Bad News for Debtors?

The Utah Supreme Court gave debtors a lump of coal for Christmas in the form of its opinion in Gladwell v. Reinhart, 2012 UT 82 (December 4, 2012), a case certified to it by the Tenth Circuit Court of Appeals in Denver to answer a question of state law.  The issue arose in Dr. Reinhart's bankruptcy.  Dr. Reinhart claimed an exemption in 75% of the wages owed to him but unpaid as of the date of his bankruptcy petition.  This is common practice among bankruptcy attorneys in Utah and it had been universally recognized.  Occasionally a trustee would demand the other 25% that wasn't exempt under Utah's exemption statute, but most of the time the debtor kept 100% of any unpaid wages as of the filing date.

In the Reinhart case, the Chapter 7 trustee challenged the claim of exemption.  The bankruptcy court denied the trustee's objection, following the practice that had been in place for years.  The district court upheld the bankruptcy court.  On appeal to the Tenth Circuit, the Court of Appeals certified the case to the Utah Supreme Court.  "Certification" is a process by which a federal court, called upon to answer a previously unanswered question of state law, can ask the highest court of the state to determine the answer.

On certification the Utah Supreme Court held that the exemption statute in question, Utah Code section 70C-7-103, does not to allow a debtor in bankruptcy to claim an exemption for 75% of the wages owed to him but unpaid as of the date of filing.  In other words, 100% of what a debtor is expecting in his next paycheck after he files is subject to being taken by the bankruptcy trustee as "property of the estate."

In the past most debtors' attorneys have timed the filing of the bankruptcy petition to a date just before a payday so that what is in the debtor's checking account at the time of filing is almost nothing, relying on section 70C-7-103 to exempt what is owed to the debtor.  With the ruling in Reinhart debtors risk losing their entire next paycheck after they file.  And, if they wait and file the day after payday, so that what is owed but unpaid is a small amount, any money still in their account from that paycheck on the day they file is subject to being taken.  The Utah Supreme Court has effectively ruled that the debtor's last paycheck before filing is forfeited to his estate, meaning debtors will have to skip a payday in order to file.

Utah being the debtor-unfriendly state that it is, don't expect the Utah legislature to correct this problem any time soon.

Is Best Buy Headed to Bankruptcy?

In 2008 Circuit City filed bankruptcy, leaving Best Buy as the remaining entity under the business model both had used: Selling consumer electronics in large retail stores.  Best Buy has survived but it hasn't thrived.  Store sales have fallen in each of the last eight fiscal quarters.  Many observers feel it's only a matter of time before Best Buy faces the same fate as Circuit City.

The problem Best Buy faces is the same as that faced by most large retailers, that of competition from online retailers such as Amazon, eBay and even Walmart.

If you got a Best Buy gift card for Christmas you might want to use it soon.  If Best Buy files bankruptcy, holders of gift cards become unsecured creditors and the likelihood of getting anything back as an unsecured creditor is virtually nil.

Beware the Purchase Money Security Interest

When filing bankruptcy, or any time you're buying on credit, beware of the Purchase Money Security Interest (PMSI).  A PMSI gives the seller of the goods a security interest in whatever you purchase.  This is especially sneaky when you use an in-store credit card, such as one issued by Best Buy, Sears or, in the Salt Lake City area, R.C. Willey.  When you applied for credit with these companies the credit application you signed says that you grant a PMSI in whatever you buy using the card.  This extends to EVERYTHING you buy, even if you bought it five years ago and think you long ago paid that purchase off.  If you still owe money on the card, those items are probably collateral for the debt.

Suppose that last Christmas you used your Best Buy card and purchased a laptop and an iPod.  You kept the laptop but you gave the iPod as a gift.  Now you find you have to file bankruptcy and you list Best Buy as a creditor.  Everything seems fine until a representative of Best Buy calls and asks if you intend to reaffirm their debt.  It's a credit card, you say.  I'm not reaffirming with VISA or Master Card, why would I reaffirm with them?

