Cite as: Keith M. Lundin, Lundin On Chapter 13, § 125.1, at ¶ ____, LundinOnChapter13.com (last visited __________).
11 U.S.C. § 1325(c) provides: “After confirmation of a plan, the court may order any entity from whom the debtor receives income to pay all or any part of such income to the trustee.” Variously known as “income deduction orders,” “take out orders” or “payroll deduction orders,” practice varies dramatically around the country whether employers are routinely ordered in Chapter 13 cases to remit a portion of the debtor’s wages to the trustee and at what point in the administration of the case.
In some jurisdictions, income deduction orders are issued in every Chapter 13 case in which the debtor has an employer.1 In other jurisdictions, deduction orders are voluntary, and the debtor determines whether the order will issue or whether the debtor will make payments directly to the trustee (“direct pay”).2
In some jurisdictions, an income deduction order is issued automatically and immediately upon the filing of every Chapter 13 case. In other jurisdictions, the income deduction order is issued after confirmation. Section 1325(c) authorizes the issuance of an income deduction order “after confirmation of a plan.” Some courts interpret this clause to prohibit issuing income deduction orders until a plan is confirmed. Other courts read § 1325(c) to be permissive and not preclusive of issuing an income deduction order at the filing of the case.3
Issuing the income deduction order at the filing of the case is a quick test of the debtor’s ability to fund the proposed plan. Issuing the order at the filing eliminates the need for concocting some other scheme for managing payments prior to confirmation. In some districts that do not immediately issue deduction orders, local practice requires the debtor to make payments before confirmation to the debtor’s lawyer4 or to creditors. These alternatives put (nonbonded) lawyers in the role of bankers for their clients or effect distributions to creditors before court approval of a plan. The simple expedient of immediately issuing an income deduction order for payments to the Chapter 13 trustee eliminates the need for other awkward arrangements.
With the 1984 amendments to § 1326, the debtor is required to commence making the payments proposed by a plan within 30 days after the plan is filed.5 Issuing an income deduction order directly to the debtor’s source of income at the filing of the case is consistent with the language and intent of § 1326(a)(1).6 An income deduction order assists the trustee to satisfy the statutory duty to ensure that the debtor commences the payments required by § 1326(a).7
Section 1326 was further amended by the Bankruptcy Reform Act of 1994 to provide that, if a plan is confirmed, the trustee shall distribute any payments made by the debtor in accordance with the plan “as soon as practicable.”8 Issuing an income deduction order at the filing of every Chapter 13 case facilitates getting money to the Chapter 13 trustee and enhances the trustee’s ability to begin distributions immediately after confirmation.
There are other advantages to early issuance of the income deduction order. Typically, the income deduction order contains special instructions to the debtor’s employer, for example, forbidding other deductions on account of any garnishment, levy, execution or voluntary assignment to a credit union, insurance or pension program. Issuing an income deduction order at the filing of every Chapter 13 case gives the debtor and the trustee immediate control of all of the debtor’s wages and stops all other deductions. The likelihood of success of the plan is enhanced, and the automatic stay is implemented without separate orders, for example, to stop garnishments.
Debtors’ attorneys can enhance the likelihood of success of their clients’ cases and, incidentally, enhance the likelihood of payment of attorneys’ fees by insisting upon income deduction orders at the filing of every Chapter 13 case. An income deduction order is the surest way to accumulate a pot of money from which claims will be paid, including administrative expenses. If the plan is not confirmed and the case is dismissed or converted, the money held by the Chapter 13 trustee is counsel’s best chance for recovery of fees.9
In jurisdictions that issue income deduction orders at the filing of a Chapter 13 case, debtor’s counsel must include with the petition very precise information to enable issuing an accurate order. The proposed plan must specify the amount of the deduction, the frequency of the deduction (typically, weekly, biweekly, twice monthly or monthly), the name and address of the employer and an employee or “badge” number for the debtor, if any.10 In some jurisdictions, the income deduction order is prepared and issued by the clerk of the court. In other jurisdictions, it is submitted or issued by the Chapter 13 trustee. In still other districts, a separate income deduction order must be prepared by debtor’s counsel.
