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Uniform Bankruptcy Plan Proposals � Taming the Wild West of Chapter 13

Karen Cordry, NAAG Bankruptcy Counsel

Bankruptcy – like Gaul – is divided into three main types of proceedings: Chapter 7 cases, Chapter 11 cases, and Chapter 13 cases.[1] Of those three, Chapter 7 cases are by far the most numerous, with about 875,000 filings, but very few (less than 5 percent) have any non-exempt assets for creditors. Chapter 11, which is the primary business chapter, with the mega bankruptcies one often hears about such as Enron, Lehman Brothers, and Hostess Brands (home of Twinkies and Ding Dongs), had less than 11,000 cases in fiscal year 2012. Of those, there are only a few hundred truly large cases a year with the bulk of the assets and claims. They may take months and years to conclude and, by virtue of their small number, creditors can generally stay current and closely peruse a plan if it is of interest.

Chapter 13, on the other hand, which wage earners use to complete their own small scale reorganizations to save their homes and cars, is a very different proposition. The 375,000 cases filed in fiscal year 2012 are more than the 373,000 total for all other civil and criminal cases combined.[2] Moreover, unlike those other federal cases, which typically involve one or a few plaintiffs or defendant, even the smallest bankruptcy case often had a dozen or more (often many more) unrelated claims filed by different parties and arising under different laws. Debtors must decide whether to accept or dispute those claims, while at the same time contesting liens, defending challenges to their exemptions, and administering property of the estate.

That multitude of proceedings, moreover, takes place on a highly compressed schedule compared to normal federal litigation.[3] Moreover, the Bankruptcy Code and the Rules are far more stringent about allowing appeals or overturning default judgments than most other areas of federal litigation. As examples, Section 363(m) precludes a sale to a good faith purchaser from being overturned for any reason unless a stay has been obtained,[4] and notices of appeal must be filed within 10 days rather than 30 (compare Bankruptcy Rule 8002(a) to Federal Rule of Appellate Procedure 4(a)(1)).

At the same time, the potential recoveries in Chapter 13 cases are relatively minuscule. While a normal federal civil case based on diversity must have at least $75,000 at stake, Chapter 13 cases normally involve far fewer dollars. In fiscal year 2008, for instance, there was a grand total of only $5.2 billion paid to all creditors in the 353,000 Chapter 13 cases filed that year; of that, only $1.2 billion dollars went to unsecured creditors.[5] That averages out to only $3400 per case divided among all unsecured creditors, and only about $11,300 for all secured creditors. Such low returns often average out to only a few pennies on the dollar or less for unsecured creditors from which they must still deduct their cost to file a claim and review the proposed plan.

In this high-volume, high-speed, low-return arena, institutional creditors, such as taxing agencies, student loan creditors, mortgage lenders, and the like need to triage their limited enforcement resources. Creditors typically will use paralegals and other lay staff to screen the hundreds of pleadings received daily to determine which matters must be brought to counsel’s attention and which do not require further action. That screening should work reasonably well in that the Code prescribes more stringent notice and processing requirements for matters that are of particular concern to individual creditors, such as determinations of dischargeability of a debt and attacks on the validity, priority, and extent of liens. Those matters must be brought through individualized “adversary proceedings” that directly name the creditor and that are to be served on an officer or managing agent or other person authorized to receive such service.

Thus, a creditor with a nondischargeable claim, for instance, could instruct staff to look for complaints, which should be readily identifiable both by the format of the document and by the addressee on the envelope. If the plan cannot affect the discharge status of the debt or the validity of the lien, the debtor would have every incentive to make sure its plan paid those creditors as much as possible, so there would be little need for the creditor to worry about the specifics of what is in the actual plan.

That assumption would greatly benefit creditors since the Bankruptcy Code and Rules have only a few requirements for what a plan must contain; as long as one complied with those requirements, debtors’ counsel were free to exercise their creativity to draft plans that dealt with the issues in whatever order and with whatever language they found most pleasing. No two plans need look alike – and they rarely did, leaving large creditors scrambling to try to find the applicable provisions in the tens of thousands of plans they might see.

