Grace Period to Cure Arrearage Beyond Five-Year Plan Period

Posted by NCBRC - June 13, 2017

A bankruptcy court has discretion to grant a grace period at the end of the five-year plan to a chapter 13 debtor who has completed her plan payments but where there is a newly discovered arrearage. Klaas v. Shovlin (In re Klaas), Nos. 15-3341 & 16-3482 (3rd Cir. June 1, 2017).

Chapter 13 debtors, Paul and Beth Ann Klaas, successfully completed their plan according to its terms, but one month after completion, the trustee filed a motion to dismiss citing an unpaid arrearage of over $1,000. (The shortfall was apparently due to an increase in the Trustee’s fee during the term of the plan, and not to any missed payments.) In the motion to dismiss, the trustee stated that she would withdraw the motion if the Klaas’s paid the arrearage. They did so. By that time, however, a creditor, Elizabeth Shovlin, had joined the motion to dismiss and objected to its withdrawal.

Finding that the shortfall was not the fault of the debtors and did not significantly alter the payments to creditors, the bankruptcy court denied the motion to dismiss. In re Klaas (“Klaas I”), 533 B.R. 482, 488 (Bankr. W.D. Pa. 2015). The district court affirmed. Shovlin v. Klaas (“Klaas II”), 539 B.R. 465, 466 (W.D. Pa. 2015). For the same reason it had denied the motion to dismiss, the bankruptcy court also rejected Ms. Shovlin’s adversary complaint seeking to deny discharge to the Klaas’s. In re Klaas (“Klaas III”), 548 B.R. 414, 425 (Bankr. W.D. Pa. 2016). The district court affirmed. Shovlin v. Klaas (“Klaas IV”), 555 B.R. 500, 502 (W.D. Pa. 2016). The appeals were consolidated before the Third Circuit.

On appeal, the circuit court addressed the tension between the mandatory language of sections 1322 and 1329, under which a court may not approve a plan, or plan modification, for a period longer than five years, and the reality that circumstances may arise through no fault of the debtor where additional payments are discovered to be necessary at the end of a plan.

Finding that those sections did not govern the issue before it the court turned instead to sections 1307, which provides the power to grant a dismissal for cause, and 1328 which governs the granting of discharge upon completion of all payments “under the plan.” Section 1307 is permissive and makes no reference to temporal requirements. Likewise, section 1328 makes discharge contingent on completion of plan payments not on the time within which those payments are made. The court stated that, “under the plan” refers to the authority conferred by the plan rather and does not create a requirement that the payments be made in accordance with the details of the plan. The court noted that the five-year cap on bankruptcy plans was intended as a “shield” for debtors to avoid the servitude of longer-term plans, rather than a “sword” for use by creditors.

The court distinguished the power to permit a post-plan payment, from an informal, and impermissible modification of the plan itself. In so finding, it agreed with dictum from the Seventh Circuit that “allowing such curative payments would not modify the plan because the payments at issue would not be payments ‘provide[d] for’ by [a] modified plan; rather, they would be payments made to cure a default … i.e., payments made because the debtors did not make the payments ‘provide[d] for’ by the plan in the first place. Germeraad v. Powers, 826 F.3d 962, 968 (7th Cir. 2016).”

The court rejected Ms. Shovlin’s argument that the only recourse the bankruptcy court had was to grant a hardship discharge under 1328(b). That type of discharge is intended for debtors who are unable to complete their plans, not where, as here, the debtor is able to complete the plan payments but has an arrearage emerge at the end of the plan period.

Having found generally that a bankruptcy court has discretion to permit a grace period, the court turned to the relevant considerations for exercise of that discretion. It enumerated a non-exhaustive list: “(1) whether the debtor substantially complied with the plan, including the debtor’s diligence in making prior payments; (2) the feasibility of completing the plan if permitted, including the length of time needed and amount of arrearage due; (3) whether allowing a cure would prejudice any creditors; (4) whether the debtor’s conduct is excusable or culpable, taking into account the cause of the shortfall and the timeliness of notice to the debtor; and (5) the availability and relative equities of other remedies, including conversion and hardship discharge.” The court found each of these factors favored the underlying exercise of the bankruptcy court’s discretion.

Klaas 3rd Cir. opinion June 2017

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