1 13: Property of the Estate © Charles Tabb 2010

2 What is “property of the estate”? A separate legal entity, comprised of all of the DR’s property interests at the time the case is commenced + some postpetition additions

3 How & when created? How: By the filing of petition When: at the commencement of the case – Commencement  by filing of petition – Even in an involuntary case i.e., before Ct enters “order for relief”

4 Automatic transfer Thus, at instant of petition filing (whether in voluntary or involuntary case), ALL of DR’s property is transferred to “estate” DRproperty [FILING] ESTATE property

5 Even exempt property Even individual DR’s exempt property initially goes into “estate” If Dr wants it back, files schedule of exemptions If exemptions allowed, goes back to DR DR EstateDR Filing Exemption claim allowed

6 Override non-bk transfer restrictions Automatic transfer from DR to Estate occurs even if non-bk law has transfer restrictions – i.e., federal Bk law overrides non-bk transfer restrictions, see 541(c)(1) Non-Bk law:DR Transferee Bankruptcy:DR ESTATE [§541(c)(1)]

7 Why “property of estate” matters Protected by automatic stay Creditor Stay Estate safe

8 Stops race for assets Property of estate concept, coupled with automatic stay, implements core policy needed for solving bankruptcy’s collective action problem  stopping race for assets Property of estate

9 Federal court: exclusive jurisdiction The federal courts have exclusive jurisdiction over property of the estate Exclusive Jurisdiction

10 What Creditors Get In chapter 7, “property of the estate” determines what Crs receive in distribution Exempt Debtor Estate Creditors

11 “best interests” test Even in Reorg chapters, “property of estate” establishes distributional entitlement for unsecured crs  “best interests” test – Must get at least as much as in Ch 7 liquidation – And ch 7 distribution depends on size of estate – Reorg, make series of payments = value of estate # 1-> # 2 -> # 3 -> #4 ->

12 Estate rep deals with property The representative of the bankruptcy estate, either the Trustee or, in ch 11, the DIP, is given the power and authority to deal with “property of the estate”, see § 363 Can “use, sell, or lease” estate property Subject to possible court oversight

13 Inclusion – scope of estate “all legal or equitable interests of the debtor in property as of the commencement of the case” § 541(a)(1)

14 3 elements 1.Property 2.Of Debtor 3.As of commencement of case

15 “property” What is “property”? almost any conceivable interest – whether tangible, intangible, novel, contingent, etc.

16 Says who? Whether interest = “property” is a question of federal bankruptcy law under § 541 Foundational case is CBOT v Johnson – Supreme Court held that seat on CBOT = “property” in federal bk case even though Illinois Supreme Court had held ≠ “property”

17 Inclusionary policy The federal policy is one of broad inclusion Bring virtually EVERYTHING into bankruptcy “estate”

18 “of the debtor” Property comes into estate only to the extent is property of the debtor To extent DR’s interest in property was limited instant before bk filing, estate’s interest is identically limited

19 Of the debtor Sam’s bicycle  does NOT go into estate Belongs to Sam, not DR So obviously absurd for Dr’s Crs to be able to deal with Sam’s bicycle

20 Joint tenancy Example: Dr & Non-Dr each own a 50% stake in horse  What does bankruptcy estate get?

21 ½ of horse The “estate” gets ½ a horse  dr’s share In value – ( won’t cut horse in half)

22 Subject to liens Estate takes Dr’s property subject to all liens and encumbrances Security Interest SECURED CREDITOR debt = $4,000 $10,000  estate’s interest: $10K horse subject to $4k lien  so net value to estate of $6k

23 lien The collateral comes into estate in full, but the creditor’s lien remains valid against the collateral Estate might be able to satisfy the secured cr by paying it off, rather than turning over collateral to the Cr Whether will do so depends on estate’s need for property and whether any equity

24 equity Security Interest SECURED CREDITOR debt = $4,000 $10,000  estate’s interest: $10K horse subject to $4k lien  so net value to estate of $6k  Even if don’t need horse, trustee (or DIP) could SELL horse and reap net of $6k for estate - Pay off $4k from sales proceeds to Sec Cr

