not so fast…
Most higher income individuals considering bankruptcy think that if you make less than the applicable means test figure then they are automatically eligible for chapter 7 relief. That’s not always true. The Bacardi case below was written by Judge Goldgar and released on January 6, 2010. In this case, even though the debtors were eligible for chapter 7 because they passed the means test (the Bacardis passed because of their high secured debt obligations), Judge Goldgar ruled that they failed the “totality of the circumstances” test stated in 707 (b)(3).
The Bacardis make more money than most people seeking chapter 7 relief (over $200,000 per year). Plus their housing expenses were over $6000 per month. Given these facts, Judge Goldgar determined that the Bacardis should be forced to repay at least some of their creditors in a chapter 11. In summary, the means test is sufficient in the vast majority of cases to determine whether or not a debtor is eligible for chapter 7 relief. However, high income debtors should be aware that they must also pass the totality of the circumstances test.
The opinion is below:
UNITED STATES BANKRUPTCY COURT
NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
In re: BRIAN E. BACARDI and JEAN M. BACARDI
Judge Goldgar
MEMORANDUM OPINION
This matter is before the court for ruling on the motion of the U.S. Trustee to
dismiss the chapter 7 case of debtors Brian and Jean Bacardi for abuse pursuant to
section 707(b)(3) of the Bankruptcy Code. The motion is well-taken. For the
reasons that follow, the Bacardis will be given 14 days to file a motion to convert
their case to chapter 11. If no motion is filed, the case will be dismissed.
1. Facts
The facts are taken from the Bacardis’ petition, schedules, and other filings
with the court, as well as from the parties’ memoranda. No facts are in dispute.
Brian Bacardi is a podiatrist with his own practice. The practice is a mobile
one: Dr. Bacardi sees patients in their homes. Jean Bacardi is a chemical engineer.
The Bacardis have three sons, ages 13, 12, and 8, and live in Hawthorn Woods,
Illinois.
The Bacardis together earn $18,000 per month, some $216,000 annually
before taxes. They own three properties: their current residence, a house on Deer
Point Drive in Hawthorn Woods, valued on the Bacardis’ amended Schedule A at
$790,000; a house on Squire Road in Hawthorn Woods valued at $500,000; and a
condominium in Fort Walton Beach, Florida, valued at $400,000. The mortgage
balances on each property currently exceed the property’s value – in the case of the
Deer Point Drive property, by almost $200,000. The monthly mortgage payment
and real estate taxes on the Squire Road property total $4,419. The monthly
mortgage payments and real estate taxes on the Deer Point Drive property where
the Bacardis now reside total $6,234. The monthly mortgage payments and
assessment on the Florida condo total $3,455, until August 2009 partially offset by
$1904 in monthly rental income.
The Bacardis lived in the Squire Road property from 1994 until 2006, when
they moved to the Deer Point Drive property. The Bacardis meant to sell the Squire
Road property in connection with the move but were unable to do so. For a time
they rented the property. Then, they used more than $250,000 in retirement funds
to pay the mortgages and other expenses not only on the Squire Road property but
on the Deer Point Drive property and the Florida condo. Once the Bacardis
exhausted their retirement funds, they used their credit cards to pay the mortgages
and expenses. Meanwhile, the collapse of the real estate market not only impaired
their ability to sell the Squire Road property but reduced the market values of all
the properties below the amounts the Bacardis owed on the mortgages.
On July 16, 2009, the Bacardis filed a chapter 13 bankruptcy case. Two
weeks later, the Bacardis converted the case to a case under chapter 7. (No reason
for the conversion has been given, but it appears the Bacardis were well over the
debt limit in section 109(e) for a chapter 13 case). The Bacardis’ amended schedules
filed on July 29, 2009, disclose the three real properties and the associated
mortgages as well as three vehicles (a 2002 Ford Explorer, a 2004 Ford Taurus, and
a 2006 Dodge Caravan.) According to amended Schedule D, the Bacardis have
about $2.1 million in secured debt, of which $436,000 exceeds the value of the
collateral. Amended Schedule E discloses $52,500 in priority unsecured debt
consisting of taxes owed to the IRS and the Lake County Treasurer. On amended
Schedule F, the Bacardis report $106,000 in nonpriority unsecured debt, most of it
credit card debt.
