Opinion
Case No. 13-12810
2019-08-23
IN RE Jeffrey SCHOLL, Alison Scholl, Debtors
Paul J. Minnillo, Andrew L. Ruben, Minnillo & Jenkins Co. LPA, Cincinnati, OH, for Debtor.
Paul J. Minnillo, Andrew L. Ruben, Minnillo & Jenkins Co. LPA, Cincinnati, OH, for Debtor.
MEMORANDUM OPINION AND ORDER CONCERNING DISPOSITION OF INSURANCE PROCEEDS
Jeffrey P. Hopkins, United States Bankruptcy Judge
After fire destroyed one of Jeffrey Scholl and Alison Scholl's (the "Debtors") income producing rental properties they sought permission from the Court to keep the insurance proceeds in order to purchase or rebuild another unit on the vacant lot. This matter is before the Court on the Debtors' Motion for Order Concerning Distribution of Insurance Proceeds (the "Motion for Distribution"). (Doc. 173). Also before the Court is the Chapter 13 Trustee's Objection to Motion for an Order Concerning Distribution of Insurance Proceeds (the "Objection") and request that "[the] proceeds not paid to lienholder[s] or for demolition ... be paid into the plan and disbursed to other creditors at a higher percentage." (Doc. 174). Two hearings were held on these matters. At the behest of the Court the parties filed supplemental briefs but also continued settlement negotiations. (Docs. 185, 188). During the second hearing, the parties became joint proponents of a settlement proposal that would effect a modification of the plan under § 1329. The proposed modification attempts to resolve the Motion for Distribution and the Trustee's Objection by requiring the Debtors to use some of the insurance proceeds to increase the repayment to unsecured creditors, but keep most of the funds purportedly for their maintenance and support under § 1325(b).
The Court will treat the Trustee's request for an increase in payments to unsecured creditors stated in the Objection as an implicit motion to modify. See Solomon v. Barbosa (In re Barbosa) , 235 F.3d 31, 34 (1st Cir. 2000) (recognizing an "implicit" motion to modify a plan by a party in interest in a case where the debtor sought to shorten the term of the plan by making a lump sum payment after the sale of property of the estate which had appreciated substantially in value). Because the Debtors in this case have also joined the Trustee in proposing a modification by way of a settlement agreement, the Court will likewise treat the Debtors' concession as a motion to modify. See § 1329(a). The Trustee would be well advised in future cases to seek payment increases on unsecured claims by filing motions under §§ 1329(a) and (b).
I. Introduction
On June 12, 2013, the Debtors, who are married, filed a joint case seeking a discharge from their debts under Chapter 13 of the Bankruptcy Code. (Doc. 1). Both Debtors work and receive regular income from their jobs and jointly owned rental properties. On the petition date the Debtors had above median income (Doc. 1); thus, they were required to file a plan with a term of no less than five years or 60 months. 11 U.S.C. § 1325(b)(4) ; Baud v. Carroll , 634 F.3d 327, 335 (6th Cir. 2011) (" Section 1325(b)(4) provides that, unless the plan provides for full payment of allowed unsecured claims over a shorter time frame, the applicable commitment period is ... not less than five years for above-median-income debtors.")
On May 2, 2018, during the 59th month of the 60 month plan, one of the Debtors' rental properties located at 942 Wells Street in Cincinnati (the "Property" or "Rental Property"), suffered a total loss as the result of fire. Thereafter, Erie Insurance agreed to pay the Debtors $180,000 on a claim as the coverage limit for the loss of the Property, plus an additional $14,000 for its demolition, for a total of $194,000 (the "Insurance Proceeds"). See Doc. 173.
Ironically, on March 12, 2017, approximately one year before fire destroyed the Rental Property located at 942 Wells Street, the Debtors only other rental property, on Seton Avenue, was severely damaged by fire. See Doc. 140. Unlike the Rental Property, the Seton Avenue unit was not completely destroyed. However, the Debtors did receive a check for $55,146.81 from their insurer, which they were permitted to retain for repairs to Seton Avenue. (Doc. 145). Coincidently, the cost of repairs for Seton Avenue came back at exactly $55,146.81, based on the invoices filed with the Court and the Debtors' two cancelled checks made out to Brock Restoration, Inc, the company which apparently completed all the repairs to the Seton Avenue property. (Doc. 216).
In the Motion for Distribution, the Debtors requested that this Court issue an order requiring the following:
1) The Insurance Company, Erie Insurance, shall issue payment for the Insurance Proceeds, ... to [the Debtors], without inclusion of the mortgagees on such payment;
2) The Debtors shall be entitled to retain the Insurance Proceeds for demolition of the Property and re-building on the subject real estate or purchase of a substitute rental property.
Id.
Initially, the Debtors sought to keep all $194,000 of the Insurance Proceeds for the stated purpose of demolition, purchasing a substitute property or rebuilding a new rental unit on the vacant lot where the Rental Property had been located, while paying nothing to unsecured creditors. The Motion for Distribution drew an immediate Objection from the Chapter 13 Trustee, Margaret A. Burks (the "Trustee") and a request for a modification of the plan to increase the payment to unsecured creditors. (Doc. 174). The Trustee stated in the Objection, that "[a]s insofar [sic] as Debtors are Above Median any insurance proceeds not paid to lienholder or for demolition should be paid into the plan and disbursed to other creditors at a higher percentage." Id. (emphasis added).
However, during the second hearing on the Motion for Distribution of the Insurance Proceeds, the Trustee mollified her position. She now contends that the Debtors should be allowed to replace the Rental Property with "substitute collateral" that "returns roughly equivalent rental of $1,100 to $1,500 in gross income per month." (Doc. 188). Also, according to the Trustee, she is "amenable to substituting lost collateral, but with a reasonable equivalent. She is not taking the position that all of the insurance should inure to the benefit of the unsecured creditors, but beyond what a fair replacement of debtors' collateral would cost, any excess of insurance should be used to increase the unsecured creditors' dividend." (Doc. 188) (emphasis added). According to the Debtors' Schedules they were receiving income of $1,035 exclusively from the Rental Property when it was fully occupied. (Doc. 25). However, Unit 2 of the Rental Property had been vacant since at least September, 2016, which reduced the monthly income generated by the Property to $385. (Doc. 130).
Under the modification being proposed jointly by the parties, the Debtors would obtain a "full compliance" or "super discharge" under § 1328(a), walk away with approximately $80,000 cash-in-hand for the stated purpose of rebuilding or purchasing a "substitute" rental unit, all while "stripping down" the mortgages on the Rental Property to a value of $16,500 under § 506(a), and paying unsecured creditors holding allowed claims, according to one of the Trustee's projections, roughly 32 cents on the dollar. (Doc. 217, Ex. 4). This is hardly the stuff which makes for the bankruptcy laws affording a "fresh start" to the honest but unfortunate debtor, rather than providing them with a "fine finish." See In re Jones , 138 B.R. 536, 539 (Bankr. S.D. Ohio 1991) ("The purpose of the Bankruptcy Code is to provide a fresh start, not a fine finish.") Considering the bedrock bankruptcy principles at play–"good faith," "ability to pay," and "best interest of creditors"–the Court determined that approval of the modification or settlement agreement that was proposed at the second hearing would be improvident. The Court took the matter under advisement for a more thorough review of the law in light of the rather unique facts present in the case. (Doc. 208).
The percentage may actually be higher as this figure accounts for $10,000 in hypothetical attorney fees for the Debtors' counsel. Any award of attorneys fees is speculative at this juncture as no application for compensation has been filed pursuant to the requirements of LBR 2016. The Court has an obligation to examine the allowance of fees "based on a consideration of the benefit and necessity of such services to the debtor and the other factors set forth in [11 U.S.C. § 330 ]." Excluding attorneys fees and other administrative expenses, the dividend potentially paid to unsecured creditors appears to vary widely, depending on the source for the information. The attorneys for the Debtors and the Trustee calculate vastly different and in some cases inconsistent dividends on the amount of the payment unsecured claims are projected to receive in connection with the proposed settlement agreement or modification. See infra fn. 21.
When facing a similar set of facts as the one presently before this Court, the First Circuit, paraphrasing the learned Bankruptcy Judge Feeney, had this to say:
Finally, as the bankruptcy judge said, it is antithetical to the bankruptcy system to allow a debtor to "strip down" a mortgage, underpay the unsecured creditors, and obtain a super discharge under section 1328(a) of the Code, while selling the property mortgaged for a price of two times its estimated value for the purposes of the "strip down", and keeping to himself the excess of the proceeds. In re Barbosa , 236 B.R. 540, 552 (Bankr. D. Mass. 1999). In fact, 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. [Oversight Hearings on Personal Bankruptcy Before the Subcommittee on Monopolies and Commercial Law of the Committee on the Judiciary, House of Representatives , 97th Cong., 1st and 2nd Sess. 22-23 (1981-1982).]
