§ 123.2 — What to Do If Debtor Defaults
Revised: June 8, 2004
Once a creditor is satisfied that the debtor has defaulted by failing to make payments or by failing to carry out some other provision of the confirmed plan, it is up to the creditor to challenge the debtor’s right to continue in the Chapter 13 case. The first step is more than courtesy: contact the debtor’s attorney. Notwithstanding investigation by the creditor, debtor’s counsel may know something that isn’t obvious from court records or the trustee’s records about why the debtor is in default. That phone call to debtor’s counsel can save everyone a lot of unnecessary expense. Often there will be a benign explanation of the default that doesn’t justify bringing the matter before the court.
It is a violation of the automatic stay to contact the debtor directly about a default in payments under a confirmed plan. One bankruptcy court—frustrated by the high incidence of postconfirmation defaults in payments of home mortgages—published a decision giving mortgage holders permission to give notice of default directly to debtors on the theory there is no harm to this foul.1
When the call to debtor’s counsel doesn’t clear the air, the usual three options for bringing the debtor’s default before the court are a motion for relief from the stay,2 a motion to dismiss3 or a motion for conversion to Chapter 7.4 A fourth and typically less attractive route is a creditor’s motion for modification under § 1329.5 On especially egregious facts, one bankruptcy court voided actions by a debtor that were inconsistent with a confirmed plan, awarded damages and scheduled a hearing on sanctions for contempt of the confirmation order.6
One strategy for a creditor when the debtor has defaulted in payments after confirmation is to piggyback with a motion by the Chapter 13 trustee to dismiss the case. In many jurisdictions, after some fixed period of default—typically 45 to 60 days without full payment from the debtor—the trustee’s computer generates a motion to dismiss for noncompliance. In other jurisdictions, the trustee moves to dismiss only after a default is called to the trustee’s attention by an affected creditor. In a few jurisdictions, the trustee does not make motions to dismiss but relies upon creditors to police defaults. In some jurisdictions, it is the practice that creditor’s counsel drafts and files the motion to dismiss and, with the trustee’s permission, names the trustee as an additional moving party. In other jurisdictions, the Chapter 13 trustee files the motion to dismiss, and creditors are not named as parties to the motion. The creditor that wishes to be a moving party may have to file a separate motion to dismiss.
Strategically, creditors are best advised either to be named as a party to the motion to dismiss or to file a separate motion to dismiss because the interests of the Chapter 13 trustee are not always coextensive with those of an individual creditor. The Chapter 13 trustee may be inclined to settle a motion to dismiss on a basis that would not be acceptable to a creditor. Trustees are often willing to settle a motion to dismiss if the debtor agrees to cure the postconfirmation default through increased future payments or a special contribution, for example, of a tax refund or of a bonus from an employer.
Notice of the hearing on a motion to dismiss or convert can be a problem for creditors.7 It is not the practice in all jurisdictions that all creditors receive notice of the hearing on a motion to dismiss filed by the Chapter 13 trustee or by an individual creditor. Being named as a party in the motion ensures that the creditor will receive notice and be heard at the hearing.
Motions to dismiss Chapter 13 cases for the debtor’s default in payments are scheduled in large numbers on bulky dockets in some jurisdictions. These massive dockets are born of the experience that many of the motions are justified and debtors will either not appear or cannot contest dismissal. Many trustees’ motions to dismiss are settled in advance of the scheduled hearing by agreements allowing the Chapter 13 case to continue on various conditions, typically including a condition that the default be cured in some period of time and conditioned that the case is automatically dismissed if the debtor defaults again. Absent a separate motion by a creditor or joinder of the creditor as a party to the trustee’s motion, creditors may not be aware of a settlement between the trustee and the debtor and may not be aware of conditions on continuation of the case.
Proof of a debtor’s default at the hearing on a motion to dismiss typically focuses on the trustee’s records of receipts from the debtor. Most bankruptcy courts accept the report of receipts and disbursements generated by the trustee’s computer as sufficient evidence of default to shift the burden of proof to the debtor to demonstrate circumstances justifying a second chance. It is almost inevitable in the three- to five-year life of the typical Chapter 13 case that there will be some event—loss of a job, an accident or health disaster—that disables the debtor to make payments under the plan. Often the interruption in payments is temporary, and not blameworthy. Courts are sympathetic to giving Chapter 13 debtors a second chance, particularly if the debtor has already made substantial payments into the plan.
There are circumstances when it is in the best interests of creditors to seek conversion rather than dismissal upon a debtor’s default under the plan.8 If the debtor has assets in excess of exemptions or if the debtor committed prepetition fraudulent conveyances or preferences, conversion to Chapter 7 may be more desirable to a general creditor than dismissal. If there are questionable security interests, an unsecured claim holder’s best hope may be investigation by a Chapter 7 trustee.
Conversion to Chapter 7 is rarely the best remedy for a secured claim holder when a Chapter 13 debtor defaults in payments under a confirmed plan. Conversion to Chapter 7 introduces a Chapter 7 trustee, who is then obligated to microscopically examine all security interests for defects that would support an avoidance action. Conversion to Chapter 7 is likely to delay and increase the expense of action by the secured claim holder to realize upon its collateral.
