When you file for bankruptcy, a bankruptcy “estate” is created which includes all of your ownership interests in property. Section 541(a)(1) of the Bankruptcy Code defines “property of the estate” and determines the extent to which your property interests will be subject to the authority of the bankruptcy court upon filing a bankruptcy petition. In a Chapter 7 bankruptcy case, property acquired after filing for bankruptcy is generally not part of the bankruptcy estate. In contrast, property and income acquired during the pendency of a Chapter 13 case generally becomes part of the bankruptcy estate. There is an exception, however, where a debtor has a legal right to property but has not yet received it. Examples of such property include accounts receivable, insurance proceeds payable from a pre-petition event, wages and commissions, vacation pay, tax refunds, an inheritance, and stock options. Bankruptcy courts have held, for instance, that vacation pay that accrues prior to the filing of a Chapter 7 petition is property of the estate, even if the debtor receives it after the filing date. See In re Willman, BR 11-40709, 2012 WL 639007 (Bankr. D.S.D. Feb. 16, 2012).
Chapter 13 reorganizations are unique, in comparison with Chapter 7 bankruptcies, in that debtors must pay a portion of their excess income to a bankruptcy trustee over a three- or five-year period. Moreover, unsecured creditors generally receive the benefit of any after-acquired property a debtor receives during a Chapter 13 case. Consequently, determinations of whether certain property should be included within property of the bankruptcy estate can be contested issues in Chapter 13 cases. The Bankruptcy Code requires that the amount paid to unsecured creditors through a proposed Chapter 13 plan is at least as much as they would receive if the debtor’s assets were liquidated in a Chapter 7 bankruptcy. See 11 U.S.C. § 1325(a)(4). Accordingly, the amount a Chapter 13 debtor is required to pay to unsecured creditors may change depending on whether certain property is deemed “property of the estate” under a hypothetical Chapter 7 liquidation.
This issue can arise in the context of stock options, for example, where stock is conditionally granted pre-petition but will not be issued to the debtor until he or she satisfies certain vesting requirements at a future date. Such stock options might vest, for example, only after the debtor’s continued employment with a company for a specified period of time or by satisfactory company or individual performance. In this context, bankruptcy courts must reconcile section 541(a)(6) of the Bankruptcy Code—which excludes post-petition earnings from the Chapter 7 estate—and section 541(a)(7) of the Code—which includes the proceeds of any contingent property interest, such as some stock options, within property of the bankruptcy estate.
Courts addressing this issue have consistently characterized stock option grants as contingent contract rights and included them within the bankruptcy estate. Since vesting is often contingent on a debtor’s continued employment, however, courts have also distinguished between the portion of a stock option grant earned pre-petition and that portion attributable to the debtor’s post-petition efforts. Accordingly, after dividing pre- and post-petition stock options, these courts have determined that only the portion earned pre-petition is brought within the bankruptcy estate. See In re Wick, 276 F.3d 412 (8th Cir. 2002).
Based on the above examples, timing can be an important factor in determining whether you can keep certain assets in bankruptcy, or whether you will have to pay more to a bankruptcy trustee through a Chapter 13 plan. Only some Chapter 13 debtors will be affected by the hypothetical liquidation test explained above; and all individual debtors—whether liquidating in a Chapter 7 case or reorganizing under Chapter 13 or Chapter 11—may claim exemptions to protect certain property interests. A bankruptcy attorney can help you determine how your assets would be affected by bankruptcy. If you are considering bankruptcy and would like to speak with a bankruptcy attorney about your rights, responsibilities, and ways to protect yourself in bankruptcy, please contact attorney Preston Gardner, Tempe bankruptcy lawyer at 480-733-6800.