§ 127.5 — To Incur New Debt
Revised: June 9, 2004
A common postconfirmation modification is a motion from the debtor to incur new debt.1 Borrowing after confirmation requires a motion to modify under § 1329 because in most jurisdictions, the plan, the order of confirmation or local rule forbids debtors to incur new debt without court approval. Also, §§ 1305(c) and 1328(d) contemplate that the debtor and the postpetition lender will ask the permission of the trustee before the debtor borrows money.2 Filing a motion to modify to incur new debt is a sure way of either getting the trustee’s permission or determining before the leap that the trustee does not consent—in which case, the borrowing is a really bad idea.
Postpetition borrowing does not neatly fit into the permitted categories of postconfirmation modification in § 1329(a).3 If the new debt would be a postpetition claim under § 13054—for example, necessary medical expenses—then the debtor faces all the problems discussed above5 with respect to modifying the plan to manage a postpetition claim: If the postpetition claim is not allowable under § 1305, § 1329 is of little help in the debtor’s effort to pay the debt through a modified plan. If the new debt is not a § 1305 claim, then there is no obvious authority in the Code to incur the debt, nor would it fit any statutory category for modification of the plan.
Quite commonly, Chapter 13 debtors need to borrow money to replace personal property during the plan. When the debtor’s car expires after confirmation, the appropriate procedure to replace the car is a motion to modify the plan: to dispose of the old car by sale, trade or surrender;6 to incur a new debt for the replacement car; and to make payments on the new car through the modified plan.7 Incurring new debt necessary for performance of the plan typically meets little resistance from the Chapter 13 trustee or from creditors so long as distributions to prepetition claim holders are not affected.
Debtors sometimes purchase homes after confirmation, and this too is appropriately handled as a motion to modify the plan. It is true in some real estate markets that debtors can actually lower their monthly housing costs by buying a modest home rather than continuing to rent. If the debtor is eligible for a subsidized or government-guaranteed purchase, debtors can sometimes buy homes after confirmation and actually improve the family finances. Although a motion to buy a house hardly fits into § 1329(a), such motions are routinely granted without objection, especially when the effect is to reduce expenses. In In re Edwards,8 the court granted the debtor’s postconfirmation motion to incur credit to purchase a home and denied a creditor’s responsive motion to increase payments to unsecured claim holders when the creditor put on no evidence, the debtor’s modification did not change payments to creditors and the debtor proved that a divorce after confirmation justified a new place to live.
A particularly troublesome postconfirmation borrowing is refinancing or incurring new debt to pay off the Chapter 13 plan. Technically, § 1329(a)(2) authorizes modification to “reduce the time” for payments under the plan.9 But § 1329(a) says nothing specific about borrowing money to do so.
Philosophically, many bankruptcy courts and Chapter 13 trustees bridle at the proposition that debtors can park peacefully within the protective shell of a Chapter 13 case until they are financially able to buy a discharge by paying off the plan with a new loan. Sometimes after the claims bar date, because creditors fail to file proofs of claim, the amount necessary to complete the plan can be easily borrowed. The Chapter 13 case becomes a cleansing action to wash out the unfiled claims and restructure the debtor’s finances—not through payments under a plan, but through a “consolidation loan.”
Some courts do not approve refinancings or new borrowings to pay off Chapter 13 plans. Other courts look at how long the debtor has been in Chapter 13, the terms of the new borrowing, changes in the debtor’s financial condition after confirmation and so forth. For example, in In re Martin,10 the confirmed plan required a 10 percent dividend. Two years after confirmation, the debtors proposed to cash out the 10 percent dividend by refinancing their home. The bankruptcy court found that § 1329(a)(2) “contemplates that a debtor can reduce the amount and time for payments under a plan.”11 The court found nothing in the Code that prohibited the proposed prepayment so long as the usual tests for a modified plan were satisfied. The court described the debtors’ cash-out as “simply an anticipatory satisfaction of the obligations under the plan.”12 However, from the evidence presented, the court was not able to determine whether the proposed modification satisfied the disposable income test in § 1325(b) and the best-interests-of-creditors test in § 1325(a)(4).
In In re Easley,13 the debtor proposed to borrow money from parents to accelerate and complete payments under the plan. The court described this modification as beneficial to creditors:
Using money that the Debtor’s parents have agreed to loan him, the Debtor hopes to pay the entire amount that creditors would receive pursuant to the Plan in one single lump sum payment. . . . The Trustee . . . argues that debtors are prohibited from borrowing funds from any third party, related or not, to prepay obligations under a confirmed Chapter 13 plan unless the borrowed funds are used to increase the debtor’s Chapter 13 plan payments. . . . Although the unsecured creditors are only receiving approximately 23% of their claims under the Plan, they would receive the funds quicker and in a single payment and without risking future defaults by the Debtor. Moreover, they would receive a greater return if the Debtor prepaid the amounts rather than merely completed his payments under the Plan due to the increased time value of money. The creditors receive a substantial benefit under the Debtor’s proposal to accelerate payments.14
Postconfirmation modification to incur debt to pay off a plan is more common in districts where real estate is rapidly appreciating, making refinancing and second mortgage money more available. Borrowing the debtor’s exempt equity in a homestead to pay off the Chapter 13 plan buys the debtor a full-payment discharge,15 but the debtor emerges from the Chapter 13 case with a substantial new debt that guarantees something less than a fresh start.
1 See also § 92.1 [ Incurring Debt prior to Confirmation ] § 69.1 Incurring Debt prior to Confirmation for discussion of incurring debt before confirmation.
3 See § 261.1 [ To Provide for Postpetition Claims ] § 127.4 To Provide for Postpetition Claims for discussion of the similar question whether § 1329 permits modification to provide for payment of postpetition claims.
5 See § 261.1 [ To Provide for Postpetition Claims ] § 127.4 To Provide for Postpetition Claims.
6 See §§ 263.1 [ To Sell or Refinance Property of the Estate ] § 127.6 To Sell or Refinance Property of the Estate and 264.1 [ To Surrender Collateral, Account for Repossession or Change the Treatment of a Secured Claim ] § 127.7 To Surrender Collateral, Account for Repossession or Change the Treatment of a Secured Claim.
7 See In re Brown, 170 B.R. 362, 366 (Bankr. S.D. Ohio 1994) (Court grants debtor’s postconfirmation motion to replace nine-year-old car with newer used car and to incur $10,000 of postpetition credit at an interest rate of 25%. “In future cases before this Court, prior to filing postpetition credit motions, debtors’ counsel must know all of the terms and actively participate in aiding the debtor in obtaining the best arrangement possible. . . . It is hoped that debtors’ counsel will actively seek the assistance of the Trustee in locating alternative financing resources at reasonable rates. . . . [I]n the future, where the plan proposes a significant dividend of between seventy and one hundred percent, and there has been a favorable payment history for a significant period (one or two years), this Court will not approve financing arrangements with excessive interest rates.”).
8 190 B.R. 91 (Bankr. M.D. Tenn. 1995).
9 See § 268.1 [ To Extend or Reduce the Time for Payments ] § 127.11 To Extend or Reduce the Time for Payments.
10 232 B.R. 29 (Bankr. D. Mass. 1999).
11 232 B.R. at 34.
12 232 B.R. at 37.
13 205 B.R. 334 (Bankr. M.D. Fla. 1996).
14 205 B.R. at 335–36.