In re Barbosa , 235 F.3d at 41.
II. Jurisdiction
This is a core proceeding over which this Court has jurisdiction to hear, decide, and enter a final order, pursuant to 28 U.S.C. §§ 157(b)(2) and 1334(b). The following constitutes the Court's findings of facts and conclusions of law pursuant to Fed. R. Bankr. P. 7052, applicable to a contested matter under Fed. R. Bankr. P. 9014.
III. Summary of Relevant Facts
None of the facts in this case are disputed. As noted, the Court held two hearings and the facts contained in this memorandum opinion have been extracted from the Trustee's website and deduced from documents, briefs, and oral arguments presented by attorneys for the Trustee and the Debtors. There is no dispute that the Debtors entered into an insurance contract with the Erie Insurance Company for coverage on the Rental Property before they filed bankruptcy. Nor can there be any serious dispute that the Erie Insurance policy that the Debtors owned prepetition is property of the estate, even though they failed to list it on their bankruptcy Schedules. See Stinett v. Laplante (In re Stinett ), 465 F.3d 309, 312 (7th Cir. 2006) ("As a general matter, insurance contracts in which the debtor has an interest at the time the petition is filed constitute property of the estate for purposes of § 541(a).").
The Debtors' Bankruptcy Schedules, "Sch. B, Line 9- Personal Property," which asks them to list: "Interests in insurance policies. Name of insurance company of each policy and itemize surrender or refund value of each," was left blank. See Doc. 25.
As noted, during the last month of the plan, but before the final payment had been made, the Debtors' Rental Property was completely destroyed by fire. Prior to the fire, the Property had been subject to two mortgages, both of which were crammed down and bifurcated into secured and unsecured claims. Ocwen Loan Servicing ("Ocwen") held a first mortgage on the Property which had an approximate balance of $18,754 on the petition date. (Doc. 35). Chase Home Mortgage ("Chase") held a second mortgage on the Property in the amount of $6,765 on the petition date. Id. The Debtors valued the property at $15,000 based on an independent appraisal. (Doc. 21). Because the Property value was less than the amount owed to the first mortgage holder, Ocwen, the Debtors filed a motion to "strip-off" the second mortgage under the Sixth Circuit's Lane decision and have it declared wholly unsecured. (Doc. 35). Subsequently, the Debtors entered into an Agreed Order valuing Chase's secured claim at $1,500 and treating the remaining balance as a general unsecured debt. (Doc. 60). Accordingly, the confirmed plan lists Ocwen's secured claim at $15,000 and Chase's secured claim at $1,500, effectively cramming the Rental Property's value down to $16,500. (Doc. 51). After fire had destroyed the Rental Property, and during the last month of the plan, the Debtors filed the present Motion for Distribution seeking essentially to be able to retain the Insurance Proceeds. (Doc. 173). By that time, the allowed secured claims for both Ocwen and Chase had also been completely paid-off; thus, the Rental Property was debt-free with no liens, mortgages, or encumbrances against it when the fire occurred.
See Lane v. W. Interstate Bancorp (In re Lane ), 280 F.3d 663 (6th Cir. 2002).
See § 1325(a)(5)(B) (the mortgagee's claims were fixed in amount and status at confirmation and must be paid in full once they have been allowed); In re Hill , 96 B.R. 809, 814–15 (Bankr. S.D. Ohio 1989) ("Satisfaction of [creditor's] allowed secured claim during the term of the Plan in accordance with § 1325(a)(5)(B) ... will allow for discharge of [creditor's] allowed secured claim.").
Neither Ocwen or Chase filed an objection to the Motion for Distribution of the Insurance Proceeds, nor did their attorneys make an appearance at either of the two hearings held. This is significant because both Ocwen and Chase would stand to benefit from an increase in the dividend paid to unsecured creditors given that their bifurcated claims now fall within that class. See In re Christopherson , 446 B.R. 831, 834 (Bankr. N.D. Ohio 2011) ("Under the Bankruptcy Code, § 506(a) permits a Debtor to bifurcate a secured claim. Essentially, the claim is secured only for the extent of the value of the collateral. The amount of the lien that exceeds such value is deemed unsecured.").
IV. CONCLUSIONS OF LAW
A. Post-Confirmation Property of the Estate
The first issue raised by the Motion concerns whether the Insurance Proceeds, which did not exist until well after the plan had been confirmed, became property of the estate. To be certain, the Debtors and the Trustee both concede that the Insurance Proceeds are property of the estate. (Docs. 185 and 188). Nevertheless, a brief recitation of the law here is instructional and critical to the holding in this case. Sections 541(a)(1) and (6) provide in pertinent part that property of the estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case," plus "[p ]roceeds ... or profits of or from property of the estate " and "[a]ny interest in property that the estate acquires after the commencement of the case." (emphasis added).
All of the appellate courts which have considered the question have concluded that insurance policies in which a debtor has an interest on the petition date constitute property of the estate for purposes of § 541(a)(1). In re Stinnett , 465 F.3d at 313 ; ACandS, Inc. v. Travelers Cas. and Sur. Co. , 435 F.3d 252, 260 (3d Cir. 2006) ; Home Ins. Co. v. Cooper & Cooper, Ltd. , 889 F.2d 746, 748 (7th Cir. 1989) ("A policy of insurance is an asset of the [bankruptcy] estate...."); see also Am. Bankers Ins. Co. v. Maness , 101 F.3d 358, 362 (4th Cir. 1996) ("[D]ebtors' insurance policies clearly constitute ‘interests’ under § 541(a) of the Bankruptcy Code."); A.H. Robins Co. v. Piccinin , 788 F.2d 994, 1001 (4th Cir. 1986) ; Ford Motor Credit Co. v. Stevens (In re Stevens) , 130 F.3d 1027, 1029 (11th Cir. 1997) ; Houston v. Edgeworth (In re Edgeworth ), 993 F.2d 51, 55 (5th Cir. 1993) ("courts are generally in agreement that an insurance policy will be considered property of the estate").
Further, as the Fourth, Fifth, Seventh, and Eleventh Circuits have held "[p]roceeds of [an] insurance polic[y], if made payable to the debtor rather than a third party such as a creditor, are property of the estate and may inure to all bankruptcy creditors." In re Edgeworth , 993 F.2d at 56 ; see also Am. Bankers Ins. Co. , 101 F.3d at 364 ; In re Stevens , 130 F.3d at 1029 ; In re Stinnett , 465 F.3d at 313. Finally, because the Debtors filed for bankruptcy relief under Chapter 13, § 1306(a)(1) applies, providing that, "in addition to the property specified in section 541," property of the estate also includes, "all property of the kind specified in [ § 541 ] 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."
Despite conceding that the Insurance Proceeds are property of the bankruptcy estate, the Debtors argue that the insurance policy was maintained solely for the their benefit. According to the Debtors, "[t]hey paid for the insurance premiums exactly for the purpose of protecting their interest in the property should a casualty loss occur." See Doc. 185. Aside from being legally incorrect, as a practical matter, the Debtors' argument also fails for policy reasons. The Debtors' argument completely ignores the fact that they were only able to make payments to the insurer at the expense of their unsecured creditors. The Debtors' Schedule J, filed June 9, 2016, shows a monthly expense of $142 for Rental Property Insurance. (Doc. 117). But for payment of these insurance premiums, unsecured creditors would have received an additional $8,520 over the life of the plan. Thus, from both a legal and policy perspective, it is reasonable to expect that unsecured creditors should benefit from the Insurance Proceeds since they have received substantially reduced plan payments over the past 59 months.
Under the circumstances, the Debtors held an interest in the Erie Insurance policy on the petition date. By operation of law, the Insurance Proceeds from the Erie Insurance policy became property of the estate under §§ 541(a)(6) and 1306. The Insurance Proceeds can therefore only be used by the Debtors with Court approval. See 11 U.S.C. § 363(b) ; 11 U.S.C. § 1303.
