Chapter 6 Hot-Button Issues for Creditors' Counsel

• Jurisdiction: United States

Chapter 6: Hot-Button Issues for Creditors' Counsel

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) amended the Bankruptcy Code to include a number of provisions that now bring a chapter 11 case for individuals more in line with that of a case under chapter 13. Most counsel who represent creditors in business cases are not familiar with the chapter 13 concepts imported into chapter 11 cases of individuals. There are some decided differences between the two, but also some variants on familiar provisions. The materials below highlight several hot-button issues of which creditors' counsel should be aware.

I. Budget and Cash-Collateral Issues

When an individual files for bankruptcy under chapter 7 or chapter 13, filing eligibility is determined according to the amount of the individual's debt.¹⁹⁰ An individual chapter 11 bankruptcy is different, however, in that there is no limit to the amount of debt an individual debtor may have in order to be eligible to file.¹⁹¹

A. Budget for Living Expenses

Like all other voluntary bankruptcies, the individual chapter 11 bankruptcy begins with the filing of a petition. At the commencement of the case, individual chapter 11 debtors must file an Official Form 122B,¹⁹² the Statement of Current Monthly Income. Based on the debtor's current monthly income, the court can calculate the individual debtor's disposable income pursuant to § 1325(b)(2), which helps the debtor prepare a monthly budget.¹⁹³ The debtor should use this budget when he or she files mandatory monthly financial reports.

B. Property Acquired by the Debtor Post-Petition

To prepare a budget, the debtor must first consider what constitutes "property of the estate." Prior to the passage of BAPCPA, there was much dispute regarding the scope of "property of the estate" of an individual chapter 11 debtor.¹⁹⁴ BAPCPA made clear that "property of the estate" in an individual chapter 11 bankruptcy includes property acquired by the debtor post-petition, as well as the debtor's post-petition earnings.¹⁹⁵

190 See 11 U.S.C. § 109(b) and (e).

191 See 11 U.S.C. § 109(d).

192 Official Form 122B, available at www.casb.uscourts.gov/html/csdforms/122B.pdf.

193 While applicable to plan confirmation, § 1129(a)(15)(B) incorporates § 1325(b)(2) for the definition of "projected disposable income." Section 1325(b)(2) defines "disposable income" as the debtor's current monthly income less amounts reasonably necessary for the maintenance or support of the debtor or a dependent and for charitable contributions. This disposable-income calculation is not required in a corporate chapter 11 case. When the chapter 11 filing is for an individual with primarily consumer debts, the individual must obtain a certificate demonstrating that the individual attended a group or individual briefing on credit counseling and budget analysis. The credit counseling session is required in order to be eligible for relief under any other chapter of the Bankruptcy Code. The individual debtor also must file copies of all payment advances or evidence of payment from an employer for the 60 days preceding the petition date. See 11 U.S.C. § 521(a)(1).

194 Compare In re FitzSimmons, 725 F.2d 1208, 1211 (9th Cir. 1984) ("If Congress had intended to make the earnings exception inapplicable to Chapter 11 cases, we believe that it would have done so explicitly, as it did in § 1306."), with In re Harp, 166 B.R. 740, 753 (Bankr. N.D. Ala. 1993) (all of debtor's post-petition income is property of estate).

However, some debtors may attempt to use the exemption provisions of § 522 to counteract the seemingly broad sweep of § 1115 as to the post-petition earnings of the debtor.¹⁹⁶ Section 522(b)(1) provides: "Notwithstanding section 541 of this title, an individual debtor may exempt from property of the estate the property" provided for under § 522. Most states have opted out of the federal exemption scheme, so reference must be made in those states to the exemptions provided for under state law. Also, most states exempt from seizure a sizeable portion of a debtor's earnings.¹⁹⁷ Therefore, creative debtor's counsel may argue that, notwithstanding § 1115(b), most of a debtor's post-petition earnings are "not liable during or after the case for any debt of the debtor that arose ... before the commencement of the case...."¹⁹⁸

Even if successful, such an exemption assertion may have a practical effect only on the budgeting and cash-collateral issues that arise during the case and not on cramdown confirmation issues. Section 1129(a)(5) governs cramdown confirmations in individual chapter 11 cases. That section does not mandate the use of post-petition earnings to confirm a cramdown plan. Rather, it calculates the "value of the property to be distributed under the plan" under "the projected disposable income" formulation of § 1325(b)(2) during the five-year period post-confirmation.¹⁹⁹ Therefore, even if a sizeable portion of post-petition earnings is exempt, that income is still used in the determination of the value of the property that must be distributed post-confirmation under a cramdown plan.

