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Consumer Debt

What Is Consumer Debt in Bankruptcy?

When someone is struggling with debt, filing for bankruptcy may be the best option to get a financial fresh start. However, the type of debt that a person has may affect what bankruptcy chapter they are qualified to file for. Title 11 U.S.C. § 101(8) defines consumer debt as “debt incurred by an individual, primarily for a personal, family, or household purpose.” Any other debt not incurred for those purposes is considered non-consumer debt. Typically, this non-consumer debt is business debt, but it may be other non-consumer-based debt such as tax debt, debt incurred by negligence and not covered by insurance, or most medical bills.

The distinction between consumer and non-consumer debt is extremely important in bankruptcy, since the Means Test (under 11 U.S.C. § 707) can restrict certain debtors from qualifying to file for Chapter 7 bankruptcy. The Means Test is basically a budget test calculated under the Bankruptcy Code. With very few exceptions, all of a debtor’s household income must be included when calculating the Means Test. If a debtor’s household income is below the median for their household size in their state, the Means Test does not apply, and they may qualify for Chapter 7 Bankruptcy. However, if their household income is higher than the applicable median income figure, then they are subject to the Means Test and must perform the calculation to determine if they qualify for Chapter 7.

On the expense side of the Means Test, most of a debtor’s household expenses are substituted with the IRS living expense allowances for the county in which they live. Section 707 of the Bankruptcy Code does allow some actual expenses, such as mortgage and car payments, child support, maintenance or alimony, and charitable contributions, but not many others. If the debtor’s Means Test results’ show a surplus of income that could fund a Chapter 13 plan, they have failed the Means Test  and are restricted to filing for Chapter 13 bankruptcy. In a Chapter 13 bankruptcy filing, the debtor would be required to pay back at least a portion of the debt they owe over a Court-approved payment plan, (which is typically 60 months) while in a Chapter 7 case, the debts are eliminated with no payment plan required.

Since the Means Test only applies in cases where the majority of debt is “consumer based”, it is important to determine whether a debtor has a majority of consumer-based debt or not. If the majority of debt in a bankruptcy are classified as non-consumer, then the Means Test does not apply, and such a debtor may qualify for Chapter 7 bankruptcy. However, a debtor must still accurately disclose their income and expenses on Schedules I and J, which are filed with their petition. In the budget on Schedule J, if a debtor still has a meaningful surplus of income after factoring in their accurate income and typical expenses, they would still be required to file for Chapter 13 bankruptcy. In the alternative, if they break even or are in the negative, a debtor may qualify for Chapter 7 bankruptcy. With respect to the expenses, they still must be “reasonable”, or the U.S. Trustee that has been assigned to their case may challenge the dischargeability of their debt as an abuse of the bankruptcy system or seek to convert the case to a Chapter 13.  

Examples of Consumer and Non-Consumer Debt

Below are some common types of debt typically included in a bankruptcy petition and whether they are considered to be consumer or non-consumer debt:

Credit Card Debt. Whether credit card debt is consumer or non-consumer depends upon how the credit was obtained. If the credit card is a consumer account, it is a consumer debt. However, if the credit card is a business credit card that the debtor personally guaranteed, then it is most likely non-consumer debt.

Student loans. The question of whether a student loan is a consumer debt in the context of the Means Test has not been adjudicated in the 2nd Circuit. However, there is currently a split in the circuits on this issue, where some Bankruptcy Courts see student loans as consumer debt, while others see it as a non-consumer debt. See In re Valdivia, Case No. 20-00369-5-DMW, at *9 (Bankr. E.D.N.C. Aug. 21, 2020) (“The court finds that the student loans are consumer debt incurred primarily for a personal, family, or household purpose.”). Compare with Townson v. Ruff (In re Ruff), No. 20-68555-PWB (Bankr. N.D. Ga. Mar. 31, 2022) (“The court concludes…that the Debtor’s student loan debt is not ‘consumer debt’ as defined in 11 U.S.C. § 101(8).”). The question that most Courts have looked at is the “profit motive” of the debtor when taking out the student loan.

Mortgages. Mortgages can be either consumer or non-consumer debt but are typically consumer debt. For example, a mortgage for a primary residence or a vacation home would be considered a consumer debt, while for an investment property would be non-consumer. According to In re Lemma, 393 B.R. 299 (Bankr. E.D.N.Y. 2008) most mortgages are considered consumer debts, except where the property was purchased with a profit motive only (i.e. an investment property).

