Best Interests of Creditors An Equitable Rule in the Eighth Circuit
Protection of Unsecured Creditors
11 U.S.C. §1325 provides two standards designed to protect general unsecured claims. Section 1325(a)(4) establishes the "best interests of creditors" test, and §1325(b) establishes the "ability to pay" test. Under §1325(a)(4), the court exercises its judicial discretion to make findings that plan confirmation standards are met.
Although the National Bankruptcy Review Commission proposed guidelines to avoid variations in interpretation of "ability to pay" in the national courts, it did not address any change to the "best interests of creditors" test.1
In Van Der Heide, the Bankruptcy Court for the Eastern District of Missouri denied confirmation of the chapter 13 plan. The trustee had objected to confirmation, claiming that the plan did not meet the "best interests of creditors" test since general unsecured creditors would have received more in a chapter 7 liquidation. Proposed plan payments to general unsecured creditors were in the total amount of $2,858. The trustee claimed that a sale of the residential real estate owned by the debtor and his wife, as tenants by the entirety, would yield $24,495 after payment of the first mortgage and a real estate sales commission. Since this amount, less exemptions, was not being paid to unsecured creditors, the trustee argued against confirmation. The debtor did not disagree with the $24,495 value, but asserted that only one-half of that value was the property of the estate because of the spouse's interest. The debtor further asserted that after the deduction of Missouri exemptions totaling $9,900, only $2,858 was available for unsecured creditors, and therefore, the "best interests of creditors" test was met. The bankruptcy court denied confirmation and directed the debtor to amend the plan to pay unsecured creditors $14,595. When the debtor failed to do so, the case was dismissed. The debtor appealed to the Bankruptcy Appellate Panel (BAP) and argued that 1) the tenancy by the entireties property serving as his residence was not property of the estate; 2) the property is exempt from attachment; and 3) in any event, the debtor only owns a one-half interest in the property. In re Gerard Robert Van Der Heide, 219 B.R. 830 (8th Cir. BAP, 1998).
Affirming the bankruptcy court, the BAP cited Garner v. Strauss (In re Garner), 952 F.2d 232 (8th Cir. 1991), and held that §541(a)(1) was broad enough to include an individual's interest in property held as a tenant by the entirety. This conclusion is consistent with other circuits. Napotnik v. Equibank & Parkvale Sav. Ass'n, 679 F.2d 316 (3rd Cir. 1982); In re Grosslight, 757 F.2d 773 (6th Cir. 1985). Indeed, the Code requires this result under 11 U.S.C. §522(b)(2)(B), stating that an interest in tenancy by the entirety property is exempt if it is not subject to attachment under applicable non-bankruptcy law. The parties had stipulated that the debts burdening the entireties property were incurred jointly with the debtor's spouse and that the property was not exempt from attachment. It is not apparent why the debtor's spouse had not also filed bankruptcy given that the debts were joint, and thus the entireties property was subject to attachment.
Applying 11 U.S.C. §363(h), the BAP found that a chapter 7 trustee would be entitled to sell the entire property and distribute the proceeds to the respective interests. Looking to Missouri law, the BAP concluded that each spouse has an undivided interest in the whole, that 100 percent of the property was property of the estate and that the proceeds were distributable to the joint creditors. In affirming the bankruptcy court, the BAP pointed out that a majority of the circuits allow joint creditors to reach the non-filing spouses' interest in the tenancy by the entireties property.2
Chief Judge Koger wrote a strong dissent to the majority, stating that the holding of In re Garner required that the non-debtor spouse be paid her share of entireties property proceeds before unsecured creditors received the distribution. Therefore, he reasoned, the "best interests of creditors" test was not violated by the debtor's plan.
