Income and Expense Issues in Plan Negotiation and Confirmation
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) included provisions defining “currently monthly income” (“CMI”) and created a means test to determine whether relief under Chapter 7 of the Bankruptcy Code should be presumed abusive. CMI is defined in 11 U.S.C. §101(I0A) of the Bankruptcy Code. In both Chapters 11 and 13, CMI provides a starting point for calculating the amount of disposal income that must be contributed toward payment of unsecured creditors. Chapter 13 debtors with CMI above specific levels are required by 11 U.S.C. §1325(b)(3) to complete a means test to calculate their monthly disposable income. Applying 11 U.S.C. §1325(b)(4), the level of CMI determines the “applicable commitment period” (i.e. 3 or 5 years) over which projected disposal income must be paid to unsecured creditors. There is no specific requirement that individual Chapter 11 plans must be concluded in 5 years.
Three separate official forms have been created for calculation of CMI, one each for Chapter 7, Chapter 11 and Chapter 13. Although the forms in each chapter have a different purpose, the basic computations are the same. CMI is the monthly amount of certain income the debtor, and in a joint case, spouse of the debtor, has received in six calendar months before the bankruptcy filing. The individual Chapter 11 B22(B) form is the easiest to complete of all three chapters. The means test deductions under 11 U.S.C. §707(b)(2) are not utilized in determining the amount of an individual Chapter 11 debtor disposal income. Section 1129(a)(15) of the Bankruptcy Code requires the debtor to devote payments of disposable income, incorporating 11 U.S.C. §1325(b)(2). Calculation of disposable income in Chapter 11 is based upon judicially-determined standards not the means test deductions mandated for higher income Chapter 13 debtors in 11 U.S.C. §1325(b)(3).
Income And Expense Analysis
11 U.S.C. §1325(b)(2) does require CMI be used as the initial starting point for determination of disposable income and in Section (b)2(A)(I) allows deductions from CMI for amounts “reasonably necessary to be expended – for the maintenance and support of the debtor or a dependent of the debtor, or for a domestic support obligation that first becomes payable after the date the petition is filed.” In a business case pursuant to 11 U.S.C. §1325(b)(2)(a)(B) permits payment of expenditures reasonably necessary for the continuation, preservation and operation of such business. In seeking to confirm a Chapter 11 plan, a debtor’s post-petition income must be devoted to the plan to the extent necessary for its execution under 11 U.S.C. §1123(8). 11 U.S.C. §1115(a) specifically defines post-petition income as property of the bankruptcy estate. The definition includes all earnings from services performed by the debtor after commencement of the case but before the case is closed, dismissed, or converted to a case under Chapter 7, 12 or 13. While Chapter 13 cases require all disposable income to be contributed towards a plan, there is no similar provision in 11 U.S.C. §1123. An individual Chapter 11 plan must provide for such income to be contributed to the plan and “as is necessary for the execution of the plan” to obtain confirmation. If an objection is filed by a single unsecured creditor under 11 U.S.C. §1129 (a)15(B), the statute requires individual debtors to contribute
The value of the property distributed under the plan is not less than the projected disposable income of the debtor (as defined in §1325(b)(2) to be received during the five year period beginning on the date that the first payment is due under the plan, or during the period for which the plan provides payments, whichever is longer.
The plan confirmation requirement for above median debtors in Chapter 13 to devote their disposable income for five years is not identical to the confirmation standard of 11 U.S.C. §1129(a)(15). In Chapter 11, the debtors are not required to commence plan payments immediately upon filing of the case. A debtor can propose a plan with payment terms shorter than a five year period even if the amount to be distributed to the creditors is less than the projected disposable income of the debtor during the five year period. Nonetheless, if a creditor objects under 11 U.S.C. §1129(a)(15), a five year plan devoting all disposal income or a 100% payout will be required.
