Bad Faith Cannot Be Based on Income Determined in Compliance with Code

The Ninth Circuit BAP found that a chapter 13 plan could not be determined to be in bad faith solely on the basis of debtors’ deduction of payments made on secured debts, without regard to “necessity” of those debts, and their exclusion of social security income from their calculation of disposable income. Drummond v. Welsh (In re Welsh), No. 10-1465 (B.A.P. 9th Cir. Feb. 17, 2012).

Welsh judgment

In the plan, the debtors deducted payments on debts secured by six vehicles and did not include the husband’s social security income in their calculation of disposable income. The court analyzed the case under section 707(b)(2)(A)(ii) which permits deductions for those necessary expenses set forth in the IRS standards, and (iii) which permits a debtor to deduct payments on secured debt that will come due in the sixty months after the petition date. The court rejected the trustee’s argument that subparagraph (iii) only permits deduction of payments where those secured debts are deemed “necessary” under subparagraph (ii), finding that (ii) was not a limitation on (iii) but that under (i) both subparagraphs set out independent deductions. Thus, the court held that there was no requirement that deductions for payments on secured debts be for collateral that was “necessary” under section 707(b)(2)(A)(ii) where the debtor is not in default on those payments.

With respect to the issue of good faith under section 1325(a)(3), the court found that the fact-specific good faith standard in place prior to BAPCPA was still the proper standard for analysis. The court went on to hold, however, that lack of good faith cannot be based solely upon the debtor’s doing what the Code allows. Therefore, debtors’ deduction of payments on secured debts and failure to include social security income, standing alone, cannot be the basis of a finding of bad faith.

Judge Pappas dissented, stating that a determination of good faith under a totality of the circumstances test, required consideration of the necessity of the payments on secured debts and debtors’ social security income.