Nowhere to Go: Troubleshooting Consumer Cases Where the Debtor May Not Be Eligible for Relief under Any Code Chapter

Section 109 of the Bankruptcy Code has requirements that define who may be a debtor. In consumer cases, a debtor may be ineligible for chapter 7 if he/she has significant income; more specifically, if the debtor has failed the means test set forth in § 707‌(b).

In a chapter 13 case, § 109‌(e) mandates that the debtor must have both a regular income and debts that fall within statutory guidelines. From a policy standpoint, this makes sense: debtors who have the means to repay their creditors belong in a chapter 13. Debtors with both a high income and high debts might be exempt from the means test as business debtors and eligible for chapter 7, or may be better served in an individual chapter 11 case.

A problem arises when a given debtor does not appear to have any Code chapter available as a result of these guidelines, and is left with no bankruptcy shield to protect him/her from creditor harassment. If bankruptcy is a financial last resort, what does a debtor do when no Code chapter is available?

Statutory Gridlock

Consider the following example: The debtor/wife is married homemaker. She does not have any source of income, but her nonfiling spouse has a high-paying job; one that is well above the median household income for their area. The spouse contributes his income to cover any household expenses. The debtor incurs individual consumer debt beyond her ability to repay.[1] She files for bankruptcy, alone, under chapter 7. The U.S. Trustee files a motion to dismiss because the debtor’s filing appears abusive under § 707‌(b)‌(2) and/or (3) due to her husband’s income level. In response, the debtor converts to chapter 13, after which the chapter 13 trustee files a motion to dismiss under § 109‌(e) because the debtor does not have a regular source of income. It appears that bankruptcy is unavailable to this debtor as a result of the tension between the dueling requirements of §§ 707 and 109. The specific provisions that create this problem also help clarify exactly why this is a problem. The relevant portions are excerpted below:

§ 707‌(b)‌(2)‌(A)‌(i): … [T]‌he court shall presume abuse exists if the debtor’s current monthly income reduced by the amounts determined under clauses (ii), (iii), and (iv), and multiplied by 60 is not less than the lesser of

(I) 25 percent of the debtor’s nonpriority unsecured claims in the case, or $7,475, whichever is greater; or (II) $12,475.

§ 101‌(10A): The term “current monthly income” —

(B) includes any amount paid by any entity other than the debtor (or in a joint case the debtor and the debtor’s spouse), on a regular basis for the household expenses of the debtor or the debtor’s dependents (and in a joint case the debtor’s spouse if not otherwise a dependent)....

§ 109(e): Only an individual with regular income ... or an individual with regular income and such individual’s spouse ... may be a debtor under chapter 13 of this title.

This statutory structure gives the impression that debtors with no individual source of income but a high-earning, nonfiling spouse have no Code chapter available under which to file for bankruptcy, based strictly on the apparent letter of the law. The debtor’s household income is too high to be eligible for chapter 7 under § 707, but the debtor has no individual income to avail herself of chapter 13 due to § 109. This is especially problematic because debtors who find themselves in this situation are generally attempting to repay their creditors to some extent through a chapter 13 plan, as they would have converted out of chapter 7 and into chapter 13, rather than simply allowing their case to be dismissed upon the U.S. Trustee’s motion to dismiss.

While some proponents of a practical approach to bankruptcy may indicate that the problem lies with the chapter 13 trustee for raising the issue, asking a trustee to ignore black-letter Code is not a viable solution. However, many bankruptcy practitioners find it distasteful for a debtor to bounce between chapters, attempting to find relief, to be ultimately told that bankruptcy is not an option. Surely, Congress may not have intended to block an otherwise eligible debtor from repaying a portion of his/her debts, regardless of income source, with a statutory conflict between chapter 7 and chapter 13 eligibility. Regardless, the result is a problem consumer practitioners must address when counseling clients in the choice of which chapter to file under.

