Consumer Bankruptcy Committee

ABI Committee News

The Blind Leading the Blind: Section 1329 and Chapter 13 Modifications

by: O. Max Gardner, III
Law Offices of O. Max Gardner III PC; Shelby, N.C.

The more I look at the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), the more I am beginning to think that we have all been misled by those who either did not know or did not care to know any better.  During the past 20 months, we have been bombarded with questions about whether “projected disposable income” (PDI) is an historic fact or a future prediction.  We have been puzzled and perplexed by Form B22C and disposable income (DI).  We have wondered what Congress really intended when it adopted the IRS expense standards, which the IRS created solely for determining how much a taxpayer could pay in working out offers of compromise for tax debts. Compare In re Hardacre, 338 B.R. 718 (Bankr. N.D. Tex. 2006) (applies both PDI and DI), and In re Jass, 340 B.R. 411 (Bankr. D. Utah 2006) (ignored B22C for substantial drop in income by AMI debtors), with In re Alexander, 344 B.R. 742 (Bank. E.D.N.C. 2006) (the concept of DI as we knew it has changed), and In re Barr, 341 B.R. 181 (Bankr. M.D.N.C. 2006) (an above-median income (AMI) debtor with negative DI on Form B22C could file a good-faith plan paying less than the surplus net monthly income shown on Schedule J).

We have struggled with questions about “current monthly income” to the extent that it is not current, not monthly, and in some cases not even income.  We have wondered whether the “applicable commitment period” is a device for measuring the duration of a plan or a mathematical number to determine the total amount a debtor must repay under the plan.

For all of us who have been sleep walking through this fog of new terms and strange concepts, hold on, because relief may be on the way and the relief may be right in front of us.  In fact, it may just be hiding in §§1329(a)(1), (a)(2) and (a)(3).  It is extremely important to note that not one of these sections was modified or amended by BAPCPA with the sole exception of deleting the “or” at the end of the former subsection (a)(2).  To further compound the matter, since these sections were not amended, not one single provision of the new §1325(b) is incorporated in §1329.  In fact, the only reference to §1325(b) is to subsection (1)(B) in §1329(c).  This section simply provides that if a plan is modified under subsections (a) and (b), then the modified plan may not make payments beyond “the applicable commitment period under §1325(b)(1)(B)” unless the court, for cause, approves a longer period, provided that the court may not approve a period that expires more than five years after the time the first payment was due.

Disequilibrium and status quo “disturbances” arise from §1325(b)(4).  This section provides that in order to determine how a debtor’s projected disposable income is to be disbursed to the unsecured creditors, the court must determine the “applicable commitment period.”  If the debtor’s current monthly income (CMI) is less than the median income, then the commitment period is not less than three years. If the debtor’s CMI is more than the median family income, then the applicable commitment period is not less than five years.  This section then provides that the applicable commitment period may only be less than three or five years if the plan provides for payment in full of all allowed unsecured claims.  In short, if one wants to pay off a three-year plan in two years, then this section appears to require payment of 100 percent of all allowed unsecured claims. 

Does this consequently mean that a chapter 13 debtor must either pay a 100 percent dividend or stay in a plan for not less than 36 or 60 months?  Well (and this is where the smoke and mirrors come in), this is not necessarily what it means.  Under the pre-BAPCPA Code, §1325(b)(1)(B) required that the debtor commit his “disposable income” received for three years to the plan.  Under the old Code, however, there was no specific prohibition against modifying the plan to shorten the three-year period by way of an early pay-off without having to pay 100 percent to the unsecured creditors.  See In re Anderson, 21 F.3d 355 (9th Cir. 1994).

