§ 91.1     In General
Cite as:    Keith M. Lundin, Lundin On Chapter 13, § 91.1, at ¶ ____, LundinOnChapter13.com (last visited __________).
[1]

In 1984, Congress added § 1325(b) to the Code. Often called the “disposable income test,” this section prohibits confirmation of a Chapter 13 plan over the objection of the trustee or the holder of an allowed unsecured claim unless one of two conditions is met: (1) “the value of the property to be distributed under the plan on account of such claim is not less than the amount of such claim,” or (2) “the plan provides that all of the debtor’s projected disposable income to be received in the three-year period beginning on the date that the first payment is due under the plan will be applied to make payments under the plan.”1

[2]

At some risk of oversimplification, the projected disposable income test is satisfied if the objecting creditor is paid in full through the plan or if the plan provides that the debtor will contribute all projected disposable income for at least three years. Section 1325(b) added many new terms of art and has spawned a tremendous amount of litigation. It was intended to be an economic test of the debtor’s efforts. Upon objection, the debtor must make a “best effort,” defined as commitment of all projected income in excess of reasonable and necessary expenses for at least three years. Enactment of the section had the side effect of altering application of the good-faith test for confirmation in § 1325(a)(3), especially in jurisdictions that included economic components in the good-faith calculus.2

[3]

The disposable income test in § 1325(b) functions independently of the best-interests-of-creditors test in § 1325(a)(4)3—the plan must satisfy both tests to accomplish confirmation.4 Often the disposable income test requires greater payments to creditors than the best-interests-of-creditors test standing alone.

[4]

Section 1325(b) is applicable only upon objection to confirmation by the Chapter 13 trustee or by “the holder of an allowed unsecured claim.”5 It has been said that a Chapter 13 plan need not commit all disposable income to payments in the absence of an objection to confirmation by the trustee or an allowed unsecured claim holder.6 In many jurisdictions, the Chapter 13 trustee polices compliance with § 1325(b) and objects to confirmation if not satisfied that the debtor has committed all projected disposable income for the minimum three-year period. In other jurisdictions, unsecured creditors act as the enforcers and must file a timely written objection to invoke the test. On its face, § 1325(b) does not contemplate disposable-income-test objections by the court;7 the reported decisions reveal that some courts are unable to resist the temptation to apply the test even in the absence of an objection.8

[5]

The objecting creditor must hold an allowed unsecured claim. An unsecured claim holder that has not filed a proof of claim or whose claim has drawn an objection is not the holder of an allowed unsecured claim and lacks standing to invoke § 1325(b).9 An allowed partially secured claim holder—a claimant that holds a secured and an unsecured claim because the value of its collateral is less than the amount of its claim—is the holder of an allowed unsecured claim with standing to raise a § 1325(b)(1) objection.10

[6]

Although it is generally held that the burden of proof at a confirmation hearing is on the debtor to persuade the court that the conditions for confirmation are satisfied,11 because § 1325(b) applies only upon objection from the trustee or the holder of an allowed unsecured claim, some courts shift the burden of proof with respect to going forward with the evidence. It has been held that the creditor that files an objection to confirmation based on the disposable income test in § 1325(b) “bears the initial burden of producing evidence that the plan does not pay unsecured claims in full and that it does not require the debtor to devote all of his disposable income to the plan over its term.”12 After the objecting creditor satisfies this initial burden, the ultimate burden of persuasion rests with the debtor to prove satisfaction of the test.

[7]

Section 1325(b) seems to be worded mandatorily: the “court may not approve the plan unless . . .13 However, the word “may” has been interpreted to render the disposable income test discretionary and to allow the bankruptcy court to confirm a Chapter 13 plan even though the plan fails to satisfy § 1325(b).14 There is some logic to this holding because § 1325(a) is worded that “the court shall confirm a plan if . . .”15 This difference in language suggests that § 1325(a) is mandatory and § 1325(b), the disposable income test, is permissive or discretionary.

