Part III of Three Related Articles
[See related articles on this blog: The Bankruptcy Abuse Prevention & Consumer
Protection Act (BAPCPA), “Part I, Rationales”&“Part II, Changes in Bankruptcy Law”]
After passage of the BAPCPA in 2005, anyone wanting to file for Chapter 7 bankruptcy relief was faced with the new requirement of having to pass a “means test” to determine their eligibility. The primary purpose of the means test is to help the court determine whether an individual should be allowed to file a petition under Chapter 7, or if the filing should instead be under Chapter 13 of the bankruptcy code.
Chapter 7 versus Chapter 13 Bankruptcy:
There are fundamental differences between a Chapter 7 bankruptcy and a Chapter 13 bankruptcy. Chapter 7 is known as straight bankruptcy or liquidation bankruptcy. Under a Chapter 7 filing, there is no payment plan requirement – if all goes according to the strictures of the code, at confirmation the debtor is absolved of paying all the debt listed in the petition (with some exceptions such as child support and alimony debt, some tax debts, and student loan debt).
By contrast, a Chapter 13 bankruptcy filing centers upon a “payment plan” that is developed and presented to the bankruptcy court. Under a payment plan, the debtor proposes a schedule of debt payments that extend over a period of usually between three and five years. Once a Chapter 13 payment plan is completed (under strict guidance from a bankruptcy trustee), the debtor is entitled to a discharge of the remaining debt.
The means test formula is designed to keep high wage earners from filing for Chapter 7 bankruptcy – the test determines whether a debtor’s income is low enough for them to file under Chapter 7. As noted, a debtor who does not qualify to file for Chapter 7 bankruptcy still has the option of filing under Chapter 13.
The mere fact of having to take a Chapter 7 means test does not mean that a debtor needs to be at or near the poverty line to use Chapter 7 bankruptcy. A debtor can earn significant monthly income and still qualify if the persons’ expenses (such as a large mortgage, high car payments, and other out-of-the-ordinary monthly debts including taxes and other necessary household/family expenses) are great enough to offset the higher income. The means test uses a “current monthly income” standard (average income for the six months preceding a Chapter 7 filing) to calculate the debtor’s monthly “disposable income”.
Business versus Consumer Debt / Bankruptcy:
When the BAPCAP was being drawn up, the framers designed the means test to limit the use of Chapter 7 filings to “…those debtors who truly cannot pay their debts…” (by deducting specific monthly expenses from the debtor’s “current monthly income” to come up with monthly “disposable income” to determine a “means” by which to pay down debt). The higher a debtor’s disposable monthly income, the more likely that person would not be allowed to file for Chapter 7 bankruptcy.
Only petitioners with consumer debt are required to take the means test (those with business debt are exempted from the means test requirement). A business debt is one where a majority of the debt is business-related debt. When a filer is actively engaged in business via a partnership, limited partnership, corporation, etc., the determination as to what type of debt is in question is relatively easy. However, when a filer is a person who also operates some type of business and there is some business debt, if most of the debt is consumer in nature, then the means test requirement would apply.
Veterans’ Exception to Means Testing:
A disabled veteran who became disabled while on active duty in the military is exempted from means testing despite income and expense considerations. Such veterans must have a disability rating at or above thirty percent (30%) with at least 50% of their debt having been acquired during active military duty. The same exception applies to veterans who were engaged in so-called “homeland defense activities” (i.e. serving at the southern border assisting Homeland Security forces with border and immigration control units).
A “veterans’ exemption” applies only to Chapter 7 and means testing. Chapter 13’s “disposable income test” does not contain a similar exemption for veterans. Commentators have questioned the rationale for giving disabled veterans an exception under Chapter 7 but not under Chapter 13. It seems odd and anomalous that disabled veterans’ service-connected disability is recognized as being worthy for an exemption for testing under one Chapter of the Bankruptcy Code but not under another Chapter (the “other” being the less-stringent in terms of filing and qualification requirements).
At present, there is no apparent active movement in the Congress to remedy this situation of having two different exception/exemption policies for Chapter 7 and Chapter 13.
Means Testing – a two-step process:
In step 1 of the process, the means test compares the debtor’s average monthly income (averaged over the 6 months prior to the filing of a bankruptcy petition) with their residency state’s median monthly family income. A debtor with an average monthly income that is less than or equal to the state’s median is putatively eligible to file for Chapter 7 bankruptcy. In all cases, a bankruptcy trustee has the power to later determine that a debtor has sufficient income after paying allowable expenses to repay his or her creditors under a Chapter 13 repayment plan. In those instances, the trustee notifies the court and the bankruptcy judge, at his or her discretion, may convert the Chapter 7 proceedings to a Chapter 13 case.