While the Sixth Circuit has not yet had an opportunity to address the "perceived [ ] contradiction" between §§ 1306 and 1327, this Court follows the majority approach which has been adopted by courts in this Circuit. See Boddie v. PNC Bank , NA , No. 2:12-CV-158, 2013 WL 443773 (S.D. Ohio Feb. 5, 2013) ; U.S. v. Harchar , 371 B.R. 254 (N.D.Ohio 2007). This approach "holds that all property or earnings acquired after confirmation remains with the estate." Harchar , 371 B.R. at 265.
B. Debtors' Use of Property of the Estate
Section 1303 expressly provides that a debtor in a Chapter 13 case has, "exclusive of the trustee, the rights and powers of a trustee under 11 U.S.C. §§ 363(b), 363(d), 363(e), 363(f), and 363(l )." In this instance, § 363(b)(1) gives the Debtors the right "after notice and hearing, [to] use ... other than in the ordinary course of business, property of the estate." A debtor's rights to use property of the estate, however, must be tempered against the more forceful provisions of the Bankruptcy Code that instruct on the manner in which a debtor who seeks to obtain a discharge of debts under Chapter 13 must conduct himself or herself, including §§ 1322, 1325(b)(1)(B), 1326, 1327 and, quite relevant here, § 1329. As several courts have suggested these provisions "are difficult to reconcile," and may even be "impossible to reconcile." In re Rangel , 233 B.R. 191, 193 (Bankr. D. Mass. 1999) ; In re Barbosa , 236 B.R. 540, 546 (Bankr. D. Mass. 1999). However, reconcile these inconsistent Bankruptcy Code sections we must.
C. Timeliness of Request for Modification
Before delving into the discussion on whether the parties' proposed settlement agreement, vis a vis the modification, meets the requirements under § 1329, the Court must first address whether the Trustee's request for an increase in the distribution paid to unsecured creditors, through her Objection, was filed timely. (Doc. 174). While it is true that a plan cannot be modified after the "completion of payments," Meza v. Truman (In re Meza ), 467 F.3d 874, 878 (5th Cir. 2006), a motion to modify filed in the final month of a Chapter 13 plan is subject to the same rules as one filed in the very first month. See 11 U.S.C. § 1329(a) ; Germeraad v. Powers , 826 F.3d 962, 969 (7th Cir. 2016) (a motion to modify is timely filed so long as the request was made after the plan was confirmed but before the plan payments have been completed); see also In re Scarver , 555 B.R. 822, 827 (Bankr. M.D. Ala. 2016).
Here, upon discovering the Insurance Proceeds, the Trustee rightfully sought an increase in the payments to unsecured creditors under the plan, albeit by filing an Objection on July 17, 2018 (Doc. 174) to the Motion for Distribution filed on June 27, 2018 (Doc. 173). See Fed. R. Bankr. P 3015(f). As noted, courts have long recognized the ability of a party in interest to seek a modification even when the request must be "implied" from a pleading filed in a bankruptcy case. Barbosa , 235 F.3d 31, 34 (1st Cir. 2000) ; see also fn.1. Initially, the Debtors argued that the Trustee could not seek modification of the plan to increase the percentage to unsecured creditors under § 1329 because they had already made the last payment that became due under the plan. (Doc. 185). The Debtors do not provide further briefing or argument on the issue. Nevertheless, the Court finds that the Trustee's request is timely under the terms of the confirmed plan. See In re Haddad , 572 B.R. 661 (Bankr. E.D. Mich. 2017) (allowing modification where debtor had completed her plan payments and the Trustee had filed her Notice of Final Payment, but the time for objection on the Notice had not yet run).
As noted in the June 2019 Update to Chapter 13 Practice & Procedure, a modification based on a debtor's liquidation of property or postconfirmation acquisition of assets is typically presented to the Court in two ways. "A debtor herself may either propose a modification or file a motion that the trustee or a creditor contends should be considered as a modification , and the trustee or creditor objects to the modification . Alternatively, the trustee or a creditor may propose a modified plan and the debtor objects. Both scenarios require determination of whether the proposed modification complies with Code § 1329 and whether, in the court's discretion, it should be approved. " Hon. W. Homer Drake, Jr., Hon. Paul W. Bonapfel & Adam M. Goodman, Chapter 13 Practice and Procedure § 11:13 (2019 ed.)(emphasis added).
The Trustee filed the Objection requesting an increase in payments to unsecured creditors on July 17, 2018, well before any Notice of Final Payment has been made. See Doc. 174. Indeed, the Trustee has yet to file her Notice of Final Payment in this case. Thus, the time for objection to the Notice has yet to run. Under the guidance provided by Haddad and Barbosa , the Trustee's request for a modification that would require the Insurance Proceeds to be applied towards increasing the payments on unsecured claims must be honored as having been brought timely.
Aside from the support found in Haddad and Barbosa , other factors exist which militate against the Court siding with the Debtors' contention that the modification sought here by the Trustee was untimely. In the case at bar, the Debtors have moved for, and have been granted, three modifications throughout the life of the plan–each time lowering the payments to unsecured creditors. (Docs. 72, 124, 169). The Debtors' most recent motion to modify, filed on April 21, 2018, reduced the percentage paid on unsecured claims from 10% to 3%. (Doc. 167). Importantly, the Court notes that the Order granting the Debtors' modification was entered on May 24, 2018, only weeks after the May 2, 2018 fire at the Rental Property, and just a month prior to the present Motion for Distribution being filed on June 27, 2018. (Doc. 169).
Against this backdrop, the evidence demonstrates that Debtors filed a claim with Erie Insurance immediately upon learning of the May 2, fire at the Rental Property. While the Debtors contend that they made the last payment "on or around July 1, 2018," in an apparent attempt to foreclose the Trustee's ability to seek a modification under § 1329, it is evident that the Debtors knew of the existence of the Insurance Proceeds well before July 1. See Doc. 185. In a letter from Erie Insurance, dated June 5, 2018, the Debtors were not only informed of the existence of the Insurance Proceeds and that a check in the amount of $135,652.88 would soon be arriving at their doorstep, the letter also indicated that a check for an undisclosed amount was enclosed. (Doc. 185, Ex. 1). Rather than bringing this information to the immediate attention of the Trustee and the Court, or perhaps more importantly, turning those funds over to the Trustee as required by the confirmed plan, the Debtors waited for more than three weeks, until June 27, 2018, before filing the present Motion for Distribution seeking to retain the Insurance Proceeds. (Doc. 173). Indeed, during the three week interim, the Debtors failed to amend the motion to modify or to otherwise apprise the Trustee or the Court of the insurance claim with Erie Insurance, even though both their insurance claim and motion to modify the plan from 10% to 3% were still pending. See In re Wimpee , 343 B.R. 845, 849 (Bankr. W.D. Ky. 2006) ("The Court does not look kindly or with favor on debtors who, in an effort to thwart the modification process, attempt to pay off a plan prior to the Trustee discovering information that should have been fully disclosed."); see also Waldron v. Brown (In re Waldron ), 536 F.3d 1239, 1245 (11th Cir. 2008) ("The disclosure of postconfirmation assets gives the trustee and creditors a meaningful right to request, under section 1329, a modification of the debtor's plan to pay his creditors.... If post confirmation assets were not subject to disclosure, modifications for increased payments would be rare because few debtors would voluntarily disclose new assets, and the trustee and creditors would be unlikely to obtain this information from sources other than the debtor.") (emphasis added).
The Debtors' Reply to Trustee's Response to Debtors' Motion for Reconsideration, filed on May 3, 2019, reveals for the first time that the Debtors received a check in the amount of $18,126.28 as a first installment on the Insurance Proceeds in the letter dated, June 5, 2018, from Erie Insurance. This revelation came nearly one year after the June 5 letter and check had been sent to the Debtors. (Doc. 221).
