Opinion
No. 01-82782.
March 18, 2002
OPINION
This matter is before the Court on the U.S. Trustee's ("U.S. TRUSTEE") motion to dismiss this Chapter 7 case under Section 707(b) of the Bankruptcy Code. 11 U.S.C. § 707(b).
Under this section, the court may dismiss a case filed by an individual debtor under Chapter 7 whose debts are primarily consumer debts if it finds that the granting of relief would be a substantial abuse of the provisions of Chapter 7. The Debtor, Timothy J. Ditch ("DEBTOR"), does not dispute that he is an individual debtor whose debts are primarily consumer debts.
The focus of the dispute is whether granting the DEBTOR a Chapter 7 discharge would be a substantial abuse of the provisions of that chapter in light of his ability to pay his debts in Chapter 13.
The DEBTOR is in his mid-thirties, is single and has no dependents. He holds a blue collar job as a factory worker at Mitsubishi Motors in Bloomington, Illinois. He has been employed by Mitsubishi Motors for twelve years. Although he is currently "on the wagon," the DEBTOR has an alcohol addiction and is a member of Alcoholics Anonymous. The DEBTOR attributes his financial problems to a failed romantic relationship. After he became engaged, his fiancie convinced him to borrow money to pay off her debts. He borrowed more than $30,000 for this purpose, most of it from his 401(k) retirement account. The rose soon withered and she left him with little more than memories and debts.
The DEBTOR lives an extremely modest lifestyle. He owns no real estate and lives in a mobile home valued at $4,000. He drives a 1987 Dodge pickup truck with almost 200,000 miles valued at $500. With one exception, the total value of his remaining assets is $422 consisting largely of clothing and household goods. The exception is his 401(k) account which is valued at $90,000, accumulated over the term of his employment at Mitsubishi Motors.
As reflected on Schedule J, his monthly living expenses are $1,026. His largest expenditures are $175 for lot rent for the mobile home, $200 for food, and $175 for transportation expenses. These expenses are well within the range of reasonableness and the expense for lot rent of $175 is significantly below the average mortgage or rent payment of similarly situated bankruptcy debtors. The DEBTOR has no secured creditors. He owes the Internal Revenue Service $12,351 for unpaid income taxes for the year 2000, payable as a priority claim. Not counting his 401(k) loans, his remaining unsecured debts total $16,338.
ANALYSIS
Section 707(b) provides that there is a presumption in favor of granting the relief sought by the DEBTOR, i.e., a Chapter 7 discharge. 11 U.S.C. § 707(b). In light of this presumption, solvency alone is not a sufficient basis for a finding of substantial abuse; the "total picture" must be abusive. In re Green, 934 F.2d 568, 572-73 (4th Cir. 1991). Since the Bankruptcy Code and Congress favor the granting of bankruptcy relief, the presumption effectively means that the court should give the benefit of any doubt to the debtor and dismiss the case only when a substantial abuse is clearly present. In re Kelly, 841 F.2d 908, 917 (9th Cir. 1988). The U.S.
TRUSTEE bears the burden of overcoming the presumption by proving that the Chapter 7 filing should be dismissed under Section 707(b) because it is abusive and that the level of abuse is substantial. In re Farrell, 150 B.R. 116 (Bankr.D.N.J. 1992).
A debtor's eligibility for Chapter 7 relief is not conditioned upon an inability to pay his debts. See, 11 U.S.C. § 109. Since Congress chose not to make Chapter 13 mandatory, via an "ability to pay" test, courts should be cautious in applying the substantial abuse standard of Section 707(b) to avoid imposing a strict, single-factor eligibility test through de facto judicial legislation. In re Degross, 272 B.R. 309 (Bankr.M.D.Fla. 2001). In addition, premising a "substantial abuse" dismissal solely on a finding that the debtor is able to pay most or all of his debts in Chapter 13, has the anomalous result of permitting abusers of consumer credit with large amounts of credit card and other consumer debts to take advantage of Chapter 7 without fear of being forced into Chapter 13, while denying to those with more frugal restraint, and less debt, the benefits of Chapter 7. Furthermore, since Section 707(b) is not systematically applied to all individual Chapter 7 debtors, additional caution is warranted to ensure that the provision is not applied in a manner that unfairly discriminates against a handful of debtors arbitrarily picked out of the crowd. The purpose of Section 707(b) is to weed out those few cases where the debtor's use of Chapter 7 is an abuse of the bankruptcy system and the abuse is substantial. In those cases where a substantial abuse is present, courts are not reluctant to order dismissal.
