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!
Whether the Means Test in Debtor’s Case Would Trigger a Presumption of Abuse
The Jameses adduced testimony from a bankruptcy lawyer about what the Debtor’s means test would show if a means test were prepared based on the income and expenses in her Schedules I and J. (The Jameses designated the attorney as an expert witness; the Court granted in part the Debtor’s motion in limine to exclude any expert testimony by the attorney on the ultimate legal issue of whether the case is presumed an abuse.)
Based on this evidence, the Court finds and concludes that if the Debtor were to file a means test she would show disposable income of $1,918.08 per month, triggering the presumption of abuse. For Chapter 13 purposes, this means that, under § 1325(b), the Debtor might be required to contribute this amount to pay her unsecured creditors over 60 months (minus the Chapter 13 trustee fees and other allowed deductions), even though her actual budget based on the amended Schedules I and J shows she has much less left over ($592) in her monthly budget.
Whether the Jameses’ Judgment is a Consumer Debt; Definitions of Relevant Terms
Turning back to the issue of whether the case should be dismissed or converted under § 707(b), the first issue is whether the Jameses’ judgment is a “consumer debt.” “Consumer debt” is defined by § 101(8) as “debt incurred by an individual primarily for a personal, family, or household purpose.” The term “debt” is defined in § 101(12) as “liability on a claim.” “Claim” is defined in § 101(5) as a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.” Under these definitions, the James’ judgment is without question a “debt.” The question is whether the Debtor incurred the debt “primarily for a personal,family, or household purpose.” This phrase is not defined, and therefore the Court looks to case law to determine what this phrase means.
Definition of “Primarily”
The Eighth Circuit has not addressed the meaning of “primarily” in the context of § 707(b), but the majority of cases elsewhere hold that “primarily” means more than half by total dollar amount of all debt. See, e.g., In re Kelly, 841 F.2d 908, 913 (9th Cir. 1988). The “primarily” component is not in issue here since it is undisputed that the Jameses’ debt is much more than half of the Debtor’s total debts.
Consumer Debt is Based on Purpose/Intent
Courts in the Eighth Circuit have addressed what constitutes a consumer debt, however. To determine whether a debt is a consumer debt, courts look to the debtor’s purpose or intent in incurring the debt. E.g., In re Lapke, 428 B.R. 839, 843 (B.A.P. 8th Cir. 2010). A mortgage-type debt, or a debt secured by real property that is voluntarily incurred to buy a home or make improvements, is the paradigm example of a consumer debt. Lapke, 428 B.R. at 843; In re Cox, 315 B.R. 850, 855 (B.A.P. 8th Cir. 2004). “With respect to debt secured by real property, if the debtor’s purpose in incurring the debt is to purchase a home or make improvements to it, the debt is clearly for family or household purposes and fits squarely within the definition of a consumer debt under § 101(8).” Cox, 315 B.R. at 855.
The converse of a consumer debt is a debt “incurred for business ventures or other profitseeking activities” — these debts do not fall into the category of debt incurred for personal, family, or household purposes. In re Hoffner, No. 07-30461, 2007 WL 4868310, at *1 (Bankr. D.N.D. Nov. 21, 2007)). Even if a debtor’s purpose or intent is mixed, such as to buy the home and later sell it at a profit, the debt is still considered a consumer debt so long as the debtor ntends to live in the home. Cox, 315 B.R. at 855; In re Grover, No. BR 12-01069, 2013 WL 3994608, at *4 (Bankr. N.D. Iowa Aug. 2, 2013).
Whether a debt is a consumer debt is thus a question of fact. Cox, 315 B.R. at 855.
Parties’ Arguments About the Jameses’ Debt
In this case, the Debtor contends that the Jameses’ debt is a business debt, arguing that her intent in buying the Jameses’ home was to turn it into a bed and breakfast (“B&B”), a profit motive that would render the debt a business debt. She testified that although she did not have the income or assets to purchase the home, she was relying on Knowles’ wealthy brother and a friend, who were going to be investors in the B&B and advance the money for the purchase. She testified that she trusted and relied on Knowles, and left the bulk of the financial and real estate details to him; that he told her the closing with the Jameses had fallen through but that his brother and friend were still working on another way to acquire the Jameses’ home; and that she was otherwise assuming the B&B deal was still in process, even though she had not closed on the Jameses’ home in May 2013; and was otherwise unaware that there was no deal and that she had been sued until she received the wage garnishment in January 215.
