ABI's essential guide to all aspects of consumer bankruptcy practice, updated with relevant case references and recent court decisions. Available for purchase at store.abi.org.
Here's a brief excerpt from the book:
I. Introduction to Consumer Bankruptcy
Definition and Goals
1. Definition of a Consumer Bankruptcy
In the context of this handbook, “consumer bankruptcy” applies to a bankruptcy case of an individual debtor whose debts were incurred primarily for a personal, family or household purpose. The first step in making this determination is to review the consumer’s debts.
Each debt should be classified as either consumer or non-consumer. Generally, classification depends on the purpose of the loan proceeds or, in the case of purchase money obligations, the use of the property. A single obligation may have characteristics of both consumer and non-consumer debt. Generally, the language of 11 U.S.C. § 101(8) (defining “consumer debt”), as well as § 707(b)(1) (limiting the application of the means test to debtors with primarily consumer debts), is construed to require the entire amount of a debt to be classified as consumer so long as the primary purpose of the debt is “personal, family, or household.” The term “primarily” in this context means more than half. Where the relative difference between the amount of consumer and non-consumer debt is minimal, the number of consumer debts compared to non-consumer debts can tip the scales in favor of whichever classification has the greater number of debts.
Factors used to distinguish between consumer and non-consumer debt include:
i. whether the monies were used for a commercial purpose or enterprise;
ii. whether the monies were used for the production or preservation of income;
iii. whether the debtor had a profit motive in incurring the obligation; and
iv. the deductibility of interest for federal income tax purposes.
b. Special Debts
Three common “big-ticket” obligations that should be examined carefully are mortgages, tax obligations and student loans.
i. Mortgages. Characterization of a secured debt as “consumer” is generally based on the nature of the security, rather than the fact that an obligation is “secured.” For example, a debt secured by a personal residence is a consumer debt, while a debt secured by business equipment is not.
ii. Taxes. A majority of the courts have held that tax obligations do not meet the definition of consumer debts. This is a logical conclusion in that taxes are not debts incurred for personal or family use but are involuntary contributions exacted by the government for a general public use.
iii. Student loans. Loans taken out for educational purposes may not automatically be classified as consumer debts. To the extent that the proceeds are used to pay living expenses, e.g., housing, food and everyday living costs, a student loan is properly classified as a consumer debt. To the extent that the proceeds are used to pay for tuition, books and fees, classification turns on the purpose for which the education was pursued — vocational or avocational — and is determined on a case-by-case basis.
c. Evidentiary Burden
When classification of a debt as consumer or nonconsumer is contested, the debtor bears the evidentiary burden to show the classification asserted.
2. The Goals of Consumer Bankruptcy
The principal goals of bankruptcy are twofold: to provide an equitable distribution of the nonexempt property of the debtor among creditors, and to provide the debtor with a “fresh start” by relieving the debtor of the burden of many existing debts. The Bankruptcy Code effects these goals by (1) providing certain protections for creditors, either as a class or as a whole; (2) establishing the priority in which creditors receive distributions; (3) discharging a debtor from all obligations, except those specifically enumerated; and (4) allowing the debtor to retain certain property as exempt, unencumbered by debts that are discharged, and allowing the debtor to retain a minimal standard of living and to support himself and his dependents.
Types of Consumer Proceedings
In the consumer context, there are two principal bankruptcy processes: (1) chapter 7 liquidation, wherein the debtor’s nonexempt assets are sold and the proceeds distributed among creditors; and (2) chapter 13 reorganization, wherein the debtor retains his property but pays creditors, in full or in part, from future income.
1. Chapter 7
Historically, most consumer debtors have filed for bankruptcy under chapter 7, sometimes referred to as “liquidation.” In chapter 7, all of the debtor’s property or interests in property, other than certain excluded property, becomes the bankruptcy “estate.” A trustee is appointed to liquidate the nonexempt property of the estate and distribute the proceeds.
Property other than real property may be sold via auction or negotiated sale. Real property will be listed, usually at a price that will facilitate a reasonably quick sale and minimize costs to the estate of holding the property. Property remaining at the conclusion of the case is returned to the debtor. Generally, the trustee in a chapter 7 will not operate a business enterprise owned by the debtor.
While most chapter 7 cases are “no asset” cases, resulting in no distribution to unsecured creditors, a small percentage result in the sale of assets and recovery of cash, which is paid to creditors according to their priorities. After the estate has been liquidated, the claims of creditors having security interests in liquidated property are satisfied, and the expenses of administration are paid. Any remaining cash is then distributed to unsecured creditors, and possibly the debtor, who receive distributions in order of priority as follows:
i. priority unsecured claims;
ii. timely filed unsecured claims, or tardily filed unsecured claims if the creditor did not have notice or actual knowledge of the case in time for timely filing;
iii. other tardily filed claims;
iv. claims for fines, penalties, forfeitures and punitive damages that are not compensation for actual pecuniary loss suffered by the holder of the claim;
v. interest at the legal rate from date of filing until date of payment on any claim under the preceding four paragraphs; and
vi. the debtor.