[8]

But further analysis of the Code does not support this construction of § 1325(b). Section 102 contains general rules of construction. Section 102(4) states that the phrase “may not” is “prohibitive, and not permissive.”16 The rule of construction in § 102(4) would read the phrase “may not approve” in § 1325(b) to prohibit confirmation, without discretion, of any plan that fails the disposable income test. Nothing in the legislative history to § 1325(b) or to § 102(4) suggests that the disposable income test was intended to be discretionary or permissive.17

[9]

The disposable income test will often determine the minimum amount that the debtor must pay into the plan to accomplish confirmation. If the liquidation value of the estate in a hypothetical Chapter 7 case would be zero so that the best-interests-of-creditors test in § 1325(a)(4) would not require any payment to unsecured claim holders,18 then the disposable income test will define the minimum amount that must be paid to unsecured claim holders. If the debtor has no disposable income after deduction of reasonable and necessary expenses,19 the test is satisfied without a commitment from the debtor to pay unsecured claim holders any more than they would receive in a hypothetical liquidation under § 1325(a)(4). The disposable income test is satisfied when the debtor’s proposed monthly payment under the plan leaves the debtor with a negative disposable income.20 However, feasibility problems are then indicated.21

[10]

Interesting questions are presented when the debtor has sufficient disposable income to more than pay unsecured claim holders in full through the plan. Imagine a debtor who proposes to pay unsecured claims in full in three years, and the payment necessary to accomplish full payment leaves the debtor with excess disposable income. Does § 1325(b) require the debtor to pay unsecured claims in fewer than three years if the debtor has sufficient disposable income to do so? Must the debtor pay interest to unsecured claim holders if the debtor could retire all claims with interest in three years or less?

[11]

Some courts have concluded that the disposable income test requires the payment of interest if the debtor could pay unsecured claim holders in full in fewer than three years.22 Other courts disagree, concluding that a Chapter 13 debtor need not pay interest when the plan proposes to pay unsecured claims in full in 36 months or less, notwithstanding that the budget shows excess disposable income not committed to plan payments during the three years following confirmation.23

[12]

Section 1325(b) is not a model of clarity with respect to interest and the disposable income test. The first sentence of § 1325(b)(1) contains the magic present value phrase “as of the effective date of the plan.”24 It could be argued that “as of the effective date of the plan” applies to both subsections (b)(1)(A) and (b)(1)(B); however, the effective date language makes little sense as a predicate to subsection (b)(1)(B). More logically, the effective date language modifies only “value of the property to be distributed under the plan” in subsection (b)(1)(A). As discussed below,25 when a Chapter 13 debtor proposes to satisfy the disposable income test by paying claim holders in full under § 1325(b)(1)(A), “as of the effective date” requires present value, typically in the form of interest.

[13]

Even if the effective date language in § 1325(b)(1) modifies only subsection (b)(1)(A), it can still be argued that interest is payable to unsecured claim holders to satisfy the disposable income test whenever the debtor proposes to pay unsecured claims in full. Maybe the issue is best restated as, under which subsection of § 1325(b)(1) is the debtor proceeding? If the plan proposes to pay unsecured claim holders in full but without interest and if the budget shows that the plan does not exhaust projected disposable income during the three-year period described in subsection (b)(1)(B), then the debtor can only satisfy the disposable income test under subsection (b)(1)(A), not under subsection (b)(1)(B). Any Chapter 13 plan that does not apply all projected disposable income to make payments under the plan for the three years described in § 1325(b)(1)(B) cannot be confirmed over objection unless it satisfies the payment in full “as of the effective date of the plan” option in § 1325(b)(1)(A). Any such plan must pay present value (interest) to unsecured claim holders.

[14]

The debtor with excess disposable income might try to overcome a § 1325(b) objection by proposing to pay all disposable income for three years or until all allowed unsecured claims are paid in full without postpetition interest. The debtor will argue that adding the phrase “as of the effective date of the plan” to § 1325(b)(1)(B) leads to a nonsense: what would it mean to require “as of the effective date of the plan” that “the plan provides that all of the debtor’s projected disposable income to be received in the three year period beginning on the date that the first payment is due under the plan will be applied to make payments under the plan”? It is a more obvious use of language to apply the effective date language to only the phrase that appears before the disjunctive “or” in § 1325(b)(1)(A). That there is no phrase similar to “value . . . as of the effective date of the plan” in § 1325(b)(1)(B) is evidence that the disposable income test can be satisfied without the payment of interest even if the debtor’s projected disposable income is sufficient to pay interest.

