Feeling Guilty About Considering Filing a Bankruptcy Case? Don’t.

The biggest hurdle I face in my area of legal practice is this: Helping people come to the realization that they shouldn’t feel guilty about filing a case with the Bankruptcy Court.

I never use the phrases “declare bankruptcy” or “go bankrupt.” What I do is help my clients file a very specific kind of legal case and take advantage of very specific legal tools that exist to help them. And those kinds of cases happen to be heard by the Bankruptcy Court. There is no moral judgment in filing such a case. It doesn’t mean that you’ve failed somehow. All it means is that you need protection from the Court while you restructure your debts.

Not to be overly melodramatic, but modern America has in many ways become a system for extracting wealth from ordinary, hard-working people. The clients and potential clients I meet every day each have their own unique situations, but in one respect they are similar: they’ve found themselves in a financial situation that’s not entirely of their making. Maybe they’ve fallen behind on their mortgage after one spouse gets sick or loses her job. Maybe they put their retirement money into an investment property that has plummeted in value. Maybe in a time of desperation they took out an exorbitant title loan on their car. Maybe they’ve been trying to make payments to keep debt collectors at bay, but their salary just doesn’t go as far as it used to.

The individual doesn’t have too many weapons in such situations. Trying to fight them in the civil courts is expensive and often fruitless. Debt consolidators do little else but take your money. The big banks string you along with their promises of loan modifications, but in the end wind up foreclosing anyway.

The Bankruptcy Court is one of the very few places where an individual can go to get real, fast, and relatively inexpensive relief that carries the full force of law. When you file a case, the Court issues an Order telling your creditors they can’t try to collect from you. When your case closes, it issues another Order telling certain of your creditors that you don’t owe them anything else. Creditors take those Orders VERY seriously.

Big companies don’t get caught up with some kind of moral compunction about using the legal tools available to them. For them, filing a bankruptcy case is ultimately a numbers-based decision, and it should be for you too. Big companies know that after they emerge from bankruptcy, they will actually be more credit-worthy. Big companies know that they stand to be far more successful in a future free from bad debt.

Don’t listen to your creditors; they are not your friends. Of course they don’t want you to file. They’ve helped create a whole culture that makes you worry about your credit score and feel guilty about taking advantage of the legal system’s tools. Take your own counsel and decide what is best for you.

401(k) Contributions in Bankruptcy: A Debtor-Friendly Decision

A debtor-friendly decision on 401(k) contributions in bankruptcy came out of Washington state last week, but it requires some background to explain:

The Chapter 13 Means Test

One of the factors determining the size of your Chapter 13 Plan payments is your income; the more money you make, the more money your unsecured creditors need to be paid. The process of arriving at that number is called the Chapter 13 Means Test.

In the Chapter 13 Means Test, you start by taking your average income for the past 6 complete months. Then you subtract amounts that the government thinks people nationally and in your area spend on necessities, as well as amounts that you specifically spend on necessities (e.g. income tax, health insurance, mortgage, etc.). The result is your Disposable Monthly Income (“DMI”), the minimum amount that, based on this analysis, your unsecured creditors must receive per month through your plan.

In re Parks: Harsh Treatment for 401(k) Contributions in Bankruptcy

In August 2012, the Bankruptcy Appellate Panel (“BAP”) for the Ninth Circuit published an opinion in In re Parks. In Parks, the question was: Can a person’s ongoing 401(k) contributions be subtracted from income when calculating DMI? The BAP answered no, holding that post-petition 401(k) contributions are NOT excluded from the bankruptcy estate. Amounts that would otherwise have gone into a 401(k) must be paid to creditors, and cannot be deducted from income on the Means Test.

In re Bruce: Taking the Sting Out of Parks

In December 2012, the Bankruptcy Court for the Western District of Washington revisited the subject of 401(k) contributions and the Chapter 13 Means Test in the case of In re Bruce, and found favorably for the Debtor in two ways.

The Bruce Court’s first holding has to do with the different treatment of above and below-median debtors. You only have to go through the full Means Test process described above if your average income is above the median income for a household of your size in your state. If your income is below the median, then you are assumed not to have any disposable monthly income.