Necessary and Ordinary Expenses of the Debtor Pre-Confirmation
Chapter 11 debtors are routinely allowed to use property of the estate in the ordinary course of business without notice or a hearing. 11 U.S.C. §363(c)(1). Prior to BAPCPA, individual debtor’s post-petition wages were not included in the bankruptcy estate and were permitted to be used for living expenses. 11 U.S.C. §541(a)(6). Oddly, the new section of the Bankruptcy Code 11 U.S.C. §1115 on its surface appears to leave individual debtors without the ability to use their income to pay living expenses. One Court in In re Seely, 492 B.R. 284 (Bankr. C.D. Cal. 2013) examined the need for debtors to use post-petition wages and specifically held Bankruptcy Code Section 11 U.S.C. 363(c) authorized individual debtors in possession to use property of the estate to pay post-petition living expenses without court approval. The court cautioned that the amounts expended are to be for “ordinary course living expenses”. The ruling was supported by review of Congress’ attempt to make individual Chapter 11 cases similar to Chapter 13 where debtors can use their post-petition wages for certain expenses without the necessity of court approval. Some jurisdictions have adopted Local Rules or practices requiring submission and approval of a budget by an individual Chapter 11 debtor before personal living expenses can be paid. In one case, Villalobos, 2011 W.L. 4485793 (9th Cir. B.A.P. 2011), the court permitted payment of personal and ordinary course expenses including school tuition and for high end automobiles. Nonetheless, the court remanded the case since the Bankruptcy Court had failed to make specific findings as to reasonableness of the expenses and what test was utilized to approve the disbursement. The court recognized the lack of authority to guide Chapter 11 debtors as to what personal expenses can be paid.
In re Goldstein, 383 B.R. 496 (Bankr. C.D. Cal. 2007) food and rent were considered ordinary course transactions permissible without court authority under 11 U.S.C. §363(c). Express guidance in case law for authority to pay non-essential living expenses is not prevalent. By way of comparison, Chapter 11 debtors are allowed to pay non-essential expenses to the extent necessary to (i) provide support for the debtor, (ii) provide support for the debtor’s payment, (iii) pay domestic support obligations, and (iv) make limited charitable contributions. Strangely, there is no express authority for a Chapter 11 debtor to pay increased health insurance premiums as would be permitted by a Chapter 13 debtor under 11 U.S.C. 1329 (a)(4). As a practice suggestion, it would be advisable for debtors in individual Chapter 11 cases to establish a budget for their household during Chapter 11, including their specific personal expenses with a request that the normal expenses be paid in the ordinary course of business, and incurred monthly without the necessity of court order. Once a case is filed, the debtor’s monthly operating reports should reflect income and expense and creditors. The U.S. Trustee or a creditor could potentially object in the event the monthly expenses are considered to be extravagant pre-confirmation. The definition of an “ordinary course living expense” is likely to be negotiated. If brought before a court, the legitimacy of each expense will have to be determined based upon the facts and circumstances of the case. In extreme circumstances, it is possible for a post-petition transfer to be challenged under 11 U.S.C. §549 and voided if considered to be a non-essential living expense, i.e. rent for a child or relative’s apartment that was paid out of post-petition earnings that are property of the estate.
It is important to note that the Chapter 11 disposable income test in 11 U.S.C. §1129(a)(15) does not specifically incorporate the IRS expense limits applicable to above median Chapter 13 debtors.
