Two New Issues in Post-BAPCA 13 Cases
- Along with most other bankruptcy attorneys, I have had to apply a number of new or amended provisions of bankruptcy law in the year since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (Pub. L. 109-8) (BAPCA) became effective. In recent cases, I have discovered two changes that I had not expected; both imported principles I was familiar with in Ch. 11 to Ch. 13 cases. First, the rule that postpetition interest on nondischargeable tax or other debt survives discharge will be more noticeable in Ch. 13 cases. Second, there will be an issue of whether attorneys’ fees with respect to dischargeability and related objection to claim litigation will be entitled to administrative expense status.
Postpetition Interest on Nondischargeable Debt
Prior to October 17, 2005, a Ch. 13 discharge generally discharged all tax liabilities “provided for” under a Ch. 13 plan. For cases filed on or after that date, a Ch. 13 discharge does not apply to, inter alia, debts of the kind specified in §507(a)(8)(C) or in paragraphs (1)(B) or (1)(C) of §523(a).1
The 26 U.S.C. §6672, trust fund recovery penalties, also known as the 100 percent penalty, is one liability described under §507(a)(8)(C): “[A] tax collected or withheld and for which the debtor is liable in whatever capacity.” An employer’s liability for the taxes it withheld and state sales taxes collected from consumers would also be within the scope of this provision. In Ch. 13 cases, these liabilities are normally paid in full, but without interest.2
Liabilities for taxes where no return has ever been filed, or where the return was filed late and within two years of the petition date, are made nondischargeable by 11 U.S.C. §523(a)(1)(B). Taxes in which the debtor made a fraudulent return or willfully attempted in any matter to evade or defeat tax are made nondischargeable by 11 U.S.C. §523(a)(1)(C).3 Unlike the liability for withheld taxes, these liabilities are general unsecured claims, normally paid (or not paid) along with other nonpriority unsecured claims. Student loan debt nondischargeable under §523(a)(8) was nondischargeable in Ch. 13 cases even before BAPCA.
BAPCA also made §523(a)(2), fraud and fraudulent credit debts, §523(a)(3), unscheduled debt, and §523(a)(4), embezzlement and larceny debt nondischargeable in Ch. 13 cases. Section 523(a)(2) applies not only to situations where a creditor relies on a materially false financial statement given by a debtor with the intent to deceive, but also provides for a presumption of nondischargeability for certain purchases of luxury consumer goods within 90 days prior to the petition date and certain cash advances within 70 days of the petition date.
It should be noted that the nondischargeability provisions for tax debt, unscheduled debt, and student loans apply regardless of whether the creditor brought a dischargeability action.4 Otherwise, the strict time limits of Bankruptcy Rule 4007(c) for filing a dischargeability complaint apply.5
While these changes to the Ch. 13 “super-discharge” were widely recognized, the effect on postpetition interest was not. While research has not revealed any post-BAPCA cases on point, case law from other chapters made it well established that postpetition interest on nondischargeable liabilities is itself nondischargeable.6Both of those cases did deal with situations where the underlying tax was never paid. However, the overwhelming majority of the courts dealing with the issue have applied the rule in Bruning v. United States, 376 U.S. 358 (1964), to hold postpetition interest nondischargeable even where some or all of the underlying tax was paid in the bankruptcy case.7 In In re Tuttle, 291 F.3d 1238 (10th Cir. 2002), the circuit court stated that not only was the case law on the point overwhelming, but the only cases that failed to apply the Supreme Court’s ruling in Bruning had been reversed.8 The rule has also been applied to student loan debt in Ch. 13 cases.9
As noted by the Fifth Circuit in In re Johnson, 146F.3d 252 (5th Cir. 1998), the fact that some or all of the underlying tax will be paid in the plan is not a basis to distinguish Bruning.10In view of the 2005 limitations on the scope of Ch. 13 discharge, liability for postpetition interest on nondischargeable taxes, student loans, and other nondischargeable debt will survive a Ch. 13 case. Counsel should advise their clients that obligations for student loans, taxes where the returns were not filed as of the petition date, or taxes where the returns were filed late and within two years of the petition date will survive the Ch. 13 discharge, and that postpetition interest on those obligations will also survive.