The Court held that the Parks prohibition on deducting post-petition 401(k) applies only to above-median debtors. For below-median debtors, whether those contributions are reasonable and necessary is still a question of fact for the court. And this Court, noting that modernly people primarily save for retirement not through pensions but through 401(k)s, held that these contributions were in fact reasonable and necessary.

Secondly, the Court held that when calculating income for the past 6 months, a debtor may subtract 401(k) contributions made during those 6 months. Thus, even though you can’t take future 401(k) contributions into account when calculating the Means Test, you can take past contributions in account. (Indeed, calculating it in this way may be much better for debtors as it may enable more of them to qualify for 3-year plans. But that’s a subject for a different post.)

This is a debtor-friendly decision that takes some of the sting out of Parks while still being consistent with it. As a Western District of Washington case, it’s not binding on the Northern District of California, where I practice, but the reasoning could very well be applied to cases here.  The opinion can be found here.

What Happens to HOA Dues In Bankruptcy?

The treatment of HOA dues in bankruptcy is quite different from the treatment of other types of debt. They might be secured (the HOA has recorded a lien) or unsecured (no lien).  And even if they are unsecured, they’re the only type of unsecured debt where you know you’re going to begin incurring again immediately once your case is filed. On top of that, Congress gave them special treatment as part of the 2005 revamp of bankruptcy law, so that you might have to keep paying them for a while, even if you surrender the property.

The main factors that determine what happens to them are: Under what Chapter is your bankruptcy case filed? Are you seeking to keep or surrender the property? Does the HOA have a lien? Here’s what happens to HOA dues in bankruptcy, broken down in chart form:

HOA Dues in Bankruptcy – Chapter 7

  No Lien Lien
Surrender the Property
  • Pre-filing dues: Discharged.
  • Post-filing dues:  You remain liable until bank takes title.
  • Pre-filing dues: Your personal liability is discharged. (HOA’s lien goes with the property.)
  • Post-filing dues: You remain liable until bank takes title.
Keep the Property
  • Pre-filing dues: Discharged.
  • Post filing dues: You keep paying them.
  • Pre-filing dues: You still owe them (and so probably consider filing a Chapter 13 case instead).
  • Post-filing dues: You keep paying them.

HOA Dues in Bankruptcy – Chapter 13

  No Lien Lien
Surrender the Property
  • Pre-filing dues: HOA gets portion of your Plan payments; remainder discharged at Plan’s completion.
  • Post-filing dues: You remain liable until bank takes title
  • Pre-filing dues: HOA gets portion of your Plan payments; remainder of your personal liability discharged at plan’s completion (HOA’s lien goes with the property)
  • Post-filing dues: You remain liable until the bank takes title.
Keep the property
  • Pre-filing dues: HOA gets portion of Plan payments; remainder discharged at Plan’s completion.
  • Post-filing dues: You keep paying them.
  • Pre-filing dues:  If you are under water on the mortgage, HOA lien is “stripped” and pre-filing dues are treated as unsecured debt.  If you are not under water on the mortgage, you get five years to repay full amount at 0% interest and no collection attempts allowed.
  • Post-filing dues: You keep paying them.

See those boxes where the phrase “until bank takes title” is in italics?  That’s the special treatment the HOAs received in the 2005 law, and is unlike the treatment of any other debt by the Bankruptcy Court: Even if you’re no longer living in the property, don’t have a tenant there, and have indicated to the Court your intent to surrender it, you still have to pay HOA dues until the bank takes title, which unfortunately, the banks are not always in such a hurry to do.  I wouldn’t let this fact discourage you from surrendering the property in you bankruptcy case if that’s the best thing for you to do.  However, it’s something you need to be aware of going in.

Also, take another look at that bottom right box, where you’re filing Chapter 13, there’s a lien, and you want to keep the property.  That situation is where a bankruptcy case really stands to do an enormous benefit for you.  If you’re under water on your mortgage, the Court “strips” the HOA lien, and the HOA gets treated like any other unsecured creditor (i.e. they only get a portion of your plan payments, and the remainder is subject to discharge).  Even if you’re not under water, you still get five years to get caught up, during which time the HOA can’t try to foreclose or otherwise try to collect on the debt.

