Chapter 13 Bankruptcy
Why Chapter 13?
Chapter 13 is one of the several reorganization chapters available under the bankruptcy code. Congress, in writing the code and as a matter of policy, has developed these reorganization chapters as an alternative to liquidation under Chapter 7. Chapter 13, formerly known as a "wage earner plan" under the Bankruptcy Act, was expanded with the 1978 revisions which resulted in the Bankruptcy Code to include any person who has regular income. In fact, the title of Chapter 13 is now known as "adjustment of debts of an individual with regular income." Don't look under Chapter 13, however, to determine who may be a Chapter 13 debtor. This definition is found in Section 101 of the Bankruptcy Code, which is the general definition section of the entire Code. Subparagraph (30) defines "individual with regular income" as an "individual whose income is sufficiently stable and regular to enable such individual to make payments under a plan under Chapter 13 of this title, other than a stock broker or a commodity broker. The question, then, is what is the definition of "individual." Paragraph (41) of Section 101 defines "person" to include an individual, partnership, and corporation, so an individual would be someone other than a partnership or corporation, which apparently means that an individual must be a living, breathing person. Further reference to who may be a debtor is found in Section 109. Subparagraph (e) is, as follows:
(e) only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $250,000.00 and noncontingent, liquidated, secure debts of less than $750,000.00, or an individual with regular income and such individual's spouse, except a stock broker or a commodity broker, that owe, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts that aggregate less than $250,000.00 and noncontingent, liquidated, secured debts of $750,000.00 may be a debtor under Chapter 13 of this title.
Note that this definition is based on claims that are not contingent and are liquidated. If a claim is noncontingent or unliquidated, then these claims do not count toward the jurisdictional amount. For example, a debtor could be a defendant in a pending lawsuit for negligence seeking $1,000,000.00. The claim is contingent because the liability has not been adjudicated. In that circumstance, the claim is also unliquidated because the actual amount of damages would have yet to be determined.
In a conversion from Chapter 7 to Chapter 13, the issue of whether a claim is unliquidated or contingent is determined at the time of filing of the Chapter 7 petition, not the time of conversion. In re: Bush, 120 Bankr. 403 (B.C. 6., East. Dist. of TX. 1990).
It should be noted that the debt limits for Chapter 13 were increased to the limits described above in 1994, from the previous lower limits of $350,000.00 for secured creditors and $100,000.00 for unsecured creditors. The impact of this 1994 change was to open up Chapter 13 to more individuals operating small businesses who are in need of reorganization, and who desire to do so under the more expedited procedures available in Chapter 13 compared to those found in Chapter 11.
The legislative history pertaining to small business operations operated by a husband and wife is important to note, and the entire paragraph from that history is quoted here:
Whether a small business operated by husband and wife, the so-called "mom and pop grocery store," will be a partnership and thus excluded from Chapter 13, or a business owned by an individual, will have to be determined on the facts of each case. Even if partnership papers have not been filed, for example, the issue will be whether the assets of the grocery store are for the benefit of all creditors of a debtor or only for business creditors, and whether such assets may be the subject of a Chapter 13 proceeding. The intent of the section is to follow current law that a partnership by estoppel may be adjudicated in bankruptcy and therefore would not prevent a Chapter 13 debtor from subjecting assets in such partnership to the reach of all creditors in a Chapter 13 case. However, if the partnership is found to be a partnership by agreement, even an informal agreement, then a separate entity exists and the assets of that entity would be exempt from a case under Chapter 13.
As the legislative history of the 1994 revisions also note, creditors generally benefit when a debtor elects Chapter 13. This has been the policy statement enunciated by Congress throughout the Bankruptcy Code which, again, is to encourage debtors whenever possible to seek bankruptcy protection under the umbrella of a reorganization chapter.
Whether an individual client may benefit from filing under Chapter 13 must obviously be determined on a case-by-case basis. First and without question, the client must have regular income from some source, that is "sufficiently stable and regular" to allow for the formulation of a Chapter 13 plan. For example, a question could be raised as to whether a client who is not employed but is drawing unemployment insurance benefits qualifies under Chapter 13. These weekly benefits usually terminate after a period of twenty-six weeks. Obviously, the income is probably stable, but can it truly be defined as "regular"? The income in the form of unemployment benefits will undoubtedly expire after the twenty-six eligibility period, and perhaps sooner, if the client fails to look for work as required by the unemployment insurance laws. However, no cases could be found which denied confirmation on that basis.
When to Consider Ch 13 as an Alternative to Ch 7
Assuming that the client passes the regular income test, then what benefits can accrue to the client by filing Chapter 13, as compared to a Chapter 7? An answer of "yes" to one or more of the following questions would indicate to the practitioner that his or her client may benefit from a Chapter 13 filing:
1. Is the client "upside down" on the purchase of a vehicle?
2. Is the client in arrears on payments due to a home mortgage lender?
3. Does the client owe taxes which would not be dischargeable in a Chapter 7 (generally synonymous with "priority" taxes defined in 11 U.S.C. Section 507, i.e. individual income taxes incurred within three years of the filing or property taxes incurred within one year of the filing)?
4. Has the client obtained a Chapter 7 discharge within the past six years?
5. Does the client have debts which might be nondischargeable in a Chapter 7 (i.e., student loans, criminal restitution, child support arrearages, or debts incurred through fraud)?
