X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
The “means test” provision of Section 707(b) of the Bankruptcy Code probably generated more commentary than any other single provision of the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act. However, it has also led to some confusion, and now a 3rd U.S. Circuit Court of Appeals case, dealing with its impact on the provisions of Section 707(a). While Section 707(b) may lead to dismissal or conversion because of presumed abuse based upon a debtor’s income and expenses if debts are primarily consumer debts, Section 707(a) makes no mention of income or expenses in evaluating a motion to dismiss. Should evidence of substantial income and expenses be considered under this subsection? The 3rd Circuit’s recent decision in In re Perlin arose from a failed business venture. The debtor-husband was a licensed radiologist who, working only part-time, earned approximately $370,000 working for his wife, the owner and operator of a medical imaging company. The debtors lived well, owning luxury cars, paying private school tuition and setting aside over $430,000 for retirement. In connection with Mrs. Perlin’s opening of her medical imaging company, the company entered into a lease with Hitachi Capital America, which leased the company its diagnostic equipment. Initial monthly lease payments were only $2,000, but after six months they rose to $70,000. The total due to Hitachi over the term of the lease was in excess of $1.2 million. Both husband and wife guaranteed the lease payments. The company made its lease payments for the initial six-month period, but did not meet its income projections, and could not even pay Dr. Perlin his salary. The company retained a consultant, who quickly determined that the original projections were flawed. The company attempted to renegotiate the terms of the Hitachi lease, but to no avail. Hitachi sued for possession of its equipment and sued the debtors. A joint Chapter 7 filing followed. Hitachi moved to dismiss the debtors’ petition under Section 707(a) of the code. Hitachi based its motion on a variety of allegations, including the fact that the debtors enjoyed a substantial annual income and a “lavish” lifestyle, failed to make a good faith effort to repay Hitachi, artificially inflated their expenses so as to insulate their substantial income, filed misleading information, and timed their filing around the exercise of Hitachi’s rights. The bankruptcy court, relying on 3rd Circuit precedent, concluded that Section 707(a) contained a “good faith” element and that the initial evidence presented to the court by Hitachi caused the burden of showing good faith to shift to the debtors. Then, having heard evidence from the debtors, the bankruptcy court concluded that the debtors had met their burden of demonstrating good faith and denied Hitachi’s Section 707(a) motion. The bankruptcy court, quite simply, did not see a manipulation of the system. More importantly (at least for purposes of this article), the bankruptcy court concluded that a debtor’s ability to repay was not, of itself, sufficient to support a finding of bad faith. And of extreme significance was the bankruptcy court’s suggestion that the significant, substantial amendments made to Section 707(b) led to a negative implication � that is, an implication that because Section 707(b) was amended to include an analysis of income and expenses in establishing the newly created presumption of abuse, and Section 707(a) was not, the capability of a debtor to repay creditors should not be considered under Section 707(a). Using that negative implication, the bankruptcy court refused to consider the debtors’ substantial income and expenses in a Section 707(a) analysis. It accordingly denied the motion. It did, however, certify the issue to the 3rd Circuit under 28 U.S.C. 158(d)(2)(A). The question presented to the circuit court was this: “Whether, in deciding a motion to dismiss for cause under 11 U.S.C. Section 707(a), a bankruptcy court is prohibited from considering a debtor’s monthly income and expenses when assessing a debtor’s good faith in filing a bankruptcy petition.” The court began its analysis by recognizing that Section 707(a), providing for dismissal of a bankruptcy case “for cause,” does not include “lack of good faith” as a separate predicate; in fact, only three non-exclusive grounds, none referring to good faith, are set forth in the statute. Earlier case law, however, established that an absence of good faith does in fact constitute “cause” for purposes of Section 707(a). The court then addressed the bankruptcy court’s conclusion that the substantial amendments to Section 707(b), creating the presumption of abuse tied to income and expenses, while leaving Section 707(a) unaltered, created a “negative implication” precluding consideration of income and expenses in a Section 707(a) analysis. The circuit court first noted that “[t]he principle that the enumeration of one case excludes another is a canon of statutory interpretation.” It only applies, however, when the expressed item and the unmentioned item “go hand-in-hand.” In other words, courts must look to see if mentioning an item in one provision and not mentioning it in another justifies, on the whole, an inference that the item not mentioned was not mentioned intentionally, and not by inadvertence. The canon is thus a guide, and if a contrary indication appears, it should not be applied blindly. Examining the substantial revisions made to Section 707(b) in the 2005 act, the court noted that Congress was making it very clear that when dealing with a debtor with primarily consumer debts, courts must consider income and expenses, and if these fall outside what Congress considered the appropriate level, a presumption of abuse should arise. No such language was added to Section 707(a). But the circuit court concluded that the absence of such language in Section 707(a) is not determinative, since Congress has not treated consumer filings (under Section 707(b)) the same as consumer/non-consumer filings (under Section 707(a)), as “part of a �commonly associated group or series.’” First, the court stated that Section 707(a) applied to all Chapter 7 filings, while Section 707(b) applied solely to consumer filings. Second, the two subsections were