I. BRIEF OVERVIEW OF CHAPTER 13

Chapter 13 of the Bankruptcy Code (11 U.S.C. §§ 1301 - 1330) provides a set of tools for an individual with regular income to adjust debts. As discussed in our FAQs, there are three scenarios under which a filer will need to consider Chapter 13.

The first scenario is where the filer fails the Chapter 7 means test or his circumstances are such that there is a good argument for dismissal under the "totality of the circumstances" test. See means test. The second scenario is where the filer is in arrears on a mortgage, lease, or vehicle loan, and needs time to cure those arrearages. Chapter 13 gives a filer the opportunity to cure arrears over the creditor's objection (providing that the plan is feasible). Third, Chapter 13 provides an opportunity to "buy back," through plan payments, property having a value in excess of allowable exemptions.

Upon the initiation of a Chapter 13 case the filer is immediately protected by the automatic stay from any further collection efforts by creditors. 11 U.S.C. §362(a). In addition, any individual that is liable with the filer on any part of a consumer debt is also protected by a co-debtor stay. 11 U.S.C. §1301. The co-debtor stay will apply whether the filer is the primary or secondary obligor as long as the filer received the benefit of the credit, provided further, however, if the creditor will not get paid in full under the plan it will be entitled to relief from the stay.

Like other Chapters of the Bankruptcy Code, the initiation of the case creates a bankruptcy estate. The Chapter 13 estate is comprised of everything which is included in the typical Chapter 7 or 11 bankruptcy estate (defined at 11 U.S.C. §541), plus all property and earnings acquired by the filer after the commencement of the case (but excluding any post-petition contributions to a qualified pension plan (see §541(b)(7)).

There is a standing Chapter 13 trustee (automatically appointed to every Chapter 13 case). The trustee's duties include objecting to a plan which does not meet all requirements for confirmation and to distribute plan payments. See 11 U.S.C. §§ 1302(b) and (c) and 1325(b). The Chapter 13 trustee is compensated by a percentage (set by the Attorney General) of the total disbursements made by him or her under the plan. 28 U.S.C. §586(e). Note that where a plan proposes to pay unsecured creditors less than 100%, the trustee's commission comes out of the pockets of the unsecured creditors. Where, however, the filer is paying unsecured creditors in full, the commission, in effect, comes out of the filer's pockets.

As with Chapters 7 and 11, a filer must attend a first meeting of creditors (at which the filer is questioned by the trustee and any creditors who attend about his financial affairs and plan). Some districts, including the Western District of Pennsylvania, will typically combine the first meeting of creditors with a hearing on the plan.

2. ELIGIBILITY FOR CHAPTER 13

Chapter 13 is limited to individuals with: (1) regular income; (2) total noncontingent, liquidated, unsecured debts of less than $336,900; and (3) total noncontingent, liquidated, secured debts of less than $1,010,650. See 11 U.S.C. §109(e). Note that the debt limits are adjusted every three years and the above numbers are from the last adjustment on 4/1/07.

The phrase "individual with regular income" in §109(e) is defined as an individual whose income is sufficiently stable and regular to make payments under a plan. The test for regular income is not the type or source of income, but rather its regularity and stability. Accordingly, a filer may rely on outside sources of funding, including contributions from other family members, to fund a plan, provided that the family members become obligated to make the payments and themselves have a source of income that is regular and stable.

Although a filer must have regular income in order to be eligible, that need not be the sole source of plan funding. The proceeds of the sale of assets or expected recovery on a lawsuit could provide additional funding.

3. CHAPTER 13 PLAN

In order for Plan to be approved (called "confirmation") it must, among other things: (A) be proposed in good faith; (B) be feasible; and (C) must either pay all creditors in full over its duration (which can be no more then 5 years) or must propose to distribute to creditors no less than the larger of:

• (1) what the creditors would have received in a Chapter 7 (the "best interests of creditors" test); and
• (2) all disposable income over the applicable commitment period (referred to under pre-BAPCPA case law as the "best efforts" test, now the "projected disposable income" test).

