Due to the recent recession, there has been a substantial increase in bankruptcy filings. For example, personal bankruptcy filings rose to 1.41 million in 2009, a 32 percent increase from 2008. [1] Real estate-driven bankruptcies have similarly increased substantially over the last few years.[2] A new phenomenon has also arisen. Many debtors no longer fight to retain their properties, but instead are abandoning their properties in both chapter 7 and chapter 13[3] cases. This surrendering of real estate has occurred with primary residences and investment property purchased within the last seven years, and has occurred primarily in the hardest-hit real estate markets. [4] Nationwide, the hardest-hit real estate markets have been in Florida, California, Nevada and Arizona.[5]

When real estate is surrendered in bankruptcy, the debtor remains the legal owner up until the bank completes the foreclosure proceeding.[6] This is true, even if the debtor filed a statement of intention to surrender the property and has already been discharged. Since the debtor is still the owner, insurance must be maintained on the property. There have been cases where the debtor owned and abandoned investment property and received a discharge. However, the debtor had hostile tenants who, despite their failure to pay rent, filed complaints and the debtor had possible exposure for substantial fines and penalties.

The real estate decline has brought to light new issues. In chapter 13 cases, confirmation hearings are now held a few months after the case is filed. Since a lot can happen between the filing and confirmation, the proper methodology for valuing unsecured claims of property to be abandoned is difficult to determine.[7] Furthermore, in both chapter 7 and 13 cases, the ambiguous statutory language of the means test has left courts split over whether the remaining mortgage payments on a debtor’s surrendered property should be factored in or taken out of the means test calculation. This article will focus on secured mortgage abandonments and the means test.

Secured Debt on Property that the Debtor Intends to Surrender (Means Test)
The primary purpose of the means test is to determine whether an above-median-income debtor is in need of bankruptcy relief, or alternatively, whether a presumption of abuse of the bankruptcy process arises. When Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA),[8] its intent was to create a ‘mechanical’ formula for presuming abuse of chapter 7.[9]

In the context of the means test, the current conflict between the courts over whether a debtor may deduct secured debt payments on property that the debtor intends to surrender is rooted in differing statutory interpretations. The relevant statute, § 707‌(b)‌(2)‌(A)‌(iii), states that

The debtor’s average monthly payments on account of secured debts shall be calculated as the sum of: (I) the total of all amounts scheduled as contractually due to secured creditors in each month of the 60 months following the date of the petition; and (II) any additional payments to secured creditors necessary for the debtor, in filing a plan under Chapter 13 of this title, to maintain possession of debtor’s primary residence, motor vehicle, or other property necessary for the support of the debtor and the debtor’s dependents, that serves as collateral for secured debts; divided by 60.[10]

Chapter 7 Analysis
The Snapshot Approach (Majority view)[11]
Under the “snapshot approach,” the courts have held that long-term secured payments that are “scheduled as contractually due” on the date of the debtor’s petition may be deducted as a monthly expense regardless of a debtor’s intention to surrender the property in the future.[12] Under this view, the means test is believed to be a “backward-looking test” that measures a debtor’s financial health based on historic income and expense figures as of the petition date.[13] Taking a snapshot of the debtor’s obligations on the petition date is believed to be in accord with the statute’s plain meaning.[14] The phrase “scheduled as contractually due”[15] is intended to refer to payments that a debtor is legally obligated to pay under a contract on certain dates in the future.[16] A debtor’s contractual liability for the debt is not eliminated upon the surrender of the collateral securing the debt.[17] Therefore, the court should determine how many payments are owed under the contract for each secured debt at the time of filing.[18] The courts have interpreted the statute’s plain language as providing a mechanical test that “avoids the uncertainties that surround a debtor’s announced, but not yet executed, plan to surrender property or reaffirm secured debts.”[19] This mechanical test is designed to estimate, and not accurately predict, a debtor’s ability to repay creditors through a chapter 13 plan.[20] Congress chose to base the means test on historic income and fixed expense figures despite the fact that the Internal Revenue Service (IRS) collection standards and other external factors are likely to change during the course of the 60 months after the petition.[21]