6. Does the client have nonexempt assets which would be subject to turn over to the Trustee in a Chapter 7 case, but which the client desires to keep?
7. Is a co-debtor friend or relative obligated on the debt, who could be protected from collection under the co-debtor stay provisions of 11 U.S.C. Section 1301?
8. Is the client liable on a secured debt where the secured creditor might refuse to agree to a reaffirmation agreement in a Chapter 7 case?
The foregoing questions are not a complete laundry list of all of the reasons why a client should be encouraged to seek protection under Chapter 13. These, however, constitute the more common questions posed by the bankruptcy practitioner to a new client who is considering bankruptcy filing, in attempting to decide between a Chapter 13 or Chapter 7 option.
Requirements of Chapter 13 Plan: Eligibility, Feasibility and Good Faith
1. Eligibility
The general eligibility requirements of who may be a Chapter 13 debtor have been previously addressed. The Code also allows a husband and wife to file as joint debtors.
It should also be noted that a debtor may be a Chapter 13 debtor, despite a Chapter 7 discharge within six years prior to the filing of the case. In other words, a person who could not qualify for a subsequent discharge under Chapter 7 sooner than six years by virtue of 11 U.S.C. Section 727(a)(8), could nevertheless obtain discharge under a Chapter 13 plan filed sooner than the expiration of that six-year period. In fact, a vehicle known euphemistically as a "Chapter 20" combines the Chapter 7 with a Chapter 13 filing immediately upon issuance of the Chapter 7 discharge. This device is used in those cases where the debtor has unsecured debts which exceed the $250,000.00 unsecured debt limit found in 11 U.S.C. Section 109(e). A Chapter 7 case is filed to extinguish those debts, and once they are discharged in Chapter 7 (and assuming that the debtor would have some reason to seek relief under Chapter 13), a Chapter 13 petition is filed to deal with the remaining secured or priority debts. This device has been used less frequently since the enactment of the increase in Chapter 13 debt limits which occurred by way of the 1994 amendments.
Although a rare circumstance, it should be noted that a stock broker or commodity broker is not eligible for relief under Chapter 13. According to the legislative history, the reason for this exclusion is to prevent stock brokers and commodity brokers from avoiding the customer protection provisions of Chapter 7, and particularly, Subchapter III of that chapter which pertains particularly to stock broker liquidation and Subchapter IV which deals with commodity broker liquidation. The specific definition of who is a "stock broker" is found at 11 U.S.C. Section 101(53 A) while the definition of a "commodity broker" is found in sub paragraph (6) of that section.
It should also be noted that while there is a special relief chapter for family farmers found in Chapter 12, these individuals may still qualify for relief under either Chapter 11 or Chapter 13 if restructuring under either of those Chapters is more advantageous.
2. Feasibility
The definition of feasibility is not found in the Bankruptcy Code. The requirement for a regular income is the foundation for the feasibility determination. Obviously, a debtor without regular income does not have the ability for formulate a feasible plan. A person who has regular income at the inception of a Chapter 13 case, but later loses that income producing ability and has no means of support, would be subject to dismissal due to lack of feasibility of the plan, since payments could no longer be made.
11 U.S.C. Section 1322, which describes the contents of the plan, also requires that the plan be completed within five years. This requires two things. First, the debtor must have sufficient disposable income to make the payments called for by the plan. A debtor in Chapter 13 must submit a budget showing income and reasonable expenses, and there must be a sufficient surplus in that budget to allow for servicing of the proposed Chapter 13 plan. Second, even if the would-be debtor has a budget surplus, he must formulate a plan which can be completed within sixty months. Obviously, a debtor with $100.00 in budget surplus could not feasiblely propose a plan which would pay for a $40,000.00 car in five years. Using this example, a plan could be formulated, but it would require surrender of the vehicle.
The issue of feasibility could also come up under other factual scenarios. For example, a debtor with regular income who was also suffering from a terminal illness with a life expectancy of a few months or less could be denied confirmation of a proposed plan on that basis. Feasibility issues also sometimes arise where married debtors separate and divorce following plan confirmation, thus incurring increased expenses through the maintenance of separate households. The solution in that circumstance might be to dismiss the existing case, and to refile separate Chapter 13 bankruptcies for each individual following completion of the divorce proceedings.
This method is certainly superior to attempting a division of the Chapter 13 payments between the spouses in a divorce decree. In that instance, should one of the spouses fail to make his or her Chapter 13 payments as ordered in the divorce decree, the entire Chapter 13 case would be subject to dismissal.
3. Good Faith
What exactly constitutes "good faith" under Chapter 13 is not statutorily addressed by the code. Before 1982, the majority of the courts followed the reasoning that low payouts to unsecured creditors in Chapter 13 violated the good faith requirement. These courts held that good faith required that payments to unsecured creditors be meaningful, less they violate the spirit and provisions of Chapter 13. In re: De Simone, 6 Bankr. 89, 91 (Bnkrtcy Ct, S.D.N.Y., 1980). However, year of 1982 stands as a turning point in the treatment of the good faith standard. No fewer than four circuit court cases dealt with the substantial payment requirement as a prerequisite to good faith and uniformly held that substantiality of payment to unsecureds was merely one of many elements of good faith. The first case to deal with this was In re: Rimgale, 669 F. 2d 426 (7th Cir., 1982). Rimgale looked beyond the previous substantiality of payment holdings and instead inquired into whether or not the plan abused the provision, purpose, or spirit of Chapter 13 (an equally vague standard!). In addition, Rimgale listed five possible indicia of good faith, four of which dealt with the accuracy of the details of the plan and one of which dealt with the issue of "fundamental fairness." The second case ruling on the substantiality of payment requirement was In re: Goeb, 675 F. 2d 1386 (9th Cir. 1982). In upholding a one percent plan, the Goeb court defined good faith as follows:
The proper inquiry as whether the [debtor] acted equitably in proposing [his] Chapter 13 plan. A bankruptcy court must inquire whether the [debtor] has misrepresented facts in his plan, unfairly manipulated the Bankruptcy Code, or otherwise proposed his Chapter 13 plan in an equitable manner. Though it may consider the substantiality of the proposed payment, the court must make its good faith determination in light of all mitigating factors.
