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Giving Congress What They Want, Not What They Wrote

posted by Bob Lawless

This morning, I was preparing for class with a new case that I had assigned, Perlin v. Hitachi Capital America Corp. (In re Perlin), No. 06-3199 (3d Cir. Aug. 3, 2007). Although the case came out a few weeks ago, I still wanted to post about it, because the case shows how the post-2005 U.S. bankruptcy law often can be a "heads I win, tails you lose" proposition for consumer debtors. The court seemed to go out of its way to interpret ambiguities in the statute against the interests of consumer debtors and hands large financial institutions a potentially troubling tool to use against consumers in bankruptcy court. With all of the lobbying that went into the 2005 bankruptcy bill, one might think that ambiguities would best be resolved against the consumer credit industry as they are the ones with the clout to get changes in the law. Interestingly, the court might have taken its cue from the position of the United States Trustee, who filed an amicus brief on behalf of the financial institution. (I wonder how many appellate court amicus briefs the U.S. Trustee files on behalf of consumer debtors?)

Because the case revolves around the interaction of several different subsections of the Bankruptcy Code, some explanation is in order. As Jon Stewart once said (paraphrasing here)--"Yes, it's boring. That's why they can get away with it." Nonetheless, I'll try to keep it brief.

Under section 707, there are two grounds to dismiss a chapter 7 bankruptcy case:

(a) in all cases including consumer cases--"for cause" including unreasonable delay, failure to pay fees, or failure to file required schedules
(b) in consumer cases only--for "abuse"

The means test, about which so much has been written, technically only creates a presumption of abuse if the debtor has (in most cases) $100 in monthly disposable income left to pay creditors, but it can be a difficult presumption to overcome. The means test itself is three pages of densely worded, complex statutory language that incorporates densely worded, complex regulation from the IRS. Debtors who fail the means test must convince the bankruptcy court that they had "special circumstances" that the law did not contemplate. (§ 707(b)(2)(B))

In Perlin, the debtors were not very sympathetic, which maybe influenced the court. One was a licensed radiologist earning over $370,000 per year on a part-time basis. As the court put it, "Together, the Perlins expended a considerable amount of money on certain luxury items, such as two Lexus automobiles and private school tuition totaling $5,000 per month." The Perlins had filed bankruptcy after their medical imaging business failed and after Hitachi Capital came around looking for them to make good on the guaranty they had signed to ensure payment on leased imaging equipment.

Hitachi Capital moved to dismiss the debtor's bankruptcy, not because a presumption of "abuse" had arisen under 707(b) but on the more general ground of "good faith" under 707(a). Under Hitachi Capital's reasoning, the debtors' ability to repay some of their debts meant their bankruptcy filing was in "bad faith." This would seem like a losing argument as ability to repay would seem to be covered under the "abuse" standard of 707(b). It was as if Hitachi Capital was asking the court to give creditors two bites at the apple--if the specific tests of 707(b) did not indicate an ability to repay, then Hitachi Capital wants to use 707(a) to create a free-floating test of substantial ability to repay that a bankruptcy court can use in its discretion to get rid of bankruptcy cases. Amazingly, the Third Circuit agreed with Hitachi Capital.

A major problem with Hitachi Capital and the court's position is that section 707(b)(3) already says that where the means test does not create a presumption of abuse, the bankruptcy court may consider bad faith or the totality of the circumstances to decide that abuse exists anyway. The court's decision makes 707(b)(3) superfluous. I cannot find a reference to that section in the court's opinion, which makes me wonder whether the court was aware of it.

One possibility does exist and that is to carefully note that the 707(b) test of abuse only applies in cases where the debt is primarily consumer debt. Because the Perlins had such a large guaranty connected with their business, it may be likely that they did not have primarily consumer debt. Then, the court should have limited its holding to non-consumer cases, although such a holding would leave a small business owner in bankruptcy in worse shape than a consumer (not something most members of Congress would have wanted).

As written, the court's opinion would apply to all bankruptcy cases, consumer and business, and would leave a free-floating "bad faith" rule in place with which creditors could deploy against consumers. This would not be the first time that a generalist appellate court has blundered with the specialized bankruptcy law, unwittingly creating precedent that gives creditors a huge hammer against consumers. On this occasion, we might be particularly concerned. In creating the means test, Congress was very careful in delineating who could bring motions for "abuse," limiting the ability to bring such a motion when the debtor fell below the state's median income. By creating a free-floating "bad faith" rule creditors can deploy outside the means test, the court gave creditors a weapon they can use against below-median income consumer debtors. To be fair, the court does not say that the ability to repay some debt is bad faith--the ability to repay would have to be substantial. The creditors may not win a lot of those cases, but it will be one more motion that large financial institutions can use to wear down consumers in bankruptcy court.


Bob -- I'm glad you posted on this case. I am aware of it and too was most surprised by its omission of reference to 707(b)(3). Not one of CA3's better outputs.

You left out the punch line--in spite of creating a free-floating bath faith rule, the 3d Cir. found there was no abuse in the particular case. Also Isaac Lidsky, who argued the case on behalf of the UST, was well-trained in bankruptcy law at Harvard and clerked for Tom Ambro on the 3d Cir.

Considering the result was not to dismiss the case, I don't find it so analytically troubling. My read of the case was simply that the court wants bankr judges to have as much flexibility as possible to dismiss truly "egregious" cases even if the precise statutory criteria are not present. That's neither unprecedented nor unwise. If you look at the 3rd Cir opinions on dismissing chap 11 cases, such as Integ Telecom Exp, cited in the opinion, and its predecessor, SGL Carbon, you see the court taking a similar stand in favor of a free-floating (to use your words) power to dismiss 11's as well. If you think about the circuit's supervisory relationship to the very active Del. forum, it is reasonable for them to lean in favor of guiding bankr judges to dismiss extreme cases. Finally, if you consider bankr law in its overall context as an exception to commercial and contract law, it is not unwise to hand bankr judges a free floating power to dismiss "egregious" cases, just as it was not unwise to allow Judge Lifland to use 105's free floating power to enjoin suits against third parties to resolve the first asbestos cases. Judges should have a residual power to handle the most extreme and unforeseen problems, subject to abuse of discretion review

There is hope. In the Souther District the US Trustee has started investigations into the way certain Mortgage co. have been conducting themselves. Hasn't made it to the cir. yet but fireworks went off in court this last tuesday 2/19/2008. Adv. 07-07007 and Mcallen Bankruptcy 03-70543. Havent found the cite yet but I hear its In Re: Clancy as well.

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  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless (rlawless@illinois.edu) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.