A chapter 13 debtor proposes a plan to pay creditors over a period of time. Their creditors may include credit cards and utilities, and as in most cases I deal with, prepetition mortgage arrears. In some cases, debtors simply make a monthly payment to the chapter 13 trustee over the life of the plan. In others, debtors propose plans that provide for gradual increases in monthly payments (what might be referred to as a “step plan”). Other proposals might include monthly payments, with the last payment being a large balloon. That final balloon payment might be paid by the sale of an asset or a refinancing of property. However, a recent Massachusetts Bankruptcy Court decision says that this practice is no longer permissible since BAPCPA. The decision is on its way to the Bankruptcy Appellate Panel and debtors and practitioners should follow it closely.
Why?
There are many reasons why these types of plans are proposed. Some debtors have seasonal employment, while others expect raises or bonuses that they can use to fund future plan payments. Other debtors expect to refinance their property in 3-5 years, or perhaps sell property to make a balloon payment. The more practical reason is this: at the time the debtor’s file their chapter 13 plan, they do not have the income or resources to make equal monthly payments enough to fund a confirmable plan. For many debtors, step or balloon plans are the only way some debtors can keep their homes.
This decision comes from two separate cases. In one, the debtors proposed a step plan: 12 $500 per month payments, 12 $1,000 per month payments, 35 $1,500 per month payments and one balloon payment of about $105,000. The other debtors proposed 59 payments of $550 per month, with one balloon payment of about $38,000.
The Bankruptcy Court found that the plans did not comply with Section 1325(a)(5)(B)(iii)(I) which was added by BAPCPA which requires that a chapter 13 plan provide for periodic payments to a secured creditor in equal amounts. “[I]t seems apparent that once periodic payments to that creditor commence, a subsequent balloon payment would be unequal to those that preceded it.” Because the Court found that this was a requirement for confirmation of the plan, the Court could not confirm the plans.
In referring to In re Erwin, 376 B.R. 897 (Bankr.C.D.Ill. 2007), the Court noted that “[s]ecured creditors, particularly those secured by a vehicle, viewed [step plans or balloon payments] as unfair, exposing them to undue risk in light of the constant depreciation of their collateral.”
In one of the cases, the creditors did not object and the debtors argued that the creditor's silence should be construed as consent to their treatment under the plan. However the court noted from a prior decision that “even in the absence of objection by a creditor, the court has an affirmative duty to review [a Chapter 13 plan] and ensure its provisions comply with the provisions of the Bankruptcy Code.”
This decision is headed to the BAP for review, and given the importance of the issue, it is likely to head to the First Circuit. Reasonable minds can disagree as to what the outcome will be or should be. For now, debtor’s attorneys can at least try – at least in this district – to propose a step or balloon plan. However, debtor’s attorneys and prospective debtors should watch this issue closely. If this Bankruptcy Court decision is upheld by the higher courts, many debtors will not benefit from the protections afforded by chapter 13 because they will not be able to fund a confirmable plan.
Stay tuned.
In re: Melillo, Chapter 13 Case no. 07-10238 (Bankr.D.Mass 2008).
In re: Flynn, Chapter 13 Case no. 07-15470 (Bankr.D.Mass 2008).