Chapter 13 Cases Regarding Calculation Of Disposable Income Under 11 U.S.C. 1325(B)(2)
Courts Will Likely Follow Chapter 13 Case Law Regarding Specific Projected Disposable Income Challenges
In Chapter 11 cases where disbursements have become an issue in plan negotiation, I have addressed objections from creditors’ attorneys challenging the specific expenses listed on Schedule “J” of the Chapter 11 bankruptcy petition. Since the means test and calculation of disposable income are reduced by authorized expenses, the issues of contributions to 401(k) plans and IRAs, repayment of 401(k) loans and pension fund loans and other itemized expenses may be raised. In the case of In re Roth, 2010 W.L. 2485951 (Bkrtcy. D.N.J.), Judge Wizmur addressed the issue whether regular 401(k) contributions and repayments of loans from 401(k) accounts constituted disposable income that must be applied to pay unsecured creditors under a Chapter 13 plan. The court reviewed the 2005 BAPCPA amendments and concluded that neither regular 401(k) contributions nor repayment of 401(k) loans constitute disposable income that must be paid to unsecured creditors. See 11 U.S.C. §541(b)(7) and In re Lenton, 358 B.R.61 (Bankr. E.D. Pa 2006) The court noted that the debtor’s 401(k) contributions had remained constant for several years and the debtor was not required to apply the funds towards the plan. Nonetheless, it was necessary to inquire whether the debtor will be paying the loan for the entire plan period.
In the case of In re Nowlin, 576 F.3d 258 (5th Cir 2009), the Fifth Circuit Court of Appeals held that an above median Chapter 13 debtor who would have fully repaid borrowings from a 401(k) fund in the 24th month of the plan would have to contribute the amounts necessary to pay the loan for distribution to creditors. The Court’s task was to interpret the phrase “projected disposable income” in light of the new definition of disposable income in 11 U.S.C. §1325(b)(2). This concept will have the same application in a Chapter 11 case. The income of the debtor constituting statutorily defined disposable income projected into the future will provide creditors an opportunity to rebut the presumption that the income will remain constant if evidence of reasonably foreseeable changes in the debtor’s financial situation can be demonstrated.
One Bankruptcy Court was asked to determine whether to confirm a debtor’s Chapter 13 plan that proposed after completion of a payment of a 401(k) loan, that the payroll deductions be continued as 401(k) contributions immediately after the loans were fully paid. The plan did not provide that, after the satisfaction of the 401(k) loans, there would be a “step up” increase in the debtor’s plan payment. The Chapter 13 trustee in the case of In re Seafort, 2009 W.L. 1767627 (Bankr. E.D.Ky.) had argued that contributions to a retirement plan should be excluded from property of the estate as disposable income only if the contributions were being made at the time the petition was filed. The court concluded that since the income stream funding both loan repayments and the plan contributions was the same as alternate participation methods, no change to the plan was necessary. The court cited In re Mati, 390 B.R. 11 (Bankr. D.Mass.2008), where another Bankruptcy Court recognized Congress’ policy of encouraging retirement savings. Unfortunately, for higher income earners in both Chapter 13 and Chapter 11, courts have not allowed any means test deduction from disposable income for college tuition and living expenses. In the case of In re Goins, 372, B.R. 824 (Bankr. S.Car. 2007), debtor’s budget included payment of $250 per month for their daughter’s college tuition and $500 for monthly living expenses. The court considered the pre and post BAPCPA case law defining disposal income and concluded that expenses for college education and a 19 year old college student were not includable as permissible deductions from income. The court stated that the means test in 11 U.S.C. §707(b)(2) does permit limited expense deductions for dependent children less than 18 years old not to exceed $1500 per year for private or public elementary or secondary school. The court expenses for a college education suggests that the exclusion under principals of statutory construction demonstrate Congress’ interest to prohibit debtors from deducting college expenses for children over 18 years old.
In light of the developing case law in individual Chapter 11 cases as to what constitute legitimate post-filing, pre-confirmation expenses, counsel should promptly address any formal or informal challenge to the debtor’s expenses. Any communication from a creditor who has reviewed a debtor’s schedule (“J”) or the monthly operating reports and raises questions or concerns should not be ignored. Avoidance of an objection by a creditor at the time of plan confirmation made under 11 U.S.C. §1129 (a)(15) should be a primary objective. Working collaboratively with creditors and the U.S. Trustee on the terms of a Chapter 11 plan may provide for flexibility in reaching a fair conclusion in the calculation of disposable income and the term of the plan of reorganization.
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