This section of the seminar deals with issues which typically arise when the record title holder of the property subject to the mortgage you are foreclosing upon (the “Mortgagee” or “Debtor”) files for relief under the Bankruptcy Code. This section assumes little or no working knowledge of the Bankruptcy Code. It is not intended to be an exhaustive study of all possible issues which may arise in this context, but rather is intended to provide an overview of the primary issues which typically arise. This paper assumes that a foreclosure is pending at the time the mortgagor files a voluntary petition for relief under the Bankruptcy Code and that your client is the holder of the mortgage (the “Mortgagee” or “Creditor”). Is it not the intention of this paper to educate you on every possible issue that may arise in every type of bankruptcy case, but rather to give you the basic tools to deal with such event. Many times, bankruptcy cases turn into very complex matters which are far beyond the scope of this paper and in such event, it is highly recommended you associate with experienced Bankruptcy counsel.
I. INTRODUCTION TO THE BANKRUPTCY CODE
All Bankruptcy Cases are governed by the provisions of 11 U.S.C. §101 et seq, referred to herein after as the Bankruptcy Code or simply, “the Code.” All statutory citations in this paper refer to specific sections of the Code unless otherwise stated. This paper deals with the Code as it has been amended to date, including the most recent amendments of the Bankruptcy Abuse and Consumer Protection Act of 2005 (the “Reform Act”). The Reform Act was signed by the President on April 20, 2005; however, the majority of its provisions did not become effective until October 17, 2005. This paper will assume that the Bankruptcy Case was filed after October 17, 2005 and that such case is subject to all provisions of the Reform Act.
The Code creates 6 different types of bankruptcy cases which may be filed. Specifically, Chapters 7, 9, 11, 12, 13 and 15 all create different types of relief available to various different types of debtors. Chapter 7 is what is known as liquidation bankruptcy, although, the actual liquidation of an asset only occurs in about 5% of such cases filed in Oklahoma.
Chapters 9, 11, 12 and 13 are all referred to as “reorganizations” because they all contemplate a continuation of the debtor in some form subject to debts which have been modified by a device known as a plan. A plan is really nothing more than a court enforced loan modification agreement wherein the debtor rewrites the terms of all their debt on a global basis.
Chapter 9 is a municipal reorganization which is a very specialized type of bankruptcy case and is far beyond the scope of this seminar.
Chapter 11 is designed for public corporations, but almost any type of entity or individual may file such a case.
Chapter 12 is a very powerful, but also a very limited reorganization which may only be utilized by family farmers. There are very few Chapter 12 cases filed and therefore, such matters are beyond the scope of this seminar.
Chapter 13 is a sort of individual reorganization which may only be used by natural persons.
Finally, Chapter 15 is limited to what are referred to as “Cross-border insolvency cases” wherein the primary insolvency proceeding is filed in a foreign country and such company has assets located within the United States. Such cases are far beyond the scope of this seminar.
Each reorganization chapter has subchapters which define the administration of the estate under rules which are unique to the particular chapter and which define the various rules related to each unique chapter.
The Bankruptcy Code as we know it today was passed in 1978 as a complete overhaul of the then existing Bankruptcy Act. It has been amended several times, but none of the amendments really made sweeping types of changes and were mostly limited to smaller adjustment types of amendments. Most recent of these amendments is the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Reform Act”) The Reform Act made substantial changes to many aspects of the Code.
II. INITIAL CONSIDERATIONS
The first notice of bankruptcy that a creditor will receive is known commonly as the “341 notice”. This notice will be received in the mail and involves several important pieces of information. One of the initial reactions to the receipt of a 341 notice, especially if litigation is pending, is anger. Creditors, and in particular mortgagees, are not without defense to a bankruptcy. However, more so than any other area of the law which I have encountered, you must take an aggressive stance in the case before any relief may be received. Anyone who stands by and does nothing upon receiving a bankruptcy notice generally will get out of it exactly what they put into it. Upon receipt of the 341 notice, you should diary the dates for the initial meeting of creditors, 30 days thereafter to object to exemptions, 60 days thereafter to object to the discharge or file a complaint to determine dischargeability and any bar date for filing proofs of claim.
Also, you must determine what chapter the debtor is filing. This is simply a matter of reading the notice. If the case is a “reorganization” chapter, i.e., Chapter 11, 12 or 13, the considerations for creditor’s counsel are far more complex than in a Chapter 7. It is recommended that if you have never been involved in such a case before, that you associate with someone who has experience in such matters.
III. AUTOMATIC STAY
Most of the time, the mortgagee will prefer to simply continue with its foreclosure action. The impediment to this preferred course is the Automatic Stay which comes into existence upon the filing of the bankruptcy case. The Automatic Stay comes into existence upon the filing of the petition in virtually every case, hence the term “Automatic”. The Court will issue an initial document known as “the §341 notice” which provides for notice of the imposition of the Automatic Stay. It is beneficial to conceptualize a bankruptcy case as really a request for an equitable injunction. The issuance of the Automatic Stay amounts to an ex parte temporary restraining order which ultimately ripens into a permanent restraining order upon the issuance of the discharge. The automatic stay is governed by §362. Essentially, this injunction enjoins virtually all creditors from taking any action against the debtor or their property.
Exceptions to the automatic stay are set forth in §362(b); however, most mortgagee’s claims will not be exempt from the stay. It is critical that all foreclosure and collection actions be stopped upon being given notice of the filing of the case. If you discover that for some reason such activities have not ceased, take corrective measures to stop them at once. §362(k)(1) creates a cause of action for damages, both actual and punitive, attorney’s fees and costs, for any creditor who willfully violates the provisions of §362. Bankruptcy Judges take a very dim view of creditors who intentionally violate the stay after they have been asked to stop and usually require such creditors to pay for such transgressions. You can’t win this one, so don’t try it.
Any act taken in violation of automatic stay, which violator knows to be in existence, justifies award of actual damages which includes attorney’s fees. If there are additional finding of maliciousness or bad faith on part of the creditor, then the imposition of punitive damages is appropriate. In re Crysen/Montenay Energy Co., 902 F.2d 1098 (2d Cir. 1990). For example, in one local case in Tulsa, Judge Terrence L. Michael awarded $2,850.00 in actual damages, $15,000.00 in attorney’s fees, plus $40,000.00 in punitive damages against a creditor who repossessed a debtor’s car in violation of the stay in a Chapter 13 case. In re Diviney, 211 B.R. 951, (Bankr.N.D.Okla. 1997). It is a very risky course to assume that the stay does not apply to you. If you are wrong, then you will have to pay any damages which result from your acts. The best course is to obtain relief from the stay. The Reform Act created a few limited situations where you may be able to proceed without seeking relief from the stay.
As will be discussed below, the Reform Act created a new section in §362(h) which provides for automatic termination of the stay. If a creditor violates the stay in the mistaken, good faith belief that the stay was automatically terminated under new §362(h), the damages are limited to actual damages, NOT including attorney’s fees.
A. Automatic Termination of the Automatic Stay
There are several provisions under the Code which effectuate an automatic termination of the automatic stay. In essence, if these situations apply to your case, you don’t have to do anything but wait the appropriate period of time for the automatic stay to simply “go away”.
1. Failure to File and Perform Statement of Intention
If the Bankruptcy Case is one under Chapter 7, then §362(h) provides for the automatic termination of the stay and for abandonment of the property if the debtor fails to timely perform their intentions under §521(a)(2) unless they attempt to reaffirm based on the original contract terms and the creditor refuses to agree to such reaffirmation. Since we are assuming a foreclosure is pending at the time the Bankruptcy Case is filed, then this narrow exception would virtually never be true because the debtor in a Chapter 7 case has no ability to compel a cure of a default under a mortgage and almost no way to come up with the cash to effect such a cure.
Specifically, §521(a)(2)(A) requires the debtor to file a statement of intention within earlier of 30 days after the petition date or the date set for the creditor’s meeting (unless extended by an order of the Court). Thereafter, §521(a)(2)(B) requires the debtor to perform their stated intention within 30 days after the creditor’s meeting (unless such time period is extended by a court order obtained before the 30 day period expires). Therefore, in the vast majority of foreclosure cases, the Debtor will have no practical ability to reaffirm the debt and thus, in most typical Chapter 7 cases, the Automatic Stay will automatically terminate in no more than approximately 60 days.
The statement of intention provides the debtor must either surrender, reaffirm, redeem, avoid the lien under §522(f)(1)(B) or assume an unexpired lease of personal property under §365(p). §362(h)(A) provides the debtor must timely file the statement of intention and §362(h)(B) requires that such stated intentions must be performed within the time frames established by §521(a)(2). If the debtor fails in any of these obligations, then the stay automatically terminates. Also, note that not only does the stay terminate, but also, the property in question is abandoned from the Bankruptcy Estate. No motion, notice or order is required.
Note that the Chapter 7 Bankruptcy Trustee (and only the Trustee) may obtain relief from the automatic termination of the stay by filing a motion, upon notice and opportunity, before the stay automatically terminates as provided in §362(h)(2) as follows:
Paragraph (1) does not apply if the court determines, on the motion of the trustee filed before the expiration of the applicable time set by §521(a)(2), after notice and a hearing, that such personal property is of consequential value or benefit to the estate, and orders appropriate adequate protection of the creditor’s interest, and orders the debtor to deliver any collateral in the debtor’s possession to the trustee. If the court does not so determine, the stay provided by subsection (a) shall terminate upon the conclusion of the hearing on the motion.
This section would likely only be used when there is significant equity in non-exempt property, or if the Trustee believes the creditor’s lien upon such non-exempt property is defective in some manner so that such lien is avoidable. It is important to note that the automatic provisions also provide for automatic abandonment of the property in question from the Bankruptcy Estate. Thus, if the Trustee fails to timely seek relief from the automatic termination of the stay, then the Trustee’s avoidance claims related to the liens upon the property under §544 are also terminated.
In the event you are feeling somewhat uneasy about whether the stay is in effect, new §362(j) provides that “On request of a party in interest, the Court shall issue an order under subsection (c) confirming that the automatic stay has been terminated”. Note that this provision does not provide for notice and opportunity for a hearing, thus is appears it is intended that obtaining such an order is to be done on ex parte application. The new and revised Federal Rules of Bankruptcy Procedure were adopted and became effective December 1, 2007. The specific rule related to stay relief is Fed. R. Bankr. P. 4001, which states:
(a) Relief from stay; prohibiting or conditioning the use, sale, or lease of property
A motion for relief from an automatic stay provided by the Code or a motion to prohibit or condition the use, sale, or lease of property pursuant to § 363(e) shall be made in accordance with Rule 9014 and shall be served on any committee elected pursuant to § 705 or appointed pursuant to § 1102 of the Code or its authorized agent, or, if the case is a Chapter 9 municipality case or a Chapter 11 reorganization case and no committee of unsecured creditors has been appointed pursuant to § 1102, on the creditors included on the list filed pursuant to Rule 1007(d), and on such other entities as the court may direct.
