Adequate Protection in Chapter 13 Cases under the New Code §1326(a)

Has Learned Hand Finally Come Home?

The new Bankruptcy Code, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA, Title 11 U.S.C.), has made some controversial and sweeping changes in the area of adequate protection in chapter 13 cases. While the case law throughout the circuits recognizes that secured creditors were entitled to some form of adequate protection, it is a fair statement of the law throughout the circuits to say that enforcement was varied. For example, in the Ninth Circuit, the case of In re Andrews, 49 F.3d 1404 (9th Cir. 1995), held that a plan would not be confirmable unless before, and after confirmation, adequate protection could be provided to secured creditors. The Ninth Circuit also held however, in another decision, that adequate protection would be payable only from the point the creditor asked for it, In re Deico Electronics Inc., 139 B.R. 945 (9th Cir. BAP 1992). In a recent thoughtful decision, In re Stembridge, 394 F.3d 383 (5th Cir. 2004), the Fifth Circuit reiterated the rights of a personal property creditor to adequate protection from petition filing.

Perhaps to recall the historical underpinnings of adequate protection, a review of the holding of Judge Learned Hand in In re Murel Holding Co., 75 F.2d 941 (2nd Cir. 1935), is helpful to gain a bit of perspective. In the oft-quoted passage, Judge Learned Hand holds that a creditor is entitled to not only adequate protection but “the indubitable equivalent” of its collateral. In the context of personal property loans, and in particular auto loans, creditors do not believe they are consistently getting this treatment in chapter 13 cases.

Apparently to address this perception and also to make chapter 13 plans more uniform throughout the country, 11 U.S.C. §1326(a) was modified. Additionally, it should be noted that 11 U.S.C. §1325(a)(5)(B)(iii) was added. It provides plan payments shall be “equal” and “shall not be less than an amount sufficient to provide the holder adequate protection.” Section 1326(a) now appears to require the following:1

1. Adequate protection must be made by the debtor “within 30 days of filing” unless the court orders otherwise.
2. Sections 1325 and 1326 require that all plan payments be level and thus, the pro-rata plan payments for secured creditors appear to be no longer confirmable. The literal reading of the statutory language appears to be the debtor must calculate in his or her plan what amount is to be paid on the claim and that amount must be paid to the trustee monthly, for disbursement.
3. Finally, failure to so perform makes the case subject to relief from stay by the creditor or a motion to dismiss.

I would like to consider each in order.

First, as to the payments by the debtor, this is probably the most controversial provision of this statute and, maybe even of some 230 pages of changes Congress legislated. The author’s perception is that all the parties at the bankruptcy table, in considering this, seem to have uniformly agreed that the debtor making payments after 30 days might not be the best idea. The reasons for this belief arise from the correct perception that the trustees’ accounting and payment tracking will be far superior to that of the debtors’. Trustee payments will provide a reliable and readily accessible record of what was paid when and to whom. Rather, the courts will be asked throughout the country to “order otherwise,” through either local rule or general order. In one of the jurisdictions where we practice, there is already a final draft of a rule, which provides exactly this.2 The rule has not been passed and is not part of the local rules as of the date of this writing. The author believes that this, or a similar rule, will be in place by Oct. 17, 2005. Other jurisdictions are opting for standing general orders, and corresponding plan provisions.

Second, secured creditors have varying success in pro rata plans that provide for their claim. In a pro rata plan, the secured creditor can never be sure what will be received in any given month, therefore, making calculation of default rather difficult. Additionally, claims for fees, support or other matters, always threatened to dilute the pro rata payment. Finally, at times such plans actually accelerate payments on the claims to the detriment of other creditors. The changes call for monthly payments which are level and are paid and disbursed monthly. (But see §1326(a)(2) as to plan payments). The changes mandated by §1325(a)(5)(B)(iii) appear to contemplate paying the scheduled plan amount to the trustee for disbursement. This would obviate pro rata plans for secured claims. These payments would be the regularly scheduled “level” plan payments.

Third, a blend of the new provisions of §1326 and an unchanged portion of §1307(c) create a powerful enforcement mechanism. Under the prior Code, failure to make payments was a ground to dismiss the case. Simple enough. This, of course, remains the same under the new Code. However, §1307(c)(4) mandates that payments pursuant to §1326 must be made or the case shall be dismissed. Thus the §1326(a) mechanism outlined above is subject to enforcement, presumably both by the trustee and an injured creditor, on the grounds of §1307(c)(4).

Are These Changes in Any Way Beneficial to Debtors?

Many chapter 13 cases fail early on because of motions for relief from stay filed by secured lenders. If §1326 is successfully implemented, its effect could lead to a precipitous decline in the frequency of these motions, therefore a higher success rate for plans. Moreover, it is certainly believed by many that the payments by the trustee on these claims will be extremely reliable and eliminate the related litigation that detracts from the debtors’ main goal, which is of course, plan confirmation.

This additional role by the trustee may also lead to earlier intervention in those plans that are not likely to achieve confirmed status.

Is There Prior 13 History That May Predict the Success of the Trustee’s Payments?

Again, the author would suggest that there is. Many jurisdictions require all monthly payments to be through the trustee, by wage directive. Studies have found that chapter 13 cases that are subject to the mandatory wage deduction are much more likely to succeed than those that leave the discretion of making payments to the debtor. The trustee’s intervention cannot help but be a boon to the administration of this confirmation process and speed up confirmation.

Conclusion

Section 1326(a) has mandated that payments on secured property be made commencing 30 days after the filing. Trustees, debtors and creditors appear to be in accord that the best way to make this disbursement is through the Office of the Chapter 13 Trustee. Implementation can be by local rule, general order, plan provision or a combination of all three. The fact that the trustee will be making these payments should be beneficial both to the debtor and to the creditor. The provision likewise appears to eliminate pro rata plans to secured creditors, and also appears to require adequate protection in the amount of the plan payment from the outset. Similar requirements regarding debtors’ payments, to ensure completion of plans, have been successful in the past and it is hoped (I believe) by both bench and bar, this will be successful under the new version of §1326(a).

To answer the original question posed; Yes, in chapter 13 cases, Judge Learned Hand’s words may finally have come home. Only time and how the courts confront interpretation and enforcement of §1326(a) will tell.

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