Chapter 9 Secured Claims in Consumer Bankruptcies

• Jurisdiction: United States

Chapter 9: Secured Claims in Consumer Bankruptcies

Mark G. Stingley and Michelle M. Masoner

Achapter 13 bankruptcy is similar to a business reorganization under chapter 11, but chapter 13 is limited to natural persons with limited debts. The debtor uses future earnings to pay off current debts with the current debts being restructured to make repayment possible. A chapter 13 bankruptcy allows individuals to pay off all or a portion of their debts over a period of three to five years. A chapter 13 bankruptcy proceeding is for the consumer debtor with regular income who wants to retain property encumbered by consensual or nonconsensual liens that would otherwise be liquidated in a chapter 7 proceeding.

The most common types of secured claims administered through chapter 13 proceedings are mortgages and vehicle liens. The chapter 13 plan must address each secured claim by either surrendering the collateral, reaching an agreement with the secured creditor, or paying the value of the lien over time.⁹⁹⁰ However, before determining treatment, the plan must determine whether a claim is secured and, if so, in what amount. Section 506(a) provides that a claim is secured to the extent of the value of the property. Section 506(a) bifurcates a claim secured by property into an allowed secured claim equal to the value of the property and an allowed unsecured claim for the deficiency. With the exception of claims secured only by the debtor's home, allowed secured claims may be bifurcated and treated accordingly under the plan.

If a plan proposes to modify a secured claim and pay the value of the collateral, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) added certain provisions to chapter 13 to prevent frequent problems in pre-BAPCPA cases. Previously, the Bankruptcy Code did not require adequate-protection payments, and some chapter 13 debtors did not provide payments to lenders at the beginning of their plans.⁹⁹¹As a result, some lenders waited months before receiving payments from debtors while the debtors continued to use the depreciating collateral. In the worst cases, while lenders waited for payments, some debtors converted their cases to chapter 7 and surrendered the collateral without compensating the lender for its depreciation during the period prior to conver-sion.⁹⁹² BAPCPA now requires adequate-protection payments to prevent these results.⁹⁹³

A. Adequate Protection Pending Confirmation of a Chapter 13 Plan

One of the protections afforded secured creditors who are prevented from taking back their collateral in bankruptcy is their entitlement to adequate protection of their security interests. With BAPCPA, Congress required pre-confirmation adequate protection in the form of cash payments by an amendment to Section 1326.⁹⁹⁴ Section 1326(a) mandates that payments on secured property be commenced 30 days after filing. Section 1326(a)(1) of the Bankruptcy Code states in relevant part:

Unless the court orders otherwise, the debtor shall commence making payments not later than 30 days after the date of the filing of the plan or order for relief, whichever is earlier, in the amount

(A) proposed by the plan to the trustee;
....
(C) that provides adequate protection directly to a creditor holding an allowed claim secured by personal property to the extent the claim is attributable to the purchase of such property by the debtor for that portion of the obligation that becomes due after the order for relief, reducing the payments under subparagraph (A) by the amount so paid and providing the trustee with evidence of such payment, including the amount and date of payment.⁹⁹⁵

This provision requires a debtor to provide adequate-protection payments to a creditor when three elements are present.⁹⁹⁶ First, a portion of the creditor's claim must become due after the order for relief, which in most cases is the bankruptcy petition date.⁹⁹⁷ Second, the creditor's claim must be based on an obligation incurred to purchase the property. Third, the debtor must have purchased the property securing the claim.⁹⁹⁸ When all three elements are met, a creditor with an allowed claim secured by a purchase-money security interest is entitled to adequate protection for the period of time between the filing of the case and the confirmation or dismissal of the case.⁹⁹⁹

Adequate protection is often defined as protection from the depreciating value of the collateral before the confirmation of a plan and does not include any payment of interest.¹⁰⁰⁰ In Timbers, the Supreme Court held that a secured creditor's interest in property is not adequately protected if the property is depreciating during the automatic stay.¹⁰⁰¹ In such a situation, the Supreme Court explained, the creditor is entitled to either cash payments or additional security in the amount of the decline in value.¹⁰⁰² Timbers was decided under § 362(d) (1), which remains another source for adequate protection. Section 362(d)(1) provides that when requested by a party-in-interest and after notice and a hearing, the court shall grant relief from stay for cause including lack of adequate protection of an interest in property. Of course, this provision requires the creditor to file a motion for relief from stay. Upon such motion, the court may order a continuation of the automatic stay conditioned upon the provision of adequate protection to the creditor.

