MOTIONS TO DISMISS UNDER 707(b)(2) and 707(b)(3)

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1 MOTIONS TO DISMISS UNDER 707(b)(2) and 707(b)(3) Southeastern Bankruptcy Law Institute Atlanta, Georgia April 12-14, 2007 Carey D. Ebert Ebert Law Offices, P.C Chadwick Ct., Ste. 100 Hurst, Texas (817)

2 MOTIONS TO DISMISS UNDER 707(b)(2) and 707(b)(3) A. Amendments to Section 707(b) Generally The Bankruptcy Abuse Prevention and Consumer Protection Act ( BAPCPA ), the most thorough revision of the Bankruptcy Code since its enactment, went into effect in October, Among its provisions are the twin dismissal provisions now codified in Section 707(b)(2) and 707(b)(3) of the Bankruptcy Code. Broadly, these provisions authorize the court to order the dismissal of a Chapter 7 case for abuse of the bankruptcy process where there is reason to believe the debtor could pay his unsecured non-priority creditors at least some portion of what they are due under a hypothetical Chapter 13 plan, In re Reinecker, 342 B.R. 304, 308 (Bankr. W.D. Mo. 2006), and to a lesser extent they help determine whether a debtor in a Chapter 13 case is committing a sufficient amount of his resources to repay his creditors. 1 Congressional intent in amending Section 707(b) in the BAPCPA is clear: Congress sought to remedy perceived abuses that occurred when consumer debtors receive a discharge under Chapter 7 despite the fact they have regular income that could be used to repay a portion of their debts through a Chapter 13 plan. In re Wilson, 2006 WL at * 3 (Bankr. D. Del. Dec. 11, 2006); In re Singletary, 2006 WL at * 1 (Bankr. S.D. Tex. Oct. 19, 2006); see also In re Hill, 328 B.R. 490, 494 (Bankr. S.D. Tex. 2005) ( Legislative history suggests that Congress enacted 707(b) in an effort to deny Chapter 7 relief to the dishonest or non-needy debtor ); and see In re Guzman, 345 B.R. 640, 641 (Bankr. E.D.Wisc. 2006) (quoting remarks made by the President at the BAPCPA signing ceremony). Towards this end, Congress reduced the standard necessary to have a Chapter 7 case dismissed from that of substantial abuse to merely abuse, compare, 11 U.S.C. 707(b) (2004) with 11 U.S.C. 707(b)(1). The question of whether or not the debtor is guilty of such abuse is determined in one of two different ways: (1) through the application of a blind legislative formula that purports to determine a debtor s ability to repay his creditors, a formula codified in 11 U.S.C. 707(b)(2); and (2) through the application of a fact-driven facts and circumstances-type test codified in 11 U.S.C. 707(b)(3); see also Singletary at * 1 (noting that the description of Section 707(b) as a means test is something of a misnomer; instead, it is a series of requirements with multiple opportunities for debtors to be pushed into Chapter 13 ). Each of these provisions will be considered in turn. 1 Some of the case cited herein are decided under Chapter 7, others under Chapter 13. To the extent that the BAPCPA makes some of these issues the same in both chapters, I will not note under which chapter a given case was decided unless it is somehow germane to the discussion. 1

