Ongoing Saga of Homestead Proceeds

In the latest installment of the homestead proceeds saga, the US District Court for the Western District has issued an opinion reversing Judge Gargotta’s opinion in In re DeBerry, 2015 WL 6528024. The District Court opinion can be found on the Western District Court website under Case N. 5:15-cv-01135-RCL, Docket No. 9.

This case starts with an unusual fact pattern as the property in question was the separate property of the debtor husband at the time of filing. The property was sold pursuant to a court order post-petition and the trustee requested and obtained a paragraph in the order approving the sale that stated:

ORDERED, ADJUDGED and DECREED that nothing in this Order shall prohibit John Patrick Lowe, as Chapter 7 Trustee (the “Trustee”) for the bankruptcy estate (the “Estate”) of the Debtor, or any other successor trustee, from seeking to recover the proceeds from the sale of the real property located at 8 Tudor Glen, San Antonio, TX 78257 as an asset of the Estate under 11 U.S.C. §541, to the extent the proceeds from such sale are no longer exempt under Texas Prop. Code §41.001.

Upon sale of the homestead on September 26, 2014, the Debtor netted $364,592. The proceeds were deposited into a bank account solely in the name of the non-filing spouse. $85,000 of those proceeds were subsequently transferred into another account, also solely in the name of the non-filing spouse. Out of that account $50,000 was transferred to Goldstein, Goldstein & Hilley, a criminal defense firm that had previously been engaged to represent the Debtor, by check dated September 29, 2014. The $85,000 in proceeds were not reinvested in another homestead within six months of the sale of the property. (The record is unclear what happened to the remaining $280,000 in proceeds.)

Mr. Lowe then filed an adversary in which he sought declaratory relief that the proceeds of Mr. Deberry’s separate property homestead were also his separate property and that the proceeds became property of the bankruptcy estate, and sought turnover of the proceeds from the non-filing spouse, the criminal defense attorneys and unidentified Jane or John Does.

The defendants filed a motion to dismiss contending that the Texas Proceeds Rule and In re Frost, 744 F.3d 384 (5th Cir.2014) do not apply in Chapter 7 cases. Judge Gargotta agreed, relying primarily on Judge Davis’ opinion in In re D’Avila, 498 B.R. 150 (Bankr.W.D.Tex.2013) and rejecting Judge Bohm’s opinion in In re Smith, 514 B.R. 838 (Bankr.S.D.Tex.2014).

Mr. Lowe appealed and on March 10, 2017, the District Court issued its ruling holding that Judge Gargotta was incorrect and that Frost and the Texas Proceeds Rule do apply in Chapter 7 cases, relying primarily on Judge Bohm’s opinion in Smith. The court also relied on In re England, 975 F.2d 1168 (5th Cir.1992) for its oft cited statement that the purpose of the proceeds exemption “was solely to allow the claimant to invest the proceeds in another homestead, not to protect the proceeds in and of themselves.” The court also relied on In re Zibman, 268 F.3d 298 (5th Cir.2001) which held that a debtor who sold his homestead prior to filing Chapter 7 and was holding proceeds on the petition date was subject to the Texas Proceeds Rule.

This is an important and binding opinion for attorneys in the Western District of Texas and is clearly an important opinion for attorneys everywhere in Texas. (At least until the Fifth Circuit tells us what the official answer is.)

Now for my soapbox. Please feel free to stop reading at this point.

1. Texas enacted the first version of what is now Texas Property Code Sec. 41.001(c) in 1897. That’s 120 years ago. The statute provides, in total: “The homestead claimant’s proceeds of a sale of a homestead are not subject to seizure for a creditor’s claim for six months after the date of sale.” There is nothing in the statute (nor has there ever been) that says that the homestead claimant cannot use the proceeds for some other lawful purpose. What if the debtor needs to buy a car to get to and from work? What if he needs to acquire tools or equipment to perform his vocation? What if he needs to feed his kids? It is not the function of the courts to create statutory limitations through judicial gloss when the legislature has failed to act to impose those limitations.

2. There is a clear rule of statutory construction that Texas exemption statues are to be liberally construed, particularly with respect to homesteads. Woods v. Alvarado State Bank, 19 S.W.2d 35 (Tex. 1929): “The rule that homestead laws are to be liberally construed to effectuate their beneficient purpose is one of general acceptation.” Trawick v. Harris, 8 Tex. 312 (Tex.1852): “Profoundly impressed with the wisdom in which our homestead policy is founded, and fully impressed with its ameliorating influences, we admit that it is entitled to the most liberal construction for the accomplishment of its object.”

3. As noted above, England is almost invariably cited for the proposition that proceeds were never meant to be protected as proceeds, but only to allow the debtor to re-invest the proceeds in another homestead. England cites no authority to support that “holding.” (It isn’t actually holding, by the way.) England is a 1992 opinion. Was there no precedent in 99 years that supports England’s statement?

4. The District Court opinion in DeBerry lists six bankruptcy sections that courts addressing this issue have relied upon: 541(a)(1), 541(a)(6), 522(c), 1306(a), 1306(b), and 1327(b). I have another one that DeBerry and none of the other homestead proceeds cases mentions – 1307(b) which provides:

On request of the debtor at any time, if the case has not been converted under section 706, 1112, or 1208 of this title, the court shall dismiss a case under this chapter. Any waiver of the right to dismiss under this subsection is unenforceable. [Emphasis added.]

