In re Croft

• Citation: 539 B.R. 122
• Decision Date: 14 October 2015
• Docket Number: CASE NO. 12–10071–TMD
• Parties: In re: Robbie Thomas Croft, Gayle Lynne Patek, Debtors.
• Court: United States Bankruptcy Courts. Fifth Circuit. U.S. Bankruptcy Court — Western District of Texas

539 B.R. 122

In re: Robbie Thomas Croft, Gayle Lynne Patek, Debtors.

CASE NO. 12–10071–TMD

United States Bankruptcy Court, W.D. Texas, Austin Division.

Signed October 14, 2015

Alexander B. Wathen, Wathen & Associates, Houston, TX, for Debtors.

MEMORANDUM OPINION

TONY M. DAVIS, UNITED STATES BANKRUPTCY JUDGE

Choices.

This case is about choices: the choices made by a family facing financial problems and the choices available under the Bankruptcy Code for resolving those problems. Weighing the choices made in this case, and the choices now available, this Court must choose between dismissal and chapter 7. The U.S. Trustee urges dismissal, which would leave the Debtors to choose between trying to resolve their debts outside bankruptcy or trying to discharge their debts under chapter 13, even though they just failed to complete a chapter 13 case. The Debtors ask the Court to let them remain in chapter 7, despite the fact that they chose to not pay their current income taxes during their failed chapter 13 case, and have made a series of unfortunate financial choices.

I. BACKGROUND AND FACTS

A. The story begins with financial difficulties and unpaid taxes.

The Debtors, Robbie Croft and Gayle Patek, are married. Together, they run a residential real estate appraisal service: he does the appraisals; she keeps the books. In the early 2000s, this business was so successful that the Debtors had as many as five employees.¹ The Debtors' lifestyle kept pace with the success of their business, and then some. In 2007, they chose to lease a Hummer. In 2008 they chose to buy a second home worth over $350,000. And the Debtors continued to own their prior home, using it as a rental property. But prior to acquiring the Hummer and the second home, the Debtors were already financing their lifestyle by failing to pay federal taxes.

Their real estate appraisal business did not escape the economic recession of the late 2000s. Indeed, according to Mr. Croft, “the bottom fell out” in 2008.² Making matters worse, in May of 2009, regulatory changes to the way in which residential real estate lenders engaged appraisers forced the Debtors to essentially start over and rebuild their business model in the midst of the down market.³ By two measures, the Debtors' efforts were successful. First, during their chapter 13 case, the Debtors maintained an average gross income in excess of $140,000,⁴ which is more than twice the median income for a household of three. Second, they managed to avoid bankruptcy for another three years.

B. The bankruptcy begins in chapter 13.

On January 13, 2012, Mr. Croft and Mrs. Patek filed bankruptcy under chapter 13 in order to thwart an attempt by the Internal Revenue Service (IRS) to levy their bank accounts.⁵ At that time, the Debtors' owed the IRS $92,000,⁶ an astonishing amount that goes far in explaining how the Debtors were able to hold off filing for bankruptcy from 2009 to 2012. Of this total, priority status was claimed for only $41,000. The remaining $51,000 was claimed as general unsecured debt as it was over three years old⁷ —a long time to finance expenses with unpaid taxes. And although the $51,000 could be discharged as an unsecured claim, the priority claim of $41,000 remained an obstacle. In order to discharge this debt, the Debtors would have to pay it off in full over the five years of their chapter 13 plan.

The Debtors' other debts were not trivial. Their home, for which the Debtors claimed a value of $360,000, secured a $360,000 debt.⁸ Their prior home, still being held as a rental property, was valued at $155,000 but secured debt totaling $163,000.⁹ On top of that, the Debtors had incurred $259,000 of unsecured debt to non-IRS creditors.¹⁰

The Debtors' path to a confirmed chapter 13 plan was neither direct nor easy. Consideration of their first plan, filed on February 8, 2012, was held up by the Debtors' delay in filing their tax returns. Also, the chapter 13 Trustee repeatedly objected to the expenses claimed by the Debtors in their expense schedule (Schedule J). In support, the chapter 13 Trustee noted the Debtors' claimed monthly expenses of $850 for food, over $1,000 for transportation, and $770 for leasing the Hummer.¹¹ Simply put, the chapter 13 Trustee felt that the Debtors should spend less on themselves and pay more to creditors. An amended plan was filed, which drew another objection, but ultimately the Court confirmed a plan for the Debtors on April 10, 2012.

