[T]here is nothing wrong with the means test. People who make high incomes–lawyers, doctors and accountants are examples–and file bankruptcy, wiping out all their debts, who don't care who got hurt by their failure to pay and they care only about themselves, this will crack down on those people.
–Statement of Sen. Jeff Sessions, March 8, 2005. Cong. Rec. S2219

Imagine a person with a high income–a corporate CEO, for example–whose company goes out of business and who finds himself temporarily unemployed. While waiting for his next opportunity, he maintains his lifestyle by depleting his personal savings and incurring substantial debt, both secured (his normal annual purchase of a new Jaguar and new home equity loans) and unsecured (cash advances and other charges on his credit card, which has a very high limit). After a few months, he finds new employment, with even higher compensation than before, but he wonders if there isn't some way that he could avoid repaying some of the debt he incurred. Chapter 7 of the Bankruptcy Code¹ seems to present a good possibility; it offers an immediate discharge of all unsecured debts in exchange for the debtor's nonexempt assets.² That's no problem for our executive, because the remaining equity in his home is protected by a generous state exemption, his cash is gone (or in exempt retirement accounts), and his cars are encumbered by liens. There's nothing that a chapter 7 trustee could sell for debt repayment.

Indeed, the only problem the executive might seem to have is the means test that was added to §707(b) of the Code³ by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).⁴ As reflected in the quotation from Sen. Sessions above, the means test was designed to "crack down" on debtors with sufficient income to repay a substantial portion of their debt. It does this through a formula that determines how much income a debtor may have available for debt repayment. If this amount exceeds defined levels, the debtor is presumed to be abusing chapter 7 and will be denied chapter 7 relief if the presumption is not rebutted. But as it turns out, the means-test formula is also no problem for our executive. It measures a debtor's income during the six months before a bankruptcy filing, and he would have been unemployed during most of this period. Moreover, it allows a deduction from income in the amount of whatever secured debt payments the debtor is obligated to make–even debts secured by luxury vehicles or other unnecessary items. So although the executive has plenty of income to pay his debts, he passes the means test; there is no presumption of abuse.

To discharge all of his unsecured debt in chapter 7, the executive needs to leap just one more hurdle. Section 707(b)(3) of the Code,⁵ added by BAPCPA, governs situations in which the means-test presumption does not arise, and it provides that the court can find abuse in such situations by considering "the totality of the circumstances...of the debtor's financial situation." One might think that this provision allows a judge to look at how much money a debtor actually has available to pay debts and "crack down" on genuinely wealthy debtors who pass the means test.⁶ But according to a recent article by Profs. Culhane and White,⁷ that is not so. Once a debtor passes the means test, the article contends, the debtor's financial situation is irrelevant to a finding of "abuse;" relief can be denied only for dishonesty or similar "serious debtor misconduct."⁸ Our executive, then, having told no lies and having made no lifestyle changes to facilitate bankruptcy, can both keep his income and discharge his unsecured debts in chapter 7.

This article suggests the contrary–that if the question is properly raised in a §707(b) motion, bankruptcy judges have a duty to consider the actual financial situation of debtors who are not subject to a means-test presumption, that judges should find abuse where debtors can repay a sufficient amount of unsecured debt, and that the means test serves to guide–rather than foreclose–such determinations of abuse.

The Means Test as a Presumption of Ability to Repay Debt

The key to understanding the proper role of the means test in chapter 7 is to recognize that it is simply a mechanism for generating a presumption; it does not result in any final determination. Although the means test itself is complex, its function as a presumption is clear from the interaction of five provisions of §707(b):

•Paragraph (b)(1) provides that a court may deny chapter 7 relief "if it finds that the granting of relief would be an abuse of the provisions of this chapter."

