Cite as: Keith M. Lundin, Lundin On Chapter 13, § 160.4, at ¶ ____, LundinOnChapter13.com (last visited __________).
Section 1328(b)(2) prohibits discharge before completion of payments under the plan unless “the value, as of the effective date of the plan, of property actually distributed under the plan on account of each allowed unsecured claim is not less than the amount that would have been paid on such claim if the estate of the debtor had been liquidated under Chapter 7 of this title on such date.”1 This language is similar to the best-interests-of-creditors test applicable at confirmation under § 1325(a)(4),2 and the courts apply similar standards to determine satisfaction of the test for hardship discharge.
The purpose of this condition is to ensure that no discharge is entered in a Chapter 13 case before creditors have received at least what they would have been paid had the debtor commenced a Chapter 7 case in the first instance. Put another way, Congress intended to preclude the use of hardship discharge in a Chapter 13 case to avoid the minimum entitlement that creditors would have in a liquidation under Chapter 7. If unsecured creditors would receive no distribution under Chapter 7, then “any payment to them in a Chapter 13 plan satisfies [the second subsection of § 1328(b)].”3
Application of the best-interests-of-creditors test at a hearing under § 1328(b) focuses on “the effective date” of the plan—typically the date of confirmation or the date the confirmation order became final.4 The “as of the effective date” language requires a present value calculation back to the effective date of the plan with respect to the money (or other property) actually distributed during the Chapter 13 case.5
For example, if at confirmation, § 1325(a)(4) required the debtor to pay at least 34 percent to unsecured claim holders, a hardship discharge is not available until after the debtor has actually paid unsecured claim holders an amount that, when present valued to the effective date of the plan, at least equals 34 percent of each allowed unsecured claim.6 It is not enough that the debtor has paid the same amount unsecured claim holders would have received in a Chapter 7 case—the present value of the stream of payments that unsecured claim holders have received between confirmation and the hardship discharge would be less than a lump-sum payment of that same amount on the effective date of the plan. In the 34 percent example, if the case was two years past confirmation when the debtor sought a hardship discharge, to satisfy a 34 percent best-interests-of-creditors test, using a 10 percent discount rate, the debtor had to pay unsecured claim holders approximately 41.5 percent of claims through the plan.7
In re Easley8 is an excellent illustration of the best-interests-of-creditors-test limitation on hardship discharge under § 1328(b). In Easley, at confirmation of the 100 percent plan, the debtors valued a nonexempt boat, motor and trailer at $10,000. A year later, the debtors sought hardship discharge. Unsecured claim holders had received $4,371 through the plan. The bankruptcy court concluded that the debtors were not entitled to hardship discharge, applying § 1328(b)(2) as follows:
The Code does not allow this Court to grant a hardship discharge to Chapter 13 debtors who have retained nonexempt assets of a greater value than the sum of the plan payments made to those same debtors’ unsecured creditors. The Easleys listed a boat, motor and trailer on their bankruptcy schedules as nonexempt personal property. They scheduled the value of this property at $10,000. . . . [T]he liquidation analysis, or best interest of creditor’s test, is performed only once in Chapter 13, and that is at the time of confirmation. If the Easleys valued their boat, motor, and trailer at $10,000.00 prior to confirmation, and the plan was confirmed based upon that valuation, then that is the value to be used throughout the case for purposes of the liquidation analysis. Since they have had possession and use of the boat for over 18 months, any depreciation in its value since the effective date of the plan is not to be considered in determining whether the best interest of creditors’ test has been met. I, thus, find that the Easleys have not paid to their unsecured creditors a sum equal in value to the value, on the effective date of the plan, of the nonexempt assets they retained in this Chapter 13 case.9
Exemptions are important to determine entitlement to a hardship discharge. Exemptions are considered to determine whether the debtor satisfies the best-interests-of-creditors test at confirmation under § 1325(a)(4),10 and exemptions must be considered to determine whether § 1328(b)(2) is satisfied.11
Given that most Chapter 13 estates would be no-asset Chapter 7 cases, the best-interests-of-creditors test is rarely a significant obstacle to entry of a hardship discharge. However, debtor’s counsel must be prepared to put on some evidence in the face of an objection, because failure to prove satisfaction of the best-interests-of-creditors test can be fatal to the debtor’s right to a hardship discharge.12 Because § 1328(b)(2) targets the best-interests-of-creditors calculation “as of the effective date of the plan,” property or income received by the debtor or debts incurred after that date are not relevant to entitlement to a hardship discharge.
1 11 U.S.C. § 1328(b)(2).
2 See discussion beginning at § 90.1 In General: Plan Payments vs. Hypothetical Liquidation.
3 In re Cummins, 266 B.R. 852, 856 (Bankr. N.D. Iowa 2001).
4 The “effective date” language in § 1325(a)(4) is not without problems of interpretation at confirmation, see §§ 160.1 [ In General: Plan Payments vs. Hypothetical Liquidation ] § 90.1 In General: Plan Payments vs. Hypothetical Liquidation and 161.1 [ Exemption Issues ] § 90.2 Exemption Issues, and at modification after confirmation, see § 254.1 [ Application of Tests for Confirmation ] § 126.2 Application of Tests for Confirmation.
5 Identical “effective date of the plan” language appears in 11 U.S.C. § 1325(a)(4) (the best-interests-of-creditors test at confirmation), in 11 U.S.C. § 1325(a)(5)(B)(ii) (cramdown of secured claims at confirmation), and in 11 U.S.C. § 1325(b)(1) (the disposable income test at confirmation). In each of these situations, and elsewhere under the Code, the phrase “as of the effective date of the plan” is interpreted to mean present value. See, e.g., § 77.1 “Value, As of the Effective Date of the Plan” Means Interest and § 90.5 Discount Rates and Interest If Liquidation Would Produce Dividend.
6 In re Dark, 87 B.R. 497 (Bankr. N.D. Ohio 1988) (Section 1328(b)(2) conditions entitlement to a hardship discharge that the debtor must satisfy the best-interests-of-creditors test in § 1325(a)(4). At the time of confirmation of the original plan, § 1325(a)(4) required the debtor to pay at least 34% to general unsecured creditors. Debtor is not entitled to hardship discharge when unsecured claim holders have received less than half that amount.). See also In re Roberts, 247 B.R. 592 (Bankr. D.R.I. 2000) (Debtors do not qualify for a hardship discharge because, six years after confirmation, the 10% promised to unsecured claim holders has not been paid because the debtors failed to segregate and pay postpetition trust fund taxes.).
7 This 41.5% calculation is based on a 10% discount factor, 24 months of payments, and a further (unrealistic) assumption that payments were made monthly under the plan to unsecured creditors in equal amounts. The timing and amounts of payments between the effective date of the plan and the date of the motion for hardship discharge would alter this present value calculation.
8 240 B.R. 563 (Bankr. W.D. Mo. 1999).
9 240 B.R. at 565.
10 See § 161.1 [ Exemption Issues ] § 90.2 Exemption Issues.
11 Thurman v. CIT Fin. Servs., 20 B.R. 978 (Bankr. W.D. Tenn. 1982) (Although exemptions are of less practical utility in Chapter 13, exemptions must be considered in determining whether the hardship discharge test in § 1328(b) can be met.). See In re Thornton, 21 B.R. 462 (Bankr. W.D. Va. 1982).
12 See, e.g., In re White, 126 B.R. 542 (Bankr. N.D. Ill. 1991) (Debtor was denied hardship discharge in part because debtor failed to present any evidence to establish satisfaction of the best-interests-of-creditors test in § 1328(b)(2).).