Death and Bankruptcy Discharge Are Not Mutually Exclusive
Reprinted with permission from the April 17, 2015 issue of The Legal Intelligencer. © 2015 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
Typically, upon completion of a Chapter 13 plan, a debtor can expect to receive a discharge and a "fresh start" free of his or her prior obligations. What happens, however, if the debtor dies before the end of the five-year plan term, but the liquidation minimum under Section 1328(b)(2) has been met? Is the debtor still entitled to a discharge, or do the prior debts now become claims against the decedent's probate estate? In a recent decision, In re Lizzi, 2015 Bankr. LEXIS 1098 (Bankr. N.D.N.Y. Apr. 3, 2015), a New York bankruptcy court addressed this question in favor of the debtors over the objection of the Internal Revenue Service by finding that a deceased debtor may obtain a hardship discharge.
The Lizzi decision was a consolidation of two separate cases involving deceased debtors, Frank Lizzi and Dorothy Devane-Jones, each of whom faced IRS objections requiring a determination of identical issues.
Debtor Lizzi filed a voluntary petition for relief under Chapter 13 of the Bankruptcy Code in early 2009. Lizzi's bankruptcy filing was evidently precipitated in significant part by a tax arrearage owed in connection with his residence, as well as a large obligation owed to a family member, student loans, and debt arising from his medical practice. The IRS filed a claim consisting primarily of priority unsecured debt. Lizzi's Chapter 13 plan was confirmed in mid-2009. The confirmed plan provided for monthly payments for 60 months. Lizzi made 50 monthly payments prior to his death in 2013. At that time, creditors holding priority claims had not been paid in full, and unsecured creditors had received nothing. Lizzi's daughters proposed to pay the balance needed to satisfy the liquidation minimum.
Debtor Devane-Jones filed her Chapter 13 petition in late 2010, which was precipitated by a failed business venture and her husband's job loss. Devane-Jones had substantial debt associated with her business, including payroll and sales tax debt owed to the IRS. The IRS filed a claim consisting of secured, priority unsecured, and general unsecured debt. Her Chapter 13 plan was confirmed in early 2011. The plan provided for 36 monthly payments of which approximately 29 were made prior to her death in early 2013. Neither secured or priority unsecured claims were paid in full, and unsecured creditors had not received the minimum distribution required under the plan. Devane-Jones' husband paid the balance needed to satisfy the liquidation minimum.
The debtors' counsel asserted that the Chapter 13 cases should proceed despite their deaths and sought a "hardship discharge" pursuant to 11 U.S.C. Section 1328. The IRS contended that a hardship discharge may not be granted to a deceased debtor or to a deceased debtor's probate estate pursuant to Section 1328 and Federal Rule of Bankruptcy Procedure 1016. The IRS further argued that once a Chapter 13 debtor dies, a primary purpose of bankruptcy—to provide the debtor a fresh start—is no longer a relevant consideration. Rather, the IRS contended that creditors would be better served by the dismissal of the bankruptcy cases and resolution of the creditors' claims through the probate process. Interestingly, the IRS did not actually articulate how dismissal would benefit the parties. The debtors' families had agreed to pay the liquidation minimum for each debtor. Therefore, the granting of a hardship discharge would have resulted in the unsecured creditors' receipt of a distribution equal to what they would have received had the debtors filed under Chapter 7. If the cases were dismissed, the unsecured creditors would have received no additional payments but would have had claims against the debtors' respective probate estates. However, the IRS presented no evidence to show that the creditors would have received more via the probate process.
Pursuant to Section 1328(b), the court may grant a discharge to a debtor who has not completed payments under a confirmed Chapter 13 plan only if: "(1) the debtor's failure to complete such payments is due to circumstances for which the debtor should not justly be held accountable; (2) the value, as of the effective date of the plan, of property actually distributed under the plan on account of each allowed unsecured claim is not less than the amount that would have been paid on such claim if the estate of the debtor had been liquidated under Chapter 7 … on such date; and (3) modification of the plan under Section 1329 … is not practicable."
The debtor has the burden of proving that all three requirements of Section 1328(b) are satisfied, and once all three requirements are established, the court has the discretion to grant a hardship discharge. The terms of Section 1328(b) do not address the effect of the debtor's death, but Federal Rule of Bankruptcy Procedure 1016 provides that "death or incompetency of the debtor shall not abate a liquidation case under Chapter 7 of the code. In such event the estate shall be administered and the case concluded in the same manner, so far as possible, as though the death or incompetency had not occurred. … If [an] individual's debt adjustment case is pending under … Chapter 13, the case may be dismissed; or if further administration is possible and in the best interest of the parties, the case may proceed and be concluded in the same manner, so far as possible, as though the death or incompetency had not occurred."
In Lizzi, the IRS relied upon a line of cases holding that Rule 1016 prevents a deceased debtor from being granted a hardship discharge under Section 1328(b). The cases included In re Miller, 2014 U.S. Dist. LEXIS 133435 (D. Colo. Sept. 23, 2014); and In re Hennessy, 2013 Bankr. LEXIS 3034 (Bankr. N.D. Cal. July 29, 2013). The IRS sought to have the court adopt the logic applied in Miller and Hennessy, which narrowly read Rule 1016 to prevent a hardship discharge because a hardship discharge could not have been sought if the debtor never died, and therefore the case could not be found to have proceeded in the "same manner … as though the death ... had not occurred." Based on this strict reading of Rule 1016, both Miller and Hennessy determined that Rule 1016 only offered one other option—dismissal of the Chapter 13 case. The Lizzi court rejected the narrow reading of Rule 1016, determining that such an interpretation impinges on a debtor's substantive rights under Section 1328(b).
The IRS further argued that discharge is moot in the case of a deceased debtor because there is no longer "personal" liability for debts, rather such liability transfers to the decedent's estate. Thus, since a decedent's estate may not be a debtor under the Bankruptcy Code, it cannot receive a hardship discharge. The Lizzi court rejected this argument, finding that eligibility is determined at the commencement of the case, and the automatic substitution assertion by the IRS was without support under the Bankruptcy Code.
The Lizzi court determined that entry of a hardship discharge is not in conflict with Rule 1016 because if the death had not occurred, the case could proceed to two possible conclusions: (1) the debtor could have received a discharge by making the required plan payments, or (2) the debtor could have been granted a hardship discharge. In addition, the court pointed to a policy consideration in favor of a deceased debtor's access to a hardship discharge. Specifically, if a debtor had filed under Chapter 7 and died before discharge, the case would still have proceeded and the discharge issued. The court reasoned that the result should not be different for a deceased Chapter 13 debtor.
It's fair to say that most Chapter 13 debtors would prefer to live at least long enough to fulfill their 60-month plan obligations. However, maybe, there is some small comfort in knowing that even if you do not, you might still be able to pass on to the great beyond debt-free.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.
Content contributed by attorneys of Troutman Sanders LLP and Pepper Hamilton LLP prior to April 1, 2020, is included here, together with content contributed by attorneys of Troutman Pepper (the combined entity) after the merger date.