(2) Ex parte relief
Relief from a stay under § 362(a) or a request to prohibit or condition the use, sale, or lease of property pursuant to § 363(e) may be granted without prior notice only if (A) it clearly appears from specific facts shown by affidavit or by a verified motion that immediate and irreparable injury, loss, or damage will result to the movant before the adverse party or the attorney for the adverse party can be heard in opposition, and (B) the movant’s attorney certifies to the court in writing the efforts, if any, which have been made to give notice and the reasons why notice should not be required. The party obtaining relief under this subdivision and § 362(f) or § 363(e) shall immediately give oral notice thereof to the trustee or debtor in possession and to the debtor and forthwith mail or otherwise transmit to such adverse party or parties a copy of the order granting relief. On two days notice to the party who obtained relief from the stay without notice or on shorter notice to that party as the court may prescribe, the adverse party may appear and move reinstatement of the stay or reconsideration of the order prohibiting or conditioning the use, sale, or lease of property. In that event, the court shall proceed expeditiously to hear and determine the motion.
(3) Stay of order
An order granting a motion for relief from an automatic stay made in accordance with Rule 4001(a)(1) is stayed until the expiration of 10 days after the entry of the order, unless the court orders otherwise.
As you can see, there is nothing in the new and improved Bankruptcy Rules to address relief under §362(j). Although neither the Western nor Eastern Districts of Oklahoma have any local rule specifically addressing this issue, the Northern District has adopted a specific local rule addressing this point NDOK L.R. 4001(G) states:
G. Confirmation that Automatic Stay is Terminated. A request for an order under 11 U.S.C. § 362(j), confirming that the automatic stay has been terminated, may be made by application. An application pursuant to 11 U.S.C. § 362(j) shall provide the following information, as appropriate in the circumstances for each prior case: (1) if the prior filing was in this Court, the complete case caption, date of filing and date of dismissal; and/or (2) if the prior filing was in any other court, then, in addition to the requirements of (1), the movant shall also file relevant copies of all court records reflecting the information provided in subsection (1).
In any event, it seems clear that you should be able to get this statutory “comfort order” quickly. Just how quick remains to be seen depending upon which court you find yourself.
2. Serial Filings
For years, creditors have been frustrated by debtors who file multiple cases, particularly, Chapter 13 cases which allow for instanter dismissals with no prohibition to re-filing an unlimited number of sequential cases (i.e., “Serial Filing”). Each filing creates an automatic stay, thereby delaying recovery of collateral for what sometimes seems like eternity at the cost of thousands of dollars to the creditor. §362 was amended to stop this practice.
§§362(c)(3) and (4) specifically address Serial Filings. §362(c)(3) automatically terminates the stay 30 days post-petition in the case of an individual debtor who files a second case under Chapter 7, 11 or 13 within one year after the dismissal of the first case, unless the second case is not a Chapter 7 and the first case was a Chapter 7 that was dismissed under §707(b). An extension of the automatic termination is possible only if the second case is filed in good faith and the order granting such extension must be entered BEFORE the 30 day period expires. The standard for good faith is also statutory and requires the moving party must comply with the following sections:
(C) for purposes of subparagraph (B), a case is presumptively filed not in good faith (but such presumption may be rebutted by clear and convincing evidence to the contrary) –
(i) as to all creditors, if –
(I) more than 1 previous case under any of Chapters 7, 11, and 13 in which the individual was a debtor was pending within the preceding 1-year period;
(II) a previous case under any of Chapters 7, 11, and 13 in which the individual was a debtor was dismissed within such 1-year period, after the debtor failed to –
(aa) file or amend the petition or other documents as required by this title or the court without substantial excuse (but mere inadvertence or negligence shall not be a substantial excuse unless the dismissal was caused by the negligence of the debtor’s attorney);
(bb) provide adequate protection as ordered by the court; or
(cc) perform the terms of a plan confirmed by the court; or
(III) there has not been a substantial change in the financial or personal affairs of the debtor since the dismissal of the next most previous case under Chapter 7, 11, or 13 or any other reason to conclude that the later case will be concluded—
(aa) if a case under Chapter 7, with a discharge; or
(bb) if a case under Chapter 11 or 13, with a confirmed plan that will be fully performed; and
(ii) as to any creditor that commenced an action under subsection (d) in a previous case in which the individual was a debtor if, as of the date of dismissal of such case, that action was still pending or had been resolved by terminating, conditioning, or limiting the stay as to actions of such creditor;
If the debtor files a case and there were 2 pending within the previous year that were dismissed unless the third case is not a Chapter 7 and the other cases were Chapter 7’s that were dismissed under §707(b), then there is NO STAY upon the filing of the 3rd case. §363(c)(4)(A)(i). There is also the right to a comfort order under §363(c)(4)(A)(ii) just like §363(j) above, although this seems redundant.
As with §363(c)(3)(B) above, §363(c)(4)(B) provides for obtaining a stay in the third serial filing case only by compliance with the following:
(B) if, within 30 days after the filing of the later case, a party in interest requests the court may order the stay to take effect in the case as to any or all creditors (subject to such conditions or limitations as the court may impose), after notice and a hearing, only if the party in interest demonstrates that the filing of the later case is in good faith as to the creditors to be stayed;
(C) a stay imposed under subparagraph (B) shall be effective on the date of the entry of the order allowing the stay to go into effect; and
(D) for purposes of subparagraph (B), a case is presumptively filed not in good faith (but such presumption may be rebutted by clear and convincing evidence to the contrary) –
(i) as to all creditors if –
(I) 2 or more previous cases under this title in which the individual was a debtor were pending within the 1-year period;
(II) a previous case under this title in which the individual was a debtor was dismissed within the time period stated in this paragraph after the debtor failed to file or amend the petition or other documents as required by this title or the court without substantial excuse (but mere inadvertence or negligence shall not be substantial excuse unless the dismissal was caused by the negligence of the debtor’s attorney), failed to provide adequate protection as ordered by the court, or failed to perform the terms of a plan confirmed by the court; or
(III) there has not been a substantial change in the financial or personal affairs of the debtor since the dismissal of the next most previous case under this title, or any other reason to conclude that the later case will not be concluded, if a case under Chapter 7, with a discharge, and if a case under Chapter 11 or 13, with a confirmed plan that will be fully performed; or
(ii) as to any creditor that commenced an action under subsection (d) in a previous case in which the individual was a debtor if, as of the date of dismissal of such case, such action was still pending or had been resolved by terminating, conditioning, or limiting the stay as to such action of such creditor.
It is important to note that under both §§362(c)(3) and (4), any creditor who obtained an order “terminating, conditioning or limiting the stay as to such action of such creditor” or who had an unresolved, pending motion for such relief, is essentially exempt from any continuation or imposition of the stay in a second or third serial case. So, despite all of these automatic terminations of the stay, it is still good practice to file a motion for relief from stay and obtain an order to essentially immunize the creditor from serial filings.
3. In Rem Enforcement Exception
A new subsection 362(b)(20) is added to exclude from the automatic stay actions to enforce liens or security interests following entry of an in rem order described in the new §362(d)(4), unless the debtor in the subsequent bankruptcy case successfully reinstates the automatic stay under the provisions of (d)(4).
Code §362(d)(4) provides that, as to real property, if the court finds that the bankruptcy case was filed as part of a “scheme to delay, hinder, and defraud creditors”, either by the transfer of all or part of an interest in the realty without the secured creditor’s consent or by multiple bankruptcy filings that affect the realty (presumably stopping foreclosure actions, for example), the court may grant in rem relief from the automatic stay. While this may seem to be a good avenue in cases of serial filing, early cases imposed an obligation to prove traditional common law fraud which is virtually impossible. More recent cases have defined fraud much more broadly and now permit such to be inferred from a series of filings with no good faith effort to prosecute such cases. As of July 6, 2010, a search for cases decided under §362(d)(4) found:
In re Young, 2007 WL 128280, 10 -11 (Bankr.S.D.Tex.,2007)
In re Wilke, 2010 WL 2384836, 6 (Bankr.N.D.Ill.) (Bkrtcy.N.D.Ill.,2010)
In re Montalvo, 416 B.R. 381, 387 (Bkrtcy.E.D.N.Y.,2009)
In re Blair, 2009 WL 5203738, 4 (Bankr. E.D.N.Y.,2009) (unreported).
In re Duncan & Forbes Development, Inc., 368 B.R. 27, 32 (Bankr.C.D.Cal.,2006)
In re Abdul Muhaimin, 343 B.R. 159, 167 (Bankr.D.Md.,2006)
In re Gould 348 B.R. 78, *80 -81 (Bankr..D.Mass.,2006)
In re Van Eck, 425 B.R. 54, 71 (Bankr.D.Conn.,2010)
In re Poissant, 405 B.R. 267, 273 -274 (Bankr.N.D.Ohio,2009)
In re Russell, 2010 WL 1740643, 1 (Bkrtcy.E.D.N.C.,2010)
In the opinions wherein relief under §362(d)(4) was denied, the Court focused on each element of scheme to delay, hinder, and defraud, requiring the moving creditor to prove each “delay,” “hinder,” AND “defraud” as independent elements requiring separate proof and required proof of “fraud” under a traditional common law standard. For example, In re Poissant, held:
While the serial filings reflect a delay in allowing the Bank to foreclose on the property, there is nothing before the Court to prove that the Debtor intended to defraud the Bank. See, In re Gould, 348 B.R. 78, 80 (Bankr.D.Mass.2006); In re Abdulla, 2009 WL 348365, at 1 (Bankr.D.Mass. Feb.6, 2009); In re Young, 2007 WL 128280, at 8-9 (Bankr.S.D.Tex. Jan.10, 2007); In re Smith, 395 B.R. 711, 719 (Bankr.D.Kan.2008); and In re Lemma, 394 B.R. 315, 325 (Bank.E.D.N.Y.2008).
The elements of fraud are: i) false representation of a material fact; ii) knowledge of or belief in its falsity by the person making it; iii) belief in its truth by the person to whom it is made; iv) intent that it should be acted upon; and v) detrimental reliance upon it by the person claiming to have been deceived. In re Meridia Products Liab. Litig., 328 F.Supp.2d 791, 819 (N.D.Ohio 2004).
Some of the recent decisions cited above granting relief have digressed from this position, thereby breathing life into this section. The case of in In re Wilke, offers some hope for creditors as it defined “fraud” as “not limited to misrepresentation, but may encompass “any deceit, artifice, trick or design involving direct and active operation of the mind, used to circumvent and cheat another.” Citing McClellan v. Cantrell, 217 F.3d 890, 893 (7th Cir.2000). The decision in In re Blair shows a line of cases which trend away from the initial strict standard requiring proof of traditional, “actual fraud” as follows:
As this Court also noted in Montalvo, Courts have varied on whether a bankruptcy court can infer an intent to hinder, delay, and defraud creditors from the fact of serial filings alone. Compare In re Poissant, 405 B.R. 267, 273 (Bankr.N.D.2009); In re Abdulla, No. 08-16802, 2009 WL 348365 at *1 (Bankr.D.Mass. Feb. 6, 2009); and In re Smith, 395 B.R. 711, 719-20 (Bankr.D.Kan.2008) (several filings alone are not adequate to find intent to hinder, delay and defraud, which requirements are in the conjunctive and must all be demonstrated); with In re Hendersen, 395 B.R. 893, 902 (Bankr.D.S.C.2008); and In re Johnson, No. 07-33312, 2008 WL 183342 (Bankr.E.D.Va. Jan. 18, 2008) (finding multiple, strategically timed bankruptcy filings can be basis for inference of debtor’s intent to hinder, delay and defraud). In Montalvo, this Court joined those courts which hold that the mere timing and filing of several bankruptcy cases is an adequate basis from which a court can draw a permissible inference that the filing of a subsequent case was part of a scheme to hinder, delay, and defraud creditors.
