No Chapter 13 Deduction for Payments on Surrendered Assets

Chapter 13 debtors who propose to surrender vehicles, real estate or other secured assets cannot deduct the payments made on those debts in calculating the "projected disposable income" available to unsecured creditors, a bankruptcy appellate panel has ruled.

The U.S. Bankruptcy Appellate Panel for the 9th Circuit ruled that 11 U.S.C. §§ 1325(b)(2) and (3), when read together, provide that if an expense is not reasonably necessary for the maintenance and support of a debtor or the debtor's dependents, it is excluded in the calculation of disposable income.

The 2-1 split decision came in the case of Timothy and Karrie Smith, who filed a Chapter 7 petition in the U.S. Bankruptcy Court for the Western District of Washington.

The case was subsequently converted to a Chapter 13. Under their repayment plan, the Smiths proposed to surrender two houses and a vehicle.

The Smiths then filed Form B22C, which was created by Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 under Section 1325(b)(1)(B) and determines the debtor's "projected disposable income" available to unsecured creditors.

According to the court's opinion, the form showed the couple had a negative monthly disposable income. The calculations included deductions for the monthly payments on the assets the Smiths intended to surrender.

Thus, the proposed plan provided that unsecured creditors would only receive about 4 percent of the total they were owed.

The Bankruptcy Appellate Panel said in its opinion that if the payments on the surrendered property were not deducted, the Smiths could pay off their entire amount of unsecured debt in full over 24 months.

Unsecured creditor American Express Bank, the U.S. trustee and the Chapter 13 trustee handling the case each objected to confirmation of the plan, arguing that the couple cannot deduct the payments on the property to be surrendered.

The Smiths' case required the Bankruptcy Court to interpret Sections 1325(b)(2) and (3) of the Bankruptcy Code.

Section 1325(b)(2) provides that only "reasonably necessary" expenses may be deducted when calculating disposable income available to unsecured creditors.

Meanwhile, Section 1325(b)(3) incorporates BAPCPA's means testing provisions for Chapter 7, making them applicable to the formulation of Chapter 13 plans. The means test allows debtors to exclude certain payments "scheduled as contractually due to secured creditors."

The Bankruptcy Court overruled the objections, and the three objectors appealed.

The majority of the Bankruptcy Appellate Panel, in an opinion written by Judge Dennis Montali, found that Sections 1325(b)(2) and (3) must be read sequentially. Thus, if an expense is not "reasonably necessary" for maintenance and support, it is not deductible, and the inquiry ends before any determination under the means test.

The majority took issue with the 9th U.S. Circuit Court of Appeals' decision in In re Kagenveama, which said courts must calculate disposable income as of the time the case was filed, rejecting the use of a forward-looking approach to make such calculations.

The Kagenveama approach would require bankruptcy judges to look at what payments on secured debts are being made at the filing of the case, not what payments will actually be made in the future.

The Bankruptcy Appellate Panel majority said it did not find Kagenveama to be binding precedent on the issue at hand: whether payments on secured assets that are to be surrendered may be deducted from disposable income.

Judge Eileen Hollowell dissented, saying said she did not believe that Sections 1325(b)(2) and (3) were meant to be read sequentially. The majority's ruling "upends the statutory inclusion of the means test in Chapter 13," she added.

The panel's ruling will be reviewed, since the panel has certified the case to the 9th Circuit.

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