Chapter 12 Working Group:
Direct Payments


Background

The chapter 12 trustee system was modeled after the chapter 13 trustee system. As a result, trustees play a central role in the administration of chapter 12 cases. [ FN: The United States trustee system, originally constituted in 1978 as a pilot program in only a few judicial districts, was permanently adopted in 1986 in virtually every jurisdiction (Bankruptcy Administrators are used in Alabama and North Carolina rather than U.S. trustees). Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act of 1986, Pub. L. No. 99-554, 100 Stat. 3088 (codified as amended at 28 U.S.C. § § 581-589a (1994)). The system was created in order to remove case administration responsibilities from the judiciary. H.R. Rep. No. 178, 99th Cong., 2d Sess. 1, 18-22 (1986), reprinted in 1986 U.S.C.C.A.N. 5227, 5229-34. The legislative history reveals that the appointment of private trustees to administer bankruptcy estates adequately separates administrative and judicial functions and places the administrative duties in the branch of government most capable of exercising independent oversight. Id.] Among standing trustees’ statutorily-prescribed duties, [ FN: If the case load in a particular region warrants, the United States trustee for each region may, subject to the approval the Attorney General, appoint and supervise a standing chapter 12 trustee. 28 U.S.C. § 586(b) (1994).] are a host of services that benefit the court, the debtor, and the creditors. These duties include: accounting for all property received; investigating the financial affairs of the debtor; ensuring that the debtor performs in accordance with the provisions of a confirmed plan; maintaining information regarding the administration of the estate and furnishing information regarding the estate’s administration to creditors and other parties in interest; making a final report and filing a final accounting with the bankruptcy court and the United States trustee; appearing and being heard at any hearing concerning the confirmation of a plan or the sale of property of the estate; and taking control of the debtor’s assets and operating the farming operation if the court removes the debtor as debtor in possession. [ FN: 11 U.S.C. § 1204(a) (1994). It has been recognized that: The trustee is the nucleus of a reorganization; his or her responsibilities begin the day the case is filed and continue until the day the case is closed. The trustee is a fiduciary to all parties in interest, an advisor to the court and a source of information, education and mediation leading hopefully to confirmation. . . .[I]n the real world of debtors, creditors and the attendant emotions and fragile psyches, the trustee is often the difference between success and failure. His or her voice is one of reason endeavoring to find a common ground among the various adversaries. In re McCann , 202 B.R. 824, 830 (Bankr. N.D.N.Y. 1996).]

Disbursing plan payments is another important duty that standing trustees perform in connection with the administration of chapter 12 bankruptcy cases. [ FN: 11 U.S.C. § 1202(b) (1994).] The Bankruptcy Code requires the chapter 12 plan to "provide for the submission of all or such portion of future earnings or other future income of the debtor to the supervision and control of the trustee as is necessary for the execution of the plan." [ FN: Id. § 1222(a)(1). Accord id. § 1322(a)(1).] Additionally, the Code directs the standing trustee to make payments to creditors under the plan " [e]xcept as otherwise provided in the plan or in the order confirming the plan . . . ." [ FN: Id. § 1226(c). Accord id. § 1326(c).]

