A TALE OF TWO HOUSES

Recently I had to defend a motion to dismiss a chapter 7 bankruptcy filing, which motion was brought by the office of United States trustee. A private lender had lent $100,000 to the debtor. The debtor was a contractor who had fallen on hard times due to a collapse of the new home construction market. The debtor lived in a million-dollar mansion, which he had used as a model home for his business. The private lender had a single-family residence and he had extracted hundred thousand dollars of equity from his more modest residence. The private lender photographed the million-dollar mansion and lobbied the US trustee's office, complaining that it was not fair that the contractor could live extravagantly while he the private lender lived in a more modest house. The US trustee's office sided with the private lender and filed a motion to convert or dismiss the chapter 7 bankruptcy.


While luxury goods may be maintained by the debtor in a bankruptcy filing, the court will examine whether the retention of luxury items works to the detriment of unsecured creditors. A luxury good maintained by the debtor for many years prior to the bankruptcy filing and which did not contribute to the events causing the bankruptcy probably can be kept or reaffirmed in the bankruptcy whether under Chapter 7 or 13. To require the debtor to surrender an item securing a debt which he had been paying faithfully in the years preceding the filing is prejudicial to the secured creditor. On the other hand, the debtors' retention of luxury items acquired in the years immediately preceding the filing are likely to result in the filing of a motion for abuse under section 707(B)of the bankruptcy code. A debtor may not prefer himself over his creditors.This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.

This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.

TO SHORT SELL OR NOT TO SHORT SELL?

Clients frequently ask me whether they should short-sell property or not.  My answer is that one should consider a short sale within the context of a bankruptcy.  I DO NOT THINK ONE SHOULD SHORT SELL PROPERTY WITHOUT CONSULTING WITH COUNSEL. 

Case in point, recently I met a client who short sold his residence because it was substantially underwater.  He had first and second deeds of trust and had consulted with a real estate agent specializing in short sales.  The client sold the property, but did not receive a release from the second deed of trust holder.  When I met the client, he was being sued by the second trust lender.  This has happened time and time again. 

I would have advised the client differently.  If he could have short sold the property with a release from the second trust lender or for a small payment to that lender, then I would have blessed the transaction.  If not, then bankruptcy is a consideration among other factors.

Credit Consequences

I have continued to monitor on-line publications from Freddie Mac, Fannie Mae and FHA concerning the consequences of a short sale or bankruptcy.  While a short sale may be equivalent to a material adverse credit event or a chapter 13 bankruptcy filing, it has a less dramatic impact on credit scores than judgment liens, a foreclosure or a chapter 7 filing.  Using a dart board, the biggest impact on credit score would be a foreclosure, then the entry of judgment liens against the debtor, then a chapter 7 filing, then a deed in lieu of foreclosure, then a short sale and in the center of the bull's eye would be a chapter 13 filing or voluntary debt resolution (if the latter works).  The center of the bull's eye represents the smallest impact on credit, around 150 points on the FICO score.  Hence, the best way to preserve your credit score would be to file a chapter 13 and to short sell a property during the bankruptcy.

Bankruptcy

If the above client had qualified for bankruptcy, I would have advised the client to remain in the house and file.  The client could have stated his intention on his bankruptcy filings that he wanted to retain the property and continue to pay.  In such an event, he would have been relieved of his obligation to pay on the second deed of trust.  After the bankruptcy, the client could have short sold the property without the threat of a lawsuit by the second trust lender.  In a Chapter 7, the underwater property could have been abandoned.  In addition, the administration of a chapter 7 case is relatively brief.  In a chapter 13, the court may have granted permission to short sell the property.  The court will not approve a short sell over the objections of a lender, but if the chapter 13 trustee will otherwise endorse the order, then the court will let the sale go through. 

Tax Considerations
We expressly do not give tax advice.  However, one should be aware that a short sale, foreclosure or surrender of a primary residence (upon the expiration of a patch Congress passed in 2008) or of an investment property can result in the realization of taxable income.  Sometimes, a taxpayers' basis in property will be so low that even in the event of a foreclosure, the disposition of the property results in capital gains.  Moreover, if the lender foregives some of the debt, the taxpayer may have phantom income known as "discharge of indebtedness income."  The short sale, surrender or foreclosure of investment properties in highly inflated markets, such as Florida, Arizona or California, may result in the realization of substantial discharge of indebtedness income.  According to the Internal Revenue Code, a bankruptcy filing offers an exception to the discharge of indebtedness rule. 

