Chapter 7 Bankruptcy for the Insolvent Consumer and the Key Changes Brought by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
August 2007
By:
Fred Stevens
Fox Rothschild LLP
100 Park Avenue, 15th Floor
New York, NY 10017
Tel: (212) 878-7905
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TABLE OF CONTENTS
I. Introduction To This Outline 1
II. Introduction to the Chapter 7 Process 2
III. Qualification to File – Reform Act Additions 5
A. Who May Be a Debtor? 5
B. The Means Test 6
1. Introduction 6
2. Persons Not Subject to the Means Test 8
3. The Calculations 9
IV. The Commencement of the Case 14
A. Required Filings - Generally 14
B. The Traditional Bankruptcy Filings (Non-Reform Act) 15
C. New Forms With the Reform Act 22
V. The Chapter 7 Trustee 24
VI. The Discharge 27
VII. Summary of Important Changes of the Reform Act 29
A. The Means Test 30
B. Prohibitions on Multiple Discharges 30
C. Credit Counseling and Debtor Education 31
D. Discharge of Debts 31
E. Limitations on the Automatic Stay 31
F. ATTORNEYS BEWARE 31
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I. Introduction To This Outline
Chapter 7 of the Bankruptcy Code is entitled “Liquidation.” It is often referred to by the non-attorney public as “straight bankruptcy” or “simple bankruptcy.” Needless to say, chapter 7, like any legal process, can be extremely complex. However, a vast majority of individual chapter 7 cases (as opposed to business cases) result in very efficient and economical dispositions.[1] These cases are typically referred to as “no asset” cases. Only a small handful of cases result in a recovery of assets for the benefit of creditors. This outline focuses on the most common of all bankruptcy proceedings, the “no asset” chapter 7, and explains the most significant changes in the bankruptcy law (Title 11 of the United States Code enacted in 1978, with major changes in 1984, 1988 and 1994) brought by the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Reform Act”) (collectively, in its present form, referred to herein as the “Bankruptcy Code” or the “Code”).
Because many attorneys presume that chapter 7 is just a simple formulaic process, they often put their clients and other parties at risk. Every attorney planning to represent a prospective chapter 7 debtor should, at the very least, be able to identify the issues that may lead to the trustee’s recovery of assets, or the possible denial of the debtor’s discharge, and the key elements of the Reform Act. The attorney may then, at her discretion, (i) thoroughly research the issue so that she can properly advise her client, or (ii) refer the case to another attorney competent to handle the more complex issues. The changes implemented by the Reform Act have further complicated the chapter 7 process and increased the level of sophistication required of debtor’s counsel to successfully navigate the process.
Important Note – The Reform Act requires that you, as debtor’s counsel, certify as to the accuracy of the debtor’s petition as well as provide documents to the court and the case trustee. As a result, it is imperative that any attorney planning to represent a chapter 7 debtor be fully familiar with the law (as they should be anyway), and that the client interview and pre-filing phase of the case involve significant due diligence by the attorney, including document collection and review, making tricky calculations, and asking a number questions to determine whether the client is eligible for relief under chapter 7.
This outline is intended to provide an overview of the chapter 7 process for individuals, to highlight the key changes implemented by the Reform Act, and to provide some of the tools necessary to identify the issues that may lead to the trustee’s recovery of assets, or other types of bankruptcy litigation. This outline is divided into six parts that map the chronology of the chapter 7 process: (i) an introduction to the chapter 7 process; (ii) qualification for chapter 7 (New for the Reform Act); (iii) the commencement of the case; (iv) the role of the chapter 7 trustee; (v) the discharge; and (vi) miscellaneous standout changes implemented by the Reform Act.
II. Introduction to the Chapter 7 Process
The ultimate goal for a debtor in a chapter 7 case is to obtain a discharge of most or all of her debts, giving the debtor the “fresh start” envisioned by the Bankruptcy Code. The extreme relief granted by a chapter 7 discharge is to be afforded only to the “honest but unfortunate debtor.”[2] The debtor must first qualify to file under the Reform Act[3] and must then fulfill all duties set forth in section 521 of the Bankruptcy Code before a discharge will be awarded.[4]
Regardless of size or complexity, each chapter 7 case involves the appointment of a trustee, the trustee’s investigation as to whether the debtor has any assets or claims that can be pursued for the benefit of creditors, the U.S. Trustee’s review to ensure the debtor qualifies under the “means test”, a meeting of creditors, and a fair and adequate opportunity for creditors to be heard. A typical time line for a chapter 7 case would be:
1. February 1, 2006 – Debtor meets with her counsel and determines that she qualifies under the “means test”[5], and that she should file for relief under chapter 7;
2. February 5, 2006 – Debtor completes mandatory credit counseling[6];
3. February 6, 2006 – Debtor completes with her attorney and files with the court her voluntary petition and all required forms, schedules and statements[7];
4. February 7, 2006 – The United States Trustee appoints Jane Doe as the interim Chapter 7 Trustee of the debtor’s estate[8];
5. No Later Than 45 Days After the Petition Date – The Debtor must file all documents required to be filed pursuant to Section 521(a)(1)[9], or her case will be dismissed automatically on the 46th day[10];
6. February 15, 2006 – Debtor’s counsel provides all necessary documents to the Trustee and United States Trustee;
7. March 9, 2006 – Jane Doe qualifies and becomes permanent trustee of the Debtor’s estate[11] and conducts the Meeting of Creditors, and after the Debtor is thoroughly examined, the trustee closes the meeting[12];
8. April 15, 2006 – The debtor completes a debtor education class and files proof of same with the court.[13]
9. May 8, 2006 – Sixty days lapses from the date of the Meeting of Creditors. This marks the deadline for (i) creditors to object to the dischargeability of a debt[14]; (ii) parties to move to dismiss the case for substantial abuse[15]; or (iii) parties to object to the debtor’s discharge[16]; and
10. May 25, 2006 – Assuming the debtor has complied with all applicable provisions of the Bankruptcy Code and Rules, the bankruptcy court enters the discharge order.[17]
The chapter 7 trustee’s and United States Trustee’s role will be discussed in greater detail below. However, in order to put many of the discussions into proper context, we should briefly discuss it now. First, the chapter 7 trustee is a private party who sits on the panel of private trustees. The chapter 7 trustee is not an employee of the federal government. In general, the trustee must investigate the assets and financial affairs of the debtor, reduce any non-exempt property of the debtor to money, pursue any claims that the debtor may have under applicable law, or the trustee may have under the Bankruptcy Code, and distribute any recovery to the proper creditors. As previously stated, a vast majority of chapter 7 cases are “no asset” cases and do not result in a distribution to creditors. In such cases, the trustee’s investigation is normally limited to reviewing the debtor’s schedules and statements, and interviewing the debtor at the meeting of creditors.