As recompense for performing the services in connection with the administration of the chapter 12 case, the standing trustee is directed to deduct from "each" of the debtor’s plan payments a percentage based upon any payments made under the debtor’s plan. [ FN: Id. § § 1202(d); 1226; 28 U.S.C. § 586(e). The Bankruptcy Code specifies the order in which plan payments are to be disbursed: (b) Before or at the time of each payment to creditors under the plan, there shall be paid-- (1) any unpaid claim off the kind specified in section 507(a)(1) of this title; and (2) if a standing trustee appointed under section 1202(c) of this title is serving in the case, the percentage fee fixed for such standing trustee under section 1202(d) of this title. 11 U.S.C. § 1226(b) (1994) (emphasis added).] The Attorney General, after consultation with the United States trustee, fixes the percentage fee to be charged by the standing trustee. In chapter 12 cases, the percentage fee may not exceed 10% of the first $450,000 "made under the plan" plus 3% of payments "made under the plan" after the "aggregate amount of payments made under the plan exceeds $450,000." [ FN: 28 U.S.C. § 586(e)(1)(B) (1994) (emphasis added).] The standing trustee "shall collect such percentage fee from all payments received" by the trustee in the cases in which such individual serves. [ FN: Id. § 586(e)(2) (emphasis added).] The amounts levied upon payments made under the plan are applied to offset three costs of the system. First, as previously indicated, a portion of such fees are applied toward the payment of the standing trustee’s personal compensation. [ FN: Id. § 586(e)(2)(A), (B)(i).] Second, a part of the fees are used to pay the salaries of the trustee’s staff and other actual overhead expenses. [ FN: Id. § 586(e)(2)(B)(ii).] Third, a portion of the fees are remitted to the "United States Trustee System Fund." [ FN: Id. § 586(e)(2).]

The laudable purpose of the Congressionally mandated payment structure is to maintain a predominantly self-funding program which compensates standing trusteesfrom funds generated by debtors who elect to participate in the bankruptcy system. More specifically, Congress intended those who reap the benefits of chapter 12 to assume a substantial portion of the costs of administering the bankruptcy estate by requiring that a percentage of estate assets be dedicated to funding the trustee system. This purpose is consonant with the long-standing precept under all chapters of the Bankruptcy Code that the payment of administrative expenses should be derived from the assets administered. [ FN: George H. Singer, Zeroing Out the Standing Trustee ’ s Percentage Fee: The 8th Circuit Approves " Outside the Plan " Payments for chapter 12 Debtors , 11 Norton Bankr. L. Adviser 7, 7 (1994). It is important to note that a chapter 12 standing trustee assumes significant financial risks. A trustee receives absolutely no remuneration for the services performed in any case in which judicial confirmation is not obtained. The compensation structure ’ s economy-of-scale results in trustees often receiving no compensation in cases in which substantial effort and outlay have been expended and receive increased compensation in other cases where the labor and expense have not been as great. See In re Harris , 200 B.R. 745, 748 (Bankr. D. Mass. 1996)(quoting with approvalIn re Savage , 67 B.R. 700, 706-08 (D.R.I. 1986)( " The ‘ no asset ’ or ‘ meager asset ’ cases can be handled professionally, because the system is not dependent on each individual matter to generate its own fees. " )).]

A number of the provisions of the Bankruptcy and Judicial Code governing the distributions to creditors and the trustee’s percentage fee refer to payments "made under the plan" or to claims "provided for by the plan," suggesting that Congress contemplated that certain payments might not be "made under the plan" or that there may be claims which are not "provided for by the plan." [ FN: See, e.g. , 11 U.S.C. § § 1225(a)(5), 1226(b) & (c) (1994); 28 U.S.C. § 586(e) (1994).] The directive is not, however, altogether clear on whether those payments can be sheltered from the statutory fee. Seizing the permissive grant of authority in the Code, [ FN: Section 1225, which sets forth the requirements of plan confirmation, provides: (a) . . . the court shall confirm a plan if-- . . . (5) with respect to each allowed secured claim provided for by the plan-- . . . (B)(ii) the value, as of the effective date of the plan, of property to be distributed by the trustee or the debtor under the plan on account of such claim is not less than the allowed amount of such claim . . . . 11 U.S.C. § 1225(a)(5)(B)(ii) (1994) (emphasis added). Accord id. § 1226(c) (set forth supra at text accompanying note 6). Notably, the ostensibly affirmative grant contained in section 1225(a)(5)(B)(ii) is absent from chapter 13 despite its many mirror-image similarities. See id. § 1325(a)(5)(B)(ii).] chapter 12 debtors have drafted plan provisions that enable them to act as disbursing agents in order to make "direct payments" (often inappropriately referred to in bankruptcy parlance as "outside the plan" payments), thereby avoiding payment of the statutory fee. [ FN: It is frequently argued that if a chapter 12 plan provides for direct payments, submitting that portion of the income to the standing trustee is not necessary to the execution of the plan as required under the statute because the plan specifically provides for the debtor to deal with that creditor ’ s claim in a manner that is separate and apart from the plan itself. See Jason S. Brookner, Primer on Debtor Direct Payments in chapter 12 Cases , 15 Am. Bankr. Inst. J. 26, 26 (1996). See also 11 U.S.C. § § 1222(a)(1), 1226(c), 1322(a)(1), 1326(c) (1994) (discussed supra at text accompanying notes 5-6).]

