In re Anderson.

No. 587-03218 JRG, No. 587-03236 JRGUnited States Bankruptcy Court, N.D. California
September 8, 1989

Michael Malter, Binder Malter, Milpitas, California.

Dee Ann Dugan, San Jose, California, United States Trustee.

Mary Jansing, San Jose, California.

Philip Bluer, San Jose, California.

William Priest, Jr., San Jose, California.

Individual Repayment Plans — Modification of Plans —Changes in Circumstances — Substantial and Unanticipated. —
When there are substantial and unanticipated changes of circumstances during the payment period of a Chapter 13 plan, the plan can be modified under Section 1329(a) so long as the requirements of Section 1329(b) are met. Here, a state law entitled debtors to a homestead exemption for equity held in property, but the residence was not exempted. In two Chapter 13 cases, the homes of debtors were voluntarily sold after the residences appreciated in value substantially and unexpectedly. The sales generated proceeds which exceeded liens and their allowed exemptions. However, due to the profits, the creditors were to receive less under the plan than they would in liquidation. Therefore, the Chapter 13 plans were modified to allow for an increase in plan payments.

See Sec. 1306(a) at ¶ 13,016, Sec. 1327(a) at ¶ 13,221 and Sec. 1329(a) at ¶ 13,229.

GRUBE, Bankruptcy Judge

In each of the above cases the Chapter 13 Trustee filed a post-confirmation motion to modify the Debtor’s Chapter 13 Plan pursuant to 1195,999 U.S.C. § 1329. The Trustee’s Motions were joined by other creditors and by the U.S. Trustee. An evidentiary hearing was held by the Court on May 23, 1989. The Court took the motions under submission to consider the evidence presented, the arguments of counsel, and the points and authorities filed by the moving parties and the Debtors.

The Anderson Case
Steven and Mary Anderson filed a petition under Chapter 13 of the Bankruptcy Code on June 12, 1987. Part of the Anderson’s bankruptcy estate consisted of their residence located at 525 Pine Street, Aptos, California (“Aptos residence”). The fair market value of this residence as listed in Anderson’s schedules was $160,000. Anderson elected a homestead exemption of $45,000 as provided under California Code of Civil Procedure § 704.710. Although the Anderson Chapter 13 case was filed as a joint petition, the Anderson marriage was dissolved during the pendency of the case leaving Steven Anderson (“Anderson”) with the equity in the residence. After filing the petition, Anderson filed a Chapter 13 plan on June 26, 1987. The plan provided that Anderson would pay to the Trustee $400 per month which would result in a 15% dividend to unsecured creditors. Paragraph 7 of the plan states that “[P]roperty of the estate shall remain so after confirmation.” On November 9, 1987, the plan was confirmed.

Fifteen months later, on February 15, 1989, Anderson filed an application with the Court seeking authority to purchase certain real property in Danville, California (“Danville residence”) for $314,000 as well as to incur secured debt with respect to such purchase. This property was to be the new residence of Mr. Anderson and the application also referred to a proposed sale of the Aptos residence with the net equity resulting from such sale, approximately $95,000.00, to be applied towards the down payment on the Danville residence.

Prior to the hearing on Anderson’s application the Chapter 13 Trustee filed an objection to the proposed purchase. It was the Trustee’s position that the “excess equity” in the Aptos residence, net proceeds over and above the homestead exemption, should be contributed to the plan so as to increase the dividend to unsecured creditors from 15% to 100%. This would require an increase in the aggregate payments from $8,000 to $51,000.

On March 16, 1989, Anderson filed his application seeking authority to sell the Aptos residence for a gross sales price of $217,000. The Trustee also objected to this sale, reiterating his position that the dividend to unsecured creditors should be increased and the Trustee then filed his motion to modify the plan pursuant to Section 1329 of the Bankruptcy Code. Specifically, the Trustee’s motion called for monthly payments to increase from $400 per month to $1,340 per month and for the term of the plan to be extended to 58 months so as to provide for a 100% dividend to unsecured creditors. The Trustee’s motion was joined in by the United States Trustee, the United States Attorney on behalf of the Internal Revenue Service, and the San Jose Municipal Employees Credit Union.

On March 13, 1989 the Court approved the purchase of the Danville residence and on March 24, 1989 the Court approved the sale of the Aptos residence. In both instances the Court overruled the Trustee’s objection without prejudice and set May 23, 1989 as the date for hearing the Trustee’s motion to modify the plan.

The Clark Case
Ronald and Jacqueline Clark (“Clark”) filed a petition under Chapter 13 on June 12, 1987. Part of the Clark bankruptcy estate consisted of their residence located at 4569 Shadowhurst Court, San Jose, California (“Shadowhurst residence”). The fair market value of the residence as listed in Clark’s schedules was $112,500. Clark elected and claimed a homestead exemption of $45,000 as provided under California Code of Civil Procedure § 704.710.

