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Means Test Fail

posted by Bob Lawless

As has been widely reported, the football coach of the University of Arkansas Razorbacks, John L. Smith, has filed chapter 7 bankruptcy. ESPN summarized his financial circumstances:

Arkansas coach John L. Smith is trying to wipe away $25.7 million in debt in bankruptcy court and hang onto $1.2 million in retirement accounts and some personal property . . . .

Smith was coaching Louisville when he began investing in real estate, which he has said, was profitable until land values took a nosedive. Smith filed for Chapter 7 bankruptcy on Sept. 6, and court papers filed Wednesday detail the depth of his financial losses.

As of the filing, Smith had received $115,000 from his 10-month, $850,000 contract with Arkansas, plus $35,643 from his alma mater, Weber State, which he left before coaching a game to return to Fayetteville after Bobby Petrino's firing. He also picked up $9,810 from Nike and $1,057 from a football camp, according to the court documents.

Smith has two retirement accounts, each worth about $600,000, which his filing lists as exempt from liquidation, along with household furnishings.

If you want to see for yourself, Smith's bankruptcy schedules are availabe at Scribd.

In 2011, the median chapter 7 debtor had $32,556 in annual income. WIth an $850,000 salary, Smith is certainly not the typical chapter 7 filer, and the Bankruptcy Code will protect his future salary. Moreover, Smith's principal assets--his retirement accounts--are exempt from the bankruptcy process. Thus, barring any hiccups, Smith should be able to walk way from $25.7 in million debts with a substantial salary and retirement savings.

Granted, Smith's salary would cover only a small percentage of his $25.7 million in debts, but it is still a nontrivial sum in absolute terms. Smith would seem to have the capacity to make some partial repayment to creditors. Congress should do something to deal with "can pay" debtors using the bankruptcy system to walk away from obligations where they can make some repayment.

Oh, that's right, Congress did make these changes in 2005, adopting a "means test" that was supposed to direct people into a chapter 13 repayment plan when they had the capacity to repay. The means test, however, does not apply to Smith because his debts are related to a business and not "primarily consumer debts." Even the general standard of dismissal of a chapter 7 for "abuse" does not apply.

On the other hand, a single Arkansan like Smith with consumer debts and with an income over $35,283 potentially gets caught in the means test web. Congress was quick to go after $35,000/year debtors but did almost nothing to deal with cases like Smith's. The financial industry was lobbying against their credit card customers not persons who can afford to participate in high stakes real-estate partnerships. Congress listened to the lobbyists. The game does seem to be rigged against the middle class (to quote Elizabeth Warren . . . whatever happened to her after she left the blog?).

No blame attaches to Coach Smith. He is only doing what the law permits him to do. Smith's case is a reminder that, although almost seven years have passed since the 2005 bankruptcy law went into effect, it still needs fixing.

And, it is possible that there may still be a move to dismiss Smith's chapter 7 case given his apparent ability to repay at least some of his debt. Courts have sometimes read a "good-faith" filing requirement into chapter 7, which makes sense as a policy matter but is hard to justify as a matter of sound statutory interpretation when Congress has so clearly spoken on the issue of who belongs in chapter 7. There is the related question of how it is "bad faith" to do something permitted by statute. Yeah, the courts can "fix" the problem, but if the courts shoud just fix the statute's problems, why do we have a statute? In class, I refer to this idea as the "Bill & Ted" problem. If we can trust the courts to do what is right, why don't we just have one statute that reads "Be excellent to each other." Once you commit to the idea that the legislature writes the rules, the courts have constraints.

Hat tip to my former student Dimitris for both directing me to the story and for the subject line.


I think there are actually good cases to be made here under Sections 706(b) and 707(a).

First, let’s look at the Debtor’s income and expeses. He claims $5,000 a month on attorney fees, $11,666 a month for a Dr. Juneja, $100 a month on a Fifth Third loan, $2,000 to American Express, $117 a month in credit card fees, and $60 a month in credit protection. This $18,943 should no longer be payable due to the automatic stay.

That alone is enough to make him show positive income each month, notwithstanding some rather egregious expenses, including $1,000 a month on recreation, $200 a month on holidays, $300 a month on CPAs, $1,000 a month on gifts, $290 a month on grooming, and $200 a month to savings.

This $2,990 could also be increased by some excessive expenses (e.g. $2,000 a month on food, $300 a month on unexplained business expenses). Thus, we have between $21,933 and about $22,500 to contribute toward creditors.

As to Schedule I, where does the $19,856 figure come from? The $115,000 received divided by 6 I presume, but should his income be calculated on Schedule I in the same means as it would be on B22A? A forward looking projection ($850,000/year = $70,833/month) is arguably superior. In short, his income and expenses are somewhere between willfully false and recklessly inaccurate. I'm assuming even Southern football coaches don't get to live this large.

Creditors should look to 706(b), which permits conversion from Chapter 7 to Chapter 11 at any time on a motion by a party in interest, with language markedly different from 706(c), which does not permit conversion to Chapter 12 or Chapter 13 without the Debtor’s consent. Traditionally, it has been read to only apply to corporate debtors. In re Graham,21 B.R. 235 (Bankr.N.D.Iowa 1982). It has been more recently applied to individual debtors as well. In re Lenartz, No. 01-40268, 2001 WL 35814401 (Bankr. D. Idaho May 3 2001) (finding Congressional awareness of the issue following Graham in 1982 and a failure to correct in 1994 decisive). After BAPCPA and Marrama v. Citizens Bank of Massachusetts,549 U.S. 365 (2007), this argument is only strengthened. Moreover, as the Debtor is ineligible for Chapter 13 under 109(e), and his debts are business debts, precluding analysis under 707(b), this argument becomes particularly powerful.

If this fails, creditors should consider 707(a), which authorizes dismissal for cause, but "the statute does not define ‘cause’, beyond setting forth three specific examples. Use of the introductory word “including” means that these three types of “cause” are nonexclusive.” Huckfeldt v. Huckfeldt (In re Huckfeldt), 39 F.3d 829, 831 (8th Cir. 1994). The Debtor’s ability to repay debts should not serve as cause. Id. (citations omitted). Dismissal should only be permitted where the in “egregious cases.” In re Zick, 931 F.2d 1124, 1127, 1129 (6th Cir.1991).

The 8th Circuit is admittedly not the most hospitable jurisdiction for this argument, and Huckfeldt seems to limit it to cases of prepetition bad faith. Here, while the Debtor seems to have timed his filing and manipulated his schedules to maximize his chances at a discharge, the only real argument is his ability to repay. However, his case does cry out for some relief.

This raises a real issue. What if a Debtor makes a ton of money, has few expenses, and only has business debts. Can he really file for Chapter 7, and there is no way to touch him because of his debts? I wouldn’t be surprised to see a court work out some relief.

Still, calls to fix the Code following BAPCPA are appreciated, though this one seems to be more toward yet more tightening of eligibility for Chapter 7.

If this is your biggest issue with the brown-acid experience that is the means test, I don't know what to say. As for Smith, this is what he gets for dumping Utah State.

It is not my biggest issue, Knute, just one of many issues I have with the mean test.

His Schedules I and J do seem, as Doug so succinctly states, willfully false or recklessly inaccurate. Given the meticulous itemization in his Statement of Financial Affairs, I lean towards the former.

While Doug references creditors acting, this seems a pretty good opportunity for the U.S. Trustee to step in and protect the integrity of the bankruptcy system.

If he is granted a discharge under Chapter 7, then I think I give up on America.

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