Wednesday, June 19, 2013

INDIVIDUAL NON-CONSUMER BANKRUPTCY CASES: Being aggressive does not always pay off! The 706(b) problem.

Pigs get fat, Hogs get slaughtered!

INDIVIDUAL NON-CONSUMER BANKRUPTCY CASES:  Being aggressive does not always pay off!  The 706(b) problem.

Published on June 19, 2013 by: Ian M. Falcone

For lack of a better explanation, the main focus of our bankruptcy practice has always been “putting square pegs in round holes.”  We have always handled the complicated cases.  We developed the tools and expertise for finding solutions to difficult problems.  Can you file Chapter 7 as a divorced father earning $172,000 per year?  (Under the right circumstances – yes!)  How do you handle more than $500,000 of personal income tax debt in a Chapter 13 case when some is secured, some is priority unsecured and some is general unsecured?  (Very carefully and with lots of documentation)

One of our many "tricks" is simply knowing and understanding the Bankruptcy Code.  That means knowing when the means test applies and when it doesn’t, knowing what types of debts are considered non-consumer and which are not, and, most importantly, knowing when to be aggressive and when not to be. 

When BAPCPA went into effect, the means test effectively began determining abuse and whether a debtor qualifies for Chapter 7. In a consumer filing, a case could be dismissed or converted if the debtor could not pass the means test, but this provision is expressly limited to an individual debtor under this chapter whose debts are primarily consumer debts.[1]  As a result, our office often looked for ways to see if the case could be classified as “non-consumer.”

While our office is thorough and takes advantage of the Bankruptcy Code, we are never unduly aggressive.  As a result, we always had a nagging question:  Assuming the debtor qualifies as a non-consumer case, thereby eliminating the means test analysis, but has substantial net monthly income as determined by the difference between schedules I & J, is there a risk of conversion or dismissal?

On January 24, 2012, in the In re:  Derrick Gordon case, Judge Wendy Hagenau (NDGA), partially answered that question.[2]  In that case, a creditor (Proudfoot Consulting Company) obtained a judgment against the debtor, Derrick Gordon, in the amount of $1.6 Million for breach of an employment agreement.  In response, Mr. Gordon filed a Chapter 7 bankruptcy case hoping to discharge his obligations.  Since the case did not consist of “primarily consumer debts” the means test did not apply, nor did the abuse standards in 11 U.S.C. 707(b).  It’s a good thing too, since the debtor reported monthly net income of almost $14,000.

In a very creative move, Proudfoot filed a Motion to Convert Chapter 7 Case to One Under Chapter 11.   Proudfoot relied on 11 U.S.C. §706(b), which provides, “[o]n request of a party in interest and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 11 of this title at any time.”

The debtor responded by claiming that this section does not apply to individual debtors, and, more importantly, even if it did, forcing such a conversion would amount to involuntary servitude in violation of the Thirteenth Amendment.  After addressing and dismissing the debtor’s concerns, the Court concluded that conversion was proper.

We have always advised clients that, “When you look like poster-child for abuse of the system, someone will come after you,” but after the entry of Judge Hagenau’s order, our concerns escalated.  Despite our concerns, however, we had not seen any increased litigation.  That is, until now.

On June 12, 2013, our local United States Trustee filed a motion to dismiss or convert a Chapter 7 non-consumer case.[3]  In that case the debtor has $3,700 net monthly income; considerably less than Mr. Gordon’s $14,000, but substantial nonetheless.  No response has been filed to the motion and the hearing has not occurred.  However, it once again raises concerns that being too aggressive can be counterproductive for your clients.

Right now, there are no clear answers, just concerns.  But certainly, at least locally, even if the means test does not apply,  you need to advise your client of the potential that someone will file an objection to a chapter 7 case with "too much" net monthly income.   After having lived in Atlanta for almost 20 years, I have learned that there is wisdom in many Southern expressions:   “Pigs get fat, Hogs get slaughtered” comes to mind.  Make sure your client is not a hog!

[1] 11 U.S.C. 707(b)(1)  “After notice and a hearing, the court, on its own motion or on a motion by the United States trustee, trustee (or bankruptcy administrator, if any), or any party in interest, may dismiss a case filed by an individual debtor under this chapter whose debts are primarily consumer debts, or, with the debtor’s consent, convert such a case to a case under chapter 11 or 13 of this title, if it finds that the granting of relief would be an abuse of the provisions of this chapter. In making a determination whether to dismiss a case under this section, the court may not take into consideration whether a debtor has made, or continues to make, charitable contributions (that meet the definition of “charitable contribution” under section 548 (d)(3)) to any qualified religious or charitable entity or organization (as that term is defined in section 548 (d)(4))
[2] Proudfoot Consulting Company v. Derrick Gordon, In re: Derrick Gordon 11-62509-WLH (NDGA) (Doc 111)
[3] In re:  Tommy Bennett, Jr.  12-80601 (NDGA) (Doc 38)