In re Scholl, Case No. 13-12810

• Decision Date: 23 August 2019
• Docket Number: Case No. 13-12810
• Citation: 605 B.R. 163
• Parties: IN RE Jeffrey SCHOLL, Alison Scholl, Debtors
• Court: U.S. Bankruptcy Court — Southern District of Ohio

605 B.R. 163

IN RE Jeffrey SCHOLL, Alison Scholl, Debtors

Case No. 13-12810

United States Bankruptcy Court, S.D. Ohio, Western Division.

Signed August 23, 2019

Paul J. Minnillo, Andrew L. Ruben, Minnillo & Jenkins Co. LPA, Cincinnati, OH, for Debtor.

MEMORANDUM OPINION AND ORDER CONCERNING DISPOSITION OF INSURANCE PROCEEDS

Jeffrey P. Hopkins, United States Bankruptcy Judge

After fire destroyed one of Jeffrey Scholl and Alison Scholl's (the "Debtors") income producing rental properties they sought permission from the Court to keep the insurance proceeds in order to purchase or rebuild another unit on the vacant lot. This matter is before the Court on the Debtors' Motion for Order Concerning Distribution of Insurance Proceeds (the "Motion for Distribution"). (Doc. 173). Also before the Court is the Chapter 13 Trustee's Objection to Motion for an Order Concerning Distribution of Insurance Proceeds (the "Objection") and request that "[the] proceeds not paid to lienholder[s] or for demolition ... be paid into the plan and disbursed to other creditors at a higher percentage."¹ (Doc. 174). Two hearings were held on these matters. At the behest of the Court the parties filed supplemental briefs but also continued settlement negotiations. (Docs. 185, 188). During the second hearing, the parties became joint proponents of a settlement proposal that would effect a modification of the plan under § 1329. The proposed modification attempts to resolve the Motion for Distribution and the Trustee's Objection by requiring the Debtors to use some of the insurance proceeds to increase the repayment to unsecured creditors, but keep most of the funds purportedly for their maintenance and support under § 1325(b).

I. Introduction

On June 12, 2013, the Debtors, who are married, filed a joint case seeking a discharge from their debts under Chapter 13 of the Bankruptcy Code. (Doc. 1). Both Debtors work and receive regular income from their jobs and jointly owned rental properties. On the petition date the Debtors had above median income (Doc. 1); thus, they were required to file a plan with a term of no less than five years or 60 months. 11 U.S.C. § 1325(b)(4) ; Baud v. Carroll , 634 F.3d 327, 335 (6th Cir. 2011) (" Section 1325(b)(4) provides that, unless the plan provides for full payment of allowed unsecured claims over a shorter time frame, the applicable commitment period is ... not less than five years for above-median-income debtors.")

On May 2, 2018, during the 59th month of the 60 month plan, one of the Debtors' rental properties located at 942 Wells Street in Cincinnati (the "Property" or "Rental Property"), suffered a total loss as the result of fire.² Thereafter, Erie Insurance agreed to pay the Debtors $180,000 on a claim as the coverage limit for the loss of the Property, plus an additional $14,000 for its demolition, for a total of $194,000 (the "Insurance Proceeds"). See Doc. 173.

In the Motion for Distribution, the Debtors requested that this Court issue an order requiring the following:

1) The Insurance Company, Erie Insurance, shall issue payment for the Insurance Proceeds, ... to [the Debtors], without inclusion of the mortgagees on such payment;

2) The Debtors shall be entitled to retain the Insurance Proceeds for demolition of the Property and re-building on the subject real estate or purchase of a substitute rental property.

Id.

Initially, the Debtors sought to keep all $194,000 of the Insurance Proceeds for the stated purpose of demolition, purchasing a substitute property or rebuilding a new rental unit on the vacant lot where the Rental Property had been located, while paying nothing to unsecured creditors. The Motion for Distribution drew an immediate Objection from the Chapter 13 Trustee, Margaret A. Burks (the "Trustee") and a request for a modification of the plan to increase the payment to unsecured creditors. (Doc. 174). The Trustee stated in the Objection, that "[a]s insofar [sic] as Debtors are Above Median any insurance proceeds not paid to lienholder or for demolition should be paid into the plan and disbursed to other creditors at a higher percentage." Id. (emphasis added).

However, during the second hearing on the Motion for Distribution of the Insurance Proceeds, the Trustee mollified her position. She now contends that the Debtors should be allowed to replace the Rental Property with "substitute collateral" that "returns roughly equivalent rental of $1,100 to $1,500 in gross income per month." (Doc. 188). Also, according to the Trustee, she is "amenable to substituting lost collateral, but with a reasonable equivalent. She is not taking the position that all of the insurance should inure to the benefit of the unsecured creditors, but beyond what a fair replacement of debtors' collateral would cost, any excess of insurance should be used to increase the unsecured creditors' dividend." (Doc. 188) (emphasis added). According to the Debtors' Schedules they were receiving income of $1,035 exclusively from the Rental Property when it was fully occupied. (Doc. 25). However, Unit 2 of the Rental Property had been vacant since at least September, 2016, which reduced the monthly income generated by the Property to $385. (Doc. 130).