The sequencing of events and failure by the Debtors to more promptly disclose important information reasonably within their control raises serious concerns regarding the Debtors' bona fides : (1) The motion to modify the plan reducing the percentage paid to unsecured creditors from 10% to 3% was filed on April 21, 2018 (Doc. 167); (2) Fire destroyed the Rental Property on May 2, 2018, while that motion was still pending; (3) Immediately after May 2, the Debtors filed a claim with Erie Insurance on the loss related to the Rental Property; (4) Fewer than three weeks later, on May 24, 2018, the Order approving the motion to modify reducing the percentage from 10% to 3% was entered while the Debtors' claim with Erie Insurance was still pending (Doc. 169); (5) Then, less than two weeks later, on June 5, 2018, the Debtors received a letter from Erie Insurance, informing them that the insurance claim would be paid and that a check for partial payment in an undisclosed amount had been included (Doc. 185, Ex. 1); (6) The Debtors then waited for more than three weeks, until June 27, 2018, before filing the Motion for Distribution, even though they began spending those funds for household and living expenses, on June 7, 2018, only two days after the letter and first check from Erie Insurance had arrived (Doc. 224); (7), The Debtors only disclosed receipt of the June 5, 2018 check for $18,126.28 from Erie Insurance, following inquiries by the Court nearly a year later, on May 3, 2019. See Docs. 183, 220, 221, 222 and 224. Given these revelations, the Debtors' assertion that they tendered the final payment "on or around July 1, 2018," seems specious at best. See In re Wimpee , 343 B.R. at 849 ("The Debtors were aware of additional funds available to satisfy more fully their creditors, yet chose to use stealth, possible deception or inappropriate lack of care in an attempt to circumvent these obligations.... The Court balances a debtor's desire for a fresh start against the obligations owed to Trustees and unsecured creditors and the duties and responsibilities owed to the Court.").
This Court will not, in the face of the Debtors' conduct, expropriate from the Trustee a meaningful opportunity to exercise the right to request, under § 1329, a modification of the Debtors' plan to pay their creditors more. The Debtors became aware of the Insurance Proceeds well in time to inform the Trustee and Court, but chose instead a pathway intended to obfuscate the facts in an apparent attempt to manipulate the situation to their own advantage. Had the Court been informed of the insurance claim pending with Erie Insurance, that information would certainly have been considered when deciding to reduce the plan percentage to just 3%. At the very least, the Court would have delayed its ruling on the Debtors' April 21 motion to modify, pending the outcome of the determination by Erie Insurance whether to pay the insurance claim resulting from the May 2 fire. The potential for a substantial payout intersected with the filing of the motion on April 21, the fire on May 2 at the Rental Property, and the Court's decision on May 24 to reduce the dividend from 10 to 3% in ways that clearly signaled to the Debtors that their financial condition was about to substantially improve, yet they told no one. As the court in Wimpee aptly stated, "[h]ad the Debtors' true financial picture been presented, the terms of the [modified] plan would have been different." Id.
Based on the totality of the circumstances, the Court finds that the modification sought by the Trustee under § 1329(a) was timely and that the Debtors contentions to the contrary are completely without merit. See Doc. 185. The evidence supports the finding that the Trustee timely sought a modification when making the request for an increase in payments to unsecured creditors in her Objection because the Trustee has yet to file her Notice of Final Payment, and the time for objection to the Notice has not run. See §§ 1329(a) and (b) and the Debtors' confirmed plan. To hold otherwise would result in these Debtors, and perhaps others, coming before this Court in search of a Chapter 13 "super discharge", and being handed a license to game the system and forgo an important responsibility to adhere to the terms of the confirmed plan, in contravention of § 1327(a) ("The provisions of a confirmed plan bind the debtor"). It would also allow these Debtors, and others, to ignore another important obligation, which when stated holds that Chapter 13 debtors must always deal forthrightly and with transparency with creditors, trustees, and courts, during confirmation or, in this context, modification of a plan in exchange for enjoying the protections of the Bankruptcy Code. See Wimpee , 343 B.R. at 849 ("It is based on this understanding of not only the binding language of the Confirmed Plan but also the purpose and spirit of the Bankruptcy Code that this Court finds that the Debtors have non fulfilled all their obligations under their Confirmed Plan.")
Paragraph 16 of the confirmed Plan provides in relevant part, "Debtor shall keep the Trustee informed as to any change in status of any claims for personal injury, workers compensation, social security or any other claim to which Debtor may be entitled .... Debtor's case will not be complete until the claim has been settled and shall remain open for administration purposes until the claims have been paid into the Plan or the Court orders otherwise ." (Doc. 51) (emphasis added). Paragraph 20 further provides, "All insurance proceeds must be turned over to the Trustee unless Debtor files a motion to retain proceeds." Id. (emphasis added).
As the Trustee correctly notes, "the Cincinnati form [Chapter 13 plan in effect at the time] defaults to having the insurance come to the Trustee for administration. The Debtors would then have to move with a justification to use proceeds for replacement of collateral." (Doc. 188). When the Trustee's Objection was filed July 17, 2018, the Insurance Proceeds had not been turned over to the Trustee as required under the terms of the plan. (Doc. 174).
D. Post-Confirmation Modification
Having concluded that the Insurance Proceeds are property of the estate, and that the Trustee's request that these funds be used to increase the payments to unsecured creditors was filed timely, the Court next turns to the issue of whether the parties' jointly proposed modification meets the requirements under § 1329. Under the terms of the modification, the Debtors would retain $80,000 to replace the Rental Property, after payment of demolition costs and income taxes , with only $70,429.16 going to the Trustee for distribution to unsecured creditors.
The present proposal would allow the Debtors to retain $101,350 of the Insurance Proceeds. This includes $3,237 for additional demolition costs and $18,112 for payment of capital gains tax with the remaining $80,000 being retained for the so called replacement or substitute rental property. See Doc. 217, Ex. 4.
The Debtors and the Trustee have provided widely different and inconsistent projections regarding the amount of the dividend that might be paid to unsecured creditors if the proposed modification is approved. At the second hearing held in the matter sub judice , the Trustee's attorney stated orally that "depending on [Debtors' counsel]'s fee", the proposed modification would increase the percentage to somewhere between 53-56%. [HEARING AT 3:03]. Alternatively, the Debtors' counsel indicated that the dividend to be paid to unsecured creditors would be approximately 28%. [HEARING AT 3:05 ]. Subsequently, the Trustee filed a Response to the Debtors' Motion to Reconsider (Doc. 201), which attached an exhibit which indicates that, after including hypothetical attorneys fees of between $10,000-$15,000, the dividend paid on allowed unsecured claims is projected of between 29.5 and 31.9%. (Doc. 217, Ex. 4). Under either of these scenarios, the modification would result in only a modest increase in the dividend paid to unsecured creditors, which is an improvement over the 3% dividend that the Debtors have been paying under the plan, or the approximate 23.5% dividend, which the Debtors had offered originally as a compromise to the Trustee's Objection.
At the second hearing on the Motion for Distribution of the Insurance Proceeds and Objection, the parties initially proposed a modification providing for $56,429.16 of the Insurance Proceeds to be paid on unsecured claims, resulting in a dividend of 23.5%. Hearing at 3:07, (Doc. 206, Ex. 4). However, this initial proffer failed to account for the $14,000 of Insurance Proceeds issued for the demolition. The parties then amended their proposed settlement to include the $14,000 in the amount to be paid to the Trustee for a total of $70,429.16, and represented orally that after including the additional funds the dividend to unsecured creditors would be increased to 28%, subject to Debtors' counsel's final fee application and the Court's approval of the same. Hearing at 3:06. Using the figures provided by the Trustee in this example, it would appear that the proposed modification in a hypothetical Chapter 7 case would actually result in 35% dividend payment to unsecured creditors, rather than those expressed during oral argument. See also Doc. 217, Ex. 4.
1. Section 1329(a)
When examining the Trustee's motion to modify under § 1329(a), the Court looks to the operative language of the statute which provides in relevant portion:
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....
(Emphasis added).
Courts in the Sixth Circuit, however, have long "reiterated the necessity of only permitting modifications that strictly fall within the parameters of § 1329, due in part to the binding effect of confirmation under § 1327." Storey v. Pees (In re Storey) , 392 B.R. 266, 271 (6th Cir. BAP 2008). While it is axiomatic that a modification under § 1329(a) cannot be used to circumvent a confirmed plan, a change in a debtor's financial condition post-confirmation, for better or for worse, is precisely what Congress contemplated when promulgating the provisions of § 1329(a).
The rule is also well established in our Circuit that § 1329(a) does not require an unanticipated or substantial change as a prerequisite to modification. Ledford v. Brown (In re Brown ), 219 B.R. 191, 194 (6th Cir. BAP 1998) ; In re Fields , 269 B.R. 177, 180 (Bankr. S.D. Ohio 2001). All that is required is that there be a change in the debtor's financial condition post-confirmation. Id. ; Germeraad , 826 F.3d at 974 ("[T]he courts have long recognized that a trustee or unsecured creditor may seek modification when the debtors financial circumstances change after confirmation and result in the debtor's having the ability to pay more."); see also In re Barbosa , 235 F.3d at 40-41 ; Arnold v. Weast (In re Arnold ), 869 F.2d 240, 241–42 (4th Cir. 1989) (requiring debtors to repay creditors to the extent that they are able is supported by the legislative history of the 1984 amendments to Chapter 13).
