Restructuring

Contributed by Kyle J. Ortiz
For those of us growing up in the nineties the name Shelbyville instantly brings to mind the TV show “The Simpsons.”  Shelbyville is Springfield’s neighboring town and the two towns have a fierce rivalry dating back to a dispute between their respective founding fathers.  In the classic episode Marge v. the Monorail, con man Lyle Lanley takes advantage of this civic rivalry to dupe the people of Springfield into investing city revenues in a sham monorail system:

Lyle Lanley: The name’s Lanley. Lyle Lanley. And I come before you good people tonight with an idea. Probably the greatest . . . Aw, it’s not for you. It’s more of a Shelbyville idea.
Mayor Quimby: Now wait just a minute! We’re twice as smart as the people of Shelbyville! Just tell us your idea and we’ll vote for it!
– Marge v. the Monorail, the Simpsons, Season Four, Episode 12.

No monorail was involved in Lawrence v. The Commonwealth of Kentucky Transportation Cabinet (In re Shelbyville Road Shoppes, LLC), Case No. 11-30124 (Bankr. D. Ky. June 3, 2013), and nobody was duped by a “Shelbyville idea,” but the case did involve a Shelbyville interest in property that turned out to be just about as worthless as Lyle Lanley’s monorail.
In July of 2007, a third party unaffiliated with the Shelbyville debtor entered into a purchase agreement with a Kentucky state agency for a parcel of property.  The third party made a down payment of roughly $1 million on the $4.8 million property.  A month later, in August of 2007, the third party assigned the purchase agreement to the Shelbyville debtor.
The purchase had still not been fully consummated when the Shelbyville debtor filed its petition for relief under chapter 7 in January of 2011.  Thus, shortly after the filing, the chapter 7 trustee appointed in the case made a demand on the state agency to return the down payment.  After the state agency refused the trustee brought the present adversary proceeding seeking turnover of the down payment under sections 541 and 542 of the Bankruptcy Code.  The state agency responded that the down payment was not property of the estate, and thus, that the trustee had no right to compel turnover of the down payment.
The court began its analysis of the dispute by declaring that “[t]here is only one discernible issue with regard to liability under [section 542]: whether the [down payment] constitute[d] property of the estate under [section 541]” as of the commencement date.  The court explained that the question hinged on whether the down payment constituted property of the estate because section 542 is dependent upon sections 363 (use, sale, or lease of property) and 522 (exemptions), which, in turn, are dependent on section 541’s definition of property of the estate.
Turning to section 541, the court stated that it must first determine the Shelbyville debtor’s rights to the property under state law because property interests are created by state law.  Thus, although “the determination as to whether a debtor’s interest in property constitutes estate property is a question of federal law,” “state law controls what interest, if any; a debtor actually has in property.”  The state law step is critical because “[s]ection 541(a) specifies that the estate is comprised of only the debtor’s “interest” in property, not the actual property.”  This “distinction is more than just academic,” because although a trustee may have an “interest” in certain property, and such “interest” is property of a debtor’s estate, if that “interest” does not provide a right of immediate possession, section 542 will not expand the trustee’s interest and create a right of possession.
Applying this standard, the court examined the Shelbyville debtor’s interest in the down payment under the purchase agreement and found that the purchase agreement provided only two options with regard to the down payment: (i) it could be applied to the purchase price, or (ii) forfeited as liquidated damages if the purchase was never completed.  Consequently, the court concluded that because no provision in the purchase agreement or under Kentucky law authorized the Shelbyville debtor to regain possession of the down payment, the trustee was not entitled to turnover of the down payment.
Thus, Shelbyville reminds us that whether the property in question is a purchase agreement, a monorail, or a “Krusty Burger,” section 541 will only bring into a debtor’s estate the same interest the debtor would have in such property under non-bankruptcy law.  Accordingly, if the interest a debtor has in property does not grant a possessory right, section 542 will not provide the debtor such a right.  The Marge v. the Monorail episode ends with Homer preventing disaster on a runaway monorail by tearing a giant “M” logo off the side of the monorail and using it as an anchor that brings the monorail to a halt when it fortuitously latches to a giant doughnut atop a doughnut shop, prompting Homer to ask: “Doughnuts, is there anything they can’t do?”  I don’t know about doughnuts, but Shelbyville makes clear there is plenty that section 542 can’t do.