Cite as: Keith M. Lundin, Lundin On Chapter 13, § 89.9, at ¶ ____, LundinOnChapter13.com (last visited __________).
Here and there in the case law, clever (desperate?) debtors have concocted exotic classifications of unsecured claims, sometimes with success. One court permitted the separate classification of the holder of an avoided lien—that is, an unsecured claim holder that was once secured by a lien that was avoided under § 522(f).1 This is an odd outcome. After avoidance of a lien under § 522(f), the claim is an ordinary unsecured claim. The avoided lienholder’s only special attribute is that, absent a court order to the contrary, dismissal of the Chapter 13 case reinstates the lien under § 349(b)(1)(B).2 Using separate classification to provide favorable treatment to an avoided lienholder in excess of that already allowed by § 349 is a hard fairness argument to win. Other courts have recognized that unperfected lienholders and lienholders whose liens are avoidable are properly classified as ordinary unsecured claim holders for purposes of distribution under a Chapter 13 plan.3 The same logic makes it unfair discrimination to classify an unsecured debt as a secured claim when there is no lien under nonbankruptcy law.4
Separate classification has been used successfully when a debt is subject to subordination by contract or law. For example, in In re Patin,5 the debtor separately classified nonpecuniary loss tax penalties for no payment in a plan that proposed 100 percent payment of other unsecured claims. Under 11 U.S.C. § 507(a)(8)(G), tax penalties are entitled to priority if in compensation for “actual pecuniary loss.” The penalties in Patin were “pure penalties,” not the sort required to make the IRS whole. Reviewing the fairness of the debtor’s proposed discrimination, the bankruptcy court found that “the penalty claim of the IRS would be subordinated to the other claims pursuant to § 726(a)(4). . . . It is difficult for the court to see how the discrimination against the penalty claim proposed by the debtor is unfair to the IRS, since the Bankruptcy Code . . . itself discriminates against penalty claims.”6
One bankruptcy court approved separate classification for full payment of the portion of a line of credit used to pay priority income taxes when the plan would pay other unsecured creditors 2 percent.7 The court reasoned that the taxes would be entitled to payment ahead of other unsecured creditors if not paid before the petition; thus, “in reality there is no effective discrimination here.”8 When the IRS had a “community claim” against a nonfiling spouse that was secured by a lien on the debtor’s homestead, it was fair discrimination to separately classify the claim for no payment because, in a Chapter 7 case, the community claim would not be entitled to any distribution.9 In a community property state, it was not unfair discrimination for a nonfiling spouse to pay her separate creditors a greater percentage than unsecured claim holders will be paid through the plan when the nonfiling spouse’s separate income was not community property under state law.10
On the right facts, one court acknowledged the possible separate classification of retail merchants and finance companies.11 Friends are important, but maintaining friendships is a long-shot basis for separate classification in a Chapter 13 case.12
Can the unfair discrimination test in § 1322(b)(1) be a sword in the hands of the debtor? That was one of the theories in Kerney v. Capital One Finance Corp. (In re Sims).13 Sims was a class action by the standing Chapter 13 trustee and debtors alleging that Capital One Financial systematically overstated the amount of its debt in proofs of claim. One of the plaintiffs’ theories was that, by filing overstated proofs of claim, Capital One created for itself a separate classification that was unfairly discriminatory against unsecured claim holders with accurate proofs of claim. The independent cause of action the plaintiffs sought to imply under § 1322(b)(1) didn’t materialize.14
1 Household Fin. Corp. v. Snow, 8 B.R. 113 (Bankr. S.D. Ohio 1980). See discussion of lien avoidance beginning at § 49.1 Available in Chapter 13 Cases.
2 See § 338.1 [ In General ] § 153.1 In General.
3 See In re Harris, 120 B.R. 142 (Bankr. S.D. Cal. 1990) (Judicial lien is avoidable under § 522(f), and thus the creditor’s claim is properly classified as an unsecured claim.); In re Carroll, 67 B.R. 1020 (Bankr. N.D. Ala. 1986) (It is “highly unfair discrimination” to propose to pay in full a lienholder whose lien is probably unperfected under state law while paying nothing to other allowed unsecured claim holders.). See also § 51.2 [ Protecting Lienholder after Lien Avoidance ] § 49.5 Protecting Lienholder after Lien Avoidance.
