Best Interests of Creditors An Equitable Rule in the Eighth Circuit

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May 1999

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In order to confirm a chapter 13 plan, the court must find that the plan meets the "best

interests of creditors." The Eighth Circuit recently arrived at an equitable formula in deciding

whether the debtor's interest in an estate in the entirety is property of the bankruptcy estate. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Gerard Robert Van Der Heide, 164 F.3d 1183 (8th Cir. 1999)</a> (rehearing denied March 8, 1999).

<h3>Protection of Unsecured Creditors</h3>

<a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…;

11 U.S.C. §1325</a> provides two standards designed to protect general unsecured claims.

Section 1325(a)(4) establishes the "best interests of creditors" test, and §1325(b)

establishes the "ability to pay" test. Under §1325(a)(4), the court exercises its judicial

discretion to make findings that plan confirmation standards are met.

Although the National Bankruptcy Review Commission proposed guidelines to avoid variations in

interpretation of "ability to pay" in the national courts, it did not address any change to the

"best interests of creditors" test.<a href="#1" name="1a">1</a>

In Van Der Heide, the Bankruptcy Court for the Eastern District of Missouri denied confirmation

of the chapter 13 plan. The trustee had objected to confirmation, claiming that the plan did not

meet the "best interests of creditors" test since general unsecured creditors would have

received more in a chapter 7 liquidation. Proposed plan payments to general unsecured

creditors were in the total amount of $2,858. The trustee claimed that a sale of the residential

real estate owned by the debtor and his wife, as tenants by the entirety, would yield $24,495

after payment of the first mortgage and a real estate sales commission. Since this amount, less

exemptions, was not being paid to unsecured creditors, the trustee argued against confirmation.

The debtor did not disagree with the $24,495 value, but asserted that only one-half of that

value was the property of the estate because of the spouse's interest. The debtor further

asserted that after the deduction of Missouri exemptions totaling $9,900, only $2,858 was

available for unsecured creditors, and therefore, the "best interests of creditors" test was met.

The bankruptcy court denied confirmation and directed the debtor to amend the plan to pay

unsecured creditors $14,595. When the debtor failed to do so, the case was dismissed. The

debtor appealed to the Bankruptcy Appellate Panel (BAP) and argued that 1) the tenancy by the

entireties property serving as his residence was not property of the estate; 2) the property is

exempt from attachment; and 3) in any event, the debtor only owns a one-half interest in the

property. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Gerard Robert Van Der Heide, 219 B.R. 830 (8th Cir. BAP, 1998)</a>.

Affirming the bankruptcy court, the BAP cited <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Strauss (In re Garner), 952 F.2d

232 (8th Cir. 1991)</a>, and held that §541(a)(1) was broad enough to include an individual's

interest in property held as a tenant by the entirety. This conclusion is consistent with other

circuits. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Equibank & Parkvale Sav. Ass'n, 679 F.2d 316 (3rd Cir. 1982)</a>; <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re

Grosslight, 757 F.2d 773 (6th Cir. 1985)</a>. Indeed, the Code requires this result under <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=…

U.S.C. §522(b)(2)(B)</a>, stating that an interest in tenancy by the entirety property is exempt

if it is not subject to attachment under applicable non-bankruptcy law. The parties had

stipulated that the debts burdening the entireties property were incurred jointly with the

debtor's spouse and that the property was not exempt from attachment. It is not apparent why

the debtor's spouse had not also filed bankruptcy given that the debts were joint, and thus the

entireties property was subject to attachment.

Applying <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §363(h)</a>, the BAP found that a chapter 7 trustee would be entitled to sell the

entire property and distribute the proceeds to the respective interests. Looking to Missouri law,

the BAP concluded that each spouse has an undivided interest in the whole, that 100 percent of

the property was property of the estate and that the proceeds were distributable to the joint

creditors. In affirming the bankruptcy court, the BAP pointed out that a majority of the circuits

allow joint creditors to reach the non-filing spouses' interest in the tenancy by the entireties

property.<a href="#2" name="2a">2</a>

Chief Judge Koger wrote a strong dissent to the majority, stating that the holding of In re Garner

required that the non-debtor spouse be paid her share of entireties property proceeds before

unsecured creditors received the distribution. Therefore, he reasoned, the "best interests of

creditors" test was not violated by the debtor's plan.

<h3>Test Is an Equitable One</h3>

The protections for unsecured creditors are enforced at the discretion of the courts. The

statutory scheme requires that the debtor's property rights and value (the estate) must be

determined on the date of the petition. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Carpet Mills v. Tedford, 691 F.2d 392 (8th Cir.

