Summary
stating that "regular income that is otherwise exempt must nevertheless be factored into the disposable income calculation in Chapter 13"
Summary of this case from In re LaunzaOpinion
No. 04-81133.
March 30, 2005
Gary T. Rafool, Peoria, IL, Attorney for Debtors.
Michael D. Clark, Peoria, IL.
Andrew W. Covey, Peoria, IL, Attorney for Chapter 13 Trustee.
David French, Peoria, IL, Attorney for Federal Insurance.
U.S. Trustee, Peoria, IL.
OPINION
There are three main issues in this case. First, whether an objection to eligibility for Chapter 13 relief based upon an excessive amount of unsecured indebtedness may be raised for the first time after confirmation of the plan. Second, whether the assignee of a claim held by a prepetition creditor may have a late filed claim allowed where the assignorcreditor failed to file a proof of claim. Third, whether life insurance proceeds to which a Chapter 13 debtor becomes entitled on account of her joint debtor-husband's death after confirmation of the plan, which proceeds were neither anticipated at the time of confirmation nor addressed in the plan or confirmation order, and which are fully exempt, must nevertheless be paid to the Chapter 13 Trustee for distribution to unsecured creditors under the plan.
FACTUAL AND PROCEDURAL BACKGROUND
Joseph L. Pitts (JOSEPH) and Sandra C. Pitts (SANDRA) (together, the DEBTORS), filed a joint voluntary petition for protection under Chapter 13 on March 11, 2004. SANDRA had been employed as a bookkeeper by Wenona State Bank (the BANK), but her employment was terminated prepetition after she was caught embezzling money from the BANK. She was prosecuted in the U.S. District Court and on September 2, 2004, pleaded guilty to the crime of Embezzlement by a Bank Employee. Federal Insurance Company (FEDERAL), the insurer on the Security Bond that covers the BANK against losses caused by employee theft, asserts that the amount embezzled by SANDRA exceeds $240,000.
The Chapter 13 plan, confirmed on May 10, 2004, calls for payments of $1,640 per month for thirty-six months for a total of $59,040. After secured creditors, the DEBTORS' attorney and the Trustee are paid, unsecured creditors are to receive $35,836, or 29% of the scheduled $120,586.29 in unsecured indebtedness. As of the claim bar date, however, proofs of claim for unsecured debts had been filed only in the amount of $104,250.
On September 17, 2004, JOSEPH died. SANDRA, as the beneficiary on two life insurance policies insuring JOSEPH'S life, became entitled to receive insurance proceeds totaling $226,321.23. The insurance proceeds were deposited into an account at the State Bank of Graymont and, to the Court's knowledge, remain on deposit subject to this decision. On November 18, 2004, SANDRA filed an amended schedule of exemptions claiming the insurance proceeds fully exempt under 215 ILCS 5/238 and/or 735 ILCS 5/12-1001(f).
After JOSEPH'S death, SANDRA filed a motion requesting authority to pay off the plan, and to receive a full compliance discharge, using only enough of the life insurance proceeds necessary to pay the remaining balance of the $59,040 originally due under the confirmed plan. In her motion, SANDRA asserted that the balance of the insurance proceeds would be needed to pay toward an expected restitution order likely to be entered in her criminal case.
At the hearing on SANDRA'S motion, the Chapter 13 Trustee (TRUSTEE) took the position that, since the amount of life insurance proceeds exceeds the amount of allowed unsecured claims, SANDRA should be ordered to pay into the plan that much of the proceeds necessary to pay unsecured creditors 100% of their allowed claims. The TRUSTEE thereafter filed a Motion to Modify Plan suggesting that $112,789 would be required to accomplish a 100% payout, and also requesting reimbursement of his attorney fees and costs. The Court set a schedule for the parties to file briefs in support of their positions.
On December 1, 2004, FEDERAL filed its objection to the TRUSTEE'S Motion to Modify. FEDERAL asserts that it was a prepetition creditor omitted from the bankruptcy case. If its claim for $242,000 had been properly scheduled as an unsecured claim says FEDERAL, it would have been apparent that the DEBTORS were not eligible for Chapter 13 relief on account of having too much unsecured debt.
Concurrent with its objection, FEDERAL filed a Motion to Dismiss or Convert the Case and a Motion, in the alternative, to allow it to file an untimely claim. Under the terms of its Surety Bond, FEDERAL received an assignment of the BANK'S rights against SANDRA. Not having received a formal notice of the bankruptcy filing from the Court, FEDERAL claims not to have become aware of the bankruptcy case until after the plan was confirmed and the claim bar date had passed. But for the DEBTORS' failure to schedule it as a creditor, argues FEDERAL, it would have had notice of the case and would have been able to file a timely proof of claim.
