no explanation of how the $76K increase would be funded (the existence of a $500K homestead exemption in Massachusetts was no doubt also in the judge’s mind).

The lessons of the Garajau case appear to be two-fold: first, that confirmed plans will be respected by bankruptcy courts and should still give debtors at least a moderate amount of peace-of-mind.

The second lesson is that in a time of fewer bankruptcy filings, aggressive (and sometimes, perhaps over-aggressive) actions by trustees will be encountered far more frequently.

by Doug Beaton

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