9th Circuit: Funds Offset by Checks in Transit Are Subject to §542(a) Turnover (Henson)

Ninth Circuit on Bankruptcy Trustee’s §542(a) Turnover Power:

On January 9, 2014, the Ninth Circuit issued an opinion in Shapiro v. Henson (In re Henson), where the debtor had filed her Chapter 7 case before over $6,000 in outstanding checks had cleared.  The trustee sought turnover of the funds that were in the debtor’s checking account as of the petition date, which were not exempted.  The bankruptcy court denied the turnover request because Ms Henson was not in possession of the funds at the time of the request.  The district court affirmed, and the trustee appealed to the Ninth Circuit.

11 U.S.C. § 542(a) provides: “[A]n entity . . . in possession, custody, or control, during the case, of [property of the estate, or exempt property], shall deliver to the trustee, and account for, such property or the value of such property, unless such property is of inconsequential value or benefit to the estate.”

In an opinion by Judge N. Randy Smith, the Court held that the phrase “possession … during the case” contemplates possession at any time during the case, and that the phrase “or the value of such property” indicated intent by Congress to provide an alternative if a debtor no longer possessed a specific item of property (i.e. if it had been sold).  The Court also looked to historical practice in turnover actions, where present possession was not always necessary, and also to the practical consideration that if possession were required, a debtor could easily frustrate the trustee’s turnover powers by simply transferring the property.

The opinion puts the Ninth Circuit at odds with the Eighth Circuit, which held the contrary position in In re Pyatt (486 F.3d 423).

The upshot to people considering filing a bankruptcy case: Funds in your bank account at the time of filing are property of the estate, even if offset by checks in transit, and (in the 9th Circuit, at least), a chapter 7 trustee may demand turnover of those funds even if you no longer possess them.

You Can’t “File Bankruptcy On” Just Some Debts

Every now and then, a potential client says to me in reference to some debt or other, “I don’t want to include that in my bankruptcy.” Maybe it’s an amount owe to a doctor they like, or maybe to a family member. Maybe it’s a credit card they’ve had for ages and that bears a picture of their cat.

What I have to tell people at this point is that filing a case with the Bankruptcy Court isn’t a matter of “including” or “not including” specific debts. You don’t file bankruptcy “on” specific debts and “not on” others.

The Bankruptcy Code is very clear on this topic. When you file your case with the Court, you must provide a list of your creditors. That list must include the names and addresses of everybody to whom you owe even a penny. The law then puts your creditors into categories, based on the nature of the debt. For example, the debts in the “general unsecured” category (e.g. credit cards and medical bills) are subject to discharge. On the other hand, recent taxes go into the category of debts that are not subject to discharge.

The reason for this is that the Court can’t abide by similarly situated people being treated differently. Imagine you had five credit cards, and paid 100% to one, but nothing to the other four. One bank got its money, but the other four got the shaft, and the Court doesn’t like that. In order to preserve basic fairness, they all have to be treated the same.

So when you file your case, you have to list everybody. And when you get your Discharge Order, It applies to everybody. There isn’t any personal discretion involved.

What’s more, the reason why you’re going through all of this is to get rid of your debts. Why keep any of them? Even if it didn’t violate fairness principles, the fresh start, the very thing you’re trying to accomplish, would be impaired.

Bankruptcy Around the Web: September 2013

Here are some of the interesting and informative blog posts from bankruptcy lawyers around the country for this month:

  • Pittsburgh lawyer Shawn N. Wright has a blog post advocating for a “special classification” of student loans in Chapter 13 (i.e. continuing to pay them outside the plan), advice I agree with, but only IF you can afford to (and that’s a big if for most Chapter 13 debtors).
  • John Orcutt in North Carolina has an interesting post about the treatment of gambling debts in bankruptcy.  The upshot?  It’s dischargeable, but watch out for intent to pay at the time it was incurred.
  • At her own website, Cathy Moran has a blog post about a 9th Circuit decision holding that after a successful loan mod trial, mortgage lenders have to make the mod permanent or explain why not.  Meanwhile, over at the Bankruptcy Law Network, she has an interesting post about tax liens after Chapter 7 cases.



