The Chapter 7 Means Test

WHAT DOES IT “MEAN” FOR WEALTHIER CLIENTS CONSIDERING FILING FOR CHAPTER 7 BANKRUPTCY PROTECTION

As of the publication of this Article, amendments to the United States Bankruptcy Code 11 U.S.C. §101 et. seq., which passed in October, 2005 pursuant to a bill entitled “The Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”),” have been in effect for 8 years.  One of the most controversial changes, often difficult to understand, is known as the “means test” which affects individuals considering bankruptcy relief.  The means test includes formulas to be utilized by courts to determine if individuals are eligible to file Chapter 7 bankruptcy cases in which they are allowed to discharge the majority of their debt with certain exceptions.  If they are not eligible to file under Chapter 7, they may be required to file Chapter 13 individual reorganization cases, commonly known as wage earner plans.  The stated purpose of the means test is to prevent individuals from abusing the bankruptcy process by seeking to discharge debt when they have a significant ability to repay some or all of their debt to their creditors.  A Chapter 13 bankruptcy requires the debtor to make payments to unsecured creditors over a three to five year period after they have met other Plan confirmation requirements, including establishing to the satisfaction of the Chapter 13 trustee that the proposed plan is feasible based upon their existing income.

If an individual debtor fails to pass the means test, the case is presumed abusive, therefore forcing the debtor to convert a filed Chapter 7 case to Chapter 13 case, or possibly resulting in a case dismissal.  A typical Chapter 7 case is essentially a liquidation usually completed in approximately 4 to 6 months resulting in a discharge of most types of debt.  The debtor is also entitled to keep exemptions as defined in the Bankruptcy Code at 11 U.S.C. §522.  In most circumstances, filing a Chapter 7 case, where an individual qualifies for that relief, is the preferable course of action.  Chapter 13 reorganization plans require debtors to devote their disposable income to repayment of debt over a three to five year period.  Unfortunately, many Chapter 13 debtors fail to complete their Chapter 13 plans and receive a discharge of the difference between what is paid under the plan and the total amount of debt owed.

The starting point for analysis of whether individuals qualify under the means test, but certainly not the entire test, begins with a state median income based upon family earners and the size of the family.  In New Jersey, the chart is as follows:

For cases filed on or after April 1, 2013, add $8,100 for each individual in excess of 4.

In addition to salary wages that individuals earn, tips, bonuses, overtime, commissions, and income from real estate, interest, dividends, royalties and pension and retirement income are included in the analysis.  To correctly apply the means test, a debtor’s average income over the six months immediately preceding the month in which the case is filed is compared to the state median income based upon a family of the same size.  A non-filing spouse’s income is also included in the means test.  In addition to income, the debtor’s actual expenses for food, apparel, services, personal care, healthcare, housing, and other non-mortgage expenses are included in the analysis based upon state and national standards.  This is not an exclusive list of expenses subject to the average national local standards, but secured debt expenses, vehicle expenses, and medical and health insurance payments are also factored in the analysis to determine if an individual passes the means test.

Strategic Considerations Related to Chapter 7 Means Testing