The issues of how long a debtor must stay committed to a chapter 13 plan is not a new issue; in fact, it has been extensively litigated in numerous pre-BAPCPA cases.  One of the first significant cases was In re McKinney, 191 B.R. 866 (Bankr. D. Or. 1966).  The debtor’s confirmed plan in McKinney provided for a 0 percent dividend to the unsecured creditors and the payment of scheduled priority debt of approximately $10,000 to be paid over 36 months.  Id. at 867.  The actual priority claims filed and allowed totaled substantially less than $10,000, and as a result, the debtor was able to complete all plan payments in 12 months.  The trustee responded by filing a §1329 motion to modify the plan to increase the percentage to the unsecured creditors and to require the debtor to continue paying all projected disposable income to the trustee for at least 36 months, as provided by §1325(b)(1).  The bankruptcy judge granted the trustee’s motion and held that the modification of a confirmed plan had occurred because of the initial underestimation of priority claims, and that, upon the objection of the trustee by way of the motion to modify, the court had to look at §1325(b).  More importantly, the court reasoned that while §1325(b) was not directly incorporated into §1329(b), it was “indirectly incorporated therein via its reference in §1325(a).” 

The first signs of serious doubts about this so-called “incorporation” theory arose in Max Recovery Inc. v. Than, 215 B.R. 430 (9th Cir. BAP 1997).  The plan in Than was confirmed, without objection, with terms providing monthly payments of $300 for 38 months or until the plan achieved an 11 percent dividend on those claims. The plan therefore appears to have been a hybrid pot plan.  When filed claims proved to be lower than scheduled, the plan would pay the 11 percent dividend in 32 months instead of 38.  Max Recovery, an unsecured debt buyer, moved under §1325(b) to increase the term of the plan to not less than 36 months.  The bankruptcy court held that §1325(b) was inapplicable and denied the motion.  Id. at 436.   In affirming, the BAP stated that “the Code does not prohibit a plan that is less than 36 months in duration in the absence of any objection by the trustee or a creditor to ‘the confirmation of the plan.’”  Id. at 437, citing §1325(b)(1).  The BAP also noted in passing that §1329(b) does not expressly incorporate §1325(b).  Id. at 434.

The next case-important modification was In re Sounakhene, 249 B.R. 801 (Bankr. S.D. Cal. 2000).  In Sounakhene, the debtors, prior to the expiration of a 37-month plan, refinanced their home mortgage and made a single lump-sum payment to the trustee equal to the aggregate amount of their disposable income over the remaining life of the plan.  The trustee moved to modify the plan to require that payments nonetheless be made for at least 36 months.  The court denied the motion on the ground that the plan was complete when the trustee received the amount required under the plan.  Id. at 804.  The court also specifically held, however, that §1325(b) was not incorporated into §1329 based on a “plain interpretation of the statute.”  Id. at 803.  Rather than applying the so-called disposable-income test, the court determined that the better approach would be to utilize the analysis underlying the disposable-income test in exercising the court’s judgment and discretion.  Id. at 805.  Citing Than, the court stated that “the only limits on modification are those set forth in the language of the Code itself, coupled with the bankruptcy judge’s discretion and good judgment in reviewing the motion to modify.”  Id.  The court also noted that even if §1325(b)(1)(B) did apply, nothing in §1325(b) prohibited a lump-sum payment where no pre-payment discount was requested.

The next significant case was In re Casper, 154 B.R. 243 (N.D. Ill. 1993).  In Casper, as a result of priority claims being allowed in amounts significantly less than scheduled, the debtors were able to complete their 60-month plan in 24 months.  The confirmed plan paid a 10 percent dividend.  The trustee filed a motion to modify the plan to a 60-month term and to increase the dividend from 10 percent to 80 percent.  The bankruptcy court granted the trustee’s motion.  On appeal, the district court reversed, holding that §1325(b)(1)(B) only required the debtors to commit the amount representing their projected disposable-income over three years to the plan.  The district court also clearly stated that §1325(b) does not prohibit the payment of such an amount in less than the prescribed term of the plan.  Id. at 245-46.

