§ 101.1 — What Do Unsecured Creditors Get?
Revised: March 28, 2006
Under pre-BAPCPA law, there was a certain logic about what unsecured creditors could expect as distributions under a Chapter 13 plan.1 Somewhat oversimplified, on the asset side, unsecured creditors were entitled to receive the present value of what unsecured creditors would be paid in a hypothetical Chapter 7 case if the debtor’s assets were collected and liquidated (net of exemptions)—the so-called best-interests-of-creditors test.2 On the income side, Chapter 13 trustees policed the disposable income test in § 1325(b) so that debtors were required to pay all projected income after deduction of reasonable and necessary expenses for at least 36 months.3 The disposable income test was based on the best information available at the time of confirmation with respect to the actual income and expenses of the debtor. The maximum that creditors could demand from Chapter 13 debtors was marked by the feasibility test in § 1325(a)(6): the debtor must be able to make the payments proposed by the plan based on financial circumstances at the time of confirmation.4
BAPCPA pulls the props from under two of these three standards for ensuring the rights of unsecured creditors in Chapter 13 cases. With respect to assets, except for the exotic case in which the debtor has homestead equity in excess of $125,000 or in which the debtor has committed crimes or made fraudulent conveyances over a period of years,5 BAPCPA increases the exclusions from property of the estate, reducing the amount that would be available for unsecured creditors in a hypothetical liquidation.6 This is particularly true for debtors with employee benefits such as retirement accounts and health care accounts.
The impact of BAPCPA on distributions to unsecured creditors in Chapter 13 cases is even more pronounced with respect to income issues. For all Chapter 13 debtors, the substitution of current monthly income (CMI) for the pre-BAPCPA evaluation of the debtor’s actual income means that Chapter 13 trustees and unsecured creditors have less leverage at confirmation to require debtors to account for and commit income to payments under the plan. Ironically, this loss of leverage amplifies for wealthier Chapter 13 debtors with CMI greater than applicable median family income. For over-median-income Chapter 13 debtors, “amounts reasonably necessary to be expended—” are determined by a statutory formula that substitutes for the policing function exercised by the Chapter 13 trustee. Without that oversight, the expenses of Chapter 13 debtors with CMI greater than applicable median family income will exhaust a greater portion of CMI than would be allowed by Chapter 13 trustees under the pre-BAPCPA reasonable and necessary test.
Specific examples of how unsecured creditors are likely to suffer under BAPCPA are easily collected. Before BAPCPA, Chapter 13 trustees routinely litigated the extent to which Chapter 13 debtors could exempt pension funds, private retirement accounts, IRAs and the like.7 After BAPCPA, the value of most retirement assets will be unreachable in any individual bankruptcy case. The same will be true for education IRAs and for funds used to purchase tuition credits or contributed to a state tuition program.8
On the income side, there is a double whammy for unsecured creditors. Because the CMI calculation in § 101(10A) is an average of the six months before the month in which the Chapter 13 petition is filed,9 CMI will routinely overestimate the financial ability of some Chapter 13 debtors and underestimate the financial ability of other Chapter 13 debtors. If the debtor has recently lost a well-paying job, CMI will overestimate the amount of income available to fund a plan. If CMI is substantially higher than the debtor’s actual income at confirmation, the feasibility test in § 1325(a)(6) will prevent confirmation of a plan.
On the other hand, if the debtor’s income is improving at the time of confirmation, CMI is still based on the historical six-month average before the petition and the debtor’s actual financial ability to fund a plan may exceed the amount required to satisfy unsecured creditors under the disposable income test as reworked by BAPCPA. The trustee or an allowed unsecured claim holder will be in the awkward position of arguing that some other provision of the Bankruptcy Code requires the debtor to make a greater commitment than the disposable income test.
The second part of the double whammy is the way expenses and priority claims are paid after BAPCPA. In all Chapter 13 cases, to determine disposable income, CMI is reduced by child support, foster care and disability payments, amounts required to repay pension loans and contributions withheld or received by an employer for a retirement plan.10 Before BAPCPA, these amounts were not deducted from income to determine disposable income available for distributions under the plan.