[15]

If § 1325(b)(1)(B) does not require the payment of postpetition interest, committing to pay all projected disposable income for three years or until unsecured claim holders are paid in full will satisfy § 1325(b)(1)(B) even when the effect is to pay unsecured claims more quickly than three years. Such a plan would mathematically require less money from the debtor than any proposal to pay all allowed unsecured claims in full with interest under § 1325(b)(1)(A). The debtor might point out that the Code elsewhere requires interest to be paid to unsecured claim holders in Chapter 13 cases only when a hypothetical liquidation would pay interest under the best-interests-of-creditors test in § 1325(a)(4).26

[16]

Although § 1325(b)(1)(B) does not mandate the payment of interest, if the debtor has sufficient disposable income to pay unsecured claim holders with interest, then § 1325(b)(1)(A) contemplates that the debtor can elect to satisfy the objection of an allowed unsecured claim holder by payment in full with interest.27 Any such proposal would require classes of unsecured claims and would be subject to the unfair-discrimination test in § 1322(b)(1).28 If the debtor pays interest to all unsecured claim holders, not just to the objecting unsecured claim holder, the plan would present no unfair discrimination for purposes of the classification rules in § 1322(b)(1).

[17]

Calculating projected disposable income, and in particular determining the portion of the debtor’s income that is “not reasonably necessary . . . for the maintenance or support of the debtor or a dependent of the debtor,”29 is a difficult, fact-bound undertaking that requires familiarity with local judges and local practice. The courts are struggling because the disposable income test inevitably involves bankruptcy judges in lifestyle decisions for Chapter 13 debtors.


 

1  11 U.S.C. § 1325(b)(1)(A); (B).

 

2  See discussion beginning at § 108.1  Economic Components of Good Faith—In General.

 

3  See discussion beginning at § 90.1  In General: Plan Payments vs. Hypothetical Liquidation.

 

4  In re Miller, 247 B.R. 795, 797 (Bankr. W.D. Mo. 2000) (That the plan satisfies the disposable income test in § 1325(b)(1) does not suffice to confirm a plan that does not satisfy the best-interests-of-creditors test in § 1325(a)(4). “[T]he mandate of section 1325(a)(4) operates independently of the requirements contained in section 1325(b)(1).”).

 

5  11 U.S.C. § 1325(b)(1).

 

6  See Villanueva v. Dowell (In re Villanueva), 274 B.R. 836 (B.A.P. 9th Cir. 2002) (Absent objection from the trustee or from an allowed unsecured claim holder, § 1325(b) “does not apply.”); In re James, 260 B.R. 498, 514 (Bankr. D. Idaho 2001) (Although a provision requiring all disposable income to be paid to the plan “‘is not mandatory in all circumstances,’” when trustee or allowed unsecured creditor objects to confirmation such a provision must be included: “Due to the absence of a clause in Debtor’s plan providing that all his disposable income will be paid into the plan the Court will deny confirmation for this reason as well.”).

 

7  See § 219.1 [ Standing to Object ] § 116.1  Standing to Object.

 

8  See, e.g., In re Stein, 91 B.R. 796 (Bankr. S.D. Ohio 1988) (Court denies confirmation sua sponte on good-faith grounds because debtor fails to satisfy disposable income test under § 1325(b). Court applied good-faith test because no formal objection had been filed by a party with standing under § 1325(b).).