added to the Bankruptcy Code at different times � there was no dismissal provision specifically directed at consumer filings until the predecessor to current Section 707(b) was added in 1984. Thus, from an historical perspective, Congress treated the issue of dismissal of consumer filings somewhat differently from the issue of dismissal generally. The two sections, accordingly, can hardly be said to be part of a package or commonly associated group or series. Third, the legislative history of the 2005 act to which the court referred does not at all suggest that the changes to Section 707(b) imply anything about Section 707(a) dismissals. The legislative history of Section 707(b) refers continuously to consumer abuse. Nothing in the legislative history suggests an intention to tighten courts’ discretion in deciding motions to dismiss under Section 707(a). The court concluded that for all these reasons, the “negative implication” found by the bankruptcy court should not be applied, as the changes to Section 707(b) were “� not meant to signal any exclusion of income-and-expense factors from a bankruptcy court’s consideration of motions to dismiss under Section 707(a).” Having so concluded, the court next considered the extent to which a court should consider income and expenses in the context of a Section 707(a) motion. Hitachi contended that Chapter 7, being reserved for the “honest but unfortunate debtor,” should never apply to one with substantial income or a lavish lifestyle. By contrast, the debtors contended that the legislative history of Section 707(a) makes clear that the ability to repay should never be considered. Section 707(a) does not address � in fact, does not even touch on � the issue presented. Accordingly, resort to legislative history was necessary. Both the House and the Senate committee reports state in part that Section 707(a) “� does not contemplate � that the ability of the debtor to repay his debts in whole or in part constitutes adequate cause for dismissal � . [this] would be to enact a non-uniform mandatory Chapter 13, in lieu of the remedy of bankruptcy.” The circuit court read this language, as did previous courts, to mean that ability to repay is not a sufficient reason for dismissal. That is not to say, however, that this fact should not be considered at all. The only thing the legislative history establishes is that ability to pay is not of itself sufficient to warrant a dismissal: “It [the legislative history] does not indicate that a bankruptcy court must ignore the economic reality of a debtor’s financial situation in determining whether a valid cause for dismissal exists.” In other words, the bankruptcy court should perform a fact-intensive good faith inquiry. And in this case, as a part of this inquiry, the economic circumstances of a debtor, like other factors, should be considered. As to income and expense factors, the circuit court determined it wise to provide parameters to guide bankruptcy courts in considering income and expense factors. As an initial matter, stated the court, if assets are concealed or misrepresented or sources of income are disguised, or where expenses are artificially inflated, dismissal would be entirely appropriate. Lavish living and substantial earnings in the absence of such dishonesty, by contrast, may be considered as evidence of bad faith, but an ultimate finding of bad faith may not be based exclusively or primarily on substantial financial means. That, stated the court, would be contrary to legislative history. But such evidence, coupled with additional, aggravating circumstances, could well enable a bankruptcy court to conclude that a debtor’s filing was in bad faith. Thus, according to the court, in deciding a motion to dismiss under Section 707(a) for lack of good faith, a bankruptcy court “� may consider all the facts and circumstances surrounding the debtor’s filing of the bankruptcy petition, including the reality of the debtor’s financial condition.” Turning to the case at hand, the circuit court concluded that the bankruptcy court reached the correct ultimate result. The evidence submitted at the trial revealed no concealment, misrepresentation, inflated expenses or other misconduct. The debtors were straightforward in their financial reporting, and Hitachi did not take issue with those findings. And the debt leading to the filing � the guarantee of a business loan � was incurred in connection with a venture that had a business plan with definite income projections. While the debtors had a substantial income and a comfortable lifestyle, the court stated, those factors, standing alone, were insufficient to demonstrate bad faith. The court thus affirmed the bankruptcy court’s denial of the Section 707(a) motion. Practitioners representing high-income individuals with primarily business debts should be especially sensitive to this case. You may find that your “wealthy” client, despite your knee-jerk reaction, just may qualify for a Chapter 7 discharge. Myron A. Bloom is a shareholder with the firm of Hangley Aronchick Segal & Pudlin. His practice is concentrated in the areas of corporate organization, bankruptcy, commercial workouts and creditors’ rights.

This content has been archived. It is available exclusively through our partner LexisNexis®.

To view this content, please continue to Lexis Advance®.

Not a Lexis Advance® Subscriber? Subscribe Now

Why am I seeing this?

LexisNexis® is now the exclusive third party online distributor of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® customers will be able to access and use ALM's content by subscribing to the LexisNexis® services via Lexis Advance®. This includes content from the National Law Journal®, The American Lawyer®, Law Technology News®, The New York Law Journal® and Corporate Counsel®, as well as ALM's other newspapers, directories, legal treatises, published and unpublished court opinions, and other sources of legal information.

ALM's content plays a significant role in your work and research, and now through this alliance LexisNexis® will bring you access to an even more comprehensive collection of legal content.

For questions call 1-877-256-2472 or contact us at [email protected]

 
 

ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2020 ALM Media Properties, LLC. All Rights Reserved.