You Say Strike It, I Say Dismiss It - What Happens When an Ineligible Debtor Files

Certain elements of the new BAPCPA pre-filing credit counseling requirements are clear in their effect: generally, under 11 U.S.C. 109(h), a debtor who fails to obtain counseling before filing for bankruptcy will be deemed ineligible, with a limited extension available for debtors who certify that they face exigent circumstances and that they requested but were unable to obtain counseling from an approved agency within five days after requesting it. What is less clear, though, is what should happen if the debtor has not complied with these requirements. Does the case get dismissed? If so, and the debtor then obtains the required counseling and refiles, he or she may find that the bankruptcy relief they get may be limited -- in particular, the provisions for termination of the automatic stay after 30 days under 11 U.S.C. 362(c)(3) may be triggered by the prior dismissed case.

In order to address this concern, some courts have suggested that the initial filing ought to be stricken rather than dismissed, on the theory that a filing by an ineligible debtor is void ab initio and no case is commenced. This fixes the 362(c)(3) problem, but creates its own set of problems: if no case is commenced by such a filing, does that mean that no automatic stay is (or was) in effect as a result of the initial filing? If so, are creditors free to simply pursue their remedies regardless of a bankruptcy filing if the debtor has not completed the counseling necessary to satisfy the eligibility requirements?

While courts grapple with the question of striking or dismissing, there is little doubt that Congress has no intention of calling the whole thing off, so we will take a closer look at the cases on both sides of the debate. We first highlighted the issue in the Got Credit Counseling? post, where we mentioned the Hubbard, 333 B.R. 377, Valdez, 335 B.R. 801, and Rios, 336 B.R. 177 cases, all of which have effectively held that a filing by a debtor who has not completed the counseling requirements should be stricken, such that it will not count as a prior case in the event of a subsequent filing (the Valdez case actually "dismisses" rather than "strikes", but nonetheless makes clear that it will not be considered as a "case in which the individual was a debtor" for purposes of a later filing). Since those decisions were issued, several more courts have taken on the issue, with varying results.

The most rigorous argument for striking was made recently in In re Salazar, 2006 WL 827842 (Bankr. S.D. Tex. 3/29/06). In Salazar, Judge Isgur (not one to be shy about venturing opinions construing BAPCPA) presented the question in terms of whether the automatic stay should be regarded as having been invoked by an ineligible debtor's filing. He finds the answer to be clear:

"The legal question is: Did Congress intend to impose an eligibility requirement on putative debtors, but also intend for an ineligible person to receive the benefits of the automatic stay? The answer is: It is impossible to believe that Congress specifically identified people to exclude from the bankruptcy process, yet permitted those same people to benefit from bankruptcy's most powerful protection: the automatic stay."

Judge Isgur supports this conclusion with an analysis of three relevant statutes:
Section 362 says that "a petition filed under section 301, 302 or 303 ... operates as a stay ..."
Section 302 says that "a case under a chapter of this title is commenced by the filing with the bankruptcy court of a single petition under such chapter by an individual that may be a debtor under such chapter ..." (302 applies to joint cases, 301 uses similar language for an individual case)
Section 109 addresses "who may be a debtor," and specifies in 109(h) that "an individual may not be a debtor under this title unless such individual ..." has completed the pre-filing credit counseling.

From these three sections, Judge Isgur draws the following "syllogism": (1) individuals who have not received counseling and do not qualify for a waiver are ineligible to be debtors under 109; (2) only eligible debtors may file a petition under 302; therefore (3) without the filing of a petition under 302, the automatic stay provisions in 362 are not invoked.

*(Close readers may note a possible flaw in the syllogism, which will be discussed further below.)