The simple answer is the PMSI.  As a secured creditor Best Buy is entitled either to be paid the value of what you want to keep or have the merchandise returned.  You probably don't want to go to whomever you gave the iPod to and ask for it back so you have no choice but to pay for it.  Reaffirmation is a negotiated agreement between debtor and creditor and a creditor doesn't have to reaffirm, so if Best Buy demands that you reaffirm the entire debt if you want to keep the iPod you might have to pay the entire debt, even though you'd be happy to give back the laptop.

The reason you don't have to reaffirm with VISA or Master Card is that they are unsecured creditors.  They did not get a PMSI in whatever you bought using the card so they have no right to demand anything back.

Bankruptcy Exemptions

I was faced with an interesting question from a client this week.  Up until recently ago he lived in California.  For six years he has owned a condo in Utah.  Four months ago he moved to Utah and now lives in the condo.  He needs to file bankruptcy and wants to know which state's exemptions, Utah or California, he can use.  He wants to use California because their homestead exemption is $75,000 whereas Utah's is $20,000.

Section 522 of the Bankruptcy Code says that a person uses the exemptions in the state where he has had his domicile for the past 730 days (two years), unless the person hasn't lived in a single state for that time.  If, like this person, a debtor has lived in two or more states in the past two years, then he uses the exemptions in the state where he lived the longest portion of the 180 days immediately preceding the two year period.  This convoluted and confusing statute is part of the BAPCPA enacted in 2005 and its purpose is to prevent debtors from moving to states with more liberal exemption laws and then filing bankruptcy.

In this case, section 522 helps my potential client because he lived in California for the full 180 days prior to the two year period back to August 2009.  So he will get to claim the California exemption even on his condo in Utah.

Living Reality?

I follow a number of bankruptcy blogs and today read a great post by a bankruptcy attorney in Kansas City, Missouri, about reality and bankruptcy.  Rachel Foley makes the point that the so-called "reality" shows have twisted our view of the world.  Many of us try to emulate any number of people in these shows and end up both spiritually and financially bankrupt.  You can read Rachel's entire post here:

http://www.bankruptcylawnetwork.com/trying-to-live-like-a-reality-star-may-lead-to-bankruptcy/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+BankruptcyLawNetwork+%28Bankruptcy+Law+Network%29

One of the key points in her post is that bankruptcy is designed to give people a fresh start, and you can't make a fresh start by continuing to spend more than you make.  You can get rid of your debt, but if you continue to live beyond your means, in five years you'll be in debt again.  Bankruptcy requires some hard decisions and may involve some pain as you give up a lifestyle that you can't support.  The client who says, "I want to get out of debt but I don't want to give up my boat" won't make a fresh start because he hasn't realized that owning a boat just isn't in the cards for him right now.

If you're not willing to engage in some soul-searching and make some hard choices, bankruptcy isn't a fresh start.  That might sound harsh, but that is reality.

Surrendering a House

In bankruptcy a debtor has three options when it comes to secured debt (debt where the creditor has collateral that can be repossessed): Surrender (give the collateral back), reaffirm (renew the contract, essentially excepting the debt from the bankruptcy), or redeem (paying the creditor a lump sum equal to the value of the collateral -- not a realistic option for obvious reasons).  To surrender means you give back the collateral and walk away from the debt, not owing any deficiency that may exist after the creditor sells the collateral.  With a car or any other personal property, surrender is fairly easy.  Drive the car to the bank, drop the keys on the manager's desk and walk away.  It's a bit more tricky with a house.  How do you give a house back?

The issue is becoming more and more important because of the backlog of foreclosures.  In years past, as soon as a person filed bankruptcy the bank filed a motion for relief from the automatic stay to get permissioin to foreclose.  Now, banks are waiting several months to act, if they act at all.  While this might seem like a great deal for the debtor because she gets to live in the house rent-free until the bank acts. there are some big downsides. If your bankruptcy schedules say you're going to surrender something, you are required to surrender within 45 days of the meeting of creditors.  For a house, this means, at the very least, to leave and notify the bank that the property is vacant. But this doesn't solve everything. As long as the debtor still has legal title, she is considered the owner.  That means if someone is hurt on the property (such as by slipping and falling on the ice), the debtor could be responsible.  If there are dues, such as condominium fees, the debtor could be personally responsible.  Same goes for assessments made by the city. If these things happen after you have filed (post-petition), the debts are not discharged by the bankruptcy. 

