Thursday, July 30, 2009

Rule Amendment Proposes to Allow Objections to Exemptions After Conversion

The Committee on Rules and Practice has recommended that the Judicial Conference approve a series of changes to the Federal Rules of Bankruptcy Procedure. One proposal is to amend Rule 1019 to allow a new period of time to object to exemptions when a case is converted from chapters 11, 12 or 13 to chapter 7. Currently, if creditors fail to object to an exemption in a reorganization case and the case is later converted to chapter 7, the chapter 7 trustee does not have an opportunity to object unless the debtor amends their exemptions. However, the rule would not apply if: (i) the case was originally filed as a chapter 7 and the period for objecting to exemptions expired or (ii) a plan was confirmed more than one year prior to conversion. If approved by the Judicial Conference, the rule will be transmitted to the Supreme Court for adoption.

Sunday, July 19, 2009

Fifth Circuit Holds That Projected Disposable Income Should Reflect Reality

In a new opinion, the Fifth Circuit ruled that the calculation of "projected disposable income" in a chapter 13 plan is not merely a mechanical calculation and may take note of events "reasonably certain" to occur. Matter of Nowlin, Non. 08-20066 (5th Cir. 7/17/09). In doing so, the Fifth Circuit sided with the Eighth and Tenth Circuits and rejected a decision from the Ninth Circuit.

Nowlin involved an above median income debtor whose means test form indicated that she could pay $38.67 per month, but whose schedules I and J indicated that she could pay $195.64. The Debtor proposed a plan to pay $195.00 per month for 60 months. The only problem was that the Debtor had a 401k loan which would pay off in two years, which would free up $947.30 per month. The Trustee objected on the basis that the Debtor was not including all of her "projected disposable income" based on the money which would be freed up in the future. The Debtor responded that all she had to do was take the number listed on the means test and multiply by 60.

The Fifth Circuit held that "projected disposable income" was something more than just a mechanical computation and could take other events into account.

We are persuaded that the independent definition of “projected” adds to the phrase’s overall meaning. The term “projected,” not defined in the statute, means “[t]o calculate, estimate, or predict (something in the future),based on present data or trends.” (citation omitted). In view of this definition, with which Nowlin agrees, we interpret the phrase “projected disposable income” to embrace a forward-looking view grounded in the present via the statutory definition of “disposable income” premised on historical data. The statutorily defined “disposable income” is the starting point—it is presumptively correct—from which the bankruptcy court projects that income over the course of the plan. Under this interpretation, the statutory definition of “disposable income” is integral to the bankruptcy court’s decision to confirm or reject a Chapter 13 debtor’s proposed plan.
Opinion, pp. 6-7.

The Court's two holdings were as follows:

Thus, we hold that a debtor’s “disposable income” calculated under § 1325(b)(2)and multiplied by the applicable commitment period is presumptively the debtor’s “projected disposable income” under § 1325(b)(1)(B), but that any party may rebut this presumption by presenting evidence of present or reasonably certain future events that substantially change the debtor’s financial situation.
Opinion, p. 12.

We hold that a bankruptcy court may consider reasonably certain future events when evaluating a Chapter 13 plan for confirmation under § 1325. Some events may be too speculative, such as the fluctuation of an investment market during the plan’s term and its impact on the debtor’s budget. Other events are much more certain, as in this case where the debtor will pay off a debt at a date certain. If the event is less than reasonably certain to occur, amendment under 11 U.S.C. § 1329 is the appropriate way to proceed if a party wishes to change the plan.
Opinion, p. 14.

While Nowlin was a defeat for the debtor in the specific case, it also offers the possibility of mitigating an unusually harsh result from the means test. In its opinion, the Fifth Circuit noted that if the debtor's six month average income was higher than his current income due to a change in job, this was something which could be factored in. Additionally, if it was reasonably certain that an expense would increase, for example, if the debtor had received notice that his rent would increase in six months, the means test could be adjusted there as well.

The Fifth Circuit has established a workable framework for making the means test conform to reality. The means test provides the presumptive starting point. If changes have already occurred or are "reasonably certain" to take place, they may be accounted for in confirmation of the initial plan. On the other hand, if the effect of a future occurrence cannot be predicted with reasonably certainty, the remedy is to file for a modification of the plan under section 1329.