The courts are sharply divided on the issue of whether chapter 12 debtors may make direct payments to creditors whose claims have been impaired or modified under chapter 12 and whether the standing trustee’s percentage fee may be avoided on those direct payments. [ FN: The same dispute has arisen in the context of chapter 13. Compare In re Aberegg , 961 F.2d 1307 (7th Cir. 1992)(finding that bankruptcy courts have the discretion to permit debtors to act as disbursing agents and make direct payments, thereby avoiding the trustee ’ s percentage fee); Foster v. Heitkamp (In re Foster ), 670 F.2d 478 (5th Cir. 1982)(examining a number of factors, including the degree of debtor responsibility and reasons contributing to the need for relief under chapter 13, which govern the determination);In re Gregory , 143 B.R. 424, 427-28 (Bankr. E.D. Tex. 1992)(requiring justifiable cause as a prerequisite and the balancing of a number of considerations) with In re Bernard , 201 B.R. 600, 603 (Bankr. D. Mass. 1996);In re Harris , 200 B.R. 745, 748 (Bankr. D. Mass. 1996)(holding that to the extent that plan payments on modified or impaired claims are funded with future income, such payments must be submitted to the trustee and the court may not permit direct payment);In re Ford , 179 B.R. 821, 823 (Bankr. E.D. Tex. 1995)(opining that allowing debtors " to pick and choose those claims they will submit to the supervision of the trustee undermines the integrity of the entire trustee system " ).] At least three divergent approaches have emerged in the reported decisions.

The first view holds that all payments to creditors whose claims are modified under a chapter 12 plan must be both collected and disbursed by the standing trustee and are subject to the trustee’s fee. [ FN: See, e.g. ,In re Marriott , 161 B.R. 816, 819 (Bankr. S.D. Ill. 1993);In re Finkbine , 94 B.R. 461, 463-67 (Bankr. S.D. Ohio 1988).] A claim is generally deemed to be "modified" or "impaired" if the plan alters the legal, equitable or contractual rights of the creditor. [ FN: Wagner v. Armstrong (In re Wagner ), 36 F.3d 723, 725 n.3 (8th Cir. 1994)(defining an impaired claim as " one whose legal, equitable, or contractual rights have been diluted by the bankruptcy plan " ). Cf. 11 U.S.C. § 1124 (1994). A claim that is in any way modified or impaired by a plan is said to be " provided for by the plan " or " made under the plan. " Marriott , 161 B.R. at 819-21.]