The other two circuits, in striking down a substantial payment test, held that low payments to unsecured is a loan not a per se violation of good faith. Barnes v. Whelan, 223 U.S. App. D.C. 10, 689 F. 2d 193 (D.C. Cir., 1982), and Deans v. O'Donnell, 692 F. 2d 968, 970 (4th Cir. 1982). The Barnes case upheld a one percent plan, while the Deans court approved a zero percent plan.
The seminal case setting down the standards for good faith under 11 U.S.C. Section 1325 is In re: Estus, 695 F. 2d 311 (8th Cir., 1982). The debtor in Estus attempted to discharge student loans in a Chapter 13, which were nondischargeable in a Chapter 7. Approximately fifty percent of the loans were student loans, with the other half being employee credit union loans. The plan provided for a zero percent payment to unsecureds. The court held that any per se minimum payment requirement "would infringe on the desired flexibility of Chapter 13 and is unwarranted." However, the court considered that percentage of payments of unsecured is one of many valid considerations in the question of good faith. To aid in a further definition of good faith, the court listed a nonexclusive itemization of relevant considerations, as follows:
(1) The amount of the proposed payments in the amount of the debtor's surplus;
(2) The debtor's employment history, ability to earn and likelihood of future increases in income;
(3) The probable or expected duration of the plan, i.e. minimum of three years or more than a three year "base" plan. In this regard, it should be noted that a plan approaching five years are often construed as implying good faith, In re: Dalby, 38 Bankr. 107, 111 (Bkrtcy. D. Utah, 1984). Conversely, a plan of three years might be taken as implying lack of good faith. In re: Nkanang, 44 Bankr. 955, 958 (Bkrtcy. N.D.Ga. 1984);
(4) The accuracy of the plan statements of the debts, expenses, and percentage repayment of unsecured debt, and whether any inaccuracies are an attempt to mislead the court;
(5) The extent of the preferential treatment between classes of creditors;
(6) The extent of which secured claims are modified;
(7) The type of debt sought to be discharged and whether any such debt is dischargeable in Chapter 7;
(8) The existence of special circumstances such as inordinate medical expenses;
(9) The frequency with which the debtor has sought relief under the Bankruptcy Reform Act;
(10) The motivation and sincerity of the debtor in seeking Chapter 13 relief;
(11) The burden which the plan's administration would place on the Trustee;
Even though the basis for the holding in Estus would no longer be viable on account of the 1990 change to the Bankruptcy Code which provided for identical treatment of student loans in both Chapter 7 and Chapter 13 cases, the laundry list described above is still helpful in determining whether a plan is filed in good faith. In the Tenth Circuit, Flygare v. Boulden, 709 F. 2d 1344 (1983), adopted a similar non-exhaustive list of factors for consideration in determining good faith. In any event, the issue of good faith must be determined on a case-by-case basis, utilizing the "laundry list" approach described above.
Some other Tenth Circuit cases concerning good faith definitions may be helpful. In In Re: Rasmussen, 888 F. 2d 703 (1982), involved a debtor who had $100,000.00 in unsecured debts including more than $40,000.00 to Pioneer Bank. Debtor had previously received a discharge of all unsecured debt in Chapter 7 except for the Pioneer debt, which was found to have been obtained through fraud and was nondischargeable under Section 523 (a)(2). Debtor filed Chapter 13 two weeks after the Chapter 7 discharge, and listed a single debt--the nondischargeable Pioneer debt. Debtor's plan proposed to pay 1.5 percent to Pioneer Bank. The court found lack of good faith. The case of In re: Gyer, 986 F. 2d 1326 (1993), debtor had previously filed Chapter 7. The debt to the bank was found nondischargeable in that case because debtor willfully and maliciously converted cattle under Section 523 (a)(6). The Chapter 13 plan proposed to discharge this same debt. The court found lack of good faith. In the case of In re: Robinson, 987 F. 2d 665 (1993), debtor appealed a District Court's reversal of the Bankruptcy Court's finding that the Chapter 13 plan had been proposed in good faith. Debtor had been sued for engaging in a sexual relationship by using his position as a pastoral counselor. The District Court denied confirmation on the basis of bad faith, which was affirmed by the Tenth Circuit.
