JEFFREY P. NORMAN Chapter 13 Trustee Southern District of Ohio Eastern Division One Columbus 10 West Broad Street, Suite 900 Columbus, Ohio 43215-3449 Telephone (614) 420-2555 Facsimile (614) 420-2550 www.ch13columbus.com Background CHAPTER 13 TRUSTEE S POSITION STATEMENT ON 11 USC 1325(a)(4) BEST INTEREST OR LIQUIDATION TEST Prior to October 1, 2011, the mathematical equation to determine the liquidation test of 11 USC 1325(a) in Chapter 13 cases was liberally construed. In determining whether or not a plan met the best interest test typically there was a deduction of 10% for costs of sale and/or a hypothetical Chapter 7 Trustee fee without further calculation or evidence. The problem with this calculation was that it was formulaic; it ignored the time value of money and/or required no evidence from the debtor that such costs of sale were reasonable. The Trustee set out to evaluate the mathematical equation and recalculate it as necessary. Interest Rate In assuming for purposes of the best interest or liquidation test of 11 USC 1325(a)(4) that a stream of Chapter 13 plan payments were the same as a lump sum payment, the pre October 1, 2011 calculation ignored the time value of money. Clearly given a choice, a creditor and the Chapter 13 Trustee would prefer a lump sum payment and not deferred monthly payments in the form of a Chapter 13 plan payment. A debtor s promise of future payments is worth less than an immediate payment of the same total amount because the creditor cannot use the money right away, inflation may cause the value of the dollar to decline before the debtor pays and there is always some risk of nonpayment. The challenge for bankruptcy courts reviewing such repayment schemes, therefore, is to choose an interest rate sufficient to compensate the creditor for those concerns. Till v. SCS Credit Corporation, 541 U.S. 465, 124 S. Ct. 1951 (2004) at 474. 11 USC 1325(a)(4) provides as follows: (a)except as provided in subsection (b), the court shall confirm a plan if (4)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; The Trustee s position is that unsecured creditors must receive the value, as of the effective date of the plan of property they would have received in a Chapter 7 liquidation on such date. In other words, the plan must pay the liquidation value and account for the time value of money. The Trustee s position is that Till interest is the interest rate that should be compounded for each period of time that payment is delayed. The Chapter 13 Trustee position based on Till, is that an interest rate of 2 points over the Wall Street Journal prime rate, as of the day of filing, should be set as the effective Till interest rate in all Chapter 13 cases. We think it likely that Congress intended bankruptcy judges and trustees to follow essentially the same approach when choosing an appropriate interest rate under any of these provisions. Moreover we think Congress would favor an approach that is familiar in the financial community and that minimizes the need for expensive evidentiary proceedings. Till at 474-75. Taking its cue from ordinary lending practices, the approach begins by looking to the national prime rate, reported daily in the press, which reflects the financial market s estimate of the amount a commercial bank should charge a creditworthy commercial borrower to compensate of the opportunity costs of the loan, the risk of inflation and the relative slight risk of default. Because bankrupt debtors typically pose a greater risk of nonpayment than solvent commercial borrowers, the approach then requires a bankruptcy court to adjust the prime rate accordingly. The appropriate size of that risk adjusted depends, of course, on such factors as the circumstances of the estate, the nature of the security, and the duration and feasibility of the reorganization plan. Till at 478-79. In Hardy v. Cinco Fed. Credit Union (In re Hardy), 755 F.2d 75 (6th Cir. 1985), the 6 th Circuit held that in a solvent estate, a plan which proposed to pay 100% of unsecured claims without interest did not comply with 1325(a)(4), because it did not account for the time value of money hence the interest is required for solvent estates rule of thumb. But 1325(a)(4) is not limited to solvent estates. In a case decided later the same year as Hardy, the 6 th Circuit interpreted 11 U.S.C. 1325(a)(4) to require interest on all deferred payments to be made under the plan. In our view, a contrary conclusion would prevent the creditor from realizing the full present value of the amount owed. Cardinal Fed. Savings & Loan Assoc. v. Colegrove (In re Colegrove), 771 F.2d 119, 121 (6 th Cir. 1985). Unfortunately in the context of a Chapter 13 these calculations are not simple or routine. Very rarely in a Chapter 13 case do unsecured creditors receive the same amount monthly from a plan payment. However, if they did receive equal monthly payments over the life 2
