Chapter 13 of the Bankruptcy Code allows individual debtors with regular income to reorganize their debts by catching up on mortgage arrearages, potentially stripping off 2nd and 3rd mortgages on their homes, restructuring payments on vehicles, and discharging a broader array of debts than can be discharged in a Chapter 7 filing. A Chapter 13 filer makes payments to a Chapter 13 Trustee who then makes payments to creditors based on the plan proposed by the Debtor.
Because the Chapter 13 plan payments are based on the individual or married couple’s “projected disposable income,” the major stumbling block for many debtors who file for Chapter 13 protection is living within a no-frills budget that allows the debtor to meet his payment obligations.
In short, the debtor’s “disposable income” is basically whatever income you might receive minus your reasonable and necessary expenses. However, in 2005, when Congress amended the bankruptcy laws, they defined a person’s “current monthly income” in such a way that it “excludes benefits received under the Social Security Act.” For Chapter 13 purposes, a person’s disposable income is defined in reference to their “current monthly income.” Thus, under a straightforward reading of the Bankruptcy Code, a debtor should be allowed to exclude any Social Security benefits in calculating their Chapter 13 plan payment – an obvious benefit to a debtor as it allows the debtor to keep such benefits without having to turnover any portion of the funds to creditors.
However, Chapter 13 bankruptcy trustees were arguing that it was, nonetheless, “bad faith” for a person to exclude Social Security income when calculating their plan payments. For debtors, the issue then became whether they are acting in good faith when they did something that the Bankruptcy Code expressly allows.
For Michigan residents, the Sixth Circuit, in the case of Baud v. Carroll (link), has held that a Chapter 13 debtor’s projected disposable income does not include Social Security benefits, but did not have the chance to consider the issue of whether a debtor acts in “good faith” by excluding the benefits.
Other recent Circuit Court decisions have stepped in and answered the “good faith” question and have found that a debtor does not act in “bad faith” when the Debtor does what the Bankruptcy Code specifically allows.
The Tenth Circuit has recently decided the case of In re Cranmer (link). In that case the court found that a debtor was not acting in bad faith by not including Social Security income when calculating plan payments.
Less than one week later, the Fifth Circuit came to the same conclusion in the case of In re Ragos (link).
These recent decisions are of tremendous benefit to Chapter 13 filers and will allow some debtors to keep more of their income during the course of their Chapter 13 plans – helping to ensure that Debtors will have adequate income to meet their needs and the emergencies that arise. Chapter 13 filers are more likely to make their plan payments when they have adequate resources to take care of their necessities.