Concurrently wih the filing of the petition Clark also filed a Chapter 13 Plan. The plan provided that Clark would pay to the Trustee $235 per month for a term of 48 months. Consummation of the plan would result in a 10% dividend to unsecured creditors. As with the Anderson plan, the Clark plan provided at paragraph 10 that the Shadowhurst residence would remain property of the bankruptcy estate and “shall revest in the Debtor(s) at such time as a discharge is granted, the case is dismissed, or is hereafter specifically ordered by the Court”. The plan was confirmed by the Court on August 17, 1987.

Fourteen months later, on October 21, 1988, Clark filed a motion to authorize the sale of the Shadowhurst residence. The gross sales price of the property was $195,000 leaving net proceeds after satisfying the demands in escrow of approximately $71,350. After deducting the homestead exemption of $45,000 there remained approximately $26,350 in net proceeds from the sale. The Trustee, on October 26, 1988 filed his objection to the sale praying that he be allowed to submit a demand in escrow in the amount of $8,700, the amount necessary to increase the dividend to unsecured creditors from 10% to 100%.

On March 24, 1989 the Trustee filed his motion to modify the payments under the plan pursuant to Section 1329. This motion was joined in by the United States Trustee. Because of the similar factual and legal issues involved, the Trustee’s motion in Clark was consolidated with his motion in Anderson for purposes of hearing by the Court.

Legal Issues Presented

1. Is the excess equity interest of Anderson in the Aptos residence, which was transferred to the Danville residence, part of the bankruptcy estate?
2. Is the excess equity interest of Clark in the Shadowhurst residence part of the bankruptcy estate?
3. Are the excess proceeds, over and above the homestead exemptions, resulting from the voluntary sales of the debtors’ residences available to increase payments under the plans pursuant to Section 1329 of the Bankruptcy Code?

When a petition is filed a date of cleavage is created separating a pre-petition debtor from the post-petition bankruptcy estate. In re Tarrant, 19 B.R. 360 (Bankr. D. Alaska 1982). Under all chapters of the Bankruptcy Code a bankruptcy estate is created that is comprised of all of the debtor’s pre-petition property as defined in Section 541 of the Code. This property includes, but is not limited to, all legal and equitable interests of the debtor in property including all proceeds, product, offspring, rents or profits of or from property of the estate and any interest in property that the estate acquires after the commencement of the case. 11 U.S.C. § 541(a)(1), (6) and (7).

In a case filed under Chapter 13 a more expansive definition is given to property of the estate. In Chapter 13, the estate is comprised not only of the property set forth in § 541 but also all such property acquired during the pendency of the case and the debtor’s earnings from services performed during the pendency of the case. 11 U.S.C. § 1306(a).

Once a Chapter 13 Plan is confirmed, it binds the debtor and all creditors. 11 U.S.C. § 1327(a). Unless the plan provides otherwise, the order confirming the plan revests all property of the estate in the debtor. 11 U.S.C. § 1327(b). Clearly, the Anderson plan and the Clark plan committed the debtors’ residences to the successful performance of the respective plans and, by retaining the residences as property of the estate, sought to provide to Anderson and Clark the protections afforded by that status such as the benefits of the automatic stay under 11 U.S.C. § 362.

Counsel for the Clarks posited the theory that a debtor’s election of an exemption for property might act as a bar to the use of that property, or its proceeds, in subsequent modifications. However, the California homestead exemption, C.C.P. § 704.730, makes it clear that a debtor is entitled to exempt a certain dollar amount of equity in the property but that the property itself is not exempted.[1]

Since the residences remained property of each estate, any increase in value was likewise property of the estate. 11 U.S.C. § 541(a)(6) and § 1306(a)(1). “Excess proceeds” resulting from these voluntary sales are available to increase the dividend to unsecured creditors pursuant to a motion for modification. However, this analysis does not address the binding effect of confirmation or the inter-relationship between confirmation as set forth in § 1327 and the modification provisions set forth in Section § 1329 of the Bankruptcy Code.

As previously stated, confirmation of a plan created a contract binding on both the debtor and creditors. 11 U.S.C. § 1327(a). The principles of res judicata underlie this provision and apply to the terms of confirmed plans. In re Evans, 30 B.R. 530 (9th Cir. BAP 1983). In re Moseley, 74 B.R. 791 (Bankr. C.D. Cal. 1987).

