New Bankruptcy Code Forces Consumer Debtors to Pay More to Unsecured Creditors

Bernstein-Burkley, P.C.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 is over two years old now. By now, most people are familiar with its terms and have adjusted to the changes. Much of the new law, however, is still subject to different interpretations and litigation is heating up on a number of fronts.

One such front should be of interest to our clients that often find themselves with large unsecured debts in consumer Chapter 13 bankruptcies. The new Bankruptcy Code requires debtors whose income exceeds the state median income in which they live to apply all of their “projected disposable income” towards making payments to unsecured creditors. See, 11 U.S.C. § 1325(b)(1)(B). The point of this provision was to curtail the practice of debtors paying their secured creditors in their Chapter 13 plan, but only making a small or sometimes non-existent percent distribution to unsecured creditors.

The point of dispute has been on how to calculate “projected disposable income.” However, using all different calculation approaches, the result of this provision in practice has been, in many circumstances, a dramatic increase in the monthly plan payments or dismissal of cases for failing to pay all “projected disposable income” to unsecured creditors.

The Means Test and Form B22C

The first hurdle is to determine whether the debtor is an above-median income debtor, which is a comparison of the debtor’s income over the prior six months before bankruptcy against the state median income. The prior six months of income is known as the “Current Monthly Income” or “CMI.”

If the debtor has above-median income, the Bankruptcy Code then provides a calculation, known as the “Means Test,” to determine if the debtor has enough available income to be forced into a Chapter 13 bankruptcy. Debtor’s expenses are determined by reference to IRS National Standards and Local Standards for certain categories and Debtor’s actual expenses for other categories. See, 11 U.S.C. § 707(b). The Means Test is the CMI minus the debtor’s standardized expenses.

A standardized form, known as Official Form B22C and titled Chapter 13 Statement of Current Monthly Income and Calculation of Commitment Period and Disposable Income, was created to facilitate this calculation. A filled out Form B22C can normally be found in all bankruptcy filings attached to the Schedules filed by the Debtor at the beginning of a bankruptcy.

A Practical Application of the Projected Disposable Income Rule

Line 58 of Form B22C, titled Monthly Disposable Income Under § 1325(b)(2), shows the result of the Means Test calculation. Holders of unsecured claims can use this number as a starting point in determining if the Chapter 13 plan is proposing to pay as much as it should to unsecureds.

As an example from a recent case in which this law firm was involved, the result of Line 58 was $799. This means that, over a sixty month plan, the debtor should propose to distribute at least $47,940 (60 * $799) solely to unsecured creditors. If the unsecured creditor pool was $100,000, that would be a 48% distribution. In that recent case, the debtor proposed a 0% distribution to unsecureds.

This law firm filed an Objection to Plan Confirmation based on Section 1325(b)(1) of the Bankruptcy Code which provides that, upon the filing of an objection by “the trustee or the holder of an unsecured claim” the court “may not approve” the plan unless plan provides that all “projected disposable income” be paid to unsecureds. This is important because the onus is on the unsecured creditor to determine that the plan is underfunded and make the objection. If the claimant does not make the objection, an underfunded plan will be approved and become the law of the case.

In the above example case, the Bankruptcy Court agreed that the debtor was not applying all “projected disposable income” to pay unsecureds and dismissed the case because the plan was not confirmable.

The Dispute Over How to Calculate Projected Disposable Income
The previous example was very simple in that it only used the Form B22C Means Test result. However, the Means Test result officially shows “disposable income” and not “projected disposable income” as that term is set forth in Section 1325(b) of the Code.

Bankruptcy practitioners throughout the United States have argued that “projected” requires a forward looking approach to the debtor’s income and should not be reliant on the backward looking six month average of the CMI discussed above. A growing number of bankruptcy courts have agreed that the most accurate reflection of projected income is set forth in debtor’s Schedule I (the Schedule in each debtor’s Voluntary Petition that shows the debtor’s monthly income as of the bankruptcy filing). See, e.g., In re Bossie, 2006 Bankr. LEXIS 3956 *5 (Bankr. D. Alaska 2006); In re Edmonson, 363 B.R. 212, 217 (Bank. D. N.M. 2007).

This is because the CMI looks back at the last six months, which may be distorted by periods of unemployment or seasonal employment, while Schedule I shows income as it is on the bankruptcy filing date.

On many occasions, such as in the one used as the example in this paper, the CMI of Form B22C and Schedule I are the same number. However, in situations where Schedule I exceeds the CMI, creditors may argue that the correct “projected disposable income” example is debtor’s income reflected in Schedule I minus the Form B22C standardized expenses. The result will be in many cases an even greater distribution to unsecured creditors.

Even though parties are still litigating its exact meaning, the requirement in the new Bankruptcy Code that above-median income debtor’s pay all of their “projected disposable income” to unsecured creditors is a very powerful tool that is dramatically increasing percentage payouts to unsecureds. Unsecured creditors can easily make a rough determination if the plan is fully funded or not by referencing Line 58 of Form B22C. If it is not paying enough to unsecureds, a timely plan objection can force a higher plan payment or result in the dismissal of the bankruptcy case.

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For additional information on perfection of security interests and the usage of other credit enhancements, please see the other articles in this Publications section.

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