Calculating a debtor’s income includes the following sources of income: wages, salary, tips, bonuses, overtime, and commissions; gross income from a business, profession, farm, or ranch; interest, dividends, and royalties; rental and real property income; court-ordered child and/or spousal support; unemployment compensation benefits; pension and retirement income; workers’ compensation benefits; annuity payments; and, state disability insurance benefits.
Certain types of income or benefits are excluded from the calculation, including: tax refunds; Social Security retirement income; Social Security disability benefits; Supplemental Security Income (SSI); and, Temporary Assistance for Needy Families (“welfare payments”).
If a debtor, under the first step, is determined to make more than the state’s median income, it becomes necessary to complete step 2 of the process. This step is where all the debtor’s expenses are examined (actual expenses plus certain standardized expenses) to determine whether such debtor has the ability to pay some amount to creditors against outstanding debt.
If the debtor’s “disposable income” is sufficient to allow payment of some portion of unsecured consumer debt under a Chapter 13 repayment plan, the debtor DOES NOT qualify for Chapter 7 relief. The alternative is to file (or be converted to) a Chapter 13 proceeding.
Failing to pass the means test is not a complete bar to filing a Chapter 7 petition. Some debtors choose to file under Chapter 7 knowing that they could face a motion in bankruptcy court to dismiss their case or divert it to a Chapter 13 proceeding. Under due process considerations, such a debtor has a right to defend the Chapter 7 filing and to present evidence that he or she does not have sufficient disposable income to pay creditors. Alternatively, a debtor is allowed to defend against such a motion by arguing “special circumstances” for a variety of reasons that the court may find acceptable.
Such special circumstance reasons could include: a recent loss of job leading to unemployment; unusually high rent or mortgage payments; or, a serious medical condition or medical circumstances that are economically burdensome. It is the debtor’s responsibility to provide documentary evidence of any special circumstances and argue to the court that they should be allowed to proceed under Chapter 7 rules and guidelines.
The Means Test – a “Presumption of Abuse”:
Near the start of the current century, the proponents of reform reasoned that it was necessary and desirable to cut down on, and limit, the number of Chapter 7 liquidation filings nationwide. Their rationale was that debtors could usually afford to pay down some of their consumer debt; the unspoken premise was that those who chose Chapter 7 bankruptcy were doing so in a way that was an abuse of the system.
Setting up the means test was the gateway to showing the validity of such premise – i.e. those who chose Chapter 7 liquidation were abusers of the bankruptcy system. For those who failed the means test, then, the reforms left but two alternatives – file for Chapter 13 bankruptcy OR forego filing for bankruptcy at all.
As a calculation, the means test is designed to determine if a debtor has any money left over at the end of a month that he/she can presumably use to pay down unsecured debt. In that case, the reform law’s expectation is that such debtor would either file in Chapter 13 or not file for bankruptcy at all. If the debtor (as is his/her right under the law) decides to file in Chapter 7 after all, he/she is doing so under the “presumption of abuse”. “Presumption of abuse” does NOT prevent the filing of a Chapter 7 bankruptcy case.
If the presumption of abuse arises under the means test calculation, it does not mean that the debtor has “failed” anything. It merely means that if a debtor continues with a Chapter 7 proceeding, the bankruptcy court has the discretion to either allow the debtor to continue as a Chapter 7 case or force either a dismissal or referral as a Chapter 13 “repayment plan” case. Again, it is up to the debtor to provide a detailed explanation of any “special circumstances” (backed up by documentary evidence) that would allow the debtor to avoid Chapter 13 proceedings.
The Principle of “Means Testing”:
A Means Test “… is a determination of whether an individual or family is eligible for government assistance, based upon whether the individual or family possesses the means to do without that help”. (“Means Test” … Wikipedia)
“Means” testing has been used in several progressive countries, including Canada, the United Kingdom, and the United States, for several decades. In the United States, the “means test” standard that was adopted with the 2005 bankruptcy reform laws for Chapter 7 cases is just one of many uses of such metric at this time.
In addition to its use in the bankruptcy system (the most recognized use in the United States), means testing is also currently utilized to test for “eligibility” in the following federal government programs:
- Temporary Assistance for Needy Families
- Section 8 Housing Assistance
- Supplemental Nutrition Assistance Program (“SNAP”)
- Pell Grants
- Federal Supplemental Educational Opportunity Grants
- Federal Work-Study Program
- Direct Subsidized Student Loan Program
“Means Testing” for government assistance dates as far back as the Great Depression of the 1930’s when the federal government used it to screen applicants for such “bail-out” programs as “home relief” and aid to farmers who were hard hit by those perilous financial times. In the 1960’s, during the administration of Lyndon B. Johnson, means testing was used to determine eligibility for such aid programs as Aid to Families with Dependent Children (“AFDC”), Food Stamps, and the then-nascent Medicaid program.
