Creditor's Best Interest Test

CHAPTER 13 TRUSTEE’S OFFICE
CIRCULAR NO. 99-01

TO : THE BANKRUPTCY BAR
FROM : José R. Carrión, Esq.
Chapter 13 Standing Trustee
DATE : April 7, 1999
(Last Revision / July 9, 1999)

MATTER : CHAPTER 13 TRUSTEE’S OFFICE POLICY REGARDING
PLAN CONFIRMATION REQUIREMENTS PURSUANT TO
§1325(a)(4) [Creditors’ Best Interest Test]

INTRODUCTION

Since I began the Chapter 13 Trusteeship administration in October of last year, I have heard different  interpretations of what are §1325(a)(4) requirements for a plan to be confirmed. I have seen different  concepts on how to perform the Creditors’ Best Interest Test, on how to perform a hypothetical Chapter  7  assets liquidation analysis, on the requirement or not to provide present value, etc. I have revised the  procedures that have been used for years by the Chapter 13 Trustee’s Office and concluded that they  need to be changed to comply more accurately with the Bankruptcy Code. Therefore, the purpose of this  circular is to communicate you the Chapter 13 Trustee’s Office Policy regarding the application of  §1325(a)(4) so that you can understand our position. This Policy will be effective immediately.

§1325(a)(4) "Creditor’s Best Interest Test"

(a) Except as provided in subsection (b), the court shall confirm a plan if –(1-3)…
(4) the value, as of the effective date of the plan
1, 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:

Hypothetical Chapter 7 Assets Liquidation

Before we can perform the test required under 11 USC §1325(a)(4) we must first make an hypothetical  asset liquidation under a Chapter 7 case, for which we will do the following.

1 The Trustee will consider the petition filing date as the effective date of the plan.
2 The Trustee will consider property of the state to be liquidated as defined by 11 USC §541.

Circular No. 99-01: Chapter 13 Trustee’s Office Policy

Regarding Plan Confirmation Requirements Pursuant To §1325(a)(4) 2

First step: We will determine the case non-exempt equity. We will use the value of assets, as of  filing  date, as stated in the schedules (absent of better evidence before confirmation). To that value we  will subtract the secured liens as stated in the schedules (unless a claim is already filed before  confirmation). As part of said operation-result, we will consider debtor’s interest in the property (100% or  less) and then subtract the Exemptions claimed.

Second step: From those assets that showed non-exempt equity, we will calculate what would be the   Chapter 7 Trustee fee for disbursing payments to the related secured creditors pursuant to §326(a), then subtract it from the non-exempt equity previously established.

Third step: If appropriate we will also take in consideration any statutory mandatory expenses (liquidation value realization cost) for liquidating an asset, and subtract it from the result of the previous  operation. (Example, i.e., 1% notarial fees for a deed of sale of a real property). We will not consider any  other asset liquidation expense, unless provided with convincing evidence that the same is not  discretionary of the Chapter 7 Trustee. The result of the operations described in the second and third  steps, will be the case GROSS Liquidation Value available for the allowed unsecured claims.

Fourth step: We will then determine if the Gross liquidation value is greater or less than the scheduled unsecured priority claims (or priority claims filed if at the time of the analysis there is any filed). (i.) If  the gross liquidation value is greater than the unsecured priority claims, we will determine the Chapter  7 Trustee fee for disbursing payment for those claims, taking in consideration previous funds distributed  to secured creditors to follow §326(a) scale of compensation percentage. The sum of the determined  Chapter 7 Trustee fee and the total allowed unsecured priority claims is subtracted from the gross  liquidation value. In this case the surplus of said operation would become the amount available to pay  allowed non-priority unsecured claims. (ii.) If the gross liquidation value is less than the unsecured  priority claims, we will determine the maximum amount that could be applied to those claims  considering  the necessary Chapter 7 Trustee fee for such disbursement. In this case there will be no  surplus to pay allowed non-priority unsecured claims.

