One common issue in Chapter 13 plans is how to deal with assets of unknown value that are later liquidated to cash. The personal injury lawsuit that may or may not have unexempt net value, for instance. Similarly, there can be some question of what happens to the proceeds of an asset with a known value that is sold during a Chapter 13, like the sale of a home. After some recent research, I don't think many attorneys are currently handling these assets properly, including myself.
One case that comes to mind is a client that wished to use a cash-out refinance of a home to fund a needed project, and we worried about the Trustee wanting some of the funds paid into the plan. I make the argument to a colleague that the Debtor had already paid into the plan a large sum of money. The amount of the cash out actually was less than the exemption, if I recall. The colleague suggested that there would be an issue with, essentially, separating the asset from the exemption. The home value was exempt as a home, but we wanted to essentially reduce the home equity to cash and spend it. Imagine, for instance, a Debtor walking off with their $15k exemption, dismissing their case, and then exempting a different $15k in value.
I found this argument compelling, but this brought to mind a question - what is the mechanism that forces us to file motions and devote certain portions of the assets into the plan?
There were two potential culprits - the Best Interest Test and the Disposable Income Test. The Best Interest Test, 11 U.S.C. §1325(a)(4) states that the creditors in Chapter 13 must receive at least as much as they would have received if any assets were liquidated in Chapter 7. The Disposable Income requirement, 11 U.S.C. §1325(b)(1)(B) states that the Debtor must pay all of their disposable income into the plan.
Enter In re Burgie, which finally answers my question. 239 B.R. 406 (B.A.P. 9th Cir. 1999). Debtors sold a home and realized a net profit from it. The Trustee sought to force them to pay the non-exempt value into the plan. The Debtors sold the home immediately after confirmation of the plan, so general unsecured creditors hadn’t received anything yet. While the Debtors originally thought they were going to use the proceeds to purchase a new home, they didn’t need it all, and specifically said that $20k was going to be used for household expenses - they were pocketing it.
Doesn’t matter, says the court. “Postpetition disposable income does not include prepetition property or its proceeds. This is the chapter 13 debtor's bargain. Creditors of a chapter 13 debtor have no claim to any of these assets.” Further, “Creditors are protected by the requirement that the plan provide them at least as much value (discounted to present value) as they would receive under a chapter 7 liquidation of the debtor's estate.”
Neither the Best Interest Test nor the Disposable Income Test prevents a Debtor from keeping the entire pre-petition asset, assuming that the plan has properly satisfied the Best Interest Test with monthly payments.
In one of the local opinions to analyze this issue, Trustee Marshall's position on the net proceeds of the sale of a home needed to be paid into the plan. But as I mentioned above, why? What is the mechanism? There is none. “Chapter 13 allows a debtor to keep her equity in those assets if she pays her unsecured creditors in accordance with the requirements of § 1325,” Judge Doyle wrote in Mangum.
Here's the part that I have never seen argued - we typically, for unknown assets, provide language like "the Debtor will pay to the Trustee the non-exempt net proceeds of [the asset] as an additional payment to general, unsecured creditors." The idea being that we can only satisfy the Best Interest Test for an unknown asset by stating, essentially, "I don't know what the value is, but whatever it is, the Trustee can have the nonexempt net value." But that's not right, is it?
We've already seen that a non-exempt net asset can be retained, provided the Best Interest Test is otherwise met. So the correct language, I'd argue, is this: "the Debtor will pay to the Trustee the non-exempt net proceeds of [the asset], less the sum required by 5.1 of the plan, as an additional payment to general, unsecured creditors." This avoid a double payment to general, unsecured creditors.
Local cases:
In re Golek, 308 B.R. 332 (Bankr. N.D. IL 2004) (Judge Black) (in the context of a post-petition sale of pre-petition real estate, “sustaining the trustee’s objection in this case would allow the trustee to do something post-confirmation that she was not able to do at the time of confirmation: force the debtor to use a pre-petition asset to fund the plan.”).
In re Mangum, 343 B.R. 185, 188 (Bankr. N.D. IL 2006) (Judge Doyle) (“Chapter 13 allows a debtor to keep her equity in those assets if she pays her unsecured creditors in accordance with the requirements of §1325.”).
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