Cite as: Keith M. Lundin, Lundin On Chapter 13, § 90.5, at ¶ ____, LundinOnChapter13.com (last visited __________).
If the liquidation value of the estate would produce a dividend in a Chapter 7 case, then the value as of the effective date of property to be distributed under the Chapter 13 plan must exceed the amount that unsecured claim holders would receive in the hypothetical Chapter 7 case. For example, if liquidation would produce a 50 percent dividend to unsecured claim holders in a Chapter 7 case, then the value of property to be distributed to unsecured claim holders through the Chapter 13 plan must equal or exceed 50 percent on the effective date of the plan.
“[V]alue . . . as of the effective date of the plan” translates most simply that the discounted present value of payments through the plan must equal or exceed the amount that would be paid in a Chapter 7 case.1 In the hypothetical above, if the debtor’s plan proposed to pay 50 percent of unsecured claims over three years, the plan would fail the best-interests-of-creditors test because the discounted present value of payments totaling 50 percent over the three-year life of the plan would be less than 50 percent payment immediately through a hypothetical liquidation.
To compensate creditors for the time value of money, the best-interests-of-creditors test can be satisfied by paying unsecured claim holders interest on the portion of their claims that will be paid during the plan.2 In the example, the present value of the three-year stream of payments could be preserved at 50 percent by paying 50 percent of allowed claims plus interest. If liquidation would result in full payment of unsecured claims on the effective date of the plan, § 1325(a)(4) requires unsecured claim holders to be paid in full with interest through the Chapter 13 plan.3
An unsecured claim holder is not entitled to interest under § 1325(a)(4) unless the amount the creditor would receive in a Chapter 7 case is greater than the present value of the amount that is to be distributed under the plan. For example, if all the funds available in the hypothetical liquidation would be payable to another class of creditors and not to an objecting creditor, then the objecting creditor is not entitled to present value payments through the Chapter 13 plan.4 A tax claimant entitled to payment in full in a Chapter 13 case under § 1322(a)(2)5 is not entitled by § 1325(a)(4) to payment of postpetition interest unless in a liquidation case the tax claimant would receive immediate payment of an amount greater than the present value of the payments through the Chapter 13 plan.6 When an unperfected security interest in the debtor’s car would be avoidable by the trustee and not subject to exemption, the debtor need only pay the value of the car as of the effective date of the plan to satisfy the best-interests-of-creditors test—the plan does not also have to pay interest on top of the present value of the car.7
If a hypothetical liquidation would produce a 20 percent dividend and if the Chapter 13 plan proposes to pay a 30 percent dividend, then the issue becomes whether the 10 percent additional dividend to be paid through the plan is sufficient to give unsecured claim holders a present value equal to or greater than the 20 percent they would receive immediately in a hypothetical Chapter 7 case. The answer depends on the length of the plan, the timing of payments and the discount rate applied to determine the present value of the plan payments. This calculation may be elusive because it is difficult to tell at the beginning of most Chapter 13 plans when or in what amount unsecured claim holders will receive distributions under the plan.8 In the example, the additional 10 percent dividend to be paid through the Chapter 13 plan will be worth more or less “as of the effective date of the plan” depending on when that extra 10 percent is actually distributed to unsecured creditors. Without revealing the basis for its calculation, one bankruptcy court held that a 33 percent payment to unsecured creditors over 60 months satisfied § 1325(a)(4) when in a liquidation unsecured claim holders would receive 28 percent.9
One reported decision worked the other side of the distribution test: the time it would take to liquidate the estate in a Chapter 7 case. In In re Lapin,10 there were assets that would be available for liquidation in a Chapter 7 case, including avoidance actions that could be brought by a trustee. To satisfy the best-interests-of-creditors test, the debtor committed substantial exempt assets to funding the plan and the plan also provided that avoidance actions would pass to the trustee for the benefit of creditors in the Chapter 13 case. When the bankruptcy court compared the amount the debtor was committing to the plan to the amount that a Chapter 7 trustee would eventually recover, the court concluded that the plan satisfied § 1325(a)(4) without a discount rate based on this logic: “the Court believes that the delay in receiving distributions would be at least as great, if not greater, in chapter 7 as in chapter 13. Therefore, that computation is not material in this case.”11
Lapin introduces a wild card into the best-interests-of-creditors-test calculation. It is difficult enough to predict when distributions to unsecured claim holders will actually occur in a Chapter 13 case for purposes of calculating a discount factor when one is necessary to satisfy § 1325(a)(4); that calculation becomes impossible if the timing of distributions in the hypothetical Chapter 7 case is also a moving target. Most reported decisions seem to assume that the hypothetical liquidation required by § 1325(a)(4) takes place instantaneously at the effective date of the plan.12 Allowing the liquidation date to move about based on the composition of individual estates is one variable too many for the best-interests-of-creditors-test calculation.