The debtor’s employer may be much confused upon receipt of an income deduction order. Debtor’s counsel can prevent problems with income deduction orders by contacting the debtor’s employer to explain the deduction order.11
A delay in commencement of deductions from the debtor’s income can create a threshold default under the proposed plan and even disable the debtor to accomplish confirmation. For example, when the plan proposes to cure default in a home mortgage, each postpetition month generates another installment that either must be paid through some mechanism before confirmation or accumulated for payment after confirmation, else the missed payment increases the default that must be cured.12 Issuing an income deduction order at the filing of the petition that includes the postpetition mortgage payment and a portion of the prepetition arrearages is the best hedge against further financial deterioration that can cripple the Chapter 13 case before it gets going.
Occasionally, the plan will be funded by an income deduction order to a nonfiling spouse’s employer. In that situation, a special form of the income deduction order should be used, explaining to the employer the spouse’s relationship to the Chapter 13 case. Also, the nonfiling spouse is not necessarily entitled to all of the protections from garnishments and other deductions to which the debtor would be entitled.
It is in the best interests of creditors that the Chapter 13 plan always be funded by an income deduction order to the debtor’s employer. Although some misguided creditors insist that they would prefer their payments directly from the debtor,13 jurisdictions that issue income deduction orders in all Chapter 13 cases show significant stability in payments and high plan consummation rates when the trustee is paid before the debtor gets the chance to spend elsewhere.
In jurisdictions that do not automatically issue income deduction orders, the method of funding the plan becomes a matter for negotiation or litigation at confirmation. Creditors should insist that all payments to the trustee be accomplished by income deduction order. An objection to confirmation on feasibility grounds is appropriate when the debtor refuses to allow an income deduction order. When a debtor has failed to make payments in a prior Chapter 13 case or has defaulted in payments in the current case but argues for a second chance, an income deduction order to an employer should not be negotiable.
In some jurisdictions, Chapter 13 trustees routinely object to confirmation of any “direct pay” plan when there is an employer available for an income deduction order. Some enlightened bankruptcy courts have concluded that the feasibility of plans is threatened absent the issuance of income deduction orders, and thus it is local practice that plans will not be confirmed without an income deduction order, except when the debtor is self-employed.14
The issue becomes more acute if the debtor claims “sensitive” employment and insists that an income deduction order to the employer could disrupt the debtor’s job. For example, a debtor who works as a bank teller will argue that an income deduction order to the bank will either get the debtor fired or interfere with advancement, overtime and so forth. The antidiscrimination provisions of 11 U.S.C. § 525 are some protection for the debtor.15 Most often, the debtor’s fears about retaliation at work are exaggerated. Employers are comforted to know that an employee with financial problems is doing something meaningful to solve the problems. Employers much prefer a single income deduction order in a Chapter 13 case to multiple garnishments and random disruptions caused by debt collection actions. If the employer understands Chapter 13 and understands that the debtor is engaged in an organized effort to repay creditors, employer cooperation, if not enthusiasm, is usually the result. In some districts, especially active Chapter 13 trustees have sought out the personnel directors and payroll staffs of major local employers to educate them about the benefits of Chapter 13 as a method of managing employee financial problems. In some districts, employers are a major source of referral for the Chapter 13 program.
There are few reported decisions discussing the mechanics of income deduction orders. One reported decision sounds a worthwhile note of caution about income deduction orders when the debtor becomes entitled to extra wages because of a bonus or termination payment. In In re Colvin,16 the income deduction order required the debtor’s employer to deduct and pay to the trustee $149.49 weekly. After confirmation, the debtor voluntarily terminated employment and became entitled to a lump-sum payment of $40,000 from the employer. Attempting to implement the payroll deduction order, the Chapter 13 trustee caused the debtor’s employer to remit $6,000 from the $40,000 lump-sum settlement. Upon receipt of the $6,000, the trustee paid creditors in full consistent with the confirmed plan. Learning of the $6,000 deduction, the debtor went ballistic and objected to the trustee’s interpretation of the payroll deduction order. The bankruptcy court held that the trustee “egregiously misappropriated” the debtor’s money; however, the debtor failed to demonstrate harm because the trustee disbursed the money in full payment of unsecured claim holders consistent with the debtor’s plan. The court left open the possibility that the debtor might modify the confirmed plan to reduce payments based on termination of employment and then seek damages for the trustee’s actions. The message in Colvin for debtors is that timely modification of the payroll deduction order may be advisable whenever the debtor experiences a substantial change in income.