Judge Isgur readily acknowledged that this interpretation may create uncertainty, since it raises questions of whether the filing of a petition really does trigger the protections of the automatic stay. Yet he noted several examples where the law tolerates uncertainty (i.e., adverse possession, unrecorded tax liens, preferences and fraudulent conveyances, and more on point, the multitude -- 28, with the BAPCPA amendments -- of exceptions to the automatic stay). Particularly in light of the "proliferation of exceptions" to the automatic stay, Judge Isgur found "no reason why certainty must trump policy." Since, under his reading, "Congress intended to make certain people ineligible to file bankruptcy," he found it implausible that Congress "specifically identified people to exclude from the bankruptcy process, yet permitted those same people to benefit from bankruptcy's most powerful protection: the automatic stay." (Judge Isgur's take on the legislative intent may be accurate but seems more cynical than many members of Congress might admit; others, such as in Rios, have more generously suggested that the intent was to ensure that potential debtors are advised of the alternatives to bankruptcy before filing).

Judge Isgur finds support for his interpretation in the amendments to Section 521 of the Code. The amendments include a provision, 521(i), that calls for the "automatic" dismissal of a case if the debtor fails to timely file certain papers. They also include a provision, 521(b), requiring the filing of a certificate confirming that the debtor obtained the required counseling. The failure to file the counseling certificate is not listed as one of the things that triggers an automatic dismissal, however - an omission which Judge Isgur finds is explainable only because Congress intended that a filing without completing the counseling requirement could not even validly commence a case subject to dismissal.

The Salazar decision rejects the argument that a contrary intention is demonstrated by the amendment to 362(b)(21) of the Code. 362(b)(21) creates an exception to the automatic stay for the foreclosure of real estate "if the debtor is ineligible under section 109(g) to be a debtor". [109(g) creates a 180 day prejudice period if a prior case was dismissed for willful failure to abide by orders or to properly prosecute the bankruptcy case, or if the debtor voluntarily dismissed after a stay relief motion was filed]. The debtor in Salazar argued that such an exception would be unnecessary, and mere surplusage, if the filing by an ineligible debtor did not trigger the stay in the first place. Noting a split of authority in the decided cases on whether a filing in violation of 109(g) is void ab initio, Judge Isgur concluded instead that 362(b)(21) was adopted "with the apparent intent to legislatively overrule courts that were misapplying the statute as written." Even if it were treated as surplusage, though, the court held that it should not give meaning to surplusage if doing so would be demonstrably at odds with the legislative intent, citing Lamie v. U.S. Trustee, 540 U.S. 526 (2004).

Accordingly, Judge Isgur in Salazar struck the debtors' petition and determined that no automatic stay arose as a result of the filing of their petition. Although he found the difference between "striking" and "dismissing" to be merely semantic, he did note that "There is a difference between a bankruptcy case and a bankruptcypetition." The consequences of dismissing a "case" under a provision such as 11 U.S.C. 707, are different from the consequences of dismissing a "petition" under 11 U.S.C. 109. "Dismissal of a petition amounts to dismissal of a 'case' prior to the case's commencement" such that no stay is ever in effect (but with the additional effect that a petition dismissed under 109 is not a "case pending within the preceding 1-year period" for purposes of 362(c)(3) and (4)). The distinction between a "case" and a "petition" will be discussed more below too.

A similar result was reached in the case of In re Calderon, 2006 WL 871477 (Bankr. S.D. Fla. 3/8/06) (the first published opinion from our former partner at KT&T, now newly appointed Judge Laurel Isicoff), where Judge Isicoff held that an individual who filed without completing the counseling requirements was not eligible to be a debtor, therefore no case was commenced, and in a subsequent case the filing would not constitute a "case of the debtor" for purposes of the 362(c)(3) stay termination provisions.

The Salazar opinion was certified for direct appeal to the Fifth Circuit Court of Appeals under the new provisions for direct certification under 28 U.S.C. 158(d)(2), and an appeal was filed on April 12.

Meanwhile, the opposite conclusion has been reached in several other decisions, the most recent and thorough of which may be In re Seaman, Case No. 05-40032 (Bankr. E.D.N.Y. 3/30/06) (no Westlaw cite available yet). In Seaman, Judge Strong noted that 109(h) is silent as to the appropriate resolution for cases where the debtor is ineligible due to noncompliance with the counseling requirements. In the absence of specific statutory guidance, she looked to decisions construing analogous provisions of the Bankruptcy Code.