To minimize problems of calculation, Chapter 13 debtors can satisfy the best-interests-of-creditors test in several other ways. One way is to calculate as precisely as possible the amount that would be distributed to unsecured claim holders in a Chapter 7 case and pay that amount (or slightly more) with interest sufficient to preserve the present value through the plan. For example, if liquidation would produce a 20 percent dividend and if unsecured claims totaled $10,000, the plan might propose to pay unsecured claims holders something more than $2,000 (say, $2,250) with 10 percent interest during the life of the plan. The interest rate, if sufficient to preserve present value,13 will satisfy the best-interests-of-creditors test.
Another way to satisfy the test is to propose to pay unsecured claim holders an amount that would exceed the present value of what would be paid in a liquidating case under any reasonable discount factor. For example, assuming again that unsecured claim holders would receive 20 percent of $10,000 or $2,000 in a hypothetical Chapter 7 case, if the debtor proposed to pay unsecured claim holders $3,000 during the life of a 36-month plan, that amount would satisfy the best-interests-of-creditors test using any discount factor less than approximately 14 percent.14
There are few reported § 1325(a)(4) decisions discussing the appropriate discount rate to determine whether the present value of payments through the plan exceeds the amount that would be paid in a hypothetical liquidation.15 The rate necessary to provide present value for § 1325(a)(4) purposes might be the same interest rate used to provide present value to the holders of allowed secured claims under § 1325(a)(5).16 In Beguelin v. Volcano Vision, Inc. (In re Beguelin),17 the Bankruptcy Appellate Panel for the Ninth Circuit found the reference to “the legal rate” in 11 U.S.C. § 726(a)(5) to be persuasive that the rate of interest on judgments under federal law controls the discount rate when a Chapter 13 debtor’s estate would be solvent under § 1325(a)(4):
We agree with the debtor that the federal judgment rate is the appropriate measure of interest under § 726(a)(5) . . . . The practicality and cost effectiveness which result from the use of the federal judgment rate under § 726(a)(5) are extremely significant. . . . It is not hard to imagine the administrative nightmare that bankruptcy trustees would otherwise face if they were required to calculate a different interest rate, based on a different source of interest rate, for each creditor.18
The best-interests-of-creditors test is not a back door to interest on unsecured claims in most Chapter 13 cases. Few Chapter 13 estates would liquidate to produce substantial dividends under Chapter 7. The payment of interest to unsecured claim holders to satisfy the best-interests-of-creditors test becomes a reality only when the debtor is protecting equity in property of the estate.
1 In re Hieb, 88 B.R. 1019, 1020, 1021 (Bankr. D.S.D. 1988) (“[I]f the creditor holding the unsecured claim receives deferred payments, the court must compare the total amount of the payments to the creditor, discounted to present value, and the amount the creditor would receive out of the estate in a straight liquidation. . . . If the present value of the deferred payments is at least as much as the creditor would receive immediately in a hypothetical liquidation . . . § 1325(a)(4) [is satisfied].” Debtor proposes to pay $16,642.71 to the IRS over 63 months and the IRS would receive $5,010.77 in a hypothetical liquidation. The present value of the 63 monthly payments to the IRS discounted at 12% per annum would be $12,426.46. “Therefore, the value of the property to be distributed under the plan to the IRS is not less than the amount that would be paid to the IRS if the estate were liquidated in a Chapter 7.” Accordingly, the IRS is not entitled to payment of interest on its claim.).
2 See §§ 111.1 [ “Value, As of the Effective Date of the Plan” Means Interest ] § 77.1 “Value, As of the Effective Date of the Plan” Means Interest and 112.1 [ Interest Rate Anarchy: Present Value Before Till ] § 77.2 Interest Rate Anarchy: Present Value before Till.
3 Hardy v. Cinco Fed. Credit Union, 755 F.2d 75 (6th Cir. 1985). Accord Beguelin v. Volcano Vision, Inc. (In re Beguelin), 220 B.R. 94, 100 (B.A.P. 9th Cir. 1998) (When estate is solvent, § 1325(a)(4) requires that unsecured claim holders be paid postpetition interest, including “gap” interest “from the date of the petition through and beyond the effective date of the plan.”); In re Boehm, 202 B.R. 99, 101–02 (Bankr. N.D. Ill. 1996) (On trustee’s postconfirmation motion, court applies best-interests-of-creditors test to determine that interest is payable. Confirmed plan provided 100% dividend to unsecured creditors. Debtor scheduled unencumbered real property with a value of $35,000. One creditor filed a proof of claim for $19,154.53, including postpetition interest of $2,774.69. Trustee filed motion to determine whether interest should be paid on the unsecured claim. “Here, the Debtor owns an unencumbered residence worth approximately $35,000. The only filed claim in the bankruptcy is the Creditor’s claim . . . . There is no doubt that if the Debtor’s estate were liquidated under Chapter 7 the Creditor would receive 100% of its claim plus interest. . . . [P]ost-petition interest should be paid on this unsecured claim.”); In re Huang, 192 B.R. 184 (Bankr. N.D. Ill. 1996) (The unsecured claim holders must be paid interest because in a Chapter 7 case, creditors would receive 100% of their claims plus interest.); In re Santa Maria, 128 B.R. 32 (Bankr. N.D.N.Y. 1991) (Debtor’s interest in unencumbered real property would liquidate and pay unsecured claim holders in full immediately in a Chapter 7 case. Section 1325(a)(4) requires that interest be included on the deferred payments to unsecured claim holders proposed by debtor’s plan. Failure of the plan to provide for present value precludes confirmation.); In re Rivera, 116 B.R. 17, 18–19 (Bankr. D.P.R. 1990) (When valuation of debtor’s property, after deduction of the administrative expenses of a Chapter 7 liquidation, results in a net equity large enough to pay unsecured claim holder 100%, the Chapter 13 plan must do more than just propose 100% payment over time. The plan must compensate creditors with “appropriate interest to bring the time payments to present value. . . . [T]o the extent liquidation in Chapter 7 would produce sufficient funds to pay all claims in full, the claimants would be entitled to interest from the date of filing at the Puerto Rico legal rate.”).
