Questions on Means Testing Answered

Among the most talked-about provisions of the new Bankruptcy Reform Act were the new "means-testing" provisions, intended to curb perceived abuses of the bankruptcy process. In one of the first published decisions on the complicated new provisions, In re Hardacre, __ B.R. __, 2006 WL 541028 (Bankr. N.D. Tex. 3/6/06) provides a helpful explanation of the impact and implementation of means-testing; clarifies what "projected disposable income" means, as that phrase is used in the amendments; and holds that debtors may not "double-dip" by taking multiple deductions from disposable income for mortgage and car expenses.

Judge Nelms explains first how means-testing is used to determine whether a Chapter 7 filing is a "substantial abuse" calling for dismissal under 11 U.S.C. 707(b). Where the statute previously failed to define "substantial abuse" and courts would typically consider the totality of the circumstances, that discretion has now been replaced with a mathematical formula. The debtor's current monthly income is calculated, then reduced by certain living expenses, and the difference is multiplied by 60. If the "income available for creditors," as Judge Nelms calls it, is greater than $10,000, abuse is presumed. If it is less than $6,000, abuse is not presumed. If it is between $6,000 and $10,000, abuse is presumed only if the income exceeds 25% of the debtor's non-priority unsecured claims. The presumption may be overcome if the debtor demonstrates "special circumstances." If a presumption arises, that court may dismiss the case, or if the debtor consents, convert it to Chapter 11 or 13.

Hardacre was filed as a Chapter 13 so substantial abuse was not an issue. But the means-testing provisions still were relevant because 11 U.S.C. 1325, which governs confirmation of a Chapter 13 plan, requires that if there is an objection to the plan, the debtor must commit all the debtor's "projected disposable income" during the "applicable commitment period" to payment of unsecured claims. If the debtor's annual income exceeds the median family income (as reported by the Census Bureau) for similar sized households in her state, then the "applicable commitment period" for the Chapter 13 plan is at least five years, unless creditors can be paid in full in a shorter time (if annual income does not exceed the median income, then the "applicable commitment period" is 3 years). Moreover, if the debtor's annual income exceeds the median income, then the permitted expenses considered for calculating "disposable income" are determining using the means test.

Judge Nelms noted that the phrase "projected disposable income" is subject to conflicting interpretations. 1325(b)(2) defines "disposable income" as "current monthly income" less certain expenses. But "current monthly income" is defined in 11 U.S.C. 101(10A) as the debtor's average income for the 6 months prior to the petition date. This can lead to anomalous results, to say the least: a debtor anticipating a significant increase in future income is incentivised to file quickly (so that the income which must be committed to the plan is based on her prior rather than future earnings), while a debtor who experiences a substantial loss of income around the time of filing might be unable to confirm a plan because she cannot devote the amount of "projected disposable income" necessary based on her prepetition income level.

After taking a close look at the statute, Judge Nelms concluded that "projected disposable income" for purposes of 1325(b) is based on the debtor's post-petition income rather than the prior six months. First, the use of "projected" before "disposable income" suggests Congress intended something other than "disposable income," under the traditional presumption that Congress acts intentionally when it uses different language in different sections of a statute. Second, the statute refers to projected disposable income "to be received" in the applicable commitment period -- language which would be superfluous (perhaps nonsensical) if Congress was referring to the debtor's pre-petition income. Finally, 1325(b)(1) requires the court to determine whether the debtor is committing all of her projected disposable income "as of the effective date of the plan." Again, the language indicates that the court should consider current income, rather than historical income.