In the 1992 Presidential election, third-party candidate H. Ross Perot suggested that means testing should be instituted for Social Security benefits; his idea did not go over well at that time, and since then it’s a subject that has not been raised again by succeeding candidates for high office.
Means Testing – “Social Programs” vs. “Poverty Programs”:
According to those who work in the realm, there are distinctions between “social programs” and “poverty programs”. A social program is designed to help all equally or in proportion to their level of taxation. A poverty program, by contrast, disproportionally helps the poor.
The issues of social vs. poverty programs that account for criticisms of means testing (while having two or more categories of programs – social-based and poverty-based) include the following factors:
Stigma: a poverty program benefitting only the poor or the poorer segments of a populace may carry a stigma on its use and be considered to be demeaning
Political Support: Programs that benefit only the poor usually lack broad-based political support, while those programs that all have a share in usually have much greater political and social support (a factor that may make it easier, eventually, to cut poverty program benefits)
Redistribution: Poverty programs purportedly move money from the rich to the poor while primarily benefitting those at the lower end of the economic scale; such programs are paid for by both groups, but disproportionately by the wealthier
Access to Programs: Means tests vary in the level of their complication and across different levels of government. Gaining access to a specific program may be problematical for some who qualify because without a centralized outreach set up many may “fall through the cracks” for programs for which they qualify
Administrative Cost Burden: At times, administrative costs associated with verifying eligibility and compliance can have a negative impact on supporting specific programs (some say, that such costs can inhibit the effectiveness of a given program, taking money away from services to cover such admin costs)
Entitlements & Promises: When means-testing is implemented in an existing program (such as pensions and medical insurance), particularly where people have paid taxes but not benefited, a reduction in benefits will be seen as a breach of promise or entitlement of the program (i.e. where retirement benefits for retirees are reduced to offset unanticipated and rising costs to fund programs for future retirees)
Means Tests and the “Poverty Trap”:
Means tests, particularly sharp cut-offs required by some, can create high marginal tax rates. Such tests, when thus coupled, can serve to keep people in poverty, both by removing social support as the person tries to escape poverty, and by discouraging such attempts by high costs.
By way of example, using “asset-based limits”, such as requiring an individual to have little or no savings to qualify, not only discourages saving (because of the cost of being disqualified from such savings and programs) but also require a person to become completely destitute to qualify.
The real-world effect of this means that certain people do not have any much-needed savings when attempting to escape poverty. Thus, the very programs that a person might try to access to gain a step up out of poverty serve to “trap” them in a cycle of poverty. Such “cycles of poverty” are often multi-generational and extend through families from generation to generation.
DOJ – U.S. Trustee Program Considerations:
The means-testing standards and provisions instituted with the adoption of the BAPCPA in 2005 are overseen and administered by the U.S. Trustee Program, a division of the United States Department of Justice. The program requires the filing of additional forms when a debtor files for Chapter 7 bankruptcy protections.
The following information is taken from the U.S. Trustee Program website:
Most individual debtors filing for bankruptcy relief are required to complete a version of Bankruptcy Form 122. Official Form 122A-1 (Chapter 7 Statement of Your Current Monthly Income), Official Form 122A-1Supp (Statement of Exemption from Presumption of Abuse Under § 707(b)(2)), and Official Form 122A-2 (Chapter 7 Means Test Calculation) (collectively the “122A Forms”) are designed for use in chapter 7 cases. Official Form 122C-1 (Statement of Your Current Monthly Income and Calculation of Commitment Period) and Official Form 122C-2 (Chapter 13 Calculation of Your Disposable Income) (collectively the “122C Forms”) are designed for use in chapter 13 cases.
[All official bankruptcy forms – including those listed above – are accessible to the general public on the website of the Administrative Office of the United States Courts]
A debtor must enter income and expense information onto the appropriate form (i.e., the 122A Forms or the 122C Forms) and then make calculations using the information entered. Some of the information needed to complete these forms, such as a debtor’s current monthly income, comes from the debtor’s own personal records. However, other information needed to complete the forms comes from websites of the Census Bureau and the Internal Revenue Service (IRS). The Census Bureau website reproduces the Census Bureau and IRS Data necessary to complete the 122A Forms and the 122C Forms.