•Subparagraph (b)(2)(A) calculates an amount of income that a debtor may have available to pay debts that are neither secured by liens on the debtor's property nor given a special priority by the Code. This available-for-ordinary-debt payment amount can be called "disposable" income, since it is the income not needed for living expenses and payment of secured and priority debts.⁹ Put another way, disposable income equates to "ability to pay" unsecured debt. The means test calculates disposable income by subtracting specified allowances for living expenses and payments of secured and priority claims from the debtor's defined "current monthly income."¹⁰

•Clause (b)(2)(A)(i) provides that "the court shall presume abuse exists" if the debtor's monthly disposable income calculated under the means test is either (1) greater than $166.66 or (2) at least $100 and sufficient to pay 25 percent of the debtor's nonpriority unsecured claims in 60 months. These amounts of monthly disposable income can be referred to as the "abuse threshold," since a debtor who has disposable income at or above these amounts is presumed to be abusing chapter 7.

•Subparagraph (b)(2)(B) provides for the only possible rebuttal of the means test's presumption of abuse: The debtor must show "special circumstances that justify additional expenses or adjustments of current monthly income" that would cause the debtor's monthly disposable income to fall below the abuse threshold.

•Paragraph (b)(3) provides in full: In considering under paragraph (1) whether the granting of relief would be an abuse of the provisions of this chapter in a case in which the presumption in subparagraph (A)(i) of such paragraph does not arise or is rebutted, the court shall consider–
(A) whether the debtor filed the petition in bad faith; or
(B) the totality of the circumstances (including whether the debtor seeks to reject a personal services contract and the financial need for such rejection as sought by the debtor) of the debtor's financial situation demonstrates abuse.

From these provisions, it is evident that the means test operates as a classic presumption–that is, a rule providing that proof of one fact (the "foundational" fact) is effective to establish another fact (the "presumed" fact).¹¹ For example, in one common presumption, the foundational fact that a child is born to a woman while she is married gives rise to a presumed fact that her husband is the biological father.¹² In the means-test presumption, the foundational fact is the amount of monthly disposable income calculated under the means test; the presumed fact is that the debtor actually has disposable income in the calculated amount.

Just as husbands can rebut a presumption of paternity by introducing evidence (such as a genetic test) demonstrating that they did not father children born during their marriages,¹³ so chapter 7 debtors can rebut the amount of disposable income calculated under the means test by showing that their actual disposable income is less than that amount, either because the means test measured income at a level inaccurately high, or because it measured deductions for living expenses and payments of secured and priority debt at levels inaccurately low.

And as with the presumption of paternity, the means test is not infallible. As noted above,¹⁴ it measures income by averaging the debtor's income from the six months before filing bankruptcy. Whenever a debtor's income has been permanently reduced shortly before filing, this six-month average income will be higher than what the debtor actually has available.¹⁵ And wherever the means test has a fixed allowance for a given expense, that allowance has the potential for being lower than what the debtor actually needs.

Thus, the provision for rebuttal in §707(b)(2)(B) reflects reality. It also brings into effect Rule 301 of the Federal Rules of Evidence. Under this rule, if a debtor contests a means-test presumption of disposable income by introducing evidence showing lower total income or higher necessary deductions, the party moving for relief under §707(b)(1) has the burden of showing actual disposable income at or above the abuse threshold. In such a situation, the court presiding over the contested motion determines–independent of the means-test measurements–the total income actually available to the debtor and the expenditures that the debtor must actually make to provide for reasonable support and pay secured and priority debts.

The status of the means test as a presumption has one final–and critical–feature. A presumption is merely one method of establishing a fact necessary to obtain relief. Where a presumption does not arise, the party seeking relief may prove the necessary fact directly, using the same kind of evidence that could be used to establish the fact in connection with a rebuttal of the presumption. A party asserting abuse under §707(b)(1) may seek to prove that the debtor's actual disposable income is at or above the abuse threshold, even if the means-test presumption does not arise, using the same type of evidence that would be presented if the debtor sought to show that the means-test presumption was inaccurate.

So, for example, a debtor subject to a means-test presumption might try to rebut it by showing housing expenses higher than what the means test allows, perhaps due to special assessments on a condominium or unusually high property taxes.¹⁶ Conversely, a movant seeking to establish that the debtor's actual disposable income is above the abuse threshold might introduce evidence that the debtor owned a home in a community with very low property taxes, so that the debtor's actual home ownership expense was less than what the means test allowed. In either situation, the court would determine the debtor's actual housing expenses, using the same kind of evidence under the same judicially determined standards.