Finally, Chapter 13 offers an additional benefit to people who are behind on their HOA dues: If, as in the Cisneros case, the HOA’s debt collection/foreclosure company is charging YOU (not the HOA) for fees that you never knew about or agreed to, in a Chapter 13 case you have an opportunity to challenge those fees.

HOA dues in bankruptcy are complicated, but as in so many other areas, the Bankruptcy Court provides very powerful tools to homeowners with HOA issues.  Yes, you have other options for challenging HOA dues (including special assessments), but if you have other debt issues as well, the fastest and most effective way to resolve them all may well be through a bankruptcy case.

Who should file a Chapter 7 bankruptcy case? Who should file Chapter 13?

The appropriateness of a type of case to your particular situation is the single most important determination in filing a bankruptcy case.  From the moment you begin your conversation, your bankruptcy lawyer will be thinking about whether your situation is Chapter 7 or Chapter 13.

By numbers alone, Chapter 7 cases are more common.  They’re what you typically think of when you think about bankruptcy cases.  You file your case, and (usually) three months later, the Court issues an Order “discharging” your unsecured, non-priority debts (e.g. credit cards, personal loans, medical bills, payday loans, deficiencies on repossessed cars, second mortgages on foreclosed homes).  “Priority” debt (e.g. recent income tax) is not discharged; you still owe it at the conclusion of your case.  With secured debt (usually car loans or mortgages), you have two basic choices: keep the car or house, and keep the debt, or get rid of the car or house and get rid of the debt.  (“Redemption” is a third option, but it’s not practical in most consumer cases.)

However, in Chapter 7, if you have certain types of assets over certain amounts (which varies from state to state), the Trustee is empowered to liquidate those assets and distribute them among your creditors.

Additionally, in Chapter 7, you have to pass something called the “Means Test.”  What the Means Test basically comes down to is, if you make too much money, you can’t file Chapter 7 and have to go to Chapter 13 instead.

Chapter 13 is quite different from Chapter 7.  You propose a Plan to the Court (which the Court either rejects or “confirms”) saying you will pay a certain amount every month to a Trustee for the next five (or sometimes three) years.  The Trustee takes that money and pays off certain debts in full, such as mortgage arrears, car loan balances, and recent taxes.

As to the aforementioned unsecured, non-priority debt such as credit cards, the Trustee pays something to those creditors too, but the amount is usually less than 100%.  Whether your unsecured creditors get 1%, 100%, or somewhere in between is determined by several factors, the most significant of which is income (as determined by the Chapter 13 Means Test, a cousin to the Chapter 7 version).  Upon successful completion of your Plan, any remaining unpaid unsecured debt is discharged.

So if Chapter 13 lasts so long, and only provides a partial discharge, why would anyone chose it over Chapter 7?

For starters, people who stand to lose property in a Chapter 7 case might opt for Chapter 13 instead because you never lose property in Chapter 13.  Another reason might by that you don’t pass the means test.  However, for most Chapter 13 filers, Chapter 13 is simply better for them.  For example, if you’re behind on your mortgage payments, a Chapter 13 case enables to you to get caught up those arrears over 5 years, at 0% interest, during which time you’re protected by the Court from foreclosure.

Here’s another benefit: If you have two mortgages, and your house is worth less than the first mortgage (i.e. you are “under water” on the first), in Chapter 13 you can “strip” that second mortgage.  The second mortgage then gets treated just like other unsecured debt.

If you’re behind on your car payments, Chapter 13 gives you five years to pay off the loan in full, during which time you’re protected by the Court from repossession.  And if you’ve had the car for more than two and a half years, you can do a “cram down.”  That means you don’t pay what you owe under the contract; instead you pay what the car is worth.

If you have recent, non-dischargeable tax debt, Chapter 13 gives you five years to pay that off, too.

Thus, generally speaking, lower income, few assets, and mostly dischargeable debts are factors pointing toward a Chapter 7 case.  Higher income, mortgage arrears, and the possibility of a lien strip or a cram down are factors pointing toward a Chapter 13 case.  People trying to stop foreclosures are almost always Chapter 13 cases.

