Considering Converting from Chapter 13 to Chapter 7 with Appreciated Real Estate? Think VERY Carefully

This is an extremely timely and relevant issue here in the Bay Area/Northern District of California, where I practice.  If you filed a Chapter 13 bankruptcy case more than a year or two ago, and owned any real estate, the value of that real estate was probably very low at the time; the market hit bottom somewhere around early 2012.  But what a difference a couple of years makes! The last couple of years has seen an enormous explosion in the local residential real estate market.  So enormous in fact, that housing values are now at or above their pre-crash peak.  Your home is probably worth significantly more now than it was back then.

So let’s say you filed a Chapter 13 case back in 2013.  Your house was worth significantly less back then, and maybe you were “underwater.”  If that was so, had you filed a Chapter 7 case, a Chapter 7 trustee wouldn’t have been very interested in your house.  (Chapter 7 trustees make their money by liquidating valuable assets for the benefit of creditors.)  Let’s also say that now you want to get out of court Chapter 13 case, sell your house, and reap your profits.  Can you do that?  Can you convert to Chapter 7, get a discharge, and move on?  The answer to that question depends on the answer to another question:  If you convert, who gets that appreciated value, you or the Chapter 7 trustee?

Prior to the 2005 changes to the Bankruptcy Code, the answer to that question was very clear: On conversion, post-filing appreciation is yours.  And in the years since then, few had even bothered to ask the question of whether that rule was altered by the 2005 changes.  (In a down market, there was no point.)  But now, with a hot real estate market, Chapter 7 trustees are starting to look into it.

The theory being put forward in certain quarters revolves around the interpretation of § 348(f)(1) of the Bankruptcy Code.  § 348(f)(1)(A) says that “property of the estate in the converted case shall consist of property of the estate, as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion.”  In other words, whatever interest the debtor had in the property on the date of filing, that’s what the Chapter 7 trustee gets on conversion.  That was the rule pre-2005, and it’s still the rule as most courts understand it.

However, proponents of this new theory argue that § 348(f)(1)(A) has to be read in conjunction with § 348(f)(1)(B), which was substantially altered by the 2005 changes.  It used to read: “valuations of property … in the Chapter  13 case shall apply in the converted case”.  However, post-2005, it now reads: “valuations of property … in the Chapter 13 case shall apply only in a case converted to [Chapter 11 or 12], but not a case under Chapter 7.”  The proponents argue that the Chapter 7 trustee doesn’t get whatever interest the debtor had at the time of filing; she gets the thing itself, and the value of her interest is that of the conversion date.  It basically turns the existing rule on its head.

This is by no means an accepted position; as of the date of writing (June 30, 2015), I know of no caselaw clearly and cleanly adopting this position. (Indeed, one court, the Bankruptcy Court for the Eastern District of Tennessee, in In re Hodges, 518 B.R. 445, declined to directly accept this theory.)  A Chapter 7 trustee may well face an uphill battle convincing a court to reverse current interpretations of law.  But this is not a frivolous argument, and at least one of the Oakland Chapter 7 trustees has stated that she intends to use this theory to pursue the asset if a case with this situation is assigned to her. If one of the trustees is looking into it, you can bet the others are, too.

Where does that leave you if you’re in such a situation?  Simply put, don’t convert.  Not now anyway.  You don’t want to be a test case.  Yes, the trustee may have an uphill battle in making this argument, but if she wins, your house will be liquidated and your appreciated value will be taken too.  The risk is just too great.

If you are a homeowner in a Chapter 13 case and are considering converting to Chapter 7, be very careful, and be sure to ask your attorney if he or she is familiar with this issue.

What Happens to My Property if I File a Bankruptcy Case?

What Happens to My Property if I File a Bankruptcy Case?

When you file for any kind of bankruptcy a bankruptcy estate is created. This is a legal concept that means some of the property you own is under the control of the bankruptcy court while your case is processed. In a Chapter 7 bankruptcy typically almost all of your property or assets are part of the bankruptcy estate. Different chapters of bankruptcy have different effects.

Does that mean if I file bankruptcy I lose everything?

