Northern District of New York Bankruptcy Judge Says Unsecured Creditors Must Get Paid Sooner In a Chapter 13

Under the former bankruptcy law, unsecured creditors in a Chapter 13 were paid only after all secured and priority creditors were paid in full. Under the new bankruptcy law (BAPCPA), Congress imposed a new formula for determining the minimum amount unsecured creditors would be paid in a Chapter 13 for debtors who were above the median income level for their state. Until now, however, the timing of when unsecured creditors were paid did not change…they still got paid last.

The “means test” set the minimum amount unsecured creditors would receive as an amount equal to the debtor’s “disposable income” each month times 60 months. So if the result of the means test showed $200 disposable income, the unsecured creditors would have to receive a minimum of $12,000 (200 times 60) over the life of the Chapter 13 plan.

Last month, Judge Robert E. Littlefield from the Northern District of New York - Albany Division, held that the change in the law for above median debtors meant that unsecured debtors had to be paid the amount of the debtors disposable each month beginning in the first month of the plan. Judge Littlefield is very knowledgeable about Chapter 13’s. He was a former Chapter 13 trustee and former President of the National Association of Chapter Thirteen Trustees (NACTT).

In the case of In re Vining , the Judge held that the current bankruptcy law “sets up a trust fund for unsecured creditors within the trustee’s disbursement account”, and that “this process begins on the date that the first payment is due under the plan”.

This decision could make Chapter 13’s more expensive for debtors. Secured creditors often receive interest on their claims. When they are paid first, there is less money required during the life of the plan to pay this interest. If unsecured creditors are receiving a major portion of the debtor’s monthly payments to the trustee, the secured creditors will be paid over a longer period, resulting in more money required to cover the interest that accrues on the unpaid balance each month.

For an illustration of how this works, just look at a mortgage amortization schedule. In the beginning of a mortgage, each payment is mostly interest. Only after several years of mortgage payments have been made does the percentage of each payment to the principle amount show a significant increase.

Judge Littlefield pointed out that if the unsecured creditors were paid last, that a Chapter 13 debtor would have little incentive to remain in a Chapter 13 plan once the secured creditors’ claims have been resolved. While there is some logic to this argument, and although there may have been some Chapter 13 debtors who have bailed out of their Chapter 13 plans after the secured creditors were paid, the vast majority of Chapter 13 debtors over all the years that unsecured creditors have been paid last have not bailed on their Chapter 13’s once their secured creditors have been paid.

This decision further shows the inequality of the bankruptcy law in that it treats over-median income debtors and under-median income debtors so differently.