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What Happens If a Debtor Inherits Money After Their Chapter 13 Plan is Confirmed?

According to Robin Miller of CBAR,  it depends on the totality of the facts and circumstances of the case. 

After the Chapter 13 debtor husband received $250,000 in life insurance benefits due to the death of his debtor wife, the bankruptcy court did not abuse its discretion in granting the husband’s motion for modification of his confirmed plan, and denying the Chapter 13 trustee’s competing plan modification proposal.

The husband’s proposed modification called for an increase in monthly plan payments to accelerate the completion of payments under the plan and for a distribution of $15,000 to holders of unsecured claims, while the trustee’s proposal provided that $104,023 of the life insurance proceeds would be used to pay all allowed unsecured claims in full as well as the trustee’s statutory fee.

The US District Court agreed with the Bankruptcy’s Court’s decision to exercise discretion under 11 USC 1329 to deny the Trustee’s Modification as follows:

[Debtors] filed this case under chapter 13 primarily to keep their residence in which they had lived since 1990. Had Mrs. McAllister not died unexpectedly and had Mr. McAllister’s physical condition not deteriorated, they would have come out of their case with their residence, Mr. McAllister would continue to work, and the life insurance policies on their lives would provide a source of funds for the survivor’s support in later years. Creditors in this case could not have had a different expectation.

Things did not work out that way. Mr. McAllister became unable to work shortly before his wife’s death, and she died unexpectedly. Given Mr. McAllister’s age, medical condition, and inability to work, it is clear to the Court that Mr. McAllister needs the insurance proceeds that the Trustee’s modification would pay to creditors for his future support and for the support of his family.

A primary factor for the Court to consider in exercising its discretion to approve or disapprove a modification is the debtor’s ability to pay. It is true, of course, that a substantial amount of money is available to pay creditors in full. But doing so would severely impair an aging, disabled debtor with little prospects for significant future income or any way to replace an asset that he and his wife counted on to sustain them in future years.

Application of the ability to pay standard requires a realistic assessment of the debtor’s financial situation and must include consideration of the debtor’s future needs. The need to consider a debtor’s future needs arises from the “fresh start” policy of chapter 13 that is one of the fundamental concepts that properly guides a court’s discretion. In the circumstances of this case, Mr. McAllister cannot use the proceeds to pay his creditors without substantial harm to future needs. Because of that clear need, he does not have the ability to pay without impairing the “fresh start” that the Bankruptcy Code promises.

Application of the ability to pay standard in this manner is not unfair to creditors. They could not have expected the untimely death of Mrs. McAllister. They did not extend credit on the basis of her life insurance policy, and they are receiving no less than what the original plan promised or what they would receive if this were a chapter 7 case.

In this regard, it is noteworthy that [Debtors] could easily have obtained chapter 7 relief, but at the cost of losing their residence of over 20 years. Their decision to proceed under chapter 13 instead of chapter 7 affected, in reality, only one other creditor: the lender holding a security deed on the home. That lender will receive at least the value of its claim, i.e., the value of its collateral, 11 U.S.C. § 1325(a)(5)(B). Taking into account the additional costs the lender would have incurred and possibly the lower value that the lender would have received if it had proceeded with foreclosure, the result of this chapter 13 case is arguably economically beneficial to the lender.

Mr. McAllister’s retention of his home is an important benefit that he received from proceeding under chapter 13 rather than chapter 7. But that benefit does not justify depriving him and his family of the expected benefit of life insurance proceeds upon the death of his wife because it occurred far earlier than anyone expected.

This is not a “windfall” case. A windfall occurs when a debtor receives an unanticipated, fortuitous, and significant benefit without earning it or planning it. Examples of windfalls include a debtor’s winning the lottery or receiving a substantial inheritance or life insurance proceeds upon the death of someone other than a spouse. The situation here differs dramatically in nature and degree from such “windfall” circumstances. A debtor in her 40’s with stable employment receiving significant proceeds upon the death of a parent is in a far different situation than Mr. McAllister because she has continuing income for her support and the opportunity in future years to save for her retirement years. Mr. McAllister, in contrast, has neither. And surely Mr. McAllister would prefer to have his wife instead of the insurance money. His situation is a tragedy, not a windfall.

To the contrary, full payment of the creditors in this case would be a windfall to them. Again, they could not have anticipated this situation and clearly did not rely on it in extending credit or in evaluating their treatment under the original plan. Of course, creditors expected to be paid and did not anticipate that [Debtors] would end up in bankruptcy. Nevertheless, a debtor’s bankruptcy is always a possibility; once it happens, consideration of fairness to creditors takes place in the context of bankruptcy principles. No concept of fairness to creditors in a bankruptcy case requires that they receive the benefit of Mrs. McAllister’s death due to the fortuitous circumstance that it occurred before the debtors completed their payments under the plan rather than after.

Finally, the Court notes that Mr. McAllister has proposed to commit a significant amount of the proceeds to his unsecured creditors that will permit them to receive almost 15 percent of their claims. This is much more than the creditors would have received in a chapter 7 case and, as such, is a fair result for them. In the totality of the circumstances of this case, the Court concludes in the exercise of its discretion that it is not appropriate to approve the Trustee’s modification.

(Modification Order at 38-40 (footnote omitted).)

Townson v. McAllister, Case No. 4:14-cv-106 (N.D. Ga., Oct. 14, 2014)