A fundamental distinction exists between a consumer chapter 7 case and a chapter 13 case. This distinction pervades the way each case proceeds through the judicial system. A chapter 7 case is static: non-exempt assets held by a debtor at the time of filing become "property of the estate," available for liquidation and distribution to creditors.¹ The changes in a debtor's circumstances that occur following filing where the debtor is generally free from the control of the bankruptcy court or the claims of a trustee are regarded, for good or ill, as the debtor's good fortune or bad luck. A chapter 7 debtor who experiences an increase in income, incurs a debt, acquires assets or wins the lottery has the personal benefit or burden of such events. The decision of a debtor to seek chapter 7 relief can provide to that debtor a prompt fresh start and a rapid discharge, and can leave the debtor free of pre-petition debts, capable of participating as a new consumer with future income available to satisfy the debtor's personal lifestyle or to satisfy newly acquired debt.

A chapter 13 case is dynamic: debtors devote future income toward the satisfaction, in whole or in part, of claims. The focus of the confirmation process is toward anticipated events: whether the debtor can satisfy all of the secured claims (paying to the secured creditors value of the collateral) using the debtor's projected disposable income; whether the debtor will perform under the plan in the future, and whether the debtor's future payments to the trustee will satisfy the best-interest-of-creditors test. Clearly, the confirmation of a chapter 13 plan is a judicial prognostication that things will happen in a debtor's life to permit the consummation of a plan and receipt of a discharge. The unfortunate truth is that often things do not turn out the way that debtors and courts anticipate at the time of confirmation. A debtor suffering the loss of a job, a medical setback or dissolution of a family is left with a chapter 13 plan that may have seemed achievable at confirmation, but grew impossible based on later developments.

Section 1329 gives the debtor confronting changed circumstances an option other than dismissal or conversion.² The Code permits the debtor to modify the plan subject to certain restrictions. The section appears to contemplate a new confirmation process since it makes reference to §1325(a) ("...Section 1325(a) of this title appl[ies] to any modification under subsection (a) of this section..."), and §1325(a) imposes the mandatory requirements of confirmation (the good faith requirement of §1325(a)(3), the best interest requirement of §1325(a)(4), the feasibility requirement of §1325(a)(6), and the "present value" requirement of treating a secured claim of §1325(a)(5)). Section 1329(c) imposes the caveat, however, that a plan modification may not cause a plan to exceed 60 months from the date of first payment.

Section 1329(a), however, specifies types of modifications to increase or reduce payment to creditors in a class, to extend or reduce the time to make payments to creditors in a class, and to alter a distribution to a creditor to take into account payments made by a third party to that creditor. Several courts have concluded that the permissible modifications of a confirmed plan are limited to this short list. Most of these courts relied upon the binding effect of confirmation of §1327, noting that the limited exception to the binding effect of §1327 is the short list of §1329(a).

Recently, the Sixth Circuit joined these courts and applied §1329 to a relatively common scenario. After a debtor's chapter 13 plan is confirmed, providing for a claim secured by an automobile, the debtor discovers that he or she can no longer afford the plan and seeks to reduce payments by surrendering the car. In Chrysler Financial Corp. v. Nolan (In re Nolan), 232 F.3d 528 (6th Cir. 2000), Ms. Nolan's chapter 13 plan was confirmed, fixing the secured claim of Chrysler at $8,200, the value of her 1995 Mitsubishi Mirage, and providing for monthly payments with interest of $207.97 by the trustee. About a year after confirmation, Ms. Nolan sought to modify her chapter 13 plan to eliminate the monthly payments by the trustee to Chrysler, surrender her Mitsubishi to Chrysler, and reduce her payments to the trustee. She simultaneously sought court approval to incur post-petition debt to finance the purchase of another, less expensive car.