SANDRA objected to FEDERAL'S request for allowance of an untimely claim or to dismiss the case, on the basis that FEDERAL'S predecessor in interest, the BANK, was properly scheduled and received notice of the bankruptcy filing. The TRUSTEE also objected to FEDERAL'S motions. The TRUSTEE then objected to SANDRA'S claim of exemption in the life insurance proceeds. The TRUSTEE alleges that the applicable exemption statute, exempting life insurance proceeds "payable" to a beneficiary, does not provide an exemption where the proceeds have been paid out to the beneficiary.
ANALYSIS
A. FEDERAL'S MOTIONS.
Viewing Chapter 13 primarily as a remedy for debtors to deal with consumer debts, Congress capped the amount of indebtedness that a debtor may have in order to be eligible for Chapter 13 relief. Since this case was filed prior to April 1, 2004, the DEBTORS must have had noncontingent, liquidated, unsecured debts of less than $290,525. 11 U.S.C. § 109 (e). Included in the computation are wholly unsecured debts, both priority and nonpriority, and the unsecured portion of any undersecured debt.
As a general rule, in determining eligibility for Chapter 13, courts rely upon the schedules filed by the debtor, as long as the representations contained therein are made in good faith. Matter of Lybrook, 951 F.2d 136 (7th Cir. 1991). A debtor who fails to accurately schedule known debts so as to manipulate eligibility, acts in bad faith. In re Alt, 305 F.3d 413 (6th Cir. 2002). In considering whether the debt representations have been made in good faith, the court may consider the proofs of claim that have been filed and other evidence offered by the parties, however, it is neither necessary nor contemplated that each and every disputed claim will be finally determined as part of an eligibility determination. See, In re Barcal, 213 B.R. 1008 (8th Cir.BAP 1997).
As most courts have recognized, eligibility for Chapter 13 as prescribed by Section 109(e) is not jurisdictional. Matter of Phillips, 844 F.2d 230 (5th Cir. 1988); Rudd v. Laughlin, 866 F.2d 1040 (8th Cir. 1989); In re Wenberg, 94 B.R. 631 (9th Cir.BAP 1988), aff'd, 902 F.2d 768 (9th Cir. 1990); In re Verdunn, 210 B.R. 621 (Bankr.M.D.Fla. 1997) (split of authority noted, but majority rule is that eligibility is not jurisdictional). It follows, therefore, in Chapter 13 cases where, for example, it comes to light only after confirmation of a plan that the debtor had excessive unsecured debt, that orders entered are not void and such cases are not subject to automatic dismissal for lack of jurisdiction. Thus, a Chapter 13 case may properly proceed to discharge even though it is discovered, after confirmation, that unsecured claims exceed the eligibility limit. This result is uncontroversial where a debtor scheduled his debts in good faith. The issue becomes more difficult, however, where the debtor is shown to have made misrepresentations on his schedules in order to squeeze under the eligibility limit for indebtedness.
One issue is whether there is a point in the case where it is too late to throw the debtor out for lack of eligibility, even though the debt amounts were intentionally misrepresented. This question is not expressly answered in the Bankruptcy Code and Rules but, in this Court's view, the answer may be gleaned from the application of two Code sections. First, the general res judicata effect of confirmation of a plan is provided in Section 1327(a), as follows:
The provisions of a confirmed plan bind the debtor and each creditor, whether or not the claim of such creditor is provided for by the plan, and whether or not such creditor has objected to, has accepted, or has rejected the plan.
As a general rule, a creditor's failure to raise an objection at or prior to the confirmation hearing or to appeal from the order of confirmation will preclude the creditor from challenging the legality of the plan or its provisions at a later point in time. Matter of Chappell, 984 F.2d 775, 782 (7th Cir. 1993). Since lack of eligibility for relief is grounds for denial of confirmation in Chapter 13, confirmation of a plan is normally res judicata with respect to that issue. See, In re Elstien, 238 B.R. 747, 753 (Bankr.N.D.Ill. 1999). In re Lochamy, 197 B.R. 384 (Bankr.N.D.Ga. 1995); In re Jones, 134 B.R. 274 (N.D.Ill. 1991). This Court agrees with that principle where no fraud is involved.
Confirmation may be revoked, however, under Section 1330(a) as follows:
On request of a party in interest at any time within 180 days after the date of the entry of an order of confirmation under section 1325 of this title, and after notice and a hearing, the court may revoke such order if such order was procured by fraud.
The 180 day limit is strictly applied. A complaint to revoke confirmation cannot be brought after expiration of the 180-day time limit, even if confirmation was obtained by fraud and the fraud was concealed until then. In re Valenti, 310 B.R. 138 (9th Cir.BAP 2004). Proof of fraud for purposes of Section 1330 must include a showing that the debtor made a materially false representation that was known to be false or made without belief of its truth or made with a reckless disregard for the truth. In re Nikoloutsos, 199 F.3d 233 (5th Cir. 2000).
In this Court's view, an intentional misrepresentation of a debt in the schedules filed by a debtor, that may affect the debtor's eligibility for relief, is an act of fraud within the scope of Section 1330(a), and is subject to the limitations period provided therein. Accordingly, this Court holds that the deadline for asserting ineligibility for Chapter 13 relief, where the debtor is alleged to have made an intentional misrepresentation on his schedules relevant to eligibility, is 180 days after the date of entry of the order of confirmation pursuant to Section 1330(a).