This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.

ATTORNEY OBLIGATION TO DISCLOSE ASSETS TO COURT

An issue recently arose concerning an attorney's obligation to disclose to the bankruptcy estate that a client's parent died leaving her an inheritance within 180 days from the filing of the bankruptcy.  See a prior blog article.  11 U.S.C. section 541 provides:

Any interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date—

(A) by bequest, devise, or inheritance;
. . .

(C) as a beneficiary of a life insurance policy or of a death benefit plan.

We concluded under the applicable Rules of Professional Conduct, Va. Sup. Ct. Rules, Pt. 6, Sec 11, Rule 1:6, that we must disclose such an event to the court because (i) our failure to do so would result in a fraud upon the court, unless we immediately withdrew from representation, and (ii) the failure to turn over assets of the bankruptcy estate would amount to bankruptcy crime.

This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.

CREDITORS MEETINGS

A creditors' meeting provides a creditors and the bankruptcy trustee with the opportunity to examine you under oath concerning your bankruptcy petition.  The proceeding is recorded by the United States Trustees office, and the statements you make are given under oath and penalty of perjury.  In Richmond, the proceedings take place in the federal Counthouse for the Eastern District of Virginia. You may not bring a cell phone into the building.  Also the marshall's service will not allow you to place your cell phone in a locker.  DO NOT BRING A CELL PHONE to the creditors meeting in Richmond.  It is very important that you give any requested documents to our office in a timely manner.  The Trustee's office wants to receive documents a week before the hearing so that the trustee and the attorneys and staff at the United States Trustee's Office have a chance to review the documentation before the meeting.  At the meeting you will be required to fill out an interrogatory form.  Except for issues concerning your statement of intention this form is not too difficult.  Clients never get the statement of intention question correct.  In the bankruptcy petition, the statement of intention is an statement by you concerning how you want to handle secured debts appearing on Schedule D and any leases appearing on Schedule G.  Frequently, clients affirm that automobile loans and mark retain and continue to pay for secured loans on real estate.  This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.

INHERITANCES IN BANKRUPTCY

As part of the intake process, I always ask clients if they have a great aunt or uncle who is going to leave them $1,000,000.  Invariably the answer is no.  I do this to alert clients to the fact that any inheritance given or to which the debtor becomes entitled within 180 days of filing for bankruptcy is part of the bankruptcy estate.  The trustees want me to give clients this information.  It is the law after all. 

Last week I had a client whose mother died within the 180 day period.  Obviously, this was sad for the client.  I think it is even sadder that her mother's assets are now being used to pay her daugther's creditors.  With proper estate planning this result could have been avoided.  In fact, good estate planning is important if one has many creditors.  If a client is being is being pursued by creditors or even before that point, if potential claims can be made against the debtor, then the debtor ought to alert relatives that this is a possibility.  In that case, a parent, for instance, can set up a testimentary trust with "spend thift" provisions.  These types of provisions allow the trustee to avoid payments to the debtor that would result in attachments by creditors.  There are exemptions under state law to protect spend thift provisions in trust documents.  We have an estate planning department and would be happy to assist you to protect prospective inheritances.

This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.

401(K) AND IRAS NOT PART OF BANKRUPTCY ESTATE; PLAN TREATMENT

Many times, I will sheepishly ask individuals about their 401(K) and 403(B) plans and IRAs in an intake interview.  I am happy when the client has saved much.  Unfortunately, usually that is not the case.  Typically clients raid their retirement plans to save their  houses from foreclosure or to pay harrassing creditors.  We should not do this.  But if the world were perfect, I would not be employed.

For some reason, this information concerning retirement benefits and balances is required to be disclosed on Schedule B of  the bankruptcy petition.  The trustees always ask about retirement assets.  It must be their curiosity.  Section 541 explicitly states that such plans or accounts ARE NOT PART OF THE BANKRUPTCY ESTATE. 

More importantly, Congress in 2005 explicitly allowed debtors in Chapter 13 plan to contribute to their retirements while in bankruptcy.  Recently, we came across an appellate decision from the United States Court of Appeals for the Sixth Circuit (BTW, we are in the Fourth Circuit!) in which the debtor increased her payments to her retirement after filing for bankruptcy under chapter 13.   The Court did not allow this.  The debtor could maintain the contribution level she had prior to the bankruptcy filing, but could not increase her contributions afterwards. 