The language of §707(b), far from rejecting this conclusion, compels it. There is no provision in §707(b) stating that the means test is the only method through which the debtor's disposable income can be established. To the contrary, §707(b)(3) explicitly states that, in the absence of the means-test presumption, "the court shall consider...whether...the totality of the circumstances...of the debtor's financial situation demonstrates abuse." Given that the means test is directed at measuring debt-paying ability as a presumption, this direction confirms that where the presumption does not arise, the debtor's actual debt-paying ability must be assessed in ruling on a motion under §707(b)(1).

Guidance from the Means Test on Nonpresumptive Abuse

When judges assess the totality of a debtor's financial circumstances under §707(b)(3) for purposes of determining whether the debtor is abusing chapter 7, they will not be exploring a wilderness. As noted above, "totality of the circumstances" itself is a judicially created construct for determining "substantial abuse" under pre-BAPCPA §707(b), and the case law applying that concept lays out the general scope of the abuse to be determined.¹⁷ The case law interpreting "disposable income" in chapter 13–an issue since 1984–provides another source of helpful precedent.¹⁸ But the detailed provisions of the means test may also provide guidance in assessing the ability to pay that BAPCPA treats as abuse. Each of the elements of the means test, its threshold of abuse, its assessment of "current monthly income" and its allowed deductions–as well as its treatment of exempt property–can be examined for potential policy indications.

The Abuse Threshold

The clearest guidance from the means test is on the question of how much disposable income should lead to a finding of abuse. The abuse threshold set out in §707(b)(2)(A)(i) is irrebuttable. Section 707(b)(2)(B) only allows a debtor to rebut the means test's calculation of disposable income in an amount above the abuse threshold; it does not allow any argument that the threshold itself is too low. Disposable income of more than $166.66 per month, or disposable income of at least $100 per month, sufficient to pay 25 percent of the debtor's nonpriority unsecured debt in five years, is always an abuse requiring a denial of chapter 7 relief.¹⁹ Since the abuse threshold cannot be challenged within the means test, there is a clear policy judgment that the threshold fixes the level at which debt-paying ability becomes abusive of chapter 7. When judges are required to make determinations of abuse under §707(b)(3), they should accordingly use the means-test threshold: If a debtor's actual disposable income, determined by the court, is below that threshold, there should be no finding of abuse based on debt-paying ability; if disposable income meets or exceeds the threshold, abuse should be found.

"Current Monthly Income"

Just as the abuse threshold is the aspect of the means-test presumption that most clearly should be incorporated into judicial determinations of nonpresumptive abuse, "current monthly income" is the aspect of the means test that most clearly should not be. When the court is determining the income that a debtor actually has available to pay nonpriority unsecured debt, it would be absurd to start with a total income figure that does not reflect the debtor's actual total income. Although an average of the debtor's income during the six months before bankruptcy can serve as a rough approximation of actual total income for purposes of the means-test presumption, it plainly will not be accurate in many situations.²⁰ Under §707(b)(2)(B), debtors can rebut a means-test presumption based on inaccurately high "current monthly income" by showing their actual monthly income during the bankruptcy case; judges assessing actual debt-paying ability under §707(b)(3) should likewise begin with an assessment of the debtor's actual total income. Thus, in the situation of a debtor who obtained new permanent employment shortly before filing bankruptcy, the salary of the new job–not average earnings during the prior six months–would be the relevant consideration.

A separate consideration is whether income items excluded from the definition of current monthly income in §101(10A)–most notably benefits under the Social Security Act–should be omitted from the actual income assessed by the court under §707(b)(3). It can be argued that the exclusion of Social Security Act benefits reflects a policy of protecting retirement income from creditors.²¹ On the other hand, when a court makes a determination of actual disposable income, the special needs of retired persons can appropriately be dealt with by allowing increased deductions from income for food, health care, housing, transportation and other items potentially affected by age or disability. The means test's exclusion of Social Security Act benefits may well have served as a proxy for this sort of individualized determination of the needs of retirees and be inappropriate in a determination of actual disposable income. Social Security Act benefits are certainly part of the "totality" of the debtor's financial circumstances, and these benefits are available for paying expenses (and unsecured nonpriority debt) just as much as other income. The plain meaning of §707(b)(3) thus should be applied, requiring that Social Security Act benefits be considered in gauging nonpresumptive abuse.