If the distributable cash is less than the amount necessary to satisfy in full the claims in any priority, the distribution is made pro rata among the claimants in that priority, in which case claimants with lower priority receive nothing.
c. Dismissal of a Case
i. Dismissal for cause. A debtor does not have an absolute right to voluntarily dismiss a chapter 7 case; a motion is required with a showing of cause. Upon request of the debtor, another party in interest or the U.S. Trustee, the court may dismiss a chapter 7 case, only after notice and a hearing, for cause, including:
• unreasonable delay that is prejudicial to the creditors;
• nonpayment of any fees or charges; or
• on the motion of the U.S. Trustee, failure to file schedules within 15 days after the petition is filed, or by any extended deadline the court may allow.
ii. Dismissal or conversion for abuse. Upon its own motion or upon the motion of an interested party, including the U.S. Trustee, the court may dismiss the case of an individual whose debts are primarily consumer debts or, with the debtor’s consent, convert the case to one under chapter 11 or 13, if the court determines that the granting of relief would be an abuse of the provisions of chapter 7. Abuse is not defined specifically, but two provisions provide guidance:
Abuse is presumed if a debtor’s “current monthly income,” reduced by allowable expenses in § 707(b)(2) and multiplied by 60, equals or exceeds the lesser of $12,850, or either $7,700 or 25 percent of total nonpriority unsecured debt, whichever is greater.
Abuse may be found if the petition is filed in bad faith or if the totality of the circumstances of the debtor’s financial situation shows an abuse. Application of these tests varies among courts, the principal difference being whether a debtor’s ability to pay his or her creditors should be a factor. Some courts have determined that the application of the means test removes a debtor’s ability to pay from a bad faith or totality-of-the-circumstances examination. Other courts have found that a debtor’s ability to pay remains a factor to be considered, either equally with others or as the paramount factor that trumps others.
iii. Dismissal for certain crimes. A voluntary chapter 7 case filed by an individual debtor convicted of a crime of violence or drug trafficking may be dismissed upon the motion of a victim of the crime when it is in the best interests of the victim. However, if the debtor establishes that the filing of the case is necessary to satisfy a claim for a domestic support obligation, the court may not dismiss the case.
iv. Failure to file schedules. If the debtor fails to file the required schedules within 45 days after the petition is filed, the case is automatically dismissed on the 46th day. Upon the request of the debtor made within the initial 45-day period, the court may extend the time for up to an additional 45 days. Upon the motion of the trustee made within the initial 45-day period, and after notice and a hearing, the court may decline to dismiss the case if the debtor has made a good-faith effort to file all required documents and the best interests of the creditors would be served by administration of the estate.
v. Failure to file post-petition tax return. If the debtor does not file a post-petition tax return or does not obtain an extension, the taxing authority may move to have the case dismissed or converted. Should the debtor fail to file the required return or obtain an extension within 90 days of the taxing authority’s request, the court must convert or dismiss the case, after taking into account the best interests of creditors and the estate.
vi. Refiling a dismissed case. No individual may refile a petition for 180 days after dismissal if (1) the case was dismissed due to the debtor’s willful failure to follow court orders or to prosecute the case, or (2) the debtor requested and obtained a voluntary dismissal of the case after a creditor filed a motion for relief from the automatic stay.
2. Chapter 13
Chapter 13 is a debt-repayment plan under which the debtor may keep nonexempt property while repaying creditors over a period of time: three or five years, depending on the income of the debtor. Repayment of debts in chapter 13 is marked by several significant themes: (1) most secured claims must be paid at least the value of the creditor’s collateral with interest; (2) the value received by allowed unsecured claimants must be at least the amount that those claimants would have received if the estate were liquidated under chapter 7; and (3) the debtor must propose a repayment plan in good faith.
b. Chapter 13 Plan
The debtor is required to abide by a plan that proposes debt adjustments and repayments. The plan must be confirmed by the court. Upon the successful completion of the terms of a confirmed plan, the debtor receives a discharge.
c. Conversion or Dismissal of a Case
i. A debtor may convert a chapter 13 case to a case under chapter 7 at any time; any attempt at waiving this right is unenforceable.
ii. If the case has not previously been converted from another chapter to a chapter 13, the debtor has an absolute right to dismiss the case; any waiver of this right is also unenforceable.
iii. Except for a case involving a farmer, the court, upon request of a party in interest or the U.S. Trustee and after notice and a hearing, may convert the case to a case under chapter 11 or 12 at any time prior to confirmation. If the debtor is a farmer, the debtor must consent to such conversion.
iv. Also after notice and a hearing, the court may convert the case to a case under chapter 7 or dismiss it, whichever is in the best interests of the creditors, for cause, including:
• unreasonable delay prejudicial to the creditors;
• nonpayment of fees and charges;
• failure to timely file a plan;
• failure to commence timely payments to the trustee;
• denial of confirmation and denial of a request to file another plan or modified plan;
• material default under a confirmed plan;
• revocation of a confirmation order and denial of confirmation of a modified plan;
• termination of a confirmed plan other than by completion of its payments;
• failure to file schedules and statements; or
• failure to pay any post-petition domestic support obligation.
v. On the request of a party in interest or the U.S. Trustee, the court must convert the case to a case under chapter 7 or dismiss it, whichever is in the best interests of the creditors, for failure to file a pre-petition tax return.
vi. If a post-petition tax return is not filed when due, by extension or otherwise, then the taxing authority may request the dismissal or conversion of the case. In such circumstances, if the debtor nonetheless fails to file the required return within 90 days of the request for dismissal or conversion by a taxing authority, the court must convert or dismiss the case, whichever is in the best interests of the creditors and the estate.