Wednesday, July 15, 2009

Ninth Circuit Joins Consensus: 401k Loans Not Deductible As Secured Debt Under Means Test

Joining what has become the consensus position, the Ninth Circuit has held that payments on a 401k loan may not be deducted under the chapter 7 means test. Egebjerg v. Anderson, 2009 U.S. App. LEXIS 11651 (9th Cir. 5/29/09). The opinion highlights a major inconsistency in the way that BAPCPA treats retirement plan loans.

The Ninth Circuit ruled that a loan from a retirement plan was not a debt and therefore was not a secured debt which could be deducted on line 42 of the means test. The crux of the ruling is found in the following language:

The reasoning behind these decisions is straightforward. Egebjerg’s obligation is essentially a debt to himself — he has borrowed his own money. (citation omitted). Egebjerg contributed the money to the account in the first place; should he fail to repay himself, the administrator has no personal recourse against him. (citation omitted). Instead, the plan will deem the outstanding loan balance to be a distribution of funds, thereby reducing the amount available to Egebjerg from his account in the future. (citation omitted). This deemed distribution will have tax consequences to Egebjerg, but it does not create a debtor creditor relationship.
Opinion, pp. 6386-87.

In my view, this is an area where the law has gone astray. I recently received a loan from my 401k plan. The document which I signed was entitled "Loan Agreement, Note and Pledge." In pertinent part, the document stated:

For value received the Borrower agrees to pay the Lender the amount of $________ principal and interest at an annual interest rate of ______%. The length of the loan shall be ___ months. Payment shall be made to the Trustee of the Plan in the amount of $_______ Semi-Monthly beginning ______ and ending _______. Prepayment of the unpaid principal and accrued interest may be made by the Borrower at any time without penalty.

Pledge to secure this loan: Borrower hereby irrevocably pledges his/her vested account balance under the Plan in satisfaction of any unpaid balance and associated costs due and payable upon default.
Thus, there is a Lender, a Borrower, a promise to pay and a security interest. The fact that the security interest is in funds contributed to a retirement plan should not make a difference. While the funds in the retirement plan originated from my contributions, they are no longer under my dominion and control. If I buy 1 share of Berkshire Hathaway and then borrow money secured by that stock, I have in essence borrowed my own money; my money has just taken the form of Berkshire Hathaway stock instead of cash. The pledge of the stock allows me to keep my money in the form of the stock while having access to it through the intermediary of the bank. The analogy of a pledge of stock is particularly appropriate, since I have the assets in my 401k plan invested in mutual funds.

Besides ignoring the form and substance of the transaction, the consensus position is inconsistent with the manner in which 401k loans are treated elsewhere by BAPCPA. BAPCPA included three provisions specifically aimed at protecting retirement plan loans. Section 362(b)(19) provides that retirement plan loans are not subject to the automatic stay, thus allowing their continued collection in a bankruptcy case. Section 523(a)(18) provides that a "debt" owed to a retirement plan is non-dischargeable, thus protecting a debtor from tax liability resulting from discharge of the loan. Finally, Section 1322(f) provides that a retirement plan "loan" may not be altered by a chapter 13 plan and may not be included in calculation of the debtor's disposable income. There are two important points here. The first is that since the Code refers to these obligations as "debts" and "loans" in other places, why would they not be a debt or a loan under the means test? Secondly, the purpose of the chapter 7 means test is to identify debtors who can afford to pay their debts under a chapter 13 plan. Therefore, it makes logical sense to interpret the chapter 7 means test in light of what would be deductible in a chapter 13 case.

Unfortunately, it looks like the train has left the station on this issue and the Ninth Circuit's position does reflect a consensus among courts. As a result, this may be an issue requiring a legislative fix.

Circuit Court Denies Claim For Lack of Supporting Documentation

The 10th Circuit has ruled that a trustee's objection to an assigned proof of claim should be sustained based on lack of supporting documentation even though the debtor scheduled a similar claim. In re Kirkland, No. 08-2017 (10th Cir. 7/14/09). The opinion can be found here.

In Kirkland, the debtor scheduled a debt in the amount of $5,004 for a credit card account ending in 2787. NextBank, N.A./B-Line, LLC filed a proof of claim in the amount of $5,328.19 for a credit card account ending in 2787, but did not include any supporting documentation. The chapter 7 trustee objected to the claim. Neither the trustee nor the creditor offered any evidence at the hearing, although the creditor asked the court to take judicial notice of the debtor's schedules. The Bankruptcy Court sustained the objection, finding that the creditor had failed to prove up its claim. In re Kirkland, 361 B.R. 199 (Bankr. D.N.M. 2007). The Bankruptcy Appellate Panel reversed. In re Kirkland, 379 B.R. 341(10th Cir. BAP 2007).