Although the Seventh Circuit has not had occasion to address Section 707(b), the District Court for the Central District of Illinois has addressed it in two opinions, In re Ontiveros, 198 B.R. 284 (C.D.Ill. 1996) and In re Pilgrim, 135 B.R. 314 (C.D.Ill. 1992). In accordance with these decisions and with the majority of courts, the bankruptcy court must consider the totality of the circumstances including the debtor's ability to pay his debts in a Chapter 13 case. When considering the totality of the circumstances, courts typically apply the following factors:
1. Whether the bankruptcy petition was filed because of sudden illness, calamity, disability, or unemployment;
2. Whether the debtor incurred cash advances and made consumer purchases far in excess of his ability to repay;
3. Whether the debtor's schedules and statement of current income and expenses reasonably and accurately reflect his true financial condition;
4. Whether the debtor enjoys a stable source of future income;
5. Whether he is eligible for adjustment of his debts through Chapter 13;
6. Whether there are state remedies with the potential to ease his financial predicament;
7. The degree of relief obtainable through private negotiations;
8. Whether his expenses can be significantly reduced without depriving him of adequate food, clothing, shelter, and other necessities; and
9. Whether the petition was filed in good faith.
See, In re Green, 934 F.2d 568 (4th Cir. 1991) and In re Krohn, 886 F.2d 123 (6th Cir. 1989).
Before applying these factors, the Court will first address two general themes that underlie the specific arguments made by the U.S. TRUSTEE. The U.S. TRUSTEE takes umbrage with the fact that the effect of permitting the DEBTOR to remain in Chapter 7 is that he will discharge his third party debts while still repaying "himself" (his 401(k) loans) with his future earnings. The Court does not share this reaction. Since postpetition earnings are not property of the estate in a Chapter 7 case, 11 U.S.C. § 541(a)(6), all Chapter 7 debtors are free to do what they choose with their future earnings. Some choose to concentrate on repaying nondischargeable debts. Some even choose to voluntarily repay discharged debts. Whether the DEBTOR, if he receives a Chapter 7 discharge, intends to buy a house, or a new car, or to repay his 401(k) loans, out of his postpetition earnings, is not material to the inquiry before the Court.
The Court also disagrees with the U.S. TRUSTEE'S suggestion that the DEBTOR'S choice of Chapter 7 over Chapter 13, precisely so that he may devote his future earnings to repayment of his 401(k) loans rather than paying his unsecured creditors, somehow constitutes bad faith or an improper purpose for filing Chapter 7. All debtors who are eligible for Chapter 13 but choose Chapter 7, do so on the basis of the differences in the consequences, financial and otherwise, to their future lives. Most debtors who, like the DEBTOR here, have no non-exempt assets to protect and no nondischargeability concerns, choose Chapter 7 because they can easily live with its quid pro quo, liquidation of all non-exempt assets in return for an immediate discharge. The fact that the DEBTOR'S only valuable asset, his 401(k) account, is fully exempt, and that he desires to do what he can, within the bounds of the law, to protect its value, cannot be held against him. The evidence supports the conclusion that the DEBTOR is playing by the rules. There is no evidence (or even an allegation) that he engaged in any improper manipulation of his assets. He has simply made the choice of Chapter 7 based upon what the law allows. There is nothing improper or abusive about that.
It is difficult to cast aspersions on the motive of protecting a retirement savings account in light of the strong Congressional policy, reflected in ERISA and the Internal Revenue Code, of encouraging Americans to save for retirement.
Turning to the "totality of the circumstances"analysis, the DEBTOR is eligible for Chapter 13 relief and the Court will first consider his ability to make payments under a three-year plan. Schedules I and J, filed in the Chapter 7, show that his monthly disposable income is only $3. Using the DEBTOR'S figures, he does not have the ability to fund a Chapter 13 plan.
The U.S. TRUSTEE, however, points out that the payroll deductions shown on Schedule I include a deduction of $129 per month for a current 401(k) contribution and a deduction of $1,158 per month representing the installment payment on the DEBTOR'S 401(k) loans. The U.S. TRUSTEE contends that these amounts are not reasonably necessary for the maintenance or support of the DEBTOR and constitute "disposable income" as defined in Section 1325(b)(2) of the Bankruptcy Code. 11 U.S.C. § 1325(b)(2). If so, then the DEBTOR'S projected monthly disposable income is $1,490. At that rate, the DEBTOR could fund a Chapter 13 plan that would pay his priority debt and his unsecured debts (not including the 401(k) loans) in twenty-five months. If his 401(k) loans in the approximate amount of $26,500 were paid as general unsecured claims, a one hundred percent (100%) plan would require a term of forty-seven months and a thirty-six-month plan would yield a percentage payment to unsecureds of seventy percent (70%).
