Chapter 7 of the Bankruptcy Code offers extraordinary relief: a fast track to walk away from all dischargeable debts. My clients are often stunned by the scope and the speed of the Chapter 7 process, because most cases are successfully closed, with discharge entered, less than 120 days after filing.
There is a bar to this relief however: the means test. If your income is above the median for your state and you don’t meet the statutory threshold even after filling out “the long form”, the door to Chapter 7 will be shut to you.
An important exception to this rule is that debtors who owe mainly non-consumer debt don’t have to fill out the long form, even if their income is way over median. The Bankruptcy Code tells us that if your debts aren’t primarily consumer debts there will be no “presumption of abuse” that the debtor will need to overcome to enjoy the benefits of Chapter 7. The definition of consumer debt is:
Debt incurred by an individual primarily for a personal, family, or household purpose.
Taxes, real estate investments gone bad and business debt are all non-consumer debts. So if you’re filing bankruptcy to get out from under defaulted real estate loans when the property is worth way less than what’s owed on the mortgage, and you don’t owe as much on credit cards or your home loan, then you won’t have to fill out the long form.
But that’s not necessarily the end of the story. Every bankruptcy case requires the debtor to file in good faith. If the bankruptcy judge finds that a case isn’t filed in good faith, that case can be dismissed.
The phrases “good faith” and “bad faith” aren’t defined in the Bankruptcy Code but courts have long repulsed debtors who flaunt their wealth:
- The ability to repay debts, living an expansive lifestyle beyond one’s means, and singling out a major creditor for nonpayment are factors that merit dismissal for bad faith.
- Courts may find a lack of good faith when a debtor fails to make candid and full disclosure.
- A number of courts have dismissed Chapter 7 cases when it appears that a debtor is living a lavish lifestyle while making no legitimate efforts to repay their debts.
Evidence of a lavish lifestyle may be maintaining a vacation home, driving a luxury vehicle, making substantial retirement fund withdrawals, or even sending children to expensive private schools. When debtors are attempting to discharge hundreds of thousands or even millions of dollars in business debt, a bankruptcy court will, if asked, consider whether those debtors are making any legitimate effort to pare down their lifestyle.
If the court finds that the debtor has failed to make that effort, the result may be that a debtor is forced into Chapter 13 or, if their debt exceeds the statutory limit, Chapter 11. Filing a Chapter 11 case may be a disaster for individuals, because the administrative costs (filing and attorneys’ fes) are much higher and creditors have a greater voice in the treatment of their claims.
The trend in bankruptcy courts across the country is that if a debtor is going to ask creditors to suffer due to nonpayment of their debts, the debtor will also need to share that pain. Refusal to take on that burden may very well lead to denial of Chapter 7 relief.