Good Faith and Disposable Income: Should the Good Faith Inquiry Evaluate the Proposed Amount of Repayment?

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1 Good Faith and Disposable Income: Should the Good Faith Inquiry Evaluate the Proposed Amount of Repayment? Brandon L. Johnson* TABLE OF CONTENTS I. INTRODUCTION II. THE BASICS OF CHAPTER III. SUMMARY OF GOOD FArrH ANALYSIS IV. THE 1984 AMENDMENTS V. GOOD FAITH ANALYSIS REQUIRES CONSIDERATION OF THE AMOUNT THE DEBTOR PROPOSES TO REPAY CREDITORS A. The Totality of the Circumstances Test Requires Consideration of Repayment B. The Legislative History of Chapter 13 Requires Consideration of Repayment VI. CONCLUSION APPENDIX A: APPENDIX B: I. INTRODUCTION More and more debtors facing bankruptcy are choosing to file for Chapter 13 relief rather than Chapter 7 relief.' The enactment of the new Bankruptcy Code in 1978 loosened the requirements to be eligible for Chapter 13 and as a result, issues relating to Chapter 13 cases are being litigated at an increasing rate. One of the most litigated issues in Chapter 13 cases is whether the debtor's plan has been proposed in good faith. Good faith litigation has generated a myriad of published decisions, many of which are utterly irreconcilable with * B.S. 1997, Washington State University; J.D., 2000, summa cum laude, Gonzaga University School of Law. The author is currently clerking for the Honorable Dennis J. Sweeney, Washington State Court of Appeals, Division IIl. The author would like to thank Professor Stephen Sepinuck for reviewing early drafts of this Article. 1. In 1978, Chapter XII filings comprised approximately 15% of total bankruptcy filings. By 1998, Chapter 13 filings had nearly doubled, comprising approximately 28% of total bankruptcy filings. Statistics available at smartbuy/debt/4955.asp (last visited Feb. 22, 2001); currentstats.html (last visited Mar. 1, 2001).

2 GONZAGA LAW REVIEW [Vol. 36:2 one another. Much of the litigation has concerned how the standard of good faith should be defined and applied to individual cases. Prior to 1984, most courts considered the amount or percentage of unsecured claims the debtor proposed to pay. The courts' interpretation of Chapter 13's legislative history led them to conclude repayment of debts was a primary objective of Chapter 13 debtors. As such, courts looked closely at how much debtors proposed to pay their unsecured creditors. In 1984, Congress amended the Bankruptcy Code and added 1325(b)(1)(b), known as the disposable income test. This provision requires a debtor who is not satisfying all debts in full to devote all disposable income into the plan for a period of three years upon the objection of any creditor or the trustee. Many courts and commentators alike saw this provision as implicitly removing any consideration of the amount to be paid to unsecured creditors from the good faith analysis under 1325(b)(3). However, some courts continue to view the amount of repayment as one factor of the good faith analysis. Currently, both bankruptcy courts and circuit courts are split on the issue of whether the amount of repayment continues to be a relevant factor when determining if a debtor's plan has been proposed in good faith. This paper will demonstrate how, in light of the legislative history behind Chapter 13, the amount a debtor proposes to pay unsecured creditors is not only a relevant factor for determining the good faith of the plan, but indeed it is a necessary factor. Section two provides a brief overview of Chapter 13 relief. Section three examines the current state of good faith analysis under 1325(a)(3). Section four describes the 1984 amendments to the Bankruptcy Code. Finally, section five explains why the amount of repayment to unsecured creditors is a critical factor for determining whether a debtor's plan has been proposed in good faith. II. THE BASICS OF CHAPTER 13 Individual debtors who desire bankruptcy protection may rehabilitate themselves under Chapter 13 of the Bankruptcy Code. 2 Chapter 13 is available to any individual with regular income who owes fixed unsecured debts of less than $269,250 and fixed secured debts of less than $807,750 at the time the petition is filed. 3 A Chapter 13 case is commenced when the debtor files a petition with the bankruptcy court. 4 Unlike Chapter 7, only the debtor may U.S.C , (1994) U.S.C. 109(e) (1994) U.S.C. 301, 303 (1994).

3 2000/01] GOOD FAITH AND DISPOSABLE INCOME 377 institute a Chapter 13 case, and the debtor may convert to Chapter 7 or dismiss at any time. 5 The Chapter 13 debtor is generally allowed to retain possession of all property,' and in exchange the debtor pays future income to a trustee who oversees the case and distributes the payments to creditors. 7 The debtor must file a plan for repayment of creditors.' The plan must provide for submission of the debtor's income to the trustee to carry out the plan, provide for full payment of priority claims under 507, 9 and treat claims within a particular class the same. 0 Plans are generally proposed to last three years, although the court may extend the plan up to five years "for cause.'' 11 Once the debtor has proposed the plan, the bankruptcy court will hold a hearing on its confirmation.' 2 For a plan to be confirmable, the court must find it meets the required elements found in 1325(a): the plan complies with the provisions of this chapter and with the other applicable provisions of this title; any fee, charge, or amount required under chapter 123 of title 28, or by the plan, to be paid before confirmation, has been paid; the plan has been proposed in good faith and not by any means forbidden by law; the value, as of the effective date of the plan, of property to be distributed under the plan on account of each allowed unsecured claim is not less than the amount that would be paid on such claim if the estate of the debtor were liquidated under Chapter 7 of this title on such date; with respect to each allowed secured claim provided for by the plan - the holder of such claim has accepted the plan; (i) the plan provided that the holder of such claim retain the lien securing such claim; (ii) the value as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim; or U.S.C. 1307(a), 301, 303 (1994) U.S.C. 1306(b) (1994) U.S.C. 1302, 1306(a) (1994) U.S.C (1994) U.S.C. 507 (1994) U.S.C. 1322(a) (1994) U.S.C. 1322(c) (1994). See In re Arnold, 869 F2d 240, 244 (4th Cir. 1989) ("Cause" is determined on a case by case basis.); In re Andrews, 155 B.R. 769, 773 (9th Cir. B.A.P. 1993) (Whether "cause" exists is left to the bankruptcy judge's discretion.); In re Coburn, 175 B.R. 400, 402 (Bankr. D. Or. 1994) ("The 'cause' to exceed over 3 years must be something for the debtor's benefit.") U.S.C (1994).