3 B. Dismissal for Presumed Abuse After accounting for expenses and adjustments to which the debtor is permitted, (done on form B-22, a form that makes income tax forms look userfriendly in comparison) the means test is applied and the court determines whether the debtor is abusing the system. If the debtor s available income exceeds the limits set in 11 U.S.C. 707(b)(2)(A)(I), the debtor is presumed to be abusing the bankruptcy system. 11 U.S.C. 707(b)(2)(A). If the means test gives rise to a presumption of abuse, the trustee, a creditor or the court may seek to have his petition dismissed. Mechanically, this dismissal is straightforward. The BAPCPA gives the trustee 10 days after the first meeting of creditors to file a statement with the court stating that there is a presumption of abuse, 11 U.S.C. 704(b)(1)(A), and then follow that statement up with a motion to dismiss (if it turns out to be justified) within 30 days. 11 U.S.C. 704(b)(2). This deadline has been literally enforced. In re Close, 2006 WL at * 2-3 (Bankr. D. Kan. Oct. 18, 2006) (deadlines run from the date the first meeting of creditors occurred, not the date the continued meeting was concluded; motion to dismiss under Section b(2) was untimely). The Means Test as a Continuation of Pre-BAPCPA Law Although the means test created by Section 707(b) is entirely new, the theory behind it is not. In pre-bapcpa cases, some of the courts charged with determining whether a debtor was guilty of substantial abuse of the bankruptcy system made this determination with a per se rule based on the court s determination of the debtor s ability (or perceived ability) to pay his debts. Some of the courts applying the means test in the aftermath of the enactment of the BAPCPA see it as a codification of the pre-bapcpa per se rule because it addresses only the debtor s ability to pay his creditors. This is in contrast to dismissal pursuant to 11 U.S.C. 707(b)(3) (discussed post), which refers to bad faith and totality of the circumstances. Because Section b(3) requires consideration of something other than gross ability to pay, it represents a codification of the pre- BAPCPA totality of the circumstances test used in connection with the prior version of Section 707(b). See, e.g., In re Nockerts, 2006 WL at * 7 (Bankr. E.D. Wisc. Dec. 14, 2006); Singletary at * 4. Interplay Between Section 707(b)(2) and Chapter 13 Finally, there is the new and somewhat odd interplay between the provisions of Section b(2) and the approval of a debtor s plan in Chapter 13. Chapter 13 generally requires a debtor to either pay his debts in full through the plan or to devote 100% of his projected disposable income (defined as income not reasonably necessary for the support of the debtor or a dependent, 11 U.S.C. 2

4 1325(b)(2)(A)) to the plan for the plan period. 11 U.S.C. 1325(b)(1). In the BAPCPA, Congress changed the operation of this settled law with respect to debtors with an income above the average for that of a similarly-sized family in the state in which they file, defining what constitutes reasonably necessary expenses for such a debtor in terms of the amounts permitted by the Section b(2) means test. 11 U.S.C. 1325(b)(3). In essence, this change now requires many Chapter 13 debtors to perform the means test, although the penalty is not dismissal of their case but rather a refusal to confirm their proposed plans. 11 U.S.C. 1325(b)(1). The question has arisen: how should the court treat a debtor who fills out Form B-22 and shows a negative monthly disposable income, but who actually has income that could be dedicated to a proposed plan? In cases where the central issue was the amount of the debtor s expenses, some courts have held that regardless of whether the debtor does or does not have any money left over at the end of the month, the debtor s plan cannot be denied if the debtor has passed the means test, i.e., the mechanistic determination mandated by Congress trumps objective reality. See, e.g., Guzman, 345 B.R. at 646; In re Alexander, 344 B.R. 742, 748 (Bankr. E.D. N.C. 2006); Barr, 341 B.R. at However, in cases where the central issue was the debtor s income, other courts have arguably reached a different result, finding that although the means test provides a mechanism for determining the debtor s current monthly income, the court may ignore this determination if it finds that the income number is likely to be an inaccurate projection of the debtor s income over the course of the plan, a finding usually based on the idea that the means test s concept of current monthly income (which, as we have seen, is a backwards-looking measure of income) is different from Chapter 13 s focus on projected disposable income (which makes an educated guess regarding the debtor s future income over the course of the plan). See, e.g., In re Fuller, 346 B.R. 472, 482 (Bankr. S.D. Ill. 2006); In re Dew, 344 B.R. 655, 659 (Bankr. N.D. Ala. 2006); In re Kibbe, 342 B.R. 411, (Bankr. D. N.H. 2006); Hardacre, 338 B.R. at 722. Finally, this analysis is not universal, with other courts struggling to find some kind of intermediate rule that is workable and which makes some kind of sense. See, e.g., In re Jass, 340 B.R. 411, (Bankr. D. Utah 2006) (court would assume income numbers determined through means test were Chapter 13 debtor s projected disposable income, but debtor could show the court that this was not the case due to a substantial change in his circumstances not reflected in that determination). In any case, the BAPCPA results in below-median-income debtors having their disposable income calculated differently than above-median-income debtors, McGuire, 342 B.R. at ; contra, Fuller, 342 B.R. at , and can also result in the confirmation of a plan proposed by a debtor who has no or even negative disposable income. Alexander, 344 B.R. at 750. The author believes that 3