Dismissal under Totality of the Circumstances
Protection for Debtor Abuses of Snapshot
Despite passing the chapter 7 means test, a debtor may have his or her petition dismissed under § 707‌(b)‌(3) if “the totality of the circumstances...of the debtor’s financial situation demonstrates abuse.”[22] In a 2009 case in the Eastern District of New York, the debtor listed two condominium properties on the schedule A and, despite the fact that he indicated his intent to surrender his properties, he deducted his future monthly payments on the debt secured by them.[23] The court found that the debtor passed the means test, and thus a presumption of abuse did not arise.[24] However, the court is permitted to consider income made available to debtors as a result of surrendering their real property under the totality of the circumstances test in § 707‌‌(b)‌(3).[25]

In Perelman, the court found that the debtor’s “stable employment, significantly above-median income, absence of dependants and major reduction in expenses through the surrender [of his property]” showed that he had more than adequate monthly disposable income to make a meaningful distribution to his unsecured creditors. Therefore, he was ineligible for chapter 7 relief.[26]

The Future-Oriented Approach (Minority View)
On the other hand, courts utilizing the “future-oriented approach” or “forward-looking approach” interpret “scheduled as contractually due” to allow deductions on the means test for only the expenses that the debtor reasonably expects to pay during the next 60 months. Most courts following this approach conclude that payments to secured creditors on property that a debtor intends to surrender cannot be deducted in the means test calculation.[27]

In Burden, the court closely examined § 707‌‌(b)‌(2)‌(A)‌(iii)‌(I) in the context of § 707‌(b)‌(2)‌(a)‌(iii)‌(II) and determined that it applies only to payments on debts secured by collateral that a debtor intends to keep.[28] “The Court has no problem binding debtors to what they say they plan to do when they file bankruptcy… If a debtor indicates that he intends to surrender property, his financial condition will be judged at the time of the statement, which, more often then not, is the petition date.”[29]
    
The Third Approach (Fifth Circuit)
In the Singletary case,[30] the court came up with a combination of the backward-looking and forward-looking approaches. It held that debtors should be allowed to include payments to secured creditors on the means test even though the statement of intention listed these debts as debts to be abandoned. However, if the property was already surrendered as of the date the presumption of abuse motion was filed, then the payments to these secured creditors are not permitted on the means test.[31]

First, the Singletary court interpreted the word “scheduled” to refer to a debt on the debtor’s official schedules, as contrasted with the Walker definition.[32] It then defined the term “as contractually due” to mean that even if the property was already surrendered, the debtor is still obligated to these debts up until the time of discharge.[33] Finally, the court defined the term “to secured creditors” and held that “upon surrender of the collateral to the secured party, the estate no longer has any interest in the collateral and the creditor’s only remaining claim for any deficiency is the unsecured Article 9 of the Texas Business and Commercial Code.”[34]

Chapter 13 Analysis 
The Future-Oriented Approach (Majority View)[35]
The future-oriented approach is commonly applied in the context of chapter 13 cases, where a debtor commits his or her projected disposable income toward paying his creditors.[36] In a chapter 13 case, per § 1325‌(b)‌(1)‌(B), if a trustee or holder of an allowed secured claim objects to the confirmation of the chapter 13 plan, the court may not approve the plan unless “all the debtor’s projected disposable income to be received in the applicable commitment period...will be applied to make payments to the unsecured creditors under the plan.”[37] Since “projected” is not specifically defined in the Bankruptcy Code, several courts looked to its dictionary definition and have concluded that a debtor must account for events that actually occur during the course of the plan.[38] Therefore, under the future-oriented approach, a chapter 13 debtor cannot claim a means-test deduction for property that he or she intends to surrender because “[i]f Congress intended to create a means test as a blunt measure of ability to pay without regard to a Chapter 13 plan, that would lead to results that are illogical and sometimes produce a strange result.”[39] As the Perelman court recently noted, the question of whether monthly payments on secured property to be surrendered can be deducted in calculating a chapter 13 debtor’s projected disposable income involves different considerations than whether the same can be done in determining chapter 7 eligibility.[40] The U.S. Trustee Program has detailed its position on many issues currently arising under the chapter 13 means test and has stated the following:

Line 47, Future payments on secured claims
Outside of the First Circuit, does not include payments when the debtor intends to surrender the collateral securing the loan either in the plan or independent of the plan.[41]

 The Snapshot Approach (Minority View)[42]
The most cited case in this category is In re Burmeister.[43] These cases follow the same reasoning of the leading cases under the chapter 7 majority approach discussed above.