4 GONZAGA LAW REVIEW [Vol. 36:2 the debtor will be able to make all payments under the plan and to comply with the plan. 13 A confirmed plan becomes binding on both the debtor and the creditors, and title to all the estate's property is vested back in the debtor.' 4 After the plan is filed, the debtor must begin making payments to the trustee within thirty days. 5 A debtor able to make all payments under the plan will receive a discharge under 1328(a) of all debts included in the plan with some exceptions, including debts for alimony and child support and certain long-term debts included in the plan that require payments beyond the length of the plan. 16 The current Chapter 13 essentially encourages debtors to exercise this option of relief by making three major changes from the old Chapter XIII. First, Congress expanded the class of debtors who are eligible to utilize Chapter 13 by making it available to anyone with a regular income, rather than only wage earners. 17 Second, Congress eliminated the requirement the plan be approved of by a majority of the creditors, instead using the elements in section 1325(a) as a basis for the confirmation of proposed plans. 1 8 Finally, Congress added further benefits to utilizing Chapter 13 by making many debts dischargeable under section 1328(a) that are non-dischargeable in a straight Chapter 7 bankruptcy case under section This is referred to as the Chapter 13 "super discharge., 20 III. SUMMARY OFGOOD FAITH ANALYSIS "Every bankruptcy statute since 1898 has incorporated literally, or by judicial interpretation, a standard of good faith for the commencement, U.S.C. 1325(a) (1994) U.S.C (1994) U.S.C. 1326(a)(1) (1994) U.S.C. 1322(b)(5) allows a debtor to cure defaults on payments within a reasonable time for debts that become due after the final payment of the plan. The most common example is the debtor who is allowed to cure arrearages on a home mortgage. See In re Winthurst, 97 B.R. 457, 460 (Bankr. C.D. Ill. 1989) U.S.C. 1095(e) (1994). See also In re Stella, 663 F.2d 326, 328 (1st Cir. 1981); In re Pearson, 773 F.2d 751, 753 (6th Cir. 1985). 18. See Barnes v. Whelan, 689 F.2d 193, 197 (D.C. Cir. 1982). 19. These include, most importantly, debts procured through fraud, embezzlement, misrepresentation, larceny, and debts resulting from willful and malicious conduct that injures a person or property. 11 U.S.C. 523(a)(1)-(10) (1994). 20. See In resolomon, 67 F.3d 1128, 1131 (4th Cir. 1995); In re Games, 213 B.R. 773, 779 (Bankr. E.D. Wash. 1997); In re Edwards, 207 B.R. 728, 730 (Bankr. N.D. Fla. 1997); First United Sav. Bank v. Edwards, 184 B.R. 46, 48 (S.D. Ind. 1995).

5 2000/01] GOOD FAITH AND DISPOSABLE INCOME 379 prosecution, and confirmation of a bankruptcy proceeding.", 2 ' The good faith requirement is said to "prevent[ ] abuse of the bankruptcy process by debtors whose overriding motive is to delay creditors without benefitting them in any way or to achieve reprehensible purposes. 22 The Bankruptcy Code does not define the concept of good faith. 23 "Good faith is an amorphous notion, largely defined by factual inquiry." 24 Some courts have found the good faith inquiry to be one of the central factors, if not the most important, when determining whether a Chapter 13 plan is confirmable. 25 The general approach of courts examining the issue of good faith with regard to whether a Chapter 13 plan is confirmable has been a "totality of the circumstances" test, usually using a laundry list of relevant factors. This is the test used by the Third, Fourth, Fifth, Sixth, Seventh, Eighth, Ninth, Tenth, and Eleventh Circuits. 26 Other circuits have chosen not to use a laundry list of factors and instead look at whether the plan was proposed with "honesty of intention," "honesty of purpose," or some other similar phrase. 27 In the circuits that have adopted a totality of the circumstances test with a laundry list of factors, one case, In re Estus, 28 has provided the list of factors most commonly cited to by other courts Little Creek Dev. Co. v. Commonw. Mortgage Corp., 779 F.2d 1068, 1071 (5th Cir. 1986). 22. Id. at In re Waldron, 785 F.2d 936, 939 (11 th Cir. 1986); In re Okoreeh-Baah, 836 F.2d 1030, 1033 (6th Cir. 1988). 24. Okoreeh-Baah, 836 F.2d at In re Smith, 848 F.2d 813, 817 (7th Cir. 1988) (quoting In re Rimgale, 669 F.2d 426, 431 n.14 (7th Cir. 1982)); In re Warren, 89 B.R. 87, 90 (9th Cir. B.A.P 1988). 26. In re Lilley, 91 F.3d 491, 496 (3rd Cir. 1996); Deans v. O'Donnell, 692 F2d 968, 972 (4th Cir. 1982); Pub. Finance Corp. v. Freeman, 712 F.2d 219, 221 (5th Cir. 1983); In re Barett, 964 F.2d 588, 591 (6th Cir. 1992); In re Love, 957 F.2d 1350, 1355 (7th Cir. 1992); In re Estus, 695 F.2d 311, (8th Cir. 1982); In re Goeb, 675 F.2d 1386, 1390 (9th Cir. 1982); Flygare v. Boulden, 709 F.2d 1344, 1347 (10th Cir. 1983); In re Kitchens, 702 F.2d 885, 888 (11th Cir. 1983). 27. See Barnes, 689 F.2d at 200; In re Johnson, 708 F.2d 865, 868 (2d Cir. 1983) F.2d 311 (8th Cir. 1982). 29. The list of factors are as follows: the amount of proposed payments and the amount of the debtor's surplus; the debtor's employment history, ability to earn and likelihood of further increases in income; the probable or expected duration of the plan; the accuracy of the plan's statements of debts, expenses and percentage repayment of unsecured debt and whether any inaccuracies are an attempt to mislead the court; the extent of preferential treatment between the classes of creditors; the extent to which secured claims are modified; the type of debt sought to be discharged and whether any such debt is non-dischargeable in Chapter 7;