1982)</a>.<a href="#3" name="3a">3</a> The exception is post-petition assets under <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §1306(a)</a>. It is reasonable to

conclude that §1325(a)(4) requires the court to determine the liquidation value of all

non-exempt property, taking into account liquidation costs or chapter 7 administrative

expenses. <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… of Barth, 83 B.R. 204 (Bankr. D. Conn. 1988)</a>. Thus, in the Van Der Heide

case, the "best interests of creditors" test should be applied based on what Missouri law allows

as exempt.

Upon review, the Eighth Circuit reversed and remanded the BAP decision. The court stated that

its holding in In re Garner dictated that "only one-half of the hypothetical sales proceeds, less

exemptions, are subject to the bankruptcy estate." <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Gerard Robert Van Der Heide, 164

F.3d 1183, 1185</a>. The Eighth Circuit panel held that the trustee could liquidate the residence

because the spouse was jointly liable for the debt, and that entireties property is not exempt

from an individual's bankruptcy estate, citing <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Sumy, 777 F.2d 921 (4th Cir. 1985)</a>. The

panel then went on to say that its prior decision in In re Garner defined the respective rights of

the debtor and his spouse and that the BAP's decision was a misconstruction of the Garner

ruling.

Holding that the result in In re Garner was an equitable rule that preserved the balance of state

and federal law, the court pointed out that the legislative history of <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… U.S.C. §541</a> requires the

protection of co-ownership interests.<a href="#4" name="4a">4</a> The court then explained that if it were to apply In re

Garner to the facts in the instant case, Van Der Heide would be entitled to pay $2,858 to

discharge the joint debts. The creditors would then be entitled to pursue the spouse; however, in

doing so, they could not reach the entireties property since there are no longer joint debts.

Pointing out these "anomalies," the court then stated that if the debtor invokes In re Garner, he

is only entitled to one-half of the total exemption allowed by law, and thus, creditors get another

$4,000. In a footnote, the Eighth Circuit said that In re Garner might not apply if the spouse

filed bankruptcy, and that such a filing also might violate the good faith provisions of <a href="#5" name="5a">11 U.S.C.

§1325.5</a>

The Eighth Circuit emphasized that property rights are determined by state law, and bankruptcy

should not require a different analysis. The court sought to balance state property law and the

confirmation requirement of the "best interests of creditors." This decision demonstrates the

difficulties resulting when a hypothetical test is manipulated by the debtor.

<hr>

<h3>Footnotes</h3>

<a name="1">1</a> Report of National Bankruptcy Review Commission, Oct. 20, 1997, p. 268. <a href="#1a">Return to article</a>

<a name="2">2</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Murphy (In re Edmonston), 107 F.3d 74, 75 (1st Cir. 1997)</a> (holding that a joint creditor "may reach and apply the entireties property."); <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… State Bank & Trust

v. Grosslight (In re Grosslight), 757 F.2d 773, 776 (6th Cir. 1985)</a> (holding that joint creditors could reach entireties property "because each spouse owns the whole estate...");

<a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… v. Equibank & Parkvale Sav. Ass'n, 679 F.2d 316, 321 (3d Cir. 1982)</a> ("[W]e hold that a creditor with a joint judgment on a joint debt may levy upon the property

itself and thus upon the interests of both spouses."). See, also, <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Smith, 200 B.R. 213, 215 (Bankr. E.D. Mo. 1996)</a> (holding that debtors' joint creditors "could access the

entirety equity under Missouri non-bankruptcy law."); <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Mayes, 141 B.R. 669, 671 (Bankr. E.D. Mo. 1992)</a> (directing trustee to distribute proceeds from liquidation of debtors'

entireties property to joint creditors only). <a href="#2a">Return to article</a>

<a name="3">3</a> See <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Ruggles, 210 B.R. 57 (Bankr. D. Vt. 1997)</a> (indicating that the chapter 13 estate is fixed at the expiration of the 30-day objection to exemption period). <a href="#3a">Return to article</a>

<a name="4">4</a> H.R. Rep. No. 95-595 at 177 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 6137. "The bill also changes the rules with respect to marital interests in property...With respect to

other co-ownership interest(s), such as tenancies by the entirety...the bill does not invalidate the rights, but provides a method by which the estate may realize on the value of

the debtor's interest in the property while protecting the (co-tenant's) rights." <a href="#4a">Return to article</a>

<a name="5">5</a> See <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… re Siegfried, 219 B.R. 581 (Bankr. D. Colo. 1998)</a>, where a bad faith conversion from chapter 13 to 7 brings §348(f)(2) into play, bringing into the

estate all property at the date of the conversion. <a href="#5a">Return to article</a>

Journal Authors

Timothy D. Moratzka

Journal Date

Saturday, May 1, 1999 - 12:00