James v West, part 2: a practical discussion of the Means Test

As a bankruptcy attorney in Mount Vernon, IL for over 20 years, I read through and analyze court rulings throughout the country. I was lucky to find this wonderful case from the Western District of Missouri (whence lay Kansas City, Independence, Branson, etc.). James v. West, 16-40358.

What a wonderful case this is: an excellently written opinion dealing with fraud, the means test and other topics important in bankruptcy.

This isn’t an opinion, this is a text book. It should be on the curriculum of anyone teaching bankruptcy law. It is that good!

Read Part One (findings of facts, etc.) here.

 

Conclusions of Law

The Amended Motion to Dismiss or Convert is pled in three counts: (1) a motion to dismiss for abuse under § 707(b)(1), (2), and (3); (2) a motion to convert to Chapter 11 under § 706(b); and (3) in the alternative, a motion to convert to Chapter 13. It is undisputed that the Jameses as movants generally have the burden of proof, except that, if a presumption of abuse arises under § 707(b)(2), the burden then shifts to the Debtor to prove “special circumstances” and that the case is not an abuse. The Court will address each count in turn.

1. Count 1: Motion to Dismiss Pursuant to § 707(b)(1), (2) & (3)

Section 707(b)(1) provides in relevant part that, “after notice and a hearing, the court . . . on motion by a party in interest . . . may dismiss a case filed by an individual debtor under this chapter whose debts are primarily consumer debts, or, with the debtor’s consent, convert such a case to a case under chapter 11 or 13 of this title, if it finds that the granting of relief would be an abuse of the provisions of this chapter.”

In this case, there has been notice and a hearing and no party has contested that the Jameses, as creditors in this case, are parties in interest to bring the motion. It is also uncontested that the Debtor as an individual Chapter 7 debtor does not consent to conversion of her Chapter 7 case either to Chapter 13 or 11. Rather, the mixed factual and legal issues in dispute under § 707(b)(1) are: (1) whether the Debtor’s debts are “primarily consumer debts,” and (2) whether the granting of relief under Chapter 7 would be an abuse of the provisions of Chapter 7.

The Jameses bear the burden of proof to demonstrate abuse. In re Booker, 399 B.R. 662, 665 (Bankr. W.D. Mo. 2009). Because the statutory language uses the word “may” instead of “must” or “shall,” the Court is under no obligation to dismiss even if all of the requirements are met. “Furthermore, the moving party bears the burden of proving by a preponderance of the evidence that [the] Debtor’s scheduled debts are primarily consumer debts.” In re Braathun, No. 07-00771-lmj7, 2011 WL 1299605, at *4 (Bankr. S.D. Iowa April 4, 2011).

At the Threshold, A Practical Discussion Regarding the Means Test

The practical importance to a litigant of seeking dismissal pursuant to § 707(b)(1) is that if the debts are primarily consumer debts, the debtor must complete an official form known as a “means test.” In 2005, the BAPCPA amendments to the Bankruptcy Code amended § 707(b)(1) and added § 707(b)(2) and (3), reflecting Congressional belief that too many debtors were filing Chapter 7 liquidation bankruptcies (instead of repayment plans, such as Chapter 13s) when they actually had the ability to devote their income to pay something back to creditors. Section 707(b)(2) sets out a complicated formula to determine if an individual debtor with primarily consumer debts has “current monthly income” – a defined term under § 101(10A)—sufficient to fund a Chapter 13 plan based on an ability to pay back a certain amount or percentage to unsecured creditors over a presumed 60-month plan.

If a debtor has sufficient “current monthly income” based on the formula set forth in § 707(b)(2)(A)(i)(I) or (II), then abuse is presumed as a matter of law and the burden shifts to the debtor to rebut the presumption of abuse by showing “special circumstances” as set forth in § 707(b)(2)(B)(i); otherwise, the case will be dismissed if the debtor does not agree to conversion. As will be discussed below, if the presumption of abuse does not arise, or if the debtor is able to rebut the presumption, the case may still be dismissed under the totality of circumstances standard set forth in § 707(b)(3).

The formula in § 707(b)(2) is implemented by the official “means test” form. The means test form follows the formula set forth in §§ 101(10A) and 707(b)(2) and determines whether the presumption of abuse arises for any given debtor. It also determines how much a Chapter 13 debtor may have to pay unsecured creditors in Chapter 13 under Section 1325(b). (The Chapter 13 Means Test Form is slightly modified from the Chapter 7 Form to reflect administrative costs of the Chapter 13, such as the Chapter 13 Trustee’s fee, among other items.)

