Last week, I had a client who had just recently filed for bankruptcy under Chapter 7. Her intention was to reaffirm on her mortgage so that she could retain her home. When she contacted her creditor to make arrangements for the reaffirmation agreement, she heard an automated message that sent her into a panic.
She called my office to ask me what they meant. I set-up a conference call with the number she had called so we could both listen to the message together. The number turned out to be a special number that people who had filed bankruptcy were supposed to call, and the automated message warned the callers that all of the client’s assets were part of the bankruptcy estate.
Technically, there was nothing inaccurate about the automated message. When a debtor files for bankruptcy, all of their assets do indeed become part of the bankruptcy estate. The problem was how the message was worded, and the fact that the message made any reference to the bankruptcy estate at all. The message was worded in such a way (and in retrospect, I think it was done so intentionally) to prey on the relative naiveté of a typical debtor in bankruptcy and cause unnecessary panic.
First of all, most people filing for bankruptcy struggle with making distinctions between assets and debts, and understanding the difference between disclosing a debt and having a debt discharged. In fact, most people refer to it as “including or not including” debts, and they think that including a debt is synonymous with disclosure and discharge, when in fact, it is not.
So, as a result of that common misconception mixed with the cryptic automated message, my client believed that her mortgage lender was telling her that she had forfeited her home in the bankruptcy. She hadn’t, of course. But that brings us to today’s topic. What is the “bankruptcy estate”?
The bankruptcy estate is one of those concepts that most people remain oblivious to because – in 99% of cases – its effects are not readily observable. It’s a sort of behind-the-scenes concept, but one that plays a very crucial role in bankruptcy.
When a bankruptcy case is filed, all assets of the debtor (including real estate, motor vehicles, personal property, financial accounts, and legal ownership interests of all other kinds) become property of the bankruptcy estate (with a few exceptions). This is laid out at 11 U.S.C. § 541.
The reason most debtors are unaware of this is because there is very rarely any manifestation of this transfer. Debtors retain physical possession of all of their assets, including the ability to use and dispose of said assets (although technically, because of the bankruptcy estate, they are not supposed to dispose of assets – this is really only relevant when it comes to larger assets).
The bankruptcy estate is analogous to a probate estate, which is the legal entity or “thing” that owns the stuff of a dead person until the probate process runs its course and the assets of the decedent have been passed on to his/her heirs.
In fact, the existence of the bankruptcy estate is one of the key components necessary to making the automatic stay function at all. One of the reasons that your creditors cannot garnish wages and repossess vehicles or foreclose property while a bankruptcy case is pending is because – technically – the assets are not yours, but instead they belong to the bankruptcy estate. And there they will remain while the case is pending, which allows the trustee and the court to review your finances without the interruption of creditors going after assets.
The existence of the estate is also a necessary component to allow the trustee to liquidate assets that may be non-exempt.
In most cases, assets are never seized by the trustee, and so the client remains blissfully unaware that although they retain possession and use of their stuff, that their stuff is technically not theirs.
But fear not! Like a probate estate, a bankruptcy estate is not permanent. After the case is no longer pending, the bankruptcy estate is dissolved and ownership interests revest back upon the original owner (you). Again, it’s very unceremonious, and chances are you’ll never notice that anything actually happened. In Chapter 7 cases, the revestment typically happens at the same time you receive your discharge. In Chapter 13, it can happen either at discharge or at confirmation of the plan (and there are strategic reasons to choose one over the other, in terms of legal protections).