A High-Income Debtor May File for Bankruptcy Under Chapter 7 of the Bankruptcy Code

By: Pamela Frederick

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Notwithstanding a debtor’s high income and ability to pay creditors, in In re Snyder,[i] a bankruptcy court in New Mexico recently refused to dismiss the debtor’s chapter 7 bankruptcy case because the court found that the debtor did not act in bad faith when filing the case.[ii] The debtor, a 63-year-old doctor with an annual salary of $290,000, filed for bankruptcy under chapter 7 of the Bankruptcy Code in order to discharge a $170,000 debt.[iii]  In response, the debtor’s sole creditor moved to dismiss the case, or alternatively, to convert the case to one under chapter 11, arguing that the debtor filed the case in bad faith.[iv]  In support of its motion under section 707(a), the creditor argued that the debtor’s high income, ability to repay, failure to try to repay, failure to schedule his wife’s jewelry, use of his historical average expenses on his Schedule J, and the fact that the movant was the debtor’s only unsecured creditor were all indicia of the debtor’s bad faith.[v]  The debtor responded that he did not file his chapter 7 case in bad faith, arguing that his age, lack of retirement savings, lack of a lavish lifestyle, and compliance with the Bankruptcy Code all indicated that he filed his petition in good faith.[vi]  The court ultimately denied the creditor’s motion, concluding that despite the existence of unfavorable factors and the debtor’s high income, the debtor’s desire to save for retirement was “consistent with good faith.”[vii]  Likewise, the court denied the creditor’s motion to convert because the evidence relied upon to support a conversion under section 706(b) was “identical” to the evidence in support of the motion to dismiss under section 707(a).[viii]

Under section 707(a), a court may dismiss a case after “notice and a hearing and only for cause.”[ix]  Courts have split on whether a debtor’s ability to repay creditors may be considered when determining whether to dismiss a chapter 7 bankruptcy case pursuant to section 707(a) of the Bankruptcy Code.[x] Relying on Congressional intent, the In re Kahn court held that the debtor’s ability to discharge debts with future income is irrelevant when determining a motion to dismiss under section 707(a).[xi] Alternatively, the majority of courts, including the Snyder court, have held that Congress’s enactment of the means test[xii] does not prohibit courts from considering income and ability to repay creditors when determining bad faith under a section 707(a) motion to dismiss, but it may not be the sole reason for dismissal.[xiii] The Snyder court considered the debtor’s income as well as the totality of the circumstances.[xiv] The court found that debtor filed the case in response to a judgment, failed to include his wife’s jewelry on his J Schedule, and inflated his monthly expenses, which were indicia of bad faith.[xv]  However, the court ultimately held that the debtor’s desire to save for retirement was consistent with a finding of good faith, and therefore, the court denied the motion to dismiss.[xvi]

In addition to dismissing a case for bad faith, under section 706(b), a “court may convert a cause under this chapter to a case under [c]hapter 11 of this title at any time.”[xvii]  There is no standard provided in the statute to indicate when a conversion is appropriate; the court has full discretion to determine whether the case may be converted.[xviii] However, courts have denied the alternative request to convert because the movant relied on the same evidence that supported the dismissal motion.[xix]  The In re Quinn court held that the movant provided insufficient evidence in support of conversion because the movant relied on the same evidence in support of dismissal.[xx] The Quinn court reasoned it was “not appropriate to compel the same end result through conversation to [c]hapter 11 when it [was] not appropriate to dismiss the [c]hapter 7 case.”[xxi]   The Quinn court’s concern was not that the debtor must repay creditors, but that by converting to chapter 11, the debtor will not want to repay his debts and then will move to dismiss the case, thereby effectively granting the relief that had been denied under the motion to dismiss under section 707(a). Similarly, the In re Lobera court also denied the motion to convert on that basis, but also reasoned that a conversion to a chapter 11 case would trap the debtor rather than provide the “fresh start” that Congress intended for a debtor who files for bankruptcy.[xxii] The Lobera court found that “anything relevant that would further the goals of the Bankruptcy Code” should be considered and the interests of the creditors and debtors should be balanced.[xxiii]  Just as courts have previously held, the In re Snyder court denied the motion to convert because it was based on the same evidence provided for the section 707(a) motion to dismiss.[xxiv] The Snyder court also found that forcing a conversion against a debtor may violate the Thirteenth Amendment’s involuntary-servitude prohibition.[xxv]

The Snyder decision may encourage a high-income debtor who has the ability to repay his creditors to file for bankruptcy under chapter 7 of the Bankruptcy Code because Snyder demonstrates that doing so does not necessarily constitute bad faith.  Yet the Snyder decision does not prevent a future court from finding that a high-income debtor filed in bad faith.  Indeed, the Snyder decision emphasized that, “Congress clearly intended [the debtor] to have [the option to file under chapter 7 of the Bankruptcy Code], regardless of income, absent other indicia of bad faith.” [xxvi] Therefore, a court could dismiss a high-income debtor’s bankruptcy case if there is other indicia of bad faith, such as manipulative behavior, absence of an attempt to repay creditors, failure to make lifestyle changes, etc.  Interestingly, the Snyder court’s holding seems to be contrary to one of the primary goals of the Bankruptcy Abuse Prevention and Consumer Protection Act, which was to ensure that debtors, who are able to pay their creditors, do pay their creditors.[xxvii]