Quick Take A post-confirmation lawsuit to generate funds to pay a chapter 13 plan establishes ‘related to’ jurisdiction for noncore claims.

The primary purposes of the bankruptcy process are to maximize the payments to a debtor’s creditors and provide debtors with a fresh start.[1] At first glance, the importance of firearm ownership appears unrelated to satisfy the purposes of the bankruptcy process. However, without the ability to exempt essential property from creditors, debtors would be left without the ability to achieve success with a renewed start. The next question then becomes, are firearms essential personal property? The answer to this question lies within subjective personal beliefs, with various degrees of an affirmation or refutation debated across the nation. This article provides insight into how states within the Fourth Circuit examine firearms as personal property for the purposes of exempting them from creditors during the bankruptcy process and highlights how a lack of uniformity toward exempting firearms leads to different outcomes on the same personal property.

An individual debtor may exempt property from the bankruptcy estate as outlined in 11 U.S.C. § 522(d). However, an individual state may forbid an individual debtor from exempting property under the federal exemptions by opting out of the exemption design of 11 U.S.C. § 522(d), and utilizing the chapter’s secession provision, by creating their own state exemptions.[2] North Carolina, like the other states in the Fourth Circuit, has opted out of the Bankruptcy Code exemptions in favor of their own enumerated exemptions.[3]

Currently, two of the five states within the Fourth Circuit allow for specific exemptions of firearms. South Carolina allows for an individual debtor to exempt any combination of up to three rifles, shotguns and pistols, as long as the value of the aggregate selection does not exceed $3,000.[4] Virigina allows an individual debtor to exempt one firearm, as long as that firearm does not exceed $3,000 in value.[5] The three remaining states within the Fourth Circuit, Maryland, North Carolina and West Virgina, do not have an enumerated exemption for firearms. However, all three remaining states provide an avenue whereby an individual debtor could exempt single or multiple firearms from the bankruptcy estate.[6] These states all require the courts’ through analysis and determination to decide whether an individual debtor’s interest in singular or multiple firearms is exemptible as generalized personal property or through a specific category, such as household goods.

Even though a debtor is required to comply with the state law in effect at the time of filing their petition, generally a party objecting to a claim of exemption bears the burden of proving that the exemptions are not properly claimed. In the event of an objection being lodged, bankruptcy courts, influenced by the U.S. Supreme Court’s decisions on the nature of the people’s right to “keep and bear arms,” as guaranteed by the Second Amendment, can be immediately thrust into the political arena in the event an individual debtor seeks to exempt firearms from the bankruptcy estate.

For instance, prior to the South Carolina Legislature codifying enumerated exemptions for firearms, the U.S. Bankruptcy Court for the District of South Carolina concluded that a magnum pistol and semiautomatic firearm were not exemptible as “household goods.”[7] The oft-cited opinion issued by the District Court of Maryland in McGreevy (applying Maryland law) affirmed the holding of the bankruptcy court on a motion to avoid a lien, holding that “household goods,” within the meaning of lien avoidance, does not extend to firearms, as firearms are not typically found in the home or facilitate the day-to-day living of the debtor.[8] Less than a decade after McGreevy, the U.S. Bankruptcy Court for the District of Maryland, applying Maryland law, held that an objecting creditor did not meet its burden of proof and therefore affirmed the debtor’s exemptions, which included firearms valued at $500.[9]

The posture of courts determining whether firearms are “household goods” thus results in different conclusions being reached on the same category of personal property. More recently, within the umbrella of the Fourth Circuit, a debtor unsuccessfully sought to exempt two firearms under the asserted qualification of “arms for muster.”[10] Rather than seeking to utilize an enumerated category of exemptions, such as “household goods,” the debtor argued that state common law provides for exemption from creditors firearms, as a civic requirement of North Carolinians is possession of operable firearms.[11] The court disagreed.[12] Nevertheless, the debtor’s argument renews the controversy caused by a state’s lack of explicit firearm exemptions.

With individual firearm ownership a hotly contested point within numerous larger issues nationwide, and bankruptcy courts and state legislatures offering conflicting guidance on whether firearms should be exemptible from creditors, debtors and courts alike would benefit from uniform guidance. The lack of uniformity will continue to place debtors and courts in a position of making determinations on the meaning of terms like “household goods” until the issue is placed squarely in front of an authoritative governing body. Until such time as the law becomes clear, concerns should be brought to the attention of counsel.

In In re Smith, [1] the Third Circuit reminded consumer bankruptcy practitioners of the wrath of res judicata. The debtor owned an encumbered rental property with an assignment of rents to her mortgage lender. The debtor’s proposed chapter 13 plan included a cramdown of the mortgage lender’s claim that reduced the secured portion of the claim from $150,000 to $95,000 — the value of the collateral. The plan further provided that the payment of rents would pay down the secured portion of the lender’s claim.

