Will My Ohio Chapter 13 Bankruptcy Be Approved? The Lesson of In re Lofty

Living Paying for the Dream: In re Lofty, 437 BR 578 (S.D. Ohio 2010)

What does it mean to act in “good faith?” When evaluating whether to approve Chapter 13 bankruptcy plans, the court is forced to answer this question.

Does it matter if the chapter 13 debtors mean well? Is the main issue their personal intention or something else?

In the case of Chapter 13 bankruptcy, it’s the latter. Personal intention is nice, but in order to approve a plan, the court wants to see objective good faith. In bankruptcy court, a “reasonable person’s hypothetical state of mind” determines the good or bad faith of a plan. In re Lofty, 437 B.R. 578, 587 (S.D. Ohio 2010), quoting In re Mandalay Shores Coop. Hous. Assoc., Inc., 63 B.R. 842, 847-48 (N.D. Ill. 1986).

The Story of the Lofty’s

The Lofty’s, Ohio residents, were living their dream. They had worked hard, raised a family, and finally retired. They owned several pieces of property in Ohio and around the country. They purchased a motor home and spent half the year in Ohio with their daughter and her family and half in warmer climes such as Texas or Florida. Unfortunately, their finances were less idyllic than their lifestyle.

Expenses Force the Family into Bankruptcy

The Lofty’s purchased the property on which their daughter and her family lived because she didn’t have the credit to obtain a mortgage on her own. She did, however, pay for the mortgage, the taxes, and the insurance. So far, so good. The Lofty’s also purchased a piece of property for their son; he and their adult grandson lived there and paid $600 monthly rent. That property cost $1,100 monthly to maintain. Maintaining their own motor home cost about $2,000 monthly and they paid mortgages on other properties on top of that. With expenses piling up, their bills got the best of the Lofty’s and they filed for Chapter 13 bankruptcy.

Disposable Income in Chapter 13 Bankruptcy

Filing for Chapter 13 bankruptcy means filing a plan for repayment with the court. That plan usually lasts for five years. The value of the assets underlying secured claims, such as home mortgages and auto loans, must be paid in full. Debtors pay unsecured claims, like credit card debt, from their disposable income after paying secured creditors. Disposable income is defined as monthly income less reasonable expenses, including supporting dependents. 11 U.S.C.A. § 1325(b)(2).

Deduct the Cost of a Motor Home?

The Lofty’s earned almost $6,700 monthly in Social Security benefits, workers compensation, and retirement income. Their monthly expenses ran around $4,000. After several modifications, they proposed a plan in which they would pay about $2,700 toward their debts. They would surrender all of their real estate except those two lots on which their children lived and they would keep their car and motor home. Lofty, 437 B.R. at 582.

The Trustee Objects

Their bankruptcy trustee objected to this plan – he wanted to deny deductions for the cost of supporting their adult son and grandson. He also argued that the plan was proposed in bad faith – the Lofty’s should sell their motor home and live on one of their parcels of land. Without those costs, the Lofty’s would spend around $2,500 monthly supporting themselves. That would be an extra $1,500 monthly to pay to creditors. Id. at 590

Are Grown Children Dependents?

The Lofty’s only claimed their son and grandson as dependents in their bankruptcy plan, not on tax returns or other formal documentation. In legalese, a “dependent” has a very specific meaning. It does not include adult children of ordinary competence, especially when that person isn’t claimed as a dependent for the benefit of the IRS. The Lofty’s felt they had a moral obligation to support their descendants, but “more than a purely moral obligation is required to qualify as a dependent. Id. at 585. In Chapter 13 bankruptcy, all disposable income must be directed toward payment of debts or support of the debtors and their dependents. 11 U.S.C.A. § 1325(b)(1)(B). The Lofty’s violated this rule by attempting to continue supporting their son and grandson.

Objective Good Faith

In addition to the technical evaluation of allowable deductions and expenses, the court looks into the “good faith” of the plan. Different decisions have set out twelve- and fourteen-part tests to determine whether a plan is proposed in “good faith,” but the court “cannot here promulgate any precise formulae or measurements to be deployed in a mechanical good faith equation.” Lofty, 437 B.R. at 586, quoting In re Okoreeh-Baah, 836 F.2d 1030, 1033. Pedantism aside, the question of good faith is, as far as the law is concerned, an objective one. The court evaluates whether a reasonable person would propose a plan such as the debtors’ in good faith.

According to the court, the Lofty’s acted either in bad faith or unreasonably. A plan that kept the motor home did not qualify as “a sincerely-intended repayment of pre-petition debt.” A debtor acting in good faith would have sold the motor home, which only depreciated in value, and lived on one of the parcels of real estate. The court also rejected the Lofty’s attempt to “support family members at the expense of the nonpriority unsecured creditors.

Plan Rejected

Their plan was going to be rejected and the Lofty’s couldn’t resist throwing one last barb at the court. They threatened to stop all payments on unsecured loans. Ordinarily, that’s an empty threat. The Lofty’s, however, received all of their income from Social Security, worker’s compensation, and retirement income – they claimed that all of these are exempt from collections. The court chose to ignore this threat; nonpayment would be handled under nonbankruptcy law. Of course, they ruined their attempted argument for good faith by making such a claim. So, the court denied the Lofty’s plan.

The Lofty’s teach us several important lessons. First, “reasonable” living expenses are not necessarily the same as current living expenses. You may have to give up your dream of roaming the country in an Airstream if you can’t pay your bills. Second, only people who are legally dependent on you can be claimed as dependents for bankruptcy purposes. The Lofty’s son suffered from depression and their grandson was a firestarter; that didn’t make them dependent. Usually, only minor children and elderly parents may be claimed as dependents. Finally, don’t threaten the court. There’s no reason to create ill will by threatening to refuse to pay (or threatening anything at all). Whatever “good faith” is, it’s not that.