Best Interests of Creditors? I Want My Bankruptcy Lawyer to Protect Me!

18 Dec Best Interests of Creditors? I Want My Bankruptcy Lawyer to Protect Me!

I was talking with a client explaining how the client’s chapter 13 plan payment was calculated. I was going over one calculation in determining the chapter 13 plan–the “best interests of creditors” test. All of sudden, the client exclaimed that he was not interested in the “best interests of creditors.”

So, what is the “best interest of creditors” test in a chapter 13 case?

Before we answer that question, it is helpful to go over why you might choose a chapter 13 case over a chapter 7 case. As has been explained before, in a chapter 7 case, you will surrender all non-exempt property to a trustee. The trustee will sell that property and out of the proceeds of the sale, use that money to pay your creditors. The creditors get whatever they get and if the creditors are still owed anything, the remaining debt is discharged.

In a bankruptcy case, you are entitled to exempt a certain amount of property. That means, you get to keep a certain amount of “stuff” because we do not want to leave people completely destitute. For example, in North Carolina for each joint debtor, you can keep or “exempt” up to $35,000 in equity in real estate used as your residence; $3,500 in one motor vehicle; up to $5,000 in household goods; $2,000 in tools of the trade and, if you do not use fully use your real estate exemption, up to $5,000 in any property–a “wildcard” exemption. There are a few other exemptions.

If you do not own stuff over and above what you may exempt (value less any liens secured by the property), then the chapter 7 trustee does not take and sell anything. You are what bankruptcy lawyers term a “no-asset” case because there are “no assets” over and above what may be exempted. However, if you do own stuff over and above what you may exempt, the trustee can sell that stuff.

So, for example, you have a car that is worth $15,000.00 and there is no lien on the vehicle. You can exempt up to $3,500 under your motor vehicle exemption and $5,000 under your wildcard (if available) for a total of up to $8,500. That leaves a fair amount of “value” left and if you file a chapter 7, the trustee will sell your car. Or, the trustee will agree not to sell your car if you pay him now $7,000. Well, if you had $7,000 lying around, you wouldn’t be talking to a bankruptcy lawyer in the first place. Oh, and the chapter 7 trustee is not interested in payments–he wants cash now or he is selling the vehicle. Because you want to keep your car, we need to figure something else out.

A chapter 13 case is the answer. One of the reasons for choosing a chapter 13 over a chapter 7 is because you have non-exempt property that you wish to keep. A chapter 13 plan will allow you to pay the non-exempt excess equity of your car in payments. Specifically, 11 U.S.C. § 1325(a)(4) states that a plan must provide the value, as of the effective date of the plan, of property to be distributed under the plan on account of each allowed unsecured claim is not less than the amount that would be paid on such claim if the estate of the debtor were liquidated under chapter 7 of this title on such date. What this means is that if you want to keep your car, you will have to at least pay, through your plan, enough so that your unsecured creditors get what would have been distributed as if your car was sold in a chapter 7 case.

For example, in the above example, if a chapter 7 trustee sold your car, he could expect to have approximately $3,600 to distribute to creditors. The trustee is entitled to a commission and there are the costs of the sale and this eats up approximately $3500 in this particular example.

So, in formulating your chapter 13 plan, you would have to propose that your unsecured creditors get paid through your plan at least $3,600. If you have secured creditors that you pay through the plan or a mortgage delinquency to catch up –all of these items would be paid through your plan. But, because of the non-exempt assets that you want to keep, you would have to pay the additional $3,600 so that your unsecured creditors get what they would have gotten had the vehicle been sold in a chapter 7. This is a mandatory requirement before a court can confirm a chapter 13 plan.

As my client said, “I kinda have a problem paying for stuff that I already own.” Fair enough. But, if your creditors sue you and get a judgment against you, assets that are non-exempt are subject to seizure by the sheriff. You may be “paying for stuff” that you already own in a chapter 13 but if you don’t take this action are are sued, stuff that you already own is going to be taken from you and sold by the sheriff. Additionally, if the sheriff’s sale does not pay the creditor in full, you will still owe on the judgment even after the asset is sold.

Sometimes dealing with debt issues involves making tough choices. A chapter 13 plan can give you the choice of retaining assets by paying the excess non-exempt equity over to creditors without losing that asset.

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Adrian Lapas, Esq.

I've been practicing bankruptcy law in North Carolina since 1993, and am certified as a specialist in consumer bankruptcy law by the North Carolina State Bar.
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