How to Compute A Plan: Paying Off the Creditor
Plan computation requires the practitioner to first read and understand 11 U.S.C. Section 1322, which describes the content of a Chapter 13 plan, and to also look at Section 1325, which are the confirmation requirements. Section 1322(a) contains the "shall" requirements which are mandatory to plan formulation, while subparagraph (b) contains the discretionary "may" requirements. Under the "shall" requirements, a plan must provide for submission of sufficient future earnings or other future income of the debtor to the supervision and control of the Trustee as is necessary for the execution of the plan. This section also requires full payment of all priority claims as defined by Section 507 of the Bankruptcy Code (although the holder of the claim may agree to different treatment of such claim). Finally, if the plan classifies claims, then creditors within each class must be treated the same. The discretionary provisions under subparagraph (b) allow the debtor to designate a class or classes of unsecured creditors similar to those allowed by Section 1122 in Chapter 11 cases. For example, a debtor could create a class of nondischargeable debts, such as student loans, to be paid in full, while other dischargeable unsecured creditors might receive less than full payment. Another important discretionary provision under subparagraph (b) allows a debtor to modify the rights of holders of secured claims, with the exception of a claim secured only by a mortgage in real property that is the debtor's principal residence. What this means is that a debtor can "cram down" a secured claim. For example, if the debtor owns a car secured to ABC Bank which has a loan of $10,000.00, but the car is only worth $8,000.00, the debtor may propose in his Chapter 13 plan to pay the value of the car, that is, $8,000.00, to the bank. The bank essentially is left with a $2,000.00 unsecured claim after payment of the secured claim. It is important to note that the "cram down" procedures are not available for use in Chapter 13 as to the debtor's principal residence. If a debtor is in arrears on his home mortgage, his only options under Chapter 13 are to either surrender the residence or to cure the mortgage arrearage through deferred payments through the Chapter 13 plan with the concurrent obligation of keeping all post-petition payments current. While this section only excludes residential real estate which is the debtor's principal residence from the "cram down" provisions, as a practical matter Chapter 13 does not lend itself to long-term modification of real estate indebtedness. Subparagraph (a)(5) provides only for curing of default and maintaining post-petition payments for secured claims which extend beyond the period of the Chapter 13 plan, as most real estate mortgages would do. This subparagraph would also apply to long-term unsecured debt. The debtor's option in these instances is to provide for cure of any arrearages through the Chapter 13 plan, with the obligation to resume making regular payments directly to the creditor involved along with the Chapter 13 plan payments.
Other discretionary provisions under Section 1322 include the acceptance or rejection of executory contracts (such as automobile leases, credit life and/or disability insurance contracts sold as part of retail installment agreements, and other executory contracts or leases); sale of property of the estate to pay secured or unsecured debts; and the vesting of property upon confirmation in the debtor or some other entity (which would allow for a sole proprietor business debtor to vest his property in a newly formed corporation or partnership).
The practitioner, as previously stated, must also be familiar with the confirmation requirements of Section 1325. One of the more significant requirements for confirmation is that unsecured creditors be paid under the plan at least that they could have received if the estate of the debtor were liquidated under Chapter 7. This is the so-called hypothetical liquidation test, although is not often a problem in Chapter 13, since most property of a Chapter 13 debtor would probably be exempt under Kansas law. If the debtor has any non-exempt property which the debtor desires to keep, then debtor's counsel must look at what the creditors could expect to receive if the debtor were seeking relief under Chapter 7. This would be the liquidation value of any non-exempt property. For example, if a client desiring relief under Chapter 13 owned a non-exempt piece of real estate worth $50,000.00, then the plan would require that unsecured creditors receive at least the liquidation value of that property. Such value might be less than the current fair market value, since a forced sale of such property might result in a lower sale price. Furthermore, the practitioner may deduct, in making these calculations, the anticipated Chapter 7 Trustee fees described in 11 U.S.C. Section 326(a), as well as estimated costs which might be associated with any such sale, such as auctioneer fees, realtor commissions, and title insurance premiums. In preparing this analysis, it is best for the practitioner to include this as part of the Chapter 13 plan, showing the non-exempt asset which would be available to creditors, the fair market value of the property, the expected liquidation sale price, and a deduction of fees and costs as described above, with a net amount reflected in the plan as what would be available to creditors in a Chapter 7 case. The plan would then also need to show that this amount is being paid to unsecured creditors during the life of the plan. Obviously, if the total amount owed unsecured creditors is less than this nonexempt property net value, then the plan would need to be a full repayment plan to unsecured creditors. A sample form to use in performing the liquidation analysis is attached as Appendix I, and could be included as part of a Chapter 13 plan or as an exhibit to the plan.
In contrast to the procedure under the Bankruptcy Act, the Code does not require creditors to accept the plan for confirmation to occur. Although creditors may do so if they so desire, the court still has authority to approve a plan over creditor rejection so long as the holder of secured claims retain liens securing such claims, secured creditors are paid the value of their collateral or the debtor has surrendered property securing the claim, and the court finds that the debtor will be able to make payments called for by the plan and otherwise comply with it. As to unsecured creditors, plan confirmation will occur over such creditors' objections so long as they are receiving what they would receive in a Chapter 7 case, as described above, and the debtor has devoted all disposable income to the plan for a period of at least three years.