It is my opinion that 1307(b) represents a fundamental difference between Chapter 13 (Frost) and Chapter 7 (Smith). 1307(b) allows a debtor in a Chapter 13 case to dismiss his/her case without any cause. One of the very basic goals of Chapter 13 is to encourage/allow debtors to save their home and vehicles and to pay something to unsecured creditors. Many of my debtor Chapter 13 clients file to try to keep their home that they are in default on. If they try to save their home by curing the default but are unable to do so, there are several options available: (1) allow the mortgage holder to foreclose; ( 2) sell the house while in a Chapter 13 and use the proceeds to buy a new homestead; (3) sell the homestead and turn over the proceeds to the Chapter 13 trustee; or (4) dismiss the Chapter 13 and use the proceeds to play “let’s make a deal” with the debtor’s unsecured creditors.

5. Unfortunately, the courts talk about the debtor buying a new homestead while in a pending bankruptcy case as if it is a realistic financial option. For most debtors, that is a false option. If the debtor has sufficient equity in the prior homestead to purchase a new homestead for cash, that is one reality. Most of my clients have relatively low amounts of equity – $50,000 to $100,000. That may suffice as a down payment on a home, but it won’t buy a home Austin, Texas. And lenders will not finance the purchase of a home for a debtor in a pending bankruptcy case.

Home Equity Loan Violations

This is a very long post describing some recent case law with respect to home equity litigation in Texas. These events are significant to a consumer bankruptcy practice, but if the subject is of no interest, you may want to skip it.

The Texas Supreme Court issued two opinions on May 20, 2016 regarding issues related to the home equity loan forfeiture provisions of the Texas Constitution. These opinions make significant changes to Texas case law regarding applicability and enforcement of those provisions. The first case was Garofolo v. Ocwen Loan Servicing, L.L.C., 497 S.W.3d 474 (Tex.2016) and the second is Wood v. HSBC Bank USA, N.A., 2016 WL 2993923 (Tex.2016). It is important that the cases are read in sequential order as Wood relies on Garofolo in reaching its conclusion. (All references to the Texas Constitution herein are to Article XVI, section 50(a)(6) and its subsections unless otherwise noted.)

I found these cases to be confusing (as did my sister who edits my posts) so I write to provide my understanding/interpretation of what they mean. To help you understand where we are going let me summarize at the beginning. Garofolo holds that there is no constitutional violation if a lender violates 50(a)(6) by not curing a violation if none of the cures enumerated in 50(a)(6)(Q)(x) will actually cure the violation. The court goes on to state (in dicta) that a borrower may have a breach of contract claim if the lender fails to cure after notice from the borrower and suffered actual damages. More significantly, Wood holds that if an equity lien does not include all of the terms and conditions required by 50(a)(6), it is not a valid lien under 50(c), and since it is not a valid lien, limitations does not start to run until the lender fails to cure after notice. (The statute of limitations ruling is the big news out of these two cases.) Wood also confirms Garofolo’s statements that a borrower may assert a claim for forfeiture as a breach of contract claim if the claim is asserted under 50(c) as opposed to 50(a).

In Garofolo, the Fifth Circuit certified two questions to the Texas Supreme Court because they involved interpretation of the Texas Constitution. Those two questions were:

1. Does a lender or holder violate Article XVI, Section 50(a)(6)(Q)(vii) of the Texas Constitution, becoming liable for forfeiture of principal and interest, when the loan agreement incorporates the protections of Section 50(a)(6)(Q)(vii), but the lender or holder fails to return the cancelled note and release of lien upon full payment of the note within 60 days after the borrower informs the lender or holder of the failure to comply?

2. If the answer to Question 1 is “no,” then, in the absence of actual damages, does a lender or holder become liable for forfeiture of principal and interest under a breach of contract theory when the loan agreement incorporates the protections of Section 50(a)(6)(Q)(vii), but the lender or holder, although filing a release of lien in the deed records, fails to return the cancelled note and release upon full payment of the note within 60 days after the borrower informs the lender or holder of the failure to comply?

50(a)(6)(Q)(vii) states that a home equity loan is made on the condition that:

(vii) within a reasonable time after termination and full payment of the extension of credit, the lender cancel and return the promissory note to the owner of the homestead and give the owner, in recordable form, a release of the lien securing the extension of credit or a copy of an endorsement and assignment of the lien to a lender that is refinancing the extension of credit;

To avoid the suspense, the Court answered both questions “no.” Garofolo starts with one atypical fact – the equity loan in question had been paid in full and the lender filed a release of lien in the real property records before litigation ensued. Ocwen, however, failed to send the borrower the cancelled promissory note and a release in recordable form within a reasonable time after full payment of the loan as required by 50(a)(6)(Q)(vii) and by the deed of trust and the lender failed to cure within 60 day after notice from the borrower as provided in 50(a)(6)(Q)(x). The Garofolo Court held that a breach of the terms of the extension of credit under the terms of the loan documents – in this case, failure to timely return the note and send a release after demand – did not give