It should be noted that because of plan objectives (such a curing a mortgage in default), it may be that a filer will need to pay into a plan an amount greater than that indicated by the best "interests of creditors" and "best efforts" tests. Again, these tests provide the minimums that must be paid into a plan (if the creditors are not going to be paid in full).

(A) Good Faith

The "good faith" requirement comes into play in a Chapter 13 plan in two ways. First, the court needs to find that the action of the filer in filing the bankruptcy was in good faith. §1325(a)(7). Secondly, the court needs to find that the plan has been proposed in good faith. §1325(a)(3).

The good faith in filing requirement was expressly added by the 2005 Bankruptcy Amendments ("BAPCPA"), but had existed under prior case law. In the Third Circuit, good faith in a Chapter 13 filing must be assessed on a case-by-case basis in light of the totality of the circumstances. Factors relevant to the totality of the circumstances inquiry include: the nature of the debt; the timing of the petition; how the debt arose; the filer's motive in filing the petition; how the filer's actions affected creditors; the filer's treatment of creditors both before and after the petition was filed; and whether the filer has been forthcoming with the bankruptcy court and the creditors. See In re Lilley, 91 F. 3d 491 (3d Cir. 1996).

The requirement that the plan has been proposed in good faith is also assessed on a case-by-case basis in light of the totality of the circumstances (and, not surprisingly, the factors overlap with those relevant to the question of whether the case was filed in good faith). Factors to be considered include: the amount of the proposed payments and the amount of the filer's surplus; the filer's employment history, ability to earn and likelihood of future increases in income; the probable or expected duration of the plan; the accuracy of the plan's statements of the debts, expenses and percentage repayment of unsecured debt and whether any inaccuracies are an attempt to mislead the court; the extent of preferential treatment between classes of creditors; the extent to which secured claims are modified; the type of debt sought to be discharged and whether any such debt is nondischargeable in Chapter 7; the existence of special circumstances such as inordinate medical expenses; the frequency with which the filer has sought relief under the Bankruptcy Code; the motivation and sincerity of the filer in seeking Chapter 13 relief; and the burden which the plan's administration would place upon the trustee. See In re Alexander, __ B.R.__, 2007 WL 738778 (10th Cir. BAP 2007).

A creditor or the trustee may raise a good faith argument where the plan is in technical compliance with the requirements for confirmation, but they believe it is somehow unfair to creditors. The filer has the burden of proving good faith. See, e.g., In re McNeely, --- B.R. ---, 2007 WL 1068132 (Bkrtcy.N.D.W.Va. 2007) (finding a lack of good faith where the debtors proposed to retain (and pay) an overencumbered houseboat); In re Shelton, --- B.R. ---, 2007 WL 1856949 (Bkrtcy.N.D.Ga. 2007) (denying confirmation on a lack of showing of good faith where debtors proposed to continue to pay on their 401(k) loan and make a zero distribution to unsecured creditors (even though payment of that loan was expressly authorized under the statute)).

(B) Feasibility

To secure confirmation of a plan, a filer must show that he can make all payments under the plan and otherwise comply with the plan. §1325(a)(6). This is generally referred to as the feasibility requirement. To satisfy feasibility, a filer's plan must have a reasonable likelihood of success, i.e., that it is likely that the filer will have the necessary resources to make all payments as directed by the plan.

Feasibility can be an issue, among other places, where a mortgage is in substantial arrears, and the amount necessary to cure (and to remain current on a going forward basis) appears to exceed the filers likely available income (after taking into account the filer's other reasonable and necessary living expenses).