It is also noteworthy that your author has personal knowledge that Judge Michael followed the analysis of the courts that denied relief under §362(d)(4), although the case was dismissed. See In Re Light of the World Interdenominational Deliverance, Case No. 06-10583-M, Docket Entry 61. There is no order or opinion in the case as such was a telephonic bench ruling. Judge Michael used the a traditional common law fraud standard. To the knowledge of this author, the alternative and more relaxed definition of fraud has not been presented to the Courts in Oklahoma.
In the event one chooses this approach, counsel must be prepared to somehow prove that the bankruptcy filing was part of a scheme to defraud creditors arguing that the series of cases filed and not prosecuted in good faith are sufficient factual basis for the court to infer a scheme to hinder, delay and defraud. Whether Oklahoma Bankruptcy Courts will follow this line of reasoning remains to be seen.
If on manages to obtain relief under this section, such relief from the stay has a binding effect in any other bankruptcy case that might be filed within two years of the entry of the order, provided that the order was also recorded in compliance with state real estate noticing laws. A debtor in a subsequent case who may be affected by this in rem order could move for relief from the order to reinstate a stay, provided that the debtor must show a change of circumstances since entry of the order or other good cause. The subsection specifically provides that federal, state, or local governmental units must accept a certified copy of the in rem order for “indexing and recording”.
The sad reality of this section is that although Congress attempted to provide a form of relief that would be very helpful in the context of mortgage foreclosures, the use of the conjunctive word “AND” rather than the time honored, traditional disjunctive “OR” renders this provision problematic.
4. Single Asset Real Estate
The Reform Act modified the procedure for stay relief in single asset real estate cases. The definition “single asset real estate” is found in §101(51)(B).
The term “single asset real estate” means real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental.
Essentially, the stay is automatically modified 90 days post petition unless a plan is filed or monthly cash payments are commenced “in an amount equal to interest at a current fair market rate on the value of the creditor’s interest in the real estate”. See §362(d)(3)(B). which states:
(3) with respect to a stay of an act against single asset real estate under subsection (a), by a creditor whose claim is secured by an interest in such real estate, unless, not later than the date that is 90 days after the entry of the order for relief (or such later date as the court may determine for cause by order entered within that 90-day period) or 30 days after the court determines that the debtor is subject to this paragraph, whichever is later –
(A) the debtor has filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time; or
(B) the debtor has commenced monthly payments that –
(i) may, in the debtor’s sole discretion, notwithstanding section 363(c)(2), be made from rents or other income generated before, on, or after the date of the commencement of the case by or from the property to each creditor whose claim is secured by such real estate (other than a claim secured by a judgment lien or by an unmatured statutory lien); and
(ii) are in an amount equal to interest at the then applicable nondefault contract rate of interest on the value of the creditor’s interest in the real estate; or
In the context of a Chapter 11 case, this provision gives mortgage holders additional leverage to obtain payments of money fairly early on in the case. Creditors may want to negotiate for an agreement that the debtor is in fact a single asset real estate case. Debtors will want to have a provision that the payments made under the cash collateral order are “equal to interest at a current fair market rate on the value of the creditor’s interest in the real estate”. Note that this particular automatic modification of the Automatic Stay does not effect an abandonment of the Property.
In the context of a Chapter 7, this provision may provide assistance to mortgage holder in an entity bankruptcy where the Trustee thinks there may be some value in the single item of real property, but where such property is not generating income. This provision mandates relief from the stay if actual monthly payments in real money do not start within 90 days.
5. Motion for Relief from Stay
An order granting relief from the stay requires the filing of a motion for relief from the stay pursuant to §362(d). Although this is often referred to as “lifting the stay” it should be noted that the Code refers only to termination, modification, annulling or conditioning the stay. In a Chapter 7, the debtor generally cannot successfully oppose a motion for relief from stay. §362(d) provides for relief from the stay when there is no equity in the property and the property is not necessary for an effective reorganization. Obviously in a Chapter 7 there is not ever going to be a reorganization so the creditor is almost always going to be entitled to relief from the stay. Even if there is equity in the property, unless the Trustee gets involved, most Bankruptcy Courts are not sympathetic to a Debtor’s resistance of a Motion for Relief from Stay based solely upon alleged equity particularly if the property is the Debtor’s homestead.
The trustee may oppose relief from the stay on the basis that the property not claimed as exempt has value in excess of the creditor’s secured claim. If this becomes an issue consider having the trustee sell the property pursuant to §363. This will avoid most of the problems which will arise. Be sure to get a deadline for the sale since most trustees are very busy and your collateral can easily get lost in the crowd.
The sale of the property by the trustee is a good alternative in some cases. The trustee may sell any non-exempt property on 20 days notice. Be sure to determine the tax basis of any business property to be sold. If the debtor has depreciated the property, the estate will be liable for any gain on the sale, and the trustee will want to take the taxes out before turning over the proceeds to the creditor. If the tax basis is low, get the stay modified, and sell the property outside of the bankruptcy estate. The creation of a tax liability from the sale of the property has a direct impact on the benefit to the Estate from such a sale. Sometimes, the tax liability will off set any equity in the property so that there is no real benefit to the Estate.
One other issue is the Trustee’s fee based upon a percentage of the disbursements made by the trustee. Specifically, 11 U.S.C. §326(A) provides:
(A) In a case under Chapter 7 or 11, the court may allow reasonable compensation under §330 of this title of the trustee for the trustee’s services, payable after the trustee renders such services, not to exceed 25 percent on the first $5,000 or less, 10 percent on any amount in excess of $5,000 but not in excess of $50,000, 5 percent on any amount in excess of $50,000 but not in excess of $1,000,000, and reasonable compensation not to exceed 3 percent of such moneys in excess of $1,000,000, upon all moneys disbursed or turned over in the case by the trustee to parties in interest, excluding the debtor, but including holders of secured claims.
This statute provides for the maximum amounts a trustee may be paid, but the reality is that unless you negotiate a specific agreement with the trustee, you are probably going to wind up paying the maximum. If the property is worth a substantial amount of money, this could be significant. Strike a deal with the trustee in advance and save money. Objections to the fees after the trustee has done the work are usually difficult to win.
In the case of a motion for relief related to a foreclosure action, it is also important the property is abandoned from the estate pursuant to §554. If it is not, you must give notice to the trustee of any subsequent action taken. The abandonment of property is accomplished through a motion to compel abandonment under §554 and the issue is value to the estate. If the property is burdensome to the trustee and has no value, the Court will determine it to be abandoned. This is the same issue which will arise with the trustee in a motion for relief from the stay. Consequently, most Courts do not have a problem with a combined motion for relief from stay and to compel the trustee to abandon the property. In the case of mortgaged real property, abandonment is a very important issue as a subsequent title examination will require this before the property’s title will meet the title standards. In fact, it is a good idea to review the title examination standards before moving for relief to make sure you identify issues important to the title examiners. The title standards are found at 16 O.S. Ch 1. App. Std 20.1. The combined motion for relief from stay and for abandonment of the property is hereinafter referred to as the “Motion”.
Notice is an area where many inexperienced counsel err. It is my recommendation that you give notice of the Motion to all creditors listed on the matrix. If the Court determines the notice of the Motion is defective, then it may be denied on a technical basis and you will get to do it over again, usually at your expense!
If the creditor matrix has a large number of creditors so that giving notice to all of them is too expensive, then you are permitted to file an application to limit the notice under Federal Rules of Bankruptcy Procedure Rule 9029 and the corresponding local rule. Such an application must allege cause for limiting the notice. Language such as the following will usually suffice:
There are approximately 125 creditors and other parties in interest in this case. Providing full notice to all such parties of the Motions in this case is very costly and not necessary to provide due process in this case. The limited notice proposed herein is sufficient to serve the constitutional requirement of fair and reasonable notice in this case. Debtor proposes to limit the notice of the Motions to the parties identified in paragraph 4. Debtor will mail the Notice of the Sale which also contains notice of the hearing and notice to file objections to all parties on the matrix. Debtor submits all notices should be limited to the United States Trustee, all attorneys requesting notice, any committees appointed, all parties claiming
If you have an order limiting the notice to a specific group of parties, then make sure you give notice to that group and file a certificate of service reflecting such.
The pivotal issue in all Motions for relief from stay is value, i.e., what is the property worth if it’s sold? In a Chapter 7 case, value is typically the only issue. If the Trustee believes there is significant equity in the property, you will undoubtedly draw an objection to the Motion. In this case, since the property is by definition real property, then the issue of value is really a question of fact. There are only two types of witnesses competent to testify as to the value of real property: (1) the owner. “An owner of real property is competent to testify as to its value. III Wigmore on Evidence § 714; Arkansas Louisiana Gas Company v. Ackley, 410 P.2d 35 (Okl.1965).” In re Ferris, 415 F.Supp. 33, 40 (D.C.Okl. 1976); and (2) an expert who is an appraiser. “As the owner of real estate, the debtor is entitled to render his opinion as to the fair market value of the property. With that one exception, only the testimony of a qualified expert, such as an experienced appraiser, would be admissible on the issue.” In re Donoway, 139 B.R. 156, 158 (Bankr.D.Md.,1992). Real Estate brokers are not appraisers. Oklahoma now requires a license for real estate appraisers, so don’t waste your time on any expert who is not a licensed appraiser. Finally, make sure that you tell the appraiser you hire that they will most likely have to testify in court. Many appraisers will refuse the engagement if they know they will have to go to Court. After all, a reluctant expert is really not much help to your case.
Get the property appraised and then show the appraisal to the Trustee. Many times, this will resolve the issue. Otherwise, get ready to go to court and prove your case. 11 U.S.C. §362(g)(1) specifically provides that the burden of proof as to the issue of value is upon the Movant. That’s you.
IV. CASH COLLATERAL
A. What is Cash Collateral?
Cash collateral seems to be an area of a good deal of “floundering” by many Debtors’ counsel. The appropriate handling of cash collateral issues is vital to the success of any business reorganization. Consequently, you must first consider what precisely is cash collateral. Fortunately, the Code provides a good deal of guidance in this area. The primary Code section for consideration is 11 U.S.C. §363. §363(a) provides a definition of cash collateral:
Cash collateral means cash, negotiable instruments, documents of title, securities, deposit accounts or other cash equivalents whenever acquired in which the estate and an entity other than the estate have an interest and includes the proceeds, products, offspring, rents or profits of the property subject to a security interest as provided in §552(b) [11 U.S.C. §562(b)] whether existing before or after the commencement of a case . . .
