Opinion
Case No. 94-13771-SSM
December 4, 2000
Tina M. McMillan, Esquire, McMillan Lang, P.C., Fairfax, VA, of Counsel for the debtors
MEMORANDUM OPINION
An evidentiary hearing was held in open court on November 14, 2000, on (a) the chapter 13 trustee's amended motion to dismiss and (b) the debtors' motion for entry of a discharge. The debtors were present in person and were represented by counsel. The chapter 13 trustee was present in person. The court took the motions under advisement to determine (a) whether the debtors are entitled to a "hardship" discharge under § 1328(b), Bankruptcy Code; or (b) whether dismissal is proper based on the debtors' failure to pay tax refunds to the chapter 13 trustee, as required under the order confirming their plan. For the reasons stated, the court concludes that the requirements for a hardship discharge have not been satisfied, but that, before the case is dismissed, the debtors should be afforded an opportunity to receive a discharge by converting their case to chapter 7.
Facts
The debtors, who are husband and wife, filed their petition for relief under Chapter 13 of the Bankruptcy Code in this court on October 3, 1994. Their amended plan filed on November 3, 1995, was confirmed on December 20, 1995. That plan required the debtors to pay to the chapter 13 trustee, commencing on November 25, 1994, the sum of $885.50 for nine months, $1,400.00 for three months, and finally $1,371.20 for 48 months, for a total 60-month plan term and a projected dividend on unsecured claims of 20 cents on the dollar. Additionally, the order confirming the plan required the debtors to turn over to the chapter 13 trustee all federal and state income tax refunds in excess of $250.00. To date, the debtors have paid $77,646.32 into the plan, with the most recent payment being made on March 10, 2000. On July 17, 2000, the chapter 13 trustee filed his amended motion to dismiss, based on the debtors' failure to turn over $14,779.00 in tax refunds from 1995 through 1999. The debtors responded on September 5, 2000, by filing their motion for entry of a discharge.
At the hearing on November 14, 2000, Mr. Khou testified that he, his wife, his eight children, and his mother-in-law recently moved to Utah where he works as a television closed captioner. He further testified that he is the sole source of income — approximately $6,000.00 per month — for his family, who reside in Utah with him. Mr. Khou admitted that he had received substantial tax refunds that he did not turn over to the trustee. He testified, however, that his income fluctuated, and that on a number of occasions his monthly income was insufficient to satisfy both the mortgage and the plan payments, with the result that he and his spouse had to use the tax refunds to make those payments. No evidence was presented showing the actual amounts of the income fluctuations, or what amount of income was earned in each plan year, nor was any evidence presented showing the debtors' current monthly expenses.
In response, the chapter 13 trustee, Gerald M. O'Donnell, argued that unsecured creditors in this case are still due money under debtors' plan, and that the shortfall roughly equates to the value of debtors' tax refunds accumulated during the life of the plan. In support of this argument the chapter 13 trustee submitted to the court a report of receipts and distributions under the plan showing a balance of $14,898.95 owed to unsecured creditors as of November 13, 2000.
The trustee's calculations are based on an assumed 85% dividend on unsecured claims. It is not clear how the trustee calculated that percentage. The court notes, however, that the debtors' amended plan is a "pot plan," see Matter of Witkowski, 16 F.3d 739, 741 (7th Cir. 1994), which only requires a debtor to pay a fixed amount or "pot" of money into the estate, and which hinges the percentage payment that creditors ultimately receive based on the total amount of claims that are allowed. Id. Thus, while debtors' amended plan required them to pay at least $77,987.10 over the 60-month term, and while it estimated a 20% dividend to unsecured creditors, the specific percentage individual creditors would receive has never been set in stone.
Conclusions of Law and Discussion I.
There is no dispute that the debtors have made $77,646.32 of the $77,987.10 in monthly payments required by their plan. There is also no dispute that they did not pay the trustee, over and above those periodic payments, any portion of the approximately $14,000.00 in Federal or state income tax refunds they received in the nearly five years their plan has been in effect. Although there is no apparent reason why they could not promptly make up the $340.78 shortfall in periodic payments, they represent that they are unable at this time to come up with the income tax refunds. The term of the plan cannot be extended any further. See §§ 1325, 1329, Bankruptcy Code. Thus, the court is now faced with two conflicting choices: (a) to dismiss this case based on the debtors' failure to pay the tax refunds to the chapter 13 trustee; or (b) to relieve the debtors from the failure to make those payments by granting them a hardship discharge. The court will address these issues in reverse order.
This has resulted in a payment of $5,618.21 (25%) on the $22,151.60 in allowed general unsecured claims. Secured and priority claims have been paid in full.
A.
Under § 1328(b), Bankruptcy Code, a debtor who has not completed payments under a chapter 13 plan may nevertheless be granted a discharge if the following conditions are met:
(1) the debtor's failure to complete such payments is due to circumstances for which the debtor should not justly be held accountable;
(2) the value, as of the effective date of the plan, of property actually distributed under the plan on account of each allowed unsecured claim is not less than the amount that would have been paid on such claim if the estate of the debtor had been liquidated under chapter 7 of this title on such date; and
(3) modification of the plan under section 1329 of this title is not practicable.
(emphasis added). In the present case, the debtors' schedules reflect that unsecured creditors would likely have received nothing in the event of a chapter 7 liquidation. Their home was encumbered by deeds of trust exceeding its market value, and their personal property — which in any event was relatively modest in value — was entirely claimed exempt. Additionally, modification of the plan under § 1329, Bankruptcy Code, is not a viable option at this time, since the maximum 60-month plan term has now run. The issue, therefore, is whether the failure to complete the plan is due to circumstances for which the debtors should not justly be held accountable.
