In re Harris, Bankruptcy No. 85-08004.

• Decision Date: 13 June 1986
• Docket Number: Bankruptcy No. 85-08004.
• Citation: 62 BR 391
• Parties: In re Jon Stuart HARRIS and Barbara Vallet Harris f/d/b/a The Mustard Seed, Debtors.
• Court: U.S. Bankruptcy Court — Eastern District of Michigan

62 B.R. 391 (1986)

In re Jon Stuart HARRIS and Barbara Vallet Harris f/d/b/a The Mustard Seed, Debtors.

Bankruptcy No. 85-08004.

United States Bankruptcy Court, E.D. Michigan, S.D., at Flint.

June 13, 1986.

Samuel S. Reiter, Owosso, Mich., for debtors.

Timothy E. Baxter, Grand Rapids, Mich., for Spring Arbor Distributors.

Carl L. Bekofske, Flint, Mich., Chapter 13 trustee.

MEMORANDUM OPINION REGARDING DEBTORS' PROPOSED CHAPTER 13 PLAN

ARTHUR J. SPECTOR, Bankruptcy Judge.

The debtors filed their joint petition for relief under Chapter 13 on August 19, 1985. In their petition, they list their unsecured debts in two separate categories: one for debts incurred during the operation of their bookstore, The Mustard Seed; the other for unsecured consumer debts. According to their schedules, the business debts are in the amount of $19,697.80, plus a debt of $50,438 to Old Kent Bank-Central representing the unsecured portion of its claim, for a total of $70,135.80; the consumer debts total $1,920.70.

The debtors' proposed Chapter 13 plan continues this distinction between business and consumer unsecured debt. Consumer debts are listed as "Class 3" debts, on which the debtors propose to pay 100% over three years. "Class 5" debts constitute the unsecured business debts. The debtors estimated that there will be no distribution to this class. Moreover, as counsel for the debtors stated on the record, it was their intention not to pay business creditors when they formulated their plan. However, it appears that there may in fact be some distribution to Class 5 creditors due to the failure of some Class 3 creditors to file proofs of claim. In their confirmation worksheet filed after the confirmation hearing on April 16, 1986, the debtors state that filed unsecured consumer claims total $1,521.62, and filed unsecured business claims total $57,426. Assuming that these figures are correct, consumer creditors would still receive 100% payment, and business creditors would receive 4.82% on their claims. By way of comparison, if all unsecured creditors are paid without regard to how the debt was incurred, each would receive 7.28% of its claim.

On March 29, 1986, Spring Arbor Distributors, an unsecured business creditor of the debtors, filed an objection to the debtors' plan. The basis of its objection is that the above classification of unsecured creditors unfairly discriminates against the business creditors, and that such treatment is barred by the Bankruptcy Code.¹ After a hearing on April 16, the Court took the matter under advisement.

The debtors' authority to classify unsecured claims separately is contained in 11 U.S.C. § 1322(b)(1). Under this section the debtors' plan may:

(1) designate a class or classes of unsecured claims, as provided in § 1122 of this title, but may not discriminate unfairly against any class so designated; however, such plan may treat claims for a consumer debt of the debtor if an individual is liable on the consumer debt with the debtor differently than on other unsecured claims.

There is no indication that the unsecured consumer debts being paid 100% under the proposed plan are debts on which third parties are liable as co-obligors; thus, the last clause of § 1322 is inapplicable.

Section 1122, to which § 1322 refers, does not offer much guidance. It provides that a debtor may designate various classes of creditors, so long as each member of that class holds a claim or interest that is "substantially similar" to the claims or interests of other class members. There is, unfortunately, no statutory definition of what makes claims or interests "substantially similar" to each other. Section 1122(a) has been characterized as "not a model of statutory clarity", In re Wolff, 22 B.R. 510, 515, 9 B.C.D. 451, 454, 6 C.B.C.2d 1282, 1288 (9th Cir. B.A.P. 1982) (concurring opinion), and we are therefore reluctant to rely on it.

Fortunately, there have been a considerable number of cases discussing what sorts of classifications of unsecured claims are permissible under § 1322. The debtors rely on In re Cook, 26 B.R. 187, 7 C.B.C.2d 1079 (D.N.M.1982). There, the debtor sought to pay unsecured debts guaranteed by a co-signor and claims for child support, but nothing to other unsecured creditors. The court adopted the "emergent majority view" that "a classification is not ipso facto unfairly discriminatory because it provides for a greater percentage of payment to some unsecured creditors than to others." Id. 7 C.B.C.2d at 1082. In order to determine whether a particular classification was fair, the court went on to espouse a four-factor test developed by other courts.² Those factors are:

(1) Whether the discrimination has a reasonable basis;

(2) Whether the debtor can carry out a plan without such discrimination;

(3) Whether such discrimination is proposed in good faith; and

(4) the treatment of the class discriminated against.