Allowed Deductions

Turning from income to deductions, it is notable that most of the living expense deductions specified by the means test are limited to amounts "reasonable and necessary." These include expenses in the "other necessary expense" categories listed by the Internal Revenue Service, allowed as deductions by §707(b)(2)(A)(ii)(I),²² as well as the special statutory deductions allowed by §707(b)(2)(A)(ii)(I)-(V) in addition to the IRS deductions.²³ The "reasonable and necessary" limitation of these allowances provides for judicial discretion to be exercised even when the allowances are used in the means test; that discretion would apply similarly in determining nonpresumptive abuse under §707(b)(3). Nevertheless, the inclusion of expenses in these categories as allowable deductions in the means test does have at least one impact on the nonpresumptive determination: Expenses in each of the categories must be recognized as at least potentially reasonable. Thus, a court would not be justified in concluding that contributions to health savings accounts are never necessary expenses, since "reasonably necessary" expenses of this kind are specifically allowed as deductions in §707(b)(2)(A)(ii)(I). On the other hand, where the statute limits the amount of the deduction for purposes of the means test–as in the annual limit of $1,500 per minor child for private elementary or secondary school–a court could find that a higher expenditure was reasonably necessary, both in determining actual disposable income under §707(b)(3) or in rebuttal of a means-test presumption under §707(b)(2)(B).

A more significant issue arises in connection with deductions for living expenses that the means test allows in fixed amounts. Under §707(b)(2)(A)(ii)(I), the means test allows deductions for food, clothing, housekeeping supplies, personal care and miscellany in a lump sum fixed by the "National Standards" of the IRS.²⁴ Deductions for housing and transportation are similarly allowed in amounts fixed by the IRS's "Local Standards."²⁵ Since these amounts do not vary with the debtor's actual needs, the means test's allowances for these expenses may well be inaccurate as applied in a given case.²⁶ Thus, judges would not be bound to accept them, either in means-test rebuttals or nonpresumptive determinations of abuse.

Perhaps the most debatable aspect of the means-test deductions is the unlimited one for current secured debt payment. As set out in §707(b)(2)(A)((iii)(I), the means test provides a deduction for 1/60 of "the total of all amounts scheduled as contractually due to secured creditors in each month of the 60 months following the date of the petition." This allowance is not subject to any "reasonable and necessary" limitation and so, for purposes of the means test, debtors may deduct debt secured by vacation homes, pleasure boats and other items manifestly not necessary–and even include the entire amount of balloon mortgages in the secured debt amount that is divided by 60, as long as the mortgage became due in the five years following bankruptcy.

As with the exclusion of Social Security Act benefits from current monthly income, it can be argued that this secured-debt deduction reflects a general policy of BAPCPA–here, a policy favoring secured creditors over unsecured–so that in assessing the totality of the debtor's financial circumstances, a court should allow the full deduction for secured debt payments that the means test specifies.²⁷ However, as with its treatment of Social Security Act benefits, the means test's secured-debt deduction can more reasonably be understood as a proxy for more individualized determinations. Certainly, the means test evidences no policy that all secured obligations be repaid rather than enforced through repossession or foreclosure. To the contrary, if a debtor is in default, the means test allows a deduction for cure payments needed to retain the collateral only if the collateral is reasonably necessary for support of the debtor or the debtor's dependents.²⁸ The means test thus appears to use current payment status as a rough measure of the debtor's need for particular collateral, reflecting a judgment that debtors are less likely to default on loans secured by collateral necessary for their support. When an individualized determination of the totality of a debtor's financial circumstances is conducted, such presumptions are not appropriate, and the debtor's real need for collateral, whether or not the loan is in default, can properly be considered.

