§ 1325(b)(2) - IRS Local Standards for Transportation Ownership/Lease Expense

In re Crews, Case No. 06-13117 (Bankr. N.D. Ohio February 23, 2007) (J. Harris). The Court wrote a combined opinion on whether the Chapter 13 Trustee’s Objection to Confirmation of two debtors’ respective Chapter 13 plans should be sustained where both debtors claimed transportation ownership/lease expenses under the Local Standards of the Internal Revenue Service for vehicles that they owned free and clear of any liens.

The Court overruled the Trustee’s Objections. The Court concluded that the debtors were entitled to claim the transportation ownership expense even for vehicles owned free and clear of liens, hinging its analysis upon whether the “Local Standards” promulgated by the Internal Revenue Service and incorporated by reference into 11 U.S.C. § 707(b)(2)(A)(ii) are (1) fixed allowances, or (2) merely caps for actual ownership expenses, whichever is less.

The Court concluded that the “Local Standards” were not caps but rather actual deductions allowed under the Bankruptcy Code. First, the Court examined the Advisory Committee Note to Forms 22A, 22B, and 22C, wherein it was stated that:

The IRS Local Standards provide one set of deductions for housing and utilities and another set for transportation expenses, with different amounts for different areas of the country, depending on the size of the debtor’s family and the number of the debtor’s vehicles. Each of the amounts specified in the Local Standards are treated by the IRS as a cap on actual expenses, but because § 707(b)(2)(A)(ii) provides for deductions in the ‘amounts specified under the . . . local standards’ the forms treat these amounts as allowed deductions. The forms again direct debtors to the website of the U.S. Trustee program to obtain the appropriate allowances.

Further, the Court noted that the Advisory Committee Note to Forms 22A, 22B, and 22C indicates: “The ownership/lease component [of the local standards for transportation] may involve debt payment.” The Court found that the use of the word “may” implied that, for some debtors, the ownership/lease component may not involve debt payment. Finally, the Court acknowledged that the Internal Revenue Manual did indicate that the transportation ownership standards are caps in the context of analyzing a taxpayer’s ability to pay, but, § 707(b)(2)(A) of the Bankruptcy Code only incorporates the “Local Standards” contained in the Internal Revenue Manual and not all of the detailed collection procedures contained in the Internal Revenue Manual. Thus, the Court acknowledged the split in bankruptcy courts on this particular question, however, the Court stated that it believed the better statutory analysis rested with the line of cases holding that the applicable Local Standards are fixed allowances, not caps.

COMMENT: We’ve previously seen in the Chapter 7 context that Judge Speer has decided that you can claim a vehicle expense without actually having a vehicle ownership expense. This time, however, this rule is applied to a Chapter 13 case. It still seems odd to this author that one can deduct an expense for something which is not actually an expense. I suppose one could always reason that the debtor might have to incur a vehicle expense during the pendency of the Chapter 13 proceeding, but it seems that an amended means test form could be filed once such an expenditure becomes necessary.

§ 706(a) - 6th Circuit BAP sets forth standards to examine good faith of proposed conversion from Chapter 7 to Chapter 13

Condon v. Smith (In re Condon), --- B.R. ----, 2007 WL 78980 (6th Cir. BAP 2007). The debtor was a professional photographer who was convicted of multiple counts of abuse of a corpse, which resulted from photographs he had taken of dead bodies at the coroner’s office. During the pendency of a class action lawsuit by the debtor’s victims, the debtor filed a voluntary petition for relief under Chapter 7. After the victims were granted relief from the stay, the debtor filed a motion to convert his case to Chapter 13 to avoid a potential nondischargeability determination under 11 U.S.C. § 523(a)(b). The victims objected and the debtor was forced to testify as to the circumstances that led to his bankruptcy filing and his reason for requesting the conversion. The court then denied the motion to convert.

On appeal, the BAP noted the split in the circuits as to whether a debtor has an absolute right to convert from a Chapter 7 to a Chapter 13 case,[1] but the BAP noted that most reported decisions regarding a request to convert focus on whether the right to convert is absolute and not the factors to be examined to determine good faith or lack thereof. Additionally, the Court noted that in most reported cases that have concluded that a debtor’s motion to convert may be denied for lack of good faith, the debtor’s behavior is almost always shockingly egregious. Thus, most courts, including the 6th Circuit Court of Appeals, have not had to closely examine the standard for determining whether a debtor’s motion to convert was filed in bad faith. Therefore, the BAP addressed this issue of first impression. The Court concluded that the same good faith standard shall apply when evaluating a debtor’s motion to convert to Chapter 13 as is utilized when considering dismissal of a case under 11 U.S.C. § 1307(c). Thus, the Panel concluded that bankruptcy courts should exhibit the same “reluctance” to deny a motion to convert to Chapter 13 that they employ when dismissing a petition for lack of good faith under § 1307(c), and the panel concluded that the burden of proving a lack of good faith in the context of 11 U.S.C. § 706(a) is on the party opposing the conversion.

