There are two tests that control your eligibility for Chapter 7 bankruptcy: (1) the means test, and (2) the totality of circumstances test. It’s this second test I’ll address is this post.
The issue with this second test is whether, under the totality of circumstances, your Chapter 7 bankruptcy filing is abusive. You might think, that’s kind difficult to define. And I would agree. It’s really a matter of how your bankruptcy judge views the facts of your case. To explain how this works, I’ll examine a case decided right here in the District of South Carolina. Were this a more academic forum, I’d give you the case name and citation. However, I’m not going to do this here. The Debtor’s names really don’t matter, and this is about their personal finances, so I’ll just refer to them as the Debtors.
Here are the facts:
- The Debtors, a retired husband and wife, lived in a four bedroom, three bathroom, 3300 square foot home.
- The Debtors attempted to sell their home after their last child left home but were unsuccessful. Rather than continuing to try to sell the home, they made substantial renovations to it which cost $130,000.
- The Debtors had a lien-free 1995 Ford F-150 and a leased 2007 Honda Accord.
- The husband had a very generous pension which paid him $7313 per month. In addition, he received $1459 per month in Social Security.
- The Debtors’ mortgage payment was $2151 per month.
- The Debtors’ budget had several expenses which were excessive. Food for the husband and wife was listed at $930 per month. Transportation expenses were listed at $350 per month. (Remember, they were retired.) Life insurance was $439 per month. Continued charitable contributions were listed at $880 per month. (Charitable contributions are also an allowed deduction on the means test.)
- The Debtors had $1592 left in net income (income less expenses) if the husband’s Social Security was counted. Note that under the means test, Social Security benefits are not counted. But this income must still be listed on the income schedule, Schedule I.
- The Debtors’ annual household income was $105,262. At the time the Debtors filed bankruptcy, median income for a South Carolina family of two was only $46,521. ( Median means the 50th percentile, so at $46,521 half the South Carolina families of two make more than that amount, and half make less.)
- The Debtors had $106,000 of non-priority unsecured debt–things such as credit cards are examples of this kind of debt. The Debtors admitted that their need to file bankruptcy largely stemmed from mounting credit card debt.
- For almost two years prior to filing bankruptcy, the Debtors were enrolled in a Debt Management Plan (DMP) and paid $2638 per month into the plan. A DMP is essentially an out-of-court repayment plan negotiated between debtors and their creditors with the assistance of an agency. (Family Services does this here in Charleston.)
- The husband was a retired Chief Financial Officer and testified that, prior to filing bankruptcy, he completed the means test and passed. The court noted that he was sophisticated in financial matters.
The Law Applied to the Facts
The court noted that the ability to repay debts, standing alone, is enough to find abuse under the totality of circumstances test. The court also looked at several of what I call, bad facts, listed above. Let’s take a look at those:
First, this is a retired couple with no children at home with over $105,000 in annual income. This is a substantial amount of income for a couple with no child-related expenses. (After all, we know that children are little money pits!)
Second, many of the expenses listed were excessive. $930 in food per month for only two people? Life insurance of $439 per month? Why would a retired couple with this much annual income even need life insurance? Perhaps a small amount might be justified, but paying $439 is excessive.
Third, the Debtors listed $880 per month for charitable contributions, which also deserves mention. Charitable contributions are allowed if they can be established. This means if you can show an established pattern of charitable giving, that amount can be legitimately counted as an expense on the means test and that it will be viewed as a legitimate expense on your expense schedule, Schedule J. But with all these bad facts, let’s face it. It just looked bad.
Fourth, the husband was financially sophisticated, and, somehow, his completing the means test came up at trial. My feeling is that this just didn’t play well with the judge. Why do I know this? Because the husband’s means test calculations are totally irrelevant to the case, yet the judge mentioned it in his opinion. Perhaps the husband mentioned it on the witness stand in support of his justification for filing Chapter 7 bankruptcy, rather than a Chapter 13 payment plan bankruptcy. It’s evident to me that the judge wasn’t impressed with the debtor husband playing lawyer.
Fifth, on the means test, Social Security is excluded from the current monthly income (CMI) calculation (the pointless–yet required–calculation in which you must show income for each month in the six months prior to the month in which you file your case). As the court pointed out, just because you don’t count Social Security as part of your CMI, doesn’t mean it’s ignored when applying the totality of circumstances test. What does this mean? It means you can’t file a Chapter 7 with large amount of net income and say it doesn’t count because it’s all from my Social Security. It just ain’t gonna fly here in South Carolina, and it probably won’t fly in most other bankruptcy districts throughout the country.
Sixth, the Debtors had participated in a debt management plan (DMP) for almost two years prior to filing their bankruptcy. They paid over $2600 per month into the DMP during that time, and there were no changed circumstances justifying the fact that they couldn’t continue making similar payments. (Things like change of income, declining health, increased medical expenses, and so on.)
There’s also a lesson here. If you do a DMP, it just might be used against you if you later file bankruptcy. My advice: either do a DMP and stay in for the duration–usually five years–or don’t bother with the DMP. Playing around in a DMP for a year or two is just a waste of time and money, and it could be used against you if you later decide to file bankruptcy. You’ll have what I call a “proof is in the pudding” problem. If you could do it then, why can’t you do it now? Here, had the Debtors just filed a Chapter 13 bankruptcy rather than wasting two years and $40,000 in a DMP, they would now–at the time of this post–be done with their Chapter 13 bankruptcy and have their discharge. Instead, they were required to dismiss their case or file a Chapter 13 bankruptcy.
Seventh, these folks had a large amount of consumer debt, apparently almost all credit card debt. This didn’t go over well with the judge given the fact that the husband was a retired Chief Financial Officer. I’ll bet a bit of “you should know better than this” was going through the judge’s mind.
In short, the case involved affluent debtors with excessive expenses, a big house, a large amount of consumer debt, high charitable giving expenses, and a proven track record of having the ability to repay their creditors. And, under the totality of circumstances, our court deemed this an abuse of Chapter 7, despite the fact that these Debtors, as the husband testified, passed the means test.
But What if We Change the Facts?
Could a married couple with $105,000 in annual income ever qualify for a Chapter 7 bankruptcy? Sure. Let’s change the facts. What if the husband was divorced and paying $1000 a month in child support and $2500 a month in alimony? What if the wife had diabetes and needed to eat a special diet, thereby justifying the $930 a month listed in the couple’s food budget? What if the couple also had high out-of-pocket medical expenses because of the wife’s condition? Would they qualify for a Chapter 7? Most likely, yes. The husband’s alimony and child support would use up $3500 net income alone, and the wife’s medical problems might justify the $930 a month for her special food needs. Add to this another $200 or so in out-of-pocket medical costs, and we would have a completely different outcome.
The bottom line about the totality of circumstances test is that it’s all about the facts of your case. And to “pass” the test, you need to be able to justify the expenses you claim.
In “The Bankruptcy Means Test (Part Five),” I’ll tell you about circumstances where neither the totality of circumstances test nor the means test apply.