As of April 16, 2018, updated data on the Administrative Expense Multipliers (and IRS data) became available from the Census Bureau and the IRS. The Administrative Expense Multipliers and IRS’s National Standards for Allowable Living Expenses and Local Standards for Transportation and Housing and Utilities Expenses accessible through the websites were updated. The revised multipliers and standards now apply to cases filed on or after May 1, 2018.
Updated Census Bureau data necessary for the completion of bankruptcy means testing forms became available as of March 14, 2018. The Census Bureau’s Median Family Income Data accessible through the bureau’s website was updated. The U.S. Trustee Program began applying the updated data to cases filed on or after April 1, 2018.
Bankruptcy: A Part of the Nation’s “Social Insurance” System:
According to Stanford University scholar Jonathan Fisher, “Bankruptcy protection is part of the social insurance system. Bankruptcy is insurance in that it provides debt forgiveness and asset protection in the face of negative events…”. (Center for Economic Studies, Project CES 1734, September 2017)
The Stanford / CES study seems to give validation to the aims of the BAPCPA proponents that were outlined in the related blog post: “The BAPCPA – Part II, Changes in the Bankruptcy Law” – that is, to cut down on the number of debtors who were filing for Chapter 7 liquidation bankruptcy and “push a substantial number of debtors…” to Chapter 13 bankruptcy (where creditors at least stood a good chance of recovering some portion of the debt they were owed). Other studies that have been done since the 2005 reforms went into effect show a similar result.
Fisher, in the cited study, goes on to state:
Debt forgiveness amounts to an average transfer of future income equal to $59,000
per household, (in the United States) not counting the interest that would have
accrued had the debt not been forgiven… Bankruptcy provides not only a large
transfer, but it has also become a more important component of the social insurance
system. In 1980, there were 287,564 (consumer) bankruptcy filings, and annual filings
steadily increased until they reached 1.5 million in 2004. After passage of the BAPCPA
in 2005, bankruptcy filings decreased dramatically. Several elements of the BAPCPA
may have contributed to the decrease in the number of filings, namely the Increase in
the cost for filing for bankruptcy in attorney fees and court fees, and most certainly
the “means test” that was meant to push a substantial number of debtors to the less
generous Chapter 13…
The Stanford / CES study seems to give validation to the aims of the BAPCPA proponents that were outlined above – that is, to cut down on the number of debtors who were filing for Chapter 7 liquidation bankruptcy and “push a substantial number of debtors…” to Chapter 13 bankruptcy (where creditors at least stood a good chance of recovering some portion of the debt they were owed). Other studies that have been done since the 2005 reforms went into effect show a similar result.
Statistics re: Bankruptcy Filings – 2006 to 2017:
The chart that follows shows the number of Chapter 7 and Chapter 13 nonbusiness bankruptcy filings for fiscal years 2006 through 2017. The fiscal year 2006 was the first full year of data after the BAPCPA went into effect in the prior year. The reader should keep in mind that 2004 had a total of 1.6 million filings just prior to the institution of the rules and strictures of the BAPCPA.
Total Chap. 7 Filings
Percent of Total Filings
Total Chap. 13 Filings
Percent of Total Filings
(Source of data: Administrative Office of the United States Courts)
According to a cnn.money.com report in March of 2006, the number of Chapter 7 and Chapter 13 personal bankruptcies hit an all-time high in fiscal year 2005. There were 2,078,415 personal bankruptcies filed in 2005. That figure was 30% greater than the previous year total of 1,597,462 personal bankruptcy filings. Of the 2005 total, 1,700,201 were filed under Chapter 7 and 378,214 were filed under Chapter 13. For that period, Chapter 7 filings rose 46% over the previous year, while Chapter 13 filings fell by 8 percent during the same period
According to a statement posted on the website of the Administrative Office of the United States Courts, the 30% spike was “…largely in response to debtors ‘rushing to file petitions’ before the anticipated passage of new restrictions…” (that were eventually embodied in the BAPCPA that went into effect late 2005).
From the figures presented above, it seems that there were several anomalies in the statistics that track personal bankruptcy filings. One such anomaly is the “spike” that occurred in 2005 in anticipation of the passage of stricter filing restrictions that were then on the horizon.
Another anomaly can be found in the filing statistics (see chart above) for the years 2008 through 2013 – there was a steady rise in overall filings during those years that hit a high in 2010 and then began a gradual decline to 2013 (probably not something that the proponents of “reform” were thinking about back in 2004/2005). Analysts attribute this rise/peak/fall to the recession that began in 2008/2009 that was largely a result of the crash in the housing and financial markets at the end of the Bush #43 presidency.