 

9  See In re Nottingham, 228 B.R. 316 (Bankr. M.D. Fla. 1998) (Surety that filed a claim to which the debtor objected does not hold an allowed unsecured claim and lacks standing to object under § 1325(b).); In re Turpen, 218 B.R. 908, 912 (Bankr. N.D. Iowa 1998) (“Although Comprehensive and the United States are creditors, neither yet has an allowed unsecured claim. Comprehensive’s claim, proof of which has been filed, is not deemed allowed because of the debtors’ objection. . . . The United States has not yet filed a proof of claim. . . . Neither Comprehensive nor the United States is the holder of an allowed unsecured claim whose objection to the plan triggers the disposable income requirement of 11 U.S.C. § 1325(b)(1)(B). Nonetheless, the disposable income issue is before the court in considering debtors’ plan as the objection was made by the standing trustee.”).

 

10  In re Crompton, 73 B.R. 800 (Bankr. E.D. Pa. 1987).

 

11  See § 217.1 [ Burden of Proof ] § 115.3  Burden of Proof for discussion of burden of proof at confirmation.

 

12  In re McGilberry, 298 B.R. 258, 260 (Bankr. M.D. Pa. 2003).

 

13  11 U.S.C. § 1325(b)(1).

 

14  See In re Otero, 48 B.R. 704 (Bankr. E.D. Va. 1985) (Court interprets the phrase “court may not approve” in § 1325(b)(1)(B) to render the disposable income test discretionary.). Accord In re Colon Vazquez, 111 B.R. 19 (Bankr. D.P.R. 1990); In re Schyma, 68 B.R. 52 (Bankr. D. Minn. 1985).

 

15  11 U.S.C. § 1325(a).

 

16  11 U.S.C. § 102(4).

 

17  See H.R. Rep. No. 95-595, at 315–16 (1977) (discussing § 102(4)).

 

18  See § 160.1 [ In General: Plan Payments vs. Hypothetical Liquidation ] § 90.1  In General: Plan Payments vs. Hypothetical Liquidation.

 

19  See § 165.1 [ Reasonably Necessary for Maintenance or Support ] § 91.3  Reasonably Necessary for Maintenance or Support.

 

20  In re Kazzaz, 62 B.R. 308 (Bankr. E.D. Va. 1986).

 

21  See § 198.1 [ Able to Make Payments and Comply with Plan ] § 111.1  Able to Make Payments and Comply with Plan.

 

22  In re Weiss, 251 B.R. 453, 463–64 (Bankr. E.D. Pa. 2000) (“Solvent” Chapter 13 debtor whose projected disposable income for the first three years exceeds the total amount of unsecured debt must either pay all projected disposable income until unsecured claims are paid in full or must pay interest to unsecured claim holders. The debtor’s annual disposable income was $97,837. Over a three-year plan, the debtor could pay $293,511 to unsecured creditors. The only unsecured claim holder, the IRS, had a nondischargeable tax claim of $193,466.17. “[T]he upward limit of what the Debtor must pay in a confirmable Chapter 13 plan is the lower of (1) his disposable income; or (2) all claims against the Debtor which are payable under the Plan. That is because any surplus arising from the Debtor’s solvency or ability to pay more than his debts would simply be returned to him and therefore need not be paid out in the first place. This truism is not recited in any known cases, probably because it is unusual to be confronted—as we are here—with a Chapter 13 debtor whose disposable income exceeds his total debts. . . . [P]ost-petition interest may be awarded to a creditor when a debtor’s estate is solvent. . . . [T]he Debtor may propose a plan which will pay the [IRS] claim in full including such post-petition interest, or he may construct a plan that proposes to devote all of his disposable income [to] the IRS’s claim for a shorter period.”); In re Rhein, 73 B.R. 285 (Bankr. E.D. Mich. 1987) (Section 1325(b)(1)(B) requires denial of confirmation of a 100% plan that omits paying interest on unsecured claims where the plan does not provide that all of the debtor’s disposable income be applied to make payments under the plan for three years.). See In re Brennan, 208 B.R. 448, 454 (Bankr. S.D. Ill. 1997) (In dicta, although debtor need not pay interest on the value of a car that is recovered by the Chapter 13 trustee from an unperfected security interest to satisfy best-interests-of-creditors test, “[t]here may, of course, be instances in which a debtor’s proposed plan payment is sufficient to pay interest on the secured creditor’s claim, and, following avoidance of the creditor’s lien, the debtor would be required to pay the same amount into the estate under the ‘disposable income’ requirement of 11 U.S.C. § 1325(b).” In this case, it was undisputed that the debtor was not able to pay interest.).

