The Limited Lifespan of the Bankruptcy Estate: Managing Consumer and Small Business Reorganizations

• Publication year: 2020

The Limited Lifespan of the Bankruptcy Estate: Managing Consumer and Small Business Reorganizations

Jonathan M. Seymour

THE LIMITED LIFESPAN OF THE BANKRUPTCY ESTATE: MANAGING CONSUMER AND SMALL BUSINESS REORGANIZATIONS

Jonathan M. Seymour^*

Abstract

Congress has a great affinity for debt adjustment bankruptcies. These are bankruptcies in which a debtor keeps rather than liquidates her assets and instead repays creditors out of future income. Chapter 13, which allows individual consumer debtors to reorganize in this way, was supplemented in 1986 by chapter 12 for farm bankruptcies. In 2019, in the largest expansion of debt adjustment bankruptcies since the Bankruptcy Code was enacted, Congress made debt adjustment bankruptcy available to small businesses.

The reality is, however, that most debt adjustment bankruptcies fail. For that reason, the relative rights of debtors and creditors when tensions arise are of great importance. The bankruptcy court must know what protections a debtor may resort to if she is struggling to make payments under her plan, and whether new, unpaid creditors may undertake their own collection efforts if doing so will jeopardize the bankruptcy case. Although these questions are basic, they are unresolved. A deep split among bankruptcy courts and courts of appeals has persisted in the law of chapter 13 since the early years of the Code. This disunity threatens the bankruptcy courts' ability to coherently implement Congress's new small business bankruptcy provisions. This Article proposes a solution to this Gordian Knot, and then attempts to situate that solution within a broader normative conception of debt adjustment bankruptcy law.

Doctrinally, the key division among courts concerns the lifespan of the bankruptcy estate. Property within the estate is subject to court supervision and protected by the automatic stay. This Article defends a theory of the bankruptcy estate in debt adjustment bankruptcies known as the estate termination theory. This theory holds that the bankruptcy estate is of a limited lifespan. Once the debtor has secured court approval for a repayment plan and the case is

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underway, she is both free from bankruptcy court supervision and without special bankruptcy court protection. Moreover, although a default rule, the early termination of the bankruptcy estate is sticky. Preserving property within the estate is possible, but the power to do so is limited. Some valid bankruptcy law purpose is necessary before property can be retained within the estate.

On a broader level, this Article attempts to situate the limited lifespan of the bankruptcy estate within a model of bankruptcy it dubs "light-touch" bankruptcy. This model emphasizes the advantages of simple, streamlined, and cheaply administrable procedures, and suggests that debtors may benefit most by being able to enjoy a financial fresh start, free from entanglement with the bankruptcy court, at the earliest possible moment during their bankruptcy cases.

Introduction.................................................................................................3

I. The Debt Adjustment Bankruptcy Bargain.................................7

A. Debt Adjustment under Chapter 13 .............................................. 9

1. The Chapter 13 Estate and the Automatic Stay...................... 9
2. The Chapter 13 Plan ............................................................ 13

B. The Debt Adjustment Bargain for Businesses ............................ 15

II. The Lifespan of the Bankruptcy Estate.....................................16

A. The Life of the Chapter 13 Estate............................................... 18

1. Estate Preservation .............................................................. 20
2. Estate Reconciliation............................................................ 24
3. Estate Transformation .......................................................... 27
4. Estate Termination ............................................................... 33
5. A Defense of Estate Termination .......................................... 35

a. Stay Relief and Administrative Expenses....................... 36
b. The Place of Postpetition Expenses in Bankruptcy........ 38

B. The Life of the Bankruptcy Estate in Chapter 12 and Small Business Cases ............................................................................ 39

III. Extending the Life Of the Bankruptcy Estate..........................43

A. The Holder of the Power to Delay Revesting ............................. 46
B. The Scope of the Power to Delay Revesting ............................... 49

1. Valid Bankruptcy Purpose.................................................... 49
2. Necessity to Fulfilment of the Plan....................................... 55

IV. Light-Touch Bankruptcy...............................................................59

Conclusion...................................................................................................63