Under the modification being proposed jointly by the parties, the Debtors would obtain a "full compliance" or "super discharge" under § 1328(a), walk away with approximately $80,000 cash-in-hand for the stated purpose of rebuilding or purchasing a "substitute" rental unit, all while "stripping down" the mortgages on the Rental Property to a value of $16,500 under § 506(a), and paying unsecured creditors holding allowed claims, according to one of the Trustee's projections, roughly 32 cents on the dollar. (Doc. 217, Ex. 4).³ This is hardly the stuff which makes for the bankruptcy laws affording a "fresh start" to the honest but unfortunate debtor, rather than providing them with a "fine finish." See In re Jones , 138 B.R. 536, 539 (Bankr. S.D. Ohio 1991) ("The purpose of the Bankruptcy Code is to provide a fresh start, not a fine finish.")⁴

Considering the bedrock bankruptcy principles at play–"good faith," "ability to pay," and "best interest of creditors"–the Court determined that approval of the modification or settlement agreement that was proposed at the second hearing would be improvident. The Court took the matter under advisement for a more thorough review of the law in light of the rather unique facts present in the case. (Doc. 208).

II. Jurisdiction

This is a core proceeding over which this Court has jurisdiction to hear, decide, and enter a final order, pursuant to 28 U.S.C. §§ 157(b)(2) and 1334(b). The following constitutes the Court's findings of facts and conclusions of law pursuant to Fed. R. Bankr. P. 7052, applicable to a contested matter under Fed. R. Bankr. P. 9014.

III. Summary of Relevant Facts

None of the facts in this case are disputed. As noted, the Court held two hearings and the facts contained in this memorandum opinion have been extracted from the Trustee's website and deduced from documents, briefs, and oral arguments presented by attorneys for the Trustee and the Debtors. There is no dispute that the Debtors entered into an insurance contract with the Erie Insurance Company for coverage on the Rental Property before they filed bankruptcy. Nor can there be any serious dispute that the Erie Insurance policy that the Debtors owned prepetition is property of the estate, even though they failed to list it on their bankruptcy Schedules.⁵ See Stinett v. Laplante (In re Stinett ), 465 F.3d 309, 312 (7th Cir. 2006) ("As a general matter, insurance contracts in which the debtor has an interest at the time the petition is filed constitute property of the estate for purposes of § 541(a).").

As noted, during the last month of the plan, but before the final payment had been made, the Debtors' Rental Property was completely destroyed by fire. Prior to the fire, the Property had been subject to two mortgages, both of which were crammed down and bifurcated into secured and unsecured claims. Ocwen Loan Servicing ("Ocwen") held a first mortgage on the Property which had an approximate balance of $18,754 on the petition date. (Doc. 35). Chase Home Mortgage ("Chase") held a second mortgage on the Property in the amount of $6,765 on the petition date. Id. The Debtors valued the property at $15,000 based on an independent appraisal. (Doc. 21). Because the Property value was less than the amount owed to the first mortgage holder, Ocwen, the Debtors filed a motion to "strip-off" the second mortgage under the Sixth Circuit's Lane⁶ decision and have it declared wholly unsecured. (Doc. 35). Subsequently, the Debtors entered into an Agreed Order valuing Chase's secured claim at $1,500 and treating the remaining balance as a general unsecured debt. (Doc. 60). Accordingly, the confirmed plan lists Ocwen's secured claim at $15,000 and Chase's secured claim at $1,500, effectively cramming the Rental Property's value down to $16,500. (Doc. 51). After fire had destroyed the Rental Property, and during the last month of the plan, the Debtors filed the present Motion for Distribution seeking essentially to be able to retain the Insurance Proceeds. (Doc. 173). By that time, the allowed secured claims for both Ocwen and Chase had also been completely paid-off; thus, the Rental Property was debt-free with no liens, mortgages, or encumbrances against it when the fire occurred.⁷

Neither Ocwen or Chase filed an objection to the Motion for Distribution of the Insurance Proceeds, nor did their attorneys make an appearance at either of the two hearings held. This is significant because both Ocwen and Chase would stand to benefit from an increase in the dividend paid to unsecured creditors given that their bifurcated claims now fall within that class. See In re Christopherson , 446 B.R. 831, 834 (Bankr. N.D. Ohio 2011) ("Under the Bankruptcy Code, § 506(a) permits a Debtor to bifurcate a secured claim. ...