Trustee May Not Compel Use of Non-Estate Property in Modified Plan

Posted by NCBRC - June 6, 2014

Relying on Eleventh Circuit precedent, a Georgia bankruptcy court found that a debtor could not be compelled to contribute life insurance proceeds received more than 180 days post-petition to his modified chapter 13 plan. In re McAllister, 2014 WL 1624106 (Bankr. N.D. Ga. April 3, 2014).

Two years after filing a joint chapter 13 plan the joint debtor’s wife died. The husband (Debtor) amended his schedules to show life insurance proceeds in the amount of $250,000.00 which he claimed as exempt. He also proposed a plan modification to take into account a portion of the additional funds, but which did not fully repay unsecured debts. The trustee also moved to modify the plan using a greater portion of the life insurance proceeds to pay all allowed unsecured claims in full. In a lengthy opinion, the court addressed both party’s objections to the other’s proposed modifications ultimately approving the modification proposed by the debtor.

The court framed the issues before it as: “whether the failure of Mr. McAllister’s modification to [pay all claims in full] violates either the best interest of creditors test of § 1325(a)(4), the projected disposable income test of § 1325(b), or the good faith requirement of § 1325(a)(3). If his modification does not contravene any of these requirements, the Court must then decide whether to approve it.”

The court rejected the trustee’s argument that the debtor’s plan failed to satisfy the “best interest of creditors” test which is made applicable to modifications under section 1329(b)(1). It reasoned that had the case been converted to chapter 7 the creditors would not have been entitled to the funds under section 348(f)(1)(A) which uses the original petition date to establish the contents of the bankruptcy estate upon conversion (unless converted in bad faith under section 348(f)(2)).

The court also rejected the argument that the funds must be applied to the plan as “projected disposable income.” Even though section 1329(b) does not directly incorporate section 1325(b)’s “projected disposable income” test, the trustee argued that it does incorporate section 1325(a) which, in turn, references subsection 1325(b).

The court noted that there is a split in the circuits as to whether the absence of a direct reference in section 1329 to section 1325(b) should be interpreted to exclude application of the projected disposable income test from modification consideration. Compare In re Mattson, 468 B.R. 361 (B.A.P. 9th Cir. 2012); In re Sunahara, 326 B.R. 768 (B.A.P. 9th Cir. 2005); In re Forbes, 215 B.R. 183, 191 (B.A.P. 8th Cir. 1997) (finding that the test is not applicable in modifications), with In re Cormier, 478 B.R. 88 (Bankr. D. Mass. 2012); In re Stretcher, 466 B.R. 891 (Bankr. W.D. Tex. 2011); In re Heideker, 455 B.R. 263 (Bankr. M.D. Fla. 2011); In re Buck, 443 B.R. 463 (Bankr. N.D. Ga. 2010) (test applies to modifications). The court found this controversy was put to rest by BAPCPA’s definition of “disposable income” which is tied to the definition of “current monthly income,” which, in turn, is defined to consist of  funds from the six month period prior to filing. Because post-confirmation income cannot qualify as “current monthly income,” it cannot fall into “projected disposable income.” Therefore, the debtor’s modification did not fail the “projected disposable income” test.

The court further found that where the debtor proposed to apply some of the funds to the plan even though he was not required to do so, his modification was proposed in good faith, and the fact that application of more of the funds could pay off the unsecured creditors in their entirety did not change that conclusion.

For these reasons, the debtor’s plan met the requirements for modification. That did not end the inquiry, however, as the next step in the process under section 1329 is the exercise of judicial discretion. Therefore, the court turned to whether the trustee’s proposed modification also met the requirements of section 1329.

The debtor objected to the trustee’s modification on the bases that the insurance proceeds could not be reached because they were not property of the estate, and if they were, he properly exempted them. In the alternative, the debtor argued that even if the court found that the funds could be reached, it should exercise its discretion to reject the trustee’s modification.

As to the issue of whether the funds became estate property through operation of section 1306(a), the court found they did not. The court agreed with the reasoning of two other Georgia courts which found that section 1306(a) excludes the same property excluded by section 541. See In re Key, 465 B.R. 709 (Bankr. S.D. Ga. 2012); In re Walsh, 2011 WL 2621018 (Bankr. S.D. Ga. 2011). Section 541(a)(5)(C) specifies that funds received post-petition from a life insurance policy must be received within 180 days of the petition to be included in the bankruptcy estate. Having found that the insurance proceeds were not property of the estate, the court did not need to determine whether the debtor could exempt them.

The court then turned to the question of whether the trustee could compel use of non-estate property in a plan modification. It found that, on its face, “[s]ection 1329 does not limit the sources of a debtor’s ability to pay to increases in income or reductions in necessary expenditures or to the receipt of assets that are property of the estate. It states a general principle that a modification can require the debtor to increase payments based on the debtor’s ability to do so without regard to how that is possible.”

Nonetheless, Eleventh Circuit precedent precluded the court from compelling the debtor to devote non-estate property to a modified plan. In Gamble v. Brown (In re Gamble), 168 F.3d 442 (11th Cir. 1999), the debtors sold exempt property post-petition, and sought to retain the proceeds for themselves. The lower courts found that the debtors were required to retain the asset while the bankruptcy was pending in the event that the case would be dismissed and that asset would no longer enjoy exempt status. The Eleventh Circuit reversed finding that exempt property was not under the control of the bankruptcy court and, therefore, the debtors were free to use it as they chose. The McAllister court concluded that the trustee’s proposed modification violated the rule set forth in Gamble and that the debtor could not be compelled to use excluded property for the benefit of his creditors.

The court went on to address whether it would have exercised its discretion to grant the trustee’s modification if it had found that the trustee was able to access the funds. The court found the issue required a balance between the debtor’s fresh start and fairness to creditors. It considered such factors as the debtor’s physical infirmities, lack of employment opportunities, responsibility for the care of his grandchildren, and his and his wife’s expected use of the life insurance proceeds as provision for the surviving spouse. Concluding that the debtor’s “situation is a tragedy, not a windfall,” and that the creditors did not lend money on the basis of the life insurance policy nor could they have had any expectation of reaping its benefits, it found that the equities weighed in favor of the debtor.

The trustee has filed an appeal to the District Court for the Northern District of Georgia. Townson v. McAllister (In re McAllister), No. 14-106 (N.D. Ga.).

McAllister opinion


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