On the expense side, things get even darker. BAPCPA increased the kinds and amounts of debts that will be entitled to priority and full payment ahead of general unsecured creditors in a Chapter 13 case. The class of taxes entitled to priority was enlarged.11 The definition of domestic support obligation (DSO) was enlarged, creating a larger class of alimony, maintenance and support debts that must be paid in full—with postpetition interest—to accomplish confirmation.12 New debts such as claims for personal injury or death resulting from the debtor’s operation of a motor vehicle while intoxicated were added to the list of priority claims that must be paid in full.
Absent consent of the priority claim holder, in any case in which the debtor cannot pay all unsecured claims in full, these new and enlarged priority claims will be separately classified for full payment. The pool remaining for general unsecured creditors will be reduced accordingly.
This reduction of available funds in favor of priority claims is even more pronounced because of the way BAPCPA calculates disposable income. When the debtor has CMI greater than applicable median family income, § 707(b)(2)(A)(iv) reduces CMI by 1/60th of the total of all debts entitled to priority.13 In effect, the money necessary to pay priority claims in full is deducted from CMI within the disposable income calculation before the amount available for payment to general unsecured creditors is calculated. The over-median-income debtor pays a DUI claim with the unsecured creditors’ money and can confirm a plan so long as there is enough future income to pay the DUI claim in full, without regard to whether the general unsecureds are left anything. Substitute “taxes” and “DSO claims” for the DUI debt in that sentence and it is clear that BAPCPA pushes the general unsecureds further into the bottom of the available income pool.
The math gets even stranger. Because of the way § 707(b)(2)(A) is constructed, 1/60th of the total of all priority debts comes out of the debtor’s CMI before disposable income is determined for a debtor with CMI greater than applicable median family income. The reduced amount of CMI is then multiplied by the applicable commitment period to determine the amount of disposable income that must be applied to unsecured debt under the plan.14 But after confirmation, priority claims such as taxes, DSOs and DWIs are unsecured debts that will be paid from the disposable income just determined. In other words, when the debtor has CMI greater than median family income, disposable income—the amount that is multiplied by the commitment period to determine what unsecured creditors must be paid—is first reduced by priority debt, and then priority debt is paid from the balance before nonpriority, unsecured creditors get the first cent. This may not be a logical distribution scheme, but it is the way new § 1325(b) works.
On a smaller scale, similar things will happen with respect to debtors with CMI less than applicable median family income. For under-median-income debtors, CMI is reduced by “amounts reasonably necessary to be expended—,” and included in that reduction is a DSO that “first becomes payable after the date the petition is filed.”15 This means that DSOs that first become payable after the petition are taken out of CMI to determine disposable income for a debtor with CMI less than applicable median family income.
That reduced CMI amount is then multiplied by the applicable commitment period to determine the amount that must be applied to make payments to unsecured creditors under the plan.16 Once again, DSO claims will be unsecured claims that share in the pool that has already been reduced to reflect DSOs that first become payable after the petition. This double reduction for a portion of the DSO claims is written into the statute by BAPCPA.
Some folks will undoubtedly say that the drafters of BAPCPA couldn’t have intended to allow Chapter 13 debtors to account for priority claims as a reduction in CMI and then to pay those same priority claims from the resulting reduced pool of money available for unsecured creditors. On the other hand, this is hardly the only reduction in CMI that is not logical if the goal was to maximize the money available to pay general unsecured claims. Don’t forget the statutory reduction of CMI for all scheduled contractually due secured debts when the debtor has CMI greater than applicable median family income.17 Chapter 13 debtors with CMI greater than applicable median family income are instructed by BAPCPA to reduce CMI by the 60-month average of all contractually due secured debts without regard to whether those debts will actually be paid through the Chapter 13 plan. The over-median-income debtor is required to reduce the pool of money available for unsecured creditors by the amount of scheduled contractually due secured debt even if the debtor has no intention of actually paying that secured debt through the plan.
For example, if the debtor owes $10,000 secured by a $10,000 car, that $10,000, plus interest, fees and costs contractually due during the 60-month commitment period is divided by 60 and subtracted from CMI before arriving at disposable income. The $10,000 reduces the pool of money available for unsecured debts. If the debtor surrenders the car through the plan, the $10,000 does not miraculously reappear in the calculation of what general unsecured creditors will get. Instead, the debtor keeps the $10,000, and unsecured creditors receive no part through the new disposable income test.