Of course, no one’s actual situation is this simple.  People’s lives are complex, and there are many more factors than the ones I’ve briefly outlined here.  It is your lawyer’s job to consider and balance those factors and to determine which Chapter (if any) stands to provide you the greater benefit.  Regardless of the complexity of your situation, at the end of an initial consultation your lawyer should be able to recommend one Chapter or the other to you.

See our other blog post for more information on the difference between Chapter 7 and Chapter 13 bankruptcy.

Cisneros: Court Rejects HOA Collection Fees in Chapter 13 Case

On October 1, 2012, Judge Jaroslovsky of the Santa Rosa Division of the U.S. Bankruptcy Court for the Northern district of California issued an opinion in the matter of In re Cisneros (Case No 12-10468).  Mr. Cisneros was the owner of two condominiums in Santa Rosa.  He had fallen behind in his HOA payments, and proposed to cure those arrears through his Chapter 13 plan.  He did not dispute the HOA’s claim for unpaid dues or actually incurred collection fees, which together amounted to approximately $19,093.  What he did dispute, however, was an additional $14,744 in further collection fees tacked on by the HOA’s collection/foreclosure company.

Judge Jaroslovsky found that the HOA had never paid the collection company’s fees, and under the terms of their contract, it was under no obligation to pay them.  The collection company’s fees were not incurred by the HOA, and were not necessary to defray costs incurred by the HOA.  The fees were thus unenforceable under California law, and so were not allowable as claims against the Debtor in his Chapter 13 bankruptcy case.

As to the rights of the collection company itself against the Debtor, Judge Jaroslovsky found that it had none: “It is not in privity with Cisneros.  Any rights it has against Cisneros stem from the HOA, so it cannot have more rights than the HOA against Cisneros.”

This decision represents a substantial victory for homeowners against HOAs and their collection companies, an area which, sadly, remains vulnerable to considerable abuse of the kind represented here.

North: Chapter 20 Lien Strips OK in Northern District of California

“Chapter 20” is the term commonly applied to situations where a debtor files a Chapter 7 bankruptcy case and then some time shortly after receiving a discharge, files a Chapter 13 case.

Why might someone do this? Here’s a common hypothetical: A debtor cannot file Chapter 13 because her unsecured debts exceed the $360,475 Chapter 13 limit. Instead, she files a Chapter 7 case and receives a discharge, reducing her unsecured debts to $0. However, she still has a second mortgage on her house, and the first mortgage is “under water.” That second mortgage was not stripped because lien stripping is not available in Chapter 7. Can she then file a subsequent Chapter 13 case (for which she now qualifies) in order to strip the second mortgage?

Some courts have responded with a no, agreeing with trustees that § 1325(a)(5)(B)(i)(I), read in conjunction with § 506(d), makes lien stripping dependent on the debtor receiving a discharge. However, this debtor has already received a discharge in her Chapter 7 case and is not entitled to a second one. Ipso facto, no discharge, no lien strip.

In an opinion issued on October 15, 2012 the case of In re North, Judge Efremsky of the United Bankruptcy Court for the Northern District of California came down on the other side of the argument, finding that permanent lien stripping is dependent not on receipt of a discharge, but on completion of the Chapter 13 Plan’s payments.

Thus, since the Chapter 7 case extinguishes the debtor’s personal liability for the second mortgage but not the creditor’s in rem rights (i.e. the lien), since and those in rem rights can be restructured in Chapter 13 (i.e. the lien stripping, which is permissible under the rationale above), at the completion of the debtor’s Plan the creditor is question has no recourse against either the person or the property. The is, for all effective purposes, gone.

Thus Chapter 20 cases, and the ability to strip liens within them, remain a powerful tool in the hands of debtors, especially in Northern California where the regularity of million-plus mortgages puts many ordinary homeowners in danger of running afoul of the debt limits. However, Chapter 20 cases are rife with other potential pitfalls, not least of which are bad faith issues, and so you should make sure you find a lawyer who knows what he or she is doing. Additionally, the Chapter 13 Trustee in the North case has indicated that she intends to appeal the decision.