Exempt Property

The means test says nothing about the extent of a debtor's property, either exempt or nonexempt. However, in determining presumptive disposable income, the means test's starting point, current monthly income, includes income "from all sources...without regard to whether such income is taxable."²⁹ Thus, the means test requires inclusion of income received from any number of exempt sources, such as retirement accounts and life insurance proceeds.³⁰ This is in keeping with pre-BAPCPA case law, which considered exempt income in determining "substantial abuse."³¹

Consistent with the means test, then, a court determining actual disposable income under the "totality of the circumstances" may take into account the extent of a debtor's exempt property in determining the actual expenses that the debtor is required to incur. For example, the expenses incurred by a debtor for transportation can vary depending on the extent to which the debtor's automobile is exempt. If a debtor owns a valuable, lien-free automobile that can be fully exempted in bankruptcy, it is unlikely that the debtor would need to incur any vehicle-acquisition costs for the period after a bankruptcy filing, thus eliminating an expense allowed in the means test.³² However, if the automobile could not be exempted, it would likely be sold by a chapter 7 trustee, eliminating any concern that the debtor's ownership of the vehicle was an abuse of chapter 7 and justifying a deduction for vehicle acquisition expenses in calculating actual disposable income. Pre-BAPCPA case law recognized the reality that the extent of debtors' exempt property can bear on their debt-paying ability.³³ There is no policy inherent in the means test that would prevent a court from considering the extent of exempt property in making a nonpresumptive determination of abuse under §707(b)(3).

Conclusion

Let's return to the recently re-employed CEO hypothesized at the beginning of this article. Despite his new salary, huge home and ample retirement accounts, he could pass the means test. However, he does not thereby evade consideration of his actual disposable income under §707(b)(3). If, as is highly likely, his actual disposable income is at the abuse threshold, the CEO will either have to pay his debts outside of bankruptcy or obtain a discharge through a payment plan under chapter 11 or 13.

In this hypothetical, the means test itself failed to accomplish the goal of its sponsors. And situations like the hypothetical will arise not infrequently, since the means test is inefficient in identifying likely abuse of chapter 7. However, BAPCPA did not exacerbate this flaw by making the absence of a means-test presumption conclusive of debt-paying ability. Section 707(b)(3) requires judges, when an abuse motion is raised, to determine the debtor's actual financial condition, including debt-paying ability. Ultimately, even when the means test does not presume abuse, genuinely wealthy debtors may be denied chapter 7 relief.

 

---

Footnotes

1 11 U.S.C. §701, et seq.

2 See 11 U.S.C. §§541 (defining property of the debtor's estate and allowed exemptions); 704(a)(1) (requiring a chapter 7 trustee to collect and reduce to money the property of the estate); 727(a) (providing for the chapter 7 discharge); Fed R. Bankr. P. 4004(c) (providing for prompt entry of chapter 7 discharge).

3 11 U.S.C. §707(b).

4 Pub. L. No. 109-8, 119 Stat. 23 (2005).

5 11 U.S.C. §707(b)(3).

6 See Wedoff, Eugene R., "Means Testing in the New §707(b)," 79 Am Bankr. L. Rev. 231, 236 (2005) (reading §707(b)(3) to allow judicial determination of debt-paying ability).

7 Culhane, Marianne B. and White, Michaela M., "Catching Can-Pay Debtors: Is the Means Test the Only Way?" 13 Am. Bankr. Inst. L. Rev. 665 (2005).

8 Id. at 666, 687.

9 Cf. 11 U.S.C. §1325(b)(2) (providing a similar definition of "disposable income" for use in chapter 13).

10 See 11 U.S.C. §110(10A) (defining "current monthly income" as the monthly average of income from all sources that the debtor receives, derived in the six calendar months prior to filing bankruptcy).

11 Park, Roger C., Leonard, David P. and Goldberg, Steven H., Evidence Law §4.08 at 106-07 (2004); see, also, McCormick on Evidence §342 (5th ed. 2003) (providing a similar explanation of presumptions).