The DEBTOR'S schedule of expenses reflects, of course, only those expenses which he actually incurs as of the petition date. No provision is made for items routinely allowed for most Chapter 13 debtors such as a newer vehicle and a house with all its accompanying expenses for a mortgage payment, real estate taxes, homeowner's insurance, and increased utilities and maintenance expenses. The hypothetical Chapter 13 case envisioned by the U.S. TRUSTEE sentences the DEBTOR for three years to a poverty level existence rarely experienced by Chapter 13 debtors.
If the DEBTOR'S 401(k) loans are not repaid and are declared as income, the DEBTOR would incur an income tax liability of approximately $13,000. If this liability was paid through the plan as a priority claim, the DEBTOR could still fund a one hundred percent (100%) plan in approximately three years.
Based upon several recent decisions, the emerging trend appears to be that courts should use a case-by-case approach in determining whether pension loan repayments qualify as a reasonably necessary expense in Chapter 13. In re Taylor, 243 F.3d 124 (2d Cir. 2001); In re Bell, 264 B.R. 512 (Bankr.S.D.Ill. 2001); In re Mills, 246 B.R. 395 (Bankr.S.D.Cal. 2000). The court in Taylor set forth various factors which might be considered in making such a determination, including but not limited to:
[T]he age of the debtor and the amount of time until expected retirement; the amount of the monthly contributions and the total amount of pension contributions debtor will have to buy back if the payments are discontinued; the likelihood that buy-back payments will jeopardize the debtor's fresh start; the number and nature of the debtor's dependents; evidence that the debtor will suffer adverse employment conditions if the contributions are ceased; the debtor's yearly income; the debtor's overall budget; who moved for an order to discontinue payments; and any other constraints on the debtor that make it likely that the pension contributions are reasonably necessary expenses for that debtor.
Taylor, 243 F.3d at 129-30. In Bell, Judge Kenneth Meyers added the following factors to the list:
(a) the purpose of the loan, (b) what the proceeds were used for, (c) when the loan was taken out, i.e., how long before bankruptcy, (d) whether any proceeds of the loan are left, (e) how much of the repayment period remains, and (f) the effect of the debtor's proposed repayment of the loan on creditors in his Chapter 13 case.
Bell, 264 B.R. at 516-17.
Applying these factors to the case at bar yields a mixed bag of results. Working against the DEBTOR are his relatively young age, the relatively large amount of the loan payment, the fact that the DEBTOR is single and has no dependents, the fact that the DEBTOR'S job will not be jeopardized if he does not repay the 401(k) loans, and the potentially adverse effect of the proposed repayment of the loans on his creditors in a hypothetical Chapter 13 case. Working in the DEBTOR'S favor is that the loans were taken out to pay off his fiancie's debts and that all of the proceeds were used for that purpose, the loans were not taken out on the eve of bankruptcy, the DEBTOR'S austere budget, and the substantial tax liability and early withdrawal penalty which will be incurred by the DEBTOR if the loans are not repaid.
Nonpayment of the loans will have a significant, adverse impact on the value of the DEBTOR'S 401(k) account, which is the only asset he has that has substantial value and which is fully exempt under applicable law. This Court is not willing, in this hypothetical context, where the issue is neither directly before the Court nor fully briefed, to rule categorically that the DEBTOR would not be able to repay the 401(k) loans in Chapter 13 as a reasonably necessary expense.
If not permitted to be paid as a reasonably necessary expense under Section 1325(b), loans from a debtor's retirement account neither enjoy a priority nor suffer a subordination, and are, in general, payable as unsecured claims.
The other "totality of the circumstances" factors are applied as follows.
1. This bankruptcy case was triggered by the DEBTOR'S breakup with his former fiancie after he paid off her debts with loans from his 401(k) account, and was unable to obtain additional loans from the account to pay off his own debts.
2. There is no evidence to indicate that the DEBTOR incurred cash advances or made consumer purchases far in excess of his ability to repay. In fact, the evidence indicates that the DEBTOR lives a modest lifestyle indulging in few, if any, luxuries. (The DEBTOR probably could have borrowed the funds to pay off his fiancie's debts from private lenders, but chose to borrow from his 401(k) account, thereby limiting the effect of financial difficulties on third party creditors.)