Although there is no case law binding in this Circuit, the majority of courts addressing the issue of consumer debt hold that a mortgage lien that’s secured by real property is a consumer debt. In re Kelly, 841 F.2d 908, 913 (9th Cir. 1988); In re Davis, 378 B.R. 539, 546-47 (Bankr. N.D. Ohio 2007); In re Hall, 258 B.R. 45, 50 (Bankr. M.D. Fla. 2001) (majority position is the better reasoned on the issue that purchase money mortgage on debtor’s former residence is a consumer debt); In re Vianese, 192 B.R. 61 (Bankr. N.D.N.Y. 1996) (mortgage on debtors’ residence and home equity loan are debts incurred primarily for personal purposes). In determining whether a debt falls within the statutory definition, these courts look to whether the debt incurred serves a family or household purpose, In re Kelly, 841 F.2d at 913, or whether the debt was incurred with an eye toward profit, In re Booth, 858 F.2d 1051, 1055 (5th Cir. 1988). “It is difficult to conceive of any expenditure that serves a `family . . . or household purpose’ more directly than does the purchase of a home and the making of improvements thereon.” In re Kelly, 841 F.2d at 913.

Taxes. Taxes are generally not consumer debts. Most courts consider taxes to be non-consumer debt since no one voluntarily incurs tax debt for personal, family, or household purposes. According to In re Ibbetson, Bankruptcy Case No. 19-21109-PRW (Bankr. W.D.N.Y. Mar. 5, 2020), “[d]ebts for income taxes do not meet the definition of consumer debts under 11 U.S.C. § 101(8).”

Car Loans. Much like credit cards, whether a car loan is a consumer debt depends on how the vehicle was obtained. If a car or truck was purchased with a consumer loan, it is consumer debt. If the vehicle was purchased in a business name with a personal guarantee on the debt, then that debt is non-consumer.

Medical Bills. Similar to taxes, necessary medical expenses are typically classified as non-consumer debts. This is because most people do not voluntarily incur medical debt. However, if a medical expense is for elective cosmetic surgery, it would be classified as consumer debt, since the debtor is choosing the surgery for personal reasons.

Personal Guarantees. Personal guarantees of business debts are, by definition, non-consumer. However, a personal guarantee of a residential lease for a family member could be considered a consumer debt.

Legal Fees. If legal fees are incurred for family or household purposes such as divorce, child custody, and support obligations, they will most likely be considered consumer debt. On the other hand, if they are incurred when litigating business disputes or for business related transactions, they are non-consumer debt.

Accident Liabilities. Debt that results from an accident is not consumer debt. According to In re Ajunwa, Case No. 11-11363 (ALG) (Bankr. S.D.N.Y. Sep. 4, 2012): “no court has held that a debt incurred from the negligent operation of an automobile is a consumer debt. In re Alvarez, 57 B.R. 65, 66 (Bankr. S.D. Fla. 1995); In re White, 49 B.R. 869, 872 (Bankr. W.D.N.C.) (holding that debts arising from negligence cannot be “incurred”, as volition is required); In re Marshalek, 158 B.R. 704, 707 (Bankr. N.D. Ohio 1993) (“Simply stated, a judgment resulting from a vehicular accident, per se, is not a ‘consumer debt’ as that term is defined under the Code.”)”

For many higher income earners that are above the median household income who want to file for Chapter 7 bankruptcy, the Means Test can be a major stumbling block. However, their underlying debt at issue may provide them with a path to still qualify for Chapter 7 bankruptcy. Accordingly, if you are contemplating filing for bankruptcy, it is important to speak with an experienced bankruptcy attorney, who can properly analyze your debt and determine whether a majority of your debt is non-consumer. If so, the Means Test may not apply in your case, and Chapter 7 bankruptcy may be an option to obtain a fast fresh start.

Contact the Law Offices of David I. Pankin, P.C.

At the Law Offices of David I. Pankin, P.C., we have over 28 years of experience helping debtors receive a fresh financial start through both Chapter 7 and Chapter 13 bankruptcy. If you are struggling financially, please do not hesitate to contact our office for a free consultation. We can be reached at (888) 529-9600 or by using our online contact form.

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