Section 1329 was originally part of the Bankruptcy Reform Act of 1978 which became effective in October 1979. Pub.L. 95-598, 92 Stat. 2549. The Section as originally adopted read in pertinent part:

(a) At any time after confirmation of the Plan but before the completion of payments under such Plan, the Plan may be modified to —
(1) Increase or reduce the amount of the payments on such claims of a particular class provided for by the Plan;

11 U.S.C.A. § 1329(a) (1979).

In 1984 Congress responded to calls for reform of the Bankruptcy Code and passed the Bankruptcy Amendments and Federal Judgeship Act of 1984. Pub.L. 98-359, 98 Stat. 333. Among the amendments to the Code was a provision in Section 1329 clarifying and confirming that a motion to modify a Plan could also be brought by “the trustee, or the holder of an allowed unsecured claim.” 11 U.S.C.A. § 1329(a) (1989). Prior to the 1984 Amendments only one court had found standing for the trustee to bring a motion to modify under Section 1329. In re Koonce, 54 B.R. 643
(Bankr. D.C. 1985). While the obvious effect of the 1984 amendment was to confirm that the trustee or an unsecured creditor had standing to bring a modification motion, it remains a point of debate as to just what changes in circumstances warrant modification. See Gross, Preserving a Fresh Start for the Individual Debtor: the Case for Narrow Construction of the Consumer Credit Amendments, 135 U. Pa. L.Rev. 59 (1986).

A clear pattern seems to be emerging in other jurisdictions which have considered the question. A two-pronged test is developing which provides that a change in circumstances must have arisen since confirmation of the plan which is both substantial and unanticipated. In re Arnold, 869 F.2d 240
(4th Cir. 1989); In re Fitak, 92 B.R; 243 (Bankr. S.D. Ohio 1988); In re Euerle, 70 B.R. 72 (Bankr. D. N.H. 1987); and, In re Koonce, 54 B.R. 643
(Bankr. D. S.C. 1985).

This Court finds this two-pronged test, and the analysis upon which it is based, persuasive. By limiting upward modification to circumstances which were unanticipated at the time of confirmation, the res judicata effect of confirmation and the provisions of Section 1327 are recognized and preserved. By requiring that the circumstances must change in a substantial fashion, the debtor is also protected from normal variances in the value of assets which should be anticipated at the time of confirmation. Such approach protects the interest of the debtor and preserves the integrity of the confirmation process while, at the same time, recognizes the intent expressed by Congress in Section 1329.

To interpret Section 1329 in narrower fashion would potentially render the provision meaningless. To suggest that creditors cannot share in a debtor’s $1,300,000 winnings from a state lottery would fly in the face of the plain meaning of the Section. In re Koonce, 54 B.R. 643 (Bankr. D.C. 1985). Neither should a debtor be protected when his earnings rise from $80,000 to $200,000 per year even if his expenses rise in corresponding fashion. In re Arnold, 869 F.2d 240 (4th Cir. 1989). The Congressional intent underlying Chapter 13 is that the “debtor repay his creditors to the extent of his capabilities during the Chapter 13 period.” Id. at 242.

The approach is equally applicable when a downward modification is sought. A debtor who is required to pay 100% to unsecured creditors by the “best interest test” set forth in Section 1325(a)(4) should not be allowed, through the revesting provisions in Section 1327, to modify a plan downward to 10% without a clear showing of a substantial and unanticipated change in circumstances. In re Aneiro, B.R. 424 (Bankr. S.D. Cal. 1987); In re Root, 61 B.R. 984 (Bankr. D. Colo. 1986); In re Adams, 12 B.R. 540 (Bankr. Utah 1981). If the effect of revesting was to deny a Court power over property of the debtor following confirmation it would render Section 1329 a nullity from a practical point of view.

The Court concludes that the requirement for substantial and unanticipated change to have occurred is a “threshold” test which must be met in order for the Trustee’s motion to be considered. The Court finds that the requirements have been met. The Trustee presented the testimony of John V. Pinto, a real estate broker licensed since 1974, President Elect of the San Jose Real Estate Board, an instructor of real estate at San Jose State University, Director of the County Board of Realtors and a broker involved in the sale of over 1000 single family houses with an aggregate value of over $90,000,000. Mr. Pinto was certified by the Court as an expert in the sale of single family residences in Santa Clara County.

Mr. Pinto testified at length regarding the housing market in Santa Clara County from 1981 to the present, and particularly with respect to the unpredictability and volatility of the housing market from 1987 to the present time. Mr. Pinto testified with respect to two neighborhood marketing zones impacting on the Anderson and Clark residences, zones 23 and 12, that during the period from 1982 through 1986 the average increase in home prices was approximately 6%. Following the “Super Bowl Sunday” weekend of the 1987 prices generally increased at a rate of 15% and that figure remained consistent until late 1987. At that point in time, and continuing through 1988, home prices increased at the astronomical rate of 33% to 37%. Mr. Pinto stated that such increases were totally unanticipated and that real estate brokers would have anticipated appreciation of 10% to 20% at most.

During the fourteen months between confirmation of Anderson’s Plan and his motion to sell the Aptos residence, the residence appreciated $57,000 or 36% above its confirmation value. During the fourteen month period between confirmation of Clark’s plan and their motion to sell the Shadowhurst residence, the residence appreciated $82,500 or 73% above its confirmation value.