(C)(1) The "Best Interests of Creditors'" Test

This is a fairly straightforward test (imposed by §1325(a)(4)). This test requires the plan to distribute to the creditors at least as much as they would receive if the filer's assets were liquidated in a Chapter 7 case. Note that if the filer's disposable income is insufficient to satisfy this test over the maximum five (5) year term of a Chapter 13 Plan, the filer will need to consider a sale of some of the property, borrowing against the property (and using the loan proceeds to fund the plan), or possibly filing Chapter 11.

(C)(2) The "Projected Disposable Income" Test

The pre-BAPCPA "best efforts" test (now the Projected Disposable Income Test) required that all of the filer's "projected disposable income" in the "applicable commitment period" be applied to make payments to unsecured creditors under the plan. 11 U.S.C. §1325(b)(1). BAPCPA had a material impact on the operation of the best efforts test.

Under pre-BAPCPA law the presumed plan duration was three years, although 5 year plans were permissable to the extent necessary to meet plan objectives. Under BAPCPA, the "applicable commitment period" (i.e., the plan duration), depends on whether the filer's "annualized income," as calculated under the means test, is above the median for his or her state and household size. See §1325(b)(4). If so, the minimum plan length is five (5) years (unless, of course, creditors will be paid in full in a shorter period). Otherwise, the minimum plan length is three (3) years.

"Disposable income" is defined, under BAPCPA as the "current monthly income" (which under BAPCPA is the 6 month historical average) (but excluding child support payments, foster care payments, or disability payments for child (provided the payments are expended for the child)) less amounts reasonably necessary to be expended for the maintenance or support of the filer or a dependent of the filer and allowable charitable contributions. §1325(b)(2)(A). If the filer is engaged in business, the definition is further refined by excluding amounts reasonably necessary for the continuation, preservation, and operation of the business. 11 U.S.C. §1325(b)(2)(B).

Prior to BAPCPA, the determination of what was reasonably necessary to be expended for maintenance and support was flexible. The general standard of reasonableness was that necessary to sustain basic needs (and though it was not necessarily related to the filer's former status in society or the lifestyle to which he was accustomed, some allowance was made for the fact that higher income individuals generally had higher levels of expenses). Even with some allowance for former status, however, "belt tightening" was generally necessary. Case law provided some guidance of what constituted reasonable and necessary expenses. Payments for “luxury” items (including overly expensive housing or vehicles), private schooling, recreational spending or assets, contributions to voluntary pension plans, excessive food or clothing bills, charitable contributions (over certain limits), to name a few, were typically considered unnecessary and/or unreasonable.

The existing body of caselaw would appear to remain applicable, at least in the case of below median income filers. Under BAPCPA, however, the determination of reasonable expenses (in certain categories) are statutorily limited to the IRS standards allowed under the means test. Some of the issues arising in determining "projected disposable income," include the following:

• Whether "projected disposable income" is the same as "disposable income. There is apparently a minority view that the income is annualized on the 6 month pre-filing average (i.e., projected disposable income is what you come up with under Form 22C). See discussion in In re Edmondson, ___ B.R. __, 2007 WL 656457 (Bankr. D.N.M. 2007). Edmondson found, however, as both a matter of practicality and statutory construction, that income, for purposes of Chapter 13, must be "forward" looking (in other words, the concepts are different). See also In re May, 381 B.R. 498 (W.D. Pa. 2008)(per Deller, J.) (holding, in case of above median income filers, that the amount reflected on Form 22C for “disposable income” is merely a starting point for determining the “projected” amount of a debtor’s disposable income ("projected" being a forward looking concept); the court held that the Form 22 calculation for disposable income created a rebuttable presumption of the projected disposible income, but that creditors or a trustee may show that particular figures reflected on the form are not accurate in the context of plan confirmation and request that the court deviate from the calculation proscribed).
  
  
• Whether reasonably expenses for above median income filers are limited to the IRS Standards set by the means test. Again, there are cases going both ways. Again, Edmondson is illustrative (finding that the statutory language limited above median income filers to those expenses, and in those amounts, set by Form 22C, regardless of what their Schedule J might show (provided, however, the "means test" does allow for further adjustment for "special circumstances")). Note, however, that under Edmondson this standard is a double edged sword.
  