Lack of eligibility may be raised by motion prior to confirmation. Since a proceeding to revoke an order confirming a Chapter 13 plan is defined as an adversary proceeding by F.R.B.P. 7001(5), a post-confirmation attack on eligibility should be made by adversary complaint.
In the case at bar, the attack on eligibility comes too late, even assuming that the DEBTORS misrepresented information on their schedules. The plan was confirmed on May 10, 2004. FEDERAL'S pleadings raising lack of eligibility were filed on December 1, 2004, more than 180 days after confirmation. But FEDERAL alleges that it was an omitted prepetition creditor of SANDRA, without timely knowledge of the case, so that it shouldn't be held to the usual deadlines, including the claim bar date. FEDERAL'S position is unavailing for several reasons.
First, contrary to its assertion, FEDERAL did not hold a claim against SANDRA as of the petition date. FEDERAL is merely the postpetition assignee of a prepetition claim held by the BANK. Theft gives rise to liability for return of the stolen property or its value. At the time of each act of embezzlement, SANDRA became liable to the BANK in the amount of the embezzled funds and the BANK held a prepetition claim against SANDRA for those funds. FEDERAL had a contract to indemnify the BANK against such a loss and to compel the BANK to assign its rights of recovery to FEDERAL upon FEDERAL'S payment to the BANK. According to FEDERAL'S Motion to Dismiss or Convert, the BANK'S rights against SANDRA were not assigned to it until November 18, 2004. FEDERAL had no contract with SANDRA and no independent right to payment against her. Even the holder of a "contingent" claim must have a "right to payment." 11 U.S.C. § 101(5)(A). Without any direct liability from SANDRA to FEDERAL that arose prepetition, notwithstanding its surety bond obligation to the BANK with right of assignment, FEDERAL did not hold a claim against SANDRA, not even a contingent one, and was not her prepetition creditor. Therefore, FEDERAL is incorrect in its assertion that it was a prepetition creditor entitled to be scheduled as such and to receive the official notice of the bankruptcy filing.
SANDRA'S liability to the BANK was fixed prepetition and was not subject to any contingency. The fact that FEDERAL'S potential ownership of that claim, via assignment from the BANK, was subject to the satisfaction of the conditions of the surety bond and the execution of the assignment, does not make FEDERAL the holder of a contingent claim as defined in Section 101(5)(A). There is only a single claim in play — SANDRA'S debt for the embezzled funds. There could be any number of potential assignees of the claim, but the only properly scheduled creditor is the one who owns the claim as of the petition date. In re Chandler Airpark Joint Venture I, 163 B.R. 566, 569 (Bankr.D.Ariz. 1992). FEDERAL'S acquisition of the BANK'S claim against SANDRA may have been subject to certain contingencies, but SANDRA'S liability for the debt was absolute and not "contingent." FEDERAL'S argument fails to appreciate this distinction.
The issue of FEDERAL'S status arises in an unusual context. FEDERAL'S attempts to shoehorn itself into this case as a prepetition creditor are made solely in an effort to avoid the consequences of its assignor's (the BANK'S) failure to file a timely proof of claim. That omission is properly addressed between FEDERAL and the BANK rather than by crafting an "equitable" solution in this bankruptcy case that will work an injustice, by diluting the distribution, upon those creditors who followed the rules and filed timely proofs of claim.
Second, even if FEDERAL could be characterized as a prepetition creditor who should have been scheduled and noticed but wasn't, it would not be entitled to the remedies it seeks. Confirmation of the plan and expiration of the 180 days thereafter precludes FEDERAL from having the discharge vacated for lack of eligibility, even if the DEBTORS acted fraudulently. See, Valenti, supra. Since that issue is now res judicata, FEDERAL'S request for dismissal of the case must also be denied, as it is premised on the same theory.
If FEDERAL was an omitted prepetition creditor, the obligation due it would survive the discharge since debts owed to omitted creditors are not "provided for" in the plan and are not discharged. In re Trembath, 205 B.R. 909 (Bankr.N.D.Ill. 1997); In re Gray, 174 B.R. 228 (Bankr.E.D.Ky. 1994). However, since the BANK was scheduled as a creditor and SANDRA'S liability for the theft was listed on Schedule F, the embezzlement debt was "provided for" and is subject to the discharge unless a basis for nondischargeability exists. The postpetition assignment of the claim from the BANK to FEDERAL does not alter that result.
Finally, FEDERAL'S motion that it be permitted to file an untimely proof of claim, and to have that claim allowed as if it had been timely filed, must also be denied based upon the Seventh Circuit's decision in Matter of Greenig, 152 F.3d 631 (7th Cir. 1998). If the BANK had filed a timely proof of claim for the debt created by SANDRA'S embezzlement, FEDERAL, as the BANK'S assignee, would have been entitled to receive the distributions that would have been paid on account of that claim. Unfortunately for FEDERAL, the BANK did not file a proof of claim for that debt. Neither FEDERAL nor the BANK may receive any distribution from the TRUSTEE on account of the embezzlement debt.