We conclude that a post-confirmation fire that results in a total loss of the Debtors' Rental Property, which has appreciated in value and leads to a substantial payment from an insurer, constitutes the sort of financial change that justifies a request for an increase in the payments unsecured creditors should receive. See §§ 541(a), 1306(a) and 1329. Based on the facts present in the case, it cannot be said that the Trustee has in any manner attempted to circumvent the binding effect of § 1327. The fire and subsequent demolition of the Rental Property were completely unforeseen, as was the substantial appreciation in value of the Property before it was destroyed. Those events gave rise to a dramatic change in the Debtors' financial condition post-confirmation, and that change became subject to the provisions of § 1329.
The attorneys for the Debtors make much of the fact that the post-confirmation fire that destroyed the Rental Property resulted from an involuntary act or occurrence and that this somehow differentiates the case sub judice from Barbosa where increased value of the property of the estate was realized from a voluntary sale. We think that the involuntary versus voluntary nature of the events which gave rise to the Debtors' improved financial condition, post confirmation, amounts to a distinction without a difference. Post-confirmation changes in both cases caused the debtors to become better-off financially. Post-confirmation changes in both cases also provided the debtors with an ability to pay more to their creditors, while enjoying the protections of the Bankruptcy Code. When viewed in this light, we do not find the Debtors' argument persuasive and conclude that it is without merit.
2. Section 1329(b)
In addition to the requirement that modification be for one of the statutory purposes listed in § 1329(a), § 1329(b)(1) further provides that " 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 section (a) of this section." Of particular importance in this matter are the requirements under §§ 1325(a)(3) and (a)(4), which mandate that a plan be proposed in good faith and that unsecured creditors receive at least what they would in a Chapter 7 liquidation, respectively.
The majority of courts, including those in our Circuit, have consistently held that § 1329(b) does not incorporate the "ability to pay" test, also referred to as the "projected disposable income test," of § 1325(b). See In re Hill , 386 B.R. 670, 676 (Bankr. S.D. Ohio 2008) (Humphrey, J.). However, "it is appropriate for the Court to consider the standards of § 1325(b) in determining whether a debtor's proposed plan comports with § 1325(a)(3)'s good faith requirement." In re Stein , 91 B.R. 796, 800 (Bankr. S.D. Ohio 1988). See also In re Fulton , 211 B.R. 247, 255 (Bankr. S.D. Ohio 1997) ("[I]t is equally clear and also appropriate for the court to consider the principles of § 1325(b) in determining whether a debtor's proposed plan conforms to the good faith requirements of § 1325(a)(3)."); also see In re Savage , 426 B.R. 320, 324 n. 3 (Bankr. D. Minn. 2010).
Thus, any modification under § 1329 must satisfy the mandatory requirements of plan confirmation under § 1325(a), along with other provisions of the Bankruptcy Code not implicated in the present case. Whether a modification will be approved is subject to the sound exercise of discretion by the bankruptcy judge, In re Barbosa , 235 F.3d at 39. It comes as no surprise that "all proposed modifications need not be approved and in practice not all modifications are approved." See In re Witkowski , 16 F.3d 739, 745-46 (7th Cir. 1994).
After careful consideration, we conclude that §§ 1322(a), 1322(b), and 1323(c), though applicable, are not implicated in the matter currently before the Court. See § 1322(a) and (b) (modification must satisfy the mandatory and permissive provisions for a Chapter 13 plan under the Bankruptcy Code), § 1323(c) (if a secured creditor has accepted a plan, it is deemed to have accepted a modified plan unless the modified plan changes the treatment of the secured creditor's claim), and § 1325(a)(1) (plan must comply with the provisions of Bankruptcy Code), § 1325(a)(2) (all fees and charges must be paid), § 1325(a)(5) (providing three options for the treatment of allowed secured claims), § 1325(a)(6) (the plan must be feasible and the debtor must have the ability to make all payments under the plan) and § 1325(a)(7) (the debtor's filing of the petition must be in good faith).
3. Debtors' Position
Among other items, the Debtors argue that requiring them to use the Insurance Proceeds to pay unsecured creditors would "jeopardiz[e] their fresh start." (Doc. 185). They also contend that requiring them to pay the Insurance Proceeds to the Trustee would "create an inequitable windfall in the direction of the unsecured creditors." Id. Finally, the Debtors assert that modification is precluded because they have "completed all payments under the plan," an argument which the Court has already disposed of in section IV.C., above.
The Court will briefly address the Debtors' other arguments. First, the Debtors' contention that a "fresh start" confers upon a Chapter 13 debtor the right to repay unsecured creditors at less than 100%, despite an ability to pay more, is at best misguided and, at worst, less than sincere. As the Fourth Circuit has noted, "[C]ongress ... intended that the debtor repay his creditors to the extent of his capability during the Chapter 13 period. Certainly, Congress did not intend for debtors who experience substantially improved financial conditions after confirmation to avoid paying more to their creditors." In re Arnold , 869 F.2d at 242 ; see also Germeraad , 826 F.3d at 975 ; In re Barbosa , 235 F.3d at 40–41.
The Sixth Circuit, moreover, adds to this concept by concluding that, "the fresh start is afforded through discharge of all or a portion of [ ] debts." In re Krohn , 886 F.2d 123, 125 (6th Cir. 1989) (emphasis added); see also Cent. Virginia Cmty. Coll. v. Katz , 546 U.S. 356, 363–64, 126 S.Ct. 990, 163 L.Ed.2d 945, (2006) ("[A] [c]ritical feature[ ] of every bankruptcy proceeding [is] ... the ultimate discharge that gives the debtor a ‘fresh start’ by releasing him, her, or it from further liability for old debts."). The "fresh start" does not, as the Debtors imply, include a right to repay unsecured creditors at less than 100%, despite having means to pay more, and receive a discharge of those debts. See Ed Schory & Sons, Inc. v. Francis (In re Francis ), 273 B.R. 87, 95 (6th Cir. BAP 2002), aff'd , 69 F. App'x 766 (6th Cir. 2003) ("The policy of allowing a fresh start does not license debtors to lightly rid themselves of the burden of their indebtedness without an honest attempt at repayment.") (quoting Mason v. Young (In re Young ), 237 F.3d 1168, 1178 (10th Cir. 2001) ).
While the "fresh start" provided by the discharge is the ultimate goal, the Bankruptcy Code also provides other advantages to debtors filing under Chapter 13. Even in cases where debtors are required to repay unsecured creditors at a 100% dividend, they still receive substantial benefits under the Bankruptcy Code. For example, Chapter 13 debtors enjoy protection from creditors via the automatic stay of § 362, they may modify the rights of secured creditors under § 1325(a)(5)(B), and they may generally avoid having to pay interest accrued on unsecured claims. See 11 U.S.C. § 502(b) ; Kuhns v. Pennsylvania Higher Educ. Assistance Agency , 33 B.R. 759, 762 (Bankr. S.D. Ohio 1983) ("As a general rule, claims for post petition interest accrued on unsecured debts are not allowable pursuant to 11 U.S.C. § 502(b)(2).").
Chapter 13 debtors also gain another important advantage as one bankruptcy court astutely articulates:
Chapter 13 is advantageous to debtors because they retain all their assets, including non-exempt assets, and make payments to creditors over a period of time during which debtors enjoy the protection afforded by bankruptcy law. This benefit to debtors is carefully balanced by the best interest of creditors' test of § 1325(a)(4). Under this statutory quid pro quo the debtor keeps his or her assets and creditors are assured of receiving what they would be paid in a Chapter 7 liquidation.
In re Keenan , 364 B.R. 786, 802, (Bankr. D.N.M. 2007), aff'd , 431 B.R. 308 (10th Cir. BAP 2009).
4. Effect of Proposed Compromise on the Plan Modification
As noted, the Trustee and Debtors have negotiated a compromise on the Motion for Distribution and the Objection and have presented the agreement to the Court for approval as the final modification, preceding the final act of the Debtors obtaining a "full compliance" discharge under § 1328(a). (Doc 206, Ex. 4). Under the modification propounded by these parties only a portion of the Insurance Proceeds, $70,429.16, less than half, would be used to increase payments to unsecured creditors, at around a 32% dividend, according to one view expressed by the Trustee. See Doc. 217, Ex. 4. Meanwhile, the Debtors would exit from bankruptcy retaining approximately $80,000, a figure that represents $10,000 more than their unsecured creditors would receive, to use at their discretion for purchasing or rebuilding another rental property, as they say, or with no court supervision, to, perhaps nefariously, go on a Hawaiian family vacation or purchase some other luxury item. As noted, the Trustee and the Debtors have both become proponents of this modification, despite the fact that full compliance with the plan confirmed would have required the Insurance Proceeds to be immediately turned over to the Trustee when they were first received. See supra fn. 13.