The 10th Circuit held that the Bankruptcy Court was correct in denying the claim. It stated:

The bankruptcy court appropriately determined that because B-Line bore the burden of proof for its claim and failed to meet its burden, its claim was disallowed. See In re Kirkland, 361 F.3d at 205. The plain language of the bankruptcy Code and its associated procedural rules support the court’s ruling. The Bankruptcy Code provides that “[a] creditor . . . may file a proof of claim.” 11 U.S.C. § 501(a). Because the code does not define “proof of claim,” we look to the Federal Rules of Bankruptcy Procedure. “A proof of claim is a written statement setting forth a creditor’s claim. . . . [It] shall conform substantially to the appropriate Official Form.” Fed. R. Bankr. P. 3001(a). The relevant form is Official Form 10, which requires a claimant to “[a]ttach redacted copies of any documents that support the claim, such as promissory notes, purchase orders, invoices, itemized statements of running accounts, contracts, judgments, mortgages, and security agreements.” Fed. R. Bankr. P. Official Form 10. Form 10 also instructs a claimant that “[i]f the documents are not available, please explain.” Id. When a proof of claim is executed and filed in accordance with the provisions of Rule 3001 (including Official Form 10), it “constitutes prima facie evidence of the validity and amount of the claim.” Fed. R. Bankr. P. 3001(f).

B-Line has failed to produce a single document to support its proof of claim. B-Line has also failed to explain its failure to provide supporting documentation. Although the bankruptcy court took judicial notice of the Debtor’s appended schedules of unsecured creditors, it correctly determined that the schedules were of no evidentiary value against the Trustee. Therefore, B-Line has failed to present “prima facie evidence of the validity and amount of the claim.” Id. In response to the Trustee’s objection, the bankruptcy court held an evidentiary hearing. Even then, B-Line produced no evidence in support of its claim and no explanation for its failure to do so. On this record, we conclude that the bankruptcy court appropriately disallowed B-Line’s claim. Had the bankruptcy court allowed B-Line’s claim despite B-Line’s failure to provide either supporting evidence or an explanation for its failure to provide supporting evidence, the burden would have improperly rested with the Trustee to disprove an unsubstantiated claim. (citation omitted).

Opinion, at 5-6.

The Court of Appeals' reasoning can be summarized as follows:

1. A properly filed proof of claim is entitled to prima facie validity.

2. A claim without supporting documentation is not a properly filed proof of claim and is not entitled to prima facie validity.

3. The trustee is not estopped by the debtor's schedules.

4. If a claim is not entitled to prima facie validity and is not supported by competent evidence, the claim must be denied without the necessity for the objecting party to offer any proof.

This is an issue which has been percolating through the lower courts for some time now. See On Gunslingers, Presumptions and Burdens of Proof and Assigned Credit Card Debt: A Problem of Paper, Electronic Images and Faith. However, this appears to be the first Circuit Court opinion to weigh in on the effect fo failure to attach documentation to a credit card claim. However, the ruling may be of primary benefit to trustees, since the trustee was not estopped by the debtor's schedules. If the objection had been brought by a debtor, the result might have been different.

Friday, July 10, 2009

More About Judge Sotomayor and Bankruptcy

Supreme Court nominee Sonia Sotomayor’s questionnaire completed for the Senate Judiciary Committee contains a mind-numbing 173 pages of details about the prospective justice. If you need to know who she gave a speech to in 1993 or which single-sex club she belonged to until recently, this is the place to look. However, the questionnaire also contains some information of interest to bankruptcy practitioners.

First, Judge Sotomayor has seen the inside of a bankruptcy courtroom. When asked to name the ten most significant cases that she litigated, Judge Sotomayor included In re Van Ness Auto Plaza, Inc., a case in which she represented Ferrari North America, Inc. in the bankruptcy of one of its franchisees. As an attorney, Judge Sotomayor successfully opposed the debtor’s attempt to assume the franchise agreement while rejecting contracts to sell vehicles to customers. Thus, the prospective Justice is not only a wise Latina who came up from the projects, but also a defender of Ferrari purchasers.