A Chapter 13 analysis form is attached as Appendix II to this paper, to assist counsel in evaluating the feasibility of a Chapter 13 plan, and explaining this analysis to clients. The upper part of the analysis looks at the feasibility question in order to determine what the net disposable income is on a monthly basis. The middle portion of the form contains common categories of creditors that are paid through a Chapter 13 plan. Calculation of the repayment of secured debt would require knowledge of the value of the property securing the debt, the contract rate of interest the creditor is charging (if it is the intent to pay the full contract rate), and the discount rate being paid by the Chapter 13 Trustee (which is ordinarily the effective interest which is paid to creditors in Chapter 13). Likewise, a mortgage arrearage calculation would require knowledge of the amount of payments which had been missed, together with the applicable contract rate or discount rate. Special class unsecured debt might include student loans or other nondischargeable obligations, co-signed debts, insufficient funds checks, or other unsecured debt which the client desires to be paid through the plan. The classification must be reasonable, and again, all members of an individual class must be treated equally. For example, if the special class designation was for physicians or health care providers, the debtor could not choose to pay his family physician, while refusing to pay a specialist, such as a radiologist. As to attorneys fees, the Code does not require that they be paid through the plan, but if any money is paid in advance, then the client must tender the entire amount of the filing fee, which is presently $160.00. The Chapter 13 Trustee's fee must also be calculated, and would include all monies which are being paid through the plan. Direct payments, such as a home mortgage, would not have to be included in this calculation. A total is then calculated, with that amount being divided by the applicable number of months which the plan will run, which must be at least thirty-six months, but not more than sixty months. This number must approximate the amount of net surplus shown in the first section of the analysis. The lower portion of the analysis may be used to make notes concerning other special provisions of the plan, such as payment of home mortgages directly to the mortgage lender, any tax returns which must be filed, any property to be surrendered, or other items which would be particular to the plan being formulated for the client. With regard to tax returns, the Internal Revenue Service generally will object to any Chapter 13 plan which is filed, where the debtor has failed to file income tax returns for the preceding five years. Before a plan can be confirmed, it will be necessary for the debtor to file with the IRS any missing returns, and of course, to include payment of any tax obligations within the Chapter 13 plan.
Putting A Plan Together: Chapter 13 Bankruptcy Schedules
The Chapter 13 analysis described previously is a good start towards putting the plan together. Obviously, the plan must accurately reflect values shown in the schedules, including the amount owed to secured, priority, and unsecured creditors, as well as the value of collateral securing debts which are to be paid through the plan. In this regard, if the numbers shown on the plan do not match those shown on the schedules, the Chapter 13 Trustee or affected creditors may then have grounds to object to confirmation of the Chapter 13 plan.
In Chapter 13, the schedules are essentially those as filed in Chapter 7 consumer cases. These schedules are as follows:
Schedule A: used to describe any interest in real estate, including leasehold interests;
Schedule B: used to describe personal property, both tangible and intangible;
Schedule C: exemptions claimed by the debtor under applicable state law and those which remain available under 11 U.S.C. Section 522(d)(10);
Schedule D: a listing of all secured creditors, including addresses, amounts owed, and a description of collateral securing the debt. (Note: the collateral should also have been described in schedules A or B, as appropriate.)
Schedule E: priority claims, including addresses and amounts owed. In Chapter 13, these are usually tax obligations;
Schedule F: a listing of unsecured creditors;
Schedule G: a listing of executory contracts and unexpired leases;
Schedule H: the names and addresses of any co-debtors or loan guarantors, along with the particular creditor holding the co-signed obligation;
Schedule I: the debtor's current income from all sources;
Schedule J: the debtor's current expenditures, i.e. the monthly budget;
All of these forms are the official forms prescribed by the Judicial Conference of the United States pursuant to authority granted by the Bankruptcy Code. In addition to the schedules shown above, a new case must be accompanied by a voluntary petition signed by both the debtor or joint debtors, and counsel. This form is prescribed by form 1 of the Official Forms. In most Chapter 13 cases, the debtor requests permission to pay the filing fee in installments, and this form is specified in form 3 of the Official Forms. A complete description of the schedules previously described is found in form 6 of the Official Forms, and in addition to the schedules described above, the debtor or joint debtors must file a statement of financial affairs found in form 7 of the Official Forms. All of these forms are available from various suppliers in pre-printed format, and there are a number of excellent software programs which allow for automated creation of these forms by the use of a computer.
Accuracy in form preparation is only as good as the information supplied by the clients. In order to assist the client in meeting his or her obligation to provide correct information, I have developed a bankruptcy information packet which is provided to prospective clients prior to our first meeting. This brochure is in two parts. The first is a synopsis of frequently asked bankruptcy questions with answers to those questions provided in understandable language. The second half of the brochure asks the client to provide the information necessary to accurately complete the bankruptcy petition, the statement of financial affairs, and the bankruptcy schedules. A copy of this brochure is attached to this paper as Appendix III. In addition to this information, I have summarized the information required to be disclosed in the statement of financial affairs which would be applicable to most Chapter 13 clients. This form is provided with these materials as Appendix IV.
When the information supplied by the client on the completed bankruptcy questionnaire is coupled with the additional information obtained by using the statement of financial affairs worksheet, the practitioner should be in a position to create accurate schedules to be filed in a new Chapter 13 case. Of course, it is advisable to file a plan with the case filing, as the clerk will then notice the plan to all creditors along with the notice of commencement of the case. Again, the Chapter 13 analysis form may be utilized, along with the schedules and other information derived from the client, in completing the Chapter 13 plan. It should be noted that if the plan is not filed at the inception of the case, counsel representing a debtor or joint debtors has fifteen days following commencement of the case to file the Chapter 13 plan. See Bankruptcy Rule 3015(b), in the regard. If the plan is not filed with the original petition, then it is the obligation of counsel for the debtor or joint debtors to not only file the plan, but notice all creditors concerning the objection deadline and the confirmation hearing.
