The Debtor and the Blown Engine Plan Flexibility in Light of Nolan v. Chrysler Financial Services

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Jul/Aug 2001

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A fundamental distinction exists between a consumer chapter 7 case and a chapter 13
case. This distinction pervades the way each case proceeds through the judicial
system. A chapter 7 case is static: non-exempt assets held by a debtor at the
time of filing become "property of the estate," available for liquidation and
distribution to creditors.<a href="#1" name="1a">1</a> The changes in a debtor's circumstances that occur following
filing where the debtor is generally free from the control of the bankruptcy court or
the claims of a trustee are regarded, for good or ill, as the debtor's good fortune
or bad luck. A chapter 7 debtor who experiences an increase in income, incurs a
debt, acquires assets or wins the lottery has the personal benefit or burden of such
events. The decision of a debtor to seek chapter 7 relief can provide to that debtor
a prompt fresh start and a rapid discharge, and can leave the debtor free of
pre-petition debts, capable of participating as a new consumer with future income
available to satisfy the debtor's personal lifestyle or to satisfy newly acquired debt.

A chapter 13 case is dynamic: debtors devote future income toward the
satisfaction, in whole or in part, of claims. The focus of the confirmation process
is toward anticipated events: whether the debtor can satisfy all of the secured claims
(paying to the secured creditors value of the collateral) using the debtor's projected
disposable income; whether the debtor will perform under the plan in the future, and
whether the debtor's future payments to the trustee will satisfy the
best-interest-of-creditors test. Clearly, the confirmation of a chapter 13 plan
is a judicial prognostication that things will happen in a debtor's life to permit the
consummation of a plan and receipt of a discharge. The unfortunate truth is that often
things do not turn out the way that debtors and courts anticipate at the time of
confirmation. A debtor suffering the loss of a job, a medical setback or dissolution
of a family is left with a chapter 13 plan that may have seemed achievable at
confirmation, but grew impossible based on later developments.

Section 1329 gives the debtor confronting changed circumstances an option other
than dismissal or conversion.<a href="#2" name="2a">2</a> The Code permits the debtor to modify the plan subject
to certain restrictions. The section appears to contemplate a new confirmation process
since it makes reference to §1325(a) ("...Section 1325(a) of this title
appl[ies] to any modification under subsection (a) of this section..."), and
§1325(a) imposes the mandatory requirements of confirmation (the good faith
requirement of §1325(a)(3), the best interest requirement of §1325(a)(4),
the feasibility requirement of §1325(a)(6), and the "present value" requirement
of treating a secured claim of §1325(a)(5)). Section 1329(c) imposes the
caveat, however, that a plan modification may not cause a plan to exceed 60 months
from the date of first payment.

Section 1329(a), however, specifies types of modifications to increase or
reduce payment to creditors in a class, to extend or reduce the time to make
payments to creditors in a class, and to alter a distribution to a creditor to take
into account payments made by a third party to that creditor. Several courts have
concluded that the permissible modifications of a confirmed plan are limited to this
short list. Most of these courts relied upon the binding effect of confirmation of
§1327, noting that the limited exception to the binding effect of §1327 is the
short list of §1329(a).

Recently, the Sixth Circuit joined these courts and applied §1329 to a
relatively common scenario. After a debtor's chapter 13 plan is confirmed, providing
for a claim secured by an automobile, the debtor discovers that he or she can no
longer afford the plan and seeks to reduce payments by surrendering the car. In
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Financial Corp. v. Nolan (In re Nolan), 232 F.3d 528
(6th Cir. 2000)</a>, Ms. Nolan's chapter 13 plan was confirmed, fixing the
secured claim of Chrysler at $8,200, the value of her 1995 Mitsubishi
Mirage, and providing for monthly payments with interest of $207.97 by the
trustee. About a year after confirmation, Ms. Nolan sought to modify her chapter
13 plan to eliminate the monthly payments by the trustee to Chrysler, surrender her
Mitsubishi to Chrysler, and reduce her payments to the trustee. She simultaneously
sought court approval to incur post-petition debt to finance the purchase of another,
less expensive car.

