Warfield v. Salazar (In re Salazar), 465 B.R. 875, 880–82 (B.A.P. 9th Cir. 2012) (Dunn, Jury, Pappas)

Although literal application of § 348(f)(1)(A) can be anomalous, when good faith is not at issue, prepetition tax refund spent by debtors during Chapter 13 case before conversion is not “in possession” of debtors and is excluded from property of Chapter 7 estate. In a Chapter 13 case filed in September of 2008 and converted to Chapter 7 in August of 2009, the debtors received tax refunds based upon 2008 state and federal tax returns and spent those refunds on living expenses. “[T]he debtor’s use of estate property in chapter 13 prior to conversion to chapter 7 is subject to ‘good faith’ scrutiny. . . . [A] plain meaning application of § 348(f)(1)(A) creates an anomaly . . . . Had the Salazars remained in chapter 13, they would have been required to account to their creditors for the Prepetition Refund even though it had been spent. . . . The value of the Prepetition Refund would have been included in the hypothetical chapter 7 liquidation in the Salazars’ chapter 13 case. . . . [I]f their case had commenced as a chapter 7, the Salazars would have been required to turn over the Prepetition Refund to the Trustee. . . . While . . . application of the plain language of § 348(f)(1) may be anomalous, . . . we do not believe such anomaly equates to producing absurd results or creating a clear contradiction in the statutory scheme in light of the remedies available to chapter 7 trustees where the debtors have not acted in good faith. . . . [T]he Salazars spent the Prepetition Refund in good faith to pay ordinary and necessary living expenses during the period from the petition date to the conversion date. . . . [T]he plain meaning of the language used in § 348(f)(1)(A) excluded the Prepetition Refund from property of the chapter 7 estate.”

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