Post Confirmation Default
Chapter 13 is an ongoing plan of repayment under court supervision, with the Chapter 13 Trustee acting as disbursing agent for the debtors. It is important to advise prospective Chapter 13 debtors that they will be obligated to continue plan payments for a minimum of three years up to a maximum of five years. The order of confirmation will include the requirement of regular payments as one of its obligations. Debtors should be advised that failure to make timely payments to the Trustee will result in eventual dismissal of their case, and that debts under Chapter 13 are not discharged until all payments have been made. In other words, failure to make timely payments will result in plan default, which will eventually result in dismissal and the undoing of everything that has been previously done to assist the clients in resolving their debt problems.
Certainly, circumstances may change which may require plan modification. Debtors unable to make plan payments for a short period of time may petition the court for abatement or suspension of their payments on a showing of such good cause, which, if approved by the court, will allow the case to continue without plan payments being made. It should be noted, however, that if the plan is approaching the five year maximum and if payments are suspended, this will result in an increase in payments once they are resumed in order to complete within the required sixty month period.
The failure by a debtor to make payments under the Chapter 13 plan will first result in a late notice by the Chapter 13 Trustee. If the default continues, then the Trustee will file a motion to dismiss, and will give the debtor and counsel an opportunity to object to the motion and state why it should not be sustained. Generally, a debtor has twenty-one days after the filing of the motion by the Trustee, to object to the motion to dismiss. It is important to note that these motions are not automatically calendered by the Bankruptcy Court, unless an objection is made. Therefore, if no objection is filed, then automatic dismissal will result. However, once an objection is filed, then this will result in a hearing before the Bankruptcy Court to determine whether the motion to dismiss should be sustained.
The obligation to pay pursuant to the confirmed Chapter 13 plan rests squarely with the Chapter 13 debtor. Oftentimes, clients who are experiencing difficulties in payment will not call their attorney to explain the problem or explore options before a motion to dismiss is filed. Presumably, any motion to dismiss is sent by the Trustee to the debtor, as well as to counsel. However, to ensure that the client has notice of any pending motion to dismiss, we routinely forward a copy of the motion along with a letter to clients explaining that the motion has been filed, the reason for the filing, and what will occur in the event that some action is not taken. A copy of this letter is attached to this paper as Appendix V. Our practice is to send the letter along with the Trustee's motion, and await a response from the client. If no response is made, then we do not object to the motion to dismiss. As can be seen from the form of the letter, it addresses other options which might be available to a debtor in default, including conversion of the case to a Chapter 7 liquidation, or application for a hardship discharge under 11 U.S.C. Section 1328(b). It also addresses the availability of suspension of payments, previously discussed.
With regard to the so-called "hardship discharge" found under 11 U.S.C. Section 1328(b), this allows a Chapter 13 debtor to obtain a Chapter 13 discharge in advance of the three year minimum plan period prescribed by 11 U.S.C. Section 1325(b)(1)(B). The hardship discharge provisions of Chapter 13 can be invoked only upon the filing of a motion demonstrating actual hardship on the part of the debtor. The type of discharge more closely approximates that which would be received under a Chapter 7 case rather than the more liberal discharge provisions found in 11 U.S.C. Section 1328(a). Under the hardship provisions, all of the debts excepted from discharge under 11 U.S.C. Section 523 could be nondischargeable debts, whereas under the regular discharge provisions found in 11 U.S.C. Section 1328(a) only the following debts would survive the discharge order:
1. A long term debt described by 1322(b)(5), which has a last payment due after the final Chapter 13 payment;
2. A debt which would be nondischargeable under 11 U.S.C. Section 523(a)(5), which would be for child support or alimony;
3. A debt which would be nondischargeable under 11 U.S.C. Section 523(a)(8) which would be for a student loan which became due less than seven years prior to the filing of the case or which would not be dischargeable upon a showing of undue hardship;
4. A type of debt described in 11 U.S.C. Section 523(a)(9) which arises out of a wrongful death or personal injury claim caused by the debtor's operation of a motor vehicle where alcohol or drug abuse was involved;
5. For restitution or criminal fine including the sentence on a debtor's conviction of a crime.
One of the important regular discharge provisions of Section 1328(a), which would be lost under a hardship discharge, is the discharge of any tax obligation which has been scheduled as part of the bankruptcy. Even if the taxing authority failed to file a proof of claim, the tax debt is discharged under 1328(a). This does not occur under a 1328(b) discharge.
Post Petition Debt
11 U.S.C. Section 1305 describes the procedure for the filing and allowance of post petition claims. The general rule in Chapter 13 cases is that a debtor is on a "cash and carry basis" during the life of a Chapter 13 plan, and is supposedly not permitted to incur any new debt without prior approval of the Bankruptcy Court after all existing creditors and the Trustee have been notified of this intent. Unfortunately, this rule is often honored in the breach. A common situation is the debtor who has insufficient or no health insurance coverage, and incurs new medical bills during the pendency of the Chapter 13 plan. These creditors can be included within the plan, but as post petition claims they must be paid in full.
Such claims can be included within the plan by two methods. First, the debtor may file an appropriate motion to include a post petition creditor in the plan and file an amended plan providing for full payment of this debt prior to entry of the discharge order. The post petition creditor may object to this treatment, and will not be added to the plan over this objection. However, the creditor would be prohibited from collecting the debt until the case is concluded either by entry of the discharge order or dismissal of the case. A second method is for the creditor to file a claim clearly showing it to be post petition, which will then be automatically allowed as part of the Chapter 13 plan.