Under pre-BAPCPA law, when a secured claim provided for by the plan was paid in full in less than the 36-month minimum required by § 1325(b), the money that was being paid each month on account of that secured claim would then become available for distribution to unsecured creditors under the plan. Chapter 13 trustees would be aware of this circumstance at confirmation and would insist that unsecured creditors get their fair share when a secured claim was retired. Because the plan worked “backward” from the actual budget, under pre-BAPCPA law, the trustee could calculate quite precisely when allowed secured claims would be paid off and, accordingly, how much money would be available for unsecured creditors.
BAPCPA explodes all those possibilities because the entitlement of unsecured creditors under § 1325(b) is now determined based on a mathematical formula that does not reflect either the actual financial circumstances of the debtor at confirmation or the terms of the proposed plan. The result is that Chapter 13 trustees are disabled to argue that the entitlement of unsecured creditors exceeds the amount produced by the formula in § 1325(b).
Add to this discussion that BAPCPA has increased the entitlement of some secured creditors at the expense of distributions to unsecured creditors. For example, purchase money car claims incurred within 910 days of a Chapter 13 petition and debts secured by any other property incurred within one year of the petition will often be entitled to special treatment under the hanging sentence at the end of § 1325(a).18 By some interpretations, the BAPCPA amendments to § 1325(a)(5) will require Chapter 13 debtors to pay 910-day PMSI car claims and lienholders with debts incurred within one year of bankruptcy more than they were entitled to under pre-BAPCPA law. It is not that BAPCPA creates more income to be distributed to creditors in Chapter 13 cases; BAPCPA simply changed the distribution scheme to favor some secured creditors over other creditors at confirmation. The inevitable result will be that those lienholders favored by BAPCPA will get more money and unsecured creditors will get less.
There is likely to be painfully disparate treatment of unsecured debt in Chapter 13 cases depending on whether the debtors have CMI less than applicable median family income or greater than applicable median family income. In the example above, for the debtor with CMI less than applicable median family income, if the plan proposes to surrender the car, it is almost unimaginable that the Chapter 13 trustee would allow the debtor to keep the income that would otherwise have been used to pay the car lender through the plan. The Chapter 13 trustee will insist that it is not reasonable or necessary for the debtor to expend that money on a car that the plan proposes to surrender to the car lender. Over the life of the plan, the $10,000 (plus) that would have been paid to the car lender will be dragged back into the debtor’s disposable income and will be applied to payments to unsecured creditors under the plan.
For the Chapter 13 debtor with CMI greater than applicable median family income, the $10,000 comes out of CMI as part of the mathematical calculation in § 707(b)(2)(A), and it is beyond the Chapter 13 trustee’s reach even if the plan proposes to surrender the car. This is a strange outcome. By the happenstance that the debtor has higher CMI, the debtor gets to withhold from the general unsecured creditors $10,000 that a less wealthy debtor would be forced to apply to unsecured debt under a plan.
Something similar happens with respect to the accounting for a DSO that is assigned to a governmental unit under § 507(a)(1)(B). Detailed elsewhere,19 a DSO claim assigned to a governmental unit under § 507(a)(1)(B) is a priority debt that would ordinarily be entitled to payment in full through the Chapter 13 plan. Under new § 1322(b)(4), if the plan provides that all the debtor’s projected disposable income for a five-year period will be applied to make payments under the plan, the debtor can pay less than full payment of a claim entitled to priority under § 507(a)(1)(B).20 For a Chapter 13 debtor with CMI less than applicable median family income, if the plan proposes to pay a DSO assigned to a governmental unit under § 507(a)(1)(B) less than full payment, you can rest assured that the Chapter 13 trustee will capture any savings for payment to other unsecured claim holders. But when the debtor has CMI greater than applicable median family income, the entire amount of the DSO assigned to a governmental unit under § 507(a)(1)(B) is divided by 60 and subtracted from CMI before disposable income is determined under § 1325(b). If the plan then separately classifies the DSO assigned to a governmental unit for less than full payment, the difference does not spring back into CMI—it simply remains in the debtor’s hands under BAPCPA.