25 Totally encumbered? Security Interest SECURED CREDITOR debt = $14,000 $10,000  estate’s interest: $10K horse subject to $14k lien  so net value to estate is zero  now estate rep would NOT sell horse – no equity – would all go to Sec CR

26 Totally encumbered Trustee (or DIP) would decide: -> do I need to use the horse? – If not, just abandon to Sec Cr – If so, use the horse and give Sec Cr protection

27 Timing: as of commencement GENERAL RULE: date of filing of petition establishes property of estate Same rule applies for “claims” against DR Take all property, and all claims, as of instant of bk filing, and settle Dr’s financial affairs

28 Point of demarcation Property at instant filePost-Bk ESTATENOT estate

29 Some post-petition property included There are some exceptions to the general rule that post-petition property ≠ estate property Most common: “proceeds” rule, 541(a)(6) momma horsebaby horse estate

30 Timing problems In some cases is hard to fix the timing “as of commencement” because the property has roots in BOTH the pre-bk AND post-bk periods Tax losses Tax refund vests Segal v Rochelle

31 Butner Facts: – May 1973: Dr (Golden) file Ch XI – Butner (Sec Cr) -> 2 nd mortgage on real estate – Receiver collects rents in XII, pays per Ct order – Feb 1975: convert to Ch. VII, Tee appointed – During ch VII, Tee collects more rents – Total of $162K collected Issue: does Butner get those rents?

32 Secured vs unsecured If Butner does NOT have a valid lien on the rents, then that pot of money will be distributed to the estate’s general unsecured Crs (including the US, via an SBA loan, which is why the caption is “Butner v U.S.” – could be “secured v. unsecured”) Butner all the (secured) unsecured Crs

33 Which law? Issue is which law controls whether Butner has a perfected lien on the rents State law? – Sec Cr (Butner) has to do something to get rents – Lower cts held had not done what had to do Federal rule of equity? – Ignore state law – Give Sec CR automatic lien on rents

34 Defer to STATE law Supreme Court in Butner held that the proper approach to deciding this Q is to defer to state law unless some federal interest requires a different result STATEFEDERAL

35 The quote “Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding. Uniform treatment of property interests by both state and federal courts within a State serves to reduce uncertainty, to discourage forum shopping, and to prevent a party from receiving ‘a windfall merely by reason of the happenstance of bankruptcy.’”

36 Why defer to states re “property”? Get same results in or out of bankruptcy OUTIN No rents

37 Erie idea Federalism – Erie Similar concept as for federal diversity cases, where use state substantive law under Erie

38 Erie? In federal bankruptcy case, would not be required to follow Erie, because jurisdictional basis is independent bankruptcy jurisdiction, rather than diversity And indeed in a bankruptcy case we often apply a federal law – namely, the Bankruptcy Code! (title 11, US Code)

39 So why defer? Federal bankruptcy case is at core a procedural means for sorting out the various substantive rights and claims of all Crs and Dr And those claims, and those property interests, are created by, and exist independently of, a bankruptcy case

40 No rents So in Butner, if under state law (North Carolina), the secured cr (Butner) did NOT have a lien on the rents – which would mean that the UNSECURED Crs would get a shot at that pot of $ -- why should result be any different in bk? Butner nono

41 Forum shopping? So what is the “forum shopping” concern?  shop for what? What are the choices?

42 Windfall in federal bk Shop for federal bankruptcy if get better result than would outside of bk

43 Incentive to pick bankruptcy forum If a party could get more IN bankruptcy than OUT of bankruptcy, for no bankruptcy-specific reason, then that party has a very strong incentive to try to force a bankruptcy case And not for any reasons that normatively support bankruptcy  i.e., collective action problem

44 So Butner loses Supreme Court thus holds that Butner loses his claim to a lien on the rents in bankruptcy, because applying the state law, he had not done what he needed to do under North Carolina law to perfect an interest in the rents (e.g., apply for sequestration of rents, appointment of receiver, foreclosure)