The Sixth Circuit case suggests, if possible, one should establish a  sustainble retirement contributions prior to filing for bankruptcy under chapter 13.   Bankruptcy takes some planning, and for that reason, one should consult with counsel early in the process.   There are many steps that one make take prior to filing, and these can't be done overnight. 

This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes.  Consult with a lawyer concerning the specific application of the law to your unique circumstances.

CONVERSION FROM A CHAPTER 13 TO A CHAPTER ; NOT ALWAYS THAT SIMPLE

Recently, I had a client come into the office.  She was disappointed with her current bankruptcy counsel.  She had filed for a chapter 7 in 2002 and unfortunately recently received a divorce and therefore filed for a chapter 13 in 2010.  A year later, she could no longer comply with her chapter 13 plan and was in default.  Instead of modifying her plan payments downwards, which she is allowed to do, the debtor chose to convert her plan to a chapter 7.  Her counsel filed the documents converting the case to one under  chapter 7.  It is not hard to do, the forms for this are in Best Case, the leading bankruptcy software.  Anyway, she converted and filed the additional documents required and even attended the creditors' meeting.  She thought everything was fine.  Then the US Trustee's Office filed a motion to dismiss and a motion to disgorge the $750 the debtor paid her counsel for the conversion. 

Why?  The Bankruptcy Code provides that upon conversion, the converted chapter relates back to the filing date of the original filing.  So what, you might ask?   Well in this particular case, the debtor was ineligible to file a chapter 7 at the time she filed her chapter 13.  One can only file a chapter 7, once in every 8 years.  Therefore, the conversion was not successful and the client was very angry with her prior counsel.  I explained that I would be very happy to refile her chapter 7, for which she is know eligible, but the bankruptcy code itself is fraught with hazards, and that perhaps counsel should be forgiven.  She stated that the prior counsel refused to return her calls, etc.  That is another matter entirely.

This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.

EXEMPTIONS COMMENCING JULY 1: AUTOMOBILES, FIREARMS

The General Assembly has amended the protections given to debtors.  These protections are known as exemptions.  Under state law, the debtor asserts exemptions by filing a homestead deed in the county in which he/she resides.  A separate homestead deed is filed for each debtor, even if both spouses file in a bankruptcy.  In a bankruptcy filing, the homestead deed must be filed within five (5) days from the conclusion of the creditors' meeting.  There are numerous exemptions by amount, by category and by the status or age of the person asserting the exemption.  Commencing on July 1, 2011, a debtor may claim an exemption up to a value of $6,000 for an automobile.  Also commencing on July 1, the Commonwealth grants families an exemption to own a firearm valued up to $3,000.

This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.

DELAWARE BANK ACCOUNTS PROVIDE ASSET PROTECTION

Last year European authorities got angry with American authorities complaining about Swiss Bank accounts.  They responded to American authorties (particularly) the I.R.S., that you have Delaware and Nevada, which sometimes act as if they were offshore banking centers.  Why don't you clean these up before you find fault in the financial institutions and laws of other countries?

What does that mean to a lay person?  Well, let me be very specific.  Under Title10 Section 3502 of the Delaware Code, "banks, trust companies, savings institutions and loan associations" . . . "shall not be subject to the operation sof the attachment laws of this State."  This simply means that a creditor cannot garnish or attach funds in the bank account of a Delaware chartered banking institution or any bank or financial institution located in Delaware using state law collection procedures.  If you put your funds in the correct banking institution then your bank account is safe from creditors!  This state law does not bar the federal Internal Revenue Service.  The Supremacy Clause of the United States Consitution trumps Delaware law.

What banks do you use?  I would not use a nationally chartered bank.  That's the bank with "N.A." after its name.  Instead, use a Delaware chartered state bank that only has branches in Delaware.  You can find a list of these banks on the website of the Office of the Delaware State Bank Commissioner.  A deposit into a Delaware charted bank located in Delaware should protect your money.  Look for an account that allows you to wire money or to transfer money to other accounts online.  That way you can keep your current account in Virginia and use the Delaware savings account only when needed.

Please be aware, the Delaware account will give you only so much protection.  You may not lie on bankruptcy schedules, and if a court compels you to sign over the account on penalty of jail, then you will have to comply or else suffer the consequences.  Nonetheless, a Delaware bank account ought to be considered for asset protection



This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.