6 380 GONZAGA LAW REVIEW [Vol. 36:2 Regardless of whether a court labels its test totality of the circumstances or honesty of intention, the ultimate decision will rest on whether the court believes the plan is an abuse of the purpose and spirit of Chapter 13. IV. THE 1984 AMENDMENTS In 1984, Congress enacted the Bankruptcy Amendments and Federal Judgeship Act ("BAFJA"). 3 " The BAFJA added the disposable income requirement as a condition for confirmation of a debtor's proposed Chapter 13 plan. The disposable income requirement forces a debtor to commit all disposable income to the plan for a three-year period. 32 Thus, when the debtor proposes not to pay unsecured claims in full, the creditor or the trustee can effectively require the debtor to contribute all disposable income into the plan for at least three years. Disposable income is derived by subtracting the debtor's projected expenses from projected income. 33 The expenses a debtor may list include home the existence of special circumstances such as inordinate medical expenses; the frequency with which the debtor has sought relief under the Bankruptcy Reform Act; the motivation and sincerity of the debtor in seeking Chapter 13 relief; and the burden which the plan's administration would place on the trustee. Id. at 317. See Kitchens, 702 F.2d at ; In re Caldwell, 851 F.2d 852, 859 (6th Cir. 1988); In re Coomes, 79 B.R. 274, (W.D. Ky. 1987); In re Chase, 43 B.R. 739, 743 (D. Md. 1984). 30. Deans, 692 E2d at 972; Pub. Finance Corp., 712 F2d at 221; Estus, 695 F.2d at 317; Flygare, 709 F.2d at 1347; Kitchens, 702 F.2d at Pub. L. No , 98 Stat. 333 (1984). 32. The disposable income requirement is codified in 1325(b) and provides: If the trustee or the holder of an allowed unsecured claim objects to the confirmation of the plan, then the court may not approve the plan unless, as of the effective date of the plan- (A) the value of the property to be distributed under the plan on account of such claim is not less than the amount of such claim; or (B) the plan provides that all of the debtor's projected disposable income to be received in the three-year period beginning on the date that the first payment is due under the plan will be applied to make payments under the plan. 11 U.S.C. 1325(b)(1) (1994). 33. Disposable income is defined in the new section of the code as: [I]ncome which is received by the debtor and which is not reasonably necessary to be expended- (A) for the maintenance or support of the debtor or a dependent of the debtor, including charitable contributions (that meet the definition of "charitable contribution" under section 548(d)(3)) to a qualified religious or charitable entity or organization (as that term is defined in section 548(d)(4)) in an amount not to exceed 15 percent of the gross income of the debtor for the year in which contributions were made; and (B) if the debtor is engaged in business, for the continuation, preservation, and

7 2000/01] GOOD FAITH AND DISPOSABLE INCOME 381 expenses (utilities, taxes, and repairs); taxes; alimony and child support; insurance; loan payments; transportation; education; food; clothing; medical and dental expenses; laundry; newspapers, periodicals, and books; recreation and entertainment; charitable contributions; and other expenses. 34 Unfortunately, the legislative history of the BAFJA has provided courts and commentators with little or no guidance into its language. 35 Therefore, courts have essentially interpreted its impact on their own. V. GOOD FAITH ANALYSIS REQUIRES CONSIDERATION OF THE AMOUNT THE DEBTOR PROPOSES TO REPAY CREDITORS The good-faith inquiry is clearly important to the Chapter 13 process. Indeed, it has been labeled the policing mechanism of the Bankruptcy Code. 36 Therefore, it is imperative courts be allowed to make a complete review of all the facts of each case when determining whether a debtor has proposed the plan in good faith. In fact, both the essence of the totality of circumstances test and the legislative history of Chapter 13 require courts to examine the amount a debtor proposes to repay creditors. A. The Totality of the Circumstances Test Requires Consideration of Repayment Prior to the enactment of the BAFJA and the addition of the disposable income requirement, courts were divided: some concluded that good faith required a minimum amount of repayment, others ruled it did not. Therefore, some courts held minimum and zero-payment plans to be per se filed in bad faith, while other courts allowed minimum and zero-payment plans to pass over the hurdle of 1325(a). 37 operation of such business. 11 U.S.C. 1325(b)(2) (1994) U.S.C. Official Bankruptcy Form 6 (Schedule J) (1994 & Supp. V 2000). 35. See In re Hale, 65 B.R. 893, 895 (Bankr. S.D. Ga. 1986) ("There is no significant legislative history to guide litigants and courts in interpreting section 1325(b)(1)."); In re Davis, 68 B.R. 205, 211 (Bankr. S.D. Ohio 1986) (The court found the legislative history to be vague and unenlightening, concluding the duty to arrive at an appropriate standard was left to the courts.); In re Jones, 55 B.R. 462, 465 (Bankr. D. Minn. 1985) (calling the legislative history "vague and unenlightening"). 36. Chase, 43 B.R. at Courts finding a substantial amount of repayment necessary generally based it on Chapter 13's legislative history. See In re lacovoni, 2 B.R. 256 (Bankr. D. Utah 1980); In re Hurd, 4 B.R. 551 (Bankr. W.D. Mich. 1980). Courts finding no minimum amount of repayment to be required generally based their analysis on Congress' intent to make Chapter