12 See McCormick on Evidence §343 (5th ed. 2003); see, e.g., 750 Ill. Comp. Stat. 45/5(a)(1) (2002).

13 See, e.g., 750 Ill. Comp. Stat. 45/5(b) (2002), providing for rebuttal of the marital paternity presumption by clear and convincing evidence.

14 See n.9, supra.

15 See Wedoff, supra note 6 at 248-51 (giving examples of situations in which the defined "current monthly income" differs greatly from actually available income).

16 The means test uses housing allowances specified by the Internal Revenue Service as part of its Collection Financial Standards for collecting delinquent taxes. The housing allowance is based on a county-wide average and does not take into consideration the fact that costs in individual communities (or condominium developments) may vary greatly from the county average. See Wedoff, supra note 6 at 259-60 (discussing anomalies caused by county-wide averaging).

17 The Culhane/White article does not appear to propose any alternative definition of "totality of the circumstances...of the debtor's financial situation." At one point, it states that the phrase "must be read as limited to serious debtor misconduct." Culhane/White, supra note 7 at 666. At another, it suggests that the phrase "should encompass debtor actions...not illegal or necessarily dishonest [but] nonetheless manifestly unreasonable under the debtor's circumstances." Id. at 687. Neither of these suggestions is supported by any textual analysis and–wholly apart from the contrary case law–it is difficult to see how the "totality" of the circumstances bearing on a debtor's financial situation can be shriveled up to address only certain debtor misconduct. Indeed, since §707(b)(3) sets out "bad faith" as a ground for finding abuse separate from the "totality of the [debtor's financial] circumstances," it strongly suggests that debtor misconduct of any kind should be treated under "bad faith" rubric, leaving the "totality of the circumstances" to address the debtor's financial status–including disposable income most prominently.

18 The relevant case law is collected and discussed in Lundin, Keith M., Chapter 13 Bankruptcy §§163.1 -167.1 (3d ed. 2004).

19 However, the dollar amounts in §707(b) are subject to periodic adjustment for inflation under 11 U.S.C. §104(b)(1), and so the abuse threshold will likely rise over time.

20 See note 15, supra.

21 See Culhane/White, supra note 7 at 676.

22 See Wedoff, supra note 6 at 261-64.

23 See Id. at 264-71.

24 See Id. at 253-55.

25 See Id. at 255-61.

26 See, e.g., the potential variances in housing costs discussed supra at note 7 and the accompanying text.

27 See Culhane/White, supra note 7 at 674.

28 See 11 U.S.C. §707(b)(2)(A)(iii)(II).

29 11 U.S.C. §101(10A)(A).

30 Tax-exempt retirement funds are generally exempted from a debtor's bankruptcy estate under 11 U.S.C. §522(a)(3)(C), added by BAPCPA. A debtor's right to receive life insurance proceeds from a former supporter of the debtor is part of a debtor's federal bankruptcy exemptions. See 11 U.S.C. §522(d)(11)(C). Section 541(b)(7)(B) provides that contributions made by debtors to certain retirement plans will not constitute current monthly income for purposes of chapter 13, but this limitation does not apply in chapter 7 and would not affect distributions from the retirement account in any event. The Culhane/White article appears to misconstrue §541(b)(7)(B) on this point. See Culhane/White, supra note 7 at 690 n.111.

31 See, e.g., Taylor v. United States (In re Taylor), 212 F.3d 395, 396 (8th Cir. 2000) ("The question of whether income from a pension is exempt from creditors is a wholly independent inquiry from the question of whether the pension income is reasonably necessary to support the debtor"); In re Shields, 322 B.R. 894, 898 (Bankr. M.D. Fla.) ("Social security benefits, disability benefits and retirement benefits should be treated as 'income' for purposes of determining whether a debtor has 'disposable income'...even though such benefits are exempt from the claims of the debtor's creditors").

32 See Wedoff, supra note 6 at 257-58.

33 See, e.g., In re Kornfield, 164 F.3d 778, 781 (2d Cir.1999) ("A totality-of-the-circumstances inquiry is equitable in nature, and the existence of an asset, even if exempt from creditors, is relevant to a debtor's ability to pay his or her debts").