November 29, 2016
- Part 1 - Notes on claims or causes of action that arise before, during, and after a bankruptcy case, and whether those claims are property of the estate.
“When” is a cause of action property of the estate? The answer can be extremely complex. This is especially true when the debtor has a cause of action that may not have matured pre-petition. In answering this question, bankruptcy practitioners are required to determine when the cause of action matured. Thereafter, the bankruptcy practitioner must distinguish between pre-petition, post-petition, post-confirmation, and post-discharge causes of actions. Depending upon where the cause of action falls in relation to the bankruptcy filing, the debtor may or may not be entitled to keep all of the proceeds generated from the cause of action. Alternatively, the bankruptcy estate might be entitled to the proceeds.
Determining the time at which a cause of action becomes bankruptcy property can be complicated. The question is not “what is property of the estate” but is rather “when is property of the estate.” This determination requires fact intensive analysis. Whatever opinion the Debtor or counsel may have – full and complete disclosure is required and full disclosure is the best means by which to preserve a cause of action for the debtor and the estate. Failure to do so can result in the Debtor being estopped from pursuing a cause of action.
I. Pre-petition Property
Depending on the relief pursued – (1) liquidation under chapter 7, or (2) reorganization under chapter 13 – there is a sliding spectrum between causes of action that are “property of the estate” and claims that are not property of the estate.
A. 11 U.S.C. 541
In its simplest form, a bankruptcy estate is formed upon the filing of a bankruptcy petition. According to the Bankruptcy Code, the 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). Sometimes this is a challenge for clients to understand. The bankruptcy estate includes all causes of action that exist and have matured as of the date of the petition. State substantive law determines the "nature and extent" of causes of action, see Tyler v. DH Capital Mgmt., Inc., 736 F.3d 455, 461 (6th Cir. 2013), but federal bankruptcy law dictates when that property interest becomes property of the estate for purposes of § 541, see In re Terwilliger's Catering Plus, Inc., 911 F.2d 1168, 1172 (6th Cir. 1990).” In re Underhill, 579 F. App'x 480, 482 (6th Cir., 2014).
B. “Sufficiently rooted in the pre-bankruptcy past…”
In determining whether a cause of action is pre-petition belonging to the estate, or post-petition belonging to the debtor, the Sixth Circuit applies the approach described in Segal v. Rochelle, 382 U.S. 375, 380, 86 S. Ct. 511, 15 L. Ed. 2d 428 (1966). See In re Underhill, 579 F. App'x 480, 482 (6th Cir., 2014). (applying Segal). Under Segal, pre-petition assets are those that are “sufficiently rooted in the pre-bankruptcy past.” Tyler v DH Capital Mgmt., 736 F.3d 455, 461 (6th Cir., 2013) “Pre-petition conduct or facts alone will not 'root' a claim in the past; there must be a pre-petition violation.” Id. at 462. That is, a cause of action qualifies as bankruptcy estate property only if the claimant suffered a pre-petition injury.
C. When did the violation occur?
In dissecting whether there is a pre-petition or post-petition cause of action, the case of Underhill is instructive. In re Underhill, 579 F. App'x at 482. In Underhill the debtors filed for bankruptcy on January 6, 2010. On the date of filing, the debtors had a 100% interest in Golf Chic Boutique (“Golf Chic”). Three months after the debtors received their discharge, Golf Chic sued a competitor, Ladies Pro Shop. According to Golf Chic, Ladies Pro Shop continually contacted one of Golf Chic’s major suppliers complaining about Golf Chic’s prices. Ladies Pro Shop’s communications predated the petition date. However, after the debtors’ discharge, the supplier cut ties to Golf Chic due to Ladies Pro Shop’s complaints. Ultimately, Golf Chic settled with Ladies Pro Shop for $80,000.
The issue in the case focused on whether Golf Chic’s claim against Ladies Pro Shop was part of the bankruptcy estate. The Sixth Circuit determined that the Golf Chic claim was not part of the estate because a violation, namely the supplier cutting ties, did not occur until post-petition. In reaching this result, the Sixth Circuit examined the elements of a tortious interference claim and determined that the claim was not mature until the supplier cut ties, which occurred long after the petition date.
The Underhill decision is helpful for practitioners when determining whether a “violation” has matured pre-petition or at some other time. This requires debtor’s counsel to examine the applicable state cause of action and its elements. The Underhill decision also assists practitioners in determining where the line for pre-petition and post-petition property may fall in a given bankruptcy case. It is also worth noting that the line between pre-petition and post-petition property does not depend upon the filing of a formal complaint, but rather, when a complaint could be filed.
D. How should the test be applied?
How this test should be applied to causes of action is the subject of disagreement. Certain courts have applied the test expansively, including contingent and unripe claims as property of the estate. For instance, in Mueller vs. Hall (In re Parker), 2007 Bankr. LEXIS 1523, the court held that the legal malpractice claim of the debtors became part of the estate at the time of negligence, not when damages were incurred. The court went on to hold that the question was not whether the malpractice case accrued based on the moment the last element of the cause of action accrued, prior to the debtor filing bankruptcy, but whether the malpractice claim is sufficiently rooted in the debtors pre-bankruptcy past to constitute property of the estate. Courts have consistently held that § 541(a) is not restricted by state law concepts such as when a cause of action ripens or a statute of limitation begins to run, and “property of the estate” may include claims that are inchoate on the petition date. When I think about this concept, I think about the Chapter 7 Trustee’s question, “Do you hold any lottery tickets?” Certainly, the debtor cannot make a claim to the lottery winnings before the numbers are called, but the ticket, in and of itself, is in fact “property of the estate” and that expansive definition serves the bankruptcy code and serves your client when considering analysis of disclosure on bankruptcy schedules with respect to a pre petition cause of action.
As can be seen, the facts of each circumstance can effect whether a claim or cause of action might be considered property of the estate. We will issue a forthcoming follow up article to further explore the issue of timing of when claims arise and how some courts have examined the issue specifically.