Indeed, before the BAPCPA amendments, a debtor could be ineligible under 109 for a variety of reasons other than failure to complete the counseling requirements. One example is where a debtor files a Chapter 13 petition but is not eligible for relief under that chapter under 109(e), either because they do not have regular income or because they have debts that exceed the statutory limits. Judge Strong notes that courts have "with apparent unanimity" concluded that when a Chapter 13 petition is filed by a debtor ineligible for relief under that provision, a case is nonetheless commenced which can either be voluntarily converted or dismissed. Likewise, courts have dismissed, rather than stricken, cases filed by petitioners who are ineligible because of their corporate or entity status. Judge Strong also notes that courts have dismissed, rather than stricken, cases filed by petitioners who are ineligible under 109(g) (although she fails to note the conflicting opinions on the issue).

Judge Strong then turned to the several cases that had evaluated whether to strike, or dismiss, a petition filed without complying with the pre-filing counseling requirements, including Hubbard, Rios, and Valdez, as well as In re Ross, 338 B.R. 134 (Bankr. N.D. Ga. 2/8/06), In re Tomco, 2006 WL 459347 (Bankr. W.D. Pa. 2/27/06), and an unpublished opinion in In re Taylor, Case No. 05-35381DM (Bankr. N.D. Cal. 3/9/06). While those first three opinions held that striking was the appropriate disposition, Ross, Tomco and Taylor concluded to the contrary that dismissal rather than striking was warranted.

In Ross, Judge Bonapfel noted that the BAPCPA amendments did not provide any different consequence for 109(h) ineligibility than for any other type of ineligibility, and that there was no indication of an intent to establish a new rule. As a result, 109(h) ineligibility should be treated like any other type of ineligibility. Like Judge Strong, Judge Bonapfel also noted that courts uniformly recognize that a Chapter 13 filing by an ineligible debtor still commences a case. While he noted the split of authority on 109(g) ineligibility, he recognized that courts had formulated a variety of ways to deal with serial filing abuse, such as through annulment of the stay, dismissals with prejudice, and in rem stay relief orders. As a result, he found that 109(g) was not jurisdictional such that a filing by a debtor who was not eligible under its terms still commences a case that is not a "nullity" or void ab initio. Unlike Judge Isgur, Judge Bonapfel found this interpretation to be ratified by the 362(b)(21) amendment creating an exception to the stay for real estate foreclosures against debtors ineligible under 109(g) -- if such a filing were void ab initio, there would be no reason for the amendment.

Since there was no evidence that Congress intended to treat 109(h) ineligibility any differently than any other form of ineligibility, it follows that a filing by a debtor ineligible under 109(h) is effective and is not a nullity or void ab initio. While recognizing that this may implicate the 362(c)(3) and (4) provisions in a later case, Judge Bonapfel suggests that treating an ineligible filing as void ab initio might result in a "pyrrhic victory" in the meantime if a creditor completes a repossession or foreclosure because no stay is in effect.

The Tomco case also concludes that dismissal rather than striking is appropriate. Judge Deller initially noted the "profound" effects of the new pre-filing counseling requirement and the practical difficulties they present. Most debtors, he notes, are not meeting with lawyers well in advance of a potential filing to figure out their options -- instead, they are usually trying to negotiate with their lenders or landlords, trying to refinance their debtors, or busily trying to supplement their income. They typically will have little funds with which to hire counsel because their income is being used for family expenses. Then, when efforts to resolve their financial problems fail, "the honest debtor is caught by surprise by the nuances of the credit counseling briefing provisions of the 2005 Act and finds that bankruptcy relief may be beyond his or her reach." Nonetheless, Judge Deller rejected the earlier decisions, such as Rios, which struck petitions filed by debtors who had not fulfilled the counseling requirements, which he believed were rationalizing their result on equitable grounds in light of the concern that the filing would create a "strike" for purposes of a subsequent filing and the 362 "not-so-automatic stay" termination provisions.