The case law reveals that virtually anything arising from encumbered property could be considered cash collateral. For example, rents from real estate have been considered cash collateral by various courts. In Re: Village Properties Ltd., 723 F.2d. 441 (5th Cir. 1984); In Re: Casebeer, 793 F.2d. 1436 (5th Cir. 1986); Virginia Beach Federal Savings & Loan v. Wood, 901 F.2d. 894 (10th Cir. 1990). Whether or not rents from real estate are cash collateral is generally determined by state law. See Village Properties and Virginia Beach, supra. The Reform Act clarifies that hotel rents from mortgages premises are in fact cash collateral. 11 U.S.C. §363(a).
B. Use of Cash Collateral
It is critical to remember that the use of cash collateral is not authorized unless the Court enters an order providing for such use. This means the Debtor-In-Possession or Trustee will not be able to continue what probably had been the ordinary course of their business by using income from the real property to pay current operating expenses. Conceptually, the DIP or Trustee is using funds that, but for the filing of the bankruptcy, the creditor(s) would have taken through a state court action anyway. In effect, the DIP or Trustee is using funds they would not otherwise be able to use but for the bankruptcy filing. 11 U.S.C. §363(c)(2) provides:
The trustee may not use, sell or lease cash collateral under paragraph 1 of this section unless:
(A) Each entity that has an interest in such collateral consents; or
(B) The court, after notice and a hearing authorizes such use, sale or lease in accordance with the provision of this section.
Regardless of the party’s pre-petition conduct, the filing of a petition for relief imposes immediate restrictions on the use of cash collateral. In Re: Pine Lake Village Apartment Co., 16 B.R. 750 (B.C.S.D. NY 1982). The DIP/Trustee is thus subject to the same restrictions on the use of cash collateral as is the trustee. The DIP/Trustee is absolutely prohibited from using cash collateral unless the parties consent or unless an order is entered. In Re: Kain, 86 B.R. 506 (B.C.W.D. Mich. 1988). Consequently, in any case where there is a question regarding cash collateral, this issue must be dealt with immediately.
The best course of action is to reach an agreement with the various creditors prior to filing the bankruptcy. Upon filing the case, file a stipulation with the Court and circulate the same to the interested parties to the case. It is the opinion of this author that since the unsecured creditors may actually have some indirect claim to cash collateral, that all parties to the case should ultimately be noticed regarding an agreement to allow the use of cash collateral. This is particularly true in light of the expanded period for the assertion of reclamation claims, discussed below. If an agreement cannot be reached, a motion to use cash collateral should be prepared and filed with the petition or immediately thereafter and a hearing date should be obtained immediately. Fed. R. Bankr. P. 6004 controls the setting and noticing of hearings under this section.
The question arises as to what notice must be given of the hearing. Cases reveal that the bankruptcy courts are willing to fashion remedies to meet this need in accordance with the particular facts and circumstances of the case. While it has been held that one day notice by mailgram was not sufficient, In Re: Center Wholesale, Inc., 759 F.2d. 1440 (9th Cir. 1985), one court has held that appropriate telephonic notice of the hearing was sufficient. In Re: James A. Phillips, 29 B.R. 391 (S.D. NY 1983). Other courts have held that 72 hours notice was sufficient in a case where the need for cash was immediate to preserve the property of the estate. In Re: Sheehan, 11 B.D.C. 835 (Bankr. D.C. S.D. 1984). The courts may shorten the notice period required for hearings as set forth in Fed. R. Bankr. P. 6004, et seq., where the facts and circumstances of a case necessitate such action. In Re: Plaza Family Partnership, 95 B.R. 166 (E.D. Cal. 1989).
C. Basic Concepts of Adequate Protection
The key issue in obtaining an order allowing the DIP or Trustee to use cash collateral or retain property in the face of a Motion for relief from stay is adequate protection. This concept is also one way that a party opposing a Motion for Relief from Stay can prevail. The concept of adequate protection in a Chapter 11 is governed by a specific Code section. 11 U.S.C. §361 provides:
When adequate protection is required under §§362, 363 or 364 of this title of an interest of an equity in property, such adequate protection may be provided by
(1) requiring the trustee to make a cash payment or periodic cash payments to such entity to the extent that the stay under §362 of this title, use, sale or lease under §363 of this title, or any grant of a lien under §364 of this title results in the decrease in the value of such entity’s interest in such property;
(2) providing to such entity an additional or replacement lien to the extent that such stay, use, sale, lease or grant results in a decrease in the value of such entity’s interest in such property; or
(3) granting such other relief, other than entitling such entity to compensation allowable under §503(b)(1) of this title as an administrative expense, as will result in the realization by such entity of the indubitable equivalent of such entity’s interest in such property.
What may be determined to provide adequate protection is a matter of significant litigation. A creditor is entitled to maintain its secured position as of filing and a DIP/Trustee may not do anything to diminish a creditor’s secured position. However, creditors are not entitled to better their positions or receive a windfall. In Re: Texlon Corp., 596 F.2d. 1092 (2nd Cir. 1979).
Precisely what is sufficient for adequate protection is limited only by the facts and circumstances of a particular case and the imagination of a good lawyer. Anything the bankruptcy court finds will protect the creditor’s secured position may serve as adequate protection. On appeal, whether or not a particular concept actually provides adequate protection will be a question of fact subject to review only under the clearly erroneous standard. In Re: O’Connor, 808 F.2d. 1393 (10th Cir. 1987). The basic analysis of whether or not the matter offered as adequate protection is appropriate in a particular case is determined by:
(1) The value of the secured creditor’s interest;
(2) A determination of the risks to that value that will result from the debtor’s use of the property; and most importantly;
(3) A determination of whether the adequate protection proposed protects the creditor’s value from the risk to which it is being exposed.
The primary inquiry is whether the proposed use of the collateral places the creditor’s interest at risk despite the offer of adequate protection. In Re: Mangus, 50 B.R. 241 (B.C.D.C. ND 1985). The various types of adequate protection, considered as proposed by §361 above, are essentially limited only by the attorney’s imagination.
D. Methods of Providing Adequate Protection
One of the best means of providing adequate protection is to provide for cash payments to the creditor to compensate them for any diminution in value as a result of the debtor’s use of the property. Adequate protection payments made should be applied to compensate a secured creditor for any diminution in value of collateral resulting from the use, depreciation, destruction or other caused reduction in value. In Re: Kain, 86 B.R. 506 (B.C.W.D. Mich. 1988). This concept is reinforced by the Reform Act in its amendment to §362 when the bankruptcy case is a single asset real estate case. In such instances, the stay will terminate unless a plan which has a reasonable probability of success is filed within 90 days or cash payments of interest accruing upon the value of the real property are commenced. This new concept is discussed in more detail below.
The second method of providing adequate protection is by granting a replacement lien. While 11 U.S.C. §552 limits liens on after-acquired property, if the creditor has a valid and enforceable contractual provision providing for liens on after-acquired property due to proceeds, replacement liens offered are not sufficient, In Re: Bohne, 57 B.R. 461 (B.C.N.D. 1985). In other words, the debtor was denied the use of cash collateral since the replacement lien tendered as adequate protection was for a lien the creditor already had an interest in. The test of whether the creditor’s cash collateral is adequately protected is whether the debtor has provided a method of ultimately giving creditor the value of their cash collateral. In Re: Johnson, 87 B.R. 204 (B.C.W.D. Wis. 1985).
The Code also provides a “catch-all” provision in 11 U.S.C. §361(3) by providing for the “granting of such other relief as will result in the realization of such entity of the indubitable equivalent of such entity’s interest in such property”. This gives lawyers the ability to propose anything which passes the “smell test” and appears reasonable. Consequently, the guaranty by a third party, whether secured or unsecured, has been held to serve as adequate protection. In Re: Diaconx Corp., 69 B.R. 333 (B.C.E.D. Pa. 1987), see later proceedings, 69 B.R. 343, (B.C.E.D. Pa. 1987). In one Chapter 11 case, it has been held that adequate protection was provided by the debtor’s continued use of dairy cows, the milking of cows and exerting his best efforts toward effectuating a plan of reorganization. In Re: Underbakke, 60 B.R. 705 (B.C.N.D. Iowa 1986). However, this is probably the most extreme case found.
The courts have held that if the parties are unable to reach an agreement as to what constitutes adequate protection, the court itself may decide what constitutes appropriate adequate protection under the circumstances. In Re: Kielhafner, 69 B.R. 51 (B.C.E.D. Mo. 1986). However, counsel for the debtor certainly would not want to merely ask the court to order whatever adequate protection it felt was appropriate without articulating one or more reasonable scenarios.
The providing of an equity cushion may be sufficient for adequate protection, In Re: THB Corp., 94 B.R. 797 (B.C.D. Mass. 1988). However, mere administrative priority is not sufficient. 11 U.S.C. §361(3).
E. Valuation and Superpriority Administrative Claims
It is important that whatever the method of providing adequate protection be truly adequate. If the collateral becomes diminished in value as a result of its use and the secured creditor becomes less secured, the creditor is entitled to a super priority administrative claim. 11 U.S.C. §507(b). This section provides that when adequate protection has been given to a secured creditor and later proves to be inadequate, the creditor becomes entitled to a super priority administrative expense claim to the extent that the proffered adequate protection was insufficient. In re Carpet Center Leasing Co., Inc., 991 F.2d 682 (11th Cir. 1993) and Grundy Nat’l Bank v. Rife, 876 F.2d 361, 363 (4th Cir.1989). Such a claim has priority over attorney’s fee claims for counsel, as well as all other administrative claims. Claims such as this can be an unwelcome guest at a confirmation hearing as the creditor may demand cash payment in full as of confirmation, which could defeat the entire reorganization if not placed in the budget, see 11 U.S.C. §1129(a)(9)(A). Creditors should be aware of their ability to assert such claims as it is a way to help insure that the creditor’s secured position is not diminished during the case.
This also once again raises the question of value. From the secured creditor’s perspective, should there be a value of the collateral determined at the time the order is entered? If a stipulation can be reached, then this is not too difficult. However, many times, the value of the collateral is a hotly disputed issue to which no stipulated resolution can obtained. If the property is valued at this point, then a baseline is established for later determination as to potential §507(b) super priority administrative claims. Since it is very common not to have current appraisals early in the case, how can this be resolved quickly? One suggestion is that a value be agreed upon which does not prejudice the parties’ right to seek a judicial determination of the value at a later date. If no agreement can be reached and, as is almost always the case, the entry of a cash collateral order cannot be delayed for 30 to 60 days, then put a provision in the order which reserves your right as a secured creditor to have a determination of the value as of the entry of the cash collateral order date made at a later time. Remember to have your appraiser make such a determination at the time of the appraisal, put this into evidence and ask the court for a finding in the §506 order. This will be of great assistance in a case which lasts a long time and, in particular, where there is a risk of devaluation in the collateral.