The BANK did file a timely proof of claim for three secured loans and two unsecured loans, but not for the embezzlement debt. Even if the amount of that debt was not yet determined, the BANK could have, and should have, filed a proof of claim for the stolen funds in an estimated amount or even showing the amount as "unknown." As long as the claim was timely filed, the amount could have been determined later, and the claim could have been transferred to FEDERAL as the BANK'S assignee.
In Chapter 13, debts for embezzlement are discharged where the debtor receives a full compliance discharge pursuant to Section 1328(a). Restitution ordered as part of a criminal sentence, however, is nondischargeable under Section 1328(a)(3).
Notwithstanding the denial of FEDERAL'S motions, it is clear to this Court that the manner in which the DEBTORS scheduled the embezzlement debt was improper. In their schedule of creditors holding unsecured nonpriority claims (Schedule F), the DEBTORS listed the liability to the BANK for "Wife's anticipated Restitution" as a "contingent claim," with the amount of the claim "Unknown." The claim is not scheduled as unliquidated or disputed. The DEBTORS otherwise scheduled $120,586.29 of unsecured nonpriority claims, and a $300 unsecured portion of an undersecured debt listed on their schedule of secured claims. Accordingly, the maximum allowable amount for the embezzlement debt for eligibility purposes was $169,638.70.
Both the description of the nature of the claim as one for "restitution" and its status as "contingent" were incorrect and misleading. Contrary to Schedule F, SANDRA'S liability to the BANK, in the amount of the funds embezzled, arose prepetition, at the time the embezzlement was committed. Scheduling it as a debt for "anticipated restitution" makes it seem as if the obligation itself would arise only at the time a restitution order was entered, if at all, and then only in the amount of restitution ordered. This is simply contrary to law and not true. See, Matter of Knight, 55 F.3d 231 (7th Cir. 1995) (liability for wrongful conduct arises when conduct occurs, not when a subsequent judgment or restitution order is entered).
Neither was the debt "contingent" upon entry of a restitution order or any other event. When all of the events giving rise to liability occurred prepetition, the debt is not "contingent." Knight, 55 F.3d at 236. This is a critical misrepresentation since debts that are truly contingent are not counted against the debt ceiling imposed for eligibility. 11 U.S.C. § 109(e).
Whether the TRUSTEE and creditors were misled by these inaccuracies is difficult to say. Perhaps if the TRUSTEE had been presented with a schedule that correctly listed the debt as a noncontingent one for embezzlement or theft that occurred prepetition, he may have investigated whether the amount of the debt exceeded $169,638.70. Based upon the record before the Court, it cannot be determined whether scheduling the amount of the debt as "unknown" was improper. It may be that SANDRA had no idea how much money she had stolen from the BANK. On the other hand, she may have kept records of the amount or she may have remembered how much she took. If so, she had an obligation to disclose or to make a good faith estimate of the amount on Schedule F. Given FEDERAL'S assertion that the amount embezzled exceeds $240,000, there is enough in the record to raise a valid suspicion that the incorrect scheduling of the debt was a deliberate attempt to evade an eligibility problem.
In any event, since the issue was not raised within 180 days after confirmation, it is time-barred. Even if SANDRA intentionally misrepresented the nature and/or amount of her embezzlement liability on Schedule F in order to manipulate eligibility, she now gets away with it because no one caught it in time.
B. EFFECT OF POST-CONFIRMATION RECEIPT OF LIFE INSURANCE PROCEEDS.
The third issue is whether the life insurance proceeds are required to be paid into the plan so as to increase the distribution to unsecured creditors to 100% of filed claims. This issue may be broken down into two sub-issues. First, whether the proposed modification is of the kind permitted by the Bankruptcy Code. Second, whether, and to what extent, SANDRA'S claim of exemption in the proceeds should matter.
1. Plan modification.
Modification of a confirmed Chapter 13 plan is governed by Section 1329 of the Bankruptcy Code, which provides as follows:
(a) At any time after confirmation of the plan but before the completion of payments under such plan, the plan may be modified, upon request of the debtor, the trustee, or the holder of an allowed unsecured claim, to —
(1) increase or reduce the amount of payments on claims of a particular class provided for by the plan;
(2) extend or reduce the time for such payments; or
(3) alter the amount of the distribution to a creditor whose claim is provided for by the plan to the extent necessary to take account of any payment of such claim other than under the plan.
(b)(1) Sections 1322(a), 1322(b), and 1323(c) of this title and the requirements of section 1325(a) of this title apply to any modification under subsection (a) of this section.
(2) The plan as modified becomes the plan unless, after notice and a hearing, such modification is disapproved.