“Bar Study” Loan Determined to be Dischargeable

Not to sing my own praises, but I’m quite proud of this one: On October 3, 2012, Judge Carlson in San Francisco issued an order in the adversary proceeding, McGinnis v. Citibank (Bankr. N.D. Cal, Case No. 12-03111), where I represented the Debtor/Plaintiff.

The Debtor is a relatively newly admitted attorney who filed a Chapter 13 case. Among her debt s was approximately $15, 000 in a “bar study loan.” Taking out bar study loans is quite common among lawyers-to-be; such loans cover their bar exam tutoring and living expenses while they’re preparing and awaiting their results. The lender filed a claim in the Debtor’s Chapter 13 case, claiming the loan was a “student loan” and therefore not subject to discharge.

The Debtor initiated the adversary proceeding, claiming that the loan was not a “student loan” as defined by law. It was not intended to cover the costs of attending a Title IV institution; Indeed, there was no “institution” at all; she was engaged in self-study and had tutoring from private “bar prep” companies. Moreover, she was pursuing a professional license, not an academic degree.

Though it had adequate notice, the lender failed to respond to the Debtor’s complaint. Judge Carlson’s Order on October 3 was therefore a “default judgment” and so has little if any value as precedent.

However, I think there’s a lesson here: If you have a bar study loan and are filing a bankruptcy case, be sure to talk to your lawyer about whether or not that’s really a student loan. Also, if you’re in a non-law profession but still took out some kind of loan while you studied for a professional license, that debt may not be a student loan, either.

Unfortunately, under current law, there’s not much I or any other debtors’ attorney can do about student loans. However, there are things at the margins, such as this, where we can make significant inroads.

Jacobson: Big Change to California Homestead Exemption in Chapter 7

“Exemption Laws” are those laws that allow people who file bankruptcy cases to keep certain amounts of certain categories of assets.  Like most states, California (where I practice) has its own set of exemption laws.

If you’re over 65 or disabled, California allows you to keep $175,000 worth of equity in your house.  That’s called the “Homestead Exemption.”

So, for example, if you’re a Californian over 65 and owe $500,000 on your house, and it’s worth $675, 000 or less, then that $175, 000 in equity is fully protected.  If a Trustee in a Chapter 7 case took your house and sold it, she’d have to pay the mortgage holder (the bank) first, and then give you a check for $175, 000 before she had any assets with which to pay your creditors.  That being the case, she’s not going to bother trying.

However, if the house was worth $700, 000, she would be much more likely to go after your house: She would sell it for $700,000, give $500,000 to the bank, give $175,000 to you, and then distribute the remaining $25,000 to your creditors.

A recent Ninth Circuit Court of Appeals decision (Wolfe v. Jacobson, U.S. Court of Appeals, Ninth Circuit, No. 10-60040) stands to have an enormous impact on the bankruptcy cases of people who make use of the Homestead Exemption.

In this case, the Jacobsons, both over 65, had more than $150,000 equity in their home. ($150,000 was the Homestead Exemption amount at the time they filed their case.) A creditor asked for, and the Court granted, permission to proceed with a foreclosure of the home.  The house was sold, the Jacobsons got $150,000, and everything else went to pay off the creditors.

However, the Jacobsons didn’t use that money to buy another house; they put it in the bank to use for ordinary expenses.  The Trustee in their Chapter 7 case then pursued the $150,000, claiming that because the Jacobsons didn’t use it for a new home within six months, it had lost its exempt status.  The Bankruptcy Court and the Bankruptcy Appellate Panel decided against the Trustee, but the Ninth Circuit Court of Appeals reversed those decisions.

An appeal is pending, and a question remains as to whether this applies to sales by the Trustee as well as to sales by creditors, but under this precedent, a debtor who receives proceeds from the sale of his or her house pursuant to the Homestead Exemption, must reinvest those proceeds in to a new home within 6 months or lose those proceeds.

Fighting Fraud In Bankruptcy Act Introduced

On May 24, 2011, Senate Judiciary Committee Chairman Pat Leahy (D-Vermont) introduced the Fighting Fraud in Bankruptcy Act (S. 1054). Among other things, the Act is intended to bolster the ability of the Executive Office of the U. S. Trustee (EOUST) to fight creditor fraud and protect homeowners.