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Introduction

Outside of the world of big business, debt adjustment plans are Congress's favored form of bankruptcy law.¹ Congress has deployed both carrot and stick to encourage individual debtors to seek relief under chapter 13 of the Bankruptcy Code, preferring that debtors attempt to repay their debts over time rather than liquidate their existing assets.² As a result, hundreds of thousands of consumer debtors file for chapter 13 each year. owners of family farms and fisheries take advantage of a similar invitation from Congress by seeking relief under chapter 12 of the Code. Congress has now taken its enthusiasm for debt adjustment plans one step further. In 2019, Congress responded to complaints that the traditional forms of business bankruptcy under chapter 11 of the Code are unworkable or prohibitively expensive for owners of small businesses by passing the Small Business Reorganization Act ("SBRA").³ The SBRA makes debt adjustment plans available to businesses with less than $2.7 million in debt,⁴ a category that may comprise more than 40% of all business debtors.⁵

The SBRA went into effect in February 2020; bankruptcy courts, therefore, are only just beginning to grapple with the applicable rules for such cases.⁶ In all forms of debt adjustment bankruptcy, however, the basic mechanics of the bankruptcy case are the same. Instead of liquidating their assets, debtors keep all their pre-existing property and commit to paying their projected disposable income to their pre-bankruptcy creditors during a repayment plan that typically lasts from three to five years.⁷ After making those payments, and with certain

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exceptions, the debtor's remaining liabilities that pre-date the bankruptcy case are discharged.⁸ The statutory language in large part tracks from chapter to chapter of the Code. The pre-existing law of chapters 13 and 12, therefore, should tell us much about how small business reorganizations are to be administered.

Even if simple in concept, the law of debt adjustment plans is far from settled.⁹ When all does not go according to plan, the hierarchy of rights among the bankruptcy case's stakeholders is unclear. That lack of clarity is particularly important given debtors' low rate of success in completing reorganization plans.¹⁰ Individual debtors in as many as two-thirds of all chapter 13 cases fail to make all payments required by their plans and are forced either to dismiss their cases or convert to another form of bankruptcy relief (most likely simple liquidation under chapter 7 of the Code).¹¹ Similarly, about 60% of chapter 12 reorganizations do not result in a completed plan.¹² There are thousands of new small business cases expected each year. Once tensions arise in these cases, just as in the failed chapter 12 and 13 cases, the bankruptcy court must determine whose rights take precedence among three groups of parties to the case: the debtor herself; the debtor's pre-bankruptcy (or prepetition) creditors; and the debtor's new, postpetition creditors to whom she has incurred debts only after filing the bankruptcy case. Yet, the law on which bankruptcy courts must base these determinations is subject to bitter dispute.

Consider a debtor who has begun a debt adjustment bankruptcy and some months later wants to buy a truck. This may be a consumer debtor who wants to buy a truck for personal use or to drive to and from work, or a small business debtor who wants to use the truck in its business. In either case, the debtor expects to use some of her pre-bankruptcy savings to make the down payment for the truck and, thereafter, to use a portion of her income earned during the bankruptcy case to make monthly payments, while continuing to make her ongoing payments to prepetition creditors. May the debtor make these expenditures, or does the use of either pre-existing savings or current monthly income require the bankruptcy court's permission? And if the debtor's

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prepetition creditors believe the deal is a bad one, may they object and be heard in the bankruptcy court?

Next, assume that the debtor has purchased the truck, but has fallen behind on his payments. May the auto lender repossess the truck from the debtor (as it would do if no bankruptcy case existed), or must the lender also obtain permission from the bankruptcy court? And does it matter whether taking the truck would interfere with the debtor's ability to make her continuing payments to prepetition creditors or to provide for her own needs?

The unanswered question is this: when a debtor has already finalized the details of her repayment plan and begins making payments to creditors, is the debtor fully in control of all of her other assets—meaning she is able to immediately enjoy the benefits and responsibilities of the fresh start—or does her property remain subject to bankruptcy court supervision and protection while she is making payments in accordance with her plan?

Although...