Four recent opinions from the Northern and Western Districts of Texas have addressed the mechanics of means testing. The trend from this group of cases is that the courts have not been receptive to overly creative arguments and have tried to remain faithful to the spirit of the means testing. The courts have managed to do this while pointing out specific instances in which the law is an ass. The recent opinions include In re Oliver, No. 06-10134, 2006 Bankr. LEXIS 1992 (Bankr. W.D. Tex. 8/8/06); In re Barraza, 2006 Bankr. LEXIS 1536 (Bankr. N.D. Tex. 8/1/06); In re Lara, 2006 Bankr. LEXIS 1170 (Bankr. N.D. Tex. 6/28/06); and In re Hardacre, 338 B.R. 718 (Bankr. N.D. Tex. 2006).
Introduction to Means Testing
Means testing under 11 U.S.C. §707 is a three part process. First, the Court looks to see whether the debtor’s income based upon the previous six places him above or below the median income. If the debtor is below the median income, the formal part of the process ends. 11 U.S.C. §707(b)(6) and (7)(providing that no motion to dismiss may be filed under means testing provision if annualized income is below the median). If the debtor’s income is above the median, then the means testing formula of §707(b)(2) applies. If the result of that process is that the debtor’s hypothetical net income exceeds $10,000 (or between $6,000-$10,000 if such amount exceeds 25% of the debtor’s unsecured nonpriority debts), then abuse is presumed. 11 U.S.C. §707(b)(2)(a)(i). If the presumption of abuse arises, it may be rebutted by “special circumstances, such as a serious medical condition or a call or order to active duty in the Armed Forces.” 11 U.S.C. §707(b)(2)(B). The test is quite complex and has justifiably been described as arbitrary. As a result, there is both the incentive and the opportunity for lawyers to test its boundaries.
Timing Your Income
Determining income under the means test is the first of many artificial provisions which apply. The debtor must take the previous six months income divide by six and multiply by twelve. Thus, if the previous six months income is not representative, the means test will yield a skewed starting point. As Judge Monroe pointed out in the Oliver case:
“The ‘means test’ attempt to create a formula to apply to all situations. However, the average of the last six months of income may or may not be an accurate picture of any person’s real financial situation. It is merely a snapshot as of the petition date. For instance, a debtor may have made $5,000 a month for 4 months and then lost his job; but he may still qualify under the means test presumption as an abusive filer [and have his case either dismissed or converted to Chapter 13] even though because of his job loss he has not current ability to pay a dime to his creditors. Another debtor, however, may not have worked for the first 5 months and then obtained a job making $5,000 per month; yet no presumption of abuse would arise even though this debtor would probably have the ability to repay his creditors a substantial amount.”
In re Oliver, slip opinion at 7-8.
In the Oliver case, the debtor filed his petition on February 7. He had previously received a $1,500 bonus, but claimed that he might not be receiving a bonus again in the future. Because the debtor filed within six months after receiving his bonus, his annual income was increased by $3,000 ($1,500/6 x 12) even though he might not receive the same bonus again. If the debtor had waited to file until July (assuming that the bonus was received at year end), his means test generated income would have been lower because the bonus would not have been in the six month look back window.
The Trouble With Transportation
Transportation costs have been a recurrent theme in the recent cases. The IRS Collection Standards, which form the basis for the means test, allow both an ownership allowance and an operating allowance for vehicles. The ownership allowance is set at $475 for the first car and $338 for the second car. BAPCPA also provides that the means test “shall not include” the amount of secured debt payments averaged over a 60 month term. These transportation allowances have already given rise to several published opinions.
In Hardacre, Judge Nelms addressed the problem of double dipping. The debtor in that case argued that BAPCPA “compelled” him to include both the ownership allowance and the amount of his car payment. Finding that statutory construction was a holistic endeavor, Judge Nelms found that the debtor was entitled to deduct the greater of the secured debt payments or the IRS allowances but not both. In the Lara case, Judge Houser was faced with another type of double dipping. In that case, the debtors each sought to claim the $475 ownership allowance. However, Judge Houser ruled that they were one unit for purposes of means testing so that they received only one allowance.