In re Flores: Ninth Circuit Overturns Kagenveama

On August 29, 2013, the Ninth Circuit issued an en banc opinion in the case of In re Flores, holding that above-median income Chapter 13 debtors only qualify for five-year plans, even if the Means Test shows a negative disposable income. This decision overturns In re Kagenveama (541 F.3d 868, 9th Cir., 2008), which had held that three-year plans were permissible in such cases.

When you file a Chapter 13 bankruptcy case, one of the documents you must file is the “Chapter 13 Means Test.” You add all the money you’ve earned over the past six complete months and divide by six. If that number is below the median household income in your state for a household of your size, you are a “below-median debtor,” and you qualify for a three-year plan. (A three-year plan may not be in your best interest, but at least you qualify for one.)

If the six-month average is above your state’s median for your household size, things get more complicated. You deduct standard amounts that the government thinks people nationwide spend on certain necessities. You deduct state standard amounts for other necessities. You deduct amounts that are specific to your situation, such as taxes, health insurance, payments on priority and secured debts, and so forth.

When you get to the end of the analysis, after all the deductions are accounted for, the resulting number is your Disposable Monthly Income (DMI). That number is the minimum amount that, based on this analysis, your unsecured creditors must receive per month through your plan. (There are other factors that also affect how much you pay your unsecured creditors, such as your assets and your anticipated future income.)

Under Kagenveama, if that number was negative (i.e. your allowed expenses exceeded your six-month average income), you could qualify for a three-year plan, despite having above-median income.

But in 2010, the U.S. Supreme Court decided the case of Hamilton v Lanning (130 S. Ct. 2464, 2010), which rejected a “mechanical approach“ to payments to unsecured creditors; bankruptcy courts were required to take into consideration “known or virtually certain changes” in a debtor’s income. (Lanning dealt with a debtor who, in the six-month period, had received a bonus she would never receive again, but such a “known or virtually certain change” could also be a layoff or a promotion.)

In Flores, the Court held that Kagenveama was “clearly irreconcilable” with the rationale of Lanning. True, an above-median debtor with a negative DMI would probably be paying nearly nothing to her unsecured creditors. However, with the forward-looking, non-mechanical approach dictated by Lanning, such a debtor has to be kept in her plan for five years due to the possibility that she might experience an increase in income, which would enable her to pay more.

Flores isn’t a great decision for debtors, but Lanning was, and the result in Flores is necessary to maintain logical consistency. Moreover, I think its impact will be somewhat small since (in my experience) relatively few above-median debtors with negative DMI would actually benefit from a shorter plan.  And what’s more, if a debtor is paying 100% to her unsecured creditors, a less than 60-month plan will still be available.

“Breaking Bad” and Chapter 13 Bankruptcy: Why Cooking Meth to Eliminate Debt is a Bad Idea

I’m late to the “Breaking Bad” party. As I write this, there are only four episodes remaining in the show, and I’ve only recently started watching it from the beginning. (I’m currently on Season 2.)  It’s a great show, with fantastic writing, and I’m burning through the episodes quickly. Its writers excel at putting the characters into, and getting them out of, difficult situations.

Still, there’s something about the show’s basic premise that I have trouble with.

Early on, Walter White is motivated to start producing methamphetamine to prevent his family from being saddled with debt after what he assumes is his impending death.

What Walter seems not to know is that medical debt, and the credit cards Skyler uses to pay the doctors, are unsecured, non-priority debts. They are subject to discharge in a bankruptcy case.

It’s a sad fact that medical debt plays a role in approximately half of all consumer bankruptcy cases.  If Skyler were eventually to file a bankruptcy case, that debt would be treated in her case just as it is in all those other cases. Her liability to repay would literally be gone.

But something else also got me thinking about potential a bankruptcy case for her: In one episode, Walter mentions a home equity line of credit, or HELOC.

The show doesn’t say, but I strongly suspect that the White’s house is worth less than what they owe on their first mortgage. Here’s why that’s important:

One of the greatest benefits of filing a Chapter 13 bankruptcy case is the possibility of “stripping” junior liens such as HELOCs and second mortgages. The idea is that if your first mortgage eats up all the equity in your house, there is no equity to secure a second lien. The second lien is “stripped,” and thus becomes ordinary unsecured debt just like medical bills or credit cards, i.e. subject to discharge.