(c) A plan modified under this section may not provide for payments over a period that expires after three years after the time that the first payment under the original confirmed plan was due, unless the court, for cause, approves a longer period, but the court may not approve a period that expires after five years after such time.
11 U.S.C. § 1329. In the Seventh Circuit, a trustee seeking to modify a confirmed plan in order to increase distribution to unsecured creditors does not have to make a threshold showing of a change in the debtor's circumstances. Matter of Witkowski, 16 F.3d 739, 748 (7th Cir. 1994). An increase in payments to a class of creditors is an express basis for modification. 11 U.S.C. § 1329(a)(1). The question is whether insurance proceeds received by a debtor on account of a post-bankruptcy (in this case, post-confirmation) event, are required to be used to pay the claims of the prepetition creditors. The answer is found in the way that "property of the estate" is defined and the purpose behind that bankruptcy term of art.
Section 541 of the Bankruptcy Code, generally defining "property of the estate" as all interests of the debtor in property as of the commencement of the case, also includes certain property acquired after bankruptcy, as follows:
(a) The commencement of a case under section 301, 302, or 303 of this title creates an estate. Such estate is comprised of all the following property, wherever located and by whomever held:
* * *
(5) Any interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date —
(A) by bequest, devise, or inheritance;
(B) as a result of a property settlement agreement with the debtor's spouse, or of an interlocutory or final divorce decree; or
(C) as a beneficiary of a life insurance policy or of a death benefit plan.
11 U.S.C. § 541(a)(5). This section is implemented by Fed.R.Bankr.Pro. 1007(h), which requires the filing of a supplemental schedule for such interests acquired postpetition. In Chapter 13 cases, Rule 1007(h) requires the debtor to file a supplemental schedule so long as the property is acquired prior to the debtor receiving a discharge.
One of the primary purposes of Section 541 is to define what a trustee can and cannot distribute to a bankruptcy estate's creditors. U.S. v. Sabbeth, 262 F.3d 207, 215 (2nd Cir. 2001). "Property of the estate" defines the pool of assets potentially available to pay the allowed claims of creditors. Property interests that, by definition, are excluded from the bankruptcy estate, are not subject to the claims of those creditors.
A special provision expands the definition of "property of the estate" in Chapter 13 cases. Section 1306(a) provides as follows:
(a) Property of the estate includes, in addition to the property specified in section 541 of this title —
(1) all property of the kind specified in such section that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first; and
(2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first.
11 U.S.C. § 1306(a). The definition of "property of the estate" in a Chapter 13 case is intentionally broader than in a Chapter 7 case. It includes all property acquired by the debtor during the pendency of the Chapter 13 proceeding to the same extent as if the property interest had arisen prepetition. In re Steenstra, 307 B.R. 732 (1st Cir.BAP 2004). Thus, life insurance proceeds that are property of a Chapter 7 estate only where the insured dies within 180 days after the beneficiary files bankruptcy, become property of the Chapter 13 estate even if the insured's death comes more than 180 days after the beneficiary's bankruptcy filing.
JOSEPH died more that 180 days after the petition was filed and SANDRA, as beneficiary, became entitled to the life insurance proceeds upon his death. Bank of Lyons v. Schultz, 22 Ill.App.3d 410, 415, 318 N.E.2d 52 (Ill.App. 1 Dist. 1974) (upon death of insured, named beneficiary obtains "vested and absolute right" to proceeds of life insurance policy). Therefore, the proceeds became part of SANDRA'S bankruptcy estate upon JOSEPH'S death.
All courts do not agree with the plain language application of Section 1306(a)(1). Some courts have perceived a conflict between Section 1306(a)(1) and Section 1327(b) which states that unless the plan or confirmation order provides otherwise, confirmation operates to vest "all of the property of the estate in the debtor." 11 U.S.C. § 1327(b). This Court perceives no such conflict and interprets Section 1327(b) as affecting only that property that is part of the estate at the time of confirmation and not property subsequently acquired by the estate.
In so holding, this Court agrees with the First Circuit in Barbosa v. Soloman, 235 F.3d 31 (1st Cir. 2000). Noting that courts have used four different analytical approaches to harmonize Sections 1306 and 1327, the First Circuit adopted the approach that holds that the effect of Section 1327 is to vest in the debtor, free of creditors' claims, the property that was part of the estate at the time of confirmation. The estate continues to exist postconfirmation and continues to be funded by the debtor's regular income and postpetition assets as specified in Section 1306(a). 235 F.3d at 36-37. After adopting this approach, the court explained its application as follows:
However, we note that this rule cannot be applied in an inflexible manner, for in spite of the "vesting" provided by section 1327 of the Code, until all payments due under the plan are made, both the trustee and the unsecured creditors have an interest in the preservation of the debtor's financial situation, and in the extension of the ability-to-pay standard to future situations under the plan. In this particular case, "receiving proceeds has also altered the debtors financial circumstances", which brings into play § 1329 of the Code. (Citation omitted).