The bankruptcy court administers the property in the bankruptcy estate, but you remain the owner of all of the property unless the court enters an order for you to sell or turnover some property. All of the property in the bankruptcy estate is also sheltered from creditor actions by the automatic stay.

If you owned a car, but were behind on the payments and you filed for bankruptcy the creditor would not be allowed to repossess the car because of the automatic stay. The car would be a part of the bankruptcy estate. But, the court would ultimately decide whether or not you got to keep the car based on a variety of factors.

Most people who file for bankruptcy find that they do not lose anything because the value of their assets is so low.

Can I sell my property during a bankruptcy?

While you remain the owner of the property during a bankruptcy, the bankruptcy court controls all of the property that is part of the bankruptcy estate. You are not allowed to sell any of the property that is part of the bankruptcy estate without the prior approval of the bankruptcy court. Usually, the bankruptcy court appoints a trustee to monitor the administration of the bankruptcy estate. The bankruptcy trustee is charged with making sure the creditors get what they are legally entitled to.

This means that if you own a car and file for bankruptcy, and you own the car outright, you cannot sell the car or even give the car away, without first getting the permission of the bankruptcy trustee. This also applies to stocks, jewelry, or any other kind of property.
Property can be removed from the bankruptcy estate if certain conditions and procedures are met.

Is there ever anything not part of the bankruptcy estate?

The law excludes some property from being a part of the bankruptcy estate. Social Security payments, generally any property received after the filing of the bankruptcy, and certain pension or retirement benefits are not a part of the bankruptcy estate and are not subject to any control from the bankruptcy court.

What happens once the bankruptcy is over?

Once the bankruptcy has been completed the bankruptcy estate disappears. Any property that was not ordered to be sold or turned over to a creditor is back under your control. For most people almost nothing ends of being sold. Once the bankruptcy is completed you can sell or gift your property as you see fit.

Bankruptcy is a highly technical area of law with many complicated rules and procedures. If you are thinking about filing a bankruptcy, you need to consult with an experienced bankruptcy lawyer right away. Sometimes the rules of the bankruptcy estate apply to what you do with property before you even file for bankruptcy.

LVNV v. Crawford, the FDCPA, and the End of a Circuit Split?

LVNV v. Crawford: Are Bankruptcy Debtors Limited to Bankruptcy Remedies?

For years, the courts have struggled over consumers’ remedies when creditors continue collection attempts in violation of the automatic stay. Under the Bankruptcy Code, consumers can bring a contempt of court action. Also, the Fair Debt Collection Practices Act (FDCPA) enables consumers to sue when creditors attempt to collect on invalid debts, which would seem to hold true even during the course of a bankruptcy case. Previously, the Ninth Circuit (which includes California), had limited consumers to the former remedy, while (presently) the Eleventh Circuit allowed for both.

On April 20, 2015, the Supreme Court denied certiorari (i.e. it declined to hear) LVNV v. Crawford, the aforementioned Eleventh Circuit case, seemingly resolving the split & allowing consumers to pursue both contempt & FDCPA actions.

Crawford’s History

Stanley Crawford filed a Chapter 13 case, during the course of which LVNV filed a proof of claim with the court, which all parties agreed was an attempt to collect on the debt. However, the since debt was past the statute of limitations, LVNV had no right to make such a collection attempt. Mr. Crawford brought an action for an FDCPA violation, but the Bankruptcy Court held that he was limited relief provided by the Bankruptcy Code. The Eleventh Circuit reversed.

Apparent Circuit Split

The Ninth Circuit had ruled in Walls v. Wells Fargo Bank, N.A., 276 F. 3d 502 (9th Cir. 2002) that the Bankruptcy Code was the only source of relief for people in Crawford’s position. Once a bankruptcy court had jurisdiction over a debt, and even after a discharge, the FDCPA was not an option for consumers.

Since the Eleventh Circuit had found consumers could bring an FDCPA claim even if there was a bankruptcy, most observers felt that a circuit split had been created and an appeal to the Supreme Court was all but certain. However, the Supreme Court declined to hear an appeal of Crawford, denying cert. and allowing the Eleventh Circuit decision to stay in place.