Attorneys’ Fees for the Benefit of Debtor
Unlike Ch. 7 cases, attorneys’ fees in Ch. 13 cases are normally paid out of the plan as an administrative expense. Bankruptcy Code 11 U.S.C. §503(b)(2) allows administrative expense status for compensation awarded under Code §330(a). Bankruptcy Code §330(a) allows compensation for a professional person employed under §327. However, compensation under those provisions is limited to attorneys for the trustee, not for the debtor.11 It is common in Ch. 13 cases for this distinction to be blurred, as a Ch. 13 debtor exercises some of the powers of a trustee.12 This results in attorneys’ fees being paid as administrative expenses in Ch. 13 cases. Pursuant to 11 U.S.C. §1326(b)(1), these fees are often paid early in the case. Similarly, in a Ch. 11 case, compensation for debtor’s attorneys is common, as Ch. 11 debtors perform the duties of a trustee.13
Courts have denied administrative expense status to the extent the fees are for the benefit of the debtor individually, rather than the estate. Only fees for legal services which benefit the estate, not just the debtor, are entitled to administrative expense status.14 For example, legal fees for work, such as litigation of dischargeability actions in Ch. 11 cases, are not recoverable as an expense of the estate.15
In view of the former broad super-discharge, dischargeability litigation was rare in Ch. 13 cases, although there was the occasional student loan case. Thus, the issue of whether a Ch. 13 attorney’s work was compensable as work to benefit the estate, or noncompensable as work for the benefit of the debtor, rarely arose. This may well change in view of the changes to the Ch. 13 discharge. Where there is dischargeability litigation in Ch. 13 cases, the issue of whether the attorneys’ fees for that litigation should be paid out of the plan will arise. In view of the case law in Ch. 11 cases, it is doubtful that fees for work in dischargeability actions in Ch. 13 cases would be accorded administrative expense status.
The issue may also appear in claims litigation. It may be difficult to argue that legal work for the determination of the amount that must be paid on its claim would not be compensable work for the benefit of the estate. However, legal work for the purpose of absolving one of the joint debtors from a liability, such as the Trust Fund Recovery Penalty of 26 U.S.C. §6672, would not reduce the amount payable from the estate, would not benefit the estate, and should not be payable as an administrative expense. Counsel for the creditors should consider objecting to an application for employment or a request for attorneys’ fees to the extent an award of administrative expense status would be for work personal to debtors, rather than the estate.
1 11 U.S.C. §1328(a)(2).
2 11 U.S.C. §1322(a)(2).
3 Experienced bankruptcy attorneys often have their Ch. 7 and Ch. 11 clients obtain plain language account transcripts of all their federal tax liabilities from Internal Revenue Service Taxpayer Service offices. This may now be good practice in Ch. 13 cases. Addresses for Taxpayer Service offices can be found at www.irs.gov/localcontacts/index.html.
From an examination of the transcript, the attorney can see when the client’s tax returns were filed with the IRS and whether a fraud penalty was applied. This can reduce the occasions when a client is surprised to find that the government contends the tax is not dischargeable as the IRS had no record of a return, or that the Service had determined a tax liability in the absence of a return.
It should be noted that the absence of a prior assertion of the 26 U.S.C. §6663 civil fraud penalty does not foreclose the possibility that the government will assert nondischargeability under §523(a)(1)(C). The standard of proof for the fraud penalty is “clear and convincing evidence,” Korecky v. Commissioner, 781 F.2d 1566, 1568 (11th Cir. 1986), in contrast to the “preponderance of the evidence” standard in dischargeability proceedings. Grogan v. Garner, 498 U.S. 279, 291 (1991). The §6663 penalty is imposed where “an underpayment of tax required to be shown on a return is due to fraud,” while other sorts of misconduct can cause nondischargeability under §523(a)(1)(c). In re Fretz, 244 F.3d 1323, 1327-1329 (11th Cir. 2001).
4 11 U.S.C. §523(c); In re Ellsworth, 158 B.R. 856, 858 (M.D. Fla. 1993).