When the trustee is the proponent for modification of a plan under § 1329(b), "the trustee will have the burden of proof usually assigned to the debtor at a confirmation hearing." In re Moore , 602 B.R. 40, 50 (Bankr. E.D. Tenn. Apr. 25, 2019) (citing Keith M. Lundin & William H. Brown, CHAPTER 13 BANKRUPTCY, 4th Ed., § 253.1 at Para. 28, Sec. Rev. June 15, 2004, www.Ch13online.com) ("The trustee will have the burden normally assigned to the debtor, including the ultimate burden of persuasion with respect to each of the § 1325(a) elements."). And, as the Seventh Circuit noted in Germanaad , "[t]he debtor's good faith is not at issue when the modification is proposed by the trustee or an unsecured creditor." Germeraad , 826 F. 3d at 975. Here, however, since the Debtors and the Trustee both support the modification under the proposed compromise, the Debtors' good faith also has been placed squarely at issue. Id. Accordingly, the Court must also examine whether the Debtors satisfy the good faith requirement under § 1325(a)(3), even though the Trustee, not they, initiated the discussion about modifying the plan to increase payments to unsecured creditors under § 1329(a).
The Court also notes that the Debtors' Motion for Distribution must also satisfy the good faith standard imposed under § 363(b). See In re Wilde Horse Enterprises, Inc. , 136 B.R. 830, 841 (Bankr. C.D. Cal.1991) ("the debtor must also show that the [use of estate assets] is proposed in good faith.").
5. Good Faith
In summarizing the good faith analysis, the Sixth Circuit explains:
Good faith is an amorphous notion, largely defined by factual inquiry. In a good faith analysis, the infinite variety of factors facing any particular debtor must be weighed carefully. We cannot here promulgate any precise formulae or measurements to be deployed in a mechanical good faith equation. The bankruptcy court must ultimately determine whether the debtor's plan, given his or her individual circumstances, satisfies the purposes undergirding Chapter 13: a sincerely-intended repayment of pre-petition debt consistent with the debtor's available resources. The decision should be left simply to the bankruptcy court's common sense and judgment.
Metro Employees Credit Union v. Okoreeh-Baah (In re Okoreeh-Baah ), 836 F.2d 1030, 1033 (6th Cir. 1988). The Sixth Circuit's Okoreeh-Baah decision follows a long line of cases which adhere to the "totality of the circumstances test," which requires an analysis of both the subjective good faith and the objective good faith of debtors." In re McDonald , 437 B.R. 278, 286 (Bankr. S.D. Ohio 2010).
In a recent decision within our Circuit, Judge Rucker sets forth with clarity the task facing a bankruptcy court when called upon to apply the totality of circumstances test in the context of a motion to modify a plan filed by the trustee. In that case, the debtor received a lump sum payment post-confirmation from an unexpected inheritance which became property of the estate. The court in In re Moore stated the rule as follows:
With respect to the "good faith" requirement, the Sixth Circuit "does not focus on one item, but instead ‘requires consideration of the totality of the circumstances.’ " In re Martin , No. 10-64790, 2013 WL 6196566, at *3 (Bankr. N.D. Ohio Nov. 27, 2013) (quoting Soc'y Nat'l Bank v. Barrett (In re Barrett) , 964 F.2d 588, 591 (6th Cir. 1992) ). To evaluate good faith, a court should consider such factors as "the debtor's income, the debtor's living expenses, special circumstances (such as unusually high medical expenses), the amount of plan payment as indicative of the debtor's sincerity, and ‘the statutorily-mandated policy that bankruptcy provisions be construed liberally in favor of the debtor.’ " In re Martin , 2013 WL 6196566, at *3 (quoting In re Brinkley , 505 B.R. 207, 215 (Bankr. E.D. Mich. 2013) ).
An increase in the Debtors' assets available to creditors is part of the Court's consideration of a modification. "[T]he debtor's actual income and expenses at the time of the proposed modification are used to determine whether the payments should be adjusted." In re Crim , 445 B.R. at 871 (quoting In re Prieto , 2010 WL 3959610 (Bank. M.D. Fla., Sept. 22, 2010) ). The trustee's modification to require an increase in payments after allowing the Debtors to take their exemptions would support what the Sixth Circuit has describes as the hallmark of a good faith plan—"a sincerely intended repayment of prepetition debt consistent with the debtor's resources." Metro Emps. Credit Union v. Okoreeh-Baah (In re Okoreeh-Baah) , 836 F.2d 1030, 1033 (6th Cir. 1988).
In re Moore , 602 B.R. at 51.
In considering whether a proposed modification comports with § 1325(a)(3) good faith requirement, it is appropriate for the Court to consider the standards of § 1325(b), In re Stein , 91 B.R. at 800, despite the fact that § 1329(b) does not specifically incorporate the "ability to pay"/"projected disposable income test" of § 1325(b). See In re Hill , 386 B.R. at 676. Judge Colton has described the relevancy of the ability to pay standard in the context of a modification, thus:
Congress intended chapter 13 plans to be modifiable based on a debtor's increased or decreased "ability to pay" during the life of the plan. This "ability to pay" standard authorizes chapter 13 plan modifications regardless or whether the new found ability to pay constitutes "disposable income" within the meaning of section 1325 . An inheritance, a personal injury claim, even lottery winnings–all can be the basis of an upward modification of a confirmed chapter 13 plan.
In re Roscoe , No. 8:13-BK-06517-RCT, 2017 WL 2839496, at *2 (Bankr. M.D. Fla. June 28, 2017) (emphasis added). Accordingly, " § 1329's focus [is] on a debtor's actual, post-confirmation income and expenses." In re Prieto , No. 308BK3308PMG, 2010 WL 3959610, at *3 (Bankr. M.D. Fla. Sept. 22, 2010), see also In re Wetzel , 381 B.R. 247, 252 (Bankr. E. D. Wis. 2008) ("Although the disposable income test does not explicitly apply, courts have recognized that the ‘debtor's changed income and expenses are factored into the bankruptcy court's good judgment and discretion.’ ") (quoting In re Sounakhene , 249 B.R. 801 (Bankr. S.D. Cal. 2000) ). By incorporating the "ability to pay" analysis under § 1325(b) to a modified plan, "the Court's good faith inquiry should include a review of a debtor's proposed monthly budget." In re Stein , 91 B.R. at 801.
According to the Debtors, they have relied, and will continue to rely, on the rents generated from the Rental Property for their maintenance and support. On their most recent Schedules I and J, they disclose monthly income of $8,393, after payroll deductions, including income from the Rental Property of $385, and monthly expenses of $5,303. (Doc. 130). In comparison to the total amount of both Debtors' salaried income, the $385 generated from the Rental Property seems inconsequential. Even if the Rental Property were fully occupied and generating the maximum potential rent, which at the time of confirmation was $1,035, the Court is unpersuaded that it is necessary for the Debtors' maintenance and support in light of their substantial salaried income. Also, one cannot take for granted that the Debtors' other rental unit at 1011 Seton Avenue is now, or soon to be, back up and operating. Thus, there is a strong potential for Debtors to generate even more income, likely adding to their financial bottom line.
In the time since the Court has taken the matter under advisement, the Debtors have indicated that they received, and used without Court authorization, $10,616.53 of the Insurance Proceeds. Of those funds, $3,783.73 was used for vehicle repairs, $2,230.61 for property taxes, and $4,592.19 for mortgage payments. (Doc. 224).
In the Report to Court Regarding Restated Schedules I and J filed September 30, 2016, well before the loss occurred, the Debtors indicate that Unit 2 of 942 Wells Street (the Rental Property) is "not currently rented as it requires extensive repair work which Debtors cannot afford to make at this time." (Doc. 130).
Coupled with the fact that the Debtors would be retaining an $80,000 windfall from the excess Insurance Proceeds while unsecured creditors would receive only 32 cents on the dollar, the Court believes that the modification as proposed by the parties in the settlement agreement perverts the good faith test under § 1325(a)(3), rather than demonstrating fidelity to it. As Judge Feeney aptly stated in the trial court decision in Barbosa , "[t]he discharge of debts is a privilege, not a right. Overriding all other concerns is the issue of good faith . In view of [C]ongress's intent in enacting chapter 13 to encourage debtors to repay their debts to the best of their ability, it would be anomalous for this Court to determine that the Debtors can retain the excess proceeds from the [insurance policy covering] the Property without satisfying their claims." In re Barbosa , 236 B.R. at 556 (emphasis added).