There is a more basic consequence of the use of mathematical formulas in BAPCPA that will reduce payments to general unsecured creditors and probably befuddle the bankruptcy courts for years to come. Because the applicable commitment period under § 1325(b)(4) is just a number used in the disposable income test calculation and not a statement of how long the Chapter 13 plan must last,21 it is quite likely that many Chapter 13 plans—especially for debtors with CMI greater than applicable median family income—will be paid in full in relatively few months after confirmation. Under pre-BAPCPA law, the disposable income calculation was based on the debtor’s actual income at confirmation, and earlier payoff could occur if creditors neglected to file claims or if the debtor realized a new source of income after confirmation. Chapter 13 debtors occasionally pay off Chapter 13 plans more quickly than expected from selling assets, using exempt assets or refinancing a house that has appreciated or in the especially unusual case when the debtor’s income increases substantially after confirmation.22 But as a general rule, under pre-BAPCPA law, projected disposable income fairly accurately reflected the financial resources available to the debtor after confirmation and debtors generally needed the full projected length of the plan to meet the confirmation requirement that all projected disposable income be paid to creditors for at least 36 months.
BAPCPA rewired the disposable income test to disconnect from actual income the amount that must be applied to unsecured creditors. A fair number of debtors are likely to have more actual income available than the plan will require to be paid to creditors. Because the difference between actual income and disposable income based on the artificial CMI calculation is not captured for general unsecured creditors by any provision of the Code, debtors will have more opportunities to cash out their plans from income.
Chapter 13 trustees and perhaps unsecured creditors will look for theories to force debtors with actual income greater than the disposable income test reveals to pay that extra income to unsecured creditors. Reminiscent of pre-1984 practice, trustees will argue lack of good faith under § 1325(a)(3) when the Chapter 13 debtor has more income available to pay unsecured creditors than the Bankruptcy Code requires the debtor to pay to unsecured creditors.23 Ironically, it will be debtors who argue that the comprehensive statutory statement in § 1325(b) of the amount of income that must be applied to payment of unsecured debts is not appropriately enlarged by an expansive (new) interpretation of the good-faith requirement for confirmation. And it is reasonable to ask, how can it be “bad faith” for an over-median-income debtor to twice account for priority debts when the statute requires the debtor to do exactly that?
Another odd feature of the treatment of unsecured creditors by BAPCPA is the distinct possibility that some Chapter 13 debtors will strive to have CMI greater than applicable median family income to take advantage of the guaranteed statutory exclusions and reductions of CMI under § 707(b)(2)(A) and (B). It will be especially interesting to watch Chapter 13 trustees and allowed unsecured claim holders argue that a Chapter 13 debtor has less income than the debtor claims to have.
Perhaps the drafters of BAPCPA have created a new paradigm for consumer debtors. Debtors with CMI greater than applicable median family income avoid the possibility of abuse litigation under § 707(b) by filing a Chapter 13 case in the first instance. Once in Chapter 13, by maximizing the statutory reductions and exclusions in § 707(b)(2)(A) and (B), the debtor exhausts most or all CMI, leaving little or nothing that must be applied to payment of unsecured debt under the disposable income test. The plan proposes to pay secured debts as necessary to keep collateral that the debtor wants, and those secured debts are paid in full relatively painlessly in two or three years after confirmation. At that point, all the payments required by the confirmed plan have been made and the debtor is entitled to a discharge.
What happened to unsecured creditors in this discussion? The question is best addressed to those who drafted BAPCPA.
Will Chapter 13 trustees and unsecured claim holders fight back? When the mathematics of BAPCPA at confirmation allows confirmation of a plan that pays little or nothing to unsecured claim holders and allows the debtor to complete payments in two or three years or less, will trustees and creditors file motions to amend to require the debtor to pay more and longer to unsecured creditors?24 There will be many interesting arguments whether modification after confirmation provides unsecured claim holders greater leverage when the only circumstance that has changed is that BAPCPA stacked the deck against general unsecured claim holders at confirmation.
1 See § 86.1 In General.
2 See discussion beginning at § 90.1 In General: Plan Payments vs. Hypothetical Liquidation.
3 See discussion beginning at § 91.1 In General.
4 See § 198.1 [ Able to Make Payments and Comply with Plan ] § 111.1 Able to Make Payments and Comply with Plan.
5 See § 407.1 [ New Exemptions and New Exemption Limitations ] § 48.3 Exemptions and Exemption Limitations Added by BAPCPA.
