Can bad faith or excess income be “cause” to dismiss a non-consumer Chapter 7 case?

27 Mar Can bad faith or excess income be “cause” to dismiss a non-consumer Chapter 7 case?

As has been often explained, Chapter 7 Debtors with primarily business debt, or otherwise not primarily consumer debt, are not subject to the “means test” adopted in the 2005 bankruptcy reform act.In fact, they are not subject to any of the provisions of the Bankruptcy Code allowing Chapter 7 cases to be dismissed for “abuse.” Under Section 707(b) of the Bankruptcy Code, for consumer debtors, “abuse” is presumed if a debtor fails the means test, but a case can also be dismissed for abuse if the “totality of the circumstances” (generally speaking, excess disposable income with, or in some jurisdictions without, other factors) shows “abuse,” or if the “petition was filed in bad faith.”

None of these provisions apply if the debts are not primarily consumer debts, such as business debts, tort claims, and tax liabilities. In those cases, only Section 707(a) applies, permitting dismissal “only for cause.””Cause” is not defined, but the Code gives three examples: “unreasonable delay by the debtor that is prejudicial to creditors,”nonpayment of any required court fees,and failure of the debtor to file required documents.

So what is “cause,” other than these three, largely procedural,categories? The courts disagree.

The 9th Circuit Court of Appeals has held that if there is another Code provision that addresses the subject matter of the alleged cause, then it is not “cause” for dismissal under § 707(a).[1] Because Congress included both excess disposable income and bad faith under § 707(b), but limited them to consumer cases, neither bad faith nor excess disposable income can constitute cause for dismissal of a non-consumer case. The 8th Circuit also held that bad faith is not “cause.”[2]

The 6th Circuit, on the other hand, held that bad faith can be “cause,” but cautioned that it must be “generally utilized only in those egregious cases that entail concealed or misrepresented assets and/or sources of income, and excessive and continued expenditures, lavish life-style, and intention to avoid a large single debt based on conduct akin to fraud, misconduct, or gross negligence.”[3]The 3rd Circuit agreed, but held that while income and expenses can be considered, “a debtor’s ability to repay his debts out of disposable income is not a sufficient reason to dismiss a bankruptcy petition under section 707(a).”[4] At least one bankruptcy court in Michigan (in the 6th Circuit) has found that merely having excess disposable income — albeit substantial in that case — is enough to dismiss a case for cause.

So, if you have non-consumer debts but excess disposable income or other indicia of bad faith, are you safe in filing Chapter 7?Apparently, the only answer is “it depends.” It is clear that you have a big advantage over consumer debtors, but how much of one will depend on where you file. Even in courts that have allowed bad faith to be treated as “cause,” the standards being applied are inconsistent. Courts have referred to lists of between four and fourteen factors to consider, and have referred to these by names such as the “smell test.” At least one court has compared the lack of clear standards to Justice Stewart’s definition of obscenity: “I know it when I see it.”

The best approach in every case is to avoid doing anything other than having high income that could be considered bad faith.Make sure that your petition and schedules are scrupulously accurate. And work with an experienced bankruptcy lawyer who can guide you through the process.

[1] Sherman v. SEC (In re Sherman), 491 F.3d 948, 970 (9th Cir. 2007); Neary v. Padilla (In re Padilla), 222 F.3d 1184, 1193-94 (9th Cir. 2000).
[2] In re Huckfeldt), 39 F.3d 829, 832 (8th Cir. 1994)
[3] In re Zick, 931 F.2d 1124, 1129 (6th Cir. 1991)
[4] Perlin v. Hitachi Capital Am. Corp. ( In re Perlin), 497 F.3d 364 (3d Cir. 2007)

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Daniel M. Press is a bankruptcy lawyer with the law firm of Chung & Press, P.C., in McLean Virginia. He practices in the Bankruptcy and Federal District Courts in the District of Columbia (Washington, DC), and the Eastern District (Alexandria and Richmond) and Western District (Harrisonburg and Charlottesville) of Virginia, and in Maryland, as well as other U.S. Appellate, District and Bankruptcy Courts around the country. He is the District of Columbia State Chair for the National Association of Consumer Bankruptcy Attorneys (NACBA), a member of the Section Council of the Consumer Bankruptcy Section of the Maryland State Bar Association and is the Treasurer of the McLean Bar Association. He has spoken on bankruptcy and related topics at Continuing Legal Education seminars and programs locally and nationwide sponsored by groups such as NACBA, the Virginia Bar Association, Virginia CLE, the Maryland State Bar Association, and the Bankruptcy Bar Association for the District of Maryland. A 1988 magna cum laude graduate of Georgetown University Law Center, he was an editor of the Georgetown Law Journal. He received his B.A. from The Johns Hopkins University. After graduating from law school, Mr. Press served as a judicial law clerk for Judge Jaime Pieras Jr. in the U.S. District Court for the District of Puerto Rico.
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