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Recent Ninth Circuit Case Illustrates the Importance of Good Faith in a Chapter 13 Bankruptcy Plan

A recent case from the Ninth Circuit Bankruptcy Appellate Panel illustrates the importance of good faith for a Chapter 13 Bankruptcy Plan. Good faith is an essential element for a Chapter 13 Bankruptcy filer to have their plan approved and to begin repaying their debts. Good faith is not defined in the bankruptcy code, but if a filer is dishonest in disclosing assets and liabilities, or makes misrepresentations in their plan, they will likely not be in good faith.

A little background on how debt is treated in a Chapter 13 Bankruptcy:

A person who files for Chapter 13 Bankruptcy puts together a plan, based on their income, for how they will pay their secured and unsecured debts. Secured debts are those debts for which there is a property interest as collateral (such as a house or a car), whereas an unsecured debt is not backed by collateral. With a few exceptions, Chapter 13 Bankruptcy allows filers to split their secured debt into secured and unsecured portions when they owe more than the value of an asset. A chapter 13 bankruptcy filer has to pay off all of their secured debts if they want to keep the property, but the amount of unsecured debt they are required to pay depends on their income, how long their plan lasts, and the total amount of their unsecured debt.

In re Hardcastle:

This difference in how Chapter 13 Bankruptcy treats secured and unsecured debt is at issue in In re Hardcastle.

The Hardcastles, who declared Chapter 13 Bankruptcy, had two mortgages on their residence. Because the value of their residence was less than the first mortgage, they filed a motion to value the second mortgage at $0. The court granted their motion and valued the second mortgage at $0, ordering that the Bank of America’s claim on the second mortgage be treated as an unsecured claim. However, two months later Bank of America filed a secured proof of claim. The Hardcastles, in what the Ninth Circuit viewed as not in good faith, filed a second bankruptcy plan that did not include Bank of America as either a secured creditor or an unsecured creditor. Instead, they used their disposable income (that would have gone to paying Bank of America) to pay 100 percent of the claims of their other unsecured creditors. They also increased their proposed living expenses.

When the court denied their plan, the Hardcastles appealed, arguing that Bank of America submitted a proof of claim as a secured creditor for a $0.0 claim, and thus should not receive any payment. The Ninth Circuit held that the bankruptcy court, in its earlier order, had directed the Hardcastles to treat the claim as unsecured, and that the Hardcastles had manipulated the bankruptcy system in omitting Bank of America from their plan.

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