When you file a Chapter 13 bankruptcy case, your creditors must come forward and file a claim with the court in order to receive a port ion of the payment s that your will be making on your Chapter 13 Plan. The EOUST recently reviewed of proofs of claims filed by mortgage servicers, and found that the error rate was ten times higher than what representatives of the mortgage servicing industry had claimed. The EOUST has sought increased sanctions for defective and fraudulent claims, but the mortgage servicing industry has challenged the EOUST’s authority to do so.

The proposed Act clarifies that the U. S. Trustee has a duty to take act ion to remedy credit or abuse of the bankruptcy process. It also allows the court to correct or sanction credit or misconduct. It empowers the U. S. Trustee to establish procedures f or auditing claims, and it requires mortgage lenders to cert if y under penalty of perjury that foreclosure proceedings against active duty military members comply with the Servicemembers Civil Relief Act.

Introducing the bill, Senator Leahy said: “The Fighting Fraud in Bankrupt cy Act is another step forward in the Judiciary Committee’s important efforts to protect American citizens from fraud. As Congress looks at ways to mitigate the foreclosure crisis to reduce its impact on homeowners and the economy, I hope all Senators can agree that the foreclosure process for Americans should be a fair one and one in which there is account ability for fraud or other misconduct. And I hope we can all agree that the integrity of our judicial system is something worth protecting.”

Refiling After Dismissal? Make Sure You Extend the Automatic Stay

If your bankruptcy case is dismissed for any reason and you file a second case within a year, the “Automatic Stay” in the second case is different from the first. (The Automatic Stay is a protection created the moment you file.  It “stays” your creditors from trying to collect on your debts.  It stops lawsuits, foreclosures, garnishments, repossessions, and creditor phone calls and letters.) While the Automatic Stay usually last s indefinitely, in your second bankruptcy case filed within a year, it lasts only 30 days unless you ask the Court to “extend” it.

Generally, this rule exists to stop people from repeatedly filing and dismissing bad bankruptcy cases in order to thwart foreclosure indefinitely.

There’s an extra wrinkle to this rule:  The statute (11 U.S.C. § 362(c)(3)) is ambiguous as to whether the Automatic Stay’s protection terminates only as to you and your property, or if it also terminates as to the property of the “estate” that was created when you filed.  (The “property of the estate” includes all of your assets at the time of filing.  In a Chapter 13 case, it also includes your earnings during the course of your payment plan.)  As a result, a disagreement has arisen among the Circuit Courts, with a majority taking the former approach and a minority taking the latter approach.

The reasoning behind the majority approach is that it preserves the equal treatment of creditors: Let’s say you’re filing your second case within a year, following a dismissal, but fail to extend the Automatic Stay.  You have a house with equity that you want to surrender.  The house becomes property of the estate, and the Trustee takes possession, planning to sell it and distribute any proceeds to your creditors. Under the majority approach, your bank/mortgage holder can’t step in and take the house all for itself; it has to get its share from the Trustee, just like all the other creditors.  But under the minority approach, because there is no Automatic Stay as to the property of the estate, the bank can just step in and take the house all f or itself, leaving the other creditors out in the cold.

In its February 2011 decision In re Reswick (2011 WL 612728), the Bankruptcy Appellate Panel (BAP) for the Ninth Circuit (which includes California) came down on the side of the minority approach.  The facts of Reswick are atypical:  The debtor filed his second case within the year (the first having been dismissed for failure to make Chapter 13 Plan payments), but he did not obtain an extension of the Automatic Stay.  After 30 days elapsed, a creditor, based on a pre-pet it ion lawsuit, started garnishing the debtor’s wages (which, in Chapter 13 cases, are property of the estate). When the debtor sought damages f or violation of the Automatic Stay, the Court found that there was no Automatic St ay and therefore no violation. The BAP agreed.

Thus, the decision in Reswick gives preference to creditors who happen to have obtained pre-pet it ion judgments.  An appeal to the Ninth Circuit Court of Appeals is expected.  For Californians who’ve had one bankruptcy case dismissed and are contemplating a second filing within a year, the lesson of here is clear: Make sure your lawyer knows about your previous case, and make sure he or she seeks an extension of the Automatic Stay.