Alexandria, Va. — As chapter 13 bankruptcy plans are typically structured without a buffer for any unforeseen costs (such as a car repair or medical procedure), an article in the February ABI Journal explores how establishing a reserve fund in these cases helps both debtors and creditors. Chapter 13 of the Bankruptcy Code provides for the adjustment of debts of an individual with regular income by allowing a debtor to keep property and pay debts over time, usually three to five years. The chapter 13 reserve fund concept will “provide flexibility to the rigid projected-expense calculations that the Bankruptcy Code mandates, which puts debtors in a better position to withstand unexpected financial events, which are virtually certain to occur, without having their plans derailed,” judicial clerks John Andreasen and Samuel Rabuck of the U.S. Bankruptcy Court for the Northern District of Illinois (Chicago) write in their article. “Although unsecured creditors do not seem like the obvious beneficiaries of the reserve funds discussed, some simple math and common sense reveal just how much they stand to gain.”

Research pointed out that plan failure is the ultimate result of 66 percent of all chapter 13 cases filed nationwide, according to data reviewed by Andreasen and Rabuck from a 12-month-period ending June 30, 2017. “Most of these failures are due to nonpayment of monthly plans,” they write. “After a chapter 13 plan fails, debtors typically do one of two things: (1) refile a chapter 13 case; or (2) stay out of bankruptcy and allow the race to the courthouse to commence among creditors.”

To avoid jeopardizing chapter 13 plans, the authors found that the Southern District of Texas started creating reserve funds for chapter 13 debtors to allow these debtors to pay for unforeseen costs that may arise throughout the life of the plan. “Under the Southern District of Texas’s approach, the appropriateness of each reserve fund is determined on a case-by-case basis, and participation in this program is completely voluntary,” according to Andreasen and Rabuck. “Upon completion of the plan, any money remaining in the reserve fund is returned to the debtor.”

Inspired by the Southern District of Texas's initiative, the ABI Consumer Commission formally recommended adoption of this practice nationwide. Under the ABI Consumer Commission's proposed statutory amendment, the chapter 13 reserve fund would be limited to one month of the debtor's scheduled expenses, and the fund may be restored by additional debtor contributions to the extent of any disbursements from the fund. “For debtors with incomes above the median, the excess funds would be disbursed to unsecured creditors after the plan is completed,” Andreasen and Rabuck write. “Debtors with incomes below the median retain the funds at the completion of their plans.”

As debtors are provided a better cushion to make payments on their chapter 13 plans, the authors also show that reserve funds will benefit unsecured creditors “because empirical evidence suggests they lengthen the average lifespans of chapter 13 plans, which means that unsecured creditors receive more money in plan payments.”

To obtain your copy of “Water for Plants: How Reserve Funds Keep Chapter 13 Plans Alive on Rainy Days and Benefit Unsecured Creditors,” please click here.

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ABI is the largest multi-disciplinary, nonpartisan organization dedicated to research and education on matters related to insolvency. ABI was founded in 1982 to provide Congress and the public with unbiased analysis of bankruptcy issues. The ABI membership includes nearly 11,000 attorneys, accountants, bankers, judges, professors, lenders, turnaround specialists and other bankruptcy professionals, providing a forum for the exchange of ideas and information. For additional information on ABI, visit www.abiworld.org. For additional conference information, visit http://www.abi.org/education-events.