Blog sponsored by Bankrupt-Law.com


John Caher
New York Law Journal
September 20, 2006
A Northern District of New York bankruptcy judge has refused to bail out
Congress for an apparent drafting glitch in the new bankruptcy law that
frequently results in creditors getting less under the "reform" measure than
they got under the old version -- even though the clear intent of lawmakers
and the president was to aid creditors.
Chief Bankruptcy Judge Stephen D. Gerling in In re Rotunda, 06-60054, broke
with the majority of his colleagues who have considered the same issue and
said that if Congress is determined to replace judicial discretion with
formulaic mandates, it can deal with the seemingly absurd results.
"To allow a debtor with income above the state median to provide for zero
payments to unsecured creditors in a chapter 13 plan ... when ... there
remains sufficient funds to pay even a minimal dividend to them is contrary
to the approach taken by this Court for over 20 years in considering chapter
13 plans," wrote Gerling of Utica. "Yet ... it is not for the Court to
second guess Congress despite the fact that the statute, as written, may
result in a confirmed plan that is contrary to the view expressed by
President Bush."
Gerling's decision is rooted in the Bankruptcy Abuse Prevention and Consumer
Protection Act of 2005.
The bill, which took effect last October, was drafted largely by credit
industry lobbyists and was designed to prevent debtors from taking what the
creditors viewed as unfair advantage of the bankruptcy law.
Many of its provisions were directed at people with income, and premised on
the contention that debtors with the means to do so should repay their
financial obligations to the extent possible. In signing the measure,
President Bush said that under it, "Americans who have the ability to pay
will be required to pay back at least a portion of their debts."
Now, however, instead of using actual expenses and income to determine how
much a Chapter 13 debtor can afford to pay back, the law requires an
examination based on the standards the Internal Revenue Service uses to
decide how much delinquent taxpayers can commit to a repayment plan. Those
standards permit allowances for food, housing, rent and other necessities,
based on median values.
While the standards are unrealistically low in some areas -- meaning that it
really costs consumers more for basic living expenses than the law
recognizes -- they are unrealistically high in other regions, such as
economically hard-pressed upstate New York, where living costs are less than
the median, observers say.
In those areas, since the allowance is based not on actual expenses but
medians, a strict application of the law enables debtors to deduct more than
their actual living expenses. So, money that in the past would have gone
toward repaying debts is in some cases now beyond the reach of creditors. No
longer does all of the debtor's disposable income necessarily go to the
repayment plan.
The question Gerling addressed in Rotunda, and several other judges have
addressed in other cases, is how to go about determining the debtor's
disposable income.
Court records show that Elizabeth and Lawrence D. Rotunda had an annual
income of about $68,000, well above the median income for a two-person
family in New York. Consequently, their capacity to repay was governed by a
rigid "means test."
Before the Bankruptcy Abuse Prevention and Consumer Protection Act, the
calculus of how much a Chapter 13 debtor had to pay was measured by his or
her "projected disposable income." Under the old law this was simply the
income the debtor listed on the bankruptcy petition minus the expenses.
Whatever was left over went toward debt repayment.
The new law does not define "projected disposable income," but it does
redefine "disposable income" as current monthly income less certain expense
allowances. And under the new definition, Social Security income, like that
received by the Rotundas, is excluded from the definition of current monthly
income.
Here, the debtors argued that only their "disposable income" -- which
excludes their Social Security -- should be included in their repayment
plan. The Chapter 13 trustee objected to the plan that would allow the
Rotundas to initially pay $800 a month rather than about $2,000 per month,
arguing that it fails to make all of their "projected disposable income"
available to unsecured creditors.
CONGRESSIONAL INTENT
In his brief, Chapter 13 Trustee Mark W. Swimelar of Syracuse acknowledged
that "many parts of [the new bankruptcy law] are confusing and will spawn a
tremendous amount of litigation," adding that the issue before Gerling
represents "one of those situations where the statute is not totally clear."
Still, he argued that a contextual reading of the entire statute leaves "no
doubt that Congress intended to retain the projected disposable income test
for confirmation of Chapter 13 plans."
The debtors' attorney, Peter A. Orville of Binghamton, N.Y., said the court
should rely on what Congress said and did not say, rather than what it may
have meant or hoped to achieve.
Gerling's court is one of several across the nation where attorneys have
been debating whether the term "projected disposable income" under 11 U.S.C.
§1325(b)(1)(B) has meaning distinct from the term "disposable income" as
defined in 11 U.S.C. §1325(b)(2). Their decisions are split, with the bulk
of them distinguishing between "projected disposable" and "disposable" to
the benefit of creditors.
But in at least one of those cases cited by Orville and Gerling (see In re
Barr, 341 B.R. 181 [Bankr. M.D.N.C. 2006]), a Chapter 13 plan was confirmed
where the debtor proposed paying nothing at all to her unsecured creditors.
"The idea that a debtor may successfully confirm a chapter 13 plan without
having to make any payments to unsecured creditors, despite having what
appears to be surplus income ... understandably does not set well with the
chapter 13 trustees and the courts," Gerling observed.
Yet, he said that with the new bankruptcy law "the court's discretion to
review the totality of the circumstances and determine the reasonableness of
a debtor's expenses in calculating disposable income has been curtailed, in
some instances, by the new provisions that allow, whether or not
intentionally, a debtor to propose a plan which provides zero payments to
unsecured creditors despite having the financial wherewithal to make some
payments to them."
He continued, "If this was not Congress' intent, then it is up to Congress
to rectify the situation."
Orville said that a number of peculiar provisions and apparent
contradictions in the new law often work to the detriment of creditors, even
though lawmakers and the president were clearly attempting to help creditors
with the new law.
"Actually, the unsecured creditors got the shaft," Orville said. "They are
getting significantly less than they would have before. The legislation was
written by bank lobbyists who wanted to make it harder to file bankruptcy.
They certainly made it more expensive and more of a hassle, but the key is
bankruptcy is alive and well and many people do better under the new law,
and creditors do worse. The law doesn't necessarily do what the proponents
said it would do."
Appearing on behalf of the trustee was staff attorney Lynn Harper Wilson.
She was not immediately available for comment.
RULING ON TITHES
Coincidentally, on Friday three prominent U.S. senators who had strongly
backed bankruptcy reform issued a letter criticizing a recent decision of
the other Northern District bankruptcy judge, Robert E. Littlefield Jr. of
Albany, N.Y. Like Gerling, Littlefield stuck with what Congress wrote in the
statute even though those words may have produced an unintended result.
In In re Diagostino, 06-10384, Littlefield found that the new rules do not
permit debtors to include religious tithes as a necessary expense, a major
departure from prior practice. Consequently, the court found, money that
previously would have been safeguarded for churches and other charities is
now fair game for credit card companies. That ruling did not please
religious conservatives who had spearheaded bankruptcy reform.
On Friday, Sens. Orrin G. Hatch, R-Utah, Charles E. Grassley, R-Iowa, and
Jeff Sessions, R-Ala., wrote to Attorney General Alberto Gonzales,
complaining that Diagostino "was wrongly decided and runs counter to
Congressional intent." They urged Gonzales to direct Chapter 13 trustees
that they are not to go after legitimate tithes.