8 GONZAGA LAW REVIEW [Vol. 36:2 However, over an approximate eighteen-month period prior to the passage of the BAFJA, a new approach to addressing the amount of repayment issue arose and began to gain support. This "middle of the road" 38 approach treated the amount of repayment as merely one factor in the courts' test to determine the debtor's good faith. In all, ten circuit courts examined the issue and, while their tests for good faith are not entirely uniform, each court concluded that substantial repayment was not necessary for a plan to have been filed in good faith. 39 Courts addressing the good-faith inquiry after the enactment of the BAFJA have found Congress did not intend to displace the totality of the circumstances test. 40 However, many courts have concluded the BAFJA's passage removed a substantial number of the factors previously examined under the totality of the circumstances test. 4 ' Courts applying this more narrow totality of the circumstances test examine "whether the debtor has stated his debts and expenses accurately, whether he has made any fraudulent misrepresentation to mislead the bankruptcy court, or whether he has unfairly manipulated the Bankruptcy Code. '42 These courts have reasoned that, in order to stop the courts from denying plans based entirely on the proposed percentage of repayment, Congress intended the disposable income test to expressly replace any examination of the amount of repayment when determining good faith. This reasoning is flawed for several reasons. First, the totality of the circumstances test is expressly designed to be done on a case by case basis available to more people, thus allowing more debtors an opportunity for a fresh start. See In re Scher, 12 B.R. 258 (Bankr. S.D. N.Y. 1981); In re Thebeau, 3 B.R. 537 (Bankr. E.D. Ark. 1980). 38. See Hale, 65 B.R. at 894; In re San Miguel, 40 B.R. 481, 484 (Bankr. D. Colo. 1984). 39. See In re Hines, 723 F.2d 333, 334 (3rd Cir. 1983); Deans, 692 F.2d at 972; Pub. Finance Corp., 712 F.2d at 221; Okoreeh-Baah, 836 F.2d at 1033 (clarifying Memphis Bank and Trust Co. v. Whitman, 692 F.2d 427, 432 (6th Cir. 1982)); In re Rimgale, 669 F.2d 426, 431 (7th Cir. 1982); Estus, 695 F.2d at 316; Goeb, 675 F.2d at 1390; Flygare, 709 F.2d at 1347; Kitchens, 702 E2d at 889; Barnes, 689 E2d at See In re LeMaire, 898 F2d 1346, 1349 (8th Cir. 1990); Okoreeh-Baah, 836 F.2d at ; In re Thompson, 116 B.R. 794, 797 (D. Colo. 1990). 41. "[Section 1325(b)'s] 'ability to pay' criteria subsumes most of the Estus factors and allows the court to confirm a plan in which the debtor uses all of his disposable income for three years to make payments to his creditors. Thus, our inquiry into whether the plan 'constitutes an abuse of the provisions, purpose or spirit of Chapter 13' has a more narrow focus." Educ. Assistance Corp. v. Zellner, 827 F2d 1222, 1227 (8th Cir. 1987) (citations omitted); see also Smith, 848 F.2d at 820; In re Carsrud, 161 B.R. 246, (Bankr. D. S.D. 1993). 42. Educ. Assistance Corp., 827 F.2d at See also Carsrud, 161 B.R. at 250; In re March, 83 B.R. 270, 275 (Bankr. E.D. Penn. 1988). 43. See Goeb, 675 F.2d at ; Deans, 692 F.2d at 972; In re Rasmussen, 888

9 2000/01] GOOD FAITH AND DISPOSABLE INCOME 383 For courts to truly examine the totality of the circumstances, they must do just that; examine the totality of the circumstances. The whole point is to allow courts to examine the entire record and make a subjective determination as to whether the debtor has proposed the plan in good faith. Thus, the test must remain flexible and capable of fairly dealing with diverse factual scenarios. As such, no purpose is served by limiting the number of factors a judge may consider when making the good faith inquiry. As one court stated prior to the enactment of the BAFJA: The correct approach... is to treat the issues of substantiality and best effort as elements of good faith. Unless the courts have discretion to consider such factors, the danger exists that Chapter 13 plans could become shams that would emasculate the safeguards that Congress has included in Chapter 7 to prevent debtor abuse of the bankruptcy laws. 44 The logical approach is to allow courts to examine the entire record, determine what is relevant in a particular situation, and determine whether the debtor has acted in good faith. 45 Second, the majority of circuits have already come to the conclusion that good faith required no minimum amount of repayment. Instead, almost all circuits concluded that the amount of repayment was only one factor for determining good faith, and not dispositive either way. 46 As such, courts reasoning that Congress enacted the disposable income test to stop the courts from applying a minimum percent of repayment are simply ignoring the fact that the majority of circuit courts were not insisting on a minimum percent of repayment. In essence, these courts are asserting the disposable income test was designed to solve a problem that did not exist. Prior to the passage of the BAFJA and the addition of the disposable income test, a typical court determining whether a debtor's plan was filed in good faith would apply a list of factors similar to, or the same as, the Estus F.2d 703, 704 (10th Cir. 1989); Love, 957 F.2d at 1355; Lilley, 91 F.3d at 496; In re Chaffin, 836 F.2d 215, 217 (5th Cir. 1988); In re Warner, 115 B.R. 233, 238 (Bankr. C.D. Cal. 1989). 44. In re Burrell, 6 B.R. 360, 366 (N.D. Cal. 1980). 45. A good example of this analysis is found in In re Baker, 129 B.R. 127 (Bankr. W.D. Tex. 1991), where the court found that for an objection to a plan to be sustained, more than just low payment to creditors is usually needed. The court, although considering the amount of repayment as part of the good faith analysis, went on to confirm the debtor's low percentage plan where there was no other evidence of bad faith. Id. at See Chase, 43 B.R. at 743; Baker, 129 B.R. at (The court summarized the statement from Flygare, 709 F.2d at 1347, joining the Fourth, Fifth, Seventh, Eighth, Ninth, Eleventh, and D.C. circuits in the conclusion that the amount of repayment is not a dispositive factor on the issue of good faith.).

