Bankruptcy Estate

Section 541 of the Bankruptcy Code codifies what is included in the bankruptcy estate. The bankruptcy estate is created when the debtor files the bankruptcy petition. The bankruptcy estate is all of the property and income of the debtor that is subject to the bankruptcy, and includes all legal or equitable interests of the debtor in property as of the commencement of the case—pre-petition property. Other property that may be included are the debtor's interest in community property, certain bequests received within 180 days of the filing date, and any income earned or property acquired by the bankruptcy estate.

Although bankruptcy law determines what property of the debtor becomes part of the bankruptcy estate, nonbankruptcy law determines whether the debtor owns or has an interest in property. However, any ipso facto clauses in contracts that deprive the debtor of property because of insolvency or bankruptcy are void—if the debtor would have been entitled to the property except for the bankruptcy, then the property is included in the bankruptcy estate regardless of contract provisions or state law to the contrary.

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It may also include post-petition property, depending on the chapter of the bankruptcy. Only property and income included in the bankruptcy estate is available to pay creditors. The bankruptcy estate is a new legal entity that is administered by the trustee or the debtor in possession for the equitable benefit of unsecured creditors of the debtor as of the filing date. Most of the property included in the estate is listed in the bankruptcy petition itself.

Even though the bankruptcy estate includes most of the debtor's property, debtors get to keep most of it, since much of the property is either listed as an exemption or because its unencumbered value is less than what it would cost to sell it.

Under Chapter 7 and Chapter 11, the bankruptcy estate includes only the property that the debtor had at the time of filing. Almost all property and income acquired after filing constitutes the debtor's new fresh start estate and is not subject to the bankruptcy.

Under Chapter 13 and 12—the bankruptcy estate includes post-petition property and income until the case is converted, dismissed, or closed. Although the debtor retains possession of the property, the trustee has a legal right to control the property, but will rarely do so if the debtor continues to make payments to the trustee according to the plan for distribution to unsecured creditors.

However, under Chapter 13, 12, and 11, when a payment plan is confirmed, all property in the bankruptcy estate, unless otherwise provided in the plan, vests in the debtor. When the repayment plan is successfully concluded, the debtor can keep the property; if the debtor fails to complete the plan, as is often the case, then the case is either converted to Chapter 7, in which case, nonexempt, valuable property will be sold by the trustee to pay unsecured creditors, or the case is dismissed, leaving creditors with their original claims—and remedies—for their debt. The payment plan specifies what portion of the debtor's postpetition earnings will be used to pay creditors. The plan may also specify that some property be sold to pay creditors.

If a Chapter 13 plan is converted to Chapter 7 in good faith, then the bankruptcy estate includes only what would have been included if the debtor originally filed for Chapter 7—the property acquired after the filing date becomes part of the debtor's fresh start estate. However, if the conversion was in bad faith, then the property acquired after filing but before the conversion is included in the Chapter 7 bankruptcy estate. The Bankruptcy Code is not clear about the conversion from Chapter 12 to Chapter 7.

Turnover—Surrendering Property to the Trustee

Turnover is the surrendering of property to the trustee so that it may be used, leased, or sold for the benefit of the debtor's unsecured creditors. Section 542 requires that the debtor surrender any property and any records of property interests to the trustee that is not claimed as exempt unless it is of little benefit to the estate. Anyone else holding property of the debtor must also turn it over to the trustee.

Section 543 stipulates that if property of the debtor is held by a custodian for distribution to creditors under nonbankruptcy law, then, since the bankruptcy case supersedes any previous creditor remedy, the custodian is obliged to turn over the property to the trustee. However, any parties that have received a benefit under the distribution in good faith are protected and the custodian is compensated for its services. The custodian must cease any more distribution of the debtor's property when it becomes aware of the debtor's bankruptcy. Any creditor that fails to turn over property to the trustee when requested, unless it was acquired in good faith and without knowledge of the bankruptcy, may have its entire claim disallowed.

Property Abandonment by the Trustee

Because the debtor generally keeps most of its property under the rehabilitative bankruptcies, abandonment only occurs under Chapter 7. Under Chapter 7, the trustee is mostly limited to selling the property of the debtor to pay unsecured creditors. However, much of the property held by the debtor is abandoned by the trustee because the property is claimed as exempt by the debtor, it is encumbered by liens of secured creditors, or its value, especially after subtracting liens and exemption amounts, may be less than what it would cost to sell it.

Even if a property has significant value, it may be needed by the debtor to carry out its business, as is often the case in Chapter 11. Therefore, it would benefit the estate more to retain the property than to have the property sold to pay creditors.

Some types of property may be more of a burden than a benefit to the estate, but, because of public policy, the trustee cannot abandon it to avoid the expense. Such is the case with many polluted properties, where the state requires the owner of the property to clean it up. However, to prevent the abandonment of the property by the bankruptcy estate, some courts have required that the state prove that the pollution is hazardous to the public welfare.

Any property that remains at the close of the bankruptcy case is returned to the debtor. Property may remain either because all creditors were paid in full or because the trustee decided not to administer the property for the estate.