The second view holds that either the trustee or the debtor may disburse a particluar plan payment, but irrespective of the identity of the party making the actual disbursement, the standing trustee’s percentage fee is computed as a percentage of the aggregate of all modified claims. The identity of the payor is not considered under this view. Rather, the reference in the Bankruptcy and Judicial Code to payments "made under the plan" focuses on whether the creditors’ rights are modified by operation of bankruptcy law. [ FN: Fulkrod v. Barmettler (In re Fulkrod ), 126 B.R. 584, 586 (Bankr. 9th Cir. 1991), aff ’ d sub nom. , Fulkrod v. Savage (In re Fulkrod ), 973 F.2d 801 (9th Cir. 1992).] Courts embracing this view generally hold that it is the actual treatment of the claim that determines whether the trustee’s percentage fee is owing. [ FN: See, e.g. , id. ;In re Golden , 131 B.R. 201, 203 (Bankr. N.D. Fla. 1991);In re Oster , 152 B.R. 960, 963 (Bankr. D.N.D. 1993);In re Cannon , 93 B.R. 746, 748 (Bankr. N.D. Fla. 1988);In re Sutton , 91 B.R. 184, 186 (Bankr. M.D. Ga. 1988);In re Logemann , 88 B.R. 938, 941 (Bankr. S.D. Iowa 1988);In re Hildebrandt , 79 B.R. 427, 429 (Bankr. D. Minn. 1987);In re Hagensick , 73 B.R. 710, 713-14 (Bankr. N.D. Iowa 1987);In re Rott , 73 B.R. 366, 375 (Bankr. D.N.D. 1987).]

The first circuit court to address the issue in chapter 12 was the 9th Circuit Court of Appeals in Fulkrod v. Savage (In re Fulkrod). [ FN: 973 F.2d 801 (9th Cir. 1992).] The Fulkrod court aligned itself with the courts that have adopted the second view. The court indicated that any construction of the statutory scheme that "renders superfluous the trustee fee provision or, for that matter, the trustee himself," should beavoided. [ FN: Id. at 801.] The 9th Circuit reasoned that it "is fairly certain" that if the debtor is allowed to confirm a direct payment plan and avoid the trustee’s percentage fee, "the trustee will receive nothing." [ FN: Id. at 802.] The court therefore concluded that a chapter 12 debtor may not escape liability for the trustee’s statutory compensation by making payments directly to an impaired creditor. [ FN: Id. at 803 (rejecting the suggestion gleaned from the decision of the bankruptcy appellate panel that " limited circumstances " may justify permitting a debtor to make direct payments on impaired claims without trustee compensation as an unauthorized reading of the statute).]

The third view focuses on the language of the Judicial Code and holds that the debtor may bypass the trustee and directly disburse payments on modified claims, with the trustee’s fee being calculated only on those payments actually "received" and disbursed by the trustee. [ FN: See 28 U.S.C. § 586(e)(2) (1994). See also supra text accompanying note 9. See, e.g. , Wagner v. Armstrong (In re Wagner ), 36 F.3d 723, 725 n.3 (8th Cir. 1994). Although the diversity of tests used to reach the result has created confusion and a nonuniform body of law, the majority of the courts have held that, under certain circumstances, a court may confirm a plan proposing a direct payment to creditors whose claims have been impaired or modified under the plan. See Michaela M. White, Direct Payment Plans , 29 Creighton L. Rev. 583, 598 (1996)(collecting cases); See also 3 Collier on Bankruptcy ô 326.02[3][c][ii], at 326-16 (Lawrence P. King et al. eds., 15th revd. ed. 1996).] Some courts under this view impose little or no restriction on a debtor’s ability to make direct payments to secured creditors and thereby shelter those payments from the calculation of the trustee’s percentage fee. [ FN: See, e.g. ,In re Cross , 182 B.R. 42 (Bankr. D. Neb. 1995), aff ’ d sub nom. , Lydick v. Cross , 197 B.R. 321 (D. Neb. 1995);In re Crum , 85 B.R. 878, 879 (Bankr. N.D. Fla. 1988);In re Land , 82 B.R. 572, 578-80 (Bankr. D. Colo. 1988);In re Erickson Partnership , 77 B.R. 738, 747 (Bankr. D.S.D. 1987), aff ’ d sub nom. , Yarnall v. Erickson Partnership , 83 B.R. 725, 727-28 (D.S.D.), rev ’ d on other grounds , 856 F.2d 1068 (8th Cir. 1988).] Other courts hold that a debtor’s right to make direct payments to impaired claimants is not absolute and employ guidelines for determining when direct payments should be permitted. [ FN: See, e.g. , Overholt v. Farm Credit Servs. (In re Overholt ), 125 B.R. 202, 212-13 (S.D. Ohio 1990); Westpfahl v. Clark (In re Westpfahl ), 168 B.R. 337, 364 (Bankr. C.D. Ill. 1994);In re Teigen , 142 B.R. 397, 401-02 (Bankr. D. Mont. 1992);In re Beard , 134 B.R. 239, 243-44 (Bankr. S.D. Ohio 1991);In re Martens , 98 B.R. 530, 534 (Bankr. D. Colo. 1989);In re Bettger , 105 B.R. 607 (Bankr. D. Or. 1989)(enunciating a multi-part test to be used as a template for determining whether direct payments should be allowed);In re Pianowski , 92 B.R. 225, 233-34 (Bankr. W.D. Mich. 1988)(setting forth thirteen nonexclusive factors courts should consider when determining whether to permit a debtor to serve as a disbursing agent for plan payments). See also In re McCann , 202 B.R. 824, 830 (Bankr. N.D.N.Y. 1996)(refusing to impose a multi-factored test which would serve as a scorecard for evaluation in favor of a case-by-case assessment with the caveat that direct payments on modified or impaired claims is the exception, not the rule).] The 6th Circuit in Michel v. Beard (In re Beard) [ FN: 45 F.3d 113 (6th Cir. 1995).] and the 8th Circuit in Wagner v. Armstrong (In re Wagner) [ FN: 36 F.3d 723 (8th Cir. 1994).] have allowed debtors to bypass payment of the trustee’s percentage fee through direct payment plans.

