Why do Chapter 13 plan payments end up too high to pay if Chapter 13 is supposed to be a financial reorganization? How are plan payments allowed to consume nearly all of monthly wages?
The short answer is that the infamous means test isn’t the only factor driving the monthly payment in Chapter 13. The usual culprit is the second of the statutory tests for plan confirmation, the liquidation test. Another factor are priority claims like unpaid child support or recent unpaid taxes that the law requires that a plan pay in full to get confirmation of the plan.
It’s not just the means test
In Chapter 13, you get to keep your assets and remain in control of your income. To counterbalance that advantage to debtors, bankruptcy law says that your unsecured creditors must get at least as much through the plan as they would have had you filed a Chapter 7 liquidation instead of 13.
That’s the “best interests of creditors” requirement for confirmation of a plan.
And, what creditors would get in a hypothetical Chapter 13 is the difference between the value of your assets, after deducting the exemptions you are allowed, and the Chapter 7 trustee’s expenses.
Here’s a simplified example assuming the debtor’s house with a fair market value of $500,000 is the only asset for a Chapter 7 trustee to liquidate.
| Value of house | $500,000 |
| Exemption | 45,000 |
| Mortgage balance | 200,000 |
| Selling expenses @ 7% | 35,000 |
| Trustee statutory commission | 18,900 |
| Trustee’s accountant | 2,000 |
| Net for creditors | 199,100 |
So, if you have substantial equity in your assets, or live in a state with paltry exemptions, your plan payment may be fixed at a number that has little relationship to your actual disposable income. A plan that doesn’t meet the liquidation test cannot be confirmed.
It’s easy to assume that the liquidation pot on these facts is $255,000 ($500,000 minus $200,000 mortgage minus $45000 exemption) when in fact, after the trustee pays the expenses of administration, the pot is $199,100.
Reducing the liquidation pot
The sum necessary to meet the liquidation test is driven by the value you put on your assets and by your attorney’s attention to the expenses to be paid ahead of your unsecured creditors. It’s the net of those two that determines the the size of the pot of money available for general unsecured creditors.
Tips to reduce the value side of the pot
- Get real values for assets with non exempt equity- not necessarily the easily available, standardized values found online
- Consider exemption planning to move value from non exempt assets to exempt assets, such as contributing to retirement accounts, prepaying fixed expenses like auto insurance, acquiring life insurance, getting needed health care or performing maintenance on home or car
Tips to increase the expenses of trustee administration
- Explore the likely costs of sale a trustee would incur to sell a non-exempt asset
- Calculate the trustee’s statutory commission
- Estimate the fees of estate attorneys or tax professionals
- Include any taxes payable on bankruptcy estate income
The additional debts that swell the plan payment
The confirmation tests discussed above address what general unsecured creditors must get get through the plan.
But those filing bankruptcy often have other debts they want to pay, like arrears on a home mortgage, or the balance on a car loan. Those are debts that a Chapter 7 trustee would not usually pay in his administration of a case. Those debts are, however, critical to the debtor.
The amounts necessary to cure a mortgage default or pay off a car (or two) get added to the pot that the debtor must fund. And so the monthly payment grows. Without regard to the income available to pay.
Reorganization made challenging
So that’s how Chapter 13 plan payments can become anywhere from challenging to impossible. We’re stuck with the law, and left to careful calculation of the relevant numbers until either bankruptcy law or your available exemption amounts change.