of a Chapter 13 plan the excel calculation for the present value (PV) of a stream of future payments is: =pv(rate, nper, payment,[fv],[type]) 1. pv is the present value and is the calculated amount. 2. rate is the interest rate per month (Till interest). 3. nper is the number of payments. 4. payment is the payment amount as a negative number. 5. fv is future value. 6. type is either 0 end of period or 1 beginning of period. So the present value of an even stream of $500.00 monthly to unsecured creditors over 60 months is: =PV(.0525/12,60,-500) =$26,335.22 Adding the variables of most Chapter 13 plans which include payments of conduit mortgage payments, secured creditors and attorney s fees, all ahead of unsecured creditors makes the calculation even more difficult. The priority payment of conduit mortgages, adequate protection payments and the like leads to a stream of uneven monthly payments to unsecured creditors. Calculating present value of a stream of uneven payments to unsecured creditors is difficult because each payment must be considered to be a component of the total present value. Calculating the present value of each differing monthly payment to unsecured creditors using the same formula above but leaving the recurring payments argument blank is time consuming. So by example the present value of a single $500.00 payment, 36 months from now is: =PV(.0525/12,36,,500) =$427.29 But if you have 60 differing monthly amounts this calculation must be done sixty times and then summed. Adding up the present value of each of the single payments or string of payments gives the total present value of the stream of payments to unsecured creditors. An excel spreadsheet makes these calculations much easier but a calculated valuation of best interest or liquidation can be time consuming and for many lawyers/paralegals who are math/computer challenged impractical. 3
Costs of Sale Still further the Trustee believed that a blanket 10% deduction for costs of sale was excessive, not supported by any evidence (in most cases) or by local case law. Cases cited by the debtor s bar that a 10% deduction for costs was a reasonable standard, did not seem applicable. Based on a review of real estate closing transactions processed by the Trustee s office, it was determined that the average closing costs in a real estate transaction were 6.74%. Based on a review of sales of personal property processed by the Trustee s office, it was determined that there were very few cases that involved costs of sale. In the case of In re Weber, 140 B.R. 707 (BK S.D. Ohio 1992), the Court sustained a deduction of 10% of costs only because No argument has been advanced that 10% is an unreasonable estimate of those costs. Weber at 711. Weber did not seem to the Trustee to stand for the proposition that a debtor gets an automatic 10% deduction for hypothetical costs of sale; it is limited by its facts, specifically that there was no objection to the unreasonableness of these costs. In addition a blanket deduction of 10% without hearing effectively eliminates the introduction of evidence as to reasonableness. It also usurps the debtor s burden of proof as the plan proponent under 11 USC 1325. Conclusion Based on a net present value calculation the Trustee determined that the difference between calculating best interest with costs of sale plus Till interest vs. calculating best interest with no costs of sale with no Till interest was statistically insignificant. By example a debtor who has $30,000.00 of non-exempt assets who deducts 10% for costs of sale must make a stream of payments that has a net present value of $27,000.00. This equates to $512.62 per month to unsecured creditors in a Chapter 13 plan. Calculating a nonexempt value of $30,000.00, with no costs of sale and no Till interest, $500.00 per month for sixty months is the required plan payment to unsecured creditors and the net present value is $26,335.22 (as calculated above). In most calculations, taken by the Trustee, the difference in best interest calculations as adopted below was less than 2% and therefore insignificant. The Trustee therefore adopted for administration of Chapter 13 cases the following rules regarding satisfying the best interest or liquidation tests of 11 USC 1325(a)(4): 4
1. A debtor may deduct reasonable costs of sale and a Chapter 7 Trustee fee for determining the present value of the sum that must be paid to unsecured creditors to meet the best interest test of 11 USC 1325(a)(4). Debtors however must pay Till interest on any deferred payment to unsecured creditors. OR 2. For ease of administration the debtor may pay liquidation value without any deductions and forgo any required Till interest calculation to meet the best interest test of 11 USC 1325(a)(4). 5