235 F.3d at 37. The First Circuit affirmed the decision of the lower courts granting the trustee's motion to modify the plan to force the debtors to pay the equity from the proceeds of the postpetition sale of real estate into the plan, thereby increasing the distribution to unsecured creditors from 10% to 100%, notwithstanding that the real estate had vested in the debtors upon confirmation of the plan. The court found that the modification met the requirements of Section 1329, reasoning that "to allow the Debtors to keep the proceeds of the sale in such circumstances effectively defeats Congress' intention to extend the application of the "ability-to-pay" standard forward throughout the duration of the plan." 235 F.3d at 41.
The First Circuit recognized that a change in financial circumstances caused by a post-confirmation receipt of property by a Chapter 13 debtor is properly addressed as a modification issue under Section 1329. Interpreting Section 1327(b) in a manner that preempts the modification issue is contrary to the language of Sections 1306(a)(1) and 1327(b) and inconsistent with the policy underlying Section 1329 that allows for a modification of a confirmed plan based on an enhanced ability to pay.
The Seventh Circuit has issued two opinions that are consistent with Barbosa v. Soloman. In re Matter of Lybrook, 951 F.2d 136 (7th Cir. 1991), a Chapter 13 debtor became entitled to an inheritance more than 180 days after bankruptcy. The court determined that the bequest became property of the Chapter 13 estate by operation of Section 1306(a)(1). In Matter of Heath, 115 F.3d 521 (7th Cir. 1997), the court harmonized Section 1327(b) with Section 1306(a)(2), which makes a debtor's postpetition earnings property of the estate, as follows:
It is true that the Bankruptcy Code says that all the earnings of a Chapter 13 debtor are property of the estate. 11 U.S.C. § 1306(a)(2). But it also says that "confirmation of a plan vests all of the property of the estate in the debtor" unless the plan provides otherwise, § 1327(b) (emphasis added), which we think scotches any inference that Congress intended to render all Chapter 13 debtors legally incompetent to manage any of their property. We read the two sections, 1306(a)(2) and 1327(b), to mean simply that while the filing of the petition for bankruptcy places all the property of the debtor in the control of the bankruptcy court, the plan upon confirmation returns so much of that property to the debtor's control as is not necessary to the fulfillment of the plan.
This Court disagrees with In re Richardson, 283 B.R. 783 (Bankr.D.Kan. 2002). There, the Chapter 13 debtors received $400,000 in life insurance proceeds when their son died fourteen months after their case was filed and ten months after their plan was confirmed. Perceiving a conflict between Section 1306(a)(1) and Section 1327(b), the court stated that Section 1327(b) "negates the language of § 1306(a)(1) that would otherwise bring into the estate post-confirmation property acquired by the debtors before the closing, dismissal, or conversion of the case." 283 B.R. at 802. Based on this reasoning, the court held that the insurance proceeds were not property of the estate and were not available to satisfy the claims of prepetition creditors.
This Court also disagrees with In re Schlottman, 319 B.R. 23 (Bankr.M.D.Fla. 2004), suggesting that life insurance proceeds received by a Chapter 13 debtor-wife following the debtor-husband's death more than 180 days after commencement of the case did not become property of the wife's estate, reasoning that Section 541(a)(5), operating as a provision that excludes life insurance proceeds arising from an insured's death more than 180 days after filing, must also be applied as an exclusionary rule, to the same extent, under Section 1306(a)(1). That view is contrary to the plain language of Section 1306(a)(1), that property of the Chapter 13 estate includes, "in addition to the property specified in Section 541," all property "of the kind specified" in Section 541 that the debtor acquires at any time during the pendency of the Chapter 13 case. The cutoff point for property becoming part of the Chapter 13 estate is the time the case is closed, dismissed or converted, whichever occurs first.
This Court agrees with In re Guentert, 206 B.R. 958 (Bankr.W.D.Mo. 1997), where the debtor-husband died following confirmation of the plan. The debtor-wife moved for authorization to pay off the remaining balance due on the plan, paying 45% to unsecured creditors, from a portion of the proceeds she received as beneficiary under a life insurance policy, which she claimed as fully exempt. Reasoning that Section 1327(b) had no effect on property received post-confirmation, the court held that Section 1306(a)(1) operated to bring the life insurance proceeds into the bankruptcy estate. Mrs. Guentert claimed the proceeds as exempt, however, and the court scheduled further proceedings to make that determination.
This Court holds that by operation of Section 1306(a)(1), the life insurance proceeds became property of SANDRA'S bankruptcy estate at the time of JOSEPH'S death. As property of the estate, the proceeds are within the broad category of property that is available to pay prepetition claims. SANDRA has claimed the proceeds fully exempt, however, and it is to that issue that the Court now turns.