This problem took on much greater salience when the U.S. Supreme Court held in United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260 (2010), in agreement with the Ninth Circuit (but in disagreement with seven other Circuits,) that debtor plans that included “discharge by ambush” provisions were valid.[6] In those plans, debtors would write in provisions that were unquestionably invalid (i.e., such as simply “declaring” that a student loan debt was discharged) and wait to see if a creditor caught them. While the plan language was not necessarily unclear, it was included in the wrong form of proceeding, in the wrong sort of document, sent to the wrong address, and addressed to the wrong entity. As a result, a professional who would know what to do with the document might never see it even if the creditor actually received the document and had “notice.” When no objection was filed and a plan was confirmed, the Supreme Court held that, despite all of those deficiencies, that plan was not “void” and could not be overturned after time had elapsed for a challenge under Rule 60(b). Thus, debtors had a strong incentive to try to see what they could get away with and only remove the provision if they were caught

There were a number of possible responses to this unfortunate development. Creditors could spend much more time and money reviewing each and every plan for illegal provisions. Courts could spend time reviewing plans more carefully as well and could sanction debtor’s counsel for including illegal provisions. Or – one could take a more systematic approach and reconsider whether “creativity” was really a virtue in the context of Chapter 13 plans. While some would argue yes with vehemence and passion, many others considered the fact that the great bulk of Chapter 13 cases have much in common. There are usually one or two wage earners; they typically have a house and one or two cars they are trying to save; they have the standard array of credit card debts and other unsecured claims, and arrearages on the secured debts that they need to clear up, and expenses that hopefully are less than their income so that there is enough left to make regular payments under their plan.

Considering that bankruptcy is required under the Constitution to operate under “uniform laws,” many districts began to explore the notion of creating a uniform Chapter 13 plan template for some or all of the relevant provisions. While this started before Espinosa, that case undoubtedly accelerated the trend. The stakes for creditors in ensuring that they could adequately review a plan had become much higher and bankruptcy judges had been instructed that it was their duty to review plans and eliminate illegal provisions. Both groups saw much virtue in having plans that had the same provisions in the same place so one would know what to review; even debtors’ counsel could often agree that reinventing the wheel cost more than their clients could afford. While some variation was allowed, at least the starting point for each plan in the district would be the same.

The only problem that then occurred was that, as each district started preparing its own uniform plan, the result was that there were now 30, 40, 50 or more different uniform plans. While better than tens of thousands of different plans, this still left much to be desired since a national creditor would have to instruct its staff on where to look in each of those different plans to find the relevant provisions. The next step was obvious. The States’ Association of Bankruptcy Attorneys (SABA)--a group comprised of bankruptcy counsel in different state and local offices, including attorneys general offices, with NAAG’s bankruptcy chief counsel serving as one of the directors--wrote to the Advisory Committee on Bankruptcy Rules in February 2011 and suggested that the Committee propose a national uniform plan that would supplant all of the individual district plans. Other parties made similar suggestions.

And, so, with all due deliberation, the Advisory Committee process has been moving forward with just such a proposal. There has been a great deal of discussion about the specifics of the template to be used, how many areas would be addressed, what default position would be selected and the like. The most recent meeting of the Advisory Committee was just held on April 2-3 and the Committee concluded that the discussions had reached the point that would allow for formal promulgation of the draft rule in the very near future. Three of the most salient points of the draft are consistent with specific suggestions made by the SABA letter. First, that there must be a specific, highly-conspicuous notice given on the initial page of the plan that changes are being made to the model plan; second, that the changes should all be specified in the same place in the plan so a creditor can quickly check to see if the model plan’s treatment of their claim is being changed; and third, and most important, that any change in the plan that is not properly noted in accordance with the first two provisions is not approved by the confirmation order.

The reason for the last provision should be obvious – it matters little how clear the requirements are for the plan, its structure, its proper provisions and the like if a debtor could ignore the provisions, write in improper language and have its plan confirmed if neither the judge nor the creditor catches the change. In that case, one would simply be back in the Espinosa scenario again only one step removed. Indeed, inasmuch as creditors would now think that the problem of hidden provisions had been solved, they might be lulled even more into not carefully reading plans that did not flag that changes had been made. This provision, though, solves the problem by making crystal clear that the confirmation order does not approve altered plan provisions that are not properly noticed to all parties. It is likely that SABA may still have some comments on the final version of the plan structure and states will still need to ensure that proper care is taken to review plans as they come in the door. This change, though, will go a very long way to ensuring that the Chapter 13 plan process does not become the Wild West territory that it threatened to descend into after Espinosa.

[1] There are a tiny number of Chapter 9 cases (municipalities), Chapter 12 cases (family farms) and Chapter 15 cases (cross-border insolvencies), but collectively they comprise less than 1,000 of the more than 1.26 million filed in fiscal year 2012.

[2] Statistics are taken from

[3] Chapter 13 plans must be filed within 15 days after the case is filed and the confirmation hearing can be scheduled as early as the 40th day of the case.

[4] All Section references are to Title 11, United States Code.

[5] See FY-2008 Chapter 13 Trustee report dated June 28, 2010.

[6] See Karen Cordry, “United Student Aid Funds, Inc. v. Espinosa: A Tale of Two Holdings,” [NAAGazette, August 30, 2010, Volume 4, Number 8] for an earlier article on this case and more detailed discussion.

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