Looking forward while looking back: using debtors' post-petition financial changes to find bankruptcy abuse after BAPCPA.

• Author: Rucki, Justin H.

TABLE OF CONTENTS INTRODUCTION I. CHAPTER 7 BANKRUPTCY RELIEF AND [section] 707(b) A. Chapter 7 Bankruptcy Relief B. Section 707(b) II. A CASE OF FIRST IMPRESSION: IN RE CORTEZ A. Facts of the Case B. The Bankruptcy Court's Opinion C. The Appeal III. BAPCPA AND THE NEW [section] 707(b) A. Congressional Intent Behind the BAPCPA B. The New [section] 707(b) IV. CONSIDERING POST-PETITION EVENTS UNDER THE NEW [section] 707(b) A. Post-Petition Changes Irrelevant Under Means Test 1. Post-Petition Changes Not Used To Calculate "Current Monthly Income" 2. Post-Petition Changes Not Used To Calculate "Debtor's Monthly Expenses" 3. Ignoring Post-Petition Changes in the Means Test Calculations Makes Good Sense B. Post-Petition Changes Relevant To Rebut the Presumption of Abuse Created by the Means Test C. Post-Petition Changes Relevant To Determine Whether Petition Filed in Bad Faith D. Post-Petition Changes Relevant Under the Totality of the Circumstances Test V. A PROPOSAL A. Expressly State When Courts Should Consider Post-Petition Changes in [section] 707(b) B. Insert a De Minimis Exception CONCLUSION INTRODUCTION

On the day the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) became effective in October of that year, the nation's courts were forced to begin the process of answering a lengthy list of legal questions created by the new legislation. (1) Then, in July 2006, the Fifth Circuit Court of Appeals caught the attention of consumer bankruptcy law practitioners nationwide with its decision in In re Cortez. (2) The Fifth Circuit's decision in Cortez added another important question to this list.

At issue in Cortez was the pre-BAPCPA version of 11 U.S.C. [section] 707(b), a provision that allowed a bankruptcy court to dismiss a Chapter 7 petition for bankruptcy relief if the granting of the relief would have constituted a "substantial abuse" of the nation's bankruptcy laws. (3) The court of appeals was faced with deciding whether a court passing judgment on a motion to dismiss under [section] 707(b) could consider a post-petition change in the debtor's financial circumstances in deciding whether to grant the motion to dismiss, or whether the court could only consider the financial condition of the debtor as it existed on the day the debtor's petition for bankruptcy relief was filed. The Fifth Circuit, like the district court before it, held that post-petition changes in the debtor's financial circumstances could be considered under [section] 707(b), a reversal of the bankruptcy court's ruling on the issue. (4)

In so doing, the court expressly declined to discuss the effect that applying post-BAPCPA law would have had on its holding. (5) The Fifth Circuit's decision, coupled with the considerable changes made to [section] 707(b) by the BAPCPA, 6) has thus created another issue for courts interpreting the new text of the Bankruptcy Code to consider.

The question of whether a debtor's post-petition financial changes can be considered under [section] 707(b) is an important one that must be resolved properly. Although a debtor will rarely benefit from a post-petition increase in income, such as existed in Cortez, this scenario has already arisen again in connection with at least two different Chapter 7 cases. (7) Even more important, however, is the potential impact that considering Chapter 7 debtors' post-petition financial changes will have in other situations, such as when debtors desire to reduce their expenses in troubled financial times. Fear of jeopardizing their bankruptcy petition may force these debtors to abstain from making small, sensible reductions in their monthly expenses until after their petition for bankruptcy relief is granted. (8)

Despite the importance of resolving this point of law, the bankruptcy courts that have been tasked with deciding whether to consider post-petition events in connection with all or part of the new [section] 707(b) have reached different conclusions, and even some of those courts in agreement on certain results have reached their conclusions in different ways. The current bankruptcy literature, meanwhile, also fails to resolve the issue. Although the new [section] 707(b) has been the subject of some scholarly attention, the journal articles that have been written about the section do not discuss whether post-petition events should be considered under the provision. (9) As a result, the law on this point is quite unsettled and awaiting comprehensive assessment.

