§ 89.7 — Based on the Size of the Claim

Revised: June 7, 2004

[1]

Perhaps borrowing from Chapter 11 practice, it has occurred to some debtors’ lawyers to classify unsecured claim holders based on the dollar amount of each claim. For example, the Bankruptcy Court for the Eastern District of Tennessee upheld a classification paying 100 percent of unsecured claims up to $500 and 10 percent of claims in excess of $500.1 The effect of the classification was to disadvantage all claim holders with claims in excess of $500. The court found this discrimination was not unfair because the debtors’ payments were as large as they could afford, unsecured claim holders would get nothing in a Chapter 7 case, and a pro rata distribution would actually reduce the percentage of repayment to all creditors, including the objecting creditor.

[2]

A similar classification based on the size of claims was rejected by the Bankruptcy Court for the District of North Dakota when the debtor proposed to pay 100 percent of unsecured claims of $1,000 or less and 10 percent of unsecured claims exceeding $1,000.2 When the debtor’s financial condition was so poor that the debtor could not afford to pay a significant portion of any unsecured claim, one court concluded that a classification based on the size of claims was fair because “the amount that each of the [creditors will be paid] is so small, both in dollar amount and as a percentage, as to make the disparity between them inconsequential.”3

[3]

A classification based on dollar amount appeals to debtors with a large number of small unsecured claims. A classification based on amount typically has the effect of paying in full all but the largest claims. If there are a few large unsecured claims, a single class of unsecured claims results in a less satisfying small(er) percentage repayment of each claim. The holders of smaller claims like classification based on size because it almost always produces a higher dividend than pro rata distribution. But from the standpoint of the disadvantaged (larger) claim holder, almost any classification based on amount is unfair.

[4]

The Code specifically authorizes classification of unsecured claims based on amount for administrative convenience. 11 U.S.C. § 1322(b)(1) cross-references § 1122; in a Chapter 11 case, § 1122(b) provides: “A plan may designate a separate class of claims consisting only of every unsecured claim that is less than or reduced to an amount that the court approves as reasonable and necessary for administrative convenience.”4

[5]

It is not obvious what meaning to give administrative convenience under § 1122(b) for purposes of the unfair discrimination test in § 1322(b)(1). An administrative convenience class has some meaning in Chapter 11 cases when hundreds or thousands of smaller unsecured claim holders can be bundled for representation and distribution purposes. Administrative convenience has been considered by some bankruptcy courts as a factor bearing on the good faith of Chapter 13 plans at confirmation under § 1325(a)(3).5 The simple cross-reference to § 1122 does not suggest that administrative convenience is a per se exception to the unfair- discrimination test that follows immediately in § 1322(b)(1). The Chapter 13 trustee’s offices in most districts are sophisticated and fully computerized. It would be difficult to demonstrate administrative convenience for a classification of claims based on amount absent truly extraordinary facts.

[6]

The administrative convenience cross-reference in § 1322(b)(1) may be more a historical artifact than a useful argument in favor of classification based on amount. There are few reported decisions supporting administrative convenience as the basis for separate classification in Chapter 13 cases.6


 

1  In re Ratledge, 31 B.R. 897 (Bankr. E.D. Tenn. 1983). See In re Terry, 78 B.R. 171, 174 (Bankr. E.D. Tenn. 1987) (Court confirms plan providing payment on nonpriority unsecured claims in full up to $1,000 and 10% on any excess over objection of only unsecured claim holder with claim larger than $1,000. Case shows careful application of In re Kovich, 4 B.R. 403 (Bankr. W.D. Mich. 1980), four-part test. Method of classification is allowable if better treatment of a class of claims is necessary for the debtor to carry out the plan or may facilitate the debtor’s performance of the plan, but the classification need not be “absolutely necessary.” Debtor must demonstrate that the degree of discrimination is justified. That the objecting creditor will receive 23% of its claim rather than 37% under a pro rata distribution is not controlling. Discrimination against objecting creditor is not unfair in light of the purpose of the discrimination—so that “local creditors with whom [the debtors] might deal in the future will be paid in full.”).

 

2  In re Mielke, 39 B.R. 556 (Bankr. D.N.D. 1984).

 

3  In re Chapman, 51 B.R. 663 (Bankr. D.D.C. 1985).

 

4  11 U.S.C. § 1122(b).

 

5  See § 179.3 [ Burden of Administration ] § 104.4  Burden of Administration.

 

6  See, e.g., In re Iacovoni, 2 B.R. 256 (Bankr. D. Utah 1980) (Classification of unsecured claims based solely on amount is allowable if reasonable and necessary for administrative convenience.).