Second, this Supreme Court term has not been kind to Judge Sotomayor. While Ricci v. Destefano received more media attention, Judge Sotomayor was also part of the panel whose decision was reversed in the only major bankruptcy case of the term. In Johns-Manville Corp. v. Chubb Indemnity Insurance Co., 517 F.3d 52 (2nd cir. 2008), the Second Circuit ruled that the bankruptcy court’s jurisdiction to enter a channeling injunction in the Johns-Manville bankruptcy case did not extend to claims arising from the insurance company’s conduct as opposed to the debtor’s conduct. The court found that the jurisdiction issue could be raised when the insurance company sought to enforce the bankruptcy court’s order even though it had not been challenged on direct appeal. The Supreme Court reversed, finding that the jurisdictional challenge was an improper collateral attack on the bankruptcy court’s order. Travelers Indemnity Company v. Bailey, 2009 U.S. LEXIS 4537 (June 18, 2009). Thus, Judge Sotomayor was on the losing side of a major bankruptcy precedent.

Wednesday, July 01, 2009

Fifth Circuit Allows Ownership Expense on Paid For Vehicle

The Fifth Circuit has held that a debtor may claim an ownership expense on the chapter 7 means test even if the debtor does not have a loan or lease payment. In re Tate, No. 08-60953 (5th Cir. 6/10/09). In the Tate case, the debtors owned two paid for vehicles. If they were allowed to claim a vehicle ownership expense under the means test, their monthly disposable income was $137.66, just under the threshold of $166.67 where their case would be deemed to be abusive. A Bankruptcy Court in Mississippi dismissed the case on the Trustee's motion, a decision which was upheld by the District Court.

However, when the matter reached the Fifth Circuit, the Court concluded that "the debtors should have been able to deduct the transportation ownership deduction under the plain language" of the statute. The Fifth Circuit noted a split between courts following the "plain language" approach and the Internal Revenue Manual test. The Court described the two approaches as follows:

Both approaches start from the text of the statute, which states in part, "The debtor's monthly expenses shall be the debtor's applicable monthly expense amounts specified under the National Standards and Local Standards." (citation omitted). The approaches differ, however, in how they read the word "applicable" in the above sentence.

Courts following the "plain language" approach read the word "applicable" to refer to the selection of an expense amount from the Local Standards that relates to the geographic area in which the debtor resides and the number of vehicles the debtor owns. (citation omitted). Under the plain language approach, the vehicle ownership deduction that "applies" to a debtor is the one that corresponds to his geographic region and number of cars regardless of whether that deduction is an actual expense. (citation omitted). . . .

Courts following the IRM approach conclude that the vehicle ownership deduction is not allowed if the debtor has no debt payment. These courts reach this result by reading the word "applicable" to modify "monthly expense" amounts so the debtor can deduct this expense if he has a "relevant" ownership expense. (citation omitted). In other words, under this approach, if the debtor has no debt or lease payment related to a vehicle, he cannot take the ownership deduction because it is not applicable or relevant to him. This interpretation is called the IRM approach because the courts following it use the methology of the IRM as an interpretive guide for applying the means test. (citation omitted). Under this approach, courts look not only to the Local Standards but also to how the IRS uses the Local Standards in its revenue collection process. Under the IRM, if a taxpayer has no car payment, the taxpayer is only entitled to the vehicle operation expense, not the ownership deduction.

Opinion, pp. 4-5.

In adopting the plain language approach, the Fifth Circuit sided with the Seventh Circuit, which is the only other circuit court to address the issue. In re Ross-Tousey, 549 F.3d 1148 (7th Cir. 2008).

As I see it, the plain language approach is preferable for at least three reasons. First, it is always best to follow the plain language of the statute. Any time that courts bend a statute to arrive at the result that Congress may have intended, they stray into legislating rather than judging. Second, following the Internal Revenue Manual poses a separation of powers issue. While it is bad enough that BAPCPA relies on a standard promulgated by the executive branch to determine eligibility for bankruptcy, at least the National and Local Standards purport to be based on objective factors. However, allowing the IRS to shade those standards through the IRM effectively allows an executive branch agency to amend the statute, which is an obvious problem. Finally, allowing an ownership expense recognizes reality. A car is a depreciating asset. Even if a debtor does not have a debt payment, the trade-in value of the vehicle is going down. Thus, a prudent debtor who does not have a car payment would still be saving for the downpayment on a replacement vehicle. Allowing an ownership expense only for debtors with a car payment penalizes the debtor who keeps a car for the long term as opposed to the person who trades for a shiny, new car every year.