As long as the chapter 13 debtor completes payments under the plan as originally confirmed, Bankruptcy Judge Henry A. Callaway of Mobile, Ala., is allowing the debtor to keep any recovery resulting from a postpetition personal injury claim.
The fact that proceeds from a postpetition personal injury claim would become part of the chapter 13 estate wasn’t determinative for Judge Callaway. He parsed the statute to show how the best interests test, applied as of the filing date, keeps postpetition tort proceeds out of the hands of creditors, even though the proceeds became part of the chapter 13 estate.
The Recurrent Problem Regarding Tort Claims
After plan confirmation, chapter 13 debtors sometimes have auto accidents or sustain personal injuries. Some courts rule that proceeds from postpetition tort claims go into the chapter 13 estate to increase whatever distribution the creditors were slated to receive on confirmation.
As a result, debtors end up with no recovery. If the debtor’s car was “totaled” after confirmation, a check from the insurance company for the debtor’s equity would go to creditors, leaving the debtor with nothing to purchase a new auto.
Or, suppose the debtor sustained a physical injury after confirmation due to someone else’s negligence. Some courts would give the recovery to creditors as an enhancement to whatever the plan originally earmarked for them. The debtor would be left with pain and disfigurement, without compensation.
The problem is particularly poignant in a state like Alabama, where the state’s personal property exemption is about $8,000. Chapter 13 debtors in Alabama ordinarily will have exhausted their exemptions in confirming plans, leaving them with nothing to cover tort claims arising later.
In his May 30 opinion, Judge Callaway dealt with two cases having similar facts. One case suffices to demonstrate the situation.
The debtor confirmed a chapter 13 plan in 2018, using up her state personal property exemption. The plan had the debtor paying about $850 a month under a five-year plan, giving unsecured creditors a 40% dividend.
After confirmation, the debtor was seriously injured. With court authorization, the debtor hired an attorney to pursue a tort claim. The result was a $45,000 settlement that Judge Callaway approved.
After attorneys’ fees and medical bills, the net was about $20,000.
Laying claim to the $20,000, the chapter 13 trustee filed a motion to modify the long-confirmed plan. Were the trustee to prevail, the creditors’ recovery would rise to almost 80% while the debtor would receive nothing for her injuries, pain, suffering and disfigurement.
In his May 30 opinion, Judge Callaway refused to modify the plan, with a caveat designed to ensure that creditors would recover 40% before the debtor can touch the tort recovery.
The Statute
On the trustee’s motion to modify the plan, two statutory provisions came into play: the best interests test in Section 1325(a)(4), and the disposable income test in Section 1325(b). Under Section 1329(b)(1), both apply in confirming a plan modification via Section 1322(a), (b) and (c).
In addition, Section 1306(a)(1) brings after-acquired property, like a tort claim, into the chapter 13 estate.
Citing authorities, Judge Callaway said that some courts “mischaracterize” personal injury proceeds as “income.” He said, “Income and assets are different concepts.” Furthermore, he said that the projected disposable income test and the liquidation test are separate, not stacked, citing In re Ertha, 18-855 (Bankr. S.D. Ala. Dec. 2, 2021).
“In short,” Judge Callaway held, “the Section 1325(b) disposable income test does not apply to the settlement proceeds here because those proceeds are not ‘income.’”
Furthermore, Judge Callaway said that the “plain language” of Sections 348(f) and 541 does not bring postpetition personal injury claims into a hypothetical chapter 7 case for inclusion in the Section 1325(a)(4) liquidation test. That’s so because Section 1325(a)(4) is based on the value of estate property “as of the effective date of the plan.”
Although the hypothetical chapter 7 liquidation test applies to plan modifications, Judge Callaway said that personal injury claims would not be part of the estate were the case converted to chapter 7, assuming no bad faith.
Citing the Collier treatise, Judge Callaway held that a personal injury claim “is thus not included in the liquidation analysis because that claim would not be part of a hypothetical chapter 7 under either Section 541(a) or Section 348(f).” Judge Callaway cited other courts reaching the same conclusion. See In re Taylor, 631 B.R. 346 (Bankr. D. Kan. 2021); and In re Madrid, 19-42260, 2023 WL 3563019 (Bankr. W.D. Wash. May 18, 2023). To read ABI’s reports on those cases, click here and here.
Eleventh Circuit Precedent
Judge Callaway had a problem with an Eleventh Circuit opinion that runs counter to his statutory analysis. See In re Waldron, 536 F.3d 1239 (11th Cir. 2008).
In Waldron, Judge Callaway said that the appeals court applied an “ability to pay test” rather than the statutory liquidation and disposable income tests. However, he said that the circuit court only held that the debtor was obliged to schedule a postpetition personal injury claim.
Nonetheless, Judge Callaway said that courts in the Eleventh Circuit have held that postpetition assets, such as settlements, go to creditors “even though they would not have been included in the bankruptcy estate if the case were converted to chapter 7.”
To avoid offending Waldron, Judge Callaway said he would not change his practice and would require that the net settlement proceeds go to the trustee, but he added a wrinkle conceivably allowing the debtor to receive the tort settlement proceeds.
No Enhancement for Creditors
To conclude his opinion, Judge Callaway discussed whether settlement proceeds would enhance creditors’ recoveries. He said that the 40% recovery under the confirmed plan was res judicata and that calling for modification of the plan lay in the court’s discretion.
Judge Callaway cited other courts holding that an increase in income or a windfall is legitimate reason for plan modification. He said that a personal injury settlement is “categorically different” from windfalls like lottery winnings, inheritances or non-spousal insurance proceeds. When it’s a tort settlement, he said that the debtor would have given consideration in the form of injury to herself or to her property.
Judge Callaway held that the Waldron “ability to pay” standard did not apply.
To ensure that creditors receive what they were promised under the original plan, Judge Callaway directed the chapter 13 trustee to retain the net proceeds after paying the attorneys’ fees and medical costs. Denying the motion to modify the plan, the opinion insinuates that the debtor will be entitled to the net proceeds once creditors have been paid their promised 40%.
Observations
The trustee is appealing to the district court. If the district court reflexively applies Waldron, the debtor will lose and receive no recovery for pain and suffering.
Respectfully, the Eleventh Circuit should revisit Waldron. When it comes to confirmation of an amended plan, Judge Callaway correctly says (in this writer’s opinion) that the best interests test evaluates assets as of confirmation of the original plan. Similarly, the disposable income test looks at income, not assets.
The tort recovery was not income, and it was not an asset when the plan was first confirmed. Respectfully, the ability to pay should not govern a debtor’s ability to retain net proceeds from the post-petition tort claim, when the proceeds were not income and were not an asset on the filing date.
As long as the chapter 13 debtor completes payments under the plan as originally confirmed, Bankruptcy Judge Henry A. Callaway of Mobile, Ala., is allowing the debtor to keep any recovery resulting from a postpetition personal injury claim.
The fact that proceeds from a postpetition personal injury claim would become part of the chapter 13 estate wasn’t determinative for Judge Callaway. He parsed the statute to show how the best interests test, applied as of the filing date, keeps postpetition tort proceeds out of the hands of creditors, even though the proceeds became part of the chapter 13 estate.