Cite as: Keith M. Lundin, Lundin On Chapter 13, § 89.4, at ¶ ____, LundinOnChapter13.com (last visited __________).
For a debtor engaged in business, continued cooperation from suppliers and customers may be essential to an effective adjustment of debts. The Bankruptcy Appellate Panel for the Ninth Circuit has suggested that on the right facts it would be appropriate for a debtor to separately classify business creditors with continuing relationships to the debtor for favorable treatment—for example, the debtor’s insurance company or material suppliers.1 To demonstrate the fairness of the separate classification, the debtor may need to prove that the prepetition claim holder provides an essential product, service or raw material that is necessary to the postconfirmation production of income to fund the plan.
Arguably in dicta, the U.S. Court of Appeals for the Seventh Circuit used a trade creditor as an example of a separate classification that would be acceptable in a Chapter 13 case. Discussed in more detail elsewhere,2 in In re Crawford,3 Judge Posner offered several hypotheticals to illustrate separate classifications of unsecured claims that would and would not survive unfair discrimination analysis under § 1322(b)(1). At the acceptable end of the spectrum, the opinion describes classifications without which “the debtor is unlikely to be able to fulfill a Chapter 13 plan and the result will be to make his creditors as a whole worse off than they would be with the classification.”4 These “win-win” situations include “the creditor is a supplier of the tools of the debtor’s trade, and unless paid in full will cut him off and thereby prevent him from plying his trade . . . with the result of depriving him of the earnings he needs to fund his plan.”5
Of course, the devil is in the details of Judge Posner’s example. Chapter 13 debtors engaged in business typically owe money to several suppliers and sources of material, and all those suppliers and sources are more or less replaceable. But at the economy of scale—or lack thereof—of a Chapter 13 debtor, the transaction costs of finding new vendors may simply be beyond the debtor’s ability, especially at the inception of a Chapter 13 plan. The real test of Judge Posner’s hypothetical will be the believability of the debtor’s plea that separate classification of the tool supplier or of the ladder guy is necessary if the business is to succeed and produce enough income to make payments under the plan.
Chapter 13 debtors engaged in business may need to separately classify some prepetition debts to stay in business. At the beginning of a business Chapter 13 case, there will almost always be unpaid bills from trade creditors with whom the debtor intends to continue to do business. In the ordinary course of business outside bankruptcy, those trade creditors would expect to be paid in full during the first or second monthly billing cycle after the filing. Not to do so may force the debtor into cash terms or to lose sources of supply. A Chapter 13 debtor engaged in business might propose full payment of trade creditors with debts that mature within the regular billing cycle for the first month or two of the Chapter 13 case.
Such a plan would involve a classification of claims because other unsecured creditors—“older” trade debt, trade creditors with whom the debtor does not need to continue to do business, and other unsecured claims—will wait longer than a month or so for payment through the plan. The fairness of this discrimination under § 1322(b)(1) may turn on whether reorganization of the debtor’s business depends on continuing to do business with the favored creditors.
One reported bankruptcy decision considered without deciding an unfair-discrimination challenge to a business debtor’s proposal like the one above. In In re Grear,6 a business Chapter 13 debtor separately classified for payment in full the prepetition trade debts incurred in the month immediately preceding the bankruptcy case. The plan proposed to pay these trade creditors in the ordinary course of business without help from the Chapter 13 trustee. A challenge to this discrimination became moot before the issue could be decided. The court did observe that confirmation was unlikely because the proposal to pay some prepetition trade creditors in full with postpetition income was inconsistent with the disposable income test in § 1325(b).7
Almost any proposal to favor prepetition trade creditors will be a classification of claims in a business Chapter 13 case, and it will be measured against the unfair-discrimination standard in § 1322(b)(1). If the consequence of failing to prefer some prepetition creditors is the end of the debtor’s business and the demise of the Chapter 13 case, the debtor should have convincing evidence that discrimination is fair.
Debtors have realized little success at separate classification of business creditors for less favorable treatment than other unsecured claim holders. The division of creditors into consumer and business classes was held to be arbitrary and unfairly discriminatory against creditors of the debtor’s failed business when the debtor proposed to pay 100 percent of consumer debts and 5 percent of business debts.8 This court found that the debtor could pay approximately 7 percent of all unsecured claims to avoid the unfair discrimination. Similarly, it was unfair discrimination to pay nothing to claims arising out of the debtor’s failed oil drilling operation while paying 10 percent of other unsecured claims.9
1 See AMFAC Distribution Corp. v. Wolff (In re Wolff), 22 B.R. 510 (B.A.P. 9th Cir. 1982).
2 See §§ 149.1 [ Power to Classify Unsecured Claims: Tests for Unfair Discrimination ] § 87.1 Power to Classify Unsecured Claims: Tests for Unfair Discrimination and 152.2 [ Alimony, Maintenance and Support ] § 88.4 Alimony, Maintenance and Support.
3 324 F.3d 539 (7th Cir. 2003).
4 324 F.3d at 543.
5 324 F.3d at 543.
6 163 B.R. 524 (Bankr. S.D. Ill. 1994).
7 Satisfying the disposable income test in 11 U.S.C. § 1325(b)(1) in Chapter 13 cases involving a debtor engaged in business is discussed in §§ 57.1 [ Operating a Chapter 13 Debtor Engaged in Business ] § 52.1 Operating a Chapter 13 Debtor Engaged in Business and 167.1 [ Debtor Engaged in Business ] § 91.6 Debtor Engaged in Business.
8 In re Harris, 62 B.R. 391 (Bankr. E.D. Mich. 1986). Accord In re Burnip, 229 B.R. 904, 906–07 (Bankr. S.D. Ohio 1999) (Debtor failed to prove reasonable basis for less favorable classification of claim for repayment of commissions on the sale of interests in a partnership. “The fact that the third class of unsecured claims may be business oriented does not support less favorable treatment than proposed to consumer oriented unsecured claims. . . . Merely acknowledging a distinction between consumer and business claims does not support discriminatory treatment. The commission related claims are also unliquidated, contingent, and disputed obligations. However, none of these factors support discriminatory treatment under the circumstances of this case.”).
9 In re Baker, 66 B.R. 253 (Bankr. N.D. Miss. 1986).