Test Is an Equitable One
The protections for unsecured creditors are enforced at the discretion of the courts. The statutory scheme requires that the debtor's property rights and value (the estate) must be determined on the date of the petition. In re Carpet Mills v. Tedford, 691 F.2d 392 (8th Cir. 1982).3 The exception is post-petition assets under 11 U.S.C. §1306(a). It is reasonable to conclude that §1325(a)(4) requires the court to determine the liquidation value of all non-exempt property, taking into account liquidation costs or chapter 7 administrative expenses. Matter of Barth, 83 B.R. 204 (Bankr. D. Conn. 1988). Thus, in the Van Der Heide case, the "best interests of creditors" test should be applied based on what Missouri law allows as exempt.
Upon review, the Eighth Circuit reversed and remanded the BAP decision. The court stated that its holding in In re Garner dictated that "only one-half of the hypothetical sales proceeds, less exemptions, are subject to the bankruptcy estate." In re Gerard Robert Van Der Heide, 164 F.3d 1183, 1185. The Eighth Circuit panel held that the trustee could liquidate the residence because the spouse was jointly liable for the debt, and that entireties property is not exempt from an individual's bankruptcy estate, citing In re Sumy, 777 F.2d 921 (4th Cir. 1985). The panel then went on to say that its prior decision in In re Garner defined the respective rights of the debtor and his spouse and that the BAP's decision was a misconstruction of the Garner ruling.
Holding that the result in In re Garner was an equitable rule that preserved the balance of state and federal law, the court pointed out that the legislative history of 11 U.S.C. §541 requires the protection of co-ownership interests.4 The court then explained that if it were to apply In re Garner to the facts in the instant case, Van Der Heide would be entitled to pay $2,858 to discharge the joint debts. The creditors would then be entitled to pursue the spouse; however, in doing so, they could not reach the entireties property since there are no longer joint debts. Pointing out these "anomalies," the court then stated that if the debtor invokes In re Garner, he is only entitled to one-half of the total exemption allowed by law, and thus, creditors get another $4,000. In a footnote, the Eighth Circuit said that In re Garner might not apply if the spouse filed bankruptcy, and that such a filing also might violate the good faith provisions of 11 U.S.C. §1325.5
The Eighth Circuit emphasized that property rights are determined by state law, and bankruptcy should not require a different analysis. The court sought to balance state property law and the confirmation requirement of the "best interests of creditors." This decision demonstrates the difficulties resulting when a hypothetical test is manipulated by the debtor.
2 Edmonston v. Murphy (In re Edmonston), 107 F.3d 74, 75 (1st Cir. 1997) (holding that a joint creditor "may reach and apply the entireties property."); Liberty State Bank & Trust v. Grosslight (In re Grosslight), 757 F.2d 773, 776 (6th Cir. 1985) (holding that joint creditors could reach entireties property "because each spouse owns the whole estate..."); Napotnik v. Equibank & Parkvale Sav. Ass'n, 679 F.2d 316, 321 (3d Cir. 1982) ("[W]e hold that a creditor with a joint judgment on a joint debt may levy upon the property itself and thus upon the interests of both spouses."). See, also, In re Smith, 200 B.R. 213, 215 (Bankr. E.D. Mo. 1996) (holding that debtors' joint creditors "could access the entirety equity under Missouri non-bankruptcy law."); In re Mayes, 141 B.R. 669, 671 (Bankr. E.D. Mo. 1992) (directing trustee to distribute proceeds from liquidation of debtors' entireties property to joint creditors only). Return to article
4 H.R. Rep. No. 95-595 at 177 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 6137. "The bill also changes the rules with respect to marital interests in property...With respect to other co-ownership interest(s), such as tenancies by the entirety...the bill does not invalidate the rights, but provides a method by which the estate may realize on the value of the debtor's interest in the property while protecting the (co-tenant's) rights." Return to article
5 See In re Siegfried, 219 B.R. 581 (Bankr. D. Colo. 1998), where a bad faith conversion from chapter 13 to 7 brings §348(f)(2) into play, bringing into the estate all property at the date of the conversion. Return to article