Chapter 13 Dismissed When Infeasibility Discovered at End of Plan

Posted by NCBRC - March 4, 2015

After making plan payments for fifty-eight months, the debtors’ chapter 13 was dismissed due to infeasibility that was built into the confirmed plan. Schlegel v. Billingslea (In re Schlegel), No. 14-1132 (B.A.P. 9th Cir. Feb. 25, 2015). The debtors moved to value and avoid CitiMortgage’s lien for which CitiMortgage had not filed a proof of claim. That motion was granted and CitiMortgage then filed a claim as an unsecured creditor. In the meantime, the debtors filed an amended plan promising a 48% dividend to unsecured creditors and listing CitiMortgage as an unsecured creditor. The court confirmed the plan after CitiMortgage’s unsecured claim was allowed. However, the plan did not take CitiMortgage’s claim into account when calculating the percentage of return unsecured creditors would receive under the plan. Had CitiMortgage’s claim been included in the plan calculation it would have been clear that in order to pay 48% to unsecured creditors the plan would have to extend for 156 months. This oversight apparently went unnoticed and the debtors made payments according to the plan for fifty-eight months at which time they moved for a hardship discharge. The trustee moved to dismiss on the grounds that the promise of a 48% dividend was unfulfilled at the end of the applicable commitment period.

At a hearing on both the motion to dismiss and the motion for hardship discharge, the bankruptcy court rejected the debtors’ argument that they were unaware that CitiMortgage’s claim had been allowed. It found that based on notices provided by the trustee, the debtors knew of the claim at least four years prior to their completion of the plan. The court went on to find that because the debtors did not specifically oppose the motion to dismiss, it was uncontested. The court granted the trustee’s motion and denied the debtors’ hardship discharge.

The first issue addressed on appeal was whether the bankruptcy court properly exercised its discretion in determining that the trustee’s motion to dismiss was uncontested despite the fact that the debtors had a pending motion for hardship discharge. The BAP found that local rules permitted, but did not require, the bankruptcy court to consider a motion to dismiss uncontested if the party against whom it was filed fails to oppose it. Finding that a court has broad discretion to interpret its own local rules, the BAP found that the bankruptcy court properly deemed the motion to dismiss to be uncontested.

It went on, however, to consider whether the motion to dismiss had merit under section 1307(c)(6), based on the debtors’ failure to complete their plan payments within five years, noting that the issue is also a matter of judicial discretion. The BAP found that failure to pay the promised percentage dividend was a material default even though all payments were made in accordance with the plan. The panel rejected the debtors’ argument that CitiMortgage’s claim should not have been allowed because it was filed late. It found that, under Rule 3002(c)(3), once the lien was avoided the creditor had an additional 30 days to file as an unsecured creditor. CitiMortgage met this deadline.

What neither the debtor nor the court addressed was whether the debtors could have taken refuge in United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260 (2010). By the time the plan was confirmed, CitiMortgage’s claim had been allowed as an unsecured claim thereby rendering the payment of a 48% dividend to unsecured creditors at the payment amount called for in the plan impossible. Thus, the court confirmed a plan that was infeasible on its face. Espinosa imposes a duty on the bankruptcy court to correct plan defects prior to confirmation. In In re Butcher, 459 B.R. 115 (Bankr. D. Colo. 2011), the chapter 13 plan was confirmed prior to the claim filing deadline. When the mortgagee filed a post-confirmation allowed claim it rendered the debtor’s treatment of the debt invalid under 1322(b)(2). The court denied confirmation of the plan stating that “[t]he teaching of Espinosa is that the bankruptcy court has committed reversible error if it confirms such a plan.” See also In re Gordon, 471 B.R. 614 (D. Colo. 2012) (court declined to confirm plan that purported to bind creditors prior to the lapse of the claims filing deadline stating: “’[T]he Code makes plain that bankruptcy courts have the authority—indeed, the obligation—to direct a debtor to conform his plan to the requirements’ of the Code. United Student Aid Funds, Inc. v. Espinosa, ––– U.S. ––––, ––––, 130 S.Ct. 1367, 1381, 176 L.Ed.2d 158 (U.S.2010)”); In re Castleberry, 437 B.R. 705 (Bankr. M.D. Ga. 2010) (court’s duty applies where defect is obvious so, “[u]nlike bad faith or infeasibility, a cramdown [on a 910 claim] is not a bar to confirmation”) (emphasis added); In re Peckens-Schmitt, No. 10-4164 (Bankr. W.D. Mich. July 16, 2010) (confirmation denied where plan called for bypassing adversary proceeding and treating debt as unsecured and court found Espinosa requires it to correct a known defect in the plan). Unlike Butcher and Gordon, in which the plan was rendered infeasible by events that took place after confirmation, the debtors’ plan in this case was clearly infeasible at the time of confirmation. The court, therefore, had an obligation to correct the defect prior to confirmation. Reyes v. Brown (In re Reyes), 482 B.R. 603 (D. Ariz. 2012) (In light of the mandate in Espinosa to correct a defect in the proposed plan, the court correctly required the debtors to address discrepancies between creditor proofs of claims and provisions for them in the plan prior to confirmation). Compare, In re Walker, No. 14-1505 (E.D. La. Feb. 6, 2015) (Where debtor’s claimed mortgage arrearage not clearly erroneous the court has no obligation under Espinosa to deny confirmation).

Schlegel BAP 9th opinion




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