If you plan to surrender your house in bankruptcy. talk to your attorney about how you actually accomplish that.

Taxes in Bankruptcy

Will my tax debt be wiped out in a bankruptcy?  For many, that's a huge question.  It's also a question that a lot of professionals, bankruptcy attorneys included, don't have the answer to.  In most cases, the answer is "No."  Taxes are not discharged in a bankruptcy.  That's because the same people who wrote the Bankruptcy Code, Congress, are the same people who wrote the Internal Revenue Code and the government takes care of itself.  Letting people discharge taxes in bankruptcy would seriously hamper the government's ability to do business.

Tax debt CAN be discharged if all these conditions are met:
1.  The taxes are income taxes. Other types of tax, such as payroll taxes or the "personal liability assessment" for officers and directors of a company that didn't pay over payroll taxes, tax penalties and the like are not dischargeable, ever.
2.  You filed a return for the period in question.  If you've been delaying filing a return, the taxes can't be discharged regardless of how old they are.
3.  The taxes are at least three years past due.  Since income taxes are not due until April 15 of the year following the calendar year for which the tax applies, this means three years after April 15 for the prior year.
4.  You didn't commit fraud, such as wilfully evading paying, using a false social security number, etc.
5.  You pass the "240-day" rule, which says the IRS must have assessed the tax more than 240 days before you file, or it hasn't yet assessed the tax.  If you fall between those two deadlines, they can't be discharged.

WARNING:  Even if you are able to discharge the taxes, if the IRS filed a tax lien against any property you own, that lien, just like other liens, such as mortgages or judgments, passes through bankruptcy unaffected and can still be enforced against the property.

If you are filing bankruptcy because of tax debt (this includes state taxes as well as federal), be sure you talk to a knowledgeable tax and bankruptcy professional before filing.

Hiding Assets After Bankruptcy

A few days ago I received a call from a credit union about one of my clients.  Apparently my client is hiding his motorcycle, which was security for a loan from the credit union.  The credit union asked for my help in getting it back.

Now there's not a lot I can do for the credit union.  For one thing, my client and it are in an adversarial situation and my client comes first.  I did agree to send my client a letter telling him that he needed to either pay for the motorcycle or give it back.  That's the rule with secured debt.  The personal liability for the debt goes away, meaning the credit union can't sue my client and try to collect money from him.  But the security interest the credit union had in the collateral, in this case the motorcycle, is unaffected by the bankruptcy.  It just passes through the case without being harmed.

The bottom line is, if you want to keep your stuff, whatever that stuff is, and that stuff is collateral for a loan, you are still going to have to pay the loan after the bankruptcy.  If you aren't willing to or can't pay, you have to give it back.  Hiding it is not an option.

Gift Card from Blockbuster? Fuhgetabboudit

Did you get a gift card to Blockbuster that you haven't used completely? If so, throw it away.

Blockbuster filed Chapter 11 bankruptcy last year, as was widely expected. Up until last week, it looked like Blockbuster might be destined to become one of those companies that just quietly fade away until one day you suddenly notice they aren't there anymore. But last week Dish Network offered $320 million for Blockbuster, a higher number than the liquidation value of the entire chain. So it looks like Blockbuster might live on.

If so, its gift cards are no longer accepted. Gift cards are a form of "executory contract" under the Bankruptcy Code. An executory contract is one that still has to be performed by one or both parties. In this case, Blockbuster still had to perform by renting movies to holders of the cards. In Chapter 11 a debtor can "reject" executory contracts, meaning the debtor simply says, "I'm not going to perform my obligation under the contract." And that's exactly what Blockbuster has done. Go into any of their retail outlets and you'll see signs posted that say that after April 6, 2011, gift cards are no longer accepted.

The other parties to rejected executory contracts, in this case holders of gift cards, become general unsecured creditors in the Chapter 11 case. General unsecured creditors are the lowest form of creditor life in a bankruptcy, entitled to be paid after virtually everyone else gets something, and then only if there is any money left. In reorganizations, general unsecured creditors sometimes get a few cents on the dollar. But in order to get paid, they have to file a proof of claim. In the case of Blockbuster gift cards, the potential return to holders probably isn't worth the price of a stamp to mail the claim in.

