No Bad Faith for Failure to Voluntarily Devote Social Security Funds to Plan

Posted by NCBRC - September 1, 2017

Where the debtor’s plan proposed terms that were within bankruptcy and social security parameters, and there was no evidence of misconduct or bad faith, the bankruptcy court erred in declining to confirm his plan due to his failure to voluntarily contribute some of his social security funds. In re Manzo, No. 16-7218 (N.D. Ill. Aug. 25, 2017).

After strip-down of its lien, Carl Manzo’s petition listed an unsecured debt to Seaway of approximately $9,000. His schedules also listed over $7,000 in a bank account representing a lump sum social security benefit he had received prior to filing bankruptcy. He claimed those funds as exempt and the bankruptcy court overruled the trustee’s objection to the exemption. Mr. Manzo’s only income was $1,579 per month in social security and his monthly expenses were $1,549. He proposed to pay the $30 difference into his plan, resulting in approximately $1,000 going toward Mr. Manzo’s debt to Seaway. Seaway objected to the plan as being proposed in bad faith due to his failure to contribute any funds from his “stockpiled” bank account. The bankruptcy court agreed and ordered Mr. Manzo to propose a plan under which he would contribute half of the social security funds in the bank account or face denial of confirmation. The bankruptcy court appeared to have based its finding of bad faith on three factors: the nondischargeability of the debt under chapter 7, Mr. Manzo’s failure to voluntarily devote social security funds to the plan, and the small percentage of repayment.

Mr. Manzo obtained leave to file an interlocutory appeal.

On appeal, the district court began generally with the “good faith” requirement for chapter 13 plan confirmation under section 1325(a)(3). Because good faith is not defined in the Code, courts have addressed the issue on a case-by-case basis taking into consideration such factors as whether the plan 1) states the debts accurately, 2) states the debtor’s expenses accurately, 3) states the percentage of repayment accurately, 4) has deficiencies which amount to an attempt to mislead the court, and 5) indicates a fundamental fairness in dealing with creditors. A court will also consider how the debts arose and whether they would be dischargeable in chapter 7.

Turning to whether Mr. Manzo’s failure to include his saved social security benefits amounted to bad faith, the court began with section 407 of the Social Security Act which specifies that social security benefits are not “subject to execution, levy, attachment, garnishment, or other legal process, or to the operation of any bankruptcy or insolvency law.” Furthermore, the SSA deals with potential conflicts between federal statutes by providing that “No other provision of law . . . may be construed to limit, supersede, or otherwise modify the provision of this section except to the extent that it does so by express reference to this section.”

Finding that, under this provision, social security benefits do not enter the bankruptcy estate, the court acknowledged that, in chapter 13 a debtor may voluntarily contribute non-bankruptcy property to his plan. The question, therefore, was whether the bankruptcy court properly held that, in this instance, Mr. Manzo’s failure to contribute his own funds constituted bad faith.

Although the Seventh Circuit has not addressed the issue of whether failure to voluntarily contribute social security benefits to a plan can be considered in a good faith analysis, the court noted that the Fifth, Ninth, and Tenth Circuits have all concluded that it may not. See Drummond v. Welsh (In re Welsh), 711 F.3d 1120, 1132-33 (9th Cir. 2013) (Ripple, J., sitting by designation); Beaulieu v. Ragos (In re Ragos), 700 F.3d 220, 227 (5th Cir. 2012), Anderson v. Cranmer (In re Cranmer), 697 F.3d 1314, 1319 (10th Cir. 2012).

The court was particularly persuaded by the reasoning in Welsh where the Ninth Circuit found that Congress specifically excluded social security benefits from the definition of current monthly income in section 101(10A)(B). The Welsh court found this, taken in conjunction with the provisions in the SSA, to be a clear indication of congressional intent to break from past judicial practice and remove a court’s discretion to base confirmation or denial of confirmation on a debtor’s access to social security funds. The Welsh court concluded that a debtor who proposes a plan in strict accordance with the Code and the SSA cannot be found to be acting in bad faith on that basis.

The Manzo court agreed that Mr. Manzo’s failure to voluntarily contribute funds did not offend any provision of the Code or SSA and could not be a basis for a finding of bad faith. The court went on to find that the fact that Mr. Manzo was able to strip down Seaway’s lien under chapter 13’s liberal strip-down rules, while under chapter 7 he would not have been able to strip the lien, was also sanctioned by the Code and, therefore, not dispositive of the issue of good faith. [In a lengthy footnote, the court questioned the judicial interpretation of the Code that treats chapter 7 stripping more harshly than stripping under chapter 13.] Finally, the court found that there is no minimum percentage of repayment that must be met to qualify a plan as being in good faith.

Therefore, all three factors found decisive by the bankruptcy court were within Mr. Manzo’s prerogative to deal with as he did. In light of the fact that “[t]here was no suggestion at the confirmation hearing of any fraud, misrepresentation, or other deceptive or inequitable conduct on the part of Mr. Manzo in his bankruptcy proceedings” the bankruptcy court’s reliance on these other factors was error. The court remanded with instructions to the bankruptcy court to review the plan under a good faith analysis that takes only proper factors into account.

Manzo ND Ill opinion Aug 2017



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