In Re Carlton

United States Bankruptcy Court, W.D. New York
211 B.R. 468, 1997 Bankr. LEXIS 1147, 1997 WL 429091 (1997)

ELI5:

Rule of Law:

A Chapter 7 bankruptcy case filed by an individual debtor whose debts are primarily consumer debts may be dismissed for 'substantial abuse' under 11 U.S.C. § 707(b) if the debtor has the 'ability to pay' their debts through a Chapter 11 or 13 plan by reducing excessive expenses, and the petition was not filed due to a recent catastrophic event.

Facts:

Donn and Donna Carlton (the Carltons), a married couple with two teenage children, had a combined gross annual salary of $114,634.20, with Donn employed at Eastman Kodak for 24 years and Donna at IBM for 17.5 years.
The Carltons reported $35,525.47 in unsecured consumer debts, including a personal loan, line of credit, and credit card balances, and had payroll deductions for 401-K and SIP contributions.
The Carltons owned a residence valued at $114,900.00 subject to combined mortgages of $104,268.55, resulting in minimal equity, and maintained three vehicles, including two 1989 Ford Pick-Up Trucks.
The Carltons claimed current monthly living expenses of $4,834.02, later amended to $5,192.27, which included $850.00 for food, $150.00 for clothing, $150.00 for recreation, and $75.00 for pet care.
Robert Kornfield (Dr. Kornfield), a physician, and Karen Kornfield (the Kornfields) had a gross annual income that fluctuated but was generally in excess of $276,000.00 (with past income over $425,000.00), and held pension plans valued over $390,000.00.
The Kornfields owed $584,694.00 in unsecured, non-priority claims, primarily from two mortgages on a previously owned and foreclosed residence ($332,680.00 and $175,983.92) and approximately $34,000.00 in credit card purchases.
The Kornfields leased two luxury vehicles and reported current monthly living expenses of $13,115.00, including $3,000.00 for home rent, $1,200.00 for food, $400.00 for clothing, and $4,470.00 for tuition expenses for their four children, two of whom had special educational and medical needs.
Neither the Carltons nor the Kornfields experienced recent catastrophic events such as serious medical problems, job loss, or business failure as the primary cause for their financial difficulties, with the Kornfields' problems stemming from the foreclosure of an extravagant home.

Procedural Posture:

Donn and Donna Carlton filed a petition initiating a Chapter 7 case on October 29, 1996, and filed their initial schedules with the U.S. Bankruptcy Court for the Western District of New York.
On January 7, 1997, after their Section 341 meeting of creditors, the Carltons filed amended schedules of income and expenses.
On February 4, 1997, the United States Trustee (U.S. Trustee) filed a motion requesting dismissal of the Carltons' Chapter 7 case pursuant to Section 707(b) for substantial abuse.
On February 18, 1997, the Carltons filed an Answering Affirmation in opposition to the U.S. Trustee's motion.
Robert and Karen Kornfield filed a petition initiating a Chapter 7 case on July 30, 1996, and filed their initial schedules with the U.S. Bankruptcy Court for the Western District of New York.
On September 5, 1996, the Kornfields' Chapter 7 Trustee conducted a Section 341 meeting of creditors, and later that day the Kornfields filed an amendment to their schedules.
On September 6, 1996, the Trustee objected to the Kornfields’ claim that their Pension Plans were fully exempt.
On October 28, 1996, the court entered an order granting the ex parte motion of the U.S. Trustee, extending the time for the U.S. Trustee to bring a substantial abuse motion.
On January 7, 1997, the U.S. Trustee filed a motion requesting dismissal of the Kornfields' Chapter 7 case pursuant to Section 707(b) for substantial abuse.
On January 23, 1997, the Trustee filed an Affirmation in support of the Kornfield Substantial Abuse Motion.
On January 31, 1997, First Union Home Equity Bank filed an Affirmation in support of the Kornfield Substantial Abuse Motion.
On February 7, 1997, the Kornfields filed opposition to the Kornfield Substantial Abuse Motion and a Memorandum of Law.
On February 11, 1997, the Trustee filed a Supplemental Affirmation, and the Kornfields submitted a supplemental response.
On February 12, 1997, the court heard oral arguments on both the Carlton and Kornfield Substantial Abuse Motions.

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Issue:

Does granting Chapter 7 relief to individual debtors whose debts are primarily consumer debts constitute a 'substantial abuse' under 11 U.S.C. § 707(b) when they possess the 'ability to pay' their debts through alternative bankruptcy chapters or by reducing excessive expenses, and did not experience a recent catastrophic event as the primary cause of their financial distress?

Opinions:

Majority - John C. Ninfo, II

Yes, granting Chapter 7 relief to individual debtors, Donn and Donna Carlton and Robert and Karen Kornfield, constitutes a substantial abuse under 11 U.S.C. § 707(b) because they possess the ability to pay their debts through alternative bankruptcy chapters or by reducing excessive expenses, and did not experience a recent catastrophic event justifying immediate Chapter 7 relief. The court adopted a 'blended approach' to analyze substantial abuse, which prioritizes the debtor's 'Ability to Pay' as the primary factor, followed by a 'totality of the circumstances' test to consider mitigating or aggravating factors, and finally assessing honesty and neediness. Regarding the Carltons, the court found their unsecured debt was primarily consumer debt and they had an 'Ability to Pay' due to their eligibility for Chapter 13, excessive and potentially extravagant living expenses (food, tuition, clothing, recreation), and stable, high-income employment. The court noted that reducing their expenses by approximately $610.00 to $942.00 per month (including voluntary 401-K contributions) would allow for a significant dividend to unsecured creditors in a Chapter 13 plan. The court also highlighted that their bankruptcy was not caused by a recent catastrophic event, Mr. Carlton's assertion about overtime capacity raised honesty concerns, and they appeared unwilling to reduce expenses. Regarding the Kornfields, the court similarly found their unsecured debt to be primarily consumer debt and that they had an 'Ability to Pay'. Although their substantial debt might make them ineligible for Chapter 13, they were eligible for Chapter 11, and Dr. Kornfield could fund a Chapter 11 plan with his post-petition personal service income. Their monthly living expenses were deemed excessive and extravagant, particularly for food, rent, and private school tuition, which the court found could be significantly reduced without depriving them of necessities. Dr. Kornfield's declining income was not a catastrophic event, but rather the consequence of changes in the healthcare industry and their own past extravagance. The court was concerned by their unwillingness to consider Chapter 11 or reduce expenses, highlighting their significant retirement funds as a potential source for repayment. The court concluded that allowing both debtors a Chapter 7 discharge would be a 'head start' for non-needy individuals, rather than a 'fresh start' for honest and needy debtors.

Analysis:

This case establishes a significant precedent in the Western District of New York for interpreting 'substantial abuse' under Section 707(b) of the Bankruptcy Code, moving beyond a sole focus on solvency. By adopting a 'blended approach,' the court emphasizes that debtors with the 'ability to pay' a significant portion of their consumer debts, even if they must adjust their lifestyle, may not be entitled to Chapter 7 relief. This approach prioritizes creditor repayment and the integrity of the bankruptcy system, potentially encouraging more debtors with significant disposable income to file under Chapter 11 or 13. Future cases will likely scrutinize debtors' income, expenses, and motivations more closely to determine whether a Chapter 7 filing represents a 'head start' for the undeserving rather than a 'fresh start' for the truly needy.

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