Where Does that Leave Us?

While the Supreme Court did not issue a ruling on the merits of LVNV v. Crawford, by declining to take the case it seems to be give the Eleventh Circuit’s ruling the seal of approval. It is unclear what the courts in the Ninth Circuit will do in light if the cert denial, but it seems clear that the Supreme Court sees no reason to not allow consumers in bankruptcy access to relief from improper creditor actions under both the Bankruptcy Code and the FDCPA.

This is potentially good news for people who file bankruptcy cases in California, as this decision opens the door to cases challenging the legitimacy of Walls.

Bank of America v Caulkett: No Chapter 7 Lien Strips – Supreme Court

On June 1, 2015, the U.S. Supreme Court decided the case of Bank of America v. Caulkett and held unanimously that a debtor in a Chapter 7 bankruptcy can not “strip” a junior lien.  “Lien stripping,” a topic we have address previously, is this: When there is more than one lien on a piece of property, and the amount owned on the senior lien is greater than the value of that property, there is no equity present to secure the junior lien.  Therefore, in a Chapter 13 case, the property owner can “strip” the junior lien, causing it to be treated as unsecured debt.

Prior to today’s decision, all of the Circuit Courts to have addressed this issue (besides the Eleventh Circuit) had held that the Bankruptcy Code does not permit such lien stripping in Chapter 7 cases.  They relied (as did the decision today) on the Supreme Court’s holding in 1992’s Dewsnup v. Timm; Section 506(d) of the Code allows a lien to be voided when it secures a claim that is not an allowed, secured claim.  And while no equity was present here to secure the claim, Dewsnup says that the existence of the lien categorizes it a secured.  Case closed.

Interesting thing though: While the decision was unanimous, a single footnote in the middle of the opinion acknowledges that Dewsnup has been harshly criticized, but points out that the Debtors insisted that they were not asking it to be overruled.  Kennedy, Breyer, & Sotomayor did not join in this footnote, which raises an interesting question: what would happen if a debtor did expressly ask Dewsnup be overruled?

SB308, Increasing Homestead Exemption to $300,000, Passes CA Senate, Goes to Assembly

On Friday, May 22, 2015, the California Senate passed SB308 (proposed by Senator Bob Wieckowski), which would make changes to the exemption rules for bankruptcy cases filed in California. The bill now heads to the Assembly.

When a person files a bankruptcy case, the law puts all of that person’s assets into different categories, and then places caps on those categories. Those caps are the “exemption limits.”   If the value of the person’s assets exceed those caps, a trustee in a Chapter 7 case can liquidate that excess, while a trustee in a Chapter 13 case can demand that unsecured creditors receive at least that amount through the Chapter 13 Plan.

California has two sets of exemptions for bankruptcy debtors; one for people with equity in their home, and another for everybody else. Currently, the home equity exemption in the former category is $75,000 for unmarried people, $100,000 for married people, and $175,000 seniors, disabled people or people who are 55 or older with a limited income. SB308, if it becomes law, would increase this “homestead” exemption to $300,000.

This is very big news for Californians considering filing bankruptcy cases. Currently, because of the volatile residential real estate market in the Bay Area, many homeowners are essentially precluded from filing Chapter 7 cases: Even if they’re not clearly over the limit, there’s uncertainty over whether an aggressive Chapter 7 trustee will attempt to pursue the house.  Moreover, Chapter 13 is a less appealing option because the amount they would have to repay their unsecured creditors impairs the “fresh start” a bankruptcy case is meant to provide. Increasing the homestead exemption to $300,000 will go a long way toward improving this state of affairs, and is good policy.

An additional provision of SB308 is that it creates a $5,000 “wild card” exemption for self-employed people. (The home equity exemption scheme currently has no wild card exemption whatsoever.)

If you are a California resident considering filing a bankruptcy case, please contact your Assemblyperson and urge passage of SB308; you may wind up making things easier for yourself.

