Bankruptcy law has changed, and there’s a focus on whether debtors are “abusing” the system by filing a Chapter 7 bankruptcy.
In my Lexington bankruptcy practice, I’ve noticed that bankruptcy courts and lawyers have been overwhelmed by a preoccupation with abuse of the bankruptcy system. This disproportionate emphasis on what has always been a small part of the system has important effects on the great majority of debtors who seek bankruptcy relief honestly and in good faith.
Before 2005, the bankruptcy laws permitted judges to dismiss Chapter 7 cases based on “substantial abuse,” a term that included a number of factors such as the reasons leading to a debtor’s decision to file, the timing of the filing, and the debtor’s ability to pay any significant portion of his debts. In this part of the country, however, it was well established that if the debtor had sufficient income to pay, say, 15% of his debt over five years, a court could not dismiss his case unless some other circumstance made the case appear abusive.
In 2005, Congress – influenced by tens of millions in campaign contributions by the various lending industries – enacted BAPCPA, the biggest change to the Bankruptcy Code in almost 30 years. The stated reason for these changes was to prevent of abuse by debtors.
Congress first took out the word “substantial,” permitting judges to dismiss Chapter 7 cases based on minor or technical abuses.
Next, Congress established a means test to screen every case for abuse. The first question in this test is whether the debtor’s household income for the last six months has been above or below the median family income for his state. If above, the test then turns to the debtor’s expenses. In some categories, such as medical costs, child care, and telecommunications, the debtor must give the actual (“applicable”) expenses of his household. However, the basic expenses of owning and maintaining one’s home and cars are fixed at artificial “allowed” figures derived by the IRS. If the six-month average income, minus the expenses calculated by the hybrid applicable and allowed figures, shows any substantial amount of income left over, the debtor is presumed to be abusing the bankruptcy system. He must then rebut the presumption – that is, prove his innocence.
Finally, Congress established a second way of proving abuse: by the totality of circumstances. However, it never defined the term abuse. In effect, the new law gave the bankruptcy court a license to throw debtors out of bankruptcy court because it disapproves of their conduct, even though they meet all the tests the law sets out for debtors.
Fortunately, most bankruptcy courts have been sensible in exercising this broad new power. However, even the most honest and needy debtors are faced with the increased effort and cost (in attorney’s fees) of completing the means test. Every debtor faces the unsettling prospect that representatives of the U.S Trustee, the agency charged with policing for abuse, will appear at his creditor meeting to question him about his debts, income, and expenses. And where the means test makes it appear the debtor can pay toward his debts, even if he cannot – for example, where he had higher income in the last 6 months than he does now – he will face the additional effort and cost of responding to investigation by the UST.
The spectre of abuse thus affects everyone who files Chapter 7. The best way a debtor can deal with these effects is to select an attorney who is up to date on the emerging rules in this area, to disclose income to the attorney fully and honestly, and to discuss with the attorney well before filing how changes in income and expenses may impact the prospects of completing a Chapter 7 case.