Practical considerations also dictate that certain control features be part of any negotiated cash collateral order. Counsel for creditors will want to insure that appropriate monitoring mechanisms are in place, otherwise the cash collateral may “evaporate”. Such control features include monthly, or even in some cases, weekly reporting on the levels of collateral, income and expenses. Periodic actual inspections of the collateral, coupled with accounting controls and independent verification of the debtor’s expenditures are very useful in protecting a creditor’s interest. Also, a budget for the debtor’s expenditures should be presented to the court along with the cash collateral motion. Creditors may want to impose other restrictions on the use of cash in order to properly control the debtor’s use of the money.
F. Property Taxes
Another issue is an exception to the automatic stay for post-petition property taxes. “Both the property owner and any mortgage holder recognize that their interest in real property is subject to the local government’s right to collect such property taxes. However, several circuit courts have held that the automatic stay prevents local governments from attaching a statutory lien to property taxes accruing subsequent to a bankruptcy filing. See, e. g., In re Paar Meadows, 880 F.2d 1540 (2d Cir. 1989), cert. denied, 110 S.Ct. 869 (1990); Makaroff v. City of Lockport, 916 F.2d 890 (3d Cir. 1990). These decisions create a windfall for secured lenders, who would otherwise be subordinated to such tax liens, and significantly impair the revenue collecting capability of local governments. This section overrules these cases and allows local governments to utilize their statutory property tax liens in order to secure the payment of property taxes.” House Judiciary Committee, “Section by Section Analysis”, 1994. Mortgagees should include a provision in the cash collateral order which requires the debtor to pay all of the property taxes as they come due in order to prevent such taxes from becoming a lien which has priority over the claim secured by the mortgage. Debtors must be aware that they cannot protect their property from property tax liens by the automatic stay.
V. PROOF OF CLAIM
The second thing which you must do upon receiving a notice of bankruptcy after having diaried the appropriate dates is to examine your client’s claim. The vehicle by which you may accomplish this is to fill out the proof of claim form and attach the appropriate supporting documentation. The proof of claim form is basically a “fill in the blank” type of form which is fairly self-explanatory. It is important if your client has a security interest, mortgage or lien upon some particular piece of property to include evidence of perfection. Generally, this will be a copy of the UCC-1 filed in the proper filing office, copy of the lien entry form or a file-stamped copy of the real estate mortgage. Copies of these documents should be attached to the proof of claim and the proof of claim should be filed with the Bankruptcy Clerk, a copy mailed to the trustee and to the debtor’s counsel. The trustee is interested in reviewing the proofs of claim to determine whether or not the property which the debtor has is, in fact, subject to properly perfected liens.
If your lien is not properly perfected, you should consider the potential consequences of an avoidance proceeding by the trustee pursuant to 11 U.S.C. §544 or §547. If the claim was not properly perfected timely but was subsequently perfected, it may be subject to avoidance as a preference pursuant to 11 U.S.C. §547. On the other hand, if the claim is not perfected at all, the trustee may prevail over the unperfected secured creditor pursuant to 11 U.S.C. §544(a)(1) wherein the trustee takes on the character of a “hypothetical” lien creditor who has executed upon the property as of the date of the petition. Such creditors will prevail over unperfected security interests. If in fact your claim is unperfected, the best course of action is to do nothing and hope the trustee overlooks perfection problems. However, this is fairly unlikely since trustees always look to see if they can get property from the debtor since that is how trustees make money. If the trustee attacks your client’s claim as being unperfected, most of the time the creditor can settle out with the trustee for less than the value of the collateral, thus providing an economic benefit to your client.
If the claim is under secured or unsecured, any payments received will be avoidable as a preferential transfer pursuant to 11 U.S.C. §547 for 90 days prior to the filing of the case. If the creditor is an “insider”, 11 U.S.C. §101(31), then the time limit is extended to one year. A detailed discussion of the intricacies of avoidance proceedings is far beyond the scope of this paper.
The creditor should carefully consider the possibility of having to litigate preferences, fraudulent conveyances or other types of avoidance proceedings within the context of a bankruptcy proceeding. If such appears likely and if it does not appear that there is any reasonable likelihood of recovery of assets from the estate, then a proof of claim should not be filed in the case. The filing of a proof of claim in a bankruptcy waives the creditor’s right to a jury trial. In Re: Gran Financiera, 492 U.S. 33, 109 S.Ct. 2782, 106 L.Ed.2d 26. If, on the other hand, there appears to be a likelihood of assets being distributed, you should weigh whether or not you want to have a jury trial against the likelihood of receiving proceeds from the bankruptcy estate.
It is now possible to conduct jury trials in the Bankruptcy Court. Until the Bankruptcy Reform Act of 1994, Bankruptcy Court’s did not have the constitutional power to conduct jury trials. Now they do, but only if all parties to the matter being litigated consent. This provides yet another tactical consideration to the process which must be considered. Usually, the trial in the Bankruptcy Court will be faster than in the District Court, but the Bankruptcy Courts have little, if any experience in conducting jury trials, whereas, the District Courts do them all the time.
Note that the debtor always waives their right to a jury trial because the filing of a voluntary case is a submission to the jurisdiction of the Bankruptcy Court, thus waiving the right to a jury trial on discharge issues.
Creditors are entitled to a jury trial in Bankruptcy Court, if they have not waived it by submitting to the Bankruptcy Court’s authority, any time they would otherwise be entitled to a jury trial. In Re: Gran Financiera. The discussion of a jury trial right in Bankruptcy Court is a matter which is yet unsettled by the courts, and greatly exceeds the scope of this discussion.
After having completed the proof of claim, you should have a firm grasp upon whether or not your claim is subject to some priority pursuant to 11 U.S.C. §507 or whether the claim is unsecured, secured or under secured. If the claim is secured, the following analysis is appropriate.
VI. ISSUES COMMON TO REORGANIZATION CHAPTERS
This last section discusses the additional issues related to Chapter 13 and 11 cases, both of which are reorganization chapters. The more common of the two is Chapter 13. This is even more so since the Reform Act became effective, as one of the major goals of Congress in passing the Reform Act was to cause more debtor to file Chapter 13 as opposed to Chapter 7. Therefore, this paper will now discuss some selected Chapter 13 issues and contrast such issues with the similar issues in a Chapter 11 case.
A. Valuation of Property
Once again, the issue of value comes to the forefront. All secured creditors must be paid at least the present value of their allowed secured claims under either chapter. The provisions relating to secured creditor treatment in Chapter 13 is §1325. The corresponding provision in Chapter 11 is §1129(b)(2)(A)(i). Under either Chapter 13 or under Chapter 11, the value of the collateral is always going to be an issue, because either chapter in essence requires the lesser value of the collateral or the amount of the creditor’s claim to be paid in full with interest. As discussed below, the ability to “strip down” a secured claim does not apply to the Debtor’s primary residence. Under either chapter, the valuation will be determined under §506(a), which in a Plan where the Debtor proposes to keep the property and repay the secured creditor over time, has been interpreted by the U.S Supreme Court to mean replacement cost for the same type of asset in like condition. Associates Commercial Corp. v. Rash, 138 L.Ed.2d 148, 65 USLW 4451, 37 Collier Bankr.Cas.2d 744, 30 Bankr.Ct.Dec. 1254, Bankr. L. Rep. P 77,409, 97 Cal. Daily Op. Serv. 4527, 97 Daily Journal D.A.R. 7497, 97 CJ C.A.R. 905, 11 Fla. L. Weekly Fed. S 4 117 S.Ct. 1879, 65 USLW 4451, (1997). Once again, it is incumbent upon you as counsel for the Mortgagee to obtain an appraisal of the property. Such matters take some time, so it is recommended you engage an appraiser early on in the case.
This is also where the Reorganization Chapters diverge from Chapter 7, because in addition to the issue of value is the issue of whether or not the real property in question is “necessary for an effective reorganization”. Even if the property in question has no equity, if the Debtor can show that the retention of such property is important to their overall restructuring plan, then the Court will deny your Motion. Therefore, it is important to review the overall case to see if an effective reorganization is likely. As a result, this paper will discuss some of the major issues related to reorganization cases, with a primary focus upon Chapter 13 cases.
VII. CHAPTER 13 ISSUES
A. Restrictions on the Form of the Entity
There are certain types of debtors that may not file under various chapters of the code. For example, if the business is a family farm, then it may file a Chapter 12 in addition to Chapter 11 or 13. Usually, Chapter 12 is the choice for a farmer, but only family farmers may file a Chapter 12. If the business is a political subdivision, it has to file a Chapter 9, but only political subdivisions may file Chapter 9. Are there similar restrictions in Chapter 13? Yes.
The restrictions upon Chapter 13 debtors are found in 11 U.S.C. §109(e), which provides:
Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $336,900 and noncontingent, liquidated, secured debts of less than $1,010,650, or an individual with regular income and such individual’s spouse, except a stockbroker or a commodity broker, that owe, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts that aggregate less than $336,900 and noncontingent, liquidated, secured debts of less than $1,010,650 may be a debtor under Chapter 13 of this title.
Keep in mind that the dollar amounts in this section are adjusted annually, so always check the current version of the statute to verify the amounts applicable to the particular case.
Only individuals with regular income may file a Chapter 13. This term is defined in §101(30), which provides:
“individual with regular income means individual whose income is sufficiently stable and regular to enable such individual to make payments under a plan under Chapter 13 of this title, other than a stockbroker or a commodity broker.”
Although the Code does not define individual, §101(41) defines “person” to include individuals, corporations and partnerships. The case law makes it clear that persons include individuals and entities. In Re: Clem, 29 B.R. 3 (Bkrtcy.D.Idaho 1982). Consequently, it is generally accepted that the term “individual” means a human being and does not include any entities which are not natural persons. Thus, if the debtor is a corporation or partnership, it may not file Chapter 13. A partnership may not file Chapter 13 and the assets of the partnership entity are not property of the individual’s bankruptcy estate. In Re: Ross, 173 B.R. 943 (Bankr. E.D. Okla. 1994).
B. Dollar Amount of Debt
Only debtors who have debt under the debt limitation may file Chapter 13. The dollar limitations in 11 U.S.C. §109(e) are subject to periodic adjustment based on the consumer price index. See 11 U.S.C. §104. Note that such debt must be “non-contingent, liquidated” debt. A claim is “liquidated” for purposes of Chapter 13 eligibility only if it is capable of ready determination. Such occurs when the debtor’s liability and the amount of claim can be determined on basis of agreed upon facts without need for evidentiary hearing. A frivolous factual dispute, nor disagreement, concerning law as opposed to fact causes the claim to be unliquidated. In Re: Hustwaite, 136 B.R. 853 (Bkrtcy.D.Or.1991). An estimated tax claim is not a liquidated claim for eligibility purposes. In Re: Elrod, 178 B.R. 5 (Bankr. N.D. Okla. 1995).