The Sixth Circuit held that in approving the requested modification, the bankruptcy court went beyond what is permitted under §1329(a). Ms. Nolan's proposed treatment of the claim held by Chrysler was a reclassification of the creditor's secured claim to unsecured status. The amount of Chrysler's secured claim was fixed at confirmation to the value of the Mitsubishi ($8,200). Section 1325(a)(5) requires that the plan pay to Chrysler that present value.³ Nothing in §1329 alters that requirement, and the court held that Ms. Nolan should not be able to shift the claim from secured status to unsecured status simply because she chooses to relinquish possession of the automobile.

The Sixth Circuit clearly considered the inequity of a reading of §1329 in which a debtor could "cram down" a secured creditor's claim at confirmation but effectively and "unfairly shift away depreciation, deficiency and risk voluntarily assumed by the debtor through confirmation of the chapter 13 plan" (at 534). Considered, too, was the inequity of conferring a right upon a debtor to modify the treatment of the secured claim where the collateral is substantially depreciated (largely through the actions of the debtor who was in a better position to maintain and preserve the Mitsubishi) while denying to a secured creditor the right to modify the treatment of its secured claim upward if collateral had appreciated since confirmation (§1329 only gives debtors, trustees and holders of unsecured claims the right to seek modification).

The holding of the Sixth Circuit in Nolan is consistent with the holding of most courts faced with a similar issue. In re Meeks, 237 B.R. 856 (Bankr. M.D. Fla. 1999); In re Cruz, 253 B.R. 638 (Bankr. D. N.J. 2000); Matter of Coleman, 231 B.R. 397 (Bankr. S.D. Ga. 1999); In re Dunlap, 215 B.R. 867 (Bankr. E.D. Ark. 1997); In re Banks, 161 B.R. 375 (Bankr. S.D. Miss. 1993); In re Holt, 136 B.R. 260 (Bankr. D. Idaho 1992). These courts, and others, have regarded the list of permissible modifications in §1329(a) to be exclusive: "Nowhere in §1329(a) does the statute permit a debtor to modify the amount of an allowed secured claim. Likewise, §1329(a) does not allow a debtor to reclassify an allowed secured claim as an unsecured claim. The claim amount is fixed at the confirmation hearing, and no provision in §1329 allows for the later modification or re-examination of the claim amount." (In re Weeks, supra at 860).

To be sure, a number of courts have recognized that the restrictive reading of the permitted modifications of §1329(a) by the Sixth Circuit is not supported by the statute. In In re Townley, 256 B.R. 697 (Bankr. D. N.J. 2000), the debtors' chapter 13 plan was confirmed, valuing their 1994 Toyota, but after confirmation the debtors' income decreased. To keep the plan feasible, the debtors sought to modify their plan, surrender the Toyota, make no further payments on the secured claim, treat any deficiency resulting from the surrender as a general unsecured claim and reduce their payments to the trustee accordingly. Ford Motor Credit objected to the modification, arguing, as did Chrysler in Nolan, that §1329 does not permit a "reclassification" of the secured claim to unsecured.

The bankruptcy court disagreed, noting that Nolan and its progeny read §1329(a)(1) too narrowly. That subsection specifically permits a modification to "reduce the amount of payments on claims of a particular class," and the Nolan court has apparently added the exception "except secured claims" to the statute. If §1329 permits payments in a class to be reduced, and the claim of Ford was a claim in a class, the section clearly permits payments to Ford to be reduced; the ability to reduce payments is not limited to only unsecured claims.