In this connection, a majority of courts hold that "the granting of a hardship discharge is reserved for the most extreme and unusual of circumstances that prevent a debtor from completing payments under the plan, and not simply for economic reasons." In re Awua, 1997 WL 1524800, *7 (Bankr. E.D. Va. 1997) (citing In re Nelson, 135 B.R. 304, 307-08 (Bankr. N.D. Ill. 1991) (requiring catastrophic, not economic reasons for a hardship discharge); In re Graham, 63 B.R. 95, 96 (Bankr. E.D. Pa. 1986) (death of the debtor considered grounds for granting of hardship discharge); In re Bond, 36 B.R. 49, 51-52 (Bankr. E.D.N.C. 1984) (death of the debtor)); but see In re Edwards, 207 B.R. 728 (Bankr. N.D. Fla. 1997) (allowing hardship discharge on less than catastrophic grounds); and Bandilli v. Boyajian (In re Banditti), 231 B.R. 836, 840 (B.A.P. 1st Cir. 1999) (noting that there is no express requirement in 11 U.S.C. § 1328(b) that a debtor prove the existence of catastrophic circumstances in order to obtain a hardship discharge).
In this case, it seems clear that the debtors' condition does not rise to the threshold required for a hardship discharge. The fact that their income fluctuated, and that in lean months they needed to use the income tax refunds to make their mortgage and chapter 13 plan payments, clearly constitutes the type of economic circumstance that a majority of courts have held to be insufficient for the granting of a hardship discharge. See e.g. In re Nelson, 135 B.R. 304, 307-08 (Bankr. N.D. Ill. 1991). This is especially true given that the Code itself provides a mechanism whereby a confirmed plan may be modified based on changes in the debtor's ability to pay. See § 1329, Bankruptcy Code. Furthermore, while a small minority of courts do allow for a hardship discharge on less than catastrophic grounds, see e.g. In re Edwards, 207 B.R. at 728, such courts do so only when the economic circumstances in question are beyond the debtor's control, and where the debtor has made every effort to overcome such circumstances. Id. at 731. Here, the testimony of Mr. Khou provides no indication as to why his income fluctuated or why the debtors did not seek to modify their confirmed plan. The debtors have the burden of proof on the issue of whether the failure to complete payments is due to factors for which they should not justly be held accountable. In re Harrison, 1999 WL 33114273, *1 (Bankr. E.D. Va 1999), citing Bandilli v. Boyajian (In re Bandilli), 231 B.R. at 839. Because the debtors have not carried that burden, the court concludes that the request for a hardship discharge under § 1328(b), Bankruptcy Code, must be denied.
B.
The issue then is whether to dismiss this case based on the debtors' failure to pay their tax refunds to the chapter 13 trustee. Dismissal of a chapter 13 case is governed by Section 1307, Bankruptcy Code, which provides in relevant part as follows:
(c) Except as provided in subsection (e) of this section, on request of a party in interest or the United States trustee and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 7 of this title, or may dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, for cause, including —
* * *
(6) material default by the debtor with respect to a term of a confirmed plan; [and]
* * *
(8) termination of a confirmed plan by reason of the occurrence of a condition specified in the plan other than completion of payments under the plan[.]
Here, the chapter 13 trustee, citing § 1307(c)(8), argues that dismissal is justified based on the failure to pay the tax refunds into the plan. It is true that the plan itself does not require such payments, and that the requirement arises from the order of confirmation. However, a confirmation order, and the chapter 13 plan which it confirms, should be read together as a whole when determining whether a plan has been violated. See 8 Collier on Bankruptcy ¶ 1327.02[1], at 1327-3 (Lawrence P. King, ed., 15th ed. rev. 1997) ("Upon becoming final, the order confirming a chapter 13 plan represents a binding determination of the rights and liabilities of the parties as ordained by the plan."); see also In re Anderson, 179 F.3d 1253 (10th Cir. 1999); In re Ivory, 70 F.3d 73 (9th Cir. 1995); and In re Szostek, 886 F.2d 1405 (3rd Cir. 1989). The confirmation order in this case makes it clear that the debtors were to turn over to the chapter 13 trustee all federal and state income tax refunds in excess of $250.00 received during the life of the plan. It is undisputed that the debtors did not do so, and the amount in question — approximately $14,000 — is quite significant. Accordingly, the court can only conclude that there has been a material default.
The trustee's citation appears to be a typographical error, since the failure to turn over the income tax refunds is not "a [terminating] condition specified in the plan." It would, however, constitute a plan "default" and thus provide a basis for dismissal under § 1307(c)(6) unless the court were to determine that it was not "material."
This being said, the question then becomes whether dismissal or conversion under § 1307, Bankruptcy Code, is the best approach in this case. While the chapter 13 trustee's amended motion simply requests that the debtors' case be dismissed, the court concludes that the debtors — who aside from the payment of the tax refunds have largely complied with the plan and have made more than $77,000.00 in payments — should be afforded an opportunity to convert their case to one under chapter 7 of the Bankruptcy Code, and receive a discharge of the remaining portion of their unsecured debts under that chapter, at the price, admittedly, of having to surrender any nonexempt property to the chapter 7 trustee. But that is a decision for the debtors to make.
II.
A separate order will be entered (a) denying the motion for a hardship discharge and (b) conditionally granting the motion to dismiss unless, within ten days of the entry of the order, the debtors file a notice of conversion to chapter 7.