Overcoming a “Presumption of Abuse” in Chapter 7 Bankruptcy

Overcoming the “presumption of abuse” in Chapter 7 bankruptcy is not always as daunting as it may sound. In order to qualify for an individual Chapter 7 one either must have predominantly business debts or qualify for it under a “means test”. The means test essentially looks at your household income for the six month preceding the month in which the bankruptcy is filed. Certain things can be deducted out of that income as well as certain standardized costs of living. Once the information has been run through the formula, a potential debtor either falls under the median income for their household size and state of residence, thus qualifying for a Chapter 7, or it does not.

One might be tempted to think that failing to fall under the median income is the end of the story and they cannot file a Chapter 7 (they almost always can still do a Chapter 13). This is true for the majority of persons where the presumption arises. However, it is not automatically the end of the analysis that your bankruptcy attorney should engage in. They need to also explore any changes in circumstances that would justify going into the Chapter 7 anyway.

So, having an income above the median only creates a “presumption” that doing a Chapter 7 would be abusive of the bankruptcy process. This presumption can be overcome by a showing of a change of circumstances. For example, a sudden change in one’s health could decrease the current income or increase health costs that can be deducted from that income. Such a sudden event may not show up in the means test results for months since one is looking at a six month snapshot but, one may not be able to wait that long to file.

The way to overcome that presumption of abuse requires your attorney to prepare two extra documents. First, they should prepare a sworn statement for you to sign (an affidavit) that explains the change in circumstance that justifies overcoming the presumption. Second, they should prepare a mock means test showing what that change in circumstances would look like over time. These can be filed  concurrently with the petition.

The United States Trustee would look at these extra documents and make their own determination whether to pursue dismissal of the Chapter 7 or decline to pursue it. Even if the US Trustee declines to pursue the presumption of abuse dismissal, individual creditors could still pursue it, though they are unlikely to do so.

Working knowledge of bankruptcy essential to MANY areas of law

I was just talking the other day to a client who had a real estate transaction question. The context of the real estate transaction included a co-signed debt, a family law issue, and a high risk of bankruptcy for the co-debtor. If I only understood one of those areas of law or only knew a part of the context of his question, then I would have given the wrong advice.

If I had only thought about the transfer from the family law perspective, I would have advised against the transfer. If I have only contemplate real estate law and looked at the value of the property versus the debt load, I probably also would have advised against the transfer. However, knowing the impact of the imminent filing of bankruptcy by the co-signer and how that would interplay with the family law issue and the ability to enact a transfer post-bankruptcy, made the exact opposite answer the better advice to give him.

Bankruptcy law permeates every single other area of law that involves financial transactions of any sort. This is because the bankruptcy code preempt debtor and creditor rights and obligations of state law to a huge extent. So, whether you are contemplating a divorce settlement, a real estate transfer, a debt settlement, or a multi-million dollar contract, ask your lawyer what would happen if you or the other party ended up in bankruptcy. If they have no idea, ask them to research it or consult with a bankruptcy practitioner.

Another reason to consider a Chapter 13 instead of a Chapter 7

Let me just be clear that I want people who must file bankruptcy to find their way into the best fitting chapter; I do not have a clear preference between a Chapter 13 and a Chapter 7. If I had to pick one that I tend to lean towards, it would be a Chapter 13 because they are a little more complicated and I enjoy that. While they are more work and thus more expensive, they can also be more affordable for many debtors because the fees can often be paid post-petition (See this post on C 13 plans for more of an explanation). However, I also really like that Chapter 7 bankruptcies are focused on a narrow timeframe and get folks a great fresh start relatively quickly.

I recently met with a great couple whose situation illustrated yet another reason for looking at a Chapter 13. This was an older couple and the wife had some significant health issues that were hopefully in the past, but which raised concerns about how much longer she might be walking with us on the earth. This person was understanbably concerned about how her husband would fair financially with his passing. Both hoped to keep the house which was neither in default nor had equity in excess of their exemptions. The couple’s income was such that filing a Chapter 7 would be no problem and they would most likely be able to reaffirm on the house and keep it. However, a reaffirmation would mean keeping their personal obligation on the house.

If one keeps their personal obligation on a home loan through a Chapter 7 and then falls on harder times, they could be stuck with the deficiency debt even after their house is foreclosed on. This is because once you receive a discharge in a Chapter 7, you cannot obtain a discharge through a 13 unless you wait four years to file or eight years to get a discharge in another Chapter 7 (see this post for a little more detail on this subject). So, if they reaffirm on that debt in a Chapter 7 and either of the couple passed on before four years had passed, the surviving spouse could really be in a bind on the deficiency debt because the fixed income would not be enought to keep the house current.

So, the options were doing the Chapter 7 and hoping the lendor on the home loan would just let them keep paying and remain in the house or filing a Chapter 13. Well, the first option is a bit like rolling the dice and it is hard to gamble at on such things at that stage of life with a fixed income, so the Chapter 13 presented the best alternative. The rational for this is that if they get into the Chapter 13 and circumstances change, they can convert to a Chapter 7. In other words, a Chapter 13 gave them a second layer of protection or a safety net that would not be there in a Chapter 7.