SCOTUS: At Conversion, Undistributed Funds Go to the Debtor (Harris v. Viegelahn)

When someone converts from a Chapter 13 bankruptcy case to a Chapter 7 case when the Chapter 13 Trustee is in possession of funds that haven’t been distributed to creditors, what happens to that money? Does it go to the debtor (as the 3rd Circuit held), or does it go to the creditors (as the 5th Circuit held)? That was the issue decided today by the Supreme Court in Harris v. Viegelahn.

Charles Harris filed a Chapter 13 case in February 2010, largely to get caught up on arrears on the mortgage to his house. Unfortunately, Mr. Harris continued to fall behind on his mortgage payments during his Chapter 13 plan, and in November 2010, the mortgage holder received permission to proceed with the foreclosure. Mr. Harris then exercised his right to voluntarily convert his case to Chapter 7. After the conversion, the Chapter 13 trustee (Viegelahn) distributed $5,519 of accumulated funds to Mr. Harris’s lawyer, herself, and to unsecured creditors. The Bankruptcy Court ordered the trustee to return the funds, but the Fifth Circuit revered, holding that “considerations of policy and equity” dictated that the funds go to the creditors.

Writing for a unanimous court, Justice Ginsberg looked to the reasoning in the 2012 3rd Circuit case of In re Michael, which had gone in the opposite direction on the same issue. The Court held that, pursuant to Section 348(e) of the Code, the Chapter 13 trustee had been stripped of authority to distribute assets at the moment of conversion. Additionally, no provision of the Code provides that any property (including post-petition assets) as belonging to creditors. Thirdly, the Court rejected the 5th Circuit’s concern that such a hold would result in a windfall for the debtor; the money being returned to the debtor was money that the debtor would have kept had he filed a Chapter 7 case.

Local practice here in the Northern District of California was already in keeping with the law as laid out here, but it is nice to see the Supreme Court holding unanimously in favor of the debtor in a consumer case like this. A PDF of the opinion can be found here.

New York Bankruptcy Court: Wells Fargo’s “Administrative Freezes” Violate the Automatic Stay

When I conduct an initial consultation with a client, I’m always careful when I hear that client has a bank account with Wells Fargo.  That’s because if a person files a Chapter 7 case, and if they have more than $5,000 in Wells Fargo bank accounts at the time of filing, Wells Fargo “freezes“ those bank accounts until otherwise instructed by the Chapter 7 trustee.

Needless to say, these freezes are very frustrating to deal with, and a nuisance to have to avoid by such methods as cashing out the accounts prior to filing.  Unfortunately, in California the practice is likely to continue for the time being:  In October, the Ninth Circuit Court of Appeals (in the case of In re Mwangi, 764 F.3d 1168, 1179 (9th Cir. 2014)) affirmed its earlier holding that only the Chapter 7 Trustee has the standing to assert an injury based on such freezes.

However, in a more recent case (In re Weidenbenner, No. 14-35443, 2014 Bankr. LEXIS 5009 (Bankr. S.D. N.Y. Dec. 12, 2014)), the Bankruptcy Court for the Southern District of New York has reached the opposite conclusion.  There, the Court held that such freezes are indeed an “exercise of control over property of the estate”; they are not “mandated by the Bankruptcy Code, ordered by the Court, or requested by the chapter 7 trustee.”  It also rejected Wells Fargo’s argument that the freezes were required under § 452(b) as a misreading of prior caselaw (specifically, Citizens Bank of Maryland v. Strumpf, 516 U.S. 16 (1995)).  Finally, as to the standing issue, the Court held that the holdings in cases such as Mwangi are “not consistent with the Code and the practical realities of debtors’ lives.”

It is probably wishful thinking to hope that because the practice is now outlawed in New York, Wells Fargo will voluntarily abandon it in other parts of the country.  Perhaps the opinion will persuade other courts to come to the same conclusion, until the Ninth Circuit sees its mistake and changes its mind.  In the meantime, Chapter 7 debtors in California will just have to continue moving their money out of Wells Fargo accounts before filing.