It cannot be questioned that such appreciation is substantial as well as being unanticipated in the real estate market which existed at the time. It must also be noted that the increase in value for both properties was due solely to unanticipated appreciation and not the home improvement efforts of either debtor. “When a debtor’s financial fortunes improve, the creditors should share some of the wealth.” Arnold, 869 F.2d at 243.

The Court is satisfied that the moving party has met his burden under the previously enunciated two-pronged test that the increase in value of both debtors’ residences was substantial and unanticipated. Once the threshold test has been met, modification under Section 1329 becomes possible.

The Court must next decide if the proposed modifications satisfy the requirements Section 1329(b)(1). A literal reading of the Statute dictates that the confirmation tests set forth in Section 1325 must be reexamined in considering the proposed modification. 11 U.S.C. § 1329(b)(1). What modification under Section 1329 requires is a new confirmation analysis under Sections 1322(a)-(c) and 1325(a). Of particular interest is the “best interest” test of Section 1325(a)(4) which requires that creditors must receive at least as much as they would be paid in a liquidation under Chapter 7 and the “ability to pay test” set forth in Section 1325(a)(6).

In the cases before the Court it is clear that the sale of each of the debtor’s residences generated proceeds far in excess of liens and the allowed exemption. For the unsecured creditors of both Clark and Anderson this means that they would now receive far less under the present plan than what they would receive in liquidation.

Clark Case
Mr. Clark testified at the time of the hearing that he used $35,000 from the net proceeds resulting from the sale of the Shadowhurst residence as a down payment on a mobile home to serve as a new residence. In addition, Jacqueline Clark had a surgical hip replacement through which $24,426 in medical expenses were incurred and approximately $10,000 of this expense remains outstanding and unpaid. Finally, the Chapter 13 Trustee holds $8,700 pending a ruling by this Court.

The portion of the proceeds used as a down payment for the mobile home, $35,000.00, clearly represents a transfer of a portion of the allowed homestead of $45,000. With respect to the surgical expenses of Mrs. Clark, the Court concludes that such expenses are reasonably necessary “for the maintenance or support of the debtor or a dependent of the debtor” as provided for in Section 1325(b)(2)(A). As such, these expenses can be viewed as reducing the “disposable income” available to pre-petition unsecured creditors. It further appears that, to the extent that Mrs. Clark’s medical expenses remain unpaid, claims may be filed under Section 1305 of the Bankruptcy Code which would allow those postpetition creditors to share in the distribution of additional funds presently held by the trustee. 11 U.S.C. § 1305(a)(2).

Based on the foregoing, the motion of the Chapter 13 Trustee is granted and the Trustee shall retain the sum of $8,700 for distribution to creditors in accordance with this decision.

Anderson Case
With respect to Anderson, the evidence indicates that he used the entire proceeds from the sale of the Aptos residence, including his allowed homestead exemption, for the down-payment on the Danville residence. He testified at the time of the hearing that the new residence has increased his monthly expenses substantially and, even though his fiance helps him make the payments, they operate at a monthly deficit. The actions of Anderson were voluntary and done in the face of the Trustee’s objection and motion to modify the payments under the plan. Having transferred the excess equity in the Aptos residence to the Danville residence Anderson now asserts that his plan can not be modified because, due to his increased expenses, he still does not have more than $400 a month to contribute to the plan. This argument is unpersuasive.

The Fourth Circuit considered this argument in In re Arnold, 869 F.2d 240
(4th Cir. 1989). As the debtor in Arnold had the benefit of contributions from his wife, a Certified Public Accountant, Anderson also receives an unspecified monthly contribution from his fiance, a “manager” at Pacific Bell.

Although the Court understands the personal situation that led Anderson to sell the Aptos residence and purchase the Danville residence the Court is persuaded that his plan should be modified. As the Fourth Circuit stated in Arnold:

Arnold’s situation is not one in which the debtor had no control over the increase in his expenses. Arnold chose to incur a relatively large expense so that he could increase the size of his home. There is no indication that Arnold could not have postponed such an expansion until his discharge in bankruptcy. Although a debtor who files for bankruptcy need not live in poverty during the payment period he should have some obligation to limit his expenses.

Arnold, 869 F.2d at 244.

Based on the foregoing, the motion of the Chapter 13 Trustee is granted. The Trustee shall lodge with the Court within 20 days a proposed form of Order in conformity with this decision:

The foregoing Memorandum shall constitute the Court’s Findings of Fact and Conclusions of Law. Each party shall bear its own costs.

[1] While the California Statute protects a judgment debtor from forced sale, the exemption may remain valid following a debtor’s voluntary sale of his residence. In re Cole, 93 BR. 707 (9th Cir. BAP 1989).

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