Stacia M. Stokes, Fighting Finality and Debtor Waste in Chapter 13 Postconfirmation Collateral Surrender

• Jurisdiction: United States,Federal
• Publication year: 2011
• Citation: Vol. 27 No. 1

FIGHTING FINALITY AND DEBTOR WASTE IN CHAPTER 13

POSTCONFIRMATION COLLATERAL SURRENDER

INTRODUCTION

Historically, insolvency laws heavily favored creditors. The message was clear: "Let the borrower beware. Do not borrow recklessly, and repay what you owe."¹In fact, creditors were so powerful that they could force the debtor into prison until the debt was paid.²Insolvent debtors were left to rot in prison until someone, usually friends or family, paid the debt.³And while in prison, the debtor had to find a way to obtain food, drink, and clothing.⁴If the debtor failed in this task, the law was so harsh that an English jurist proclaimed, "let [the debtor] die in the name of God, says the law."⁵

Jurists no longer want to force debtors to rot in prison, but they also do not want to subject creditors to abusive treatment by debtors. Dueling policies of protecting creditors' claims⁶and providing debtors with fresh starts⁷have led to many splits in consumer bankruptcy law.⁸This Comment addresses a particularly troublesome area of consumer bankruptcy that is divided due to dueling policies; namely, when collateral severely depreciates after plan confirmation, some courts allow debtors to modify their plans to surrender collateral to their secured creditors⁹whereas other courts refuse¹⁰to allow such a modification. The issue is further complicated by competing policies¹¹of the binding effect of confirmation¹²and the desire to promote consumer debtor reorganization.¹³

This Comment proposes that a modification to surrender collateral should be allowed except when the collateral has depreciated due to debtor waste. This is fair to secured creditors because they are protected by adequate protection¹⁴and may request relief from the automatic stay once the collateral depreciates to a value below the claim.¹⁵At times, however, this remedy is not available because the right to request adequate protection, like all rights adjudicated at confirmation under Sec. 1325(a)(5)(B), may be lost, due to codified finality in plan confirmation, if not vigorously protected.¹⁶Therefore, secured creditors must implement several strategies to protect themselves. These strategies include zealous participation in the case through preconfirmation requests for adequate protection and monitoring their claims for grounds for relief from the automatic stay postconfirmation. Furthermore, when debtors surrender depreciated collateral, secured creditors should receive superpriority claims for any debtor-caused depreciation not covered by adequate protection. These strategies effectively implement the tools of the Bankruptcy Code ("the Code") that are intended to facilitate the policy of fair treatment of creditors. If the secured creditor fails to utilize these tools sufficiently, then allowing plan modification properly shifts the balance of the dueling policies in favor of protecting the debtor's fresh start and successful reorganization, despite an unfair effect on the creditor.

The following sections cover, in more detail, each of these strategies and the policies justifying them. Part I traces the evolution of bankruptcy from extremely pro-creditor to increasingly pro-debtor. Part II covers the Bankruptcy Code sections affecting chapter 13 plans, focusing on the provisions used by courts to permit modification of a confirmed plan and to deny motions for relief from the automatic stay. Next, Part III analyzes motions for relief from the automatic stay postconfirmation. Then, Part IV addresses the split of authority on modifying the confirmed plan to surrender collateral in satisfaction of creditors' claims. It suggests that courts must deny modification where the collateral has severely depreciated due to debtor waste but should grant the modification otherwise. Finally, Part V argues that secured creditors should receive superpriority claims for inadequate adequate protection caused by debtor waste when surrender of severely depreciated collateral is permitted as a plan modification.

I. FROM DEBTORS' PRISONS TO DEBTOR PROTECTION

A. Legislative History of Plan Modification

By the early 1900's, the "debtor beware" view began to change gradually as legislators realized that "nothing is gained for the public by keeping [an honest man] down, but, on the contrary, the public good will be promoted by having his assets distributed ratably as far as they will go among his creditors and letting him start anew."¹⁷While drafting the Bankruptcy Reform Act of

1978,¹⁸Congress foresaw that certain events, such as loss of income, new medical diagnoses, and additional dependents, sometimes threaten a consumer debtor's ability to make payments declared in the chapter 13 plan.¹⁹In response, Congress expanded debtor protection by allowing modification of the confirmed plan²⁰to increase the consumer debtor's prospects of success.²¹

