Increasingly over the last 20 years, Congress has tried to put Chapter 7 off limits to debtors who can pay a meaningful portion of their debts.
For such debtors, Congress views Chapter 7, where debtors make no payments on unsecured debt, as an abuse of the system. Bankruptcy courts must dismiss these cases unless the debtors convert to Chapter 13 and propose a repayment plan.
Restricting access to bankruptcy
The effort to restrict Chapter 7 eligibility got a boost in 2005 with the passage of the so-called Bankruptcy Abuse Prevention and Consumer Protection Act. BAPCPA established a means test – a complicated formula involving income, actual expenses, and expense allowances – to identify those who can afford to pay.
The purpose of the test was to set a uniform method of determining disposable income that is not subject to the varying standards of different bankruptcy judges. A consumer debtor who “fails” the means test – whose budget figures, plugged into the formula, suggest he can afford more than a nominal payment to unsecured creditors – is presumed to be abusive if he files Chapter 7.
Because of various artificial factors in the means test, it sometimes does not accurately depict a debtor’s real disposable income. But BAPCPA also allows a bankruptcy court to dismiss a Chapter 7 case for abuse based on the totality of the circumstances – the entire picture surrounding the debtor’s case.
So if the debtor passes the means test, may the court still consider the debtor’s ability to pay as a major part of that picture?
Courts weigh in
One U.S. court of appeals – the second-highest level of the federal judiciary – has said “yes.” Recently, another agreed.
In the first case, a couple from rural Aiken County, South Carolina, filed Chapter 7 in 2008. John and Glenda Calhoun had annual income of almost twice the state median figure, mostly from John’s generous retirement benefits, but they passed the means test. Nevertheless, the United States Trustee moved to dismiss their case as abusive.
The bankruptcy court first found that the means test did not prevent it from looking at the Calhoun’s actual ability to pay creditors. Next it concluded, contrary to pre-BAPCPA precedent, that ability to pay could, by itself, make a Chapter 7 case abusive.
Finding a number of expenses the debtors could reduce in order to pay creditors, the court dismissed their case.
After an intermediate appeal, the Fourth Circuit Court of Appeals affirmed. It found the Calhouns’ expenses bordered on extravagant and emphasized that they had been in a repayment plan, paying $2,600 a month on their debts, for almost two years before filing. The court “readily dispense[d]” with the argument that the means test is conclusive of eligibility for Chapter 7. Calhoun v. United States Trustee, 650 F.3d 338 (4th Cir. 2011).
Although the circuit court’s legal analysis was not especially detailed, ability to pay so dominated its opinion that it is clear the court concluded the means test does not preempt that issue.
Another circuit heard from
The second case arose in the Eleventh Circuit, just west of the Fourth. Robert and Jennifer Witcher of northern Alabama filed Chapter 7 in 2010.
Like the Calhouns, they passed the means test, but only after deducting expenses the bankruptcy court deemed nonessential: payments on a camper, boat, trailer, and tractor. Rejecting their argument that the means test alone determined their ability to pay, the bankruptcy court dismissed the Witchers’ case.
In a December 2012 opinion, the Eleventh Circuit affirmed. Addressing this issue more precisely than the Fourth Circuit, the court carefully limited the scope of its holding. It did not consider whether a court could dismiss solely based on the debtor’s ability to pay, nor did it determine how much weight a bankruptcy court should give to this factor.
It simply said that whatever impact that factor may have, the means test does not prevent the court from considering how much the debtors really can pay. Witcher v. Early (In re Witcher), 702 F.3d 619 (11th Cir. 2012).
Moral of the story
These holdings echo the strong weight of authority from lower courts around the country. So while the means test remains a critical consideration in determining whether debtors can proceed under Chapter 7, debtors and their lawyers must take a close look at actual income and expenditures, screening for any frivolous or luxury expenses, before deciding which chapter to pursue.
Guest author bankruptcy lawyer Lex Rogerson is a sole practitioner in Lexington, South Carolina. He has been representing consumers in bankruptcy cases for over 25 years. We’re happy to have him here on the Bankruptcy Soapbox.
Image courtesy of Sanja Mullappally