Recent Supreme Court Case
In June 2010, the Supreme Court held that the forward-looking approach is correct in determining “projected disposable income.”[44] Even though this case does not discuss the secured debt payments issue, it describes in detail the intent of the new law to take into account projected changes.[45] Since this case endorses the forward approach with respect to income and touches on expenses in the analysis, the authors would expect this approach to be used exclusively in the future, even in the First Circuit.

Nadejda Reilly never thought her kitchen equipment would become part of a federal case that eventually made its way to the Supreme Court. Her bankruptcy attorney in central Pennsylvania assured her that her property would be exempt and never be at risk. He scheduled its value at just over $10,000 and claimed that entire amount exempt. The trustee did not pay much attention. When he found out that the equipment was worth almost twice as much, he figured that he could sell the equipment for fair-market value, pay the amount that the debtor claimed as exempt and administer the balance as part of a small bankruptcy estate, but it did not work out that way.

William Schwab, the trustee, did not object to the debtor’s exemption within 30 days after the conclusion of the debtor’s meeting of creditors pursuant to § 341 of the Bankruptcy Code as required by Bankruptcy Rule 4003(b). Reilly listed the fair-market value on Schedule B as $10,718 and exempted the full value on her Schedule C using the tools of the trade exemption under § 522(d)(6) of $1,850 and a miscellaneous exemption of $8,868, all within statutory limits. After obtaining an appraisal that the equipment could be sold for as much as $17,200, Schwab filed a motion to sell, which was denied by the bankruptcy court because Schwab had not timely objected to the debtor’s exemptions.

Reilly contended that in exempting the full value of the property on Schedule C, she manifested her intent to claim the property as fully exempt. The bankruptcy court and all reviewing courts, including the Third Circuit Court of Appeals, agreed and held that the debtor had asserted that the property was fully exempt. Since the trustee did not timely object, he could not sell the collateral. Schwab v. Reilly, U.S. ___ (2010) (slip op. at 4-5).

The Supreme Court reversed, holding that Schwab had no obligation to object to Reilly’s objections. They were “facially valid” since they did not exceed the exemption amounts debtor was permitted to assert under § 522(d) of the Code. Id at 17-18. An exemption in property is an interest up to a certain dollar amount as indicated by § 522(d) or the relevant state statute, and not in the property itself.

Implications from the Debtor’s Perspective
For debtors, the holding in Schwab v. Reilly makes exemption planning to protect property in full difficult. Debtors face uncertainty if trustees are not required to object within 30 days of the 341 meeting for facially valid exemptions. A trustee may determine months—or even years—later that the property is worth more than the exemption, seek court permission to sell it and pay the debtor their exemption. Some assets may appreciate in value in which the trustee would benefit from the appreciation. In such cases, it might well be to the benefit of debtors to move to compel the trustee to abandon any interest in such property.

The Court’s ruling suggests that requiring a trustee to object within 30 days would be too burdensome given the caseloads of most trustees. However, objecting to exemptions within 30 days does not put an additional duty on the trustee as they have an existing duty to value property for the benefit of creditors. Schwab v. Reilly, 560 U.S. ___ (2010) (Ginsburg, J. dissenting) (slip op. at 12). Additionally, Rule 4003(b) allows a trustee to ask the court to extend the objection period for cause. Id at 13. The trustee could also postpone the conclusion of the meeting of creditors under Rule 2003(e) so that the 30-day deadline does not start running. Id. Finally, if there is a dispute as to valuation, the trustee could ask for a hearing under Rule 4003(c). Id.

