Cite as: Keith M. Lundin, Lundin On Chapter 13, § 89.3, at ¶ ____, LundinOnChapter13.com (last visited __________).
When the debtor assumes a lease or executory contract, the debtor will often have to separately classify for full payment the lessor’s claim for prepetition arrearages under the contract.
Under § 365, if the debtor assumes a lease or executory contract, the plan must cure prepetition default or provide adequate assurance that the debtor will promptly cure any default.1 Typically, the landlord or lessor is willing to accept payment of the arrearage over a short period through the plan. The arrearage claim is an unsecured claim. If the debtor is financially unable to pay all unsecured claim holders in full, the provision for full payment of the arrearage to the landlord or lessor requires a classification of claims that will be measured against the unfair-discrimination standard in § 1322(b)(1).
Several courts have indicated that favorable classification of a rent arrearage can be fair discrimination for purposes of § 1322(b)(1). In In re Davis,2 the debtors leased a HUD subsidized below market rate apartment for $277 per month. The debtors accumulated a prepetition rent arrearage of $6,558. The plan separately classified the landlord for 100 percent payment of the arrearages and assumption of the lease. The bankruptcy court found it was fair discrimination to pay the rent arrearage 100 percent when other unsecured claim holders would only receive 10 percent because failure to pay the rent arrearages would forfeit the below market rent property and defeat the plan:
Loss of the apartment is a virtual certainty if Debtors’ Amended Plan fails. . . . Debtors here have demonstrated their urgent necessity for full payment of the rental arrearage in order to save their home and have some cash flow to pay even the 10% to general unsecured creditors. While this treatment is certainly discriminatory, Debtors have shown that the discrimination is fair, even from the creditor’s point of view. If the Amended Plan fails, those creditors will likely receive nothing, as all of Debtors’ available income will go to pay higher rent.3
Another court applied the four-part test4 and held that a reasonable basis for separate classification of a landlord is shown by proof that the debtor has assumed the lease and must make full payment of the arrearages to satisfy §§ 365(b) and 1322(b)(7).5 This reasoning would authorize separate classification of the prepetition arrearages on any lease or executory contract that is assumed by the debtor because § 365(b) will apply to every assumption and will always require prompt payment of arrearages.6 In another district, the bankruptcy court reported one case approving the separate classification of rent arrearages7 and a second case holding that 100 percent payment of the arrearage owed a landlord is unfair discrimination when other unsecured claim holders will receive only 5 percent through the plan.8
These cases demonstrate that some courts are inclined to find fair discrimination in the separate classification for full payment of rent arrearages based on evidence that a separate class is necessary to satisfy the assumption requirements in § 365(b). Other courts require the Chapter 13 debtor to prove more than just the need to satisfy § 365(b)—the debtor must link the contract or lease assumption to performance of the plan and show that less discriminatory alternatives are not available.
If Congress intended that a debtor’s choice to assume a lease or an executory contract was itself sufficient basis for separate classification, an exception to the unfair-discrimination standard in § 1322(b)(1) would have been indicated. There is nothing in § 1322(b)(7)—the section of Chapter 13 that authorizes a Chapter 13 debtor to assume an executory contract or unexpired lease9—or in § 365 to suggest that the arrearage claim owed to a landlord or lessor is excepted from the unfair-discrimination standard in § 1322(b)(1). Debtors assuming a contract or lease in a case in which other unsecured claim holders are not paid in full should be prepared to prove some special necessity for the assumption. In jurisdictions applying the four-part test,10 the debtor should prove that the particular lease or contract is essential to the plan and that the debtor cannot carry out a plan without preferring payment of the cure amount. If the items subject to the lease are fungible—for example, a television or an apartment that can be easily replaced—the debtor may not be able to prove the fairness of paying the prepetition default in full.
1 11 U.S.C. § 365(b)(1)(A). See § 173.1 [ Debtor Must Cure Defaults and Assure Future Performance ] § 102.2 Debtor Must Cure Defaults and Assure Future Performance.
2 209 B.R. 893 (Bankr. N.D. Ill. 1997).
3 209 B.R. at 895–96. Accord In re Liggins, 145 B.R. 227, 231 (Bankr. E.D. Va. 1992) (Separate classification of landlord for full payment of rent delinquency that will permit the debtor to keep a federally subsidized lease has merit; however, debtor has the burden to prove that full payment of the rent arrearages does not unfairly discriminate against unsecured creditors who will receive only 1%. Debtor presented no evidence. “At the least, debtor must make some evidentiary showing of necessity for her to pay the claim in full so that she may continue to occupy this particular apartment.”).
4 See § 149.1 [ Power to Classify Unsecured Claims: Tests for Unfair Discrimination ] § 87.1 Power to Classify Unsecured Claims: Tests for Unfair Discrimination.
5 In re Riggel, 142 B.R. 199 (Bankr. S.D. Ohio 1992).
6 See § 173.1 [ Debtor Must Cure Defaults and Assure Future Performance ] § 102.2 Debtor Must Cure Defaults and Assure Future Performance.
7 In re Kovich, 4 B.R. 403 (Bankr. W.D. Mich. 1980).
8 In re Blackwell, 5 B.R. 748 (Bankr. W.D. Mich. 1980).
9 See § 172.1 [ Debtor Can Assume, Assign or Reject Executory Contracts ] § 102.1 Debtor Can Assume, Assign or Reject Executory Contracts.
10 See § 149.1 [ Power to Classify Unsecured Claims: Tests for Unfair Discrimination ] § 87.1 Power to Classify Unsecured Claims: Tests for Unfair Discrimination.