Casper was quickly followed by In re Phelps, 149 B.R. 534 (Bankr. N.D. Ill. 1993).  The confirmed plan in Phelps provided for a payment of secured claims in full with a 10 percent dividend to unsecured creditors and monthly payments of $282 for a projected term of 43 months.  Because allowed unsecured claims amounted to significantly less than those scheduled, the plan could be completed in 37 months.  The trustee filed a motion to modify the plan to require a full 43 months of payments.  The court rejected this motion, finding that plan completion occurs when the debtor has paid the percentage owed to each class of creditors as provided for in the confirmed plan.  Id. at 537.  While Phelps did not address the particular issue of §1325(b)’s disposable-income test and the mandatory minimum term of 36 months, its reasoning is instructive in that it interprets “completion of payments” as it is used in §1329(a), i.e., focusing on payment of the required percentage owed rather than on the duration of the plan.

Sections 1329 and 1325 were indirectly addressed by the court in In re Easley, 334 (Bankr. M.D. Fla. 1996).  In Easley, several months after confirmation of a 60-month plan, the debtor filed a §1329 motion to modify the plan by paying the entire amount due from a loan received from his parents.  The trustee objected and argued that any loan proceeds should be used to increase the plan payments and not to modify the plan.  The court agreed with the debtor and granted the motion to modify.  The court held that nothing in §1329 prohibited the debtor from borrowing money to pay his existing creditors early.  The court reasoned that the debtor was merely “substituting one set of creditors, his parents, for his former set of creditors addressed in the plan.”  Id. at 335.

The court in Forbes, 215 B.R. 183 (8th Cir. BAP 1997) directly addressed the §§1325 and 1329 issue.  After 36 months of a 60-month plan, the debtor in Forbes received settlement proceeds that would enable him to reduce the plan term from 60 to 40 months.  The debtor filed a §1329 motion to so modify the plan.  The trustee and an unsecured creditor objected to the proposed modification on the ground that settlement constituted a windfall, enabling the debtor to pay all of his creditors in full.  The bankruptcy court overruled both of the objections and approved the plan as modified by the debtor.  The trustee and the creditor appealed.  The issue before the BAP was whether the bankruptcy court erred by failing to consider the settlement funds as disposable-income under §1325(b).  In affirming the bankruptcy court, the BAP held that Congress clearly did not include §1325(b) in the requirements for post-confirmation modification of plans under §1329, and the court would not read the statute to hold otherwise.  Id. at 191.  The panel also noted that its conclusion was supported by the absurd result that would have been obtained had the disposable-income test applied:  “Mathematically, no proposed modified plan can satisfy both the disposable-income test in §1325(b) and the five-year limitation in §1329(c) if the proposed modification is filed after two years after the commencement of payments under the original plan.”  Id. at 192.

In the case of In re Smith, 237 B.R. 621 (Bankr. E.D. Tex. 1999), aff’d, 252 B.R. 107 (E.D. Tex. 2000), the debtor had proposed a 56-month plan, which was confirmed over objections.  After making payment number 26, the debtor paid the trustee the total amount due under the remainder of the plan.  The trustee then distributed the funds with a notice of plan completion.  An unsecured creditor objected and argued that the debtor had failed to submit her income to the plan for the full 36-month period as required by §1325(b)(1).  The court overruled the objection and held that the creditor’s reliance on §1325(b)(1) was misplaced because that section only applied to plan confirmations.  Id. at 625 n. 5.

The next significant holding was In re Golek, 308 B.R. 332 (Bankr. N.D. Ill. 2004).  In this case, the debtor filed a motion in month 20 of his plan to sell real property.  The court granted the motion and directed the debtor to pay the proceeds of the sale to the trustee in an amount sufficient to pay off the plan.  The debtor then filed a motion to modify the plan to the amount of payments made. The trustee objected on the ground that the debtor was proposing to terminate his plan before its 36-month term had expired.  Id. at 334.  The court rejected the trustee’s position and argument that §1325(b) was incorporated into §1329. The court stated that when “Congress wants to say something, it knows how to say it, and in this instance, Congress did not say it.  Indeed, §1329(b)(1) goes out of its way to include both §§1322(a) and 1322(b) in its list of restrictions.  While §1325(a) is expressly listed, however, §1325(b) is not.”  Id. at 337.