C. Debtors May Use Property of the Estate in the Ordinary Course of Business

Although BAPCPA clarified that estate property includes post-petition earnings, disputes regarding use of estate property may arise as the individual debtor prepares a budget. Upon commencing an individual chapter 11 bankruptcy, the debtor becomes a fiduciary to his or her creditors.²⁰⁰ As a result, courts have found that the debtor is obligated to control his or her spending in order to conserve estate resources.²⁰¹ But courts generally allow an individual chapter 11 debtor to pay for ordinary living expenses with estate property.²⁰²

Courts may be stricter when the debtor's budget includes expenses for his or her dependents. The term "dependent" is not defined in the Bankruptcy Code. Some courts have permitted a debtor to budget for non-family adult dependents, while other courts have denied a debtor's assertion that close blood relatives are de-pendents.²⁰³ One court held that payments to the debtor's spouse, from whom he recently had separated, constituted ordinary living expenses that could be paid from property of the estate.²⁰⁴

When determining the scope of "reasonable" living expenses, the majority of courts will not consider the lifestyle to which the debtor is accustomed when determining the parameters of reasonable living expenses.²⁰⁵

Consider the recent case of In re Johnson. An individual chapter 11 debtor sought to convert his case to a chapter 7 bankruptcy. His creditors objected, asserting that the debtor was filing for conversion in bad faith. In order to determine whether the debtor's intentions were earnest, the court considered whether the debtor violated his fiduciary duties to control his post-petition expenditures. The evidence revealed that throughout the chapter 11 bankruptcy, the debtor continued to incur unnecessary, excessive expenses by failing to promptly dispose of depreciating assets, including a Ferrari and three BMWs. These assets imposed costs on the estate not only because the assets lost value quickly over time, but also because of the high cost to maintain the assets, including insurance payments and vehicle maintenance.²⁰⁶ The court also found that the debtor violated his fiduciary duties by using property of the estate to pay for his younger brother's private-school tuition, permitting his parents to drive one of his BMWs and permitting his family to live at one of the debtor's properties.²⁰⁷

The Johnson case arose in the context of a motion to convert some five months after the case was commenced. The excessive and inappropriate spending issues could have been raised much earlier in the case, however. Johnson serves as a reminder to creditors' counsel to scrutinize the debtors' monthly operating report for suspicious expenditures.

D. Are Budgets Subject to Court Approval?

Courts are split as to whether debtors must obtain court approval before expending estate funds on ordinary-course living expenses. In some jurisdictions, local rules require the debtor to submit a living-expenses budget for court approval.²⁰⁸ However, in the majority of jurisdictions, courts allow the debtor to use estate property to pay for ordinary expenses without obtaining court permission.²⁰⁹ Even in jurisdictions where a budget is not required expressly, the court may indicate its preference for the establishment of a budget.²¹⁰ In jurisdictions where debtors are not required to file a budget, spending by an individual chapter 11 debtor may go unchecked without affirmative objection by a creditor.²¹¹ Creditors' counsel are well advised to raise such an objection under the appropriate factual circumstances of individual cases.

II. Proofs of Claim

A. Requirements

The requirements for filing proofs of claim in an individual chapter 11 bankruptcy are the same as the requirements applicable to a business chapter 11 bankruptcy. A creditor may file a proof of claim but is not required to do so if the debt is scheduled and not listed as disputed, contingent or unliquidated.²¹² If the creditor fails to file a proof of claim, the debtor may file a proof of claim for the creditor.²¹³

A proof of claim is filed using Official Form B-410. The proof of claim must comport with the requirements of Bankruptcy Rule 3001. In particular, in either a chapter 13 bankruptcy or an individual chapter 11 bankruptcy, a proof of claim must comport with the Bankruptcy Rule 3001(c)(2) requirements applicable to an individual debtor.²¹⁴

B. Time for Filing

In a chapter 13 bankruptcy, the deadline for filing proofs of claim is governed by Bankruptcy Rule 3002(c). This is not the case in an individual chapter 11 bankruptcy. Instead, as in ordinary business bankruptcy cases, the deadlines for filing proofs of claim are set by order of the court.²¹⁵

In both chapter 13 and chapter 11 bankruptcies, the court may...