The question remains, however, as to what type of claim the creditor has after the "surrender" of the collateral. Nolan seems to indicate that the claim remains secured after the return of the collateral. That logic was challenged in In re Johnson, 247 B.R. 904 (Bankr. S.D. Ga. 1999), a case decided prior to Nolan. There, agreeing with the argument that §1329(a) would not permit "reclassifying" the secured claim to an unsecured claim by way of plan modification, the court held that the real issue was not one of plan modification but the nature of the claim after the collateral had been returned. Section 502(j) permits the reconsideration of claims at any time. "After surrender of collateral, the deficiency portion of the claim is no longer actually secured. A claim simply cannot be secured when nothing secures it.⁴ Any deficiency claim is therefore, by definition, unsecured. That reality can and should be reflected in the allowance of claims in the bankruptcy case. Otherwise, the plan is not in accord with the Bankruptcy Code requirement that the plan must provide the same treatment for each claim within a particular class...The Johnson's confirmed chapter 13 plan, like many chapter 13 plans, classifies all unsecured claims together. The unsecured deficiency claim must be treated as all other unsecured claims allowed by the plan. To allow the claim as secured fails to treat all claims equally within a particular class. Section 502(j) is available to redress that inequity" (Johnson, supra at 908).⁵

Section 502(j) was also applied in In re Zieder, _____ B.R. ____, 2001 WL 640405 (June 4, 2001) (Bankr. D. Ariz.), to permit the modification of a confirmed chapter 13 plan to reflect the surrender of collateral. "When [§502(j) and §506] are applied to the facts of this case, they compel the conclusion that Ford's remaining claim must be reconsidered for cause and, when reconsidered, it becomes an unsecured claim by operation of law. There is now no collateral securing Ford's claim. Consequently, §506(a) by its own express terms makes Ford's entire claim an unsecured claim. There is no provision of the Code...that gives a creditor a secured claim without any collateral."

To avoid the inequity of unanticipated or negligent depreciation of the collateral recognized by the Nolan court, Johnson holds that the creditor whose claim has been reconsidered may assert a priority claim for failure of "adequate protection." To calculate this claim, the court must value the collateral as of the filing date at the liquidation value (rather than the replacement value, which would apply if the debtor sought to retain the collateral), subtracting payments made by the plan and the amount realized by the actual liquidation of the collateral. What remains reflects a failure of the plan to provide adequate protection, which must be paid in full as an administrative expense claim.

In the wake of Nolan, it appears that debtors' counsel seeking to reduce the payments made by a debtor is limited. Modifying a plan to reclassify the claim of a creditor may not be an option, but giving up collateral and reconsidering the claim remaining under §502(j) is an option. No appellate court (or lower court in the Sixth Circuit) has yet weighed in on the use of §502(j) to so restructure a plan, but, short of dismissing and re-filing or converting to chapter 7, such process may be the only avenue for relief.

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Footnotes

¹ Section 541 acknowledges that certain post-petition accessions are also included in the estate (i.e., inheritances, divorce distributions and property generated by property of the estate), but for the most part, such accessions are rare. Return to article

² Legislative history supports the conclusion that §1329 was created to allow debtors to address problems after a plan is confirmed. H.R. Rep. No. 95-595 at 265 (1977). Return to article

³ Although §1329(b) recognizes that §1325(a) applies to modifications, §1329(b) only applies to modifications permitted under §1329(a). Section 1325(a)(5) would permit the surrender of collateral "but only pre-confirmation. For §1325(a)(5)(B)(ii) to provide any protection to the creditor when the debtor chooses to retain her collateral, the secured claim must not be subject to modification throughout the life of the plan." In re Nolan, supra n. 8. Return to article

⁴ Section 1329(a)(3) does permit a plan modification to "alter the amount of distribution...to the extent necessary to take account of any payment of such claim other than under the plan." The "surrender" of the collateral—the transfer of the property to the creditor—may well be a payment of a secured claim other than under the plan and thus a permitted modification to reduce the "secured" claim amount. Return to article

⁵ To be sure, §502(j) reconsideration is not available to a debtor where the equities fail to support it. That section permits claim reconsideration only "according to the equities of the case." Thus to recognize the deficiency claim as an unsecured claim, the debtor must act in good faith. Such reconsideration may be denied if the debtor failed to maintain or insure the collateral. See Johnson, supra at 908. Return to article