San Diego now allows “McMansions” in Chapter 7 Bankruptcy

25 Jun San Diego now allows “McMansions” in Chapter 7 Bankruptcy

For many years, it was questionable whether a debtor who filed for chapter 7 relief was able to keep expensive real estate at the expense of paying other creditors. At least 5 cases have come down since the new laws passed in 2005 that held that such high expenses related to residences was an “abuse” of the Bankruptcy Code and denied discharge in those cases.

That has recently changed, at least in San Diego County. On December 8, 2008,In re Johnson, 399 B.R. 72, 2008 Bankr. LEXIS 3787, Bankr. L. Rep. (CCH) P81402 (Bankr. S.D. Cal. 2008), was decided. In that case,the debtors listed their residence that they had built in May, 2003 with a value of $900,000 and mortgage against it of $1.1 million.

The monthly mortgage expense was $6,060 and the total expenses associated with the property was scheduled as $8,286. The Debtors were about $200,000.00 upside down on their home, their income was $14,500.00 per month, and they also had over $230,000.00 in credit card and other consumer debt.

The US Trustee filed over 100 pages of pleadings in its motion to dismiss the chapter 7 bankruptcy, claiming the debtors’ mortgage and maintenance on their property was unreasonably high. The Bankruptcy Court denied the motion holding that the “presumption of abuse” under 707(b)(2) did not arise, there was no evidence of “bad faith” under 707(b)(3)(A), and analyzed the petition under the totality of the circumstances pursuant to 707 (b)(3)(B).

The court concluded that the Bankruptcy Code did not preclude consumer debtors from obtaining relief if they had too much secured debt for their principal residence. The court concluded that Congress did not intend for the debtors to be denied access to Chapter 7 relief because of the amount of their mortgage payment on their principal residence.

The court basically had three main reasons to allow for such high mortgage expenses:

1) Because 707(b)(2) applies in both Chapter 13 and Chapter 11, and because 707(b)(2) has no cap on secured debt obligations for a primary residence there is no greater ability to pay in a Chapter 13 or 11 than in a Chapter 7.

2) In 109 it has declared that debtors are ineligible for relief in Chapter 13 if they have too much secured or unsecured debt. But nowhere in Chapter 7 has Congress said that consumer debtors are ineligible for relief if they have too much secured debt for their principal residence. Section 707(b)(2) appears to declare to the contrary.

3) To the extent Congress’ decision to not put some cap on secured debt under 707(b)(2) was based on some policy concerns, as Culhane and White have stated, 13 Am. Bankr. Inst. L. Rev 665, 676 (2005), it would be wholly inconsistent for Congress to address that policy concern in 707(b)(2) with one hand, and yank it right back with the other under 707(b)(3).

So fear not you homeowners in Rancho Santa Fe, Solana Beach, La Jolla, Del Mar, and Poway with high income and expensive real estate. If own a residence with expenses associated therewith that are extremely high, you may still qualify to file for chapter 7 relief and maintain your “McMansion.”

Written by Michael G. Doan

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