What is an abusive bankruptcy filing? When does a bankruptcy court consider a debtor’s Chapter 7 filing to be an abuse of the bankruptcy process?

A bankruptcy court will look at whether the person filing the bankruptcy acted in bad faith and at the entire circumstances surrounding the debtor’s financial situation.

A Florida court addressed this issue in a recent case. Not only were the debtors living what the court considered to be “an extravagant lifestyle” both before and after their filing, but they also failed to disclose all relevant information in their bankruptcy filing.

Among other factors, the court found the following to be especially significant – the debtors:
1) Initiated a lease on a luxury car – an Infiniti – the month before filing for bankruptcy;
2) Timed the filing to be right before a significant raise in income;
3) Had excessive withholding of their Federal taxes and increased 401(k) contributions;
4) Transferred property and/or money right before and after filing for bankruptcy;
5) Tried to hide cash from the bankruptcy court; and
6) Spent a lot of money on day trading, brokerage fees, restaurants, and non-essential purchases.

The court also examined whether the debtors were able to pay their unsecured debts. With disposable income of over $3000 per month left over after monthly expenses, the court found that yes, these debtors would be able to pay back about 54% of their unsecured debts over about 60 months.

Primarily because the debtors could repay a significant portion of their unsecured debt, the court found that it would be an abuse of Chapter 7 to give them relief under that chapter. But the court took other factors into account, such as:
1) One of the debtors was experienced in financial matters and they both had experience with Chapter 7;
2) The debtors timed their filing to take place just before a raise in income;
3) They transferred money and/or property before and after their bankruptcy filing;
4) They made no effort to reduce expenses and live “a luxurious lifestyle”;
5) They decided to keep and pay on 3 luxury vehicles that had no equity;
6) They make large mortgage payments on a house that has no equity;
7) The debtors increased their monthly vehicle obligations right before filing;
The debtors provide a rent-free home to two relatives, whose utilities they also pay; and
9) Their bankruptcy filing was not the result of an unexpected or catastrophic event.

The debtors’ Chapter 7 case was dismissed and they were given time to convert their case to an appropriate chapter of the Bankruptcy Code.

The factors listed above, taken together, are enough to probably make any bankruptcy court sit up and take notice – in a bad way. The existence of just one of these factors might not be enough to lead to dismissal of a Chapter 7 case, but it really depends on the individual facts of each case.

This post is based on In re Ricci, Case No. 6:09-bk-00914-ABB, (Bankr., Middle Dist. Fla., Orlando Div. 2009).

If you are looking for a New Jersey bankruptcy lawyer, please call (201) 676-0722.

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The whole issue of whether you should repay someone to whom you owe money before you actually file for Chapter 7 bankruptcy is more complex than it looks at first glance. I introduced the issue in a previous post about repaying debts before bankruptcy, but there is a lot of detail here that is worth examining.

You may recall from my previous post that if you repay someone you owe money (whether it’s American Express or your Aunt Sally) just before filing for bankruptcy, and the total repayment is $600 or more, the bankruptcy trustee could take back that money from your creditor.

The trustee will look back only 90 days before your filing to see if you repaid any ordinary creditors, such as American Express. But for creditors like your Aunt Sally, the trustee will look back a year before your filing for repayments that they can take back. If the trustee finds loan repayments and takes them back, they can be used to repay your other creditors. The money doesn’t go back to you.

A loan repayment made before bankruptcy that the trustee can take back is known as a “preference” or a “preferential transfer.”

But even when the trustee decides that a payment made to a creditor before a bankruptcy filing was a preference that they can take back, there are defenses that might be applicable. Two of these defenses are: 1) The earmarking defense and 2) The new value defense.

The earmarking defense is available when someone provides you with money to re-pay one of your existing creditors.

In a recent decision the Third Circuit Court of Appeals found that certain things need to be present for the earmarking defense to work: 1) An agreement between you (the debtor) and the person providing you with the money stating that the new money will be used to pay the prior debt; 2) Performance of the terms of the agreement; and 3) This transaction does not reduce the value of the debtor’s estate.

The idea behind the earmarking defense is that the debtor never had an interest (in the sense of a property interest) in the funds to begin with.

The second defense is the “new value” defense. In the same decision mentioned earlier, the Third Circuit said that for the new value defense to apply, you need: 1) A preferential transfer; 2) After receiving the preferential transfer, the creditor makes a new loan to the debtor – this new loan must be unsecured; and 3) As of the bankruptcy filing date, the debtor has not yet repaid the new loan to the creditor.

An example of when the new value defense is available would be when you repay your Aunt Sally the $2500 she loaned you and then your Aunt Sally makes a brand new $2500 loan to you that you had not yet repaid by the time you filed for bankruptcy. It’s basically like reversing the loan repayment.

The Third Circuit decision I referred to above is Shubert v. Lucent Techs. Inc. (In re Winstar Communs., Inc.), 554 F.3d 382 (3d Cir. 2009).

If all this is confusing to you and you don’t know what to do, remember this: Seek advice from a bankruptcy attorney before repaying any loans to anyone in any amount, whether it’s American Express or your Aunt Sally or anyone in between! If you’d like, give me a call at 201-676-0722.

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Can you repay a debt to a friend or a creditor before you file for bankruptcy? Yes, you can, but it’s not necessarily a good idea because that repayment may be what bankruptcy law calls a “preference” or a “preferential transfer.”

After you file for bankruptcy, preferential transfers may be taken back by the trustee. Determining whether or not a transfer constitutes a preference is very fact-specific, but bankruptcy law defines a preference as a payment (not necessarily of money) made to or for the benefit of a creditor for a debt previously owed while the debtor was insolvent. To be a preferential transfer, the transfer must be made within the 90 days before filing. Except that if the transfer was made to an “insider” (such as a relative), the trustee can look at transfers made within the year before the bankruptcy filing.

But when you buy something at the grocery store, for example, that’s not a preference because it is a contemporaneous exchange for value. You are immediately getting something in return for your payment.

Section 547 of the bankruptcy code, which governs preferential transfers, contains many other exceptions to the definition of preferential transfers and as mentioned above, the analysis of whether a transfer is a preference is fact specific. If you are thinking of repaying anyone to whom you owe money before filing for bankruptcy, stop and consult an attorney first. My email address is: jweil@jenlawyer.com.

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