In the 25-plus years I’ve been helping people file bankruptcy here in the Columbia area, one of the biggest changes has been the advent of the means test, designed to limit the number of people who can take advantage of the simplest form of bankruptcy, Chapter 7.
In the late 1990s, when Congress first started trying to “reform” the Bankruptcy Code, one of its main focus areas was abuse of Chapter 7. Representatives of banks and other lenders argued that many people file this form of bankruptcy, which does not require payments to unsecured creditors, when they could afford to pay a meaningful portion of their debts.
Since 1984, bankruptcy judges have had the power to dismiss Chapter 7 cases for “substantial abuse.” Courts had developed a substantial body of law for determining when debtors were abusing the system. But the lenders thought this standard gave judges too much discretion: a judge in California might think a debtor with $150 more income than expenses should be granted a discharge, while another judge in Maine might dismiss the case of a debtor with $50 of surplus. The lenders argued there should be a standardized test to determine when a debtor should be bounced out of bankruptcy based on his income.
The lenders won that argument in 2005, when Congress enacted the so-called Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”). One of the most important provisions of BAPCPA was a mathematical formula to determine when a Chapter 7 case would be presumed to be abusive–a means test.
The means test is a sort of modified monthly budget, involving a calculation of income and–sometimes–expenses. In my office, we carefully work through this formula with the client using information he provides. It works like this.
On the income side, we begin by averaging the client’s household income over the last six months. At that point, the test divides people into two groups. If the household income is less than the median family income for households of the same size, the client “passes” the means test. The court will not presume he would be abusing the system if he files Chapter 7.
If the client’s income is above median, we then proceed to the expense side of the formula–what we call the full means test. At this stage, we deduct certain expenses from the client’s income in order to determine whether he is operating at a significant surplus.
In some categories, such as the housing, household expenses, and automobile expenses, we can deduct fixed allowances, regardless of what the client actually spends. In other areas, including taxes, support payments, child care, and telecommunications, we can deduct the actual amount of expense he incurs.
We then add up all these expense categories, producing a total that is a hybrid of allowed and actual figures. If the client’s income exceeds this expense total by more than a certain threshold amount (calculated by another formula), it’s presumed a Chapter 7 would be abusive. That doesn’t mean Chapter 7 is automatically off limits. It does mean we need to look carefully at any special circumstances that may allow the client to file Chapter 7.
The means test is important, but it’s also complicated. It requires that the debtor’s attorney be informed and experienced in applying the rules. In assisting those considering bankruptcy, we believe our clients have a right to expect us to guide them through the means test accurately and to advise them how the result affects their bankruptcy options.