Under the Collection Standards, a debtor with a car payment of less than $475 would receive an overly generous allowance. However, what about a debtor with no car payment? Apparently, this debtor does not fare as well, as shown by the recent opinions in Oliver, Barraza and Hardacre. All three opinions held that an ownership allowance is only available to a debtor with an ownership expense. In Oliver, the debtor claimed his $475 ownership allowance on Form B22A and included an anticipated future car payment of $500 on Schedule J. Judge Monroe pointed out (as did Judge Nelms in Lara), that the IRS Collection Standards grant an additional operating expense of $200 for a debtor with a vehicle which is more than six years old or which has over 75,000 miles on it. Because the Collection Standards have granted an allowance for older vehicles in one place, it is not necessary to allow an ownership expense where there is not one.
These cases highlight an important practice point. The conventional wisdom has held that it is better for a potential debtor to replace an aging vehicle prior to filing bankruptcy rather than waiting until afterwards. This view was based in part on (1) the fact that a bankruptcy filing could impair the debtor’s credit and make it more difficult or more expensive to finance a replacement vehicle and (2) in a chapter 13 case, the debtor would need to request permission to incur post-petition credit. There is now a third reason. Under the means testing formula, an inchoate need to replace a paid for vehicle in the near future is given no credit, while an actual secured debt is given full value.
Thus, if a debtor had $275 per month in excess income and had an imminent need to replace a paid for vehicle, he would fail the means test and be pushed into a chapter 13 plan which would likely be doomed to failure based on the need to replace the vehicle within the five year life of the plan. On the other hand, if the same debtor traded in his vehicle and purchased a new one with a payment of $200, he would pass the means test and be able to file for chapter 7. (This is based on the fact that eliminating the older vehicle would reduce the operating expense by $200 but would increase the ownership allowance by $475 resulting in a net reduction of $275 in excess income). The economic reality of both debtors would be the same. However, the timing of the vehicle purchase would determine their eligibility for chapter 7 relief.
It should be noted that BAPCPA prohibits a debt relief agency from advising an assisted person “to incur more debt in contemplation of such person filing a case under (title 11).” 11 U.S.C. §526(a)(4). On its face, this statute would appear to prevent an attorney from advising his client to make the sensible choice of incurring new debt to replace an aging vehicle. However, as discussed in a previous post (See BAPCPA Found to Unconstitutionally Limit Attorney Speech), this provision has been found to be unconstitutional by a judge in the Northern District of Texas. Of course, the opinion in Hersch v. United States is still interlocutory and is not binding precedent, but it offers some comfort. An additional measure of comfort is contained in the Brief filed by the United States in Connecticut Bar Association v. United States (See The Empire Strikes Back) in which the government contended that “in contemplation of” meant “because of” filing bankruptcy rather than “while contemplating” bankruptcy. This is a little bit tricky because under the government’s position, a lawyer may advise a client to incur more debt in pursuit of a goal unrelated to bankruptcy (such as obtaining reliable transportation). However, an attorney might not be able to advise the same client that the same decision would dramatically affect their eligibility to file chapter 7.
No Deduction For 401k Loan Repayments?
One of the more bizarre rulings in the recent opinions related to 401k loan repayments. Prior to BAPCPA, there was a difference in opinion as to whether loan repayments to a 401k plan could be deducted from disposable income in a chapter 13 case. BAPCPA provides that 401k plan loan repayments shall not be considered as disposable income under chapter 13, 11 U.S.C. §1322(f), and provides that they are not subject to the automatic stay, 11 U.S.C. §362(b)(19). Therefore, it should be apparent that these payments are a deduction for means testing purposes as well, right? Apparently this is not the case in Ft. Worth. When Judge Nelms was faced with this issue in Barraza, he pointed out that §707(b)(2)(A) does not incorporate either of these sections and that the Court must assume that Congress did this intentionally. The Court stated:
“(W)hy would Congress presume under section 707(b)(2)(A) that this amount of money could be used to pay unsecured creditors, and then deny unsecured creditors access to that money in chapter 13? The court confesses that it does not know. Nevertheless, the court’s lack of prescience as to Congress’s reasoning does not permit it to revise a formula that is otherwise clear on this particular point.”
In re Barraza, slip op. at 17.
Unfortunately, the Court in Barraza missed a potential explanation for the apparent inconsistency or perhaps did not have the right evidence before it. In the author’s experience, most 401k plan loans are secured by the assets in the 401k plan. If that is the case, then they would be excluded from the means test by the provisions relating to secured debts. 11 U.S.C. §707(b)(2)(A)(iii). Instead, the Court considered whether these debts could be considered as other necessary expenses for unsecured debts. Other practitioners faced with this issue would do well to obtain the documentation on the 401k plan loans and, if appropriate, to schedule such debts as secured claims. This will allow for appropriate treatment under the means test.