Fifth step: From any surplus amount resulting from the previous operation (i.), we will determine what  will be the Chapter 7 Trustee fee to pay the allowed non-priority claims. We will take in consideration  previous distribution of funds to secured and priority creditors to follow §326(a) scale of compensation  percentage. (1.) If the surplus value resulting from the operation described in the fourth (i.) step is   greater than the SUM of the determined Chapter 7 Trustee fees and all allowed unsecured non-priority  claims, both amounts will be considered to be paid in full 100%. (2.) If the surplus value resulting from  the  operation described in the fourth (i.) step is less than the SUM of the determined Chapter 7 Trustee  fees and all allowed unsecured non-priority claims, we will determine the maximum amount that could be  applied to those claims considering the necessary Chapter 7 Trustee fee for such disbursement. In this  case allowed non-priority unsecured claims will receive less than a 100%.

Circular No. 99-01:
Chapter 13 Trustee’s Office Policy Regarding Plan Confirmation Requirements  Pursuant To §1325(a)(4) 3

The sum of the amounts paid to the allowed unsecured priority claims and to the allowed unsecured non-   priority claims in the hypothetical asset liquidation just concluded is the

Case Liquidation Value.

CREDITOR’S BEST INTEREST TEST

The present value of the Case Liquidation Value must be provided to each allowed unsecured  claim in a Chapter 13 Plan to comply with §1325(a)(4) requirement.

Sixth Step: To equalize the Case Liquidation Value, as of the effective date of the plan (hypothetical  Chapter 7 liquidation) with the future value of the same amount, in deferred cash payments under the  Plan, we need to add to it a discount rate. This operation is called the Present Value calculation. This  operation take in consideration the following factors:

Case Liquidation Value (amount available for each allowed unsecured claims under the hypothetical  Chapter 7 liquidation) PLUS (+) the Puerto Rico Legal Interest3 rate for the term of the proposed  Chapter 13 Plan. The accrued interest for the repayment period will be added to the Case Liquidation  Value, to establish the present value that must be paid to each allowed unsecured creditors in a Chapter  13 Plan to comply with §1325(a)(4).

Seventh Step: To determined if a Chapter 13 Plan Base complies with §1325(a)(4), the proposed  amount to be received under the plan, by not classified general unsecured, must be equal or greater  than  the present value of the Case Liquidation Value. Otherwise the proposed plan does not comply  with the Creditor’s Best Interest Test.

(a) If the Plan classified general unsecured claims we will determine the percentage than the balances of  those classified claims represents from the total general unsecured claims. Said percentage will then be  subtracted from the 100% percent of the present value require to general unsecured claims. (Example: If  general unsecured claims are $10,000 and the Plan classified 2 co-debtor claims that aggregate to  $2,000, the classified claims will represent 20%. If the present value of the hypothetical Chapter 7  liquidation is $5,000, the distribution to not classify unsecured claims should be equal to 80% of the  $5,000, or $4,000. If the amount distributed to general unsecured claims is less than $4,000 or 80% of  the present value, the plan does not comply with §1325(a)(4).

COMMENTS

The following are some issues related to the application of §1325(a)(4) and my Office position regarding  them.

1. The amount required by §1325(a)(4) to be paid, under the plan, to allowed unsecured claims,  does not include the Chapter 13 Trustee Fee. The aforementioned Section requires the Chapter 13  Trustee to distribute to allowed unsecured claims value, as of the

3 See: In Re: Rivera, 116 B.R. 17 (1990); Puerto Rico Legal rate of 6% is establish by Article 1646 of  the  Civil Code (31 L.P.R.A. §4591) Circular No. 99-01: Chapter 13 Trustee’s Office Policy Regarding  Plan Confirmation Requirements Pursuant To §1325(a)(4) 4 effective date of the plan, not less than the  amount that would be paid on such claim if the estate of the debtor were liquidated under Chapter 7 on  such date.  The Chapter 13 Trustee is authorized by the Bankruptcy Code (28 USC §586) to collect an  administration fee in the execution of his duties, which include the disbursement to creditors under a  confirmed plan. To deduct the Chapter 13 Trustee Fee from the present value distribution to allowed  unsecured claims under the plan, required by §1325(a)(4), will prevent allowed unsecured claims to  receive what the Bankruptcy Code requires them to receive. Therefore, the Chapter 13 Trustee’s Fee  must be added to the present value of allowed unsecured claims to be distributed under the plan  pursuant  to the hypothetical liquidation under Chapter 7.