Id. These factors are not rigid rules, but are simply flexible guidelines to assist courts in deciding whether a debtor's plan ought to be confirmed. Each plan should be decided on its own merits. In re Bowles, 48 B.R. 502, 12 B.C.D. 1297, 12 C.B.C.2d 952 (Bankr.E.D.Va.1985). Although to a large extent these guidelines overlap, the reasoning of these opinions is sound and we adopt it.

The standards are consistent with two underlying purposes of the Bankruptcy Code. On the one hand, the remedies provided debtors in the Bankruptcy Code, including Chapter 13, are intended to provide debtors with the opportunity to emerge from bankruptcy with the famous "fresh start". In re Keyworth, 47 B.R. 966, 974, 12 B.C.D. 1137, 1142 (D.Colo.1985); In re Gibson, 45 B.R. 783, 787 (Bankr.N.D.Ga. 1985). Chapter 13 gives debtors wide latitude to propose a plan which will allow them to pay their debts without undue hardship, yet exit from bankruptcy in sounder financial shape than when they filed for relief. Thus, § 1322(b)(1) allows debtors to discriminate among unsecured creditors where it is beneficial to the debtor to do so. However, the objective of providing debtors with a fresh start is counterbalanced by the Congress' intent that the debtor's creditors be treated fairly. More precisely, it is fundamental to the operation of the Code that creditors of an equal status — e.g. priority, administrative and unsecured — be treated equally and equitably. See 11 U.S.C. § 726(b); In re Oak Creek Farms, Inc., 37 B.R. 178 (Bankr.D.Minn. 1984); In re Universal Research Laboratories, Inc., 13 B.R. 856, 859 (Bankr.N.D. Ill.1981). Accordingly, while the debtor may classify unsecured creditors differently, they cannot do so in such a fashion that any single class is treated unfairly, that is, inequitably. As the Code presumes that creditors of like position will be treated equally, the debtor has the burden of persuading us that a deviation from that norm is not unfair to creditors. In re Bowles, supra, 48 B.R. at 507, 12 B.C.D. at 1299, 12 C.B.C.2d at 958; In re Cook, supra.

Applying the four-part test to the facts of this case, we find that the debtor has failed to show that the proposed discrimination is fair. The first factor is whether the discrimination has a reasonable basis. We interpret this to be an inquiry into whether there is any logical or rational foundation for the classification. For example, classifying creditors alphabetically would have no rational basis in the context of a Chapter 13. Here, the debtors have divided their creditors into those who extended credit to them in the operation of their prior business, and those who extended credit for personal consumer purposes. Simply put, the debtors have closed their bookstore and have no further interest in paying the debts incurred therefrom or of maintaining an ongoing debtor-creditor relationship with their business creditors. Conversely, they wish to repay those parties who lent them money or extended them credit for personal needs, and who the debtors will likely encounter post-bankruptcy. The classification thus is rational at least from the debtors' perspective.

The proposed classification makes less sense when evaluated in terms of recourse available to the unsecured creditors. Legally, all of the unsecured creditors in this case, business and consumer, would have the same remedies under state law to pursue collection of their debts. After obtaining a judgment for the balance due, they could attempt to satisfy it through garnishment of wages and deposit accounts or by execution on the debtors' property. In reducing their claims to hard cash, the law cares not whether credit was extended to the debtors for an ill-fated business enterprise or for the debtors' personal needs. Of course, we realize that in practical terms the ability of creditors to pursue their legal remedies may differ; however, it is not the purpose for which the debts were incurred that makes them different. For example, some creditors may hold claims against the debtor for which there may be a co-obligor. Against the debtor, that creditor has the same rights as any unsecured creditor; but the creditor's ability to seek payment from a third-party (often a member of the debtor's family) gives that creditor added leverage against the debtor. Thus, § 1322(b)(1) expressly allows debtors to establish a separate class for unsecured consumer debts on which a non-debtor is liable. Additionally, some claimants may possess claims so small that it is impractical for the creditor to pursue its legal remedies. Suppose a creditor holds an unsecured claim for $100.00; even if that creditor could find counsel willing to litigate the matter, it would probably cost more than $100.00 to do so. Because creditors so situated may have fewer remedies against the debtor, § 1122(b), and by reference § 1322, provides that such creditors may be separately classified. As Colliers has noted, in enacting an amendment to § 1322(b) in 1984,

... Congress has recognized that practical

...