Income deduction orders to employers in Chapter 13 cases are not garnishments in the traditional sense of a levy on money due the debtor in aid of collecting a judgment. It has been held that an income deduction order in a Chapter 13 case does not violate a state constitutional prohibition against garnishment of wages.17 This distinction between a voluntary wage deduction order in a Chapter 13 case and involuntary execution on a judgment by garnishment is important because of laws and rules that permit the assessment of fees and collection costs from monies seized by garnishment.18 Over the years, Chapter 13 trustees have (quietly) battled all efforts by employers to deduct fees or costs for honoring income deduction orders.
1 See King v. Wood (In re King), 116 B.R. 413, 414 (D.N.J. 1990) (Bankruptcy court is not required to consider the payment record and financial history of each debtor before imposing a wage deduction order. “[Debtor] has no right to make payments directly to secured creditors. . . . [T]he bankruptcy court may impose a wage order over the objection of the debtor. . . . The Code does not require the court to anticipate which debtors will become delinquent after confirmation, but authorizes the bankruptcy court to order any entity from whom the debtor receives income to remit payments as required by the plan. . . . The bankruptcy court’s practice of requiring a wage order where feasible is not in contravention of the Bankruptcy Code.”); In re Adams, 115 B.R. 59, 62–63 (Bankr. D.N.J. 1990) (“[T]his court now imposes wage orders as to trustee and mortgage payments upon confirmation of all Chapter 13 plans, except in the small number of cases in which such orders are not feasible because of the nature of the debtor’s employment . . . or legal prohibition. . . . [W]age orders directing payment to mortgagees promote the debtor rehabilitation and creditor repayment purposes of Chapter 13.”).
2 See In re Howell, 138 B.R. 484 (W.D. Pa. 1992) (Issuance of an income deduction order to the commonwealth of Pennsylvania to require payment to the trustee of a debtor’s AFDC benefits is voluntary and can be terminated by the debtor at any time.); In re Capodanno, 94 B.R. 62 (Bankr. E.D. Pa. 1988) (Although wage deduction orders are voluntary and are the exception not the rule, in a particularly tight plan when the debtor has a large family and the probability of extra demands on the debtor’s income is great, court will condition confirmation that a wage attachment be effected to prevent the debtor from utilizing funds necessary for the plan for any other purpose.). See § 250.1 [ Direct-Pay Orders ] § 125.3 Direct-Pay Orders.
3 See In re McMillan, 285 B.R. 480, 483 (Bankr. W.D. Wash. 2002) (“Despite the language of 11 U.S.C. § 1325(c) authorizing the Court to issue a wage deduction order ‘[a]fter confirmation,’ there is also no reason in this case to wait until that event occurs. . . . It is an accepted practice in this district and others to issue such orders prior to confirmation.”); In re Torres, 191 B.R. 735, 737–38 (Bankr. N.D. Ill. 1996) (Bankruptcy court has power to issue income deduction order to employer before confirmation. At the petition, debtor agreed to payroll deduction order. Employer objected on the ground that § 1325(c) empowers income deduction orders only “after confirmation of a plan.” “Since preconfirmation wage deduction orders are not prohibited in Chapter 13 cases . . . the issue is whether it is ‘necessary or appropriate’ for such orders to be entered under Section 105(a). Plainly it is. Chapter 13 debtors are frequently required to petition for bankruptcy relief because of their inability to prioritize the expenditures they make from their wages.”).
4 See In re Barbee, 82 B.R. 470 (Bankr. N.D. Ill. 1988) (Debtor’s attorney is not permitted to escrow preconfirmation payments from the debtor pending confirmation and approval of attorneys’ fees. That the debtor’s attorney intended to pay allowed attorneys’ fees from the escrowed funds and then turn over excess to the trustee for distribution to creditors raises serious ethical and administrative problems.).