I really wish that Walter was aware that Skyler wouldn’t necessarily have to be buried in debt. I wish he was aware that she could accept the Bankruptcy Court’s helping hand, and eliminate all those medical bills, credit card bills and that second mortgage. If he were aware of that, Walter might spend what he thinks are his final days in the company of his loving family, not in the awful practice of cooking meth.

But then again, if he did that, we wouldn’t have this great show to watch.

Lawsuits Omitted from Bankruptcy Schedules: No Presumption of Deceit (9th Circ)

Kathleen Ah Quin sued her employer for employment discrimination. She also filed a Chapter 7 bankruptcy case, but failed to list the discrimination lawsuit among her assets. The bankruptcy case closed (as normal) some five months later, but when the defendant/employer found out about it, they informed the court and took the position that it was a possible ground for dismissal of the discrimination suit. Ms Ah Quin then reopened her bankruptcy case and amended her schedules to include the lawsuit. The defendant/employer sought & received dismissal of the discrimination suit, and Ms Ah Quin appealed.

The Ninth Circuit Court, in reviewing that decision (Ah Quin v. County of Kauai Department of Transportation, 9th Cir., 2013), had to interpret an earlier Supreme Court holding that a plaintiff in Ms Ah Quin’s position should be barred from continuing her action unless the omission was based on “inadvertence or mistake.”

Some courts have interpreted the words “inadvertence or mistake” narrowly: If a debtor knew about the claim and had a motive to conceal it, the omission cannot be inadvertent or mistaken. Here, the Ninth Circuit came to different holding: Bankruptcy Courts are to use the plain meaning of those words, and conduct an inquiry into whether the omission was actually inadvertent or mistaken.

This is a good decision for debtors; it eliminates the presumption of deceit from debtors who have lawsuits omitted from bankruptcy schedules. If the omission really was a mistake, he or she will have an opportunity to demonstrate that fact.

But the real importance here is that this case raises an issue that people considering filing a bankruptcy case may not have even considered: A claim against someone else (i.e. the right to sue them) is an asset. If you sue that party, you might get nothing.  But then again, you might get something, and that potential something has value.  As such, you must list it among your assets in your bankruptcy case. If you don’t, you could lose the right to pursue that lawsuit.

Tl;dr: If you have an actual or potential lawsuit against someone, make sure your bankruptcy lawyer knows about it.

Ninth Circuit Defers to Bankruptcy Court on Student Loan Discharge (Hedlund)

More on the student loan discharge in bankruptcy:

Michael Hedlund graduated from law school in 1997, owing $85,000 in student loans to the Pennsylvania Higher Education assistance Agency (“PHEAA”). He never passed the bar exam, and later worked as Juvenile Counselor. In 1999, he paid $954 of a $5,000 inheritance to PHEAA. In January 2002, PHEAA began garnishing $250/month from his wages, collecting $4,272 in total.

Hedlund filed a chapter 7 bankruptcy case on May 2003 and sought a partial discharge of the student loans under 11 U.S.C. § 523(a)(8). The bankruptcy court granted a discharge of all but $30,000 of the debt. That decision was appealed to the BAP and then to the Ninth Circuit, which remanded back to the bankruptcy court for proper application of the “Brunner test.” On remand, the bankruptcy court granted a discharge of all but $32,080. After reversal by the District Court, Hedlund then appealed again to the Ninth Circuit.

As discussed here previously, there are three “prongs” to the Brunner test, determining whether a student loan is dischargeable in a bankruptcy case:

  1. The debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for himself and his dependents if required to repay the loans; 
  2. Additional circumstances exist indicating this state of affairs is likely to persist for a significant portion of the repayment period; and
  3. The debtor has made good faith efforts to repay the loan.

In the Ninth Circuit, courts consider two factors in determining the third prong: 1) Has the debtor tried to obtain employment, maximize income, and minimize expenses? 2) Has the debtor tried to negotiate a payment plan?

As to the first factor, all three courts agreed that neither Hedlund’s failure to take the bar exam again after failing to pass three times nor his wife’s underemployment constituted bad faith. However, whereas the District Court held that the debtor’s newly leased car and two cell phones was a failure to minimize expenses fully, the Circuit Court held that it wasn’t clear error for the bankruptcy court to treat those expenses as marginal.