While § 1326 automatically provides a qualifying secured creditor with a right to adequate-protection payments, many cases follow Timbers and hold that the amount of depreciation is the appropriate amount for pre-confirmation adequate-protection payments under § 1326.¹⁰⁰³ Section 1326 is silent about whether adequate-protection payments may properly include an interest component, although at least one court has concluded that they may not.¹⁰⁰⁴ In Brown, the bankruptcy court held that adequate-protection payments are intended to compensate the creditor for depreciation in the collateral only and apply only to principal, not interest. Adequate protection is assurance to a secured creditor that the value of its interest is not reduced during the life of the bankruptcy case. The Brown court reasoned that "[i] ncluding interest as a component of adequate protection for a secured creditor would effect a change in pre-BAPCPA practice ... [and] contradicts fundamental bankruptcy principles and law on this subject."¹⁰⁰⁵ The Brown court noted that under past bankruptcy practice, a secured creditor was adequately protected when the amount of pre-confirma-tion payments equaled the amount that the collateral was depreciating, and that Congress did not indicate any intention to add to this compensation.¹⁰⁰⁶ The amount of principal paid as pre-confirmation adequate protection affects the secured creditor's post-confirmation payments because the chapter 13 trustee must take into account this reduction in principal.¹⁰⁰⁷

1. Payments to the Secured Creditor or Through the Trustee

After BAPCPA came into effect, there was some question as to which party, the debtor or the trustee, was to make the adequate-protection payments to creditors. Unless the bankruptcy court orders otherwise, § 1326(a)(1)(C) contemplates adequate-protection payments directly to secured creditors prior to the confirmation of any chapter 13 plan. This language is new with the enactment of BAPCPA. Many courts establish a procedure by local rule or order for pre-confirmation adequate-protection payments to be paid to and distributed by the chapter 13 trustee. Payments through the trustee provide the parties with the benefits of the trustee's accounting.¹⁰⁰⁸ Section 1326(a)(1) allows for the deduction of the adequate-protection payment from the plan payment to the trustee, presumably because it has been paid directly to the lender.

Immediately after the passing of BAPCPA, there were a number of cases that held that the debtor could either make the payments to the chapter 13 trustee, who would then pay the secured creditor the adequate-protection payment, or the debtor could pay the creditor directly.¹⁰⁰⁹ Pre-confir-mation direct payments to the creditor are not needed if the debtor has chosen another method of providing adequate protection.¹⁰¹⁰

In order to receive adequate-protection payments, the secured creditor must file a proof of claim. The court may, after notice and hearing, increase or reduce the amount of the payments required to secured creditors, pending confirmation.¹⁰¹¹ If the plan is not confirmed, the trustee makes a distribution to the lender pursuant to § 1326(a)(2) rather than return the payments to the debtor.

2. The Appropriate Amount of Adequate Protection

There is a difference in opinion regarding how to calculate adequate-protection payments. Some districts require that it be a nominal percentage amount, around 1 to 2 percent of the collateral's worth at the time of filing.¹⁰¹² Other districts recognize adequate-protection payments as equaling the amount by which the collateral is depreciating.¹⁰¹³ Adequate-protection payments owed by a debtor to a secured creditor collat-eralized by the debtor's vehicle should be calculated based on the amount that the vehicle depreciates in the first month following the filing of the bankruptcy petition, unless a party (typically either the debtor or creditor) establishes better evidence or expert testimony on the depreciation of a particular vehicle.¹⁰¹⁴ In this case, the creditor filed a stay-relief motion arguing that it was receiving an insufficient amount of adequate protection to protect its interest in the collateral. The creditor demanded the full contractual monthly payment or, in the alternative, the average depreciation value over the three- to four-month period following the petition date as determined by expert testimony or the National Automobile Dealers Association (NADA). The debtor countered that the value should be based on the vehicle's depreciation value between the petition date...