10 GONZAGA LAW REVIEW [Vol. 36:2 factors. 47 The examination would include an evaluation of both the amount the debtor was proposing to pay as well as other factors relating to the debtor's ability to pay, such as past and future employment and potential increases in income after the completion of the plan. 48 However, after the passage of the BAFJA, many courts substantially restricted the number of factors they examined under their totality of the circumstances test. 49 The potential fault with applying this narrow totality of the circumstances test is best demonstrated with a hypothetical Chapter 13 debtor. Our debtor can be either a law or medical student. The student performs well in school, but in the process accumulates substantial credit card debt by living lavishly, buying expensive clothes, and eating out often. Additionally, our student has taken out significant student loans to pay for tuition and books. Upon graduation, the student accepts low-paying employment as a law clerk, or practices medicine in a rural area. The young professional then files for Chapter 13 relief under the Bankruptcy Code. Our young professional's plan proposes to make minimal payments to all creditors, including the student loan and unsecured creditors. 50 The plan will then be evaluated using 1325(a) and (b). The young professional, as well as the vast majority of Chapter 13 debtors, can easily satisfy 1325(a)(1) as well as pay the fees required by 1325(a)(2). Because our young professional has virtually no nonexempt assets, any repayment to unsecured creditors is likely to be more than they would receive in a Chapter 7 liquidation. Thus, 1325(a)(4) is also easy to satisfy. Compliance with 1325(a)(5) may actually further reduce the amount of disposable income available to unsecured creditors. Our young professional does not own a home, so by applying the unused homestead exemption to a car, our debtor may even be allowed to pay off a secured car loan in full over the course of the plan. Our young professional's minimal repayment plan can also pass the feasibility of payments inquiry of 1325(a)(6). So long as the young professional's plan proposes to commit all disposable income to the plan, regardless of whether any disposable income is actually available for unsecured creditors, the plan will satisfy 1325(b). Therefore, the only hurdle left for our hypothetical debtor to clear is the good faith inquiry of 1325(a)(3). This is where the difference between a true totality of the circumstances test and a narrow totality of the circumstances test becomes crucial to the confirmation of the plan. 47. See supra note 29 and accompanying text. 48. See supra note 29 and accompanying text. 49. See supra note 41 and accompanying text. 50. Making uniform payments will remove any possibility that our debtor is unfairly discriminating between creditors. See 11 U.S.C. 1322(b)(1) (1994).

11 2000/01] GOOD FAITH AND DISPOSABLE INCOME 385 By applying a true totality of the circumstances test, the court overseeing our hypothetical debtor would examine not only the amount of repayment proposed under the plan, but also the debtor's future potential for increased income. 5 ' The court could then deny the plan for failing to be proposed in good faith based on the debtor's potential future income after moving to the private sector or a bigger city. 52 Conversely, a court applying a narrow totality of the circumstances test would be precluded from evaluating any factors relating to the amount of repayment, 53 as well as any increases in the debtor's future income occurring beyond the three year period contemplated by 1325(b). 54 It seems that unless our hypothetical debtor has lied to the court directly or inaccurately listed expenses or income, the good faith inquiry under the narrow totality of the circumstances test could not prevent the plan from being confirmed. While the narrow test includes possible manipulation of the Bankruptcy Code as a factor to be considered, 55 it is difficult to imagine how a court could find this factor present without either extreme debtor misconduct or an examination into the proposed amount of repayment. Because the narrow test does not examine 51. These are both factors included in the most common list of factors used by courts employing the totality of the circumstances test. See supra note 29 and accompanying text. 52. The likelihood of a successful law student accepting a low paying position as a law clerk is not as remote as one might think. In many cases a student can actually increase their eventual starting salary in the private sector by gaining experience as a law clerk. Similarly, a medical student may have incentives to start out in a low paying position in a rural area. Indeed, the student may actually be required to practice medicine in a remote area as part of a partial loan repayment program, i.e. "Northern Exposure". 53. Courts applying the narrow totality of the circumstances test have determined that good faith analysis includes no economic test outside the requirements of 1325(b). See In re Carver, 110 B.R. 305, (Bankr. S.D. Ohio 1990); Pierce, 82 B.R. at 879; Easley, 72 B.R. at 955. The courts applying the narrow inquiry look almost exclusively at whether the debtor has been involved in serious misconduct or has lied to the court. See Smith, 848 F.2d at ; In re Cottle, 189 B.R. 591, (Bankr. E.D. Penn. 1995). 54. In Chaffin, 836 F.2d at 216, the court instructed the trial court to examine the debtor's ability to pay through both his present and future income. However, the court specifically stated the debtor's potential income beyond the three years of the plan was not to be considered. The court reasoned that because the scope of 1325(b)(1)(B) is limited to three years, it could not examine the debtor's financial situation beyond three years. Id. Similarly, the court in In re Karayan, 82 B.R. 541 (Bankr. C.D. Cal. 1988), concluded the expectations for debtors in Chapter 13 is limited to the three year period mandated in 1325(b)(1)(B). Id. at 544. See also Easley, 72 B.R. at ; In re Red, 60 B.R. 113, 116 (Bankr. E.D. Tenn. 1986). Another court has found the debtor's employment history to be irrelevant to the good faith inquiry. See Coburn, 175 B.R. at 402. The court fails to grasp that a debtor with a history of significant income potential is far more likely to earn significant income in the future than a debtor who has no history of earning potential. Indeed, past employment is nearly as relevant to the good faith analysis as the potential for increased future income. 55. See Educ. Assistance Corp., 827 F.2d at 1227.