It is important to note that if the plan is running close to the five year maximum, the addition of post petition creditors will most likely result in an increase in plan payments. If the debtor can not increase plan payments, then the case would be subject to dismissal for lack of feasibility.
Stay Litigation
The procedure for requesting and obtaining relief from the automatic stay is found in 11 U.S.C. Section 362(d). That subparagraph provides three essential grounds for granting the request for stay relief, which are as follows:
1. For cause, including a creditor's lack of adequate protection;
2. Debtor does not have any equity in the property in questions;
3. The property in question is not necessary to an effect reorganization.
In truth, the first option contains two grounds, the first being lack of adequate protection, and the second being a generally undefined "for cause" requirement. Lack of adequate protection is included within the definition of "for cause," but the language makes it clear that there can be other "for cause" reasons where stay relief might be granted. One example is the situation where a debtor has substantial equity in his or her principal residence, but is not making the mortgage payments due to lack of income. In actuality, the creditor is adequately protected, due to the equity cushion which would exist in the property. Assuming further that the debtor were in a reorganization chapter, such as Chapter 13, such property would be necessary to an effective reorganization, as the debtor obviously would need some place to live. Regardless of the existence of these circumstances, the Bankruptcy Court would undoubtedly grant stay relief for the failure to make payments, which would be a "for cause" ground.
The legislative history makes it clear that the stay relief proceeding is an expedited hearing, and it is not an appropriate time at which to bring in other issues, such as counterclaims against the creditor, which although relevant to the question of the amount of the debt, concern largely collateral and unrelated matters to the issue of stay relief. See also In re: Essex Properties, Ltd., 430 F.Supp. 1112 (N.D.Cal. 1977). However, the legislative history also makes it clear that this would not preclude a party from requesting a continuance of the stay relief proceedings in order to present evidence on other matters, with the granting or denying of such request to be within the sound discretion of the court.
The rules pertaining to stay relief proceedings in the Bankruptcy Courts for the District of Kansas provide that the creditor requesting such relief shall give notice to the debtor, the Trustee, and any other interested parties, and that such notice shall also establish a deadline for the debtor and other interested parties to object to the stay relief request. In the event that no objection is filed, then the stay relief order will be entered ex parte. Any such objection must be filed within twenty (20) days of the motion. Local Bankruptcy Rule (LBR) 4001(a)-1 establishes the procedure for Kansas Courts. That Rule is as follows:
A motion for stay relief may be combined with a request for adequate protection. The inclusion in the motion of a request for any other relief or the setting of such motion pursuant to D.Kan. L.B.R. 9013-2 for a docket more than thirty (30) days from the filing of the motion shall constitute a waiver of the thirty (30) day requirement of 11 U.S.C. Section 362(e). Any hearing on the motion for relief from stay appearing on the motions docket within such thirty (30) day shall be considered a preliminary hearing and movant's failure to request that the final hearing be concluded within thirty (30) days thereafter shall constitute a similar waiver.
Section 362(d) and (e) provides for a two stage hearing procedure on stay relief matters. Subparagraph (e) provides for an expedited hearing on stay relief requests, which shall occur within thirty days after the motion for stay relief has been filed. At such a hearing, the court shall order the stay to continue in effect pending the final hearing under subparagraph (d) upon a finding that there is a "reasonable likelihood that the party opposing relief from such stay will prevail at the conclusion of such final hearing." The final hearing on stay relief must be held within thirty (30) days after the preliminary hearing, unless that time period is extended by consent of the parties or is extended by the court for "compelling circumstances."
The practice of the Bankruptcy Courts in Kansas is to set stay relief matters on a stay relief docket, usually scheduled for twice a month. Such matters will only be set on the docket if a timely objection has been filed by the debtor or other party objecting to the requested relief. This docket hearing, while noticed as nonevidentiary, generally is considered to be the preliminary hearing prescribed by Section 362(e). Often times, stay relief issues are resolved by agreement at or prior to the docket, and the agreement is announced by parties on the record. If an agreement can not be reached, then generally the procedure allows attorneys for each party to state their respective arguments either for or against the stay relief, and if there are no factual disputes which would require an evidentiary hearing, the court will usually rule on the stay relief request at that time. If an evidentiary hearing is required, these must be set within thirty (30) days of the preliminary hearing, unless the parties agree otherwise or the court finds existence of "compelling circumstances." A 1992 case decided by Judge Rogers of the U.S. District Court for the District of Kansas, which was an appeal from a Bankruptcy Court decision granting stay relief, is instructive. That case, The Mutual Benefit Life Insurance Company and Rehabilitation v. Stanley Station Associates, L.P., 140 Bankr. 806, involved a request for stay relief which was first heard on the Bankruptcy Court's stay relief docket. In its appellate decision, the District Court considered this the preliminary hearing prescribed by Section 362(e). The final hearing had initially been scheduled within thirty (30) days, on March 6, 1992, but was continued by the court to April 22, 1992. The Bankruptcy Court stated that the continuance was necessitated because its scheduled had been disrupted by the moving of its chambers and courtroom to a new location, and there was an upcoming regional bankruptcy conference which required the court's attendance.