In cases filed after October 22, 1994, the value of collateral and the allowed amount of secured claims determined during a Chapter 13 case “shall apply” at conversion, reduced by any payments in accordance with the plan.9 Upon conversion, secured claim holders face redemption in the Chapter 7 case at the reduced balance remaining on allowed secured claims.10
In contrast, at dismissal secured claim holders are not limited by values or by the allowance of claims determined during the Chapter 13 case. After dismissal, creditors can proceed against collateral under contract and nonbankruptcy law. Secured claim holders are typically better off with relief from the stay or dismissal of the Chapter 13 case rather than conversion to Chapter 7.
For a secured claim holder interested only in realizing upon its collateral, relief from the stay may be the most desirable procedural mechanism for bringing a debtor’s postconfirmation default before the court. Relief from the stay is specific to the moving creditor and, if granted, allows that creditor to proceed in state court against its collateral without further supervision or interference from a trustee or the bankruptcy court. Relief from the stay is relatively quick because of short statutory time constraints on court action.11 Also, the filing of a request for relief from the stay rather than a motion for conversion or dismissal triggers the 180-day bar to the refiling of a bankruptcy case in § 109(g) in the event of a voluntary dismissal by the debtor.12
An unsecured claim holder is unlikely to be granted relief from the stay based on a debtor’s postconfirmation default. Rather than grant one general creditor a “leg up” on other general creditors, most courts will dismiss or convert.13
1 See In re Martinez, 281 B.R. 883 (Bankr. W.D. Tex. 2002) (In a district where continuing mortgage payments are paid directly by the debtor and in which the plan overcomes the vesting effect of confirmation in § 1327(b), ordinarily a mortgagee must first move for stay relief before contacting the debtor about a postconfirmation default; however, in future cases, because the debtor is not damaged by an informal notice of default after confirmation, mortgagees can give notice of default rather than moving for relief from the stay.).
2 See discussion beginning at § 124.1 Procedure.
3 See discussion beginning at § 152.1 Procedure, Timing and Form.
6 See Providian Nat’l Bank v. Vitt (In re Vitt), 250 B.R. 711, 720–22 (Bankr. D. Colo. 2000) (On complaint of postpetition purchaser, debtor’s sale of property after confirmation in violation of surrender requirement in plan was void under § 105(a), and was an avoidable postpetition transfer under § 549, and the debtor was subject to sanctions. Before confirmation, mortgage holder was granted relief from the stay to foreclose on the debtor’s real property. Confirmed plan required surrender of the same property to the mortgage holder. Debtor sold the property in violation of the confirmation order. Mortgage holder to whom the plan required surrender brought complaint against the debtor and the buyer (Manion). “The Debtor and Manion interfered with—and defeated—the express terms of the Plan. As a result, the Manion Deeds of Trust are void and of no effect . . . . [A] declaratory judgment shall issue holding that the Manion Deeds of Trust are void and that the Plaintiff is the valid holder of a Certificate of Purchase on the property. . . . [T]his Court shall award damages in the principal sum of $39,221.74. . . . [E]ncumbrance of the Property by the Manion Deeds of Trust was a transfer of ‘property of the estate.’ . . . [T]he transfer . . . occurred after the commencement of the case . . . [and was] not authorized by the Code or this Court. As a result, the Manion Deeds of Trust are void pursuant to 11 U.S.C. § 549(a).” The bankruptcy court scheduled a hearing on contempt sanctions against the debtor.).
7 See § 141.2 Conversion on Request of Creditor or Trustee, § 141.4 Cause for Conversion Added or Changed by BAPCPA, § 141.5 Conversion Sua Sponte, § 141.6 Automatic Conversion: The “Drop Dead” Clause, § 152.1 Procedure, Timing and Form, § 152.3 Cause for Dismissal Added or Changed by BAPCPA and § 152.7 Sua Sponte Dismissal.
8 See also §§ 311.2 [ Conversion on Request of Creditor or Trustee ] § 141.2 Conversion on Request of Creditor or Trustee and 336.1 [ Strategic Considerations ] § 152.6 Strategic Considerations.
9 See 11 U.S.C. § 348(f), as amended by Bankruptcy Reform Act of 1994, Pub. L. No. 103-394, § 311, 108 Stat. 4106 (1994). See § 145.3 Lienholders’ Rights at Conversion under § 348(f) after BAPCPA.
12 See § 23.1 [ 11 U.S.C. § 109(g)(2)—Voluntary Dismissal after Request for Relief from Stay ] § 25.3 11 U.S.C. § 109(g)(2)—Voluntary Dismissal after Request for Relief from Stay.
13 But see In re McDaniels, 213 B.R. 197, 201 (Bankr. M.D. Ga. 1997) (On trustee’s motion to dismiss for failure to make payments, court sua sponte grants relief from the stay to all creditors but denies the motion to dismiss. Mortgage holder was granted relief from the stay before the trustee moved to dismiss. Court observes that if the trustee’s motion to dismiss is granted, the mortgage company may be precluded from completing its foreclosure sale before the debtor refiles. Debtor has no intention of making any further payments under the plan, and the court grants relief from the stay to all creditors as an equitable remedy that leaves the case pending but permits the mortgage holder to foreclose. Debtors have “a complete remedy in section 1307(b) wherein Debtor has the absolute right to cause the dismissal of the case. The fact that section 109(g)(2) may attach consequences to the exercise of that remedy which could limit the refiling of a new case does not present to the Court any imperative to construct some other course for Debtors to be dismissed from this case without such consequences.”).