45 Translation problem Problem: COULD Butner actually take the actions IN bankruptcy that he could outside of bankruptcy? NO because of automatic stay

46 Process/substance So have a problem in translating non- bankruptcy substantive rights into the bankruptcy forum, when the process is not identical in and out of bankruptcy Bankruptcy judges have to be alert to not let the Butners of the world be worse off in bk than out of bk because of process differences

47 Moral of Butner Bottom line: Butner stands for proposition that the existence, nature and character of property interests is determined by the underlying law – typically state law

48 Chicago Board of Trade So Butner says: defer to state law re property In Chicago Bd of Trade, the issue was whether Dr’s seat on CBOT was property of his bk estate, and if so, to what extent

49 Nature of interest Under the law creating the seat on CBOT (the Rules of the Board) – member can only transfer seat if has paid all claims of other members – Only sell to persons approved by Board – No power of Board or another member to compel sale – Cannot be levied upon by member’s creditors

50 State law Under State law (Illinois), because of the various limitations just described, held that seat on the CBOT ≠ “property”

51 Why doesn’t Butner control? if (1) Butner says that state law controls property interests, and if (2) Illinois state law says that a seat on the CBOT is ≠ property, then  (3) why isn't the logical QED from 1 & 2 that the bankruptcy result is that the seat is not "property"?

52 Federal question CBOT Court held that what = “property” is a federal question The fact that Illinois state law doesn’t call a seat on CBOT “property” is not controlling  In short, the state law labels aren’t dispositive. Federal law says EVERYTHING Dr has = “property”

53 Consistent with Butner? Is CBOT consistent with Butner? – Seems Butner says “state law rules” while CBOT says “federal law rules”  How reconcile?

54 What did CBOT hold on merits? seat was worth $10,500 and other members of the Board had claims of $60,000 against the bankrupt. Did the Court hold: 1. seat ≠ “property” not in bankruptcy estate at all? 2. seat = “property” AND could be sold for $10,500, free of member claims? or 3. seat = “property” BUT first had to be used to pay off the $60,000 in member claims, meaning no value remained for the other creditors?

55 State law attributes control Court in CBOT held: – Seat = “property”  federal question – Attributes of property  state law question  Does come into estate, BUT subject to member claims  Equivalent to a “lien”  So no value for estate – would have to pay member claims 1st

56 Putting Butner and CBOT together The “federal” question  whatever DR has, comes into “estate” under 541 as “property” – 1 st part of CBOT holding The “state” question  state law governs what the nature and attributes of the “property” is – 2 nd part of CBOT holding

57 Phoenix Suns case -- Harrell Dr had season tickets to Phoenix Suns games The Suns did not guarantee a ticket holder a right to renew seats Arizona law  mere “expectation” of renewal of interest in property ≠ “property”

58 Not property? 9 th Circuit held: Dr’s season ticket rights ≠ “property of estate” -Based on Arizona law And - Butner

59 What about CBOT? How reconcile with S. Ct holding in CBOT that not defer to what state law calls an interest?

60 What if … Do you think a basketball-crazy Suns fan might be willing to pay the bankruptcy Trustee some cold, hard cash to purchase the Dr’s “expectancy” to receive Suns tickets?

61 If so – what would buyer get? If basketball-crazy Suns fan did pay $ to trustee for Dr’s Suns’ tickets, what rights would that fan-buyer get?

62 Just what Debtor had The buyer gets whatever DR had – no more, no less Debtor -> If Suns decide not to renew the tickets, Buyer gets no tickets -> But if DO renew, Buyer does get tickets Estate Buyer

63 Who gets tickets? Court said tickets were ≠ “property of estate” So – WHO gets the tickets?

64 Debtor keeps “expectancy” Given court’s holding that the Dr’s “expectancy” to get Suns tickets ≠ “property of the estate”  The DEBTOR keeps his “expectancy” – never went into the estate!  Even if has VALUE – too bad Creditors!