A debt is “non-contingent” for purposes of Chapter 13 eligibility limit on non-contingent, liquidated unsecured debts, if all events giving rise to liability occurred prior to filing of bankruptcy petition. In Re: Loya, 123 B.R. 338 (9th Cir.BAP (Cal.) 1991). A claim is not contingent if no future event occurs prior to the filing of the petition for the transaction to constitute a liability as of the petition date. In Re: Jordan, 166 B.R. 201 (Bankr. D. Me. 1994). See also In Re: Knight, 55 F.3d 231 (7th Cir. 1995) and In Re: Solomon, 166 B.R. 832 (Bankr. D. Md. 1994).
If a creditor’s claim is scheduled as a “secured” claim, but in fact the lien which secures the claim is an avoidable lien because it is a preferential transfer, then the claim is in fact an unsecured claim for purposes of determining eligibility. In Re: Toronto, 165 B.R. 746 (Bankr. D. Conn. 1994). The unsecured portion of an undersecured claim is counted toward the debt limitation of §109(e). Ficken v. United States, (In Re: Ficken), 2 F.3d 299 (8th Cir. 1993).
C. Regular Income
The individual must have regular income. The Code defines this to mean the debtor has “stable and regular” income to make the payments under the Plan. §101(30). Chapter 13 contemplates some form of regular periodic payments which must begin within 30 days of the plan being filed. §1326. The debtor must have some form of regular income and must start making payments quickly after the case is filed.
D. Automatic Stay Issues Unique to Chapter 13
As we all know, one of the reasons people file bankruptcy is to receive the immediate benefit of the automatic stay. 11 U.S.C. §362 creates the stay in a Chapter 7 case. However, under Chapter 13, there is an additional element which provides protection for certain limited classes of individuals who are not debtors under bankruptcy. This is the co-debtor stay provision of §1301, which provides:
(a) Except as provided in Subsections (b) and (c) of this Section, after the order for relief under this chapter, a creditor may not act, or commence or continue any civil action, to collect all or any part of a consumer debt of the debtor from any individual that is liable on such debt with the debtor, or that secured such debt, unless —
(1) such individual became liable on or secured such debt in the ordinary course of such individual’s business; or
(2) the case is closed, dismissed, or converted to a case under Chapter 7 or 11 of this title.
(b) A creditor may present a negotiable instrument, and may give notice of dishonor of such an instrument.
(c) On request of a party in interest and after notice and a hearing, the court shall grant relief from the stay provided by Subsection (a) of this Section with respect to a creditor, to the extent that ‑‑
(1) as between the debtor and the individual protected under Subsection (a) of this Section, such individual received the consideration for the claim held by such creditor;
(2) the plan filed by the debtor proposes not to pay such claim; or
(3) such creditor’s interest would be irreparably harmed by continuation of such stay.
“The purpose of this provision is to protect a debtor operating under a Chapter 13 individual repayment plan case by insulating him from indirect pressures from his creditors exerted through friends or relatives that may have co-signed an obligation of the debtor. The protection is limited, however, to ensure that the creditor involved does not lose the benefit of the bargain he made for a cosigner. He is entitled to full compensation, including any interest, fees, and costs provided for by the agreement under which the debtor obtained his loan. The creditor is simply required to share with other creditors to the extent that the debtor will repay him under the Chapter 13 plan. The creditor is delayed, but his substantive rights are not affected. 11 USCA §1301, Stay of action against co-debtor.” 1984 Act. Statements by Legislative Leaders, see 1984 U.S.Code Cong. and Adm.News, p. 576.
When is relief appropriate from the co-debtor stay? The first question is whether or not the co-debtor received consideration for the claim. The stay may be modified as against co‑obligor not filing for bankruptcy relief, on ground that such co‑obligor “received consideration for claim”, only where such consideration ran exclusively to co‑obligor. In Re: Rhodes, 85 B.R. 64 (Bkrtcy.N.D.Ill.1988). In a recent case of In Re: Motes, 166 B.R. 147 (Bankr. E.D. Mo. 1994), the Court held it would not grant relief from the co-debtor stay if the debtor received no consideration for the loan in question. What constitutes consideration? It doesn’t have to be money. At least one Court has held that the education, meals, and books received by the daughter of debtor under this chapter were the entire consideration for a debt owed to a college, consequently, the creditor was entitled to relief from the co-debtor stay as to the non-debtor daughter. In Re: Brown, 12 B.R. 885 (Bkrtcy.N.D.Ga.1981).
The second issue is whether or not the debt is a consumer debt. Another way to ask the question is “was this a business loan”? The following cases are illustrative of this issue. Where joint debtors made a bank loan and the proceeds were used for training for a business opportunity, the debt owed to the bank was a business obligation and not a consumer debt. Therefore, the bank was entitled to relief from the co-debtor stay. In Re: Chrisman, 27 B.R. 648 (Bkrtcy.S.D.Ohio 1982). In another case, where it was admitted by one debtor that the primary reason for loan was for a business purpose and the funds were in fact primarily used for business purposes, the debt was not a consumer debt subject to the co-debtor stay. In Re: Demaree, 27 B.R. 1 (Bkrtcy.D.Or.1982). A debt was a consumer debt for purposes of the co-debtor stay even though funds representing proceeds of loan found their way into debtor’s automobile dealership business in a case where the note was a personal obligation only of the debtor and the endorsement by the co-debtor was done as a simple accommodation act of friendship having no relationship whatsoever to a business venture or ventures of the debtor. In Re: Lindamood, 21 B.R. 473 (Bkrtcy.W.D.Va.1982).
Note that the co-debtor does not receive a discharge, so if the debt in question is an unsecured, non-priority debt, the co-debtor will ultimately have to face the creditor. If such a debt is not going to be paid in full by the plan, the creditor can obtain relief from the co-debtor stay and immediately proceed against the co-debtor. This is really only meaningful if the debt in question is a priority or secured debt, which will be paid in full by the plan, thus avoiding yet another bankruptcy by the co-debtor. In the right case, this can be a very useful tool, although its’ benefit is somewhat limited.
What is the effect of confirmation of a plan upon the stay? The stay continues in effect post-confirmation even if the creditor is not provided for in the plan, although such omissions would constitute a basis for relief from the stay. Honesdale National Bank v. Mordenti (In Re: Mordenti), 164 B.R. 37 (Bankr. M.D. Pa. 1993). Thus, a motion for relief from stay is necessary prior to the creditor taking any action against the debtor post-confirmation even if the plan is in default. The confirmation of the plan bars relief from the stay where the ground for relief is an objection to confirmation which could have been asserted before confirmation. In Re: Arkell, 165 B.R. 432 (Bankr. M.D. Tenn. 1994). See also, In Re: Lee, 167 B.R. 417 (Bankr. S.D. Miss. 1992).
If an analysis of the issues reveals that relief from the co-debtor stay is appropriate, then a motion for relief from the stay should be filed seeking permission to pursue the co-debtor notwithstanding the proceedings pending on the debtor who has filed bankruptcy.
E. The Debtor Must File A Plan
The debtor shall file a plan. §1321. Only the debtor may propose a plan under Chapter 13, not the court, the creditors, or the trustee. In Re: Higgins, 43 B.R. 391 (Bkrtcy.N.D.Ala.1984). What is a plan? It was held that a plan had indeed been filed by the debtor, where debtors filed printed form entitled “Chapter 13 plan” with their petition and the form disclosed duration of plan, the amount to be paid to trustee each week, the secured creditors were listed along with percentage of secured claims to be paid under the plan, and the percentage of unsecured claims to be paid was also disclosed, as well as executory contracts which had been rejected. In Re: Purdy, 10 B.R. 902, affirmed 16 B.R. 847 (Bkrtcy.N.D.Ga.1981).
Fed. R. Bankr. P. 3015(b) requires the debtor to file a plan within 15 days of the case being commenced under Chapter 13. If there is some real reason that the plan cannot be timely filed, Fed. R. Bankr. P. 9006(b) permits the court to enlarge the time required to act as if a motion requesting such is filed within the time limit for the act in question. The failure to file a timely plan may be grounds for dismissal of the case, particularly where the case is merely a delaying tactic. In Re: Maurice, 167 B.R. 114 (Bankr. N. D. Ill. 1994) and In Re: Spurgeon, 166 B.R. 150 (Bankr. D. Neb. 1993).
F. Plan Provisions
The plan is the main issue in most Chapter 13 cases. The real issue in the plan has to do with the extent to which a debtor can modify the terms of payment to a particular creditor. In essence, the confirmation of the plan creates a new contract between the debtor and their creditors. Conceptually, the plan is a global loan modification agreement. The key difference is that it does not require the agreement of any creditor for its approval. There is no requirement in Chapter 13 that any creditor affirmatively accept the plan nor is there anything like the absolute priority rule and its’ new value exception which is found in Chapter 11 cases. “The secured creditor’s consent is not required — a Chapter 13 plan is through and through a “cram-down” plan (it is crammed down the throats of the unconsenting creditors).” In re Henry, 266 B.R. 457,471 (Bankr.C.D.Cal.,2001).
In a Chapter 13 the issue is one of statutory compliance. The plan must comply with all of the provisions of §§1322 and 1325. If it does, then the court must confirm the plan, otherwise, confirmation is denied. What are the requirements for confirmation of a plan?
G. Length Of Plan
Existing law for Chapter 13 requires the claims to be paid in full over the term of the plan which may not exceed 60 months. Under the Reform Act, the Debtor must perform a “reduced form of means testing, therefore, whether a Chapter 13 debtor’s plan must last for three or five years is determined by current monthly income measured against the median income for a family of like size”. A more detailed discussion is beyond the scope of this paper. This fairly complex analysis will most likely be something you as a creditor will not need to get involved with in most cases. As with the Means Test for Chapter 7, in a Chapter 13, the Debtor’s counsel will have to perform this analysis to determine the length of the plan and then the Chapter 13 Trustee will perform it again to verify the term of the Plan is appropriate.
H. Claims Secured By Real Property
The primary secured claim which can effectively be dealt with in a Chapter 13 case is the debtor’s home mortgage. This is the most common issue you are likely to encounter in a Chapter 13 case in the context of a foreclosure. Many mortgagors do not want to lose their homes and Chapter 13 offers them a possible way to keep it despite the mortgagee’s desires to the contrary.
While the underlying mortgage contract may not be modified if the property is the Debtor’s primary residence, any defaults may be cured by the plan. The typical means of accomplishing this is to pay any arrearage over time. This is restricted to 60 months in a Chapter 13. The required treatment for secured claims in Chapter 13 is set out in §1325(a)(5).