5 both of these results neatly illustrate just how far the means test has strayed from reality, subjecting the overwhelming majority of honest debtors to its provisions just to catch the few perceived as taking advantage of the system. C. Operation and Effect of the Test for Abuse Created by Section 707(b)(3) Even if the debtor is not presumed to be abusing the bankruptcy system under Section b(2), his Chapter 7 case may still be dismissed if the court finds that it is abusive under Section b(3). In re Richie, 2006 WL at * 5 (Bankr. E.D. Wisc. Oct. 3, 2006); Walker at * 8; In re Pak, 343 B.R. 239, 341 (Bankr. N.D. Cal. 2006). Because a motion to dismiss made under Section b(3) is relatively less common than a motion made under Section b(2) (or, if made, the Section b(3) motion is not decided because the court concludes that there is an unrebutted presumption of abuse under Section b(2)), there are relatively fewer cases discussing the operation of Section b(3) on its merits. The Structure of Section 707(b)(3) As is the case under Section b(2), the central question to be answered in a motion to dismiss brought under Section b(3) is whether the debtor is guilty of abuse of the bankruptcy system, Travis at * 7, but unlike a motion brought under Section b(2) a Section b(3) motion does not enjoy any presumption of abuse, 11 U.S.C. 707(b)(3). Therefore, the burden falls on the movant to show either that the debtor filed in bad faith or that the totality of the circumstances surrounding the debtor s financial condition shows that the request for bankruptcy relief is abusive. Nockerts at * 7. Although the term abuse is nowhere defined in the Bankruptcy Code, courts appear to give the word its commonly understood meaning. See, e.g., In re James, 345 B.R. 664, 667 (Bankr. N.D. Iowa 2006) ( I consider an abuse to be a misuse of the bankruptcy provisions, to use them wrongly or improperly ). Under Section b(3), there are two statutory grounds that support a finding of abuse: (1) if the debtor has filed his petition in bad faith, 11 U.S.C. 707(b)(3)(A); and (2) whether, under the totality of the circumstances, the court believes the debtor s financial situation demonstrates abuse. 11 U.S.C. 707(b)(3)(B). Dismissal for a Bad Faith Filing The first basis for a determination that a debtor s petition should be dismissed under Section b(3) is if the court finds it was filed in bad faith. 11 U.S.C. 707(b)(3)(A). The phrase bad faith is not defined in the Bankruptcy Code, and so courts have had to develop their own tests to determine if the circumstances show the existence of bad faith. 4

6 In deciding whether a debtor is acting in bad faith, some courts have analogized to the tests used to determine bad faith under other chapter of the Bankruptcy Code on the grounds that regardless of the chapter involved, the question of whether the debtor has acted in bad faith involves essentially the same determination, i.e., whether creditors will be unjustly deprived of their rights and whether the integrity of the bankruptcy system will be weakened. See, e.g., In re Mitchell, 2006 WL at * 8 (Bankr. C.D. Cal. Dec. 5, 2006). 2 This determination generally requires the court to evaluate all relevant facts and circumstances and decide whether the debtor s intention in filing for bankruptcy is inconsistent with the purpose of the Code. Mitchell at * 8. Because the court is supposed to consider all relevant facts and circumstances, the court in Mitchell (the only court so far to discuss the operation of Section b(3)(a) in depth) enumerated a number of factors that speak to whether a filing has been made in bad faith, including: 1. the debtor s history of filings and dismissals; 2. whether the debtor has misrepresented facts in their petition; 3. whether the debtor has unfairly manipulated the Code or otherwise acted inequitably; 4. whether the debtor actually needs bankruptcy protection; 5. whether the debtor s invocation of the automatic stay was for improper purposes, such as defeating state court litigation; 6. the debtor s actual ability to fund a Chapter 13 plan from his income; 7. whether the debtor s petition was occasioned by illness, disability, loss of employment or some other unexpected calamity; 8. the extent to which the debtor intentionally obtained cash or consumer goods in excess of his ability to repay; 9. the excessiveness of the debtor s proposed budget; 10. the presence of any eve-of-bankruptcy purchases; and 11. whether other egregious behavior is present. Id. at * 9 (citing cases). Significant by its absence from the list is any sceinter requirement, i.e., it does not have to be shown that the debtor acted with malice or an intent to defraud his creditors. Id. Ultimately, determination of bad faith vel non is necessarily fact driven, 2 Although, of course, Section 707(b)(3) applies only to cases filed under Chapter 7. In re Barajas, 2006 WL at * 4 (Bankr. E.D. Cal. Nov. 8, 2006) (not designated for publication). 5