3. The DEBTOR'S schedules reasonably and accurately reflect his true financial condition. There is no evidence of undisclosed assets or misstated liabilities. The U.S. TRUSTEE raises a question with respect to the DEBTOR'S current monthly gross wages disclosed on Schedule I as $3,862. The DEBTOR'S income was higher in 1999 and 2000, as properly disclosed in paragraph 1 on his Statement of Financial Affairs. He attributes the decrease to a cutback in his hours due to declining auto sales.
4. The DEBTOR enjoys a stable source of future income. He has been employed at Mitsubishi Motors for twelve years and there is no indication that his job is in jeopardy even if his hours have been reduced.
5. The DEBTOR is eligible for Chapter 13 relief.
6. There is no evidence of any state remedies available to the DEBTOR with the potential to ease his financial predicament.
7. There does not appear to be any relief obtainable through private negotiations. The DEBTOR attempted to obtain the release of additional funds from his 401(k) account for the purpose of paying off some or all of his debts but his request was refused by the plan administrator.
8. The DEBTOR'S budget is neither excessive nor unreasonable and is, in fact, quite conservative compared to many other bankruptcy debtors. There is no evidence that his expenses can be significantly reduced without depriving him of adequate food, clothing, shelter and other necessities. If anything, it is all but certain that his necessary expenses will increase in the near future due to the need to replace his fourteen-year-old vehicle.
9. There is no evidence that the DEBTOR'S Chapter 7 petition was filed in bad faith. None of the usual "red flags" of bad faith are present here. The DEBTOR did not incur a large amount of consumer debt just before filing for bankruptcy relief. He honestly disclosed his assets and liabilities. There is no evidence that the DEBTOR made any fraudulent transfers or preferential payments before filing. Even though the DEBTOR'S Chapter 7 proceeding is a "no asset" case, there is no indication that he has done anything improper to engineer this result. The DEBTOR'S only significant asset is his 401(k) retirement account which, under applicable law, is fully exempt, both in Chapter 7 and in Chapter 13. Neither is this a classic 707(b) case where a debtor is filing Chapter 7 just prior to a significant increase in income. The evidence indicates that the DEBTOR'S income is declining, at least in the near term.
Based upon the evidence before the Court, and with particular emphasis upon factors 1, 2, 3, 8 and 9, the totality of the circumstances militates in favor of granting the DEBTOR the relief that he has requested, a discharge in Chapter 7. The U.S. TRUSTEE has failed to offer any evidence of improper or abusive conduct by the DEBTOR, and relies solely on the "ability to pay" factor. There is at least some doubt as to whether the funds that the DEBTOR is now using to repay his 401(k) loans and to make his current 401(k) contribution would constitute disposable income in a Chapter 13 case that would have to be paid into a Chapter 13 plan.
Even so, the DEBTOR would still be entitled to repay the 401(k) loans as general unsecured claims, which would result in about a seventy percent (70%) distribution to unsecured creditors over three years. And if the DEBTOR'S expenses were increased to match those of the average Chapter 13 debtor, it is likely that the distribution would fall below fifty percent (50%).
There is no apparent "cause" to extend the hypothetical Chapter 13 plan's term beyond three years. 11 U.S.C. § 1322(d).
Dismissing this case as a substantial abuse would unfairly punish this DEBTOR'S frugality, relative to the increasing number of spendthrift debtors who, because of large consumer credit debt, are not able to pay a substantial percentage in Chapter 13. In light of the statutory presumption in favor of granting the relief requested by the DEBTOR, the Court must conclude that the U.S. TRUSTEE has failed to carry its burden to prove that the DEBTOR'S Chapter 7 filing is abusive and that the abuse is substantial. Accordingly, the U.S.
TRUSTEE'S motion to dismiss should be denied. This Opinion constitutes this Court's findings of fact and conclusions of law in accordance with Federal Rule of Bankruptcy Procedure 7052. A separate Order will be entered.
ORDER
For the reasons stated in an Opinion entered this day, IT IS HEREBY ORDERED that the U.S. TRUSTEE'S Motion to Dismiss Pursuant to 11 U.S.C. § 707(b) is DENIED.
Dated: March 18, 2002.
THOMAS L. PERKINS UNITED STATES BANKRUPTCY JUDGE