5 A complaint to determine dischargeability under §523(c) must be filed within 60 days after the first date set for the §341 meeting, the first meeting of creditors. Interim Bankruptcy Rule 4007.
6 Bruning v. United States, 376 U.S. 358, 360 (1964); In re Burns, 887 F.2d 1541, 1543 (11th Cir. 1989).
7 In re Tuttle, 291 F.3d 1238, 1243-45 (10th Cir. 2002) (gap interest in a Ch. 11 case survives); In re Cousins, 209 F.3d 38, 41-42 (1st Cir. 2000) (postpetition interest survives a Ch. 12 discharge); In re Artisan Woodworkers, 204 F.3d 888, 891-92 (9th Cir. 1999) (postpetition interest on nondischargeable tax survives Ch. 11 and 12 discharges); In re Johnson, 146F.3d 252, 260-61 (5th Cir. 1998) (postpetition interest from Ch. 11 case converted to Ch. 7 survives discharge even though underlying tax paid); In re Gill, 343 B.R. 732, 741 (Bankr. M.D. Fla. 2006) (interest on nondischargeable tax debt survives Ch. 11 discharge); In re Holway, 237 B.R. 217, 219-220 (Bankr. M.D. Fla. 1999) (postpetition interest in Ch. 13 case converted to Ch. 7 survives Ch. 7 discharge); In re Quick, 152 B.R. 902, 907-09 (Bankr. W.D. Va. 1992).
8 Tuttle, 291 F.3d at 1243. This is at least a slight overstatement. There is unreversed case law holding that a Ch. 12 discharge bars post-bankruptcy liability for interest on nondischargeable taxes paid through a plan, in reliance on the lack of a requirement that Ch. 12 plans provide for payment of postpetition interest and the “fresh start” policy. In re Mitchell, 210 B.R. 978, 982-84 (Bankr. N.D. Tex. 1997), aff’d., 241 B.R. 393 (N.D. Tex. 1997). The same logic applies in Ch. 13 cases. However, Bruning, 376 U.S. at 362, made it clear that postpetition interest on a nondischargeable debt is nondischargeable even if that postpetition interest is not payable in the bankruptcy case. Cousins, 209 F.3d at 40; In re Leeper v. Pennsylvania Higher Ed. Assn., 49 F.3d 98, 101 (3d Cir.1995).
9 In re Leeper, 49 F.3d 98, 103-105 (3d Cir. 1995) (postpetition interest on a nondischargeable student loan survives a Ch. 13 discharge); In re Murphy, 257 B.R. 72, 75-77 (Bankr. N.D. Ala. 2000) (postpetition interest on a nondischargeable student loan survives a Ch. 13 discharge); In re Shelbayah, 165 B.R. 332, 335-36 (Bankr. N.D. Ga. 1994) (interest on nondischargeable student loan debt nondischargeable). See In re Kielisch, 258 F.3d 315, 324 (4th Cir. 2001) (stating interest on a student loan can only be discharged on a showing of undue hardship).
10 Johnson, 146 F.3d at 260-61.
11 Lamie v. United States Trustee, 540 U.S. 526, 534-36 (2004).
12 11 U.S.C. §1303.
13 11 U.S.C. §1107.
14 In re Lederman Enterprises, Inc., 997 F.2d 1321, 1323 (10th Cir. 1993); In re Alcala, 918 F.2d 99, 103-04 (9th Cir. 1990).
15 In re Reed, 890 F.2d 104, 105 (8th Cir. 1989); In re Kloubec, 251 B.R. 861, 864-66 (Bankr. N.D. Iowa 2000); In re Latham, 131 B.R. 238, 239 (Bankr. S.D. Fla. 1991).
Charles Baer graduated from Holy Cross and Duke Law. He is an AUSA in Mobile, Alabama, and board certified in consumer bankruptcy and business bankruptcy by the American Board of Certification. He is also an affiliate of the American Bankruptcy Institute. Mr. Baer is a volunteer attorney with the Escambia County Guardian ad Litem office. The author thanks AUSA Gene Seidel, civil chief, S.D. Ala., for his review and comments on the article.
This column is submitted on behalf of the Tax Section, Mark E. Holcomb, chair, and Michael D. Miller and Benjamin Jablow, editors.