An amended Schedule J filed July 30, 2009, reflects, among others, the
following monthly expenses: $720 for heating, electricity, and home maintenance on
the Deer Point Drive property, $3,455 for mortgage payments and assessments on
the condominium, $115 for cable television, $130 for cell phone use, $500 for
“children’s sports activities,” and $75 for recreation. Schedule J also disclosed
$3,261 in monthly business expenses for Brian Bacardi’s practice. A separate
amended business income and expense statement broke those expenses down. They
included $718 for seminars and continuing education, $717 for billing, and $100 a
month for internet service.
The amended Form B22A filed on July 29, 2009, the means test form, showed
that the Bacardis passed the means test in section 707(b)(2), and their case did not
give rise to a presumption of abuse. The U.S. Trustee has not contested the
Bacardi’s calculations on the form and has not disputed that there is no
presumption of abuse.
On October 22, 2009, however, the U.S. Trustee filed a motion to dismiss the
Bacardis’ case under section 707(b)(3) of the Code. The U.S. Trustee argued that
given the Bacardis’ high income, a home the Trustee describes as a “luxury home on
a lake,” and many unreasonably high expenses (including expenses for a Florida
condo and certain of Brian Bacardi’s business expenses) made the case an abuse of
the provisions of chapter 7 under the “totality of the circumstances” in section
707(b)(3)(B), notwithstanding the results of the means test.
In response, the Bacardis explain how they inadvertently ended up with
three real properties on their hands. They note that they intend to surrender the
Squire Road property to foreclosure. And although they originally intended to
retain the Florida condo, they are now willing to surrender that property to
foreclosure as well.
In their response, the Bacardis concede that certain expenses (such as the
$500 for children’s sports activities and the cable television bill) are excessive.
Nevertheless, the Bacardis insist that with the surrender of the two properties and
the reduction of certain expenses, their case is not an abuse. In particular, they
argue, a revised Schedule J with hypothetical reductions in expenses would produce
only $129 in disposable income, making it impossible for them to pay any
meaningful amount to unsecured creditors or confirm a chapter 11 plan.
2. Discussion
This U.S. Trustee is correct that this case is an abuse of chapter 7. The
expenses that the U.S. Trustee identifies aside, the Bacardis are high income
debtors living in an expensive house although they have a considerably less
expensive house available to them. Surrendering the expensive house and
retaining the less expensive one would permit the Bacardis to make a substantial
payment to their unsecured creditors. Reducing some of the Bacardis’ other
expenses would permit an even more substantial payment.
Section 707(b)(1) of the Bankruptcy Code permits the dismissal of a chapter 7
debtor’s case if granting that debtor relief “would be an abuse of the provisions of
this chapter.” 11 U.S.C. § 707(b)(1). Under section 707(b)(2), the court must
“presume abuse” if a debtor fails the means test. Under section 707(b)(3), a court
may dismiss the case of a debtor who passes the means test, or who manages to
rebut the presumption of abuse under section 707(b)(2), if the debtor filed the
petition in bad faith or if “the totality of the circumstances . . . of the debtor’s
financial situation demonstrates abuse.” 11 U.S.C. § 707(b)(3)((A), (B); In re Ross-
Tousey, 549 F.3d 1148, 1161-62 (7th Cir. 2008).
“Totality of the circumstances,” a phrase that appeared in section 707(b) even
before BAPCPA’s 2005 revision of the Bankruptcy Code, is not defined, and the
Seventh Circuit has never addressed it. The post-BAPCPA structure of the statute,
however, gives some guidance to its meaning. Section 707(b)(2) creates an objective
test under which some cases are presumed abusive. Section 707(b)(3) then permits
dismissal even if a debtor passes the objective test, setting up a contrasting “totality
of the circumstances” test that requires a more subjective, holistic assessment of the
debtor and his circumstances. See In re Sullivan, 370 B.R. 314, 319 (Bankr. D.
Mont. 2007) (describing section 707(b)(3) as “subjective”); see also In re Haar, 373
B.R. 493, 499 (Bankr. N.D. Ohio 2007) (calling section 707(b)(3) an “equitable test”
as opposed to the “rigid, mechanical formula” in section 707(b)(2)).
In addition, the separate requirement in section 707(b)(3)(A) that the court
dismiss a case when the petition was filed in “bad faith” indicates that a case can be
dismissed for abuse under the “totality of the circumstances” test in (B) based solely
on ability to pay and without, for example, proof of misconduct on the debtor’s part.
