Chapter 13 Trustee May Seek to Recover the Non-Exempt Portion of a Federal Income Tax Refund for the Benefit of Creditors
by David Howard Stein
Duane Morris LLP; Newark, N.J.
The circuit court in In the Matter of Meza, 2006 U.S. App. LEXIS 26304 (5th Cir. Oct. 16, 2006), held that a chapter 13 trustee may move to modify a debtors’ chapter 13 plan to utilize the nonexempt portion of the debtors’ federal income tax refund received following confirmation of the chapter 13 plan, even though the debtors satisfied the unpaid plan balance while the trustee’s request for the modification was pending.
In Meza, the debtors filed a voluntary petition for chapter 13 bankruptcy in April 2001, and a chapter 13 trustee was subsequently appointed. On Jan. 17, 2002, the debtors filed their chapter 13 plan. The debtors’ unsecured creditors totaled $23,181 and were to receive under the chapter 13 plan a dividend payment of “approximately .00 percent” for their claims. Two years after confirmation, the trustee received the debtors’ 2003 federal income tax refund in the amount of $3,029. Under the plan, “the trustee was authorized to receive, endorse and apply to any delinquent payments under the plan, any income tax refund payable to debtors during the pendency of this case.” However, the court noted that the debtors were not delinquent in their plan payments. Nevertheless, the trustee wanted to retain the nonexempt portion of the tax refund, $1,545 of disposal income, to apply to the amounts due under the plan. Subsequently, the chapter 13 trustee filed a motion to modify the debtors’ plan that would increase the distribution to unsecured creditors from 0 percent under the plan to approximately 8.4 percent. The chapter 13 trustee provided the debtors 20 day's notice as required by Federal Rule of Bankruptcy Procedure 3015(g). However, on April 7, 2004, approximately a month before the scheduled hearing, the debtors paid the trustee the sum of $5,600, which funded the balance of all payments under the confirmed chapter 13 plan. To do so, the debtors refinanced their home, which was exempt property under the chapter 13 plan. On May 3, 2004, the debtors filed an objection to the trustee’s proposed modification asserting it was untimely. In addition, because they had already completed payments under the plan, the debtors claim that they were entitled to receive a discharge from the bankruptcy proceedings.
Following a hearing on July 7, 2004, the bankruptcy court ruled that the trustee’s modification request filed under 11 U.S.C §1329(a) was untimely since the debtors had completed all payments as required by the terms of the plan prior to the hearing. The district court affirmed the bankruptcy court’s decision.
The circuit court noted that, consistent with the language contained in 11 U.S.C. §1329(a), it is undisputed that a plan cannot be modified once all payments have been made. However, the chapter 13 trustee can seek an amendment of a chapter 13 plan if it is filed before payments are completed under the chapter 13 plan. Therefore, if the chapter 13 trustee files a modification motion and the debtor then attempts to complete the plan payments, the debtors will not be permitted to circumvent the provisions of §1329(b)(2)’s plain language that a “plan as modified becomes the plan unless, after notice and a hearing, such modification is disapproved.”
The circuit court recognized that when a debtor attempts to avoid increased payments by completing plan payments after a motion to modify is filed but before any hearing on a motion can be held, this scenario “would encourage gamesmanship on behalf of debtors and prevent them from “repaying creditors to the extent of their capabilities.” Id. at *14, citing In re Arnold, 869 F. 2d 240, 242. In this case, the chapter 13 trustee filed a proposed modification prior to the debtors' attempt to pay the plan balance, obviously making their final payment ineffective since the plan modification was timely filed and would become effective after notice. Unless the modification was disapproved, the modification as accepted precluded the debtors from making their final payment under the earlier confirmed chapter 13 plan.
Accordingly, the circuit court vacated the bankruptcy court judgment that dismissed the trustee’s modification motion and remanded the matter for further proceedings to permit the trustee to prosecute the amendment motion and to determine the motion and objection on the merits.