The lender objected to the $95,000 cramdown value, the application of rents to the secured portion of its claim, and feasibility. After the bankruptcy court sided with the debtor and held that the rents could pay down the secured portion of the lender’s claim, the lender agreed to the $95,000 cramdown value and abandoned its feasibility objections. The bankruptcy court confirmed the plan.

Later, the debtor proposed an amended plan. She retained most of the same provisions from the first confirmed plan but extended the payment period by six months under the CARES Act. The amended plan also provided for $1,500 monthly payments to the trustee for six months and $2,440 for the remaining 47 months of the plan. The lender did not object, and the plan was confirmed.

A few months later, the debtor filed yet another amended plan, again retaining most of the provisions from the first and second confirmed plans but extending the payment period to 84 months. The debtor also changed the payment schedule to $1,500 per month for eight months then $2,010 for the remaining 57 months. This time, the lender objected. The lender once more objected to the $95,000 cramdown valuation, the application of rents to the secured portion of its claim, and feasibility. The lender also argued that the plan’s payment schedule violated § 1325(a)(5)(B)(iii)(I)’s requirement of equal monthly payments, because the debtor’s monthly payment increased from $1,500 to $2,010.

The bankruptcy court determined that res judicata barred all of the lender’s objections aside from its objection to feasibility. The bankruptcy court concluded that the plan was feasible and confirmed the amended plan. The lender appealed to the district court, which affirmed the bankruptcy court but concluded that res judicata also barred the lender’s feasibility objection.

The Third Circuit agreed with the bankruptcy court that res judicata barred all of the lender’s objections except for feasibility. The court rejected the lender’s argument that an amended plan is a completely new plan. The court reasoned that res judicata bars a creditor from asserting arguments that it already had the full and fair opportunity to raise. The debtor’s first two confirmed plans included the $95,000 cramdown value and provisions allocating rents to the secured portion of the lender’s claim. The debtor’s second confirmed plan included a stepped-up plan payment. Yet because the lender did not object to these provisions when it first had the opportunity, the Third Circuit concluded that res judicata barred the lender’s later objections.

In re Smith reminds creditors that they must raise objections to plan confirmation before the first plan is confirmed, or risk the wrath of res judicata. Here, for example, the lender might have prevented the debtor from confirming her plan had it raised the § 1325(a)(5)(B)(iii)(I) issue earlier. But, as the Third Circuit explained — finality reigns supreme. Even though the bankruptcy court has an independent obligation to ensure that a plan does not violate the Code, the court will not reconsider unaltered elements of a chapter 13 plan each time the debtor amends their plan.

The Third Circuit, however, notes that feasibility can be disputed anew with each amended plan. Thus, a creditor’s ability to object to an amended plan’s feasibility remains a useful tool to prevent confirmation, because a debtor’s financial condition often changes over the life of the plan. A creditor objecting to an amended plan’s feasibility may have more evidence available to oppose confirmation. As the Third Circuit pointed out, a feasibility analysis requires the court to use past and present facts to predict the debtor’s prospective ability to comply with the plan. When sparring over feasibility of the debtor’s first proposed plan, the debtor has likely not been making payments to the trustee for very long, but if the debtor amends her plan months or years later, the creditor may be able use the debtor’s payment history to make an argument against confirmation. Indeed, if a debtor is proposing an amended plan, she could be struggling to comply with the terms of her current plan. Thus, the creditor can use evidence of the debtor’s poor payment history or worsening financial situation to argue that the amended plan is not feasible.

Another more prophylactic and unconventional option for creditors would be to advocate for the debtor to include a nonstandard plan provision waiving her right to assert res judicata. Admittedly, few debtors’ attorneys would likely agree to waive res judicata without demanding something in return, and few creditors’ attorneys aggressive enough to pursue this would likely be willing to provide anything in return.

Nevertheless, a waiver could be a suitable option to preserve a creditor’s right to object to future amended plans even if res judicata would otherwise bar the creditor’s objections. First, res judicata is not jurisdictional. [2] Thus, if no party invokes res judicata, the court is not required to overrule an objection that could be barred by res judicata. Second, because res judicata is an affirmative defense, the debtor can waive it.[3] Third, 11 U.S.C. § 1327 — the Code section that establishes the preclusive effect of confirmation — specifically binds creditors to the terms of the plan. Therefore, if the plan itself includes a waiver of the debtor’s res judicata defense, then the preclusive effect of the plan would necessarily be limited by the waiver.

In sum, In re Smith demonstrates the power of res judicata and the expansive preclusive effect of plan confirmation. However, creditors retain the ability to object to an amended plan’s feasibility, and creditors could escape the wrath of res judicata by negotiating in advance for the debtor’s waiver of the res judicata defense.