12 GONZAGA LAW REVIEW [Vol. 36:2 amount or any other economic factors, our hypothetical debtor's plan would likely be confirmed. As the preceding example demonstrates, the debtor's compliance with 1325(b) should not remove consideration of the amount of repayment or other economic factors from the good faith inquiry. B. The Legislative History of Chapter 13 Requires Consideration of Repayment The Bankruptcy Reform Act of 1978 addressed many of the shortcomings found in the old Chapter XIII. The Senate Report of the Bankruptcy Reform Act stated: In theory, the basic purpose of Chapter XIII has been to permit an individual to pay his debts and avoid bankruptcy by making periodic payments to a trustee under bankruptcycourt protection, with the trustee fairly distributing the funds deposited to creditors until all debts have been paid. The hearings record and the bankruptcy literature show uniform support for this principle. 56 The report goes on to state: As in current law, 100 percent payment plans will be encouraged by limitation on availability of a subsequent discharge in section 727(a)(8). This kind of plan has provided great self-satisfaction and pride to those debtors who complete them, and at the same time effect a maximum return to creditors... It is also necessary to prevent chapter 13 plans from turning into mere offers of composition plans under which payments would equal on the non-exempt assets of the debtor. 57 The House committee made similar findings concerning the inadequacies of the old Chapter XIII. The House Subcommittee stated: [M]ost consumer debtors would rather work out a repayment plan than file straight bankruptcy. They opt for straight bankruptcy only because the present chapter XIII simply cannot meet their needs. Only in certain areas of the country where the bankruptcy judges have taken an active interest, 56. S. REP. No , at 12 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5798 (emphasis added). 57. S. REP. No , at 13 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5799 (emphasis added).

13 2000/01] GOOD FAITH AND DISPOSABLE INCOME 387 have put in the extra effort required to make chapter XIII work, and have encouraged the bar to recommend its use, has chapter XIII provided any substantial or realistic alternative to straight bankruptcy liquidation. 58 The report goes on to explain the new Chapter 13, stating: The purpose of chapter 13 is to enable an individual, under court supervision and protection, to develop and perform under a plan for the repayment of his debts over an extended period. In some cases, the plan will call for full repayment. In others, it may offer creditors a percentage of their claims in full settlement... [c]hapter 13 also protects a debtor's credit standing far better than a straight bankruptcy, because he is viewed by the credit industry as a better risk. In addition, it satisfied many debtors' desire to avoid the stigma attached to straight bankruptcy and to retain the pride attendant on being able to meet one's obligations. The benefit to creditors is self-evident: their losses will be significantly less than if debtors opt for straight bankruptcy. 59 Courts have consistently interpreted the legislative history of Chapter 13 as suggesting Congress intended the benefits of Chapter 13 for debtors who could, over time, repay their creditors in full or in substantial measure. 6 Regardless of how a particular court has applied the addition of 1325(b)'s disposable income requirement, no court has concluded the intent of the BAFJA or the disposable income test was to dramatically change the underlying purpose of Chapter 13. Courts have almost uniformly held the good faith inquiry of 1325(a)(3) is designed to test whether the debtor is attempting to abuse the purpose, provisions, or spirit of Chapter The purpose and spirit of Chapter 13 are best derived from its legislative history, 62 yet courts choose to ignore the clear intent of Congress by refusing to examine factors indicating whether debtors are 58. H.R. REP. No , at 117 (1977), reprinted in 1978 U.S.C.C.A.N. 5787, (citations omitted). 59. H.R. REP. No , at 118 (1977), reprinted in 1978 U.S.C.C.A.N. 5787, 6079 (emphasis added). 60. Rimgale, 669 F.2d at 431. See also Baker 129 B.R. at 131 ("There can be little doubt of Congress' belief that the primary benefit of Chapter 13 relative to Chapter 7 is the expected improved return for unsecured creditors."). 61. See supra note 30 and accompanying text. 62. See County of Wash. v. Gunther, 452 U.S. 161, 182 (1981) (Rehnquist, J., dissenting) ("[It is] well settled that the legislative history of a statute is a useful guide to the intent of Congress."); Green v. Bock Laundry Machine Co., 490 U.S. 504, (1989) (The Court, in interpreting the Federal Rules of Evidence, found that when the text of a statute is ambiguous, courts should seek guidance from the legislative history.); but see Wis. Pub. Intervenor v. Mortier, 501 U.S. 597, 617 (1991) (Scalia, J., concurring).