Getting Through the Bottleneck

The “obvious” answer here is an individual chapter 11. Debtors’ counsel that regularly file consumer cases may be reluctant to advise a debtor with no income whatsoever that conversion to the same chapter as General Motors is in his/her best interests, and that finding new (and more expensive) counsel may be required. However, when faced with § 707-based motions to dismiss, courts have consistently held that chapter 11 is an option to debtors when chapter 13 is not due to § 109‌(e)’s requirements.[2] “[T]‌he Debtors’ position, that their ineligibility for Chapter 13 relief qualifies as a ‘special circumstance,’ has a more inherent flaw. This flaw arises because the Debtors have a bankruptcy option available: they can seek relief under Chapter 11 of the Bankruptcy Code.”[3] The availability of chapter 11 as an alternative makes ineligibility under chapter 13 as a response to a challenge under § 707‌(b) unworkable. “In some instances, perhaps, the significantly higher administrative costs of chapter 11 might result in that chapter not being a practical alternative, and in such instances, the debtor’s ineligibility for chapter 13 relief, although not dispositive, would be entitled to greater weight.”[4]

A debtor who is “lucky” enough to have a challenge under only § 707‌(b)‌(2) and not § 707‌(b)‌(3)’s broader totality-of-the-circumstances test might be able to remain in chapter 7 over the U.S. Trustee’s objection. “The parenthetical [reference in § 101‌(10A)] stating that, in a joint case, a debtor’s current monthly income shall include the debtor’s spouse’s income suggests that, in a single case, the spouse’s income is not included in the debtor’s current monthly income; otherwise, the parenthetical would be superfluous.”[5] However, relying on the U.S. Trustee to only file a motion to dismiss under § 707‌(b)‌(2) does not seem like thoughtful representation, and when the motion to dismiss is brought under § 707‌(b)‌(3), a nonfiling spouse’s income is included under the totality-of-the-circumstances test, even when the debtor has no independent source of income.[6] As with all § 707‌(b)‌(3) inquiries, the outcome is very fact-specific, and a debtor with a compelling scenario might be able to prevail with convincing facts regardless.

Once in a chapter 13, the debtor might be eligible for bankruptcy under § 109‌(e) based on his/her spouse’s income, depending on the factual situation and jurisdiction. Some jurisdictions may not allow payments by a nondebtor spouse to constitute regular income for eligibility purposes, particularly if there is no affirmative showing that the nonfiling spouse’s income is regular and stable.[7] This is particularly true if the debtor is not legally married but living as though married.[8] Other jurisdictions have determined that the nonfiling spouse or companion’s income is sufficient for § 109‌(e) eligibility, with a showing of commitment to fund the chapter 13 plan.[9]

Navigating Around the Traffic Jam

The best defense is a good offense.[10] Going into a case where this statutory snarl is known, debtor’s counsel may try to cut off the §§ 707‌(b) and 109‌(e) conflict prior to filing. If the debtor’s household income is close to median income, the lawyer might be able to utilize the spousal deduction on the means test and procure enough supporting documentation that filing a chapter 7 case makes sense and appears likely to survive a § 707‌(b) inquiry by the U.S. Trustee. This will take more time than the typical preparation for a chapter 7 filing, but it could be well worth it in time savings for the attorney and money savings for the debtor overall, if successful. If the household income is at such a level that chapter 13 seems inevitable, or is preferable for other reasons (such as the ability to receive a discharge or avoid liens), the debtor may want to procure a written statement from the nonfiling spouse indicating a willingness to financially support the debtor throughout the duration of the plan’s term in an effort to support § 109‌(e) eligibility. Reflecting the nonfiling spouse’s income as regular and stable on the schedules would also be prudent, if true.

A debtor who wants to “wear suspenders with his belt,” so to speak, to ensure § 109‌(e) eligibility for chapter 13 may want to proactively seek out a source of income, particularly if the court that the debtor will be filing in is known to be hostile to eligibility based on spousal support. While it might increase the debtor’s disposable income, that could be a low price to pay for the relief that chapter 13 can afford, particularly compared with the relative expense, risk and complication of chapter 11. A best practice would be to discuss the potential issues with the debtor prior to filing to ensure that the debtor is informed of all of the potential issues. Keep in mind that any source of income is sufficient, including babysitting or even social assistance.[11] A debtor that “finds” income in order to be eligible for a chapter 13 after being confronted with the issue is put in a very bad, and completely avoidable, place — between having failed to disclose income on the original schedules and committing perjury on one hand, and not being eligible for bankruptcy of any sort on the other.

On a legislative level, this statutory gridlock could be solved by opening chapter 13 to “an individual with regular household income,” rather than requiring the income-earner to be joined in the bankruptcy for explicit statutory eligibility. Since chapter 13 is designed to maximize creditor payments while minimizing administrative costs, this seems to make the most sense from a policy standpoint. Until such a time, however, proactive lawyering is the best way to help a non-earning debtor with high household income navigate the Bankruptcy Code’s statutory conflict between §§ 707‌(b) and 109‌(e) eligibility.