This issue was also recently addressed in two significant pre-BAPCPA cases, both of which were decided in 2005.  In the first case, In re Sunahara, 326 B.R. 697 (9th Cir. BAP 2005), the court held that the debtor could seek to modify a plan under §1329 without having to pay a 100 percent dividend to the unsecured creditors.  The debtor’s plan in this case provided for a total payment of $41,000 over a term of 60 months, with an estimated dividend of 50 percent to the unsecured creditors.  One day prior to the hearing on confirmation of the debtor’s third amended plan, the debtor filed a motion to refinance real estate pay off the plan and terminate the case.  The plan was confirmed without objection prior to the hearing on the motion.  The bankruptcy court sustained the objection to the debtor’s motion, and on appeal the BAP reversed.  The BAP pointed to Lamie v. U.S. Trustee, 540 U.S. 526 (2004) in holding that the “plain language of §1329(b) does not mandate satisfaction of the disposable income test of §1325(b)(1)(B) with respect to modified plans.”  The court went on to emphasize that had “Congress intended to impose such a requirement, it could have easily done so by making the appropriate incorporating reference.  If the absence of the reference to §1325(b) was indeed an oversight, it is the province of the legislature, and not the judiciary, to make the correction.” 

The Sunahara court also specifically held that the so-called “best-efforts” test of §1325(b) did not apply to a §1329 motion.  This holding was based on an unambiguous finding that the confirmation standards of §1325(b) were “not explicitly incorporated into §1329.”  Specifically, the Sunahara court held:  “Section 1329(b) expressly applies certain specific Code sections to plan modifications, but does not apply §1325(b).  Period.  The incorporation of §1325(a) is not, as has been posed by some courts, the functional equivalent of an indirect incorporation of §1325(b).”  On remand, the BAP ordered the trial court to consider the current Schedules I & J, the likelihood of any future increases in net monthly income, the time period between confirmation and modification, and the risk of a plan failure over the remaining term versus the certainty of immediate payments to creditors.

The second important 2005 case was In re Keller, 329 B.R. 697 (Bankr. E.D. Cal. 2005).  In Keller, the debtor filed a motion to modify a 36-month plan by reducing the term, by paying the base amount with a mortgage refinance, but without paying a 100 percent dividend.  The court held that the debtor could pay off the plan early without a full dividend, but that the process to follow would be a §1329 motion to modify and not a motion to approve a new mortgage loan.  However, the Keller court then found in dicta that §1325(b)(1) was incorporated into §1325(a), and since §1325(a) was in fact referenced in §1329, all of the pre-confirmation rules applied to a §1329 modification.

It is not clear how the Keller court would deal with the issue of “projected disposable income” under BAPCPA and §1329.  However, the Keller reasoning is suspect because it is based on the general requirement of §1325(a)(1) that the court shall confirm a plan if “the plan complies with the provisions of this chapter and with the other applicable provisions of this title.”  Given the very strict constructionalist approach to BAPCPA, it seems safe to assume that the vast majority of courts will follow Sunahara and reject Keller.  And, unless it were reverse the precedent of Lamie, the Supreme Court is bound to follow Sunahara.

A good predictor of what the courts will finally do on this issue can be found in a 1989 decision by the Fourth Circuit.  The case is In re Arnold, 869 F.2d 240 (4th Cir. 1989). In Arnold, the court was called on to interpret §1329 in a case where the debtor’s post-confirmation income increased from $80,000 a year to more than $200,000 per year.  The court held that in this case, where there had been an unanticipated and substantial change for the better in the debtor’s financial circumstances, then either the trustee or an unsecured creditor could file a §1329 motion to modify the plan to increase the dividend to the general body of unsecured creditors.  In a very detailed analysis of §1329, the Arnold court never once mentioned §1325(b) and certainly found no “direct” or “indirect” incorporation of that section into §1329.