The intention of the 1978 Act, however, was not simply to create a "debtor's bill"; rather, it was meant to outline more clearly creditors' rights.²²Thus, Congress struggled with balancing fairness to creditors with debtors' abilities to use chapter 13 to escape the prison created by burdensome debt. But Congress successfully balanced the competing interests by limiting debtors' voluntary modifications with the mandate that the modified plan must still adhere to plan content and confirmation requirements in Sec. 1322(a)-(b) (1978) and 1325 (1978).²³

The next major revision of the plan modification section came in the Bankruptcy Amendments and Federal Judgeship Act of 1984.²⁴There, Congress retracted some of the debtors' protections provided in the 1978 Act by returning the right to modify a confirmed plan to the trustee and unsecured creditors.²⁵Notably, secured creditors were not given the same right.²⁶

Moreover, no limitations were specified for the trustees' and unsecured creditors' abilities to modify the plan.²⁷As a result, the balance once again tilted off center and away from the debtor. But it did not tip in favor of secured creditors since they were not provided the same privilege.

Although the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA")²⁸drastically amended several sections of the Bankruptcy Code, it only added a minor change to Sec. 1329.²⁹But BAPCPA still altered the balance between debtors and secured creditors in plan modification because

Sec. 1329 references Sec. 1325(a)(5), and BAPCPA added a significant provision to that section. Specifically, BAPCPA added a requirement for adequate protection of secured creditors' claims in the plan confirmation requirements of Sec. 1325(a)(5)(B).³⁰

Since adequate protection is now explicitly litigated at confirmation,³¹the plan finality policy in Sec. 1327 acts as a bar for subsequent litigation on this issue, absent unforeseeable events.³²Thus, where debtors decide to surrender depreciated collateral through a postconfirmation modification, secured creditors have lost one of their major recourses against debtors. Once again, statutory amendments have rebalanced the policies behind treatment of debtors and creditors in bankruptcy. This time, the balance has tipped in favor of debtors.

B. Statutory Balances for Debtor Protection and Creditor Strategies

To balance against debtors' modifications of confirmed plans, creditors must robustly defend their statutory rights to adequate protection,³³superpriority administrative claims for inadequate adequate protection, and the right to relief from the automatic stay before the debtor causes excessive depreciation, even after plan confirmation. Secured creditors may not rest on the laurels of adequate protection in the confirmed plan; rather, secured creditors must vigorously defend their statutory rights to maintain the balance between fair treatment of their claims and effective reorganization of the debtor.

First, secured creditors must actively protect their right to adequate protection³⁴at confirmation.³⁵If secured creditors settle for merely having a security interest in collateral and do not negotiate adequate protection under the plan, they must then suffer the consequences if the debtor subsequently surrenders the collateral.³⁶These consequences include the risk of receiving depreciated collateral in satisfaction of their claims with no payment for the loss in value.³⁷

Second, even if secured creditors realize after confirmation that their claims are not adequately protected against depreciation, courts will often refuse to grant a relief from stay³⁸due to lack of adequate protection, since secured creditors should have negotiated adequate protection at confirmation.³⁹On first impression, confirmation barring subsequent motions for relief from stay seems counterintuitive and contrary to congressional intent to protect creditors' rights in the face of an automatic stay.⁴⁰Nevertheless, the refusal to lift the automatic stay postconfirmation does not result in deterioration of creditors' rights because secured creditors have the opportunity to defend adequate protection rights at confirmation.⁴¹Where circumstances surrounding the severe depreciation of the collateral are not foreseeable at confirmation, however, plan confirmation should not act as final on a motion for relief from the automatic stay because this issue could not have been raised at confirmation.⁴²

A third strategy to defend against plan modification is to request a special administrative priority claim in the amount of any deficiency not covered by the adequate protection requested at confirmation, even if the debtor surrenders the collateral.⁴³These three strategies are most likely to preserve the balance between fairness to creditors and debtor reorganization, but each has its own complications. Parts III and IV discuss these complications and provide suggestions on dealing with them. But first, Part II explains the relevant background Code provisions that affect these strategies.

II. CHAPTER 13: A SAFE HAVEN FOR THE CONSUMER DEBTOR

Far from...