Deviation From National Local Standards
At first glance, a “national local” standard sounds like a contradiction in terms. However, it is one of a few areas where judges have discretion to deviate from the “plugged” numbers. A national local standard is one where standards are set on an area by area basis. Thus, the cost to operate a vehicle in the Dallas region is higher than in the Houston region. The national local standards include housing, utilities and vehicle operating (but not ownership) costs. The Collection Standards allow deviation from these amounts when it is reasonable to do so. According to Judge Monroe, “The National local expenses are the only guidelines from which this Court can deviate when it is reasonable to do so under the facts of a particular case.” In re Oliver, slip op. at 12.
In the Oliver case, the debtor’s standardized operating expense was $242 per month. However, the debtor testified that as part of his job that he drove 3,000 per month and that his truck averaged 15 miles per gallon. The Court concluded that at $3.00 per gallon for gas, this would allow an operating expense of $600 per month. Thus, the debtor was entitled to an operating expense which was over double the standard amount. The Court allowed the additional operating expense based upon the debtor’s testimony without requiring specific documentation.
Special Circumstances Are Not Special Unless They Are Documented
Several of the debtors sought to establish “special circumstances.” Section 707(b)(2)(B) allows the Court to consider “special circumstances, such as a serious medical condition or a call or order to active duty in the Armed Forces.” To qualify as a special circumstance, three requirements must be met:
1. It must be documented.
2. There must be a detailed explanation.
3. It must be attested to under oath.
In Oliver, the debtor filed a Declaration of Debtor Regarding Special Circumstances in which he claimed the following:
1. He had previously been unsuccessful in making payments under a debt consolidation plan.
2. The cost of replacing his vehicle would consume a chapter 13 payment.
3. His anticipated future income and expenses as reflected on Schedules I and J were more accurate than the means testing form and indicated that he did not have the ability to pay.
The Court rejected these special circumstances. It found that failure under a prior consolidation plan was simply irrelevant. The Court also noted that the Debtor had failed to document his claimed expenses.
“Further, and problematic for the Debtor, he provided no documentary evidence to substantiate the changes in his income and expenses that he testified were anticipated. He merely testified that his income will likely decrease due to an anticipated job change with his current employer within six months, and that in that position he will not receive as significant a bonus as in the past. He did not provide any specific amounts of any decrease in salary or bonus. And, at the time of the hearing, the Debtor had not changed positions.”
In re Oliver, slip op. at 4.
This language raises an interesting question as to what would sufficient documentation of a pending decline in income. Would a note from his employer be adequate? If the debtor was unlikely to receive a bonus based on his company’s declining finances, would it be necessary for a corporate official to bring in the corporate books and records to show that sales and profits were down significantly?
In Barraza, the debtor offered several other circumstances, including:
1. That payment under a chapter 13 plan would be zero.
2. That he was paying his girlfriend $400 per month to live with her in addition to paying housing costs for his ex-wife and child.
Both of these arguments were rejected for lack of documentation.
The Means Test Can Be Mean
The Barraza case provides a potent example of how the means test can operate to punish the diligent and hardworking while rewarding the slothful. Mr. Barraza worked two jobs totaling about 80 hours per week. In return for doing the work of two men, he brought home the princely sum of $5,410 per month. He drove an eight-year old pickup truck which was paid for. Out of his income, he paid the mortgage note on the house where his wife and children lived, paid $700 per month in child support and also contributed $400 per month toward the expenses of his girlfriend’s household where he lived. In considering Mr. Barraza’s circumstances, the Court observed:
“(I)t is a mistake to view the means test as a formula for measuring the culpability of a particular debtor for the circumstances which led him into bankruptcy, and, hence, whether the debtor is worthy of one form of relief rather than another. The means test does not distinguish those who have tried hard from those who have hardly tried. It is a blind legislative formula that attempts to direct debtors to a chapter that provides for at least some measure of repayment to unsecured creditors over a period of years. Like any other effort at social or economic legislation, it is not perfect. Consequently, the fact that the debtor can hypothesize examples in which the means test operates unfairly does not, by itself, serve as a basis for the court to refuse to apply it here.”
In re Barraza, slip op. at 10-11. The unfortunate truth here is that if Mr. Barraza had only worked one job and had spent his spare time sitting in front of the TV and drinking beer, he would have been eligible for chapter 7 relief. Because he worked more than most people and did not live extravagantly, he worked himself out of eligibility for chapter 7.