Nonetheless, the Court’s opinion does clarify how debtors can claim exemptions in a way that waves a “warning flag” to the trustee that they intend to exempt the full fair-market value of the property. Debtors could simply list the exempt value as either “full fair-market value (FMV)” or “100 percent of FMV,” which makes it abundantly clear to the trustee that the debtor intends to fully protect the property at issue. Schwab v. Reilly, 560 U.S. ___ (2010) (slip op. at 20-21).

Structuring an exemption this way will likely prompt an objection from the trustee within 30 days of the creditor’s meeting. If the trustee does not timely object to the exemption, or the objection is overruled, the debtor will be able to retain the property in kind. If a trustee’s objection is sustained, the debtor could amend Schedule C and receive the cash value of their exemption upon liquidation. As the Court elaborated, “[e]ither result will facilitate the expeditious and final disposition of assets, and thus enable the debtor (and the debtor’s creditors) to achieve a fresh start.” Id at 22.

Such a declaration on Schedule C also eliminates a trustee’s concern that requiring objections to “facially valid” exemptions within 30 days “‘would give debtors a perverse incentive to game the system by undervaluing their assets.’” Schwab v. Reilly, 560 U.S. ___ (2010) (Ginsburg, J. dissenting) (slip op. at 15) (citing Brief for Petitioner 35; see Brief for United States as Amicus Curiae 27). The Court’s ruling outlines a clear path for debtors and their attorneys in completing Schedule C that is a better result than resorting to exemption strategies that would be abusive at best and perjury at worst.

While debtors’ attorneys can structure exemptions in a manner that the Court outlined, pro se debtors who simply follow the instructions attached to Schedule C would not consider listing the exemption as “full FMV” or “100 percent of FMV” as the instructions indicate to “state the dollar value of the claimed exemption in the space provided.” Id at 15 (emphasis in original). Even so, an update to the instructions to the schedules could alleviate this problem given the Court’s instructions on how to list the value of the claimed exemption.

Implications from the Trustee’s Perspective
A trustee must liquidate non-exempt assets for the benefit of creditors as quickly as possible consistent with the best interests of the estate and then make distributions and close the estate as soon as practicable. Bankruptcy Code § 704. Since chapter 7 trustees receive compensation of only $60 per case, a trustee must be able to make a prompt determination as to whether there are assets to administer. It is impractical for a trustee to have to object in every case to exemptions in kind so as to preserve the ability to administer assets for which value is not yet known. Assertion of exemptions of assets as 100 percent exempt where a statute does not permit such an exemption may be a way to “wave a flag” at the trustee—but is it a red flag of warning or a red flag of provocation? Trustees would want debtors to claim assets to be 100 percent exempt when appropriate—for example, as in the case of personal clothing which, in many states, is 100 percent exempt. However, trustees would not want debtors to follow Reilly’s example and claim exemptions in kind for property worth more than the scheduled amount of the exemption.

Conclusion
Schwab v. Reilly represents the fifth in a series of recent consumer bankruptcy cases decided by the Supreme Court including Milavetz,Gallop & Milavetz v. United States, 559 US ____ (2010); Hamilton v. Lanning, 560 US ____ (2010); United Student Aid Funds v. Espinosa 559 US ___ (2010); and Marrama v. Citizens Bank of Massachusetts 549 U.S. 365(2007). From the detailed understanding that the Court evidenced in Schwab v. Reilly, it seems that the Court is becoming increasingly familiar with the day-to-day intricacies of consumer bankruptcy practice. Consumer bankruptcy attorneys can look forward to an increasingly practical and pragmatic approach toward the Bankruptcy Code as more cases come to its attention. The next such case will likely be Ransom v. MBNA America Bank (09-907, cert granted April 19, 2010) addressing whether, in calculating the debtor’s “projected disposable income” during the plan period, a bankruptcy court may allow an ownership cost deduction for vehicles only if the debtor is actually making payments on the vehicles. Consumer bankruptcy attorneys will await further guidance from the Court in interpreting plain language of the less than clear Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).

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