As to the second factor, the Court held that it weighed against Hedlund that he hadn’t followed up on a consolidation application, that his offer of $5,000 for a more lenient plan was unrealistic, and that his research into his eligibility for the Income Contingent Repayment Plan (ICRP) could have been more searching. However, his efforts were at least better than those of the debtors in the cases on which PHEAA relied: Unlike the debtor in In re Birrane, he at least had done some research in the ICRP and was working full time. And unlike the debtor in In re Mason, he had waited four years to file his chapter 7 case, and had shown that a law license would not materially improve his situation. The Court reversed the decision below, and reinstated the bankruptcy court’s decision.

The case is one of a number of recent cases favorable to bankruptcy debtors with student loans. It represents a gradual turning away from the draconian one-two punch of § 523(a)(8) and the Brunner test.  It recognizes the complexity and grey areas of these situations, with deference to the bankruptcy judges who deal with them firsthand every day.

Can I File Bankruptcy After Taking My Name Off Title to My House?

A colleague of mine recently had a potential client come in for an initial consultation about possibly filing a bankruptcy case. This person had, a year and a half earlier, transferred his 50% interest in his family’s home to another family member. His share was worth $250,000 (it was owned free and clear of any liens), but he had received nothing in return for the transfer. He made the transfer because he was worried about his creditors coming after him and taking the house. He now wanted to file a bankruptcy case in order to stop a creditor lawsuit that had been filed in Superior Court.

Unfortunately, my colleague was not able to tell this potential client what he wanted to hear.

Section 727(a)(2) of the Bankruptcy Code states: “The court shall grant the debtor a discharge, unless: … the debtor, with intent to hinder, delay, or defraud a creditor… has transferred… property of the debtor within one year before the date of the filing of the petition.” In other words, if you transfer property in an attempt to evade your creditors (as this person seemed to have done) within a year of filing a Chapter 7 case, the court will deny you a discharge of your debts. In this instance, the transfer had taken place a year and a half earlier, so this provision didn’t come into play, but it was an important consideration.

Section 548(a)(1)(A) of the Bankruptcy Code states: “The trustee may avoid any transfer… of an interest of the debtor in property… that was made within 2 years before the date of the filing of the petition, if the debtor… made such transfer with actual intent to hinder, delay, or defraud an entity to which the debtor was or became indebted.”

Section 548(a)(1)(B)(ii)(I) of the Bankruptcy Code states: “The trustee may avoid any transfer… of an interest of the debtor in property… that was made within 2 years before the date of the filing of the petition, if the debtor… received less than a reasonably equivalent value in exchange of such transfer, and … became insolvent as a result of such transfer.” Section 101(32) of the Code defines “insolvent” as meaning that the sum of your debts exceeds the sum of your assets.

Therefore, if this person filed a Chapter 7 case, a trustee would have two bases for undoing the transaction: First, it was made less than two years earlier and had been made to hinder his creditors. Second, he received less than equivalent value and, since it was his only asset of any real value, he had become insolvent as a result. A Chapter 7 trustee could therefore undo the transfer, making the house property of the bankruptcy estate. It would not be covered by this person’s exemptions, so the trustee would sell the house, give the other family member her 50% share, and then distribute the remaining proceeds to this person’s creditors.

What about a Chapter 13 case? A Chapter 13 trustee does not have the authority to liquidate assets, but Section 1325(a)(4) of the Bankruptcy Code states that “[T]he court shall confirm a [Chapter 13] plan if the value… of property to be distributed [to unsecured creditors] under the plan… is not less than the amount that would be paid… if the estate of the debtor were liquidated under Chapter 7.” In other words, only plans that pay unsecured creditors as much as they would have received in a Chapter 7 case can be confirmed by the court. Therefore, this person could only get a Chapter 13 plan confirmed if it proposed to pay back 100% of his debtload (insofar as that debtload was less than the $250,000 in value he had given away).

My colleague’s advice to this person? Answer the Superior Court Lawsuit. The likelihood of that matter being resolved in less than six months is low. Then, when the 2-year period described in Section 548(a)(1) elapses, come back and revisit the subject of filing a bankruptcy case.

“Help, I’m Being Sued by a Debt Collector!”

What do I do if I’m being sued by a debt collector?

If a debt collector has sued you, whether it’s the original creditor or someone to whom they’ve sold the collection rights, it’s important that you respond in some way. You don’t want to ignore the lawsuit. If you do, the collector will get a “default judgment” and then may try to execute that judgment by garnishing your wages, levying your bank account, or putting a lien on your house.