Facebook and Bankruptcy

We've all heard of legal problems created by Facebook, such as employees who got fired for posting derogatory comments about bosses, customers and co-workers. Facebook could present legal problems in other ways as well.

In Pennsylvania last fall, a court ordered the plaintiff in a personal injury action to allow the defense attorney free access to all his Facebook pages. The purpose was to examine what the plaintiff might have said about his injuries and his life to attack his credibility that his injuries had affected his quality of life. For example, if the plaintiff had posted pictures of himself helping his girlfriend move, his claims that the accident had partially incapacitated him would be somewhat eroded.

It doesn't take a lot of imagination to make the next leap to a bankruptcy trustee wanting to examine a Facebook page. Is that a picture of the debtor on a new motorcycle? Wait, the motorcycle wasn't listed in his schedules and statement of financial affairs. Maybe there's some bankruptcy fraud going on. Or, is the debtor telling friends she's taking a cruise? Where did the money for that come from? Even if your privacy settings only allow Facebook friends to see what you post, if a trustee gets a court order, all bets are off.

The point of this is, be totally honest with your attorney about what you own. Don't try to game the system. It could come back to haunt you. At best your bankruptcy discharge might be denied. At worst, you could be facing prison for bankruptcy fraud.

Exemptions in Bankruptcy

When you file bankruptcy, almost everything you own becomes part of your bankruptcy estate. The estate is the pile of stuff from which the trustee can sell or liquidate to raise money. With that money, he pays creditors on a pro-rata basis. Some of the property in the estate is exempt, meaning the trustee can't touch it.

Exemptions can be full or partial. Full exemptions are things like household furnishings (subject to their being included in the list of exemptions). These include things like washers, dryers, refrigerators, beds, personal clothing, most furniture and the like. Also included in a full exemption are IRAs and 401Ks and other qualified retirement accounts. In Utah contributions made to such accounts in the past year are not exempt, but under federal law, all contributions are exempt. Make sure your attorney claims the federal exemption as well as the state exemption or you could lose contributions made in the last 12 months.

Partial exemptions are exemptions based on dollar values. For example, Utah law exempts $2,500 for a vehicle, per person. It also exempts $20,000 for a homestead exemption. Both of these dollar amounts have been on the books for over 20 years and are woefully outdated. Who can get a reliable car for $2,500? Yet that's all Utah law allows a debtor to acquire a vehicle to get to and from work. And $20,000 ($40,000 if married and filing jointly) for a house? While that's a more generous amount due to the recent downturn in the housing market, truly what does $20,000 do to protect your home, which is the purpose of a homestead exemption.

Don't count on the Utah legislature to update exemptions any time soon, though. Utah is one of the most creditor-friendly states in the nation, which is one reason it has one of the highest percentages of bankruptcy filings.

Is the Sacred Cow of Home Mortgages About to be Slaughtered?

For years, despite all the amendments to the Bankruptcy Code, one thing has remained untouchable: A debtor cannot modify the terms of her first mortgage that secures a debt on her primary residence. Debtors have been able to modify car loans, second mortgages, mortgages on vacation properties and a host of other loans for years, but first mortgage loans remained sacrosanct. All a debtor can do is catch up any arrearage through her plan, but she has to make all future payments (beginning with the payment that is next due after filing) on time and in the amount originally agreed.

The process of modifying a secured debt in bankruptcy is often called "cram down," from the graphic notion that the debtor crams the terms of the new loan down the creditor's throat with the help of the Bankruptcy Code. What happens is the debtor proposes a plan that repays the creditor only the value of its collateral. With cars, this is almost always less than what is owed. Since the housing crisis began three years ago, more and more homes are underwater and debtors want to be able to "refinance" their loans for lower principal amounts through the bankruptcy courts.

Senator Jeff Merkeley of Oregon is renewing the idea of allowing cram down for mortgages. The last attempt in 2009 failed, but this time there may be added ammunition: The housing market is still in the toilet, the job market stinks, the much-touted HAMP and other government programs to provide mortgage relief are dismal failures, and voluntary modifications by banks just don't happen. Stories of people sending the same documents a half dozen or more times and getting the runaround for months are legion. All of these things together might mean the economic and political climate are right to permit mortgage cram downs.

