Preserving Chapter 13 Debtors’ Ability to Modify Plans

A recent Fifth Circuit ruling provides significant protection of a debtor’s inherent rights under the Bankruptcy Code. In Brown v. Viegelahn,[1] the court struck down the bankruptcy court’s requirement upon confirmation that the debtor agree to add the following so-called “Molina language” to the Order confirming plan:

The plan as currently proposed pays a 100% dividend to unsecured claims. The Debtors shall not seek modification of this Plan unless said modification also pays a 100% dividend to unsecured claims. Additionally, should this Plan ever fail to pay a 100% dividend to unsecured claims the Debtors will modify the Plan to continue paying a 100% dividend. If the Plan fails to pay all allowed claims in full, the Debtors will not receive a discharge in this case. Molina v. Langehennig, No. SA-14-CA-926, 2015 WL 8494012, at *1 (W.D. Tex. Dec. 10, 2015).

Under the Molina provision, the debtor would not be required to pay all of his disposable income into the plan each month, meaning that he could make lower monthly plan payments so long as the plan eventually paid 100% to unsecured creditors. In exchange for a lower monthly obligation, the debtor reluctantly agreed to this language, which would prohibit him from reducing the 100% dividend to unsecured creditors. With this additional Molina language, the bankruptcy court agreed to confirm the plan.

In prior cases, the chapter 13 trustee who required the debtor to include the Molina provision had decided not to appeal similar district court decisions that disallowed this language. Under § 1325(b)(1)(A)(B), when a trustee or an unsecured creditor objects to confirmation of a chapter 13 plan, the bankruptcy court may not confirm the plan unless (A) the full value of all claims are to be paid under the plan, or (B) the plan provides that all the debtor’s disposable income will go toward plan payments.

On appeal, the trustee argued that § 1325(b)(1) did not give a choice between two ways of complying with § 1325(b)(1); rather, it set a minimum payment for above-median debtors. The Fifth Circuit found that the trustee’s argument was contrary to the plain text of the statute. The word “or,” which separates subparagraphs A and B, did not mandate compliance with both provisions; rather, it allowed the debtor a choice.

The Fifth Circuit was persuaded by the reasoning in Martinez,[2] in which a district court ruled that despite the bankruptcy courts’ broad equitable powers under § 105, the Molina language conflicted with § 1329. 11 U.S.C. § 1329 gives chapter 13 debtors the ability to modify a plan after confirmation if the modified plan complies with Bankruptcy Code §§ 1322(a), 1322(b), 1323(c) and the requirements of §1325(a).

In holding that that the Molina language violated § 1329, the Fifth Circuit observed that a bankruptcy court cannot circumvent a debtor’s ability to utilize the modification provision of § 1329 later on during the course of their plan. Other courts have similarly ruled that bankruptcy courts do not have the authority to require Molina-type provisions to prevent plan modifications, because courts cannot impose additional provisions or conditions upon plans that are not required under the Bankruptcy Code.[3]

The Fifth Circuit ruling seemingly allows debtors to modify confirmed plans to reduce distribution to unsecured creditors. The ability to modify a plan post-confirmation is one of the most powerful tools, perhaps the most powerful tool, available to a chapter 13 debtor. The ruling, however, does not give debtors carte blanche, since the good-faith requirement of § 1325(a)(3) is incorporated into any post-confirmation modification analysis pursuant to § 1329(b)(1).

Under § 1329, a confirmed plan may be modified at “any time after confirmation of the plan but before the completion of payments” at the request of the debtor, the chapter 13 trustee, or an allowed unsecured creditor in order to (1) increase or reduce the amount of payments on claims of a particular class provided for by the plan; (2) extend or reduce the time for such payments; (3) alter the amount of the distribution to a creditor; or (4) reduce amounts to be paid under the plan by the actual amount expended by the debtor to purchase health insurance for the debtor.

Although § 1329 expressly permits the debtor, trustee or holder of an allowed unsecured claim to request post-confirmation modification of a chapter 13 plan, debtors are far more likely than the trustee or an unsecured creditor to file a motion to modify their own confirmed plan.

Modification often permits the flexibility that a chapter 13 debtor requires to continue on in bankruptcy, when the terms of the confirmed plan may no longer be feasible. Frequently, chapter 13 debtors propose a plan that no longer works when an unexpected event occurs, such as job loss or a debilitating medical condition. These life changes experienced by consumers make it impossible to comply with the terms of a plan conceived of pre-petition. Take, for instance, the COVID-19 outbreak, which has caused financial havoc worldwide. The unanticipated pandemic has left many chapter 13 small business debtors and individuals struggling to comply with their confirmed plans.

Rather than having the entire bankruptcy dismissed, a debtor may be able to modify the plan subject to the requirements of § 1329 of the Bankruptcy Code. Not only is this flexibility provided for under the Code beneficial for the debtor to succeed in reorganizing, it may also benefit an unsecured creditor whose best prospect of maximizing payment is through the orderly distribution of a chapter 13 plan. The Fifth Circuit’s opinion in Brown v. Viegelahn is an important step toward preserving debtors’ ability to utilize § 1329.