In order to determine whether a debtor is in good faith seeking to convert from Chapter 7 to 13, the BAP Panel found that courts should apply the factors identified in Alt v. United States (In re Alt), 305 F.3d 413 (6th Cir. 2002). These factors include the following: 1. the debtor’s income; 2. the debtor’s living expenses; 3. the debtor’s attorney’s fees; 4. the expected duration of the Chapter 13 plan; 5. the sincerity with which the debtor has petitioned for relief under Chapter 13; 6. the debtor’s potential for future earnings; 7. any special circumstances, such as unusually high medical expenses; 8. the frequency with which the debtor has sought relief before in bankruptcy; 9. the circumstances under which the debt was incurred; 10. the amount of payment offered by the debtor as indicative of the debtor’s sincerity to repay the debt; 11. the burden which administration would place on the trustee; and 12. the statutorily mandated policy that bankruptcy provisions be construed liberally in favor of the debtor. Additionally, the BAP determined that a court might also consider factors that are typically used to determine whether a plan should be confirmed.

COMMENT: In addition to creating the requirement that the debtor must be seeking to convert in good faith in order to convert from a chapter 7 to a chapter 13 case, the courts have now created a 12 factor test to determine whether good faith exists. Neither are supported by a literal reading of the Code.


[1] See the blog entry of March 2, 2007, wherein the Supreme Court decision in Marrama v. Citizens Bank of Massachusetts, --- S. Ct. ----, 2007 WL 517340 (2007) is discussed that settled the split and determined an absolute right to convert does not exist.

§ 706(a) - UNITED STATES SUPREME COURT ANNOUNCES ABSOLUTE RIGHT TO CONVERT DOES NOT EXIST

Note: This is a departure from the familiar format wherein we discuss cases of interest from Ohio bankruptcy, district, and appellate courts, however, this case is of such importance that its discussion could not be omitted.

Marrama v. Citizens Bank of Massachusetts, --- S. Ct. ----, 2007 WL 517340 (2007). A split United States Supreme Court held that there is no absolute right to convert from a Chapter 7 proceeding to a Chapter 13 proceeding.

The debtor had made a number of misleading or inaccurate statements about his principal asset, a house in Maine, in his bankruptcy schedules. He had transferred the house to a trust, denied that a transfer occurred within the year preceding his bankruptcy filing, and denied that the house had substantial value. Subsequently, the debtor admitted that he had transferred the house to the trust to protect the property from his creditors.

After the trustee advised the debtor’s counsel, at the meeting of creditors, that he intended to avoid the transfer, the debtor filed a notice of conversion that was treated as a motion to convert by the bankruptcy court. The trustee and a creditor filed objections. The bankruptcy judge found that the facts established a “bad faith” case and denied the request for conversion. The Bankruptcy Appellate Panel for the First Circuit and the First Circuit Court of Appeals both affirmed on appeal.

In analyzing the issue, the Court reviewed subsections (a) and (d) of 11 U.S.C. § 706 and the legislative history. In reviewing the legislative history, the Court found that the broad description of the right to convert as “absolute” in Senate and House Committee reports fails to give full effect to the express limitation of § 706(d), which provides that “a case may not be converted to a case under another chapter of this title unless the debtor may be a debtor under such chapter.” Thus, the text expressly conditions a debtor’s right to convert on his or her ability to qualify as a Chapter 13 “debtor.” The Court went on to further find that the debtor in this case did not qualify as such a debtor under § 1307(c), which provides that a Chapter 13 proceeding may be either dismissed or converted to a Chapter 7 proceeding “for cause,” reasoning that courts routinely treat dismissal for prepetition bad-faith conduct as implicitly authorized by the words “for cause,” and thus, a ruling that an individual’s Chapter 13 case should be dismissed or converted to Chapter 7 because of bad faith is tantamount to a ruling that the individual does not qualify as a Chapter 13 debtor. Therefore, the Court held that § 706 does not limit a court’s authority to take appropriate action in response to fraudulent conduct by the dishonest debtor who has demonstrated that he or she is not entitled to the relief available to the honest debtor.

COMMENT: In this case the author thinks that the dissent has the better reasoning. Basically, the dissent's point is that the plain language of the statute provides an absolute right to convert, provided that two requirements are met: (1) that the case has not been previously converted, and (2) that the debtor may be a debtor under such chapter. The majority and dissent agree that § 109 contains requirements as to who may be a debtor and it sets out which people are not eligible to be a Chapter 13 debtor. On the other hand, § 1307 provides a mechanism by which a bankruptcy court may dismiss or convert a Chapter 13 case filed by a person who has acted in bad faith. This person is one who is eligible for a Chapter 13 filing but is undeserving of its protection due to various acts of bad faith, as determined by the court. Thus, § 1307 does not speak to who "may be a debtor under such chapter," and therefore, it does not have any bearing on the right to convert.