Cosigned Debts May Receive Higher Dividends in Chapter 13 Plan

Posted by NCBRC - January 27, 2014

Section 1322(b)(1) permits more favorable treatment of cosigned loans without regard to the degree of disparity between the payment on those loans and the payment on the general unsecured debts. In re Russell, No. 13-50045 (Bankr. S.D. Ohio Dec. 31, 2013). The debtor filed a chapter 13 plan that proposed to pay general unsecured creditors 1.6% while providing for payments to two creditors holding student loan debts cosigned by the debtor’s mother at a rate of 17.9%. The trustee objected on the basis that the plan unfairly discriminated in the treatment of unsecured creditors in violation of section 1322(b)(1). Under that section a Chapter 13 plan may: “designate a class or classes of unsecured claims . . . but may not discriminate unfairly against any class so designated; however, such plan may treat claims for a consumer debt of the debtor if an individual is liable on such consumer debt with the debtor differently than other unsecured claims[.]”

The court found that the “however clause” creates an exception to the prohibition against discrimination between classes of creditors and, as a guarantor of her daughter’s debts, the debtor’s mother fit squarely into the definition of an individual who was liable on the debt with the debtor. Having found that different treatment is permissible the court went on to discuss whether that treatment is exempt from the requirement of fairness noting that the majority of courts have carried that requirement forward to the “however clause.” See, e.g., Meyer v. Hill (In re Hill), 268 B.R. 548, 550 (B.A.P. 9th Cir. 2001) (prohibition against unfair discrimination applies to co-signed debts); In re Deen, 260 B.R. 577, 584 (Bankr. S.D. Ga. 2000) (favorable treatment of cosigned debts meets fairness requirement). But see Meyer v. Renteria (In re Renteria), 470 B.R. 838, 842 (B.A.P. 9th Cir. 2012) (“The minority [of] courts . . . have held that the ‘however clause’ . . . carves out codebtor consumer claims from the requirements of the unfair discrimination rule. . . . These cases emphasize the placement of the ‘however clause’ immediately following the unfair discrimination rule.”). Ramirez v. Bracher (In re Ramirez), 204 F.3d 595, 597 (5th Cir. 2000) (“Different treatments, which the statute expressly authorizes for co-signed debts, sometimes result in unfair discrimination.”).

The court concluded that the statute was ambiguous as to whether the fairness requirement of the first clause applied to the “however clause.” The court noted that prior incarnations of the unfair discrimination statute did not include the “however clause” and was largely interpreted to prohibit more favorable treatment of cosigned loans. Congressional discussion of an early proposed version of the “however clause” indicated that its purpose was to acknowledge a debtor’s sense of obligation on a cosigned debt which, because that sense of obligation is likely to cause the debtor to pay more on the debt regardless of its treatment in the plan, should be considered when determining plan feasibility. S. Rep. No. 98-65 (1983), available at BANKR84-LH 4 (Westlaw) (“If, as a practical matter, the debtor is going to pay the codebtor claim, he should be permitted to separately classify it in chapter 13.”).

The court concluded that “[t]he history of the enactment of the however clause, therefore, makes at least one thing clear: a plan may propose to pay creditors with cosigned consumer debts the amount they would have received but for the Chapter 13 case, while paying the holders of other unsecured, nonpriority claims less (even much less) than they would have received had they been paid pro rata with the cosigned debts.” Thus, the court found that a plan may treat a cosigned debt more favorably than other unsecured debts and the degree of disparity should not be considered by the court when applying section 1322(b)(1).

Turning to the issue of whether it was constrained to permit discrimination only where it was “fair,” the court found that it was and went on to find that plan payments that equaled what the creditor would receive in the absence of the chapter 13 bankruptcy, were by definition “fair.” In contrast, paying a higher interest rate, accelerating the loan, or inappropriately protected the debtor’s assets and income, would not be permitted under 1322(b)(1). As applied to the facts before it, the court found that there was no evidence that the debtor sought to pay more than she would outside the plan, that the debtor was motivated by anything other than the desire to protect her mother from financial distress. Therefore, the proposed plan complied with section 1322(b)(1) and the trustee’s objection was overruled.

(The fact that the loans at issue were non-dischargeable, long-term, student loans was not a factor in the court’s decision. Nor did the court decide whether a cosigned loan could receive less favorable treatment).

Russell opinion


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