14 GONZAGA LAW REVIEW [Vol. 36:2 legitimately attempting to rehabilitate themselves or merely masking their true intent of simple liquidation. Courts applying the narrow totality of the circumstances test have voluntarily stopped examining factors that may indicate whether a debtor is attempting to abuse the purpose and spirit of Chapter 13. Certainly all debtors who propose a low percentage of repayment to their creditors do not do so in bad faith. 63 However, courts should have the ability to evaluate all potentially relevant factors when determining good faith, and as the hypothetical debtor example illustrates, compliance with the disposable income requirement should not prevent courts from evaluating economic factors under their good faith analysis. While the legislative history does not impose a minimum percentage of repayment, it strongly indicates that debtors are expected to be taking substantial steps toward repaying their creditors in exchange for the benefits of Chapter 13 relief. As one court explained, the "process progresses toward answering the question 'how much can I pay?' rather than starting out trying to determine 'how little can I get by with paying?" 64 Debtors who are unable to live up to their end of the Chapter 13 bargain should not expect the benefits of Chapter 13 given to those debtors who can. VI. CONCLUSION As Chapter 7 continues to be attacked for being too easy on debtors and as Congress prepares to means-test debtors prior to allowing them to file for straight bankruptcy, 65 Chapter 13 litigation will continue to increase. A substantial part of Chapter 13 litigation will continue to involve issues of good faith as well as the role of the disposable income test. As such, the relationship between a debtor's good faith and the satisfaction of the disposable income requirement must be resolved. A textual reading of 1325(b) simply does not support the conclusion that the amount of repayment was intended to be removed from the good faith analysis. As one court stated, "[I]t is an overstatement to declare that 1325(b) resolved the judicially perceived tension between the issue of good faith and the confirmation of nominal or zero percentage plans., 66 A better reasoned conclusion is that 1325(b) answers the question of whether a minimum 63. See supra note In re Cook, 3 B.R. 480, (Bankr. S.D. W. Va. 1980). 65. See Jack F. Williams, Distrust: The Rhetoric and Reality of Means-Testing, 7 AM. BANKR. INST. L. REV. 105 (1999). 66. Davis, 68 B.R. at 211.

15 2000/01] GOOD FAITH AND DISPOSABLE INCOME 389 amount of repayment is required for confirmation while at the same time setting a minimum amount of effort under which no debtor may fall below. 67 Both the clear intent of Congress and the retention of the totality of the circumstances test demonstrate the need for courts to consider the amount of repayment proposed by the debtor when undertaking the good faith inquiry. Chapter 13, like the old Chapter XIII, was intended for debtors with a sincere desire to repay as much of their debts as possible. While this does not mandate a set minimum percentage of repayment, the amount of debts debtors propose to pay is a clear indicator of their true intentions, and the courts must be given the flexibility to determine if debtors are truly seeking a form of rehabilitation, or merely a "super discharge" from their liability. 67. The court in Hale, summarized the proper impact of 1325(b) on the good faith analysis as follows: [A] plan which meets the tests for mandatory confirmation [ 1325(a)(1)-(6)], including 'good faith' still cannot be confirmed, if after objection, the disposable earnings test is not met. Thus, Section 1325(b)(1) can be viewed only as a floor below which no plan can go and still be confirmed, even if the general good faith test is fully met to the satisfaction of the Bankruptcy Judge. It is a 'fail-safe' mechanism to insure some uniformity in the minimum effort that will be required of debtors, even when their good faith is not questioned." Id. at (emphasis omitted). 65 B.R An excellent example of the Hale court's analysis in practice is found in In re Krull, 54 B.R. 375 (Bankr. D. Colo. 1985). Although the court was satisfied that the debtor had proposed their plan in good faith, the court nonetheless denied confirmation of the plan on the basis that it failed to comply with 1325(b). Id. at 378.

16 GONZAGA LAW REVIEW [Vol. 36:2 APPENDIX A: POST BAFJA CASES THAT DO NOT EXAMINE THE AMOUNT OF A DEBTOR'S PAYMENTS WHEN DETERMINING IF THE DEBTOR HAS FILED THE PLAN IN GOOD FAITH. In re Pierce, 82 B.R. 874, 878 (Bankr. S.D. Ohio 1987); the court found that with the addition of the disposable income test, amount of payment is no longer a factor when determining good faith. The court stated the good faith inquiry is limited to acts of serious debtor misconduct or abuse. In re Castello, 98 B.R. 523, 526 (Bankr. D. Or. 1989) (overruled on other grounds); the court determined the amount of payment "should be given virtually no weight in determining good faith." In re Belt, 106 B.R. 553, 570 (Bankr. N.D. Ind. 1989); the court found once a debtor satisfies the disposable income test, amount of payment is not considered when evaluating good faith. In re Jones, 119 B.R. 996, 1002 (Bankr. N.D. Ind. 1990); the court removed the amount of payment and applied a totality of the circumstances test to the good faith inquiry. The court also stated good faith is determined according to the purpose, provisions, and spirit of Chapter 13. In re Smith, 848 F.2d 813, (7th Cir. 1988); the court determined the proper test for evaluating good faith is still the totality of the circumstances test. However, the court found the addition of the disposable income test removed the need to examine the amount of payment under the good faith test. Thus, the court applied the totality of circumstances factors from Rimgale, minus the amount of payment. In re Norwood, 178 B.R. 683, 688 (Bankr. E.D. Pa. 1995); the court applied a totality of the circumstances test to determine good faith minus the factor of amount of payment. Additionally, the court stated the main issue, with respect to good faith, is still whether the debtor has abused the purpose and spirit of Chapter 13. In re Selden, 121 B.R. 59, 60 (D. Or. 1990); the court concluded that once a debtor has satisfied the disposable income test, amount of payment is not an issue under the good faith test.