The Arnold holding was strongly reaffirmed on Jan. 18, 2006, when the Fourth Circuit filed its opinion in In re Murphy, 2007 WL 117746 (4th Cir. 2007).  Murphy involved two cases where the trustees sought to modify confirmed chapter 13 plans to increase the amount to be paid to the unsecured creditors.  The court combined both cases for decision in order to “set forth a thorough analysis on how a bankruptcy court should analyze a motion for modification pursuant to §1329(a)(1) or (a)(2).”  Slip at 8.  

The Murphy court noted that under “§1329 of the Bankruptcy Code, a confirmed plan may be modified at ‘any time after confirmation of the plan but before the completion of payments’ at the request of the debtor, the chapter 13 trustee, or an allowed unsecured creditor in order to, among other things, ‘increase or reduce the amount of payments on claims of a particular class provided for by the plan, [or to] extend or reduce the time for such payments.’” Id. at 7.  The court the made it crystal clear that any modification under §§1329(a), (a)(1) and (a)(2) had to comply with §1329(b)(1).  Specifically, the court stated that “[u]nder §1329(b)(1), any post-confirmation modification must comply with §§1322(a) and (b), and §1323(c), and §1325(a) of the Bankruptcy Code.” Id. at 7-8.  The court made absolutely no reference to § 1325(b).

The Murphy court then went on to explain that the doctrine of res judicata prevented the modification of a confirmed plan pursuant to §1329(a)(1) or (a)(2) “unless the party seeking modification demonstrates that the debtor experienced ‘substantial’ and ‘unanticipated’ post-confirmation changes in his financial condition.”  Id. at 8, citing Arnold.  The court then took pains to note that “this doctrine” of finality is designed to ensure that “confirmation orders will be accorded the necessary degree of finality, preventing parties from seeking to modify plans when minor and anticipated changes in the debtor’s financial condition take place.”  Id. To further emphasize this point, the court, quoting from In re Butler, 174 B.R. 44, 47 (Bankr. M.D.N.C. 1994), stated that “[a]s a matter of sound policy as well as appropriate judicial economy, there is no reason why either a creditor or a debtor should be permitted to re-litigate issues which were decided in the confirmation order or which were available at the time of the confirmation but not raised by the parties.  Absent this salutary policy, there is no readily available brake on the filing of motions under §1329 by creditors and debtors simply hoping to produce a more favorable plan based on the same facts presented at the original confirmation hearing.”

The most important thing about the Murphy decision is that the court never makes any reference whatsoever to §1325(b).  Simply stated, it seemed so clear to the court that, since §1325(b) was not incorporated directly into any of the relevant §1329 provisions, any reference to the section was not even worth a footnote.   The court went to some lengths on this point by including the full text of all “relevant” statutes in the footnotes. 

As noted, Murphy involved two cases.  In the first case, the chapter 13 trustee sought to modify a confirmed plan after the bankruptcy court granted the debtors permission to refinance the mortgage on their residence.  In fact, the refinance produced an excess of “cash out” equity for the debtors, and it was this extra money that the trustee sought to recapture for the unsecured creditors.  In the second case, the chapter 13 trustee sought to modify the plan after the debtor had secured authority to sell his condominium.  Because the condo had appreciated more than 50 percent in about a year, the debtor was in position to pocket about $80,000 of the appreciation after paying off the original confirmed plan amount.

As to case number one, the court held that the “cash-out refinancing” did not rise to the level of a §1329 modification and denied the trustee’s motion to modify.  The court held that all these debtors did “was eliminate a portion of their equity in the property for cash in exchange for a corresponding amount of debt.  Thus, even when one considers that the [debtors’] residence appreciated in value post-confirmation, at most, they simply received a large loan in place of a small one.  By any stretch, a loan, regardless of the size, is not income. [emphasis added].”   The court even characterized the refinancing as evidence that the debtors “unquestionably took the more noble course of seeking to fulfill their obligations under the confirmed plan. . .”  Slip at 12.  Specifically, the court held:  “A debtor’s proposal of any early payoff through the refinancing of a mortgage simply does not alter the financial condition of the debtor and, therefore, cannot provide a basis for the modification of a confirmed plan pursuant to §1329(a)(1) or (a)(2).”  Slip at 11.