In holding that chapter 12 debtors may make direct payments on impaired claims and avoid the statutory percentage fee on those payments, the 6th Circuit in Beard noted that the statute is devoid of any reference to "‘payments that could have been received’" or other similar language"‘which would mandate payment of the percentage fee on a constructive receipt basis.’" [ FN: Id. at 118 (quoting Pianowski , 92 B.R. at 232).] Similarly, the 8th Circuit in Wagner rejected the trustee’s contention that the Bankruptcy Code precluded direct payments to secured creditors whose claims were modified under the plan. The court concluded that "the code does not prohibit plan provisions of this sort." [ FN: Wagner v. Armstrong (In re Wagner ), 36 F.3d 723, 726 (8th Cir. 1994). The Wagner opinion has been broadly interpreted by a number of courts. See, e.g. ,In re Cross , 182 B.R. 42 (Bankr. D. Neb. 1995)(interpreting Wagner to hold that debtors have the unfettered right to bypass the trustee and pay any debt directly absent a court order under section 105), aff ’ d sub nom. , Lydick v. Cross , 197 B.R. 321 (D. Neb. 1995);In re Wruck , 183 B.R. 862, 864 (Bankr. D.N.D. 1995). Indeed, the standing trustee in at least one jurisdiction (North Dakota, the jurisdiction from which Wagner emanated) is relegated to a case-by-case appointment and required to seek compensation under sections 326 and 330 of the Bankruptcy Code like any other professional.] Consequently, under Wagner, a debtor has the discretion to draft a plan that provides for direct payments, thereby avoiding payment of the trustee’s fee. The court expressly rejected the Fulkrod analysis, finding that it was based upon policy arguments rather than a close textual analysis. The Wagner court found that direct payment provisions in chapter 12 plans "are not in conflict with the bankruptcy code" and are "valid" even if they preclude the payment of the percentage fees from those payments made directly by the debtor. [ FN: Wagner , 36 F.3d at 727-28. Accord Pelofsky v. Wallace , 102 F.3d 350, 353, 356 n.7 (8th Cir. 1996)(affirming the principles set forth in Wagner but indicating that because " the meaning of section 586 concerning calculation of the standing trustee ’ s percentage fee under section 586(e) has split inferior federal courts, perhaps Congress, or the Supreme Court, will clarify the issue " ).]