The protected class of secured claims is not determined by whether or not the loan is a long or short term debt, but rather whether or not it is secured solely by the debtor’s principal residence. In Re: Reeves, 164 B.R. 766 (Bankr. 9th Cir. 1994). If the claim is secured by property other than the principal residence, then it is not protected from modification. For example, a duplex or triplex where part of the property is rented to third parties. See In Re: Legowski, 167 B.R. 711 (Bankr. D. Mass. 1994) and In Re: Adebanjo, 165 B.R. 98 (Bankr. D. Conn. 1994). Contra. In Re: Guilbert, 165 B.R. 88 (Bankr. D.R.I.1994). It is fairly uniformly held that the assignment of rents and other such rights do not exclude the creditor’s claim for protection under §1322(b)(2). In Re: Hammond, 27 F3d. 325 (3rd Cir. 1994). See also, In Re: Harris, 167 B.R. 813 (Bankr. D.S.C. 1994) and In Re: Tallo, 168 B.R. 573 (Bankr. M.D. Pa. 1994).
As discussed above, if the real property is not the Debtor’s primary residence, then the Debtor may seek to reduce the claims to the value of the property. This is the process known as bifurcation of the claim, claim splitting, and lien stripping or sometimes “cramming down” a secured claim. For example, if the Debtor’s rent house is subject to a mortgage claim totaling $10,000, but the rent house is only worth $6,000, then the mortgagee’s claim is a secured claim equal to $6,000 and an unsecured claim equal to the difference in the total claim ($10,000) and the secured claim ($6,000) or $4,000. Because of the protection afforded to home mortgages, this process is not permitted as to such secured claims, but all other secured creditors are fair game under existing law. In Re: Lee, 162 B.R. 217 (D. Minn 1993); In Re: Cook, 169 B.R. 662 (Bankr. W.D. Mo. 1994); and In Re: Ross, 162 B.R. 785 (Bankr. N.D. Ill. 1993).
What if the claim is secured by a second mortgage upon the debtor’s principal residence and there is no value at all to support the secured portion of the claim, can such a claim be bifurcated? There is authority that such is not permitted, In Re: Johnson, 160 B.R. 800 (S.D. Ohio 1993), but the majority of the courts have held that such claims are not protected. In Re: Williams, 166 B.R. 615 (Bankr. E.D. Va. 1994); In Re: Sette, 164 B.R. 453 (Bankr. E.D. N.Y. 1994) and In Re: Moncrief, 163 B.R. 492 (Bankr. E.D. Ky. 1993). One recent reported local case on this point is In Re: Lee, which holds that such claims are not protected. 161 B.R. 271 (Bankr. W.D. Okla. 1993). See additional cases to the contrary: In re Barnes, 207 B.R. 588 (Bankr.N.D.Ill.1997); In re Tanner, 223 B.R. 379, 33 Bankr.Ct.Dec. 57 (Bankr.M.D.Fla. 1998); American General Finance, Inc. v. Dickerson, 229 B.R. 539, 41 Collier Bankr.Cas.2d 700 (M.D.Ga. 1999); In re Bauler, 215 B.R. 628, 39 Collier Bankr.Cas.2d 285, 31 Bankr.Ct.Dec. 1112 (Bankr.D.N.M. 1997).
If there is an arrearage on the home mortgage claim, such arrearage is not entitled to be paid interest on such arrearage unless such is permitted by local law and is specifically provided for in the contract. §1322(e). This provision of the Bankruptcy Reform Act of 1994 overruled Rake v Wade, 113 S.Ct. 2187 (1993). In that case, the court held that the Bankruptcy Code required that interest be paid on mortgage arrearage paid by debtors curing defaults on their mortgages. Notwithstanding State law, this case has had the effect of providing a windfall to secured creditors at the expense of unsecured creditors by forcing debtors to pay the bulk of their income to satisfy the secured creditors’ claims. This had the effect of giving secured creditors interest on interest payments, and interest on the late charges and other fees, even where applicable law prohibits such interest and even when it was something that was not contemplated by either party in the original transaction. This provision will be applicable prospectively only, i.e., it will be applicable to all future contracts, including transactions that refinance existing contracts. It will limit the secured creditor to the benefit of the initial bargain with no court contrived windfall. It is the committee’s intention that a cure pursuant to a plan should operate to put the debtor in the same position as if the default had never occurred. House Committee Report to the Bankruptcy Reform Act of 1994. However, the mortgage holder is entitled to add reasonable attorney’s fees and other charges to the amount of its arrearage. In Re: Henson, 182 B.R. 588 (Bankr. N.D. Okla. 1995).
The case must be filed prior to the sale of the property at the sheriff’s sale if the debtor seeks to cure the mortgage arrearage and keep their home. §1322. The Committee Report, (supra) discusses the reasoning and impact of this provision:
§1322(b)(3) and (5) of the Bankruptcy Code permit a debtor to cure defaults in connection with a Chapter 13 plan, including defaults on a home mortgage loan. Until the Third Circuit’s decision in Matter of Roach, 824 F.2d 1370 (3d Cir. 1987), all of the Federal Circuit Courts of Appeal had held that such right continues at least up until the time of the foreclosure sale.
See In Re: Glenn, 760 F.2d 1428 (6th Cir. 1985), cert. denied, 474 U.S. 849 (1985); Matter of Clark, 738 F.2d 869 (7th Cir. 1984), cert. denied, 474 U.S. 849 (1985). The Roach (supra) case, however, held that the debtor’s right to cure was extinguished at the time of the foreclosure judgment, which occurs in advance of the foreclosure sale. This decision is in conflict with the fundamental bankruptcy principle allowing the debtor a fresh start through bankruptcy.
This Section of the bill safeguards a debtor’s rights in a Chapter 13 case by allowing the debtor to cure home mortgage defaults at least through completion of a foreclosure sale under applicable non-bankruptcy law. However, if the State provides the debtor more extensive “cure” rights (through, for example, some later redemption period), the debtor would continue to enjoy such rights in bankruptcy. This issue is not controversial in Oklahoma as discussed in In re Faulkner, 240 B.R. 67, 68 (Bankr.W.D.Okla.,1999):
For over half a century, Oklahoma decisional law has held that a foreclosure sale is not complete, in fact not a sale, until it is confirmed by a Court. In State Comm’rs of Land Office v. Schneider, 198 Okla. 697, 181 P.2d 975, 978 (1947), the Oklahoma Supreme Court wrote: “A foreclosure sale is not fully a sale until confirmed by a court order.” Since then, the state’s high court has repeatedly reaffirmed that proposition: “[A] judicial sale on foreclosure is neither conclusive nor binding in the sense of transferring legal title to the purchaser until it is effectively confirmed.” Sooner Fed. Savs. and Loan Assoc. v. Oklahoma Central Credit Union, 790 P.2d 526, 529 (1989).
The changes made by this Section, in conjunction with those made in §305 of this bill, would also overrule the result in First National Fidelity Corp v. Perry, 945 F.2d 61 (3d Cir. 1991) with respect to mortgages on which the last payment on the original payment schedule is due before the date on which the final payment under the plan is due. In that case, the Third Circuit held that subsequent to foreclosure judgment, a Chapter 13 debtor cannot provide for a mortgage debt by paying the full amount of the allowed secured claim in accordance with Bankruptcy Code §1325(a)(5), because doing so would constitute an impermissible modification of the mortgage holder’s right to immediate payment under §1322(b)(2) of the Bankruptcy Code.
I. Conversion and Dismissal
One additional strategy which may be employed to oppose a Bankruptcy is to seek the dismissal or conversion of the case. Keep in mind that under the Reform Act, serial filings have a direct impact upon the stay, so that if the case is dismissed and the Debtor re-files within a year, the Automatic Stay is only in place for 30 days. Thus, dismissal may be a viable tactic.
If the case has not been converted under §706, 1112 or 1208 at any time, then the debtor has an absolute right to dismiss a Chapter 13 petition under §1307. See In re Nash, 765 F.2d 1410 (9th Cir. (Cal.) 1985) and In re Barbieri, 199 F.3d 616 (2nd Cir. (N.Y.) 1999). §1307 does not require notice and opportunity for a hearing therefore, the Court may dismiss the case instanter upon request from the Debtor. The Debtor may also convert the case to a case under Chapter 7 at anytime.
A creditor or the Trustee may move to dismiss under §1307(c) which provides:
Except as provided in subsection (e) of this section, on request of a party in interest or the United States trustee and after notice and a hearing, the court may convert a case under this chapter to a case under Chapter 7 of this title, or may dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, for cause, including –
(1) unreasonable delay by the debtor that is prejudicial to creditors;
(2) non-payment of any fees and charges required under Chapter 123 of title 28;
(3) failure to file a plan timely under §1321 of this title;
(4) failure to commence making timely payments under §1326 of this title;
(5) denial of confirmation of a plan under §1325 of this title and denial of a request made for additional time for filing another plan or a modification of a plan;
(6) material default by the debtor with respect to a term of a confirmed plan;
(7) revocation of the order of confirmation under §1330 of this title, and denial of confirmation of a modified plan under §1329 of this title;
(8) termination of a confirmed plan by reason of the occurrence of a condition specified in the plan other than completion of payments under the plan;
(9) only on request of the United States trustee, failure of the debtor to file, within fifteen days, or such additional time as the court may allow, after the filing of the petition commencing such case, the information required by paragraph (1) of §521; or
(10) only on request of the United States trustee, failure to timely file the information required by paragraph (2) of §521.
The Reform Bill added two new, additional bases for dismissal of a case, both of which seem likely to be enforced by someone other than the typical institutional creditor:
§1307(c)(11) is amended to add as cause for dismissal or conversion of a Chapter 13 case the “failure of the debtor to pay any domestic support obligation that first becomes payable after the date of the filing of the petition.” The same amendment is made in Chapter 12. See the discussion of domestic support obligation.
§1307(e) requires the court to either dismiss or convert the case upon the failure of the debtor to file a tax return as required under new § 1308, to be discussed below. A party in interest or the U.S. trustee may move for dismissal or conversion, and the court “shall” dismiss or convert the case, “whichever is in the best interest of the creditors and the estate.”
Note that the best-interest analysis does not include consideration of the debtor’s personal interest.
The most common grounds are failure to timely file a Plan or get a Plan confirmed and the failure to make the Plan payments. Usually, the Chapter 13 trustee will file the Motion on these grounds, but the creditor may do so also.
You can also move to convert the case to a case under Chapter 7, which often times is a good idea if you are dealing with a dishonest or highly combative debtor. The basis for conversion or dismissal is based on the best interest of the creditors. “…under subsection (c) the Court may involuntarily dismiss a Chapter 13 case or convert it to a Chapter 7 case only “for cause.” Furthermore, §1307(c) requires that, in selecting between conversion and involuntary dismissal, the Bankruptcy Court must consider “whichever is in the best interests of creditors and the estate….” In re Gaudet, 132 B.R. 670, 676 (D.R.I.,1991).