The Sixth Circuit held that in approving the requested modification, the bankruptcy
court went beyond what is permitted under §1329(a). Ms. Nolan's proposed treatment
of the claim held by Chrysler was a reclassification of the creditor's secured claim
to unsecured status. The amount of Chrysler's secured claim was fixed at confirmation
to the value of the Mitsubishi ($8,200). Section 1325(a)(5) requires
that the plan pay to Chrysler that present value.<a href="#3" name="3a">3</a> Nothing in §1329 alters that
requirement, and the court held that Ms. Nolan should not be able to shift the claim
from secured status to unsecured status simply because she chooses to relinquish
possession of the automobile.

The Sixth Circuit clearly considered the inequity of a reading of §1329 in which
a debtor could "cram down" a secured creditor's claim at confirmation but effectively
and "unfairly shift away depreciation, deficiency and risk voluntarily assumed by the
debtor through confirmation of the chapter 13 plan" (at 534). Considered, too,
was the inequity of conferring a right upon a debtor to modify the treatment of the
secured claim where the collateral is substantially depreciated (largely through the
actions of the debtor who was in a better position to maintain and preserve the
Mitsubishi) while denying to a secured creditor the right to modify the treatment of
its secured claim upward if collateral had appreciated since confirmation (§1329 only
gives debtors, trustees and holders of unsecured claims the right to seek
modification).

The holding of the Sixth Circuit in Nolan is consistent with the holding of most
courts faced with a similar issue. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Meeks, 237 B.R. 856 (Bankr.
M.D. Fla. 1999)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Cruz, 253 B.R. 638 (Bankr. D. N.J.
2000)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Coleman, 231 B.R. 397 (Bankr. S.D. Ga.
1999)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Dunlap, 215 B.R. 867 (Bankr. E.D. Ark.
1997)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Banks, 161 B.R. 375 (Bankr. S.D. Miss. 1993)</a>;

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Holt, 136 B.R. 260 (Bankr. D. Idaho 1992)</a>. These courts,
and others, have regarded the list of permissible modifications in §1329(a) to
be exclusive: "Nowhere in §1329(a) does the statute permit a debtor to modify
the amount of an allowed secured claim. Likewise, §1329(a) does not allow a
debtor to reclassify an allowed secured claim as an unsecured claim. The claim amount
is fixed at the confirmation hearing, and no provision in §1329 allows for the
later modification or re-examination of the claim amount." (<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Weeks, supra at
860</a>).

To be sure, a number of courts have recognized that the restrictive reading of the
permitted modifications of §1329(a) by the Sixth Circuit is not supported by the
statute. In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Townley, 256 B.R. 697 (Bankr. D. N.J. 2000)</a>,
the debtors' chapter 13 plan was confirmed, valuing their 1994 Toyota, but after
confirmation the debtors' income decreased. To keep the plan feasible, the debtors
sought to modify their plan, surrender the Toyota, make no further payments on the
secured claim, treat any deficiency resulting from the surrender as a general unsecured
claim and reduce their payments to the trustee accordingly. Ford Motor Credit objected
to the modification, arguing, as did Chrysler in Nolan, that §1329 does not
permit a "reclassification" of the secured claim to unsecured.

The bankruptcy court disagreed, noting that Nolan and its progeny read
§1329(a)(1) too narrowly. That subsection specifically permits a modification to
"reduce the amount of payments on claims of a particular class," and the Nolan court
has apparently added the exception "except secured claims" to the statute. If §1329
permits payments in a class to be reduced, and the claim of Ford was a claim in
a class, the section clearly permits payments to Ford to be reduced; the ability
to reduce payments is not limited to only unsecured claims.