Having Your Cake and Eating It Too

No, you really can't have your cake and eat it too, but that's exactly what a lot of people want and even expect from bankruptcy. They look on bankruptcy as a magic potion that will solve all of their financial problems and let them live the lifestyle they dream of (and were probably living in the first place). Bankruptcy is a serious step and requires serious effort. It is possible, even likely, that when someone files bankruptcy they will lose their house, their car, their boat, and a lot of other things that they financed. The reason is, if they can't make the payments before filing, they won't be able to make the payments after filing.

Instead of focusing on what they lose by filing bankruptcy, they should look at what they gain: Freedom from debt collectors. Freedom from robbing Peter to pay Paul. Freedom from working two or three jobs to make ends meet. Freedom to spend more time with family and friends. The chance to start over.

Bankruptcy is intended as a second chance. The "fresh start" concept is central to bankruptcy. But a fresh start doesn't mean going back and doing the same things over again, making the same mistakes, incurring the same debt. It means starting over and doing it better this time. This probably means living within your means, absolutely, positively not buying anything you don't need and setting priorities among what you do buy. It's hard, but bankruptcy wasn't meant to be a simple solution. And in the end, it's worth it.

Credit Cards or Retirement?

One of the best reasons to file bankruptcy may be to plan for your retirement. If you're paying the minimum amount each month on credit card debt, you can't be saving for retirment. If you want to retire in any form, you have to start saving now.

Suppose you have $20,000 in credit card debt and all you're paying is the minimum amount each month. Under most credit card agreements, the minimum varies, based on the outstanding balance, and is often something like 1.5% of the balance. Paid at $300/month that $20,000 will take nearly 37.5 years to be paid in full at an 18% interest rate, which is pretty cheap for a credit card.

Now suppose that instead of paying the debt, you file bankruptcy and get a discharge. Then you pay $300/month into an IRA that earns 6% a year. At the end of 37.5 years, you will have over $500,000 in a retirement account.

Lots of people feel they are being irresponsible if they don't pay their debts. Being responsible also means that you have made adequate provision for retirement so you are not a burden to your family or society. Bankruptcy may be the responsible choice.

Blockbuster Headed to Bankruptcy?

The Los Angeles Times reports that Blockbuster, the movie rental giant for the last decade, will file a "pre-planned" Chapter 11 as early as next month.

A pre-planned bankruptcy is one in which most, if not all, of a debtor's creditors agree to the reorganization plan before filing. The debtor is in and out of bankruptcy relatively quickly. In Blockbuster's case, it hopes this will be about five months. The presumed major benefit to Blockbuster will be the ability to shed its most burdensome store leases, those where the retail outlets aren't performing but the company remains saddled with long term leases with landlords. In a Chapter 11, a debtor can reject any unexpired leases, meaning it simply cancels the remaining term. The landlord has an unsecured claim for unpaid and future rents, but since most unsecured creditors receive very little in a reorganization, this is small consoloation to the landlords affected.

Beaten down by changing consumer tastes, Blockbuster, which once the the undisputed leader in DVD rentals, has seen its stock delisted by the New York Stock Exchange. The stock now trades on the OTC (over the counter) market and recently traded at 11 cents/share.

Attorney Fee Only Plan Not in Good Faith

An attorney and his client came up with a novel, but ultimately unsuccessful, way to file immediately and pay attorneys' fees -- and nothing else.

In In re Buck, 2010 WL 2746217 (Bky.D.Mass. July 9, 2010), the problem for the Bucks was they couldn't pay the attorneys' fee of $2,000 for a Chapter 7 bankruptcy. They wanted immediate relief from the harrassing collection efforts they were subject to, but, understandably, their attorney wouldn't file for them until they paid his fee. So they agreed to file a Chapter 13, which cost $4,000, but those fees would be paid through the plan, at $130/month. This allowed them to file immediately. Sounded like a good plan.