What does “it” mean? (the “means test”, that is and its overall impact):
In an article on his law firm’s blog (Rosenberg, Musso & Weiner, LLP, Brooklyn, NY) written in 2016 and titled, 10 Years After Bankruptcy Reform: Means-Testing Doesn’t Work, the author stated:
One commentator for the American Bankruptcy Institute (ABI) offered the best
Defense of the means test: Nearly all debtors pass it. In its first 9 years, roughly
1 debtor in 206 faced an “abusiveness” motion, and even then, 97% of debtors
still obtained relief. An ABI Webinar panel participant also pointed to a reduction
in filings after passage of the BAPCPA… Neither of these claims is convincing.
The issue isn’t whether debtors fail the means test. It’s not much of a test if
everyone passes it. Rather, the question is whether the means test deters the
wrong debtors from filing in Chapter 7 without burdening those who do. ‘Strategic’ debtors might instead file in Chapter 13 or not file at all… (emphasis added)
Point(s) well made!
Remember, one of the premier reasons for instituting a Chapter 7 means test in the first place was to stop purported “abuse” of the system by deterring debtors who could pay something toward outstanding debt from liquidating such debt (i.e. “forcing” debtors to file in Chapter 13 instead of in Chapter 7).
The chart shown above is another indication that “means testing” for bankruptcy did not turn out to be all that it was cracked up to be at the time of passage of the BAPCPA. Over a 13-year period, the differences in the percentages of total Chapter 7 filings and total Chapter 13 filings are not that remarkable. Especially so, given the “alarms” that were sounded by reform program proponents in the run up to passage of the 2005 reform measures.
Over the twelve years represented in the referenced chart, the percentage differences between Chapter 7 and Chapter 13 filings seem to vary remarkably. One would expect that with “reform” the differences would reflect fewer Chapter 7 filings and more Chapter 13 filings. That is not – as a trend – the reality of the situation, at least for the twelve years represented.
The only “banner year” seems to be fiscal year 2007 – 60% of the filings for that year were in Chapter 7, while nearly 40% were in Chapter 13. The intervening years (2008 – 2013) were “anomaly” years as noted earlier, largely due to the recession that began in 2008. As one who has read quite a lot about the 2005 reforms in preparation for this article, this author would expect that the percentages represented in the chart would have at least “flipped” – meaning, instead of seeing percentages in the 60% – 75% range listed under the Chapter 7 column, those should be shown under the Chapter 7 column.
That is not the case; that is another reason to say that the reforms of the BAPCPA have largely failed.
As the Rosenberg, et al. blog author went on to write:
The authors found that the BAPCPA corresponded to a reduction in both Chapter 7
and Chapter 13 bankruptcies. However, it also coincided with an increase in fore-
closures and financially distressed households with below-median family incomes.
Households substituted bankruptcy with foreclosure and insolvency without an
increase in debtors who were current on their debts. Essentially, the BAPCPA made
it harder for people who need the bankruptcy system – instead of preventing people
who could repay their debts – to file. The primary factor driving poor people away
from bankruptcy was increased filing costs, primarily a 38% rise in attorney’s fees
for Chapter 7… (emphasis added)
Again, point well made; point well taken.
In his conclusion, the author of the Rosenberg, et al. blog ends his piece with:
The authors noted that creditors have benefitted by the BAPCAP because it’s
easier to recover from insolvent debtors than those who’ve obtained bankruptcy
discharge… After a decade of means-testing Chapter 7, it’s indisputable that
debtors are worse off. Realistically, the only way the means test could be working
is by punishing people who borrow too much and hoping that others will take the
lesson. However, bankruptcy isn’t a morality play, and there are better ways of
discouraging irresponsible borrowing.
While some analysts and observers have said that the application of a “means test” in the BAPCAP for Chapter 7 bankruptcy purposes has “proven to be a failure”, others say that it is to early in the history of such means testing to make such a blanket assessment and determination.
The provisions of the BAPCAP have been in effect for some 12 years. During that period, the ups-and-downs of the financial, housing, and other markets have risen and fallen. What impact such events have had on the numbers of filed bankruptcies, the Chapter under which bankruptcies have been filed, etc. is something that is hard to assess. What a given debtor may or may not do in response to such market events varies widely. Some will try to file under Chapter 7 to liquidate their debts, while others will file directly under Chapter 13, and a few of the total will take some other course (acquiescing to foreclosure, bearing the burdens of collection efforts, etc.) and not file for bankruptcy at all.
This is a topic that will be around for the near future, so stay tuned!
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