Judge Rogers stated that "while these are good reasons to continue a hearing, they can not satisfy the command of Section 362(e) that the final hearing shall be commenced not later than thirty (30) days after the conclusion of the preliminary hearing." Judge Rogers stated that this language is mandatory and does not permit exceptions, although the decision overlooks the "compelling circumstances" language of 362(e) which does allow a final hearing later than thirty (30) days if the Bankruptcy Court finds such circumstances to exist. Judge Rogers, in his decision, noted that the goal of Congress in passing the Section 362(e) time limits was to eliminate "injunction by continuance." Judge Rogers also noted that calling the case on the March 6, 1992 docket was not sufficient to constitute a "final hearing," since a hearing required presentation of evidence. In his ruling, Judge Rogers terminated the stay, but did remand the case to the Bankruptcy Court for a full hearing and consideration as to whether the stay should be reinstituted.
It should be noted that cases involving security which constitutes "cash collateral" differ from the usual stay relief procedures if a debtor desires to use cash collateral. This procedure is specifically established by 11 U.S.C. Section 363. Cash collateral is defined as:
"cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents wherever acquired in which the estate or an entity other than the estate has an interest and includes the proceeds, products, offspring, rents, or profits of property and the fees, charges, accounts or other payments for the use or occupancy of rooms or other public facilities and hotels, motels, or other lodging property subject to a security interest as provided in Section 552(b) of this title, whether existing before or after commencement of the case under this title."
Cash collateral situations often occur. For example, if the debtor is the owner of rental real estate and if the bank holding a security interest in that real estate included rents as part of its collateral, then the debtor could not use these rents following the filing of a Chapter 13 or Chapter 11 case without obtaining permission to use cash collateral from the Bankruptcy Court. The rents would continue to belong to the creditor who would be entitled to them, until the debtor filed a motion under Section 363 and obtained an order following a hearing allowing the debtor to retain and use the rents from the rental properties. The preliminary and final hearing procedures found in stay relief proceedings under Section 362 are essentially adopted by the language of Section 363. In order to use cash collateral, the debtor would have to show that the creditor is otherwise adequately protected. Going back to the previous example of a debtor landlord, the debtor might prevail in a motion to allow use of cash collateral if he could show that there was significant equity in the real estate which constituted adequate protection to the secured creditor sufficient to allow the debtor to retain and use the rents from these properties.
In stay relief matters under 362, subparagraph (g) provides that any of the preliminary or final hearing, the party requesting relief from the stay has the burden of proof on the issue of debtor's equity in the property, and the party opposing stay relief has the burden of proof as to all other issues. In other words, a creditor seeking stay relief on the grounds of lack of equity would have to show, by competent appraisals or other admissible evidence, that the value of the property did not exceed the amount of the indebtedness securing such property. In such circumstance, the debtor would have the burden of proof on all other issues, including the showing of other adequate protection in favor of the secured creditor, that the property is necessary to an effective reorganization, or proof that no sufficient "cause" exist for the creditor to be entitled to the requested stay relief.
The allowance of setoff constitutes a subspecie of stay relief practice. 11 U.S.C. Section 553 generally preserves the right of setoff of a mutual debt existing between a creditor and the debtor, and such setoff occurring shortly before bankruptcy will generally not constitute a preference in favor of the creditor exercising the right of setoff. However, if the creditor desires setoff following the bankruptcy filing, then the stay relief provisions of Section 362 must be invoked by that creditor.
Section 362 Motions in All Cases: The "Compelling Circumstances" Test
Under 11 U.S.C. Section 362(e), the 30-day for the final hearing on a motion for relief from the automatic stay may be extended beyond that period only by agreement of the parties or if the court finds that such continuance is required by "compelling circumstances." This is to avoid what Judge Rogers referred to as "injunction by continuance" in Mutual Benefit Life Insurance v. Stanley Station, supra. The legislative history of this section indicates that Congress intended to "make clear that a final hearing must be commenced within thirty days after the preliminary hearing is held to determine whether a creditor will be entitled to relief from the automatic stay." The legislative history also states that "it is anticipated that the rules of bankruptcy procedure provide that such final hearing receive priority on the court calender." In the case of In re: Pettibone Corp, 110 Bankr. 848 (B.C.D.Ill. 1990), the court there stated that the compelling circumstances rule should be used sparingly, and suggested that such circumstances might be limited to some showing of bad faith on the part of the creditor or other entity requesting stay relief. The court in Pettibone used a hypothetical situation of a creditor who had intentionally violated the stay order prior to seeking stay relief.
Other courts used the phrase "compelling circumstances" in discussing various stay relief issues that are not within the ambit of the 362(e) language as it relates to the time for the final hearing on stay relief matters. For example, the Bankruptcy Appeals Panel for the 9th Circuit stated that a request by the Internal Revenue Service for setoff of a debt owed to the IRS against a tax refund due the debtor could be denied only upon a showing by the debtor of "compelling circumstances." In re: Medina, 205 Bankr. 216 1996). In the case of In re: Inslaw, 81 Bankr. 169 (1987), the court there held that compelling circumstances must be shown to preclude setoff of a security deposit held by landlord where the pre-petition obligation is owed to the landlord by the debtor. These courts appear to latch onto the "compelling circumstances" language of 362(e) and using it in situations involving stay relief matters which have nothing to do with the issue of continuing a final hearing on the stay relief motion beyond the maximum thirty days prescribed by Section 362.