4 See, e.g., In re Brooks, 274 B.R. 495, 502 (Bankr. E.D. Tenn. 2002) (Unfair discrimination to treat credit card debt as secured claim when “other debts clause” in residential mortgage does not apply to one spouse’s separate credit card charges. “Having concluded that the credit card debt is not secured, the court must deny confirmation of the plan on the ground that it classifies unsecured claims and unfairly discriminates between the classes.”).
5 201 B.R. 539 (Bankr. N.D. Cal. 1995).
6 201 B.R. at 540.
7 In re Foster, 263 B.R. 688 (Bankr. D.R.I. 2001).
8 263 B.R. at 690.
9 In re Whitus, 240 B.R. 705, 708–10 (Bankr. W.D. Tex. 1999) (On the debtor’s objection to the claim of the IRS, plan can separately classify the IRS’s community claim for no payment because the IRS’s claim against the debtor’s nonfiling spouse would not be entitled to distribution in a Chapter 7 case. IRS assessed 100% penalty taxes against the debtor’s nonfiling spouse. IRS perfected lien against the homestead of the debtor and nonfiling spouse, but the debtor was not directly liable for the tax. IRS had a “community claim” and could enforce its lien on the debtor’s homestead. With respect to the debtor’s postpetition income, the IRS’s collection rights through the Chapter 13 plan are limited: “The Code provides special treatment for community claims in chapter 7 case, in effect creating a sub-estate for their satisfaction. Sub-estates are created in Section 726(c) . . . . Community claims—even community claims that would otherwise fit within the rubric of section 507 as priority claims—must look solely to the subestates (and distribution scheme) set up by section 726(c). . . . There are four subestates set up under section 726(c)(2), but community claims assertable against the non-debtor are restricted to recoveries out of the first and last subestates only. . . . In a Chapter 7 liquidation, Mrs. Whitus’ earnings would not be property of the bankruptcy estate and would not be available for distribution. . . . Thus, in a Chapter 7 liquidation on our facts, the IRS community claim would receive nothing. Other unsecured creditors, on the other hand, could conceivably receive a distribution, because the liquidation test applied to them is 726(a), not (c)—they are not channeled to a subestate. In Chapter 13, Mrs. Whitus’ plan can legitimately place all community claims into a separate class, for treatment consistent with the best interest of creditor’s test. 11 U.S.C. Section 1325(a)(4). It is also legitimate for the class of community claims to receive nothing under the plan, because that is the result of the application of the best interest of creditor’s test.”).
10 In re Nahat, 278 B.R. 108, 114 (Bankr. N.D. Tex. 2002) (Plan that pays nothing to unsecured claim holders does not unfairly discriminate when nonfiling spouse will pay her separate creditors a greater percentage before contributing to the debtor’s plan. “[B]ecause Mrs. Nahat will receive no discharge of debt by reason of her husband’s chapter 13 case, it stands to reason that Mrs. Nahat should have the right to pay obligations in her name before contributing to the disposable income under the Plan. Thus, the Plan does not discriminate unfairly among unsecured creditors.”).
11 In re Hill, 4 B.R. 694 (Bankr. D. Kan. 1980).
12 See In re Tennis, 232 B.R. 403, 405 (Bankr. W.D. Mo. 1999) (Unfair discrimination to separately classify friends for payment in full and 15% payment to general unsecureds. “[T]he discrimination does not have a reasonable basis. In one instance, the Debtor wants to pay her friends and acquaintances 100% of their claims simply because she wants to maintain good relationships with them. . . . [I]t is hardly reasonable to compel certain unsecured creditors to accept payments totaling some 15% of their claims while other creditors, who happen to be friends of the debtor, are repaid 100% of the amounts they have loaned the debtor.” The money borrowed from friends was used to pay bankruptcy legal fees and filing expenses.).
13 278 B.R. 457 (Bankr. E.D. Tenn. 2002).
14 Kerney v. Capital One Fin. Corp. (In re Sims), 278 B.R. 457 (Bankr. E.D. Tenn. 2002) (Neither § 1322(b)(1) nor § 105 provides an independent cause of action on the theory that an inflated proof of claim creates an unfair discrimination.).