In re Perelman, ___ B.R. ___, ___, 2009 WL 3490758, at *8 (Bankr. E.D.N.Y. Oct. 30,
2009). Some courts have held otherwise, see, e.g., In re Nockerts, 357 B.R. 497, 506-
8 (Bankr. E.D. Wis. 2006) (holding that “more than the ability to fund a chapter 13
plan” must be shown to dismiss a case under section 707(b)(3)(B)), but these courts
are a minority, see, e.g. In re Boule, 415 B.R. 1, 5 (Bankr. D. Mass. 2009) (declining
to follow Nockerts); see also In re Jensen, 407 B.R. 378, 383 (Bankr. C.D. Cal. 2009)
(same, and noting that “the majority of courts and commentators” disagree with
Nockerts); In re Parada, 391 B.R. 492, 498 (Bankr. S.D. Fla. 2008) (same).
Before BAPCPA, the courts of appeals in six circuits had interpreted “totality
of circumstances” by adopting open-ended, multi-factor tests. See Costello v.
Bodenstein, No. 01 C 9696, 2002 WL 1821663, at *3 (N.D. Ill. Aug. 7, 2002) (citing
cases). Except for the Fourth Circuit in In re Green, 934 F.2d 568 (4th Cir. 1991),
these courts agreed that the primary factor in determining what the pre-BAPCPA
version of the statute called “substantial abuse” (rather than merely “abuse”) was
the debtor’s ability to repay his debts. See Costello, 2002 WL 1821663, at *4. These
courts of appeals also concluded that an ability to repay debts standing alone could
be sufficient to warrant dismissal, although other factors might be relevant. Id.
Other relevant factors could include whether the debtor has a stable source of
future income, whether his expenses can be reduced significantly without depriving
him of adequate food, clothing, shelter and other necessities, whether the petition
was filed because of sudden illness calamity, disability or unemployment, whether
the debtor incurred cash advances and made consumer purchases far in excess of
his ability to pay, and whether the debtor’s schedules reasonably and accurately
reflect his true financial condition. See Green, 934 F.2d at 572; In re Krohn, 886
F.2d 123, 127 (6th Cir. 1989). The “totality of the circumstances” analysis is factintensive
and performed on a case-by-case basis. In re Stewart, 175 F.3d 796, 809
(10th Cir. 1999).
In this case, the Bacardis have the ability to pay creditors even with no
reduction in the expenses the U.S. Trustee deems excessive. The amended
Schedule J shows average monthly income of $16,273 and average monthly
expenses of $18,755, resulting in negative net monthly income of $2,482.57. But
these figures assume that the Bacardis will have the expenses (and the income)
associated with the Florida condo when in fact they have decided not to keep the
condo. More important, they assume the Bacardis will continue to live on their
Deer Point Drive property with its attendant monthly expenses of $6,234 and
surrender the Squire Road property.
If the Bacardis surrendered not only the condo but the Deer Point Drive
property and instead retained the Squire Road property, they could make a
significant payment to their unsecured creditors. Surrendering the condo would
reduce the Bacardis’ income to $14,368 and expenses to $15,300. Surrendering the
Deer Point Drive property rather than the Squire Road property would replace
$6,234 in monthly mortgage and tax payments with monthly mortgage and tax
payments of $4,419, reducing the Bacardis’ expenses another $1,815 to $13,485 and
giving the Bacardis positive monthly net income of $883 ($14,368 minus $13,485).
Sixty monthly payments of $883 would total $52,980. Taking just the additional
$550 reduction the Bacardis themselves propose in expenses for cable television and
sports activities would produce monthly net income of $1,433 which over sixty
months would total $85,980. See Boule, 415 B.R. at 8 (noting that $1,000 in excess
monthly income is a number “large enough to question” why a debtor “is not making
an attempt to pay something to her creditors”).
A debtor’s budget may be excessive or unreasonable because of high housing
expenses, including a high mortgage payment. See In re Crink, 402 B.R. 159, 171
(Bankr. M.D.N.C. 2009) (citing numerous cases for this proposition). In Crink, for
example, the court found the debtors’ housing expenses unreasonable because they
totaled 61% of the debtors’ budget and were devoted to a $478,000 house in which
the debtors had no equity. Id. The court noted that in considering whether housing
expenses are unreasonable, “due regard should be given to the size of the family,
their reasonable needs, and the cost of alternative housing,” id., but nevertheless
found the housing expenses showed abuse and justified dismissal, id. at 172.