As to the second case, the court found that the debtor did experience a substantial and unanticipated change of circumstances when his condominium was scheduled for $121,000 in value as of Dec. 15, 2003, the date of the confirmation, and was sold for $235,000 in November 2004.  The  court noted that a 51.6 percent appreciation in value in less than a year constituted both a “substantial change in circumstances” and “an unanticipated change given the current market trends.”  The holding in this case is of further interest because the debtor argued that since his plan had been confirmed under §1327(b), the condominium had revested in him at the time of confirmation, and therefore, the appreciation was beyond the reach of the trustee and the bankruptcy estate.  The court noted this vesting rule and stated that under §1327(c), such vesting “is free and clear of any claim or interest of any creditor provided for by the plan.”  The court addressed the differences between §1306 and 1327 by noting the “varying interpretations,” while holding that neither statute could be used by a debtor “to shield himself from the reach of his creditors when he experiences a substantial and unanticipated change in his income.”  Slip at 16.  Since the primary purpose for filing a plan that vests property of the estate in the debtor upon confirmation is to avoid this result, it would make no sense for any attorney in the Fourth Circuit to file anything other than a plan that vests property in the estate upon completion of the plan.  

Section 1329(c), as amended, also raises additional issues that seem consistent with the pre-BAPCPA law on plan modifications.  This section was amended to include a reference to the “applicable commitment period under §1325(b)(1)(B).”  The wording of the new section is tortuous.  However, the meaning is clear: If a plan is modified under §1329, the extended time period to pay cannot exceed five years, even if the court finds good cause to so extend the plan. This limited reference to §1325(b) in §1329(c) certainly provides clear and convincing (perhaps irrefutable) evidence that Congress was fully aware of this section when it enacted BAPCPA.  The fact that Congress incorporated §1325(b) in one provision of §1329, but not in the truly substantive sections, is certainly a highly relevant fact and can only lead to the conclusion that the omission was intentional.

This startling congressional omission from §1329 (not incorporating §1325(b)) effectively writes the projected disposable income rules and the B22C analysis right out of the plan-modification process.  This also means that there is no “best efforts” test under a §1329 motion.  In addition, if a majority of courts follow the Fourth Circuit’s res judicata reasoning in Murphy, then plan a modification should not be granted absent a substantial and unanticipated change of the debtor’s financial circumstances. 

Thus, this is the reason for describing the past 15 months as a monumental smoke-and-mirrors game.  At this point, at least with respect to plan-modifications, it seems fairly clear that we are really back to the way things were in the old chapter 13 pre-BAPCPA days.  If you have a high-income, above-median-income debtor with nominal monthly net income in Schedule J, then perhaps what you need to do is get the plan confirmed under §1325(b) using the B22C numbers, and then quickly turn around and file a §1329 motion with the real Schedule I & J numbers.  On the other hand, would the “real income” on the I & J Schedules allow a chapter 13 trustee to do the same thing post confirmation?  It sounds so simple and almost too good to be true.  At the same time, it seems fully supported by the well-developed case law on §1329, which should not be modified by BAPCPA.   

At this point, it would appear that in the modification mode the only really new things to deal with are 910-day vehicles and 365-day purchase-money claims.  They still would apply to a modification, since §1325(a) is incorporated into §1329.  Although one could possibly argue that since applicable subsections of §1329 were not changed at all by BAPCPA, the old section of §1329 that incorporated the old provisions of §1325(a) WITHOUT the hanging paragraph also eliminated the 910 and 365 claims from the modification process!   But this may well be a bridge too far for many courts.

Could it really be this easy?  After all of the pain and suffering imposed on the bankruptcy system since Oct. 17, 2005, is it possible that we are really back to the way the world used to be?  Time will tell.