Proposal

28 U.S.C. õ 586(e) (1994) should be amended to clarify that the calculation of the standing trustees percentage fee should be based upon the aggregate of those payments "made under the plan" on account of claims impaired or modified by operation of bankruptcy law regardless of whom makes the payment.

Discussion

The Proposal clarifies that the calculation of the statutory percentage fee should be based upon payments made on account of claims that are "impaired" or "modified" under a plan of reorganization. The Proposal does not disrupt the provisions in chapter 12 which allow a debtor to make certain payments directly in limited circumstances. [ FN: It should be recognized that permitting a debtor to act as a disbursing agent for payments made under the plan makes it difficult for a standing trustee, who is required to monitor the plan payments and make an accounting of disbursements, to perform its fiduciary obligations. The impetus for making payments directly, however, will vanish in the vast majority of cases, if a debtor can no longer escape liability for the statutory fee.] There may be legitimate reasons for permitting such payments. The bankruptcy court should have the discretion to make the determination. Such direct payments, however, if made on claims that are impaired or modified "under the plan," would not be exempt from the calculation of the percentage fee.

The inconsistent case law that has emerged from an interpretation of the labyrinthine languagein section 586(e) threatens the integrity of the very trustee program that Congress viewed as integral to chapter 12. "Payments to creditors whose rights have been modified by operation of bankruptcy law is the essence of case administration, a function legislatively assigned to the chapter 12 trustee under the scheme Congress created." [ FN: Singer, supra note 13, at 10.] Authorizing chapter 12 debtors to distribute plan payments in order to circumvent the trustees’ fee is fundamentally inconsistent with the Congressional determination that a percentage of plan payments should fund the entire system. The system, as a result, is suffering. The present state of the law on direct payments in some jurisdictions impairs the bankruptcy system’s ability to attract and retain qualified individuals to serve as standing trustees and assume the fiduciary obligations imposed by the Bankruptcy Code.

Competing Considerations

The Proposal calls into question the necessity of a standing trustee in chapter 12 cases and whether a principled basis exists for differentiating between a chapter 12 debtor in possession and a chapter 11 debtor in possession. If the Commission views the oversight and administrative functions performed by the standing trustee in chapter 12 as necessary to the administration of chapter 12 cases, the fundamental question then becomes how best to ensure an adequate compensation structure in order to fund the system. Absent an adequate assurance of remuneration for the services provided, the United States trustee will simply be unable to attract and retain qualified individuals willing to serve as standing trustees.

It has been argued that standing trustees should be compensated like all other professionals based upon the reasonable value of the services rendered. Similarly, the reasonableness of that compensation in an individual case should be subject to judicial review. The genesis for this contention is that the statutory percentage fee in chapter 12 (due to the often very substantial debt payment being serviced under a plan) is disproportionate to the amount of time and resources actually expended in administering an individual case. Although the argument has some facial appeal, it fails to accord proper consideration to the fact that the percentage fee structure contemplates an economies-of-scale method of compensation in order to fund the administration of the entire system. [ FN: See supra note 13 (noting that standing trustees receive no remuneration for the services performed in any cases which do not result in a confirmed plan since the fee is calculated based upon disbursements made under the plan) .] Under a self-funding system entirely dependent upon fees based on a percentage of payments, some debtors will inevitably pay more than their share of the costs of the trustee program. This is, however, necessary because other debtors that avail themselves of the system will pay less, or nothing at all.

The statutory percentage fee, in some cases, adversely effects feasibility of a plan of reorganization because the larger debt service can make the fee substantial. Additionally, the imposition of the 10% fee on payments made on modified claims under a plan effectively reduces, and often eliminates, the amount of disposable income that would otherwise be available for unsecured creditors. However, the collective proceeding that chapter 12 offers is voluntary and benefits both debtors and creditors who must each share the concomitant risks and costs of administration.