An Exempt Asset Effectively Loses Its Exemption in Chapter 13

On an issue where the lower courts are divided, Bankruptcy Judge Joseph G. Rosania, Jr. of Denver decided that the net proceeds from liquidation of an exempt asset belong to creditors under a chapter 13 plan, aside from whatever is necessary for the debtor’s maintenance and support.

In substance, Judge Rosania concluded that Section 522(c) loses out to Section 1325(b)(1)(B). Section 522(c) provides that exempt property “is not liable during or after the case for any debt . . . that arose . . . before the commencement of the case.”

The essential facts were simple. The debtor was injured in an automobile accident before filing. He had not sued the at-fault driver either before filing or before the confirmation hearing. He scheduled the personal injury claim as an asset with an undetermined value.

The debtor claimed that the accident claim was exempt under Colorado law. The chapter 13 trustee objected, but Judge Romero had not ruled on the exemption claim before confirmation.

Even assuming that the personal injury claim was exempt, the trustee objected to confirmation of the plan, contending that the debtor did not satisfy Section 1325(b)(1)(B). In the event of an objection, that provision requires the debtor to apply all of her or his “projected disposable income” to the payment of unsecured claims. In the trustee’s opinion, proceeds from the personal injury claim would be disposable income earmarked for creditors.

Naturally, the debtor wrapped himself in a flag with Sections 522(c) and 1325(a)(4) sewn together. Section 1325(a)(4) is the best interests test, where unsecured creditors must receive not less than what they would recover in chapter 7.

To the debtor’s way of thinking, he should not be required to turn over exempt assets if he has met the best interests test.

Judge Rosania disagreed in his May 12 opinion. He followed the majority of lower courts by requiring compliance with both Sections 1325(a)(4) and 1325(b)(1)(B) and rejected the minority position that focuses on Section 522(c). He favorably cited courts that have noted the “diminished role” of exemptions in chapter 13 versus chapter 7.

Although the Bankruptcy Code does not define “projected disposable income,” Judge Rosania was persuaded by the definitions of “disposable income” in Section 1325(b)(2) and “current monthly income” in Section 101(10A)(A). He noted that current monthly income includes “average monthly income from all sources,” excluding only specified types of income such as Social Security benefits.

Judge Rosania adopted the Eighth Circuit’s reconciliation of Sections 522(c) and 1325(b). The St. Louis-based appeals court opined that including exempt property under Section 1325(b) did not make it “liable” for the claims of unsecured creditors. Rather, chapter 13 is optional, and Section 1325(b) only defines the terms under which chapter 13 is available. Stuart v. Koch (In re Koch), 109 F.3d 1285, 1289 (8th Cir. 1997).

[Editor’s comment: Koch predated BAPCPA, which was adopted in 2005 and forced many debtors into chapter 13. Since 2005, chapter 13 has been compulsory for many debtors. The rationale of the Eighth Circuit could be held in question after BAPCPA.]

Judge Rosania also rejected the debtor’s contention that a personal injury recovery is not “income.” He said the argument was “tenuous at best.”

Judge Rosania sustained the trustee’s confirmation objection. He held that the net proceeds from the personal injury claim must be turned over to the trustee, awaiting an agreement or court ruling on what portion, if any, is reasonably necessary for the debtor’s maintenance and support under Section 1325(b)(2)(A)(i).                                                                  

Because denial of confirmation is no longer a final, appealable order following Bullard v. Blue Hills Bank, 575 U.S. 496 (2015), Judge Rosania ended his opinion by telling the debtor he would consider authorizing an interlocutory appeal under Bankruptcy Rule 8004 and a direct appeal to the Tenth Circuit.

N.B. The debtor could not wait to sue until after receiving his chapter 13 discharge because the statute of limitations would have run out.

Observations

In Law v. Siegel, 571 U.S. 415 (2014), the Supreme Court held that courts may not employ equitable considerations to override a debtor’s statutory homestead exemption. Did the Supreme Court erect a fence around exempt property? Is there an expression of policy in Law v. Siegel that should inform a case like this?

What about other types of exempt property? Suppose the debtor decides to begin liquidating an exempt individual retirement account during the life of the plan. Are creditors allowed to recover some or all of the debtor’s withdrawals? Or what if a debtor decides to downsize by selling his exempt home and does not apply all of the proceeds toward buying a smaller home? Are creditors entitled to whatever is left over?

The issue before Judge Rosania is similar to the question of whether creditors are entitled to recover the appreciation in the value of exempt and nonexempt property during the course of a chapter 11 case. To read ABI’s reports, click here and here. The question is also similar to whether Social Security benefits can be taken into consideration under the chapter 13 “abuse” test. For an ABI report, click here.

Some courts decide these difficult questions by finding a policy in BAPCPA requiring debtors to pay as much as they can to maximize the recovery by creditors. In an era when the Supreme Court subordinates policy to the language of the statute, this writer submits that courts should not invoke policy to rule in a manner that does not comport with an absolute provision like Section 522(c).