The Office of the United States Trustee on the other hand is a division of the Department of Justice charged with the duty of overseeing the bankruptcy process. Unlike the bankruptcy judiciary, the United States Trustee will take and advocate positions. Although the United States Trustee performs many duties and functions in the bankruptcy system, in the “no asset” cases discussed herein, the United States Trustee’s principal role is to review petitions for qualification under the “means test” and for substantial abuse under section 707(b) of the Code, to monitor abuses by debtors’ attorneys and bankruptcy petition preparers, and to approve providers of credit counseling and debtor education.
III. Qualification to File – Reform Act Additions
A. Who May Be a Debtor?
Section 109(a) provides simply that any person who resides or has a domicile, a place of business, or property in the United States, may be a debtor under the Bankruptcy Code.[18] Section 109(h) was added in the Reform Action and requires that in order to file a petition, the debtor must complete a credit counseling course within 6 months of the bankruptcy filing.[19] The course must be given by an approved nonprofit budget and credit counseling agency and can be done over the internet or by telephone.[20] The following individuals are excepted from the credit counseling requirement: (i) individuals residing in districts where the United States Trustee has not determined that adequate counseling services are available; (ii) in emergency filings where debtor certifies that an emergency exists upon filing and completes counseling within 5 days of filing; and (iii) where a debtor is unable to complete the required counseling due to incapacity, disability, or active military duty in a military combat zone.
B. The Means Test
1. Introduction
Section 707(b) of the Bankruptcy Code always contained a provision which allowed the United States Trustee to make a motion to dismiss a case for “substantial abuse.” The old code never clearly defined substantial abuse and it was left to the United States Trustee to decide what constituted an abuse worth prosecuting[21], and up to the courts to define it[22].
The Reform Act changed Section 707(b) substantially to grant not only the United States Trustee the right to make a motion to dismiss for substantial abuse, but also the chapter 7 trustee and any other parties in interest.[23] Before, such right only belonged to the United States Trustee (and the court). In addition, for individual debtors with primarily consumer debts, Section 707(b)(2) presumes that an abuse exists if the debtor’s income and expenses do not fit within what appear to be an extraordinarily complex set of formulas and conditions[24]. Thus, it is incumbent upon debtor’s counsel to walk the debtor through what has become one of the most controversial and misunderstood sections of the Reform Act. At the end of the day, most attorneys agree that a vast majority of the debtors that filed under the old code still qualify under the means test. Many, however, do not.
Before jumping into the calculations under the means test, it is important to understand its intended purpose and what actually happens if the debtor does not fit within the parameters of the means test.
First, the means test says, in sum and substance, that if the debtor’s monthly budget surplus (calculated pursuant to certain standards which incorporate IRS statistics and allowances) is equal to or grater than certain statutory ceilings, the debtor’s case will be subject to dismissal. Put practically, if, over the next 5 years, the debtor has the ability to repay 25% of her debt, she should not be allowed to file under chapter 7.
Second, if the debtor fails the means test, it is not necessarily the end of the road. A party (such as the trustee, United States Trustee, or a creditor) must first make a motion to dismiss. Then, the debtor can choose to voluntarily convert her case to one under chapter 13, or the debtor can choose to defend the motion by claiming she has “special circumstances” that increase or decrease her expenses or income, respectively, such that she should qualify under the means test upon consideration of the special circumstances.[25]
2. Persons Not Subject to the Means Test
The debtor is not subject to the means test if:
Ø If the debtor’s debts are not primarily “consumer debt” as defined in Section 101(8)[26];
Ø If the debtor’s annual household income (to determine household income, see considerations in Section 3(a) below) is equal to or less than the state median income for a similar-sized household. For New York State, the following median incomes currently apply[27]:
No. in Household / 2005 Median Income1 / $ 39,463
2 / 48,492
3 / 57,430
4 / 67,564
5 / 69,803
6 / 66,927
7 / 56,510
Or;
Ø If the debtor is a disabled veteran and the debt was incurred while debtor was on active duty, or performing homeland defense activity.[28]
3. The Calculations
a. Calculate Income
For the six (6) months ending on the last day of the month preceding the debtor’s bankruptcy filing, determine the debtor’s gross income by adding up all income received by the debtor. This should include anything that falls under the following categories:
Ø Regular contributions for household expenses (e.g., the debtor’s adult son gives the debtor $400 per month to live in the basement);
Ø Gross salary including that of a non-debtor spouse, if any, unless the couple is separated and can provide proof of separation (leave in all payroll deductions which will be taken out in the expense section in the following section);