That was until the bankruptcy court determined that the plan was not filed in good faith. It turns out that all of the Bucks' property was exempt and all of their debts were dischargeable in Chapter 7. As a result, no one other than the attorney would have received a distribution under the plan. The bankruptcy judge said that this was not a "good faith" plan, it exposed the debtors to 36 months of payments and delayed their discharge by that same time. As a result, he refused to confirm the plan. The Bucks converted to Chapter 7 and the court ordered that the attorney could not receive fees for either the Chapter 13 or the Chapter 7.

Is Bankruptcy Moral?

A lot of people struggle with this question. Most people are fundamentally honest and the idea of not paying their just debts doesn't sit right with their upbringing. There is a lot of guilt associated with filing bankruptcy.

Bankruptcy goes back at least to the 14th century. The term "bankruptcy" probably comes from the Italian banco rotta, which means "broken bench." It was the custom to break the bench of a merchant who could not pay his creditors. "Bankruptcy" is also figuratively description of a ruptured bank, with a resulting loss of money. England has had a formal bankruptcy law since 1542.

Even earlier, the law of Moses in the Old Testament called for the sabbath year, a year occurring every seven years when debts were forgiven.

In America, bankruptcy is one of the few laws specifically mentioned in the United States Constitution, which provides that Congress shall have power to make and enforce a uniform law regarding bankruptcy.

The purpose of this historical review is to show that throughout history, humankind has found that a process by which debtors could be released from their debts and given a fresh start has a salutary effect. Bankruptcy is legal and while filing bankruptcy may not be the most desirable outcome, there is nothing immoral about it.

Creditors Should Read Their Mail

On March 23 the Supreme Court of the United States issued an opinion in a bankruptcy case that, in essence, says creditors need to read their mail. The case is United Student Aid Funds, Inc. v. Espinosa. Justice Thomas delivered a unanimous opinion.

The facts are fairly simple. Espinosa had several student loans that totalled $13,000. In his Chapter 13 plan he proposed to pay principal only, no interest, which resulted in a discharge of the interest. Normally, any discharge of any part of a student loan requires an adversary proceeding and a finding of a "hardship discharge." In this case, neither the creditor nor the trustee objected to Espinosa's plan. Espinosa completed his plan and received a discharge.

Several years later, United Student Aid Funds attempted to collect by garnishing Espinosa's tax refund. Espinosa responded by reopening his bankruptcy case to obtain an order prohibiting United Student Aid Funds from trying to collect. The case eventually worked its way to the Supreme Court. There were several complicated legal issues involved in the case, but the bottom line is, where a creditor admittedly received a copy of the plan and failed to object, it can't come back years later and ask the court to fix its mistake.

Automobile Claims and Bankruptcy

Toyota has recalled thousands of vehicles for accelerator problems. Now Honda has recalled over 400,000 vehicles for brake problems. With all of those recalls, it's certain that some owners of the recalled cars are contemplating filing or have filed bankruptcy.

In the case of Toyota, a few lawsuits seeking class action status for those involved in accidents allegedly caused by the defects have already been filed. Such lawsuits may be filed by Honda owners. If you are among those affected by these recalls and are in or considering bankruptcy, beware. You might have a claim against the manufacturer. If so, that claim is probably property of your bankruptcy estate and you are obligated to disclose it to the trustee, who may or may not decide to pursue it. Be sure to let your bankruptcy attorney know that you own a car covered by the recalls so he can investigate whether to list a potential lawsuit or participation in a class action in your bankruptcy filing.

The Best Time to File Bankruptcy

Since the passage of the Bankruptcy Abuse and Consumer Protection Act in 2005, timing a bankruptcy filing has become more important than ever. First is the means test, which we have discussed previously. The means test looks at a debtor's income over the past six months, so if you received a big bonus in the past six months, you might want to wait a month or two so that bonus isn't included in the calculation of average income. Secondly, if you're facing foreclosure or having wages garnished, you probably want to file as soon as possible, like yesterday. Thirdly, if you have some cash on hand or other assets that are subject to being taken by the bankruptcy trustee, you may want to delay filing while you engage in some exemption planning. There is nothing wrong with using non-exempt assets (such as cash or selling stocks) to acquire exempt assets (such as clothes, food, a new washer/dryer or refrigerator). All of these considerations have to be weighed to determine when is the best time for you to file.