In this case, the Bacardis’ housing expenses associated with the Deer Point
Drive property are likewise unreasonably high. The mortgage payment and real
estate taxes alone make up 40% of the Bacardis’ total expenses. If utilities and
maintenance are included, the expenses grow to $6,954, and the percentage of the
total increases to 45%. Not only are the Bacardis paying an excessive amount of
their income to live on Deer Point Drive, but they propose to continue making these
payments to retain an $800,000 property in which they do not remotely have any
equity.
Fortunately, the Bacardis have an alternative: the Squire Road property.
The Squire Road property is in the same municipality, Hawthorn Woods, and the
Bacardi family is no larger than it was in 2006, only three years ago, when the
Bacardis moved out. The Bacardis thus have no “longstanding, traditional ties to a
homestead” that might weigh in favor Deer Point Drive. Crink, 402 B.R. at 171.
Nor do the Bacardis offer any reason to keep the Deer Point Drive property, a
property that can fairly be termed a luxury item, In re Oot, 368 B.R. 662, 667
(Bankr. N.D. Ohio 2007) (finding that a $430,000 house with a $4,000 mortgage
payment “can only be categorized as a luxury item”), when the Squire Road
property is available. The cost of living at the Squire Road property is $1,815 less
per month than the cost of living at the Deer Point Drive property. Returning to
Squire Road, along with a little “good, old-fashioned belt-tightening,” Krohn, 886
F.2d at 128, would permit a substantial dividend to unsecured creditors. Fairness
to those creditors demands at least that much.
In opposing the U.S. Trustee’s motion, the Bacardis insist they will be able to
repay only a small percentage of their unsecured debt in a chapter 11 case. Not so.
Even if probable deficiency claims of $388,000 from the Florida condo and Deer
Point Drive property are added to the $158,500 in priority and nonpriority
unsecured debt shown on the Bacardis’ schedules, plan payments totaling $52,980
(the Bacardis’ disposable income over five years if the Deer Point Drive property is
surrendered and the Squire Road property retained) would repay 10% of the
Bacardis’ unsecured debt. Plan payments totaling $85,980 (the Bacardis’ disposable
income over five years if the Deer Point Drive property is surrendered and a few
additional expenses are reduced) would repay 16% of the Bacardis’ unsecured debt.
More important, the raw percentage of unsecured debt a debtor can
conceivably repay in a chapter 13 or chapter 11 case is not dispositive of abuse
under section 707(b)(3). If it were, a debtor could avoid dismissal for abuse simply
by incurring massive amounts of debt and reducing the percentage of his repayment
proportionally. See Boule, 415 B.R. at 7-8 (recognizing that the “amount of
unsecured debt and a potential dividend are inversely proportional so that debtors
with higher amounts of debt might skate around the totality of the circumstances
test if a strictly mathematical formula were to be applied”). What matters here is
that the Bacardis can easily rearrange their affairs to free up more than $1,400 in
monthly disposable income, allowing them to repay unsecured creditors more than
$85,000.
The Bacardis also contend that the amount they can repay their unsecured
creditors is too small to permit confirmation of a chapter 11 plan, presumably
because creditors will not vote for the plan. Perhaps not. But not every chapter 11
debtor manages to confirm a plan, and a chapter 7 debtor’s anticipated inability to
confirm a chapter 11 plan does not prevent the dismissal of his case for “abuse.”
The Sixth Circuit rejected this same contention in Krohn, where the debtor
opposed dismissal on the ground that he did not qualify for chapter 13 and “is not
likely to benefit from Chapter 11 relief because he has only minimal assets with
which to propose a plan.” Krohn, 886 F.2d at 127. The court accepted that premise
but nonetheless was unpersuaded that the debtor was “entitled to relief under some
provision of the Bankruptcy Code.” Id. (emphasis in original). Noting that
bankruptcy law is “a creature of congressional policy” and there is no constitutional
right to a discharge, the court concluded that the absence of a linkage between
chapters 7 and 13 showed “there are some circumstances where it would not be
equitable to grant a particular debtor a fresh start.” Id. The Code does not
guarantee a discharge to everyone.
In sum, it is an abuse of chapter 7 for the Bacardis – high income debtors
making over $200,000 a year – to keep an $800,000 house when they have a
reasonable housing alternative readily available that will permit a substantial
repayment to their unsecured creditors.
3. Conclusion
Debtors Brian and Jean Bacardi will be given 14 days to file a motion to
convert this case to a case under chapter 11. If no motion is filed in that time, the
motion of the U.S. Trustee to dismiss this case under section 707(b)(3) for abuse will
be granted. A separate order will be entered consist with this opinion.