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Bad Faith Dismissals in Bankruptcy, Part 2: Chapter 7 Debtors with Primarily Consumer Debts
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Bad Faith Dismissals in Bankruptcy, Part 2: Chapter 7 Debtors with Primarily Consumer Debts

December 29, 2023 Banking & Financial Services Industry Legal Blog

Reading Time: 5 minutes


When a debtor files for bankruptcy, a creditor may be able to seek dismissal of the bankruptcy if the petition was filed in bad faith. This article will provide an overview of the options available to a creditor if a debtor with primarily consumer debts files for Chapter 7 bankruptcy.

What is a Bad Faith Filing in Bankruptcy?

A bad faith filing is one that is inconsistent with the purposes of bankruptcy or is an abuse of the bankruptcy system. However, the applicable Bankruptcy Code provisions regulating dismissal of a Chapter 7 petition will differ for different types of debtors. If the debtor has primarily consumer debts, Section 707(b) will apply. If a debtor does not have primarily consumer debts, Section 707(a) will apply. This blog will delve into the potential causes for dismissal of a Chapter 7 bankruptcy case under Section 707(b).

How Do I Know If a Debtor Has Primarily Consumer Debts?

Section 707(b) applies to individuals with primarily consumer debts. This means that it does not apply to corporations or other entities. For an individual filing for Chapter 7, it is important to determine which debts are consumer debts in order to determine if Section 707(b) applies. A consumer debt is defined by the code as one incurred primarily for a personal, family, or household purpose. 11 U.S.C. 101(8). Therefore, if a debt was incurred for a business purpose, or incurred in the pursuit of income, it will not qualify as a consumer debt. However, this is not always easily determined. For example, some debts such as tax debt are not considered consumer debt.

When Must a Consumer Debtor’s Chapter 7 Bankruptcy Be Dismissed?

Section 707(b) safeguards Chapter 7 bankruptcy from abusive or bad faith filings. It is meant to ensure that debtors who can afford to make payments pursuant to a repayment plan do not abuse the bankruptcy system by filing for Chapter 7 liquidation rather than filing under Chapter 13 or Chapter 11. Accordingly, under Section 707(b), a consumer debtor’s Chapter 7 petition may be dismissed for bad faith or abuse under certain circumstances, such as if the debtor has sufficient assets for a repayment plan. Unlike Section 707(a), however, Section 707(b)(2) outlines when a petition is presumed to be an abusive filing. If the presumption of abuse arises, the bankruptcy court must dismiss or convert the case to Chapter 13.

To determine whether this presumption arises, the Bankruptcy Code employs the “Means Test.” 11 U.S.C. § 707(b)(2). The Means Test is a formula designed to indicate when a consumer debtor has sufficient excess monthly income, or the means, to make repayments under a Chapter 13 plan. The amount of income that is sufficient varies from debtor to debtor because the Means Test considers the debtor’s living expenses, administrative expenses, and projected amounts of monthly repayments of debts. If the debtor’s current monthly income affords sufficient excess after all these expenses are repaid, the presumption of abuse arises.

When a presumption of abuse arises, the debtor’s bankruptcy case must be dismissed or converted to another chapter, unless the debtor shows special circumstances or a compelling reason for why the case should not be dismissed. However, there is a “safe harbor” provision that exempts some debtors from the presumption of abuse. If a debtor’s family income is less than the state median income, the presumption will not arise.

Can a Creditor Seek Dismissal of a Consumer Debtor’s Chapter 7 Bankruptcy for Bad Faith?

Even if the debtor passes the Means Test, the bankruptcy case may still be dismissed under the totality of the circumstances or for bad faith. 11 U.S.C. § 707(b)(3). A creditor who believes the debtor has acted in bad faith may file a Motion to Dismiss the case. A determination of whether the debtor filed in bad faith is similar to the analysis employed under Section 707(a). However, unlike Section 707(a), Section 707(b) has a statutory basis for dismissal, authorizing the court to consider whether the debtor filed in bad faith.

Occasionally, a debtor may misclassify debts as non-consumer debts in an attempt to avoid the application of the Means Test. If a creditor believes that is the case, a creditor may be able to seek dismissal of the bankruptcy case by showing that the debtor has primarily consumer debts and fails to satisfy the Means Test. If so, the creditor is provided an avenue under Section 707(b) rather than Section 707(a).

Conclusion

Seeking the dismissal of a Chapter 7 bankruptcy case is a highly fact-specific inquiry, requiring a determination of which Bankruptcy Code provisions are applicable and whether the facts of a specific case demonstrate abuse of the bankruptcy system. However, filing a motion for dismissal is a powerful protection for creditors who believe a debtor may have filed in bad faith. When dealing with such a fact-specific analysis, it’s important to consult with an attorney with experience and knowledge in bankruptcy law to ensure the proper steps are taken to ensure a creditor’s opportunity to recoup from the debtor is maximized.

 

Related blogs:
Bad Faith Dismissals in Bankruptcy, Part 1: Chapter 7 Debtors with Primarily Non-Consumer or Business Debts

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