2. The amount required by §1325(a)(4) to be paid, under the plan, to allowed unsecured claims,  does not include the Chapter 13 debtor’s attorney’s fees. In order for each allowed unsecured claim  to receive a value not less than what it would receive in a Chapter 7 hypothetical liquidation for purposes  of the Creditors’ Best Interest Test, the fees for the Chapter 13 debtor’s attorney must not be included in  such analysis. First, Chapter 13 debtor’s attorney’s fees are an administrative cost that does not exist in  a Chapter 7 case. Attorney’s fees to the Chapter 7 debtor’s attorney are typically paid before the  bankruptcy filing and are not part of the Chapter 7 distribution. Second, and most importantly, Section  1322(a)(2) requires 100% payment to §507 priorities; if the attorney’s fees are included in said analysis,  they would reduce the net payments to each non-priority allowed unsecured claim, as predicated by  §1325(a)(4). The recovery for those creditors will be proportionally reduced with any attorneys fees  allowed in the case, placing in the debtors’ attorney the control, not contemplated in the Code, of how  much they will received.

3. Relation between the amount required by §1325(a)(4) to be paid, under the plan, to allowed  unsecured claims and the classification of claims under §1322(b)(1). The Debtor may chose to  designate a class or classes of consumer unsecured claims and provide different treatment under the  terms provided for in §1322(b)(1). If by this classification other not classified allowed unsecured claims  will receive less than the present value of the amount that each allowed unsecured claims will received  in the hypothetical Chapter 7 liquidation, the §1325(a)(4) test is not met.

4. You can not compare percentage % recovery of allowed unsecured in an hypothetical  Chapter 7 liquidation with the percentage % recovery of allowed unsecured under distribution  in a Chapter 13 Plan to allowed unsecured claims. You can not compare two complete different  time  values and assume that they are equal, when they are equal in number. Let’s explain by means of  an example. If you have a liquidation value for allowed unsecured claims equal to $1,000 and there are  allowed unsecured claims (priority + general unsecured) in the amount of $100,000, the percentage of  recovery will be 1.00%. If the allowed unsecured claims under a 60 months Chapter 13 Plan will receive  $1,000 it will seems that the same 1.00% had been paid to allowed unsecured. Wrong. The equivalent  value of $1,000 in deferred cash payments (60 months) at the P.R. Legal Rate (6.00%) is $1,159.97 or  1.16%, therefore the plan does not pass the §1325(a)(4) test. In order to compare percentage you must  compare equal time values, to do that you must convert first the present value of the dollar amount  available in the hypothetical Chapter 7 liquidation and Circular No. 99-01: Chapter 13 Trustee’s Office  Policy Regarding Plan Confirmation Requirements Pursuant To §1325(a)(4) 5 determine its percentage  form the allowed unsecured claim. Then you will be able to compare percentages equalized in time.

5. To determine if a Chapter 13 Plan is adequately funded we perform the following arithmetic  operation:

! First Step: We add all payments to secured claims proposed in the plan (arrears, full-inplan, value,  interest to secured claims, legal fees related, adequate protection payments, etc.) and add to it the  Chapter Trustee Fee (8.00%).

! Second Step: Add all allowed unsecured priority claims that need [§1322(a)(2)] to be paid and then  add the Chapter 13 Trustee Fee. (Note: If present value of amount available under Chapter 7 hypothetical  liquidation is greater than 100% then the difference will be added to the priority claims.)

! Third Step: To the present value determined in the hypothetical liquidation analysis for unsecured  general claims we will add the Chapter 13 Trustee Fee.

! Fourth Step: Add together results from steps 1, 2 & 3 to determine the minimum PlanBase needed.

! Fifth Step: Compare the proposed Plan Base with the determined minimum Base, if proposed Plan  Base is less than determined minimum Plan Base, the plan is insufficiently funded.

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