Finally, the Court cannot ignore the facts surrounding the Debtors' lack of candor when they first came into the knowledge that they potentially were going to receive a substantial payout on the insurance claim after fire destroyed the Rental Property. As noted, prior to the current Motion for Distribution being filed, the Debtors had sought a modification, on April 21, 2018, to reduce the dividend paid to creditors from 10% to 3% (Doc. 167), when only two weeks later, on May 2, 2018, the fire occurred. Even though the Debtors' motion to modify and the claim with Erie Insurance were both pending, the Debtors remained silent – keeping their creditors, the Trustee, and the Court completely in the dark about their potential for a substantial insurance payout. The Debtors' silence can only be viewed as an effort to thwart the modification process and as an attempt to pay-off the plan prior to the Trustee or the Court discovering information that the Debtors had an affirmative duty to disclose. See Docs. 72, 124, 169.
In this Circuit, as in most, courts have consistently held that "good faith and candor are necessary prerequisites to obtaining a fresh start." In re Zick , 931 F.2d 1124, 1129–30 (6th Cir. 1991) ; see also In re Krohn , 886 F.2d at 127 ("There is no constitutional right to a bankruptcy discharge, and the ‘fresh start’ provided for by the Code is a creature of congressional policy."). To meet requirements of candor and good faith, in this context, the Sixth Circuit has recognized that debtors have an "ongoing duty to disclose assets during bankruptcy." Kimberlin v. Dollar Gen. Corp. , 520 F. App'x 312, 315 (6th Cir. 2013) (holding that a Debtor, who was fired 41 days before last payment was due, had to disclose the cause of action based on "the importance of the bankruptcy debtor's affirmative and ongoing duty to disclose assets, including unliquidated claims."); see also In re Haddad , 572 B.R. 661. The disclosure must be made to creditors and the court. In re Waldron , 536 F.3d at 1245 ("The bankruptcy court is entitled to learn about a substantial asset that the court had not considered when it confirmed the debtors' plan."). Debtors have a ready mechanism for alerting creditors, trustees, and bankruptcy courts, about changes in their financial circumstances, including notifying them of new claims, causes of actions, and proceeds.. See 11 U.S.C. § 521, Fed. R. of Bankr. P. 1007(b) and Rule 1009 (permitting a debtor to amend his schedules and a court to order amendment upon the motion of a party in interest). The evidence clearly shows that the Debtors were quick to inform the Court of any bad news regarding their financial condition but far more willing to drag their feet when their fortunes changed.
Thus, regardless of whether one looks at the facts of this case through the lens of the Trustee or the Debtors, when considering the totality of circumstances, neither proponent for modification is able to satisfy the good faith standard under § 1325(a)(3). The Court finds unacceptable a modification request that proposes to pay unsecured creditors less than 100%, while letting the Debtors retain approximately $80,000 in Insurance Proceeds, and while the Debtors' actual monthly income clearly demonstrates that they have the financial wherewithal to fully meet all of their current monthly expenses. We believe that the proposed modification, in its present form, is indicative of a lack of sincerity on the part of the Debtors, or at the very least, evinces a less than sincere attempt to repay their prepetition debts consistent with their available resources. For these reasons, the Court concludes that the modification has not been proposed in good faith.
Even if the "disposable income" or "best efforts" test is deemed not to apply, given that the Trustee appears to have abandoned her Objection and now joins the Debtors in proposing the modification, courts have routinely recognized that the "good faith" test may be the better approach to utilize when determining whether a debtor's significant increase in available income is commensurate with an ability to pay more to unsecured creditors, post-confirmation, and comports with the provisions of § 1325(a)(3). See In re Brown , 332 B.R. 562, 566-67 (N.D. Ill. 2005). This Court restates its belief that, "[w]hile the debtors' income and expenditures, in the absence of an objection by the Chapter 13 Trustee or the holder of an allowed unsecured claim, could not be a basis to deny confirmation, it can be considered, sua sponte , as a factor in determining good faith and in this case is a factor that, under § 1325(a)(3), weighs against confirmation of this proposed plan." In re Fulton , 211 B.R. at 255 (quoting Matter of Davis , 68 B.R. 205, 216 (Bankr. S.D. Ohio 1986) ).
6. Best Interest of Creditors
The Court turns last to the best interest of creditors or liquidation test found under § 1325(a)(4) to see if it has been met. As noted, the proponent of a modification under § 1329(b) must satisfy all of the requirements under § 1325(a), including § 1325(a)(4), implicated here, to determine whether the modification should be approved.
It is well established in this district that "[t]he appropriate date for performing the liquidation analysis required by §§ 1329(b) and 1325(a)(4) is the effective date of the modified plan." In re Jefferson , 299 B.R. 468, 470 (Bankr. S.D. Ohio 2003) ; see also In re Barbosa , 236 B.R. 540 ; In re Morgan , 299 B.R. 118 (Bankr. D. Md. 2003) ; In re Stinson , 302 B.R. 828 (Bankr. D. Md. 2003). Section 1325(a)(4) provides that a plan can only be confirmed if the debtor can establish that "the value, as of the effective date of the plan, of property to be distributed under the plan on account of each allowed unsecured claim is not less than the amount that would be paid on such claim if the estate of the debtor were liquidated under chapter 7 of this title on such date." Shaw v. Aurgroup Fin. Credit Union , 552 F.3d 447 (6th Cir. 2009). Said another way, "[t]he language of § 1325(a)(4) requires the court to project what the allowed unsecured claims in this case would receive had nonexempt property been liquidated by a chapter 7 trustee." In re Smith , 431 B. R. 607, 609 (Bankr. E.D.N.C. 2010). As the Sixth Circuit has observed: "In a chapter 13 action, the debtor retains the assets in exchange for an agreement to make periodic payments to the creditors. The payments to the creditors must equal or exceed the amount that the creditors would receive under chapter 7." In re Chavis , 47 F.3d 818, 824 (6th Cir. 1995). Paying anything less than what unsecured creditors would receive in a Chapter 7 liquidation renders the plan modification unconfirmable.
In order to determine whether the Debtors have met their burden under the best interest test, the Court must engage in a two step analysis. The Tenth Circuit Bankruptcy Appellate Panel, provides a thorough explanation of the calculation required:
First, the court must consider the value, as of the effective date of the proposed Chapter 13 plan, of the property to be distributed to each unsecured creditor in Chapter 13, taking into account the Chapter 13 administrative expenses. Next, the court must consider the amount that would be paid on each allowed unsecured claim if the debtor's estate were liquidated in a hypothetical Chapter 7 case, taking into account the Chapter 7 administrative expenses.... The Chapter 13 plan will meet the best interests of creditors test if the distribution amount determined in the first, Chapter 13, calculation is not less than the amount in the second, Chapter 7, calculation.
Jensen v. Dunivent (In re Dewey ), 237 B.R. 783, 788 (10th Cir. BAP 1999) (internal citations omitted.).
As noted, the courts of appeal have consistently held that in Chapter 7 cases the "proceeds of an insurance policy, if made payable to the debtor rather than a third party such as a creditor, are property of the estate and may inure to all bankruptcy creditors." In re Edgeworth , 993 F.2d at 55-56 ; see also Am. Bankers Ins. Co. , 101 F.3d at 364 ; In re Stevens , 130 F.3d at 1029 ; In re Stinnett , 465 F.3d at 313. By excluding the Insurance Proceeds, around $80,000, purportedly earmarked for construction of the "substitute" property on the vacant lot at Wells Street or for purchase of a new rental unit, the distribution available to unsecured creditors in the Chapter 13 calculation is not more than unsecured creditors would receive in a hypothetical Chapter 7 liquidation. The payment on the unsecured claims in the Chapter 13 case must, at a minimum, match what those creditors would receive in a Chapter 7 liquidation in order to satisfy the best interests test.
