Riches to Rags: What Can a Secured Creditor can Expect from a Chapter 13 Bankruptcy?

Terry Jessop & Bitner Newsletter

Issue 26, October 2015

The federal bankruptcy law is approaching 40 years old. In that time, it has experienced thousands of court interpretations from across the country, as well as several legislative amendments. At its core is Chapter 13, which is bankruptcy for employed folks who want to pay something back to their creditors.

WHY CHAPTER 13?

People file bankruptcy for lots of reasons, but filing Chapter 13 usually boils down to keeping property pledged to creditors. Bankruptcy lets a debtor change the terms of lending contracts. He can change interest rates, extend promissory notes, modify default provisions, reinstate loans, and change the amount of debt that has to be repaid. Contrast those powers with a Chapter 7 case, where the debtor either surrenders the collateral or scrambles to keep the current contract.

CREDITORS ARE ENTITLED TO INTEREST IN CHAPTER 13

Even though interest rates can be changed, the US Supreme Court has mandated the payment of interest to secured creditors. The question is at what rate? It should never be lower than the current prime rate (i.e., 3.25%), and at least for the near future, without extenuating circumstances, probably not more than 6.25%. The amount is determined by the “formula approach.” It starts with the prime rate and is adjusted upward based upon risks, arising from the circumstances of the estate, the nature of the security, and the duration and feasibility of the Chapter 13 reorganization plan. That is a lot of fancy talk to say you ought to be getting at least 4.75% (the halfway point between prime and 6.25%) or more in every case. If you are not, you have a good reason to object to the plan.

ARE YOU GETTING WHAT YOU SHOULD?

A secured creditor in bankruptcy is also entitled to be paid the fair market value of any collateral pledged. In the case of motor vehicles, that should mean NADA retail value. The courts will generally adjust that value for the current condition of the vehicle. If a creditor is not willing to push back, debtors’ attorneys are happy to pay trade-in value or something other than retail replacement value. If you are not getting that kind of value, you ought to be objecting to the plan.

WHAT’S ADEQUATE PROTECTION?

The debtor must make monthly payments to a secured creditor with depreciating collateral in a Chapter 13 beginning approximately 45 days after filing so long as a Proof of Claim is on file. This monthly payment prior to the court’s order approving a plan is called “Adequate Protection.” The amount paid should be no less than 1% per month of the vehicle’s value and should not extend longer than six months. Debtors’ attorneys like to take advantage of creditors who aren’t vigilant. They are competing with secured creditors for dollars. If Adequate Protection offered is too much or too quick, it interferes with the fees of the debtor’s attorney. Consequently, many plans try to stretch adequate protection for as long as 12 to 14 months or pay less than 1%. If you are not getting at least 1%, or are being stretched more than 6 months, you should be objecting.

Give us a call. We will be happy to file objections or advise you on any aspect of bankruptcy law.