lose your job, file chapter 7, get a job, lose your chapter 7

From Law.com
Courtesy of Gloria B.K. Norton

By John Council
Texas Lawyer
08-01-2006

A recent 5th U.S. Circuit Court of Appeals decision that gets tough on debtors who file for Chapter 7 bankruptcy protection may have some unintended consequences.

In a case of first impression in the nation, the 5th Circuit found that a bankruptcy court can consider post-petition events -- particularly a debtor's changed employment status -- when deciding whether to dismiss a Chapter 7 petition.

Bankruptcy courts traditionally have looked only at debtors' financial situations as of the day they filed their petitions in determining whether debtors qualify for debt relief -- a notion the 5th Circuit is moving away from, three bankruptcy attorneys say.

But the ultimate message of the 5th Circuit's July 20 decision in Cortez, et al. v. United States Trustee may be to encourage unemployed debtors who file for Chapter 7 to stay unemployed until the bankruptcy is final.

Debtors often favor Chapter 7 bankruptcy, because it allows them to clear their debts after liquidating their assets and distributing the proceeds among creditors.

Last year, Congress tightened the filing requirements for Chapter 7 in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Among other things, the act requires that before filing for Chapter 7 protection, debtors must determine if they pass a means test that evaluates their finances for the six-month period prior to the filing.

The Cortez decision involves Carlos Vincente Cortez and his wife, Suzanne Hallman Cortez, who filed jointly for Chapter 7 bankruptcy protection on April 8, 2004, in a U.S. Bankruptcy Court in the Northern District of Texas. The Cortezes had owed $176,000 in secured debt on their homestead and $85,719 in unsecured debt -- most of which consisted of credit card charges -- according to the 5th Circuit opinion.

At the time of the filing, Carlos was unemployed and Suzanne worked as a registered nurse. Their monthly expenses exceeded their monthly income, which qualified them for Chapter 7 relief under pre-reform laws, according to the opinion. But four days after they filed their bankruptcy petition, Carlos was offered a position making $95,000 a year as a human resources director of a company. He accepted the job. That income made the couple's monthly income higher than their monthly expenses, the 5th Circuit wrote.

After the Cortezes provided documents related to Carlos' new employment to Chapter 7 trustee John Spicer during a creditors' meeting on May 10, 2004, the U.S. trustee, William Neary, filed a motion to dismiss their petition under 11 U.S.C. §707(b), the statute that governs bankruptcy dismissals.

Neary asserted in a motion to dismiss that the Cortezes "appear to have the means to repay a substantial portion of their debts through a Chapter 13 plan" and that it would be "substantial abuse" under §707(b) to grant the Cortezes relief under Chapter 7, according to the 5th Circuit opinion.

Chapter 13 bankruptcy allows debtors to reorganize their finances and pay off debtors over a period of years -- a plan that is less desirable to some debtors.

U.S. Bankruptcy Judge Michael Lynn of Fort Worth denied the trustee's motion to dismiss concluding that "post-petition events should not be considered in deciding whether to dismiss a case under section 707(b)."

Lynn determined that he could only consider the Cortezes' financial circumstances as they existed on the date they filed their bankruptcy petition.

U.S. District Judge John McBryde of Fort Worth reversed Lynn, holding that the language of §707(b) makes clear "that post petition events are to be taken into account in ruling" on whether to dismiss a bankruptcy petition.

The Cortezes appealed that decision to the 5th Circuit.

The 5th Circuit affirmed McBryde's decision and remanded the case to Lynn for further consideration.

The 5th Circuit, in an opinion written by Judge Carolyn Dineen King and joined by Judges Carl Stewart and James Dennis, found that §707(b) does not contain language limiting consideration of ongoing developments in a debtor's financial situation. Section 707(b) suggests that bankruptcy courts can consider subsequent developments in a debtor's financial condition -- excluding charitable contributions -- when determining whether to dismiss a Chapter 7 petition.

"Given that post-petition events should be considered up until the date of discharge, we remand this case to the district court with the instructions to return it to the bankruptcy court," King wrote.

The opinion "will tell someone who's lost a job before a bankruptcy, 'don't get a job before bankruptcy is over,' " says Behrooz Vida, a partner in Bedford's Venable & Vida who represents the Cortezes. "It's just so contradictory. That's the problem."

On remand, Vida believes his clients will still be able to qualify for Chapter 7 bankruptcy -- especially since Carlos is unemployed again, and the judge will view the Cortezes' 2-year-old case by the less strict pre-bankruptcy reform act standards.

But Vida believes Cortez will impact post-reform Chapter 7 cases filed by unemployed people, because trustees likely will move to dismiss cases in which a debtor becomes employed during the pendency of a bankruptcy.

"I would have to tell a client if you get a job, you may end up in a 13. By that I mean anyone who [should] qualify as a 7," Vida says.

Jane Limprecht, a spokesperson for the U.S. Trustee Program, declines to comment on the opinion.

MEANS TESTING

Some lawyers believe Cortez is part of an overall trend at the 5th Circuit putting the cases of debtors who pursue Chapter 7 protection through a more rigorous examination before granting them bankruptcy relief.

For example, in 2001's Zibman, et al. v. Tow, the debtors argued that proceeds from the pre-petition sale of their homestead should be protected from creditors in a Chapter 7 proceeding. Texas Property Code §41.001 gave them protection because it prevents seizure of proceeds from the sale of a homestead for six months after the sale of the property, the debtors maintained. But the 5th Circuit ruled that the debtors had to reinvest those proceeds in another homestead within that six-month period for the money to be protected.

In Cortez, the court looked forward in time to determine whether the debtors qualified for Chapter 7 protection, says Hal Lusky, a consumer bankruptcy attorney with Dallas' Lusky & Associates.

"We have always, historically, looked at bankruptcy as being a snapshot in time," Lusky says. "And the 5th Circuit has been chipping away at that pretty regularly."

Areya Pronske, an Irving consumer bankruptcy solo, says means testing -- which, under the 2005 bankruptcy reforms, requires debtors to evaluate the past six months of their finances before qualifying for Chapter 7 -- will combine with the Cortez opinion to make for rough going for some debtors.

"There's some irony here because of 707(b) and means testing," Pronske says. "They want to go back six months [with means testing], but now they want to go forward" with §707(b) analysis, she says, referring to the 5th Circuit.

"There seems to be something inherently unfair about that," Pronske says.

Trustees always inquire about debtors' employment status, says Corky Sherman, a Chapter 7 trustee in the Northern District of Texas and a partner in Dallas' Sherman & Yaquinto.

"It's a boilerplate question. But now it's an even more important question" because of Cortez, Sherman says.

But Sherman does not believe Cortez will have much of an effect on the thousands of debtors seeking Chapter 7 protection in the 5th Circuit's jurisdiction, which includes Texas, Louisiana and Mississippi.

"I would say ... a very small percentage of people are going to be unemployed for five or six months and then get a job that drastically alters their ability to get a Chapter 7 bankruptcy," Sherman says. "It just doesn't happen very often."

Carey Ebert, a Chapter 7 trustee in the Northern District of Texas who also is vice president of the National Association of Consumer Bankruptcy Attorneys, fears Cortez will lead to absurd results.

"You could win the lottery on the day after filing [and a trustee] can't look at that," Ebert says. But a person who has the good fortune of getting a job after filing could have his or her Chapter 7 petition dismissed, she says. "Isn't that ridiculous?"

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