Mixed Priorities: Courts Divided over Whether Chapter 13 Plans May Prioritize Payments to Debtors’ Counsel over Secured Creditors

May chapter 13 plans prioritize payments to debtors’ attorneys over secured creditors? Bankruptcy courts are divided, and two recent decisions have widened the gap.

Under 11 U.S.C. § 1325, a chapter 13 plan must pay secured creditors the value of their claims. If a plan proposes to pay those claims in periodic payments — as most plans do — § 1325(b)(iii)(I) requires those payments be in equal monthly amounts. Section 1325(b)(iii)(II), in turn, requires those payments to at least be sufficient to provide the creditor “adequate protection” (that is, an amount sufficient to compensate a creditor for the decline in the collateral’s value during the plan).

Although § 1325(b)(iii)(I) requires debtors to pay secured creditors in equal monthly payments, the Bankruptcy Code is silent as to when those payments start. Because § 1326(b)(1) requires debtors to pay priority administrative claims (such as the debtor’s attorneys’ fees) in full before or at the time general creditors are paid, many chapter 13 plans propose to pay off debtor’s counsel first and then begin equal monthly payments to secured creditors. Of course, § 1325(b)(iii)(II) requires that secured creditors receive adequate protection during the plan. The result, then, is that many plans include tiered payments to secured creditors: First, smaller adequate-protection payments are paid to secured creditors until after the debtor’s counsel and other priority claims are satisfied. Second, after debtor’s counsel is paid in full, equal monthly payments sufficient to pay off secured creditors begin.

This is significant. Recent studies estimate that only 38.8 percent of chapter 13 debtors complete their repayment plans.[1] So while the Code requires that secured creditors be paid equal monthly payments sufficient to pay off their claims, it is possible — and perhaps likely — that a court will confirm a plan, and debtor’s counsel and other priority claims will be paid in full, but the case will — for whatever reason — be dismissed or converted before the secured creditor’s equal monthly payments begin or are satisfied.

Are these tiered plans allowed? Bankruptcy courts are divided.

For example, in April 2018 a Texas bankruptcy court confirmed a tiered plan.[2] In that case, the court held that while secured creditors are entitled to equal monthly payments under § 1325, the Code is silent as to when those payments start. So, as long as a secured creditor receives adequate-protection payments while priority claims are paid off, the court reasoned that secured creditors are not harmed during the first tier of the plan (that is, during the period priority claims are paid off before regular monthly payments to secured creditors begin). The court held that § 1325 merely requires equal monthly payments once those payments begin.

But that same month, an Indiana bankruptcy court reached the opposite result while also relying on bankruptcy decisions from other jurisdictions.[3] In Williams, the court refused to confirm a tiered plan, holding that tiered plans impermissibly prioritize paying debtor’s counsel at the expense of secured creditors. According to the court, § 1325 requires periodic payments be in equal monthly amounts. The fact that priority claims must also be paid in full before or at the same time as secured creditors does not carve out an exception to § 1325’s mandate. Instead, chapter 13 plans “should be structured so that payments to the [debtor’s] attorney neither reduce nor delay the required equal monthly payments to secured claimholders.”

Given that bankruptcy courts are applying § 1325 differently, secured creditors should carefully examine chapter 13 plans to determine whether the proposed payments comply with applicable case law in the given jurisdiction. Given the low success rate of chapter 13 plans, the timing of plan payments to secured creditors may vary the amount that secured creditors actually recover in chapter 13 cases.