There has been significant litigation over the formula in § 707(b)(2) and how the calculation of “current monthly income” in § 101(10A) is incorporated into § 1325(b), the most notable cases being Hamilton v. Lanning, 560 U.S. 505 (2010) and Ransom v. FIA Card Services, N.A., 562 U.S. 61 (2011).

The practical difficulty with the current monthly income formula is that, generally speaking, it requires the debtor to start with six months of gross income for the six months ending on the month before the filing date (e.g., here, the Debtor filed February 17, 2016, so it would require her to list gross income for the six-month period starting on August 1, 2015, through January 31, 2016), then to divide this income by twelve and to annualize it. The “total current monthly income” thus derived is then compared to “median income” for the debtor’s household size in the state in which she lives as of the date of the bankruptcy filing.

The problem with this formula is vividly illustrated by the facts in Hamilton v. Lanning, where the debtor received a large one-time severance payment during the six-month period before she filed her Chapter 13 bankruptcy. This payment effectively doubled her annualized monthly income, resulting in a “current monthly income” that was impossibly high based on her actual, much lower income at the time she filed. It meant that the debtor did not, based on the formula, qualify for Chapter 7 since her case was presumed an abuse, but that she likewise could not fund a Chapter 13 because the formula produced a “projected disposable income” she was required to pay creditors that was not realistic. (The debtor in Hamilton v. Lanning filed a Chapter 13 case. The Bankruptcy Court, the Hon. Janice Miller Karlin presiding, confirmed the debtor’s Chapter 13 plan based on her lower, actual income, rather than the higher “projected disposable income” the means test form derived. The Chapter 13 Trustee appealed from that ruling, but the Supreme Court ultimately affirmed Judge Karlin.)

The other practical problem with the means test formula is that, rather than deducting the debtor’s actual living expenses from the formula-derived “income,” the Code requires the debtor to deduct allowances for housing, transportation, food, and utilities based on IRS collection guidelines. Thus, the formula can produce both unrealistically high or low incomes and unrealistically high or low expenses, depending on whether the debtor and any dependents are spending more or less than the IRS allowances.

Many courts and commentators have noted that the § 707(b)(2) formula, intended to prevent abuse, leaves room for manipulation and thus encourages more abuse; it may result in an artificial and arbitrary income that is neither “current” nor “monthly” nor in some cases even “income.” The Supreme Court’s ruling in Hamilton v. Lanning that a court could consider known or virtually certain information in considering projected disposable income for Chapter 13 purposes slowed the litigation under these sections, but has not eliminated it entirely; confusion and interpretation battles still persist.

In this case, since the Debtor’s income was relatively stable on a monthly basis, the income side of the formula does not result in an unrealistic income. But single individuals such as the Debtor, with inexpensive car loans and no mortgage or dependents, are often disadvantaged under the expense side of the formula. As will be seen below, with respect to the expense side, the formula produces an unrealistic result for this Debtor, particularly since she spends more to live than some of the IRS allowances, and since she is not able to take advantage of favorable allowances for those with high mortgage and car payments.

These observations are not made to justify the Court’s ruling in this case, but to provide background as to why, in the Court’s experience, a debtor and her lawyers do not voluntarily complete a means test if the law does not require it. The means test is legally and factually complicated; it puts the burden of proof on the debtor to rebut the presumption of abuse (if one arises); and it may add additional legal fees to an otherwise already expensive representation. (It is well-known that BAPCPA significantly increased the attorney fees for filing bankruptcy, and that many courts authorize additional fees if the attorney is required to complete a means test for the filing. (The Western District of Missouri, for example, authorizes an additional $500 fee for “above median” cases). In this case, Debtor’s counsel charged a flat fee of $2,500 for her Chapter 7 case.)

Since completing the means test is only required if an individual debtor has “primarily consumer debts,” a debtor who does not have primarily consumer debts would never voluntarily complete the means test unless otherwise ordered by the Court.

 

About the blogger:

Michael Curry of Curry Law Office in Mount Vernon, Illinois (http://michaelcurrylawoffice.com/) has helped thousands of individuals, family and small businesses in southern Illinois find protection under the Bankruptcy Code for almost twenty-five years. He is also available to help individuals and families with their estate planning (wills, power-of-attorney) and real estate and other sales transactions.

He is also the author of books on finance and bankruptcy available on Kindle through Amazon!

Whether you live in Mount Vernon, Lawrenceville, Centralia, Louisville, and throughout Southern Illinois call Curry Law Office today at (618) 246-0993 and Finally Be Financially Free!