I'm overwhelmed with debt and over the median income. Why won't the bankruptcy court allow me to file Chapter 7?

An article by Charles E. Andersen, December 27th 2009.

Prior to 2005, eligibility to file under Chapter 7 was not income based. The primary consideration was whether chapter 7 would permit a bankruptcy debtor to "liquidate with ease", a term that is coined in numerous case law decisions. The same idea is also litigated and decided under bankruptcy code section 707. If granting the relief of discharge would constitute substantial abuse, the Code authorizes the court to dismiss a debtor's petition, Section 707(b).

The denial of a discharge based on "substantial abuse" of chapter 7, prior to the bankruptcy reform act of 2005 was judicially litigated on a case by case basis on petitions brought by the US Attorneys Office against bankruptcy filers. The basic principle is that it is not fair to the creditors to let someone who has the ability to repay their debt, simply walk away from it by liquidating under chapter 7.

Different districts and different judges around the nations bankruptcy courts wrote opinions and adopted local standards for criteria to consider in defining substantial abuse. All decisions however center around the same theory, which is that abuse occurs when a debtor who has the ability to pay back a significant portion of his debts over a 3-5 year period files a chapter 7 case instead of one under chapter 13. Different rules of thumb were adopted by different judges as to what was a significant portion. Some judges used a simple mathematical criteria such as 50% of unsecured debts, and other judges adopted more sophisticated and subjective rules, including considerations such as the conditions under which the debt was incurred, the type of debt, and so on.

The overall result was a good and fair individual determination by a Bankruptcy Judge of a debtors eligibility for chapter 7 in situations where the eligibility was challenged.

Unfortunately for upper income debtors, people in politics and in a legislative function saw fit to try to change what non-debtors and creditors saw as abuses in the bankruptcy system, resulting in the enactment of the 2005 Bankruptcy reform act. Probably the one most overriding change in the bankruptcy law was the establishment of a cut off point for eligibility for Chapter 7 based on median income. The purpose of the cutoff point is to take the issue of "substantial abuse" out of the hands of the debtors attorney and the judicial system and make an objective statistical guidelines the decider.

There was in fact an element of abuse in the bankruptcy system prior to 2005, by debtors who were primarily over what has subsequently become the median income standard, facilitated by skilled lawyers advocating their clients position according to professional standards as lawyers must. In a game where there is a great financial advantage to be had from a chapter 7 discharge, a percentage of upper income debtors fed their attorneys false and misleading information feigning job loss, marital break ups, and sometimes provided attorneys with falsified financial records to appear to be in financial trouble.

The bankruptcy reform act now requires bankruptcy filers to disclose with the court all pay advice statements received within six months prior to the filing of the case for inspection by the US Attorney. It also bases the median income on the average of all household income received within the six months preceding the filing. More troubling is the fact that the reform act requires a bankruptcy attorney to make a judgment as to whether their client's are disclosing information truthfully and accurately raising conflicting duties with the attorneys ethical obligations to advocate his clients position in the courts. Some aspects of the bankruptcy reform act have already been held unconstitutional by the courts, however the act as a whole stands today.

The downside for upper income debtors is that those who would have been previously eligible for a chapter 7 discharge under the substantial abuse doctrine because of overwhelming debt problems, must now file under Chapter 13 solely because of this new statistical median income standard.

About the author
Charles E. Andersen is a 1986 graduate of California Western School of Law in San Diego. He was admitted to the bar in the State of Pennsylvania in 1987 and served as a Public Defender. His primary area of practice since 1996 has been bankruptcy, although he remains active in the field of criminal defense. He has a reputation of being a zealous advocate of the rights of the underdog. Since 1991 every criminal jury trial that he has been involved in has resulted in a jury verdict for his client. He is admitted to the bar in the State of California and resides in San Diego