7 and is perhaps best analyzed with reference to the old Texas aphorism that pigs get fat and hogs get slaughtered. For example, in Mitchell the evidence showed that (i) the debtor earned a total of $11,000 in income in the three years before filing for bankruptcy, but had incurred debts for such necessaries as dining out, lingerie, beauty treatments and pet pampering, (ii) never offered any convincing explanation as to why she could not get a job as a pilot (her profession), (iii) failed to disclose significant deposits on her schedules, and (iv) lied to at least one creditor about her income. Id. at * Under those circumstances the court found the debtor a hog, and ordered her petition dismissed as a bad faith filing. Totality of the Circumstances The second basis for dismissal under Section b(3) is if, under the totality of the circumstances, the court believes that the debtor is abusing the system. The section appears to be a catch-all that allows a court to dismiss a Chapter 7 case any time that the case will result in bankruptcy abuse that Congress has not already provided for. The totality of the circumstances test called for by Section b(3) itself predates the BAPCPA, and so practitioners should be prepared to consult pre-bapcpa law if this issue arises. Nockerts at * 7; Hill, 328 B.R. at 499 (BAPCPA does not displace current 707(b) jurisprudence ); see also Travis at * 8 (post BAPCPA case applying pre-bapcpa law). Consideration of the Debtor s Ability to Pay The primary issue that has arisen in cases involving dismissals under Section b(3)(b) is whether the court may consider the debtor s income in deciding whether the totality of the circumstances suggest abuse. Some courts hold that because Section b(2) represents the mechanism for determining whether a debtor has an ability to pay, the totality of the circumstances test necessarily requires the court to consider factors other than the debtor s ability to pay; to hold otherwise would be to fail to give the appropriate weight to the means test codified in Section b(2), and could result in a debtor passing the means test but being dismissed for abuse based on a consideration of nothing more than his perceived ability to pay. Nockerts at * 8. However, this does not mean the debtor s ability to pay should be ignored completely. Consideration of the debtor s means is not entirely inappropriate under Section b(3); rather, it is merely one factor that is to be considered (with others) and is not by itself dispositive of the question of abuse. Because the debtor s income is an important part of his total financial picture, courts recognize that consideration of the debtor s income and ability to pay in connection with a motion to dismiss under Section b(3) is proper. In re Paret, 347 B.R. 12, (Bankr. D. Del. 2006); Pak, 343 B.R. at Probably the most common case 6

8 when a court will take a hard look at the debtor s means in connection with a motion brought under Section b(3) is when the debtor is of below median income. Nockerts at * 9. In such a case the debtor will have never had his income subject to analysis, 11 U.S.C. 707(b)(7) (precluding the application of the means test to a below median income debtor), and so the only occasion where a court can determine the ability of a below median income debtor to pay would be in connection with a motion brought under Section b(3). 3 Courts may also consider the income earned by a non-debtor spouse (which is also not considered under Section b(2)), at least to the extent that such income could generate a significant amount in excess of the debtor s reasonable minimum needs. Compare Travis at * 8-9 (refusing to find that debtor was abusing bankruptcy system by failing to make $300 paid by non-debtor spouse to pay her own credit card debts available to debtor spouse s creditors) with In re Haney, 2006 WL at * 2 (Bankr. W.D. Ky. Oct. 19, 2006) (where debtor received $366 a month in Social Security and non-debtor spouse earned over $6,300 per month, where evidence showed debtor and non-debtor acted as a single financial unit, and where there were discrepancies between debtor s schedules and her testimony, court considered non-debtor spouse s income in finding that debtor had filed in bad faith). However, other courts go further, and apparently believe that consideration of ability to pay must be determined under the totality of the circumstances test independently of ability to pay under the means test. They reach this conclusion not by focusing on the detailed nuts-and-bolts how much do you earn, how much do you have to pay to live kind of considerations that are part and parcel of the analysis under Section b(2), but rather by taking a more global view of the debtor s ability to pay. For example, in a case involving a debtor who was then unemployed but who had just received an advanced degree that would allow her to take a professional position, the court found the debtor s unwillingness to either take a job in her field in another state and/or her unwillingness to take a job not in her field where she lived was indicative of abuse because it showed the debtor was failing to make a real attempt to repay her creditors. Richie at * Consideration of Other Circumstances as Indicative of Abuse This leaves open the question of what other circumstances the court should consider in deciding whether a Chapter 7 petition is abusive under the totality of the circumstances test. Id. at * 5. Clearly, the intentional squandering of money that could have been used to pay creditors is a circumstance courts can 3 Although as a practical matter the fact the debtor is below median income suggests that the debtor s ability to pay is limited; ability to pay is a function of income minus permissible deductions, and so a smaller income will almost always mean a lesser ability to pay. 7