You can respond to the lawsuit by filing a timely answer to their complaint or negotiating a settlement before your answer is due. If you file an answer, you could well prevail in the suit.

There’s a third option for responding to a debt collection lawsuit: File a case with the Bankruptcy Court. In fact, debt collection lawsuits are one of the most frequent reasons why people file bankruptcy cases.

When you file a case with the Bankruptcy Court, something comes into effect called the “Automatic Stay.” Your creditors are “stayed” from attempting to collect any debt from you. That means no letters or phone calls, no garnishments, no foreclosures, no repossessions, and no lawsuits. Any debt collection lawsuit must cease upon filing of a bankruptcy case.

If the debt that you’re being sued on is the only debt that you’re carrying, it may well be preferable for you to file an answer and defend that suit. But you’ll have to pay court fees and lawyer fees that will probably be higher than a chapter 7 bankruptcy lawyer’s fees. What’s more, there’s still a good chance you might not prevail.

On the other hand, if you have many outstanding debts and multiple potential lawsuits, it might make better sense for you to file a case with the Bankruptcy Court. You’ll still have to pay filing fees and lawyer fees, but you’ll do so only once, and you’ll take care of all that debt with one fell swoop. What’s more, your likelihood of success is higher: At the end of a bankruptcy case, you receive a discharge of your unsecured debts, and that discharge happens automatically, by operation of law.

What if there’s already a judgment against me?

Just because you have a judgment against you doesn’t change the your treatment by the Bankruptcy Court. The Automatic Stay still kicks in, not to stop the lawsuit, but to stop any attempts to execute the judgment (e.g. garnishment). Also, the existence of a judgment alone does not render the debt non-dischargeable because it’s still an unsecured debt.  (To be rendered non-dischargeable, they have to get a lien against your property.)

So if you have a judgment against you, and your wages are going to be garnished, or if the debt collector is threatening to put a lien on your property, call a bankruptcy attorney AS SOON AS POSSIBLE. You can’t afford to have money taken out of your paycheck, and you certainly don’t want unsecured debt converted into secured debt.

Taxes, Student Loans, and Other Non-Dischargeable Debt: What Chapter 13 Can Do for You

Chapter 7 is a fast process that results in the discharge of unsecured debts.  Common unsecured debts are credit card, personal loans, medical bills, and deficiencies on repossessed cars.  Chapter 7 doesn’t discharge secured debt (mortgages or car loans), but you have the option of surrendering the house or car to get rid of the debt.

Chapter 7 isn’t for everyone.  One reason is that if you’re behind on mortgage or car payments and are facing foreclosure or repossession, Chapter 7 can’t help you there.  At the end of a Chapter 7 case, your credit card debt will be gone, but you’ll probably still be behind on those secured debt payments, and the threat of foreclosure or repossession will still be there.

This is where Chapter 13 steps in.  Chapter 13 gives you the Court’s protection from debt collection actions for the duration of your Chapter 13 Plan (usually five years).  Since you’re not paying off unsecured debt, you can afford to start making your mortgage or car payments again.  And the amounts you’re behind get paid off through your Plan.

Another reason why Chapter 7 might not be right for you is that some kinds of unsecured debt are not dischargeable.  Those include most income taxes, student loans, and spousal or child support.  However, just because these debts aren’t dischargeable, doesn’t mean the Court can’t help you address them in a Chapter 13 case.

For tax debt, if the IRS is threatening a tax lien or won’t agree to a reasonable payment plan, you can pay them back through a Chapter 13 Plan over five years and at a relatively low interest rate, and they will have to accept it.

For spousal or child support, you will have to pay the full amount you are behind during the course of you Chapter 13 Plan and keep current with your ongoing payments.  However, as long as you do so, the Court protects your wages from being garnished.

As to student loans, Chapter 13 can provide a five-year “cushion” during which the lender will have to accept whatever amount you can afford, paid through your Plan.  The full loan will still be owed at the conclusion of your case (with interest), but you will have had that five-year breather to deal with your other financial issues.

Bankruptcy law provides many amazing tools for dealing with all kinds of debt, and this description barely scratches the surface.  If you’re having paying your bills or dealing with your debt, please contact me for a free initial consultation to see how the law can help you.