Compassion Wins the Day in Modification Case

Posted by NCBRC - October 28, 2014

The bankruptcy court properly exercised its discretion when it found that the chapter 13 debtor did not have to contribute the life insurance proceeds he received upon the death of his wife to repay his creditors in full, where the funds were necessary to his support. <i>Townson v. McAllister (In re McAllister),</i> No. 14-106 (N.D. Ga. Oct. 14, 2014).

After paying into his plan for approximately two years, the debtor’s wife died and he received $250,000 in life insurance proceeds. Shortly thereafter he moved to modify his plan to reflect both the receipt of the funds and that he was no longer employed. His proposed modification increased the total payout to unsecured creditors by $15,000. The trustee filed a competing proposal to modify the plan to pledge $135,000 to pay unsecured creditors in full.

The bankruptcy court adopted the debtor’s modification. It found that because the funds were received more than 180 days post-petition they did not become part of the bankruptcy estate and the debtor could not be compelled to contribute them to the plan. In the alternative, the court found that equities favored the debtor and it exercised its discretion to grant the debtor’s modification.

The trustee appealed, arguing that the lower court erred in finding that the insurance proceeds were not part of the estate and that her proposed modification did not comply with section 1329. The trustee also argued that the bankruptcy court improperly exercised its discretion.

Though it noted that the issue has split the courts in the Eleventh Circuit, the district court dodged the question of whether the insurance proceeds became part of the estate finding that even if they were part of the estate, the court properly exercised its discretion in rejecting the trustee’s modification and adopting the debtor’s.

Faced with what it deemed to be two statutorily acceptable modification proposals, the court looked to guideposts for assessing whether the bankruptcy court properly exercised its discretion in choosing one over the other. Certain requirements, though not expressed in the Code, are threshold, such as whether there has been a substantial change in circumstances leading to the proposed modification.

Having found that the debtor experienced a substantial change in circumstances, the court turned to the specifics of the case. The court compared the presumed goals and expectations of both the debtors and the creditors. When the plan was originally confirmed the expectation was that the debtors would keep their home, maintain employment income, and have life insurance for support later in life. The unexpected events were the wife’s death and the debtor’s inability to continue working.

Addressing the debtor’s “ability to pay,” the bankruptcy court noted that if the insurance proceeds were committed to the plan, the creditors would be largely repaid, but the debtor would be left without funds for his own support. Bankruptcy’s general principle of a “fresh start” requires consideration of the debtor’s anticipated financial condition post-bankruptcy. Where the creditors could not have extended credit in the expectation of the debtor’s wife’s death, depriving them of the insurance proceeds would not work an injustice with respect to them, and the reverse would be a windfall. Under the debtor’s proposed plan the creditors stood to collect more than they could have expected to collect under chapter 7.

In sum, the bankruptcy court’s decision to resolve the competing interests and proposals in favor of the debtor’s plan was not an abuse of discretion under section 1329. The court noted that because the bankruptcy court was presented with two competing plans, one of which proposed a small increase in the plan payments and the other (the trustee’s), complete repayment of creditors, a middle ground modification was not an option.



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