This Note explores the issue of whether a court applying post-BAPCPA law can consider a post-petition change in a debtor's financial circumstances while ruling on a motion to deny Chapter 7 bankruptcy relief under [section] 707(b). Part I provides a background discussion of Chapter 7 bankruptcy relief, including a discussion of the evolution of [section] 707(b) from its initial version, adopted in 1984, to the version that applied in Cortez. Part II details the facts that gave rise to the Cortez decision, as well as the legal arguments made on both sides of the case. Part III introduces the relevant changes the BAPCPA made to [section] 707(b). Part IV then analyzes whether a debtor's post-petition financial changes can be considered in each of the three ways post-BAPCPA courts can find abuse under the new [section] 707(b). It concludes that post-petition changes cannot be considered in performing [section] 707(b)'s "means test" calculations, but that they can be considered to rebut the presumption of abuse that can arise under the means test. It also concludes that courts can consider post-petition changes to determine whether a Chapter 7 petition was filed in good faith to the extent such changes provide evidence of the debtor's intent in filing the petition. Finally, it concludes that Chapter 7 debtors' post-petition financial changes should be considered under [section] 707(b)'s "totality of the circumstances" test. Part V then argues in favor of amending [section] 707(b) once again to make a number of changes, including the insertion of a de minimis rule in two parts of the provision.

1. CHAPTER 7 BANKRUPTCY RELIEF AND [section] 707(B)

   1. Chapter 7 Bankruptcy Relief

      A debtor who receives Chapter 7 bankruptcy relief is given an immediate and unconditional discharge of personal liability for certain debts in exchange for surrendering all of his or her assets, except certain basic assets exempted by statute, to a bankruptcy trustee for liquidation and distribution to the debtor's creditors. (10) This unconditional discharge given to a consumer debtor in Chapter 7 relief is quite different from the conditional discharge given to a consumer debtor who pursues Chapter 13 bankruptcy relief. The latter requires a debtor to commit to repay some or all of his debts in exchange for retaining all his current assets, both those exempted under Chapter 7 and those not exempted, and receiving a broader discharge of debt than is available under Chapter 7. (11)

   2. Section 707(b)

      Congress passed the Bankruptcy Code in 1978. (12) Under the initial version of the Bankruptcy Code, a debtor seeking Chapter 7 relief could have his petition dismissed only for "cause." (13) Section 707 was amended in 1984, however, to permit the bankruptcy court hearing a petition for relief to dismiss the case if the granting of Chapter 7 relief to the debtor would constitute a "substantial abuse" of the Bankruptcy Code. (14) The adoption of this "substantial abuse" provision, which gave birth to [section] 707(b), was made for the same reasons that prompted Congress to adopt the BAPCPA more than twenty years later: it was added to the Code "as part of a package of consumer credit amendments designed to reduce perceived abuses" by debtors seeking Chapter 7 relief. (15) It was adopted in response "to concerns that some debtors who could easily pay their creditors might resort to [C]hapter 7 to avoid their obligations." (16)

      In the years between its creation in 1984 and its overhaul in 2005, [section] 707(b) was amended twice The first amendment, made in 1986, expanded the scope of [section] 707(b) to allow United States trustees to move for dismissal on the grounds of "substantial abuse"; previously, only the court could move for dismissal on this ground. (17) The second amendment, made in 1998, added the following language at the end of [section] 707(b):

      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)). (18) With the addition of this wording, the whole of [section] 707(b) amounted to 139 words. (19) Despite the section's increased length, however, it still left undefined--as it had since 1984--what constituted "substantial abuse." Also missing was any guidance as to what test the courts should have applied to determine whether substantial abuse existed; the courts were told only that there was a presumption against finding "substantial abuse."

      As a result of this ambiguity, the handful of circuit courts that were called on to decide whether "substantial abuse" would have arisen in the granting of a particular Chapter 7 discharge applied different tests to decide this issue. Two circuits held that a debtor's ability to pay his debts, standing by itself, was enough to establish substantial abuse. (20) Other circuits applied a "totality of the circumstances" test, holding that the debtor's ability to repay his debts was the primary factor to be considered under such a test, but still only one of several factors. (21) Two other circuits applied a hybrid test, adopting the totality of the circumstances approach, but stating that even under this test a debtor's ability to repay his debts alone may still...