17 2000/01] GOOD FAITH AND DISPOSABLE INCOME 391 In re Metz, 820 F.2d 1495, 1498 (9th Cir. 1987); the court kept the totality of the circumstances test as the test for determining good faith. Further, the court concluded a zero amount plan can be proposed in good faith if the debtor satisfies the disposable income test. In re Cottle, 189 B.R. 591, 594 (Bankr. E.D. Pa. 1995); the court found the disposable income test requires no minimum amount and limited the good faith inquiry to whether the debtor has been honest in fact or has engaged in misconduct. In re March, 83 B.R. 270, (Bankr. E.D. Pa. 1988); the court concluded the addition of the disposable income test directly precludes the consideration of the amount of payment from the totality of the circumstances test for good faith. In re Harmon, 72 B.R. 458, 462 (Bankr. E.D. Pa. 1987); the creditor objected to the debtor's plan under good faith rather than the disposable income test. The court concluded zero amount plans may be proposed in good faith. In re Baker, 66 B.R. 253, (Bankr. N.D. Miss. 1986); the court found a plan proposing to pay nothing to an unsecured creditor is nevertheless filed in good faith so long as the debtor satisfies the disposable income test. In re Carver, 110 B.R. 305, 308, 312 (Bankr. S.D. Ohio 1990); the court determined the proper test for good faith is whether the debtor is abusing the purpose and spirit of Chapter 13. The court further concluded that once a debtor satisfies the disposable income test, the amount of payment is no longer an appropriate factor for determining good faith. In re Galt, 70 B.R. 57, (Bankr. S.D. Ohio 1987); the court found if a debtor satisfies the disposable income test, amount will not be considered when determining good faith. In re Smith, 100 B.R. 436, (S.D. Ind. 1989); the court determined the proper test for good faith, after the addition of the disposable income test, is a totality of the circumstances test minus the amount of payment factor. In re Greer, 60 B.R. 547, 551, 554 (Bankr. C.D. Cal. 1986); the court found a debtor who satisfied the disposable income test acted in good faith when filing a zero payment plan. In re Coburn, 175 B.R. 400, 402 (Bankr. D. Or. 1994); the court concluded the

18 392 GONZAGA LAW REVIEW [Vol. 36:2 amount of payment is not a relevant factor under good faith analysis where the debtor has satisfied the disposable income test. In re Chaffin, 836 F.2d 215 (5th Cir. 1988); the court found the amount of payment is governed only by the disposable income test and should not be considered under the good faith analysis.

19 2000/01] GOOD FAITH AND DISPOSABLE INCOME 393 APPENDIX B: POST BAFJA CASES THAT INCLUDE THE AMOUNT OF PAYMENT TO UNSECURED CREDITORS IN THE GOOD FAITH ANALYSIS. In re Lattimore, 69 B.R. 622, (Bankr. D. Tenn. 1987); the court determined all proposed zero percentage plans are filed in bad faith. The court reasoned the way Chapter 13 defines an "individual with regular income" in section 101 (27) contemplates payments will be made under the plan. Therefore, a plan proposing no payments "is an abuse of the purpose and spirit of Chapter 13." In re Walsh, 224 B.R. 231, 235 (Bankr. M.D. Ga. 1998); the court, citing to Hale, found the amount of repayment remains a factor for consideration under the good faith test. In re Massey, 1995 WL , at *2-3 (5th Cir. Sept. 7, 1995); the court applied the totality of circumstances test from Public Finance, which concentrates on the reasonableness of proposed payments and the purpose and spirit of Chapter 13. The court cited to Chaffin's list of factors, concluding amount is a relevant factor when determining whether a plan has been filed in good faith. In re Pickering, 195 B.R. 759, (Bankr. D. Mont. 1996); the court cites to Street, Warren, and Goeb, concluding the good faith inquiry is broad, and does not end with a showing of compliance under the disposable income test. In re Baker, 129 B.R. 127, 129, 131 (Bankr. W.D. Tex. 1991); the court applies the Estus factors, finding while amount of payment is not dispositive, it is "certainly significant" to the good faith inquiry. In re Warren, 89 B.R. 87, 90 B.A.P. (9th Cir. 1988); the court concluded the good faith inquiry must be decided on a case by case basis and include an element of judicial discretion. Additionally, the court found the good faith inquiry is a different examination into the facts of the case than the best efforts test. In re Farmer, 186 B.R. 781, 783 (Bankr. D. R.I. 1995); the court found that although a zero percent plan may be proposed in good faith, it will be subjected to heavy scrutiny. The court also concluded, citing to Jewell, the amount of payment is a factor under good faith analysis.

20 GONZAGA LAW REVIEW [Vol. 36:2 In re Jewell, 75 B.R. 318, (Bankr. S.D. Ohio 1987); the court found a payment plan providing creditors what they would have received under Chapter 7 is not per se proposed in good faith. Likewise, a plan proposing low payment is not per se filed in bad faith. However, low payment plans are subject to heavy judicial scrutiny. In re Terrill, 68 B.R. 441, 441 (Bankr. C.D. Ill. 1987); the court found the good faith inquiry is focused on whether the plan conforms to the purpose and spirit of Chapter 13 and is fair to creditors. The court concluded a Chapter 13 plan proposing zero payment to unsecured creditors, filed four years after the debtor received a Chapter 7 discharge, was done in bad faith because it violated the spirit of Chapter 13. In re Hale, 65 B.R. 893, (Bankr. S.D. Ga. 1986); the court found the creation of the disposable income test did not displace the use of the totality of the circumstances test for evaluating good faith. Further, the court concluded a plan satisfying the disposable income test must still be found to have been proposed in good faith, as they are separate tests. In re Davis, 68 B.R. 205, 211 (Bankr. S.D. Ohio 1986); the court found that Chapter 13 requires the debtor to make a substantial effort to repay his debts and that the amount of payment, while not dispositive, remains a factor when determining if a debtor has acted in good faith.