NY Appellate Court: Rent Control Laws Are a “Public Benefit”

On November 20, 2014, the New York Court of Appeals decided the matter of Santiago-Monteverdi v. Pereira (In re Santiago-Monteverdi), 2014 NY Slip Op. 8051 (N.Y. Nov. 20, 2014).  Ms Santiago-Monteverdi had lived in her New York City rent-controlled apartment for 40 years.  In 2011, she filed a Chapter 7 case, seeking to discharge approximately $23,000 in credit card debt.  Section 365(a) of the Bankruptcy Code empowers bankruptcy trustees to assume unexpired leases, and the owner of Ms Santiago-Monteverdi’s building offered the Chapter 7 trustee that, if he assumed Ms. Santiago-Monteverdi’s lease, the owner would buy him out for an undisclosed sum.  Ms Santiago-Monteverdi then sought to exempt the asset as a “Public Assistance Benefit,” as provided for by New York law.  The Bankruptcy Court sided with the trustee, and the District court affirmed.  On appeal, the Second Circuit certified the question to the New York Court of Appeals for this interpretation of state law.

The Court looked to the legislative history, finding that the rent control system had been created to allow lower-income residents to retain their housing as the cost of housing increased.  The Court also found that the law bore the hallmarks of a public assistance benefit: its continued application depended on local need, it was implements at the local and state level, and it provided assistance to a segment of population who could not otherwise afford housing.  The Court further held that direct payments are not necessary for a program to constitute public assistance, and noted that while the benefit was not paid by the government, it was conferred by the government.

The case is significant for residents of San Francisco, Oakland, and Berkeley where rent control laws are in place.  I have not heard of a local instance where a Chapter 7 trustee has pursued an rent-controlled lease as an asset, but if this case had gone the other way, doubtless we would start to hear of it happening.  Indeed, attorneys should be on their guard for this issue in case some trustee attempts to test the interpretative waters regarding the California public assistance benefit exemption.

Supreme Court Agrees to Hear Chapter 7 Lien Strip Case

On November 17, 2014, the U.S. Supreme Court granted the petition to have the case of Bank of America, N.A. v. Caulkett heard.  The case comes out of Florida and deals with ‘lien strips” of second mortgages in the Chapter 7 context.

Lien stripping is a fairly common occurrence in Chapter 13 cases; the principle is that if there is more than one mortgage (or “lien”) against a piece of property, and the property is worth less than the first (i.e. it is “under water”), then there is no equity to secure the junior mortgages.  The security interest is stripped from those mortgages, and they are treated like unsecured debt.

The general trend among the Circuit Courts has been to hold that such junior liens cannot be stripped in Chapter 7 cases, largely based on analogy to the 1992 Supreme Court decision Dewsnup v. Timm, (502 U.S. 410), which held that partially unsecured junior liens cannot be “crammed down” in Chapter 7 cases.

The Eleventh Circuit, in which Florida resides, was the only Circuit to make the distinction between cramdowns of partially secured junior liens and strips of wholly secured junior liens, allowing the latter in the case of McNeal v. GMAC Mortg., 735 F.3d 1263 (11th Cir. 2012).  Caulkett is a challenge to that decision.

Oral argument is likely to take place in Spring 2015, with a decision by June.

“When Non-Bankruptcy Clients Need Bankruptcy Advice” – Thursday, Nov. 20 Attorney Action Club Presentation

Calling all Bay Area lawyers and legal professionals:  Come to my Thursday, November 20 presentation entitled “When Non-Bankruptcy Clients Need Bankruptcy Advice.”  It’s part of the “Attorney Action Club” and will take place at 11:30 AM at the offices of City National Bank at 150 California Street, 12th Floor, in downtown San Francisco.  0.5 hours MCLE will be offered, as well as free lunch and networking opportunities.  Registration is here.

Topics to be covered:

  •  A brief overview of bankruptcy law for attorneys who represent individuals
  • Information for divorce lawyers on discharging community debt
  • Information for tenant lawyers on treatment of rent arrears
  • Estate planning in anticipation of bankruptcy
  • Civil defendants and post-litigation bankruptcy

I’m looking forward to seeing you and sharing information with you!