The Jameses vigorously dispute and question the Debtor’s intent and profit motive, flatly implying that no one could be this trusting and expressly accusing her of lying. The Jameses in closing argument pointed to evidence showing or tending to show: (1) the Debtor made her offer to the Jameses on a residential real estate contract form; (2) she never told Strong that she intended to buy the house for a B&B; (3) she admitted she intended to live in the house; (4) she personally undertook no objectively reasonable steps to verify if she could ever turn the house into a B&B or turn a profit; (5) she had no receipts or documentary proof for items such as books and accessories she claimed she bought for the B&B, nor proof that she had even looked at certain B&B-related websites before she made the offer; and (6) she was a sophisticated businesswoman who had owned and operated a small karate business previously.
Although most of this is true, the evidence of the Debtor’s intent is mixed, making the factual determination a close call. The Court ultimately believes that the issue rests on the Debtor’s credibility. The Court concludes that the Jameses have not met their burden of proof to prove the Debtor’s intent and purpose was merely to purchase a residence, thus rendering their debt a consumer debt. The Court draws this conclusion for two independent reasons, one factual and one legal.
First, the Jameses’ Debt is not a Consumer Debt but a Business Debt Based on the Court’s Factual Findings Based on Credibility
The Court Believes the Debtor That Her Intent/Purpose Was to Purchase a Home to Run a B&B
First, the Court is convinced based on the Debtor’s credible testimony that her motive and intent was to purchase the Jameses’ home for a B&B. Randy James, a lawyer representing himself, called the Debtor as a hostile witness during the first day of trial, and the Court was initially troubled by some of her evasive, waffling, and nonresponsive answers to his questions.
As the lengthy examination progressed, however, the Debtor held her own, offering numerous, consistent, and credible small details under the frankly withering examination.
It was apparent to the Court that the Debtor had not been adequately prepared by her own counsel for the degree of scrutiny by Randy James and his wife’s counsel on the issue of whether the Debtor was lying about her intent to run a B&B. Yet, the Debtor persisted with details about the intended B&B: books she or Knowles purchased; the themes of the various rooms she planned; the websites she had visited; the accessories and figurines she purchased or intended to use to furnish the rooms according to the planned theme; and even the intended name of the B&B as “Sha-Rob,” a combination of her name and Knowles.’ She testified credibly that she had considered what she could charge for a room given the house’s location compared to other nearby B&B’s, and that the house and its acreage could be used for other events and functions.
The Court believes and finds her testimony credible and consistent in that she and Knowles believed that opening and operating the B&B would be a “process” and “done in phases”; that the small amount of work she had done before she made an offer for the Jameses’ property was consistent with the idea that opening a B&B would be a “process”; that she did not keep receipts of the books or other items because they were purchased at garage or estate sales or on eBay for small amounts of money; and that it was her plan with her long-time boyfriend to retire and run the B&B, with her as the “people person” and him as the “maintenance guy.” The Debtor testified to these details in the face of a hostile cross-examination and in a heartfelt and consistent way, and the Court simply does believe that she could have fabricated these consistent details on the spot and under the pressure of cross-examination.
The Court Rejects the “Mastermind” Argument
Based on the Court’s close observations of the Debtor both times she testified, first nearly all day as a hostile witness, and then when she was called by her own counsel the second day of trial, the Court does not believe the Debtor is lying about her business motive. Nor does the Court believe, as the Jameses would suggest, that she came up with the B&B idea after the fact to be able to discharge the Jameses’ debt. There was no indication from the Debtor’s background or testimony that she was as “sophisticated” as the Jameses argued, let alone so sophisticated that she masterminded a scheme to make an offer to purchase a house she could not afford from people she did not know so that later on when she was sued she could lower her attorney fees for filing bankruptcy by not having to fill out a means test form.