6 See §§ 403.1 [ Property of the Chapter 13 Estate—New Ins and Outs ] § 46.2 Property of the Chapter 13 Estate—Changes by BAPCPA and 464.1 [ New Exclusions and Exemptions ] § 90.3 Exclusions and Exemptions after BAPCPA.
7 See § 49.1 [ Available and Important in Chapter 13 Cases ] § 48.1 Available and Important in Chapter 13 Cases.
8 11 U.S.C. § 541(b)(5) and (6), discussed in §§ 407.1 [ New Exemptions and New Exemption Limitations ] § 48.3 Exemptions and Exemption Limitations Added by BAPCPA and 464.1 [ New Exclusions and Exemptions ] § 90.3 Exclusions and Exemptions after BAPCPA.
9 See 11 U.S.C. § 101(10A), discussed in §§ 379.1 [ Form B22C: Statement of Current Monthly Income ] § 36.19 Form 122C-1: Statement of Current Monthly Income and 468.1 [ Current Monthly Income: The Baseline ] § 92.3 Current Monthly Income: The Baseline.
10 See §§ 490.1 [ Child Support, Foster Care and Disability Payments ] § 99.3 Child Support, Foster Care and Disability Payments, 491.1 [ Pension Loan Repayments ] § 99.4 Pension Loan Repayments and 492.1 [ Employee Benefit Plan Contributions ] § 99.5 Employee Benefit Plan Contributions.
11 See § 513.1 [ Taxes ] § 136.3 Taxes after BAPCPA.
12 See § 519.1 [ Domestic Support Obligations ] § 136.21 Domestic Support Obligations after BAPCPA.
13 See 11 U.S.C. § 707(b)(2)(A)(iv), discussed in § 486.1 [ Total Priority Debts and Divide by 60 ] § 97.1 Total Priority Debts and Divide by 60.
14 See 11 U.S.C. § 1325(b)(1)(B).
15 11 U.S.C. § 1325(b)(2)(A)(i), discussed in § 470.1 [ Section 1325(b)(2)(A) and (B): “Amounts Reasonably Necessary to Be Expended—” When CMI Is Less Than Applicable Median Family Income ] § 93.1 Section 1325(b)(2)(A) and (B): “Amounts Reasonably Necessary to Be Expended—” When CMI Is Less Than Median Family Income.
16 See 11 U.S.C. § 1325(b)(1)(B).
17 See 11 U.S.C. § 707(b)(2)(A)(iii), discussed in § 485.1 [ Average Monthly Payments on Account of Secured Debts ] § 96.1 Average Monthly Payments on Account of Secured Debts.
18 See 11 U.S.C. § 1325(a), discussed beginning at § 75.1 In General: Modification Without § 506.
19 See § 458.1 [ Domestic Support Obligations Assigned or Payable to Government: § 1322(a)(4) ] § 88.5 Domestic Support Obligations Assigned or Payable to Government: § 1322(a)(4) after BAPCPA.
20 See 11 U.S.C. § 1322(b)(4), discussed in § 458.1 [ Domestic Support Obligations Assigned or Payable to Government: § 1322(a)(4) ] § 88.5 Domestic Support Obligations Assigned or Payable to Government: § 1322(a)(4) after BAPCPA.
21 See 11 U.S.C. § 1325(b)(4), discussed in § 493.1 [ Applicable Commitment Period Calculation ] § 100.1 Applicable Commitment Period Calculation.
22 See §§ 263.1 [ To Sell or Refinance Property of the Estate ] § 127.6 To Sell or Refinance Property of the Estate, 267.1 [ To Account for Payments Other Than under the Plan ] § 127.10 To Account for Payments Other Than under the Plan and 268.1 [ To Extend or Reduce the Time for Payments ] § 127.11 To Extend or Reduce the Time for Payments.
23 See § 193.1 [ Economic Components of Good Faith—In General ] § 108.1 Economic Components of Good Faith—In General.
24 See 11 U.S.C. § 1329, discussed in § 506.1 [ Modification after Confirmation after BAPCPA ] § 126.6 Modification after Confirmation after BAPCPA.