The final argument which may be advanced by a creditor opposing a Chapter 13 case is to object to the plan and move to dismiss the case on the grounds of bad faith. The leading case in this circuit is In Re: Robinson, 987 F.2d 665 (10th Cir. 1993). It is very common to see debtors file a Chapter 13 case seeking to discharge a debt which would not be subject to discharge in a Chapter 7 case. If such is the case, then the only real attack is to attempt to prevent the confirmation of the plan based on bad faith. Whether a Chapter 13 plan has been proposed in good faith is a question of fact subject to the clearly erroneous standard of review. Noreen v. Slattengren, 974 F.2d 75, 77 (8th Cir.1992); In Re: Love, 957 F.2d 1350, 1354 (7th Cir.1992); Society Nat’l. Bank v. Barrett (In Re: Barrett), 964 F.2d 588, 591 (6th Cir.1992); Jim Walter Homes, Inc. v. Saylors (In Re: Saylors), 869 F.2d 1434, 1438 (11th Cir.1989); Downey Sav. & Loan Ass’n v. Metz (In Re: Metz), 820 F.2d 1495, 1497 (9th Cir.1987). A determination of good faith must be made on a case by case basis, looking at the totality of the circumstances. Pioneer Bank v. Rasmussen (In Re: Rasmussen), 888 F.2d 703, 704 (10th Cir.1989). In evaluating whether a debtor has filed in good faith, courts should be guided by the eleven factors set forth in Flygare v. Boulden, 709 F.2d 1344, 1347-48 (10th Cir.1983), as well as any other relevant circumstances. In Re: Rasmussen, 88 F.2d 703, 704 (10th Cir.1989). A detailed discussion of this issue is beyond the scope of this paper.
This final section of the paper will contrast and compare some of the Chapter 13 issues discussed above with similar issues in a Chapter 11 case. The real issue in the Plan has to do with the extent to which a Debtor can modify the terms of payment to a particular creditor. As will be seen, there are significant differences which make a major difference in the chapter of choice for a particular debtor. We have discussed the primary Chapter 13 plan issues above. This final portion of the paper will compare and contrast Chapter 13 cases with Chapter 11 cases to illustrate some of the basic issues involved. Keep in mind that Chapter 11 is very complex and therefore, a complete discussion of the many issues involved in such cases is far beyond the scope of this presentation.
A. Timing Issues
A plan must be filed under either Chapter 13 or Chapter 11. After all, the Plan is the means by which the debt structure of the debtor is modified and is the reason for filing the case in most instances. In essence, a confirmed Plan is a new contract which is binding upon the debtors and all of their creditors. In re: Vandy, Inc., 89 B.R. 342 (Bkrtcy.E.D.Pa.1995). See also, Gerson v. Booth Lumber Co., 230 F.2d 631 (C.A.9 (Cal.) 1955). There are time limits imposed under either chapter, but those in Chapter 13 present more of an obstacle than they do under Chapter 11.
1. Chapter 13
Fed. R. Bankr. P. 3015(b) requires the debtor to file a plan within 15 days of the case being commenced under a 13. However, if the case is a business case, this is really not practical given that there are usually more hotly disputed matters involving value since there are usually more dollars at stake in a business case. This reveals one of the biggest obstacles for a business case in 13. Chapter 13 has long been a consumer based system. When a business case is placed into a consumer system, there are going to be some difficulties because it is different than the usual case. Although it appears on its face that small businesses operated by sole proprietors should be able to utilize Chapter 13, the fact is that the vast majority of such efforts fail.
2. Chapter 11
The debtor has the exclusive right to file a Plan under Chapter 11 for 120 days. §1121(b). However, this time limit may be modified upon order of the Court upon request of a party in interest for good cause shown. §1121(d). If the debtor files a plan within 120 days, then they also have 180 days exclusive right to get the plan confirmed. These periods may be extended for cause if a motion requesting such is filed prior to the lapse of such time period. §1121(d). Under the Reform Act, an absolute outside limit has been set so that the exclusive period to file and confirm a plan may be not be extended beyond 18 and 20 months respectively.
If the Debtor is subject to the small business provisions of 11 U.S.C. §101(51D), then the 120 day exclusive period becomes 180 days and all plans must be filed within 300 days. 11 U.S.C. §1121(e). The time limits for small business cases may only be extended under fairly extreme cases. See 11 U.S.C. §1121(e)(3). Further, the debtor’s exclusive right terminates if a trustee is appointed.
These time limits do not mean that the case will be dismissed or converted automatically if no plan is filed and confirmed with them, but it does permit any other party to the case to file a plan of their own. Most courts will consider the debtor’s failure to file a plan within the exclusive period reason to take sua sponte action in the case, such as a status conference or show cause hearing as to why the case should not be dismissed. Also, if a creditor moves to dismiss or convert the case, such failure is one of the statutory “causes” for relief. §1112(b)(4).
B. Secured Claims
First, do not forget there is a limit on secured debts in Chapter 13 of $750,000.00, while there is no limit in Chapter 11. The different chapters have significant differences in the ability of the debtor to restructure their secured debt.
Chapter 11 has the same restriction on modification of home mortgages as Chapter 13. The debtor’s home mortgage may not be restructured at all; however, any defaults may be cured by the plan. The typical means of accomplishing this is to pay any arrearages over time. This is restricted to 60 months in a Chapter 13, while Chapter 11 only requires they be cured. The Chapter 11 seems to permit the debtor to cure the arrearage over a term longer than 60 months.
The required treatment for other types of secured claims in Chapter 13 is set out in §1325(a)(5), while in Chapter 11 the requirements for such claims are found in §1129(b)(2)(A). Chapter 13 requires the claims to be paid in full over the term of the plan which may not exceed 60 months due to the restriction of §1322(d), which provides:
(d) The plan may not provide for payments over a period that is longer than three years, unless the court, for cause, approves a longer period, but the court may not approve a period that is longer than five years.
The only exception to this rule is “cure” provisions for long term debt found in §1322(b)(5), which provides:
(b)(5) notwithstanding paragraph (2) of this subsection, provide for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim on which the last payment is due after the date on which the final payment under the plan is due;
This permits long terms debts to be cured and maintained in accordance with the pre-petition contract of the parties, but no modification of the terms of repayment is permitted. If the collateral for the debt is solely the debtor’s residence, then the claim may not be modified at all with the exception of the curing and reinstatement. If the claim is secured by property other than the debtor’s residence, it is possible to reduce the principal balance on the claim by bifurcation of the claim into its secured and unsecured parts under §506 and still reinstate the contract. In re Johns, 37 F.3d 1021 (3rd Cir. 1994). However, in no event may the long term contract payments be modified if the payments extend beyond the term of the plan. In re Richards, 151 B.R. 8 (Bkrtcy.D.Mass.1993). Be advised this procedure is not well settled law.
By contrast, Chapter 11 has no specific limit on length of time for repayment comparable to those in Chapter 13. The Bankruptcy Courts may “cram down” feasible plans of reorganization under reorganization provisions of this title where such plans seek to achieve restructuring of mortgaged debts secured by real estate. Such restructuring may include any of the following: the terms of any mortgage debt may be extended; the payments required by mortgage debt of either principal or interest may be postponed; and deferred or reduced payments of principal or interest may be added to mortgage balance. In re Hollanger, 15 B.R. 35 (Bkrtcy.W.D.La.1981). Long-term payouts are not prohibited under a plan under this chapter, notwithstanding that secured lender’s normal lending practice or policies may be only to make short-term loans. In re White, 36 B.R. 199( Bkrtcy.D.Kan.1983). It may even be possible to set up the secured creditor’s repayment treatment in a negative amortization. It has been held that although negative amortization is not per se inequitable in considering whether a bankruptcy plan meets cramdown requirements, negative amortization is highly suspect when evaluating the plan’s compliance with cramdown requirements. In re Club Associates, 107 B.R. 385, appeal decided 956 F.2d 1065 (Bkrtcy.N.D.Ga.1989). But it has been held that a negative amortization plan which provided the impaired mortgagee with at best a market rate of interest, while dramatically altering terms of mortgage agreement, was not “fair and equitable” to the mortgagee, and could not be confirmed over mortgagee’s objection under cramdown provisions. In re 8315 Fourth Ave. Corp., 172 B.R. 725 (Bkrtcy.E.D.N.Y.1994). Typically, the secured creditor can be crammed down if they are paid a market rate of interest over a commercially reasonable repayment term considering the character of the collateral and other market considerations.
This is where Chapter 11 has a big advantage on real estate based debt. Since the commercial market for real property mortgage loans is generally longer than 60 months, a Chapter 11 debtor can get a much longer repayment term than a Chapter 13 debtor. This reality was one of the major deviations from Chapter 13 in Chapter 12, which specifically allows secured debts to be paid out beyond the 60 month term. See §1222(b)(9).
Also, although confirmation of a Chapter 11 plan is consensual to some degree, as discussed below, if the only rejecting class is a secured creditor, the confirmation notwithstanding such rejection is not particularly difficult. In fact, the requirements for confirmation over the objection of a secured creditor are virtually the same for 13 and 11. Compare §1129(b)(2)(A) and §1325(a)(5). In essence, both require the payment in full of the allowed secured claim with interest. The main difference is the time over which such payments may be made. In 13, the maximum is 60 months, while under 11, it’s whatever the market is for similar claims, which may well be in excess of 60 months. In the case of real property secured claims, it will almost certainly be much longer.
Chapter 11 also has what is know as the §1111(b)(2) election. If an undersecured creditor whose claim has been bifurcated under §506 makes this election in writing prior to the conclusion of the hearing on the disclosure statement, then their lien is not avoided. Also, this provision requires creditors whose debts are non-recourse to be treated as if they had recourse notwithstanding a contract to the contrary. A detailed discussion of §1111 is far beyond the scope of this paper. It does give certain types of secured creditors more rights than they have in Chapter 13, which has no comparable section.
C. Confirmation Issues
Chapter 13 confirmation is governed by §1325 and has in essence 7 requirements to confirm a plan. In larger contrast is Chapter 11, which has 16 requirements to confirm a plan, found in §1129(a).
In the case of an individual, all of the confirmation requirements of Chapter 13 are present in Chapter 11 including the disposable income requirement. There are in essence 8 more hurdles to jump to get a plan confirmed in 11 than are present in 13. The major difference is that Chapter 11 requires a majority of the creditors to vote for the plan to obtain confirmation unless the debtor has the ability to “cram down” the plan under §1129(b). It is very difficult to obtain confirmation by cram down when the rejecting class is an unsecured class since the Debtor is required to give up ownership by cancellation of the pre-petition equity. A notable exception under the Reform Act has been created for individuals. Such Debtors may retain their pre-petition equity if they pay their disposable income to the creditors.
A complete discussion of the confirmation of Chapter 11 is far beyond the scope of this paper. In the event a comparison of the plans leads one to the conclusion that a plan can be confirmed under either chapter based on the matters already discussed, be sure to look at the addition requirements to confirm a Chapter 11 plan. Most of them are not too meaningful in an individual case, but sometimes there are issues which are barriers to Chapter 11 which are not present in Chapter 13.
Because of the voting aspect of Chapter 11, there is also the requirement that the Debtor prepare and obtain approval of a disclosure statement prior to any solicitation of binding acceptance of the proposed plan. §1125. This is an informational document which requires a lot of time and effort to prepare. If there is a confirmable plan, then it is almost always possible to obtain approval of the disclosure statement even if a creditor objects, since the only real issue is the adequate information in the disclosure statement.