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October 9, 2009

Judge Rules that Spouses' Debts are Considered Separately for Eligibility for Chapter 13

Brief by my law clerk Roksana Moradi

In re Werts, --- B.R. ----, 2009 WL 2563468 (Bkrtcy.D.Kan.)

Issue:  Do the debt limitations for filing chapter 13 apply to a husband and wife separately even though they file a joint case?  Is the unsecured portion of secured debt treated as unsecured for eligibility purposes?  Was the conversion here from chapter 7 to chapter 13 in bad faith and therefore subject to dismissal?

Holding:  The debt limitations apply to the spouses separately.  The unsecured portion of secured debt is treated as unsecured for eligibility purposes.  Here there was no sufficient bad faith to justify dismissal of the chapter 13.

Judge Janice Miller Karlin,

Mr. and Mrs. Werts, had unsecured debts of $161,977.71 and $100,913.37, respectively.  They filed chapter 7 on June 16, 2008.  The debtors were also jointly liable on a second mortgage on their residence.  Further, the debt secured by that second mortgage exceeded the value of the house by $134,760.  Their schedules had numerous deficiencies which they corrected with various amendments (and blamed most on their attorney).  Plus Mr. Werts received a cash settlement from a business deal of $75,000 on October 31, 2008.  The debtors used the “$75,000 to pay some routine bills, make several advanced payments on their first and second mortgages ($21,535 and $7,124, respectively), make car payments ($5,995), buy new furniture for their house ($5,500), make deck repairs ($750), paint their house ($3,650), pay off an unsecured consolidation loan that was guaranteed by a friend and former employer of Mr. Werts ($12,235), pay attorney fees ($3,000) and take a ski vacation in Colorado ($4,117).”
In January of 2009, the UST filed an adversary proceeding objecting to Debtors' discharge pursuant to § 727(a)(2) and (4).  The UST also filed a Motion for Dismissal for Abuse under § 707(b)(3).  Three months later, with new counsel, the debtors “filed the motion to convert to Chapter 13. . . [that is] the subject of this order. 

The first issue for the court was whether the debtors qualified for chapter 13.  The Court stated that “this issue is governed, in part, by the answer to the following question: whether the $134,760 undersecured portion of Debtors' second mortgage should be considered unsecured debt for purposes of the § 109(e) debt limitation when another section of the Code, § 1322(b)(2), specifically requires that same debt to be treated as secured for plan confirmation purposes.  This second mortgage note is secured only by a security interest in Debtors' principal residence.”  The Court concluded “that the undersecured portion of a secured debt should be treated as an unsecured debt for § 109(e) debt limitation calculations.”

The Debtors argued in the alternative that “the §506 analysis should not be applied when the debt in question will be treated as fully secured by operation of law, specifically §1322(b)(2), which requires that a claim secured only by a security interest in the debtors' principal residence cannot be bifurcated and crammed down.”  The Court disagreed ruling that the application of §1322(b)(2) does not create an exception to the general rule and declined “to graft additional content onto § 109(e) that Congress did not choose to include, to wit, that the section does not apply to those debts that are truly undersecured, but that will be treated as fully secured for confirmation purposes.”

The debtors next argument was that because each of them, individually, had “unsecured debt less than $336,900, because not all of their unsecured debt is joint debt, they should be allowed to proceed as debtors in a Chapter 13 case. The UST objected saying §109(e) requires both spouse's debts to be considered together when determining whether they fall under the unsecured debt limit.” The parties did not provide ANY case law addressing this issue, and the Court was also unable to locate any cases directly on point.   The UST’s argument focused “ on the portion of the statute that reads ‘an individual with regular income and such individual's spouse ... that owe ... unsecured debts that aggregate less than $336,900’ to support its claim that all debts of both spouses must be combined for purposes of § 109(e).”  The Court found “that a more reasonable reading of the statute, and one that furthers the goal of encouraging Chapter 13 filings, is that the provision dealing with ‘an individual with regular income and such individual's spouse’ is intended to apply in those cases where the spouse could not otherwise be a Chapter 13 debtor, because he or she is not ‘an individual with regular income.’  If each spouse has regular income, and each spouse separately qualifies under the debt limits of §109(e), then each spouse should be entitled to file his or her own Chapter 13 case-even if the debts of both spouses together would exceed the debt limits.”  The Court further stated that “if a husband and wife can each file separate Chapter 13 proceedings, where their own individual debt is within the § 109(e) limits, the Court can think of no reason why a husband and wife could not file a joint petition, as authorized by § 302(b).” 

As to good faith, the Court ruled the “key inquiry” for courts attempting to ascertain a debtor's good faith ‘is whether the debtor is seeking to abuse the bankruptcy process.’ ”  The overwhelming majority of Courts have held that the party moving to dismiss or convert a case under § 1307(c) bears the burden of showing that the case was not filed in good faith.” The Court held that, “although a debtor bears the burden of proving that a plan was filed in good faith under § 1325(a), the burden of showing that a case was filed in bad faith so as to require conversion or dismissal under § 1307(c) falls on the party seeking such conversion or dismissal.”
The UST alleged that the deficiencies in the schedules were evidence of bad faith.  The court said it was “troubled by the actions of each Debtor and [their prior attorney] regarding the errors and omissions on the schedules, the Court does not find that those actions rise to the level of bad faith that would render Debtors ineligible for Chapter 13 relief.  Critical to this finding is the testimony of the Chapter 7 Trustee, who testified that once her initial concerns about the schedules were discussed with counsel, Debtors were at all times cooperative in providing follow-up documentation about all bank accounts and other identified issues, they answered all of her questions in a timely fashion, and, most importantly, that she never felt Debtors were being deceptive or uncooperative in their responses to her.”

The Court also found “that Debtors' actions in disposing of the $75,000 payment from the EB buyout in the 7-8 months prior to the filing of the case do not rise to the level of bad faith. Typically, engaging in pre-bankruptcy planning by converting non-exempt assets into exempt assets, without more, does not constitute bad faith.  However, the UST contends that bad faith does exist here because Debtors accumulated a fairly significant amount of unsecured debt in connection with the EB business, itself, and should have used the $75,000 payment to repay some of that debt, rather than using it to pay down their mortgage or for a family vacation.  In response, Debtors testified that they did in fact intend to use the EB payment to repay some of their business debt. However, [their previous attorney] specifically advised them to use the money in a fashion that would best benefit their future financial fresh start, rather than that of their creditors or the bankruptcy estate.  “Debtors stated that they simply followed the pre-bankruptcy planning advice offered by their attorney, and were not acting in bad faith.”

In conclusion the Court held that “Debtors' actions prior to filing this case did not rise to a level of bad faith that would prevent conversion, the Court finds that the case would not be subject to dismissal or conversion under 1307(c).”

October 9, 2009 in Other Circuit Briefs | Permalink


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