Even under the best case scenario, the modification proposed by the parties projects that unsecured creditors would receive a 53-56% dividend in the Chapter 13 case. Indeed, by the Court's own calculations, if the value of the Insurance Proceeds and the vacant Wells Street lot are included in the liquidation analysis, less deductions for administrative expenses, the dividend payable to unsecured creditors is projected to be at least 68% in a hypothetical Chapter 7 case. Based on the present record, the parties' modification fails to satisfy the best interests of creditors test, if they insist upon keeping the excess Insurance Proceeds plus the value associated with the now vacant lot on Wells Street, while paying their unsecured creditors less than 100%, and obtaining a "super discharge" under § 1328(a). See In re Barbosa , 236 B.R. at 556. Were this allowable, Chapter 13 debtors pursuing a "fresh start" would in essence be gaining a "head start" to which they have "no right" under the Bankruptcy Code. See In re Zick , 931 F.2d at 1129–30 (citing In re Jones , 114 B.R. 917, 926 (Bankr. N.D. Ohio 1990) ). The "fresh start" available to debtors who file Chapter 13 does not include a right to repay unsecured creditors at less than 100%, despite having means to pay more and obtain a discharge of those debts. See In re Francis , 273 B.R. at 95 ("The policy of allowing a fresh start does not license debtors to lightly rid themselves of the burden of their indebtedness without an honest attempt at repayment.") (quoting In re Young , 237 F.3d at 1178 ).
Disappointingly, the parties did not file a liquidation analysis with the proposed modification which considered the Insurance Proceeds and vacant Wells Street lot until after all the hearings had concluded. See Chapter 13 Trustee's Response to Debtors' Motion to Reconsider (Doc. 217, Ex. 4). Moreover, the Debtors attorneys withdrew their request for an evidentiary hearing related to the proposed modification which would have provided further opportunity for the parties to explain their widely dissimilar dividend projections. See Doc. 219. Thus, the Court was deprived of having an opportunity question the parties' counsel concerning how they arrived at the projected dividends purportedly payable to unsecured creditors contained in their oral statements in open court. Depending on the source of the information, those figures ranged widely from 53-56% as stated by the attorney for the Trustee during the second hearing [HEARING AT 3:03 ], to 28% as stated by Debtors' attorney at that same hearing [HEARING AT 3:05 ], and back again to 29.5-31.9% in the final liquidation analysis filed by the Trustee, after the conclusion of the hearings. (Doc. 217, Ex.4).
The parties will be afforded the opportunity to provide the Court with a liquidation analysis consistent with this Memorandum Opinion and Order and the deductions allowed for administrative expenses identified in the Appendix filed contemporaneously, herewith. In arriving at the projected 68% dividend, the Court used values extrapolated from the Trustee's BSS website (available at https://www.13network.com/). As the party officially charged with the collection and disbursement of moneys received from the Debtors, the Court hereby takes judicial notice of the Trustee's online case profile under Fed. R. Evid. 201(b)(2). Any party wanting to object to the Court's taking judicial notice of the values extracted from the Trustee's website shall be provided with an opportunity to be heard. See Fed. R. Evid. 201(e). As later directed in this Memorandum Opinion and Order, the parties shall have 21 days from this entry to object and to be heard on the Court's decision to take judicial notice of these facts.
At bottom, the proponents of a modification have the burden of proof under §§ 1325(a) and 1329. Neither the Debtors or the Trustee have made an adequate showing that the proposed modification complies with § 1325(a)(4) or, for that matter, § 1325(a)(3). Under § 1325(a)(4), the liquidation calculation must include all of the Insurance Proceeds plus the value of the Wells Street vacant lot, less any administrative costs incurred. See In re Jefferson , 299 B.R. at 468. The compromise reached between the Debtors and the Trustee and presented to the Court as a modification, under §§ 1329 and 1325(a)(4), is unconfirmable precisely because it excludes property of the estate, Insurance Proceeds, payable solely to the Debtors, that must inure to unsecured creditors under established bankruptcy law. In re Edgeworth , 993 F.2d at 55-56 ; see also Am. Bankers Ins. Co. , 101 F.3d at 364 ; In re Stevens , 130 F.3d at 1029 ; In re Stinnett , 465 F.3d at 313.
V. CONCLUSION
Consistent with the findings and conclusions expressed in this Memorandum Opinion and Order, the Court holds that all of the Insurance Proceeds, plus the value of the vacant lot where the demolished Rental Property had been located are property of the estate. All property of the estate inures to the Debtors' bankruptcy creditors, subject to deductions allowable for administrative expenses. (The parties may refer to the Appendix filed contemporaneously and incorporated by reference herein for guidance on the best interest test calculation applicable to the unique facts present in the case). The Debtors have not shown that the property of the estate considered in this case is essential to their maintenance and support, only that they would walk away from bankruptcy proceedings with $80,000 and a "full compliance" or "super discharge" under Chapter 13, having paid their prepetition unsecured creditors well below 100%–and far less than what they could afford. For all the reasons stated, the parties' proposed settlement agreement, vis a vis , modification fails to satisfy the best interests and good faith tests and is hereby DENIED .
Based upon the foregoing, the Court ORDERS the following: 1. The Debtors shall, within 21 days of this entry, file amended Schedules I and J, stating their current income and expenses, including the income from the refurbished Seton Avenue rental property. See Fed. R. Bankr. P. 1007(b), 1009.
2. Counsel for the Debtors and the Trustee are hereby directed to confer and submit for the Court's consideration, within 21 days of this entry, a proposed order modifying the plan, consistent with the ruling in this Memorandum Opinion and Order.
3. The Attorneys for the Debtors shall, within 21 days of this entry, file a final application for compensation, pursuant to LBR 2016-1 and 11 U.S.C. § 330.
The case shall be dismissed if any of the parties fail to comply with any of the terms of this Memorandum Opinion and Order.
IT IS SO ORDERED.
APPENDIX
The attorneys for the Debtors and Trustee have been directed to submit a proposed order modifying the plan, consistent with the Memorandum Opinion and Order entered contemporaneously herewith. The property of the estate, includes among other items, the Insurance Proceeds plus the value of the vacant lot at 942 Wells Street, where the Rental Property destroyed by the fire had been located. The parties may take into consideration the following deductions from the property of the estate in making the liquidation or best interests calculation under § 1325(a)(4) :
Allowable Chapter 7 Administrative Expenses:
• In re Delbrugge , 347 B.R. 536, 539 (Bankr. N.D. W.Va. 2006) : "Appropriate deductions used in making the [liquidation] calculation ... include: Chapter 7 trustee's fees, the costs of sale, exemptions, and capital gains tax."
Capital Gains Tax:
• Matter of Young , 153 B.R. 886, 888 (Bankr. D. Neb. 1993) : "Taxes incurred as a result of liquidation of property of the estate ... are entitled to administrative expense status and priority treatment.... Therefore ... tax on capital gains should be deducted in determining how much unsecured creditors would be paid in a hypothetical Chapter 7 case."
Trustee costs and fees:
• In re McKinney , 507 B.R. 534, 540 (Bankr. W.D. Pa. 2014) : Taking Chapter 7 administrative expenses into account requires "subtraction of the costs of liquidation, including the trustee's commission, when calculating the amount available for distribution to unsecured creditors."
• In re Craver , No. 11-62129, 2012 WL 290366, at *3 (Bankr. N.D. Ohio, Jan. 31, 2012) : "for the purposes of § 1325(a)(4), the liquidation value will be reduced by a ten percent flat rate for administrative fees, expenses, and costs of sale."
• In re Bettger , 105 B.R. 607, 610 (Bankr. D. Or. 1989) : When calculating the hypothetical Chapter 7 trustee's fee, "the trustee will only receive the net equity.... The other proceeds will be disbursed directly to pay the costs of sale.... Hence, no fee should attach."
Comparison to Amount Unsecured Creditors Receive under Chapter 13
• After determining "the amount the unsecured creditors would receive if the case were administered under
Chapter 7," In re Craver, 2012 WL 290366, at *5, the Court must compare that value to the amount unsecured creditors will receive under the Chapter 13 plan. This step likewise requires consideration of administrative expenses that may be paid in the Chapter 13 case, as those expenses are entitled to priority and will be paid in full before any payment to unsecured creditors. See 11 U.S.C. §§ 503, 507 and 726(a) ; In re Goudreau , 530 B.R. 783, 787 (Bankr. D. Kan. 2015) ("the administrative expenses of the Chapter 13 case are to be considered only in the Chapter 13 calculation.").
Conclusion
The parties are not limited to the authorities cited in this Appendix in making the case for approval of a modification, under § 1329, consistent with the Memorandum Opinion and Order entered contemporaneously herewith. The Court will consider any other authorities the parties submit in connection with the proposed order modifying the plan.