Having resolved that riddle, Judge Nelms turned to the issue of allowed expenses. To determine the expenses which may be deducted from gross income to get to "projected disposable income," 707(b)(2)(A)(ii) permits the debtor to deduct standard expense allowances developed by the IRS. (The IRS uses them to evaluate a taxpayer's ability to pay delinquent taxes). There are "National Standards" that the IRS has determined to be reasonable expenditures for food, housekeeping supplies, apparel and services, personal care products and services, and miscellaneous expenses. There are also "Local Standards" for transportation and housing costs. Transportation costs include both ownership costs (allowances for lease or purchase expenses for up to two cars) and operating costs (amounts deemed necessary to operate up to two cars). Then, just to make it a little more complicated, the debtor is also allowed under 707(b)(2)(A)(iii) a deduction for average monthly payments on secured debts.

The debtor in Hardacre contended that she was entitled (indeed, specifically directed by the statutory language) to deduct for the standard housing and auto ownership allowances under (ii), and deduct for her actual mortgage and auto loan payments under (iii), to determine her disposable income. The debtor pointed out that 707(b)(2)(A) says the debtor's current monthly income is to be reduced by the amounts determined "under clauses (ii), (iii), and (iv) [payments on priority claims]," and that the use of the conjunctive "and" clearly indicated that debtors should deduct expenses under each of the clauses, even if there was some overlap.

The Chapter 13 trustee, in response, contended that such "double-dipping" was not allowed. The trustee pointed to 707(b)(2)(A)(ii)(I), which says that "Notwithstanding any other provision of this clause, any monthly expenses of the debtor shall not include any payment for debts." Judge Nelms found the meaning of this statement "anything but plain," but set out to figure out what it meant in the context of the rest of the statute, noting that "Statutory construction is a holistic endeavor."

Judge Nelms starts with the premise that the plain meaning of statutory language will control unless it is demonstrably at odds with the drafters' intentions; if a statute is ambiguous, then, Judge Nelms infers that the court clearly may reject a construction that is inconsistent with the legislative intent. Accordingly, he found it appropriate to recognize that the Congressional intent in passing the means test was to ensure that debtors who can repay some portion of their unsecured debts be required to do so.

With this guidance, Judge Nelms noted that the phrase "shall not include" as used in the above provision was open to two readings: either it could mean that in calculating the monthly expense deductions under the Local Standards for housing and auto ownership, the court should disregard any payments for debts (the debtor's position); or it could mean that the expense allowances under the Local Standards should be reduced by payments for debts (the trustee's position).

The court found the debtor's interpretation untenable because it would render the sentence above completely superfluous. The Local Standards are not based on the actual debt payments made by the debtor but are based solely on the IRS standards. If the language were construed as the debtor hoped, it would merely be instructing the court to disregard actual expenses that are not included in the Local Standards in any event. Such an interpretation would violate the rule that every word in a statute is presumed to have meaning.

The Hardacre court then turned to the alternative interpretation: that the expense allowances under the Local Standards should be reduced by payments for debts. This opened up yet another question -- which debts? Judge Nelms determined that it could not possibly mean all debt payments, because the very purpose of the means test is to determine the amount of money available to pay unsecured creditors in a plan. Since the Local Standards were issued by the IRS, Judge Nelms looked to the types of "debt payments" that could reduce allowances under the IRS standards. The way the IRS applies its standards, the taxpayer is allowed to deduct either the amount in the Local Standards or "the amount actually spent." From this, Judge Nelms concluded that the "payments for debts" in the language at issue was intended to refer to secured debts related to mortgage or car ownership expenses (as provided in (iii)).

We're not done with the questions, though: if the Local Standards deductions must be reduced by payments on home or car secured debts, does the debtor get the greater or the lesser of these? If the Local Standards exceed the actual payments, is the debtor limited to the actual payments? And if the actual payments are over the Local Standards, do the Standards impose a cap? Judge Nelms concluded that the debtor had to be entitled to take the greater of the two. The only way to get to a contrary result, he found, was if the Local Standards allowance under (ii) could be reduced to a negative number by debt payments and then subtracted from the secured debt allowance under (iii) -- something which he did not believe was contemplated by the statute.

The Hardacre decision makes a valiant attempt to provide some much-needed clarity to the means-testing provisions as they relate to Chapter 13 plan confirmation.