 

23  See In re Smith, 196 B.R. 565, 570–71(Bankr. M.D. Fla. 1996) (The disposable income test does not require interest where debtor proposes to pay unsecured claims in full under § 1325(b)(1)(A) notwithstanding that plan does not satisfy 36-month test in § 1325(b)(1)(B). “To evaluate compliance with § 1325(b), the Court must first determine whether the plan proposes to pay the full amount of unsecured claims. The IRS argues that debtor’s plan fails to satisfy this prong of § 1325(b)(1) because the plan does not include the payment of interest on unsecured claims. . . . [T]he IRS argues that because § 1325(b)(1) contains language virtually identical to the phrase ‘value, as of the effective date of the plan,’ the subsection requires the payment of interest to account for the loss of value on deferred payments paid through the plan. . . . The Court finds that sections 1325(a)(4) and (b) should be interpreted consistently. Thus, because interest payments to unsecured creditors are not required under § 1325(a)(4), they should not be required under § 1325(b). Debtor’s plan proposes to pay each unsecured claim in full. Each unsecured creditor will receive the full value of its claim, thus the plan satisfies the full payment requirement of § 1325(b)(1)(A) and an analysis of the disposable income test is unnecessary. . . . [E]ven if it were to employ the disposable income test, the IRS objection would fail. . . . Debtor’s plan proposes to pay to the trustee $2,200 per month for months one through five of the plan and $5,565.07 for months six through sixty. . . . [H]is monthly disposable income for months one through five would be $4,279. After the plan payment, debtor would still have $2,079 of disposable income. For months six through sixty, debtor would have no disposable income because the amount of the proposed plan payment exceeds debtor’s expected $4,279 monthly disposable income. Under this schedule of payment, the debtor’s contribution of his disposable income will ‘balance out’ during the life of the plan.”); In re Eaton, 130 B.R. 74 (Bankr. S.D. Iowa 1991) (Rejecting In re Rhein, 73 B.R. 285 (Bankr. E.D. Mich. 1987) § 1325(b) nowhere contains “present value” language similar to § 1325(a)(4) or § 1325(a)(5). Congress used the phrase “value, as of the effective date of the plan” where it intended that present value be paid. No such language appears in § 1325(b)(1). That the debtors have excess disposable income that could be used to make interest payments to unsecured claim holders or that could be used to retire unsecured claims more quickly than 36 months is not fatal to confirmation under § 1325(b)(1) where the plan provides for 100% payment of unsecured claims in 36 months.).

 

24  11 U.S.C. § 1325(b)(1) reads:

(b)(1) If the trustee or the holder of an allowed unsecured claim objects to the confirmation of the plan, then the court may not approve the plan unless, as of the effective date of the plan—
(A) the value of the property to be distributed under the plan on account of such claim is not less than the amount of such claim; or
(B) the plan provides that all of the debtor’s projected disposable income to be received in the three-year period beginning on the date that the first payment is due under the plan will be applied to make payments under the plan.

 

25  See § 168.1 [ Payment-in-Full Option ] § 91.7  Payment-in-Full Option. See also §§ 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 162.2 [ Discount Rates and Interest If Liquidation Would Produce Dividend ] § 90.5  Discount Rates and Interest If Liquidation Would Produce Dividend.

 

26  See § 162.2 [ Discount Rates and Interest If Liquidation Would Produce Dividend ] § 90.5  Discount Rates and Interest If Liquidation Would Produce Dividend.

 

27  See § 168.1 [ Payment-in-Full Option ] § 91.7  Payment-in-Full Option.

 

28  See §§ 149.1 [ Power to Classify Unsecured Claims: Tests for Unfair Discrimination ] § 87.1  Power to Classify Unsecured Claims: Tests for Unfair Discrimination and 168.1 [ Payment-in-Full Option ] § 91.7  Payment-in-Full Option.

 

29  11 U.S.C. § 1325(b)(2).