9 (and do) consider, James, 345 B.R. at (finding of abuse predicated on fact that debtor took two bonuses and income tax refund totaling more than 50% of the debt due and spent them on luxury items and a trip to treat or reward himself), as are circumstances that are indicative of the debtor s own belief about their future income. See, e.g., Hill, 328 B.R. at 497 (fact that debtors reaffirmed debt on inoperative automobile in need of substantial repairs indicated to court that debtors believed their income situation was relatively stable). In addition to the debtor s ability to pay, courts also consider other factors, including: 1. the stability of the debtor s source of income; 2. whether the debtor is eligible for Chapter 13; 3. whether there are other remedies (such as under state law) which the debtor may use to alleviate his financial problems; 4. whether the debtor can obtain any meaningful relief through private negotiations with his creditors; and 5. whether the debtor can significantly reduce his expenses without depriving him of necessary food, shelter and clothing. Travis at * 8; Pak at 244. Timing of the Totality of the Circumstances Determination Finally, the operation of Section b(3) also raises an issue of timing: when are the totality of the circumstances regarding the debtor s financial situation to be determined, and how should a court weigh future possibilities in determining the totality of the circumstances? The cases that have considered the first question have held that the relevant date for determination of the totality of the circumstances is as of the date of the hearing and not as of the date of the filing of the petition, see, e.g., Richie at * 8; In re Pennington, 348 B.R. 647, 651 (Bankr. D. Del. 2006) (analogizing the right of the court to consider the debtor s future income and expenses in deciding whether to confirm a Chapter 13 plan), a determination that can cut both ways. As the court in Pennington noted, this would mean that in determining whether there is evidence of abuse a court could consider the fact that the debtor traded in a more expensive car for a less expensive one and thereby lowered his monthly payments (as happened in that case), but it could also consider the fact that the debtor has incurred additional expenses post-petition, such as medical expenses or the expense of having to replace a car. Pennington, 348 B.R. at 651. Of course, the contrary argument is also obvious: if the totality of the circumstances requires the consideration and reconsideration of all circumstances as they change, is a Chapter 7 debtor ever safe from the claim that he is abusing the system. Before he receives 8

10 his discharge the answer would appear to be no, 4 giving rise to the somewhat anomalous situation of a court finding a debtor has acted abusively due to circumstances that changed post-petition and which he could have never have anticipated pre-petition. Therefore, it is at least theoretically proper under Section b(3) to find that a change in the debtor s income situation can indicate the debtor is abusing the system, even if the change occurs post-petition. For example, the court in Richie dismissed the debtor s Chapter 7 case based (at least in part) on its determination that the debtor could have tried harder to find a job both before and after her petition was filed, and that if she were to find such a job she would be in a position to repay her creditors at least some of what they were owed. Similarly, the court in Pak approved of consideration of post-petition changes in the debtor s income, a finding that lead it to conclude the debtor was guilty of abuse under the totality of the circumstances because he had found a job that paid him the high fivefigures, even though the fact he was unemployed at the time he filed his petition meant he passed the means test. Pak, 343 B.R. at Although there is no authority on point, I cannot imagine that a court would allow the trustee to reopen the case of a debtor who has received a Chapter 7 discharge because the debtor s income increased after that discharge to such a level that it would arguably sustain a finding of abuse. 9