The question remains, however, as to what type of claim the creditor has after
the "surrender" of the collateral. Nolan seems to indicate that the claim remains
secured after the return of the collateral. That logic was challenged in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re
Johnson, 247 B.R. 904 (Bankr. S.D. Ga. 1999)</a>, a case decided
prior to Nolan. There, agreeing with the argument that §1329(a) would not permit
"reclassifying" the secured claim to an unsecured claim by way of plan modification,
the court held that the real issue was not one of plan modification but the nature
of the claim after the collateral had been returned. Section 502(j) permits the
reconsideration of claims at any time. "After surrender of collateral, the deficiency
portion of the claim is no longer actually secured. A claim simply cannot be secured
when nothing secures it.<a href="#4" name="4a">4</a> Any deficiency claim is therefore, by definition,
unsecured. That reality can and should be reflected in the allowance of claims in the
bankruptcy case. Otherwise, the plan is not in accord with the Bankruptcy Code
requirement that the plan must provide the same treatment for each claim within a
particular class...The Johnson's confirmed chapter 13 plan, like many chapter 13
plans, classifies all unsecured claims together. The unsecured deficiency claim must be
treated as all other unsecured claims allowed by the plan. To allow the claim as
secured fails to treat all claims equally within a particular class. Section 502(j)
is available to redress that inequity" (<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra at 908</a>).<a href="#5" name="5a">5</a>

Section 502(j) was also applied in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Zieder, _____ B.R. ____, 2001
WL 640405 (June 4, 2001)</a> (Bankr. D. Ariz.), to permit the
modification of a confirmed chapter 13 plan to reflect the surrender of collateral.
"When [§502(j) and §506] are applied to the facts of this case, they compel
the conclusion that Ford's remaining claim must be reconsidered for cause and, when
reconsidered, it becomes an unsecured claim by operation of law. There is now no
collateral securing Ford's claim. Consequently, §506(a) by its own express terms
makes Ford's entire claim an unsecured claim. There is no provision of the
Code...that gives a creditor a secured claim without any collateral."

To avoid the inequity of unanticipated or negligent depreciation of the collateral
recognized by the Nolan court, Johnson holds that the creditor whose claim has been
reconsidered may assert a priority claim for failure of "adequate protection." To
calculate this claim, the court must value the collateral as of the filing date at
the liquidation value (rather than the replacement value, which would apply if the
debtor sought to retain the collateral), subtracting payments made by the plan and
the amount realized by the actual liquidation of the collateral. What remains reflects
a failure of the plan to provide adequate protection, which must be paid in full as
an administrative expense claim.

In the wake of Nolan, it appears that debtors' counsel seeking to reduce the
payments made by a debtor is limited. Modifying a plan to reclassify the claim of
a creditor may not be an option, but giving up collateral and reconsidering the claim
remaining under §502(j) is an option. No appellate court (or lower court in the
Sixth Circuit) has yet weighed in on the use of §502(j) to so restructure a
plan, but, short of dismissing and re-filing or converting to chapter 7, such
process may be the only avenue for relief.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Section 541 acknowledges that certain post-petition accessions are also included in the estate (i.e., inheritances, divorce distributions
and property generated by property of the estate), but for the most part, such accessions are rare. <a href="#1a">Return to article</a>

<a name="2">2</a> Legislative history supports the conclusion that §1329 was created to allow debtors to address problems after a plan is confirmed. H.R.
Rep. No. 95-595 at 265 (1977). <a href="#2a">Return to article</a>

<a name="3">3</a> Although §1329(b) recognizes that §1325(a) applies to modifications, §1329(b) only applies to modifications permitted under
§1329(a). Section 1325(a)(5) would permit the surrender of collateral "but only pre-confirmation. For §1325(a)(5)(B)(ii)
to provide any protection to the creditor when the debtor chooses to retain her collateral, the secured claim must not be subject to modification
throughout the life of the plan." In re Nolan, supra n. 8. <a href="#3a">Return to article</a>

<a name="4">4</a> Section 1329(a)(3) does permit a plan modification to "alter the amount of distribution...to the extent necessary to take account
of any payment of such claim other than under the plan." The "surrender" of the collateral—the transfer of the property to the creditor—may
well be a payment of a secured claim other than under the plan and thus a permitted modification to reduce the "secured" claim amount. <a href="#4a">Return to article</a>

<a name="5">5</a> To be sure, §502(j) reconsideration is not available to a debtor where the equities fail to support it. That section permits claim
reconsideration only "according to the equities of the case." Thus to recognize the deficiency claim as an unsecured claim, the debtor must
act in good faith. Such reconsideration may be denied if the debtor failed to maintain or insure the collateral. See Johnson, supra at
908. <a href="#5a">Return to article</a>

Journal Authors

Henry E. Hildebrand

Journal Date

Sunday, July 1, 2001 - 12:00

Bankruptcy Rule

2001