Although Congress did not amend Section 707 of the Code (dealing with "cause" for dismissal) to include ineligibility, he found found that such a failure was not indicative of any particular intention on the part of Congress; rather, there is no need to specify that ineligibility would be "cause" for dismissal (particularly since 707 is drafted as a non-exclusive list). He also rejected the notion that the language of Section 301 (that a case is commenced by the filing of a petition "by an entity that may be a debtor" under such chapter) suggests that if the debtor is ineligible, no case is "commenced." Rather, Judge Deller was of the view that the word "may" has an "expansive connotation" which as used in ordinary common parlance simply means "might" or expresses a "possibility". As such, any individual "had the possibility of being a debtor", but has to obtain the credit counseling "to be certain." (This explanation is not entirely convincing, especially since Section 109 is in fact called "Who may be a debtor." It doesn't seem to be too much of a leap to conclude that the "may be a debtor" as used in Section 301 is the same "may be a debtor" as defined in Section 109).

The Tomco court rejected the notion that ineligibility impacts the determination of whether a case is "commenced," expressing concern with the possibility that if such a filing is deemed void ab initio, there would be no stay whatsoever in effect. He was unwilling to impose the risk on the debtor or its creditors that a creditor might take unilateral action after a petition was filed in the absence of a court order or express statutory provision providing otherwise. Like Judge Bonapfel in Ross, Judge Deller also found that the amendment to 362(b)(21) confirmed that Congress did not regard filings by ineligible debtors as void ab initio. Since Congress "is presumed to know the state of existing law when it enacts legislation," the creation of an additional stay exception evidences an understanding that a bankruptcy filing in violation of 109 nonetheless commences a case and results in an automatic stay.

The Taylor case likewise concluded that dismissal rather than striking was the appropriate result "under ordinary principles of statutory construction," and suggested that the potential consequences in a subsequent filing might not be "as draconian as they first appear" because a dismissal under 109(h) would not appear to establish a presumed lack of good faith for purposes of 362(c)(3) and (4) (under which the stay can be preserved upon a showing of good faith).

After digesting all these decisions, Judge Strong in Seaman concluded that dismissal rather than striking was appropriate: (1) eligibility is not jurisdictional -- until a court determines that a petitioner is ineligible, a case is commenced by the filing of a petition and cannot be a nullity; (2) dismissal for ineligibility under 109(h) comports with other sections of the Bankruptcy Code and BAPCPA as a whole -- other ineligibility provisions are regarded as warranting dismissal rather than striking, and a conclusion that no case is commenced would make the amendment to 362(b)(21) superfluous; (3) the legislative history suggests that Congress intended to discourage abuse of the bankruptcy system and in particular to address the serial filing problem by requiring pre-filing counseling -- striking, however, could result in abuse of the automatic stay by permitting a debtor to get a temporary stay until the time a petition is stricken, again and again; (4) striking might prevent a debtor from realizing the benefits of bankruptcy through a subsequent filing if no stay goes into effect and a creditor takes action before the new filing; meanwhile, even if the petition is dismissed, a good faith debtor could still get full bankruptcy protection by moving to reinstate the stay in a subsequent filing.

So what's the right answer? My two cents -- remember that "syllogism" in Salazar which led to the conclusion that a filing of a petition by an ineligible debtor does not trigger the automatic stay? Here's where I think the flaw is. Section 362 says that "a petition filed under section 301, 302 or 303" operates as a stay. But 301, 302 and 303 do not actually say that a petition may only be filed by an eligible debtor; rather, what they is that "a case is commenced" by the filing of a petition by an eligible debtor. Thus, the filing of a petition by an ineligible debtor can trigger the automatic stay under 362 (which refers to the filing of a petition, not to the commencement of a case), but that petition will not commence a "case" unless the petitioner is eligible. So the stay would be in effect temporarily pending determination of eligibility, but if the debtor is determined not to be eligible, then the petition would be dismissed (or stricken, if you prefer), and would not be regarded as a "previous case" for purposes of 362(c)(3) or (4). To the extent this presents an opportunity for abuse by debtors seeking to take advantage of the temporary stay, courts could remedy such abuse in the same ways they have dealt with serial filings before -- through retroactive annulment of the stay, dismissals with prejudice, in rem stay relief orders, and so on. Would it work?