2. Exempt property is not liable for prepetition debts.
SANDRA argues that the life insurance proceeds are fully exempt and, as such, may not be ordered into her plan over her objection. On November 18, 2004, SANDRA filed an amended schedule of exempt property, asserting an exemption in the life insurance proceeds, alternatively, under two Illinois exemption statutes, 215 ILCS 5/238 or 735 ILCS 5/12-1001(f). As this Court recently held in In re Ashley, 317 B.R. 352 (Bankr.C.D.Ill. 2004), life insurance proceeds payable to a spousal beneficiary are fully exempt under 735 ILCS 5/12-1001(f) without regard to dependency or need.
Shortly before this Court issued its decision in Ashley, Bankruptcy Judge Lessen reached the same result in In re McKinney, 317 B.R. 344 (Bankr.C.D.Ill. 2004). That decision was affirmed on appeal by an unpublished decision, No. 043212 dated Jan. 4, 2005 (Scott, J.). Accord, In re Stilwell, ___ B.R. ___, 2005 WL 555319 (C.D.Ill. 2005) (McCuskey, J.).
The TRUSTEE argues that the exemption under this section protects life insurance proceeds only while still "payable." Once the proceeds are paid out and in the possession of the beneficiary, says the TRUSTEE, they are no longer exempt. This Court disagrees. In this Court's view, the term "payable" is not intended to draw a distinction between proceeds that are yet to be paid versus proceeds already paid. There is no indication in the legislative history that such a distinction was intended and this Court cannot fathom a rational policy that would be advanced by such a distinction.
There is a split of authority on the issue of whether a Chapter 13 debtor may be compelled to pay exempt property into a Chapter 13 plan. Most courts frame the issue as a conflict between the disposable income requirement of Section 1325(b)(1)(B) and the "not liable" status accorded exempt property under Section 522(c). With exceptions not relevant here, Section 522(c) provides as follows:
Unless the case is dismissed, property exempted under this section is not liable during or after the case for any debt of the debtor that arose, or that is determined under section 502 of this title as if such debt had arisen, before the commencement of the case.
11 U.S.C. § 522(c). Because this provision appears in Chapter 5 of the Bankruptcy Code, it applies to all bankruptcy cases, including those filed under Chapter 13. 11 U.S.C. § 103(a).
It has been characterized as the majority view that property exempt under Section 522(c) may nevertheless be treated as disposable income under Section 1325(b)(1)(B). In re Graham, 258 B.R. 286 (Bankr.M.D.Fla. 2001); In re Claude, 206 B.R. 374 (Bankr.W.D.Pa. 1997). The cases, however, are all over the lot, with regard to both factual dissimilarity and legal reasoning. In this Court's view, any attempt to reconcile the various holdings or to draw a consensus on any broad-brush rules would be futile. Accordingly, the Court will take more of a sui generis approach.
A post-confirmation change in a Chapter 13 debtor's financial circumstances is a valid basis for modification of a confirmed plan under Section 1329. A change for the better may justify an increase in payments into the plan while a change for the worse may merit a decrease. Because of JOSEPH'S death, SANDRA has experienced both a negative change resulting from the loss of JOSEPH'S income and a positive change from the receipt of substantial life insurance proceeds. She has properly claimed the proceeds as exempt and, in fact, they are fully exempt under applicable Illinois law, without regard to dependency or need. Nevertheless, SANDRA proposes to voluntarily use a portion of the proceeds to pay off, or prepay in full, her Chapter 13 plan obligation, which would result in less than a 100% distribution to unsecured creditors.
A Chapter 13 debtor may voluntarily use exempt property to fund a Chapter 13 plan. The main concern with such a proposal is to ensure that unsecured creditors receive at least as much as they would if SANDRA was compelled to pay into the plan all of her disposable income and non-exempt assets, taking into account her changed circumstances.
There are only two ways that property acquired by a debtor post-confirmation can be forced into a Chapter 13 plan: either as property of the estate under Section 1306(a)(1) or as disposable income under Section 1325(b)(1)(B). The property of the estate avenue is a dead end where exempt property is concerned. The plain language of Section 522(c) renders exempt property "not liable" for the payment of prepetition debts. The term "liable," not defined in the Bankruptcy Code, means "legally obligated." THE AMERICAN HERITAGE DICTIONARY OF THE ENGLISH LANGUAGE (4th Ed. 2000). In this Court's view, holding that a Chapter 13 debtor who acquires fully exempt property after the plan is confirmed can be compelled to pay all or a portion of that property into the plan on the basis that it is property of the estate would be in direct contradiction of Section 522(c). Property of the estate that is properly exempted passes out of the estate and prepetition creditors have no claim to it. This principle applies equally to property acquired postpetition as well as to property acquired prepetition.
As indicated earlier, a number of courts have concluded that exempt property can be forced into a Chapter 13 plan as disposable income. Several courts have avoided the proscription of Section 522(c) by reasoning that Section 1325(b)(1)B) makes no exception for exempt income. In re Tolliver, 257 B.R. 98 (Bankr.M.D.Fla. 2000); In re Lush, 213 B.R. 152 (Bankr.C.D.Ill. 1997). This Court accepts as correct that regular income that is otherwise exempt must nevertheless be factored into the disposable income calculation in Chapter 13. In re Koch, 109 F.3d 1285 (8th Cir. 1997); In re Sohn, 300 B.R. 332 (Bankr.D.Minn. 2003). It follows that a confirmed plan of a debtor who begins to receive, post-confirmation, regular income that is exempt could be modified under Section 1329 to increase the plan payments to account for the improvement in circumstances.