  
• Whether an above median income filer can deduct IRS standards for vehicle ownership or housing expenses (on his Form 22C) where he owns the vehicle outright or his actual housing expenses are less. As with so much of BAPCPA, there are cases going both ways, some allowing the deduction, others treating the IRS standard as a cap and only allowing the deduction of the lesser of actual expenses or the standard. Cases go both ways. An example of case finding that the filer is entitled to the deduction is In re Swan. See also In re Ross-Tousey, 549 F. 3d 1148 (7th Cir. 2008)(holding that above-median-income Chapter 7 debtor who has no monthly vehicle loan or lease payment may claim a vehicle ownership expense deduction when calculating his disposable income under the means test).
  
  
• Whether an above median income filer can pay off a plan in less then 5 years (provided that he pays the amount equal to the full projected disposable income times 60 months). There are cases going both ways. In re Swan held that a filer could accelerate the payments.

4. MISCELLANEOUS

(A) Debtor Education Requirement

In addition to the pre-filing credit counseling briefing (discussed on our FAQs page), the filer must also complete a debtor education course (and file certification of the completion of the course), prior to the completion of the Plan. If the filer fails to take the course and timely file the certification of completion he will not receive a discharge in the case. We recommend that the course be completed and certification of completion be filed as soon as possible following the commencement of the case. For a list of providers see Debtor Education Providers and scroll down to your district (for Pittsburgh its the Western District of Pennsylvania).

(B) Commencement of Plan Payments and proof of insurance

Pursuant to 11 U.S.C. §1326(a)(1), unless the court orders otherwise, the filer is to commence making the payments proposed by the plan (to the trustee) within 30 days after the plan is filed. In the event the plan is not confirmed, any undistributed payments, less the administrative costs of the case and payments that were to have been made to secured creditors pending plan confirmation, are to be returned to the filer. See §1326(a)(2). Outside of adequate protection payments to secured creditors and administrative expenses, there should be no distributions to creditors prior to plan confirmation.

§1326(a)(4) requires filers to provide lessors and holders of purchase money security interests in personal property with proof of insurance within 60 days after the case has been filed (and to update the proof with renewals or changes during the course of the case (so long as the filer retains possession)).

(C) Dismissing or converting Case

Under 11 U.S.C. §1307(a), the filer may convert a Chapter 13 case to a Chapter 7 at any time. Under 11 U.S.C. §1307(b), the filer has the right, if the Chapter 13 case had not been converted from another Chapter under §§ 706, 1112, or 1208, to the dismissal of the case at any time, provided, however, some courts have held that a Chapter 13 filer's right to voluntary dismissal is subject to good faith, and that if the case was filed in bad faith, the motion to dismiss could be denied and the case converted to Chapter 7 instead.

(D) Separate classification of creditors

A chapter 13 plan may designate classes, but may not discriminate unfairly against any class except claims for a consumer debt if an individual is liable with on such consumer debt with the filer. §1322(b)(1).

Notwithstanding the apparent carve out for "co-signed" debt, most Courts will not approve "preferential" treatment for co-signed debt unless (1) the obligation falls under the plain language of §1322(b)(1) (which separate treatment of co-signed consumer debt does); (2) the filer was the beneficiary of the obligation which was co-signed (which was the situation with which Congress was concerned); and (3) the plan satisfies the other confirmation standards in §1325, including the good faith requirement. See, e.g., In re Thompson, 191 B.R. 967 (Bankr. S.D. Ga. 1996).

Outside of co-signed debt, the general rule is that disparate treatment will not be permitted. Courts typically apply a four factor test in determining whether to allow disparate treatment, those being: (1) whether the discrimination has a reasonable basis; (2) whether the filer can carry out a plan without such discrimination; (3) whether such discrimination is proposed in good faith; and (4) the nature of the treatment of the class discriminated against. The four factors are seldom satisfied. See, e.g., In re Sullivan, 195 B.R. 649 (Bankr. W.D. Tex. 1996) (concluding that treating nondischargeable student loan debt more favorably then other unsecured creditors was improper discrimination after an extensive analysis of the law and issues); In re Stella, 2006 WL 2433443 (Bankr. D. Idaho 2006) (denying discriminatory treatment in favor of liability of NSF checks without a showing that there was a substantial threat of criminal prosecution). There are, however, instances where court's have upheld discriminatory treatment. See, e.g., Michelson v. Leser (In re Leser), 939 F.2d 669 (8th Cir. 1991) (indicating public policy behind full payment of support obligations dictate that a lesser payout to other unsecured creditors should be tolerated); In re Davis, 209 B.R. 893 (Bankr. N.D. Ill. 1997) (allowing filer to pay rent arrearages in full so residential lease could be assumed; without retention of lease plan was unfeasible which would have meant no distribution to other unsecured creditors).

One strategy that has been successfully used as a means to prefer student loans is to treat those obligations as long term debt, which the filer then continues to pay during the course of the Chapter 13 pursuant to §1322(b)(5). See, e.g., In re Chandler, 210 B.R. 898 (Bankr. D.N.H. 1997). While the preferential treatment under such a strategy would be limited to the regular monthly payments plus the cure of any arrearages, those amounts would still likely come at the expense of other unsecured creditors. See also In re Pora, 353 B.R. 247 (Bankr. N. D. Cal. 2006) (holding that a treating a student loan as a long term debt might pass the discrimination test with a sufficient record). At least one court, however, has even found that treatment to be unfairly discriminatory. In re Coonce, 213 B.R. 344 (Bankr. S.D.Ill. 1997).

Note that there is authority that it is not permissible to discriminate in favor of a particular unsecured creditor simply because none of the other unsecured creditors would have received any distribution in a Chapter 7. In re Alicea, 199 B.R. 862 (Bankr. D.N.J. 1996) (holding that plan could not discriminate in favor of parking tickets where only basis for doing so was the fact that the unsecured creditors would have received no distribution in Chapter 7).

(E) Ability to modify rights of certain secured creditors

The plan may modify the rights of secured and unsecured creditors subject to the following limitations:

• the claim of a creditor secured only by a consensual lien (mortgage) in the filer's principal residence may not be modified unless the mortgage is completely unsecured (i.e., if the amount of prior liens against the residence exceeds its value so that there no equity against which the mortgage to be modified can attach) or the mortgage has fully matured or will mature during the life of the plan;
  
  
• the modification of the secured claims are limited to the valuation of the secured claims (i.e., breaking the secured claims into secured (equal to the value of the collateral) and unsecured parts (called "bifurcation"), changes in the interest rate, and/or a change in the repayment duration; and
  
  
• bifurcation of secured claims is prohibited for claims secured by a motor vehicle acquired for the personal use of the filer within 910 days (2 and 1/2 years) prior to the bankruptcy filing date (the so called "hanging paragraph" of §1325(a)).

As a result of BAPCPA, a modified lien is retained until the filer fully performs the plan (unless the secured creditor is has been paid its full contractual obligation prior to that date). §1325(a)(5)(B)(i)(II). Accordingly, the effectiveness of any modification is subject to the filer's ability to fully consummate his plan.

Bifurcation of the secured claim

11 U.S.C. Section 506(a) provides the statutory authority for the bifurcation of a claim into its secured and unsecured portions. The "secured claim" is that portion of the secured creditor's total claim equal to the creditor's interest in the value of the collateral. The valuation standard used to determine the value of the collateral is replacement value (i.e., the price a retail merchant would charge for property of that kind considering the age and condition of the property at the time it is valued), without deduction for costs of sale or marketing. 11 U.S.C. §506(a)(2).

As indicated above, the ability to bifurcate a claim secured by a motor vehicle acquired for the personal use of the filer within 910 days (2 and 1/2 years) prior to the bankruptcy filing date has been prohibited by the 2005 Bankruptcy Code amendments. Accordingly, for motor vehicles falling within the "hanging paragraph," the creditor will be entitled to be paid its full claim as secured (although the filer can still modify the interest rate and the repayment term).

Changing the interest rate

Under the Supreme Court decision in Till v. SCS Credit Corp., 541 U.S. 465 (2004), the interest rate on a secured claim (that is subject to modification) is to be the prime rate plus an adjustment for risk. The Court implicitly approved a risk adjustment of 1 to 3% (although creditors are arguably not limited if they can prove that a higher adjustment is required).

It has been held that in the event of a modification to the secured claim (i.e., anything other than a cure (where relevant) and payment according to contractual terms, a secured creditor is entitled to interest under the Till formulation even if the creditor's contract rate of interest is less (even 0%). See In re Taranto, __ B.R. __, 2007 WL 935709 (6th Cir. BAP 2007).

Modification of term of payments

Unless the secured creditor otherwise agrees, a plan must provide for payment in equal monthly payments that equal at least an amount sufficient to provide the creditor with adequate protection. §1325(a)(5)(B)(iii). Accordingly, the allowable change in term cannot be longer then the remaining useful life of the property (otherwise the creditor is deprived of adequate protection). Note that in no event can the modified term be extended beyond the life of the plan.

(F) Right to cure and maintain payments of debts maturing beyond life of plan

Although Chapter 13 prohibits the modification of a claim secured only by the filer's principal residence, it does permit the filer to cure any default (provided the residence has not yet been sold at a foreclosure sale). This, of course, is one of the principal benefits of Chapter 13.

(G) Provide for payment of filed and allowed postpetition claims under plan

Section 1322(b)(6) authorizes a plan to provide for payment of all or any part of any claim allowed under §1305. Section 1305, in turn, provides that a postpetition tax creditor, or a postpetition creditor for a consumer debt that is for property or services necessary for the filer's performance under the plan, may file a claim. If the claim is filed and allowed it will be treated as an unsecured claim in the filer's plan (if the filer's plan so provides). As a claim treated in the plan, the allowed postpetition claim will be discharged (under most circumstances) just like all other prepetition claims.

There are, however, some important limitations to §1305. First, it applies only to consumer debt that is for property or services necessary for the filer's plan performance. Second, the filing of a claim is permissive. The postpetition creditor may, but is not obligated to, file a claim. Based on the fact that it is the creditor's decision as to whether to participate, a number of courts have held that a filer may not seek to modify its plan under 11 U.S.C. §1329 to bring postpetition creditors into the plan involuntarily. See, e.g., In re Smith, 192 B.R. 712 (Bankr. E.D. Tenn. 1996)

Third, even if filed, the §1305 claim will be disallowed if the creditor knew or should have known that prior approval by the trustee of the filer's incurring the obligation was practicable and was not obtained. 11 U.S.C. §1305(c). Lastly, even if filed and allowed, the obligation will still not be discharged by the plan if prior approval by the trustee of the filer's incurring such debt was practicable and was not obtained. 11 U.S.C. §1328(d).

(H) Post-Confirmation Borrowings, Refinancings, and Sales

There is some question about the extent of the court's jurisdiction over the filer's assets and affairs subsequent to the confirmation of the plan. Different districts may have different rules about whether a filer must obtain court approval before selling an asset or borrowing money (including a refinancing). Prior court approval is probably necessary for any sale that is contemplated by the Plan (unless the plan provides otherwise). The Western District of Pennsylvania requires prior court approval before any assets are sold (even if the asset "re-vested" in the filer under the plan unless those sales in the ordinary course of business) or before any debt is incurred (including automobile financing or loan refinancings).