Rather, the only reasonable explanation for someone living in otherwise modest housing accommodations and without significant means to make an offer to buy a million-dollar home is that she truly believed Knowles’ brother and his friend were going to finance the purchase of the home as an investment for a B&B. The Jameses’ argument that she fabricated the B&B story to avoid discharging their judgment is also based on a faulty assumption of the law — whether a debt is a business debt or consumer debt is not relevant to whether the debt is dischargeable under § 523. (It is relevant for purposes of fee-shifting in § 523(d), discussed below.)
The Court Rejects the “Sophisticated Businesswoman” Argument
The Court also rejects the Jameses’ argument that the Debtor is a sophisticated businesswoman. The Court finds factually that the Debtor is not a sophisticated businesswoman based on its observations of her and her testimony; these observations included her use of certain unsophisticated terms in describing her plans and sometimes less than polished grammar.
Likewise, in the absence of other evidence, running a small karate business after regular work hours for the admitted purpose of helping her son and other children — and even having a supervisory role in a hospital clinic — do not necessarily transform a person into a “sophisticated businesswoman.” It was clear that the Debtor had not established the karate business for the money. The argument that the Debtor is sophisticated financially and business-wise was also severely undercut by the evidence the Jameses adduced showing that she had other debts in collection.
The Court Rejects the Argument that the B&B Could Never Have Been Profitable as Relevant to Debtor’s Intent/Motive
The Jameses did adduce evidence that, based on their own cost to live in and maintain the Property, it was highly unlikely that the Debtor could operate a B&B there at a profit. But the Court does not necessarily find that evidence relevant to the Debtor’s purpose and intent. Again, in the face of being confronted with the high monthly living expenses the Jameses incurred, the Debtor held her own, noting that Knowles would have done the maintenance himself, among other details. The Court also does not find it nearly so troubling as the Jameses do that the Debtor did not prepare a business plan or that, if she had done so, a reasonable business person would have concluded that running a B&B would likely not be profitable. If all people approached starting a business with a business plan and realistic projections of income and expenses, there would be no need for bankruptcy protection.
Although the Court believes that the Debtor was hopelessly naive in her plans to create “Shar-Rob,” the Court finds that she did focus on the financial details she thought were relevant to her plan, and that it was subjectively reasonable for her to rely on Knowles, whom she loved and trusted, to come up with financing, as objectively unrealistic as that might seem after the fact.
The Conflicting Testimony From Strong, the Debtor’s Buyer’s Agent
There is conflicting testimony about whether the Debtor told Strong, her buyer’s agent, that she and Knowles were intending to run a B&B; Strong denies it. The Court discounts much of the testimony of the unreliable Knowles on this point. But the Court finds the Debtor’s testimony has more of a ring of truth than Strong’s, based on the Court’s observations of both witnesses.
Strong was also sued by the Jameses and was overly forthcoming and solicitous in his answers to Jameses’ questions, in contrast to the Debtor’s counsel’s questions. Strong appeared to have some incentive to provide helpful testimony to the Jameses, although any bias was not explored by the Debtor’s attorneys on cross-examination.
But Strong’s testimony that he remembers in detail what the Debtor and Knowles said when Debtor signed the Contract is also undercut by his testimony that he had participated in thousands of contracts and closings in his real estate career. It is simply unrealistic to believe that Strong remembered all the details of what was discussed at the Contract signing. Also, since the purpose of a B&B is to reside there, the Court does not necessarily put much stock in Strong’s testimony that he would have checked the “other” box on the buyer’s agent form or presented the offer using a commercial contract form if the Debtor had told him she was making the offer to buy the Property for a B&B. In sum, even if the Court believed Strong’s testimony that the Debtor did not tell him about her B&B plans, that testimony does not overcome the other evidence of intent and motive based on the Debtor’s credible testimony.
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, Xenia, Grayville, Effingham and throughout Southern Illinois call Curry Law Office today at (618) 246-0993 and Finally Be Financially Free!