4 In re Young, 61 B.R. 150 (Bankr. S.D. Ind. 1986) (When the IRS would not be entitled to any distribution in a Chapter 7 case, the IRS is not entitled to present value payments through the Chapter 13 plan under § 1325(a)(4).).
6 See In re Smith, 196 B.R. 565, 569–70 (Bankr. M.D. Fla. 1996) (The best-interests-of-creditors test does not require the payment of interest to unsecured claim holders unless all unsecured claim holders would be paid in full in a Chapter 7 case. “Section 1325(a)(4) requires a comparison of the value of a claim holders [sic] interest ‘as of the effective date of the plan’ and the amount that claimant could receive in a liquidation. The phrase ‘as of the effective date of the plan’ has prompted some controversy over whether § 1325(a)(4) requires the payment of interest on unsecured claims. . . . [T]his Court agrees with the majority of Bankruptcy courts which have found that interest payments are only required if all unsecured claims would be paid in full if the estate were liquidated. . . . [A]warding interest under § 1325(a)(4) would ‘double discount’ the value of the stream of payments the IRS would receive under the plan. . . . [Section] 1325(a)(4) does not require the payment of interest on deferred payments of unsecured claims. Under the debtor’s plan, the IRS will receive 100 percent of both the secured and unsecured portions of its claim. Debtor’s analysis, however, reveals that only $130,000 would be available for creditors upon liquidation. Thus the IRS would likely only recover the value of its secured claim and its priority unsecured claim. The Court finds it in the best interest of the IRS and the other unsecured creditors to be paid through the plan.”); In re Ridgley, 81 B.R. 65 (Bankr. D. Or. 1987).
7 In re Brennan, 208 B.R. 448, 454 (Bankr. S.D. Ill. 1997) (“While the trustee argues that the debtors must additionally pay interest on this amount in order to comply with the ‘best interests’ test, he cites no authority for this proposition, and the Court has found none.”).
8 See §§ 170.1 [ Methods of Paying Unsecured Claims ] § 101.3 Methods of Paying Unsecured Claims and 204.2 [ Order of Payments to Creditors ] § 113.7 Order of Payments to Creditors before BAPCPA.
9 In re McKown, 227 B.R. 487, 490 (Bankr. N.D. Ohio 1999) (“[U]nsecured creditors would receive approximately 28% of their claims in a chapter 7 liquidation (although presumably unsecured creditors would receive such a distribution in less than five years). This is less than the approximately 33% distribution to be paid to general unsecured creditors under the amended Plan. Even taking into account the five-year period over which unsecured claims will be paid pursuant to the amended Plan, the amended Plan satisfies section 1325(a)(4) of the Bankruptcy Code by providing unsecured creditors with a distribution under the amended Plan having a value as of the effective date that is no less than they would receive if the Debtors’ estate were liquidated under chapter 7.”).
10 302 B.R. 184 (Bankr. S.D. Tex. 2003).
11 302 B.R. at 192.
12 See § 160.1 [ In General: Plan Payments vs. Hypothetical Liquidation ] § 90.1 In General: Plan Payments vs. Hypothetical Liquidation.
13 See §§ 111.1 [ “Value, As of the Effective Date of the Plan” Means Interest ] § 77.1 “Value, As of the Effective Date of the Plan” Means Interest and 112.1 [ Interest Rate Anarchy: Present Value Before Till ] § 77.2 Interest Rate Anarchy: Present Value before Till.
14 This 14% discount rate is approximate because the discounted present value of a stream of payments totaling $3,000 will vary depending on when payments are made and in what amount.
15 Several cases mention interest rates or discount rates without discussion or analysis. See, e.g., In re Rivera, 116 B.R. 17 (Bankr. D.P.R. 1990) (interest from the date of the filing at the Puerto Rico legal rate); In re Hieb, 88 B.R. 1019 (Bankr. D.S.D. 1988) (discount rate of 12% per annum).
16 See §§ 111.1 [ “Value, As of the Effective Date of the Plan” Means Interest ] § 77.1 “Value, As of the Effective Date of the Plan” Means Interest and 112.1 [ Interest Rate Anarchy: Present Value Before Till ] § 77.2 Interest Rate Anarchy: Present Value before Till.
17 220 B.R. 94 (B.A.P. 9th Cir. 1998).
18 220 B.R. at 100–101.