But, in this Court's view, a distinction must be drawn between exempt property payable in periodic installments and exempt property that is received as a lump sum, such as a one-time distribution of insurance proceeds to a beneficiary to compensate for an insured loss. This Court agrees with the rule adopted in In re Baker, 194 B.R. 881 (Bankr.S.D.Cal. 1996), that only if the exempt asset is an anticipated stream of payments may it be treated as "income" for purposes of the disposable income calculation. A onetime, lump-sum payment is not income for that purpose.
A one-time payment is not necessarily irrelevant, however, simply because it cannot be characterized as income. As the court in Baker concluded, any interest or earnings generated from the deposit or investment of the exempt funds is properly includable as income for purposes of the disposable income calculation. In addition, the receipt of substantial funds, even though exempt, may improve the debtor's financial circumstances such that non-exempt income is "freed up" and no longer required to pay reasonable and necessary expenses. That determination must be made on a case by case basis.
These principles are applicable to the case at bar as follows. The insurance proceeds, as property received via a lump-sum distribution, properly claimed as exempt and fully exempt under applicable law, come into the estate via Section 1306(a)(1) and pass out of the estate because they are "not liable" for prepetition debts under Section 522(c). Because the proceeds were paid as a lump-sum rather than periodically, they are not "income" for purposes of the disposable income calculation. Thus, SANDRA cannot be compelled to devote the proceeds to the plan and the TRUSTEE'S motion to modify must be denied.
By her motion, SANDRA offers to voluntarily contribute a portion of the exempt proceeds to pay off the balance due under her confirmed plan. A debtor is certainly free to use exempt funds for this purpose even though she could not be compelled to do so. The issue is whether unsecured creditors are faring at least as well as they would if the debtor were paying into the plan all that she could be compelled to pay. A comparison of these amounts is called for.
As indicated earlier, JOSEPH'S death has had both positive and negative effects upon the budget. According to the amended schedules filed by SANDRA, the loss of JOSEPH'S net monthly income of $5,125 has been replaced with $854 that SANDRA now earns, plus a social security payment of $1,410 for the benefit of her son, which is scheduled to terminate in May, 2005. The amended schedule of income also shows an amount of $2,537 as other monthly income from life insurance proceeds. It appears to the Court that this amount does not represent the investment earnings on the principal amount of the proceeds but is, instead, an arbitrary amount chosen by SANDRA to make the revised disposable income amount equal to the plan payment of $1,640.
Amended Schedule J reflects a reduction in expenses of $324 per month. The net disposable income remains unchanged at $1,640 per month. An additional fact that is not reflected in the amended schedules is that SANDRA is scheduled to begin a 27-month prison sentence in June, 2005. The only remaining source of household income at that point will be the earnings from the life insurance proceeds. At an estimated annual rate of return of 4.0% on a principal amount of $226,321.23, the monthly earnings equal $754.40.
It is clear that without invading the exempt principal portion of the insurance proceeds, SANDRA can no longer afford to pay the monthly plan payments of $1,640. Accordingly, unsecured creditors will receive more if she is permitted to pay into the plan a portion of the exempt life insurance proceeds than if her motion was denied and she paid into the plan all of her disposable income for the remaining term of the plan. Under these circumstances, her motion will be granted.
Finally, with regard to the TRUSTEE'S request that his attorney fees be paid as an administrative expense, an application to pay the fees along with copies of the time records has yet to be filed and shall be filed with twenty-one days from the date of entry of this Opinion. The TRUSTEE should defer making a final distribution until an order regarding the fees is entered. This Opinion constitutes this Court's findings of fact and conclusions of law in accordance with Federal Rule of Bankruptcy Procedure 7052. A separate Order will be entered.
ORDER
For the reasons stated in an Opinion filed this day, IT IS HEREBY ORDERED as follows:
1. The Motion to Dismiss or Convert filed by Federal Insurance Company is DENIED.
2. The Motion for Leave to File a late claim by Federal Insurance Company is DENIED.
3. The Trustee's Objection to Amended Exemption is DENIED.
4. The Motion to Modify Plan, filed by the Chapter 13 Trustee, Michael D. Clark, is DENIED.
5. The Motion to Use Life Insurance Proceeds to Pay Off Debtor's Chapter 13 Plan, filed by Sandra C. Pitts, is ALLOWED.
6. The Debtor, Sandra C. Pitts, shall immediately pay to the Chapter 13 Trustee, Michael D. Clark, the sum necessary to pay off the plan.
7. The Chapter 13 Trustee, Michael D. Clark, shall file within twenty-one days his application for payment of attorney fees as an administrative expense.