Meanwhile, the Debtors filed four separate statements of income and expenses: the B22C, filed with the original schedules; the original statement of income and expenses (Schedules I and J); and two amendments to Schedules I and J, the last one filed after the plan was confirmed. Although these amendments likely delayed confirmation of the plan, they did not materially change the amount available to pay creditors. The most significant changes were a shift of some expenses from the business category to personal categories, an increase in the amounts paid for currently incurred income taxes from $1,500 to $1,800, and a reduction in the payment on the Hummer from $770 to $550 (possibly a change from a lease to a secured loan, but this is not clear).

The Debtors consistently chose to claim as expenses the $2,665 monthly payment for the mortgage on their home, as well as the $935 monthly mortgage payment on the rental property.¹² They claimed $1,300 of rental income from this property,¹³ although how much of that was collected is not clear. During the hearing, Mr. Croft admitted they were no longer receiving that income, and “guessed” that they had stopped paying the mortgage payment on that property “four to five months ago.” However, according to a pleading filed by the lienholder on that property, the Debtors had not paid the mortgage for nearly ten months prior to the hearing.¹⁴

C. The chapter 13 case fails; the Debtors then convert the case to chapter 7.

After the chapter 13 plan was confirmed in April of 2012, things went well until January of 2014 when the chapter 13 Trustee filed a motion to dismiss for failure to make plan payments. This motion was resolved a month later, but then the chapter 13 Trustee filed a notice that an IRS lien had been filed for unpaid 2012 taxes. Shortly thereafter, the IRS filed its own motion to dismiss. According to the IRS, the Debtors had failed to remain current on post-petition federal income taxes for the year 2012 and were $5,096 behind.¹⁵ An agreed order was entered by this Court on May 8, 2014, in which the Debtors agreed to pay in full their federal income taxes for 2012 and 2013 within six months of the agreed order. The Debtors also agreed that if they failed to pay these taxes in six months, the IRS could then unilaterally choose to dismiss the case.¹⁶

The Debtors chose not to pay the taxes as required by the agreed order. Indeed, the Debtors' unpaid post-petition tax debt had risen to over $34,000. But before the IRS could dismiss the case, the Debtors converted the case from chapter 13 to chapter 7. Unlike a conversion from chapter 7 to chapter 13,¹⁷ or a voluntary dismissal of a chapter 13 case,¹⁸ a debtor's right to convert from chapter 13 to chapter 7 is absolute.¹⁹ A debtor is only required to file a notice, upon which conversion is automatic: no motion or court order is required.²⁰

The Final Report filed by the chapter 13 Trustee stated that the Debtors had paid approximately $40,000 to fund the confirmed plan, of which $37,000 had been paid towards the Debtors' pre-petition IRS priority claim, with the remaining amount going toward attorney and Trustee fees.²¹

D. The U.S. Trustee's motion, chapter choice, and dismissal for abuse.

It is not at all uncommon for debtors who fail to make the payments needed to maintain chapter 13 cases to instead choose to seek relief under chapter 7; indeed, it happens often.²² The Debtors' choice of chapter 7 here is easy to understand. Although the Debtors will be unable to discharge their priority tax debt (now $3 8,000),²³ they will be able to discharge their unsecured debt of $310,000.²⁴ And they will get this fresh start without the chapter 13 requirement of a multi-year commitment to pay all of their “disposable income”—basically all income after deducting necessary expenses of living—to their creditors. The U.S. Trustee objects to this result, arguing that the Debtor's high income and excessive expenses, and persistent failure to pay current taxes, together establish “abuse” under section 707(b), and that the case should therefore be dismissed.

So what is “abuse”? Abuse is a term contained in section 707(b) that operates to limit the ability of debtors to seek relief under chapter 7. Prior to 2005, the standard for determining dismissal pursuant to 707(b) was the “substantial abuse” inquiry. A plethora of cases describe circumstances that constitute substantial abuse—from a debtor's ability to make chapter 13 plan payments to a lack of good faith.²⁵ In practice, dismissal under the substantial abuse standard was reserved for the most egregious cases. In addition, the debtor enjoyed a presumption in favor of getting relief.²⁶

This changed in 2005, when Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) in an effort to thwart the abusive use of chapter 7 bankruptcy filings and to encourage debtors to file for chapter 13 relief instead.²⁷ Congress restricted the availability of chapter 7 relief to consumer debtors by repealing the presumption in favor of granting relief to debtors, lowering the standard from “substantial abuse' to mere “abuse,” and offering a new method of determining abuse known as the Means Test.²⁸

The Means Test is a numerical analysis that determines chapter 7 eligibility based on the debtor's income and expenses. If the Means Test is not satisfied, the chapter 7 case is presumed abusive.²⁹ Unless the debtor is able to rebut the presumption under section 707(b)(2)(B), the case must be dismissed, or the...