5 See discussion beginning at § 44.1 First Test of Debtor’s Good Intentions.
6 See In re Torres, 191 B.R. 735, 737–38 (Bankr. N.D. Ill. 1996) (“[U]nless preconfirmation plan payments have been made pursuant to Section 1326(a)(1), confirmation is unlikely . . . . A preconfirmation wage deduction order establishes the debtor’s ability to make plan payments, despite prior budgeting difficulties. . . . Section 1326(a), requiring preconfirmation payments from the debtor, was added to the Code by the BAFJA legislation of 1984. . . . [W]hen Congress determined in 1984 to require that Chapter 13 debtors begin making plan payments promptly after filing their cases, it simply did not consider the question of wage deduction orders. However, the apparent intent behind allowing wage deduction orders in 1978 supports their application to all payments now required in Chapter 13.”).
7 See § 58.8 [ Ensure Debtor Commences Making Timely Payments ] § 53.9 Ensure Debtor Commences Making Timely Payments.
8 11 U.S.C. § 1326(a)(2), as amended by Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, § 307, 108 Stat. 4106 (1994).
9 See § 143.1 In Cases Filed before October 22, 1994, § 143.2 In Cases Filed after October 22, 1994, § 143.3 Payments Held by Chapter 13 Trustee at Conversion: § 1326(a)(2) after BAPCPA and § 153.1 In General.
12 See § 131.1 [ Postpetition Defaults ] § 82.2 Postpetition Defaults.
13 See § 53.10 Make Payments to Creditors Unless Plan or Confirmation Order Provides Otherwise, § 74.8 Direct Payment of Secured Claims by Debtor before BAPCPA, § 74.9 Direct Payment of Secured Debt after BAPCPA, § 85.6 Direct Payment of Mortgage or Payment by Trustee and § 89.1 Direct Payments by Debtor.
14 See King v. Wood (In re King), 116 B.R. 413, 414 (D.N.J. 1990) (Bankruptcy court is not required to consider the payment record and financial history of each debtor before imposing a wage deduction order. “[Debtor] has no right to make payments directly to secured creditors. . . . [T]he bankruptcy court may impose a wage order over the objection of the debtor. . . . The Code does not require the court to anticipate which debtors will become delinquent after confirmation, but authorizes the bankruptcy court to order any entity from whom the debtor receives income to remit payments as required by the plan. . . . The bankruptcy court’s practice of requiring a wage order where feasible is not in contravention of the Bankruptcy Code.”); In re McMillan, 285 B.R. 480, 485 (Bankr. W.D. Wash. 2002) (“Despite the best intentions of the debtor at the time of confirmation, it is the past experience of this Court that plans without income deduction orders too often prove unsuccessful.”); In re Adams, 115 B.R. 59, 62–63 (Bankr. D.N.J. 1990) (“[T]his court now imposes wage orders as to trustee and mortgage payments upon confirmation of all Chapter 13 plans, except in the small number of cases in which such orders are not feasible because of the nature of the debtor’s employment . . . or legal prohibition. . . . [W]age orders directing payment to mortgagees promote the debtor rehabilitation and creditor repayment purposes of Chapter 13.”).
15 See, e.g., In re Hopkins, 66 B.R. 828 (Bankr. W.D. Ark. 1986) (Sole reason for firing of debtor was bank president’s fear of public outrage if Chapter 13 debtor continued working at the bank. Violation of § 525 was proved, but contempt is not the proper remedy.). See also § 73.1 [ Termination of Services to Debtor and Discrimination against Debtor ] § 58.13 Termination of Services to Debtor and Discrimination against Debtor.
16 125 B.R. 182 (Bankr. E.D. Mich. 1991).
17 In re Leask, 194 B.R. 416, 418 (Bankr. E.D. Tex. 1996) (Income deduction order to an employer in a Chapter 13 case does not violate the Texas constitutional prohibition against garnishment. “Garnishment is constitutionally prohibited in Texas. . . . The purpose of the Texas constitutional provision is to insulate wage earners from involuntary garnishment and to protect their means of livelihood. . . . Nothing prohibits a wage earner from voluntarily submitting his earnings to a wage-withhold order. Chapter 13 of the Bankruptcy Code is a wholly voluntary rehabilitative vehicle . . . . [T]he Court believes that wage-withhold orders are essential to the success of many Chapter 13 plans and are authorized by the Bankruptcy Code. . . . If there is any conflict between the provisions of the Bankruptcy Code and the laws of Texas, then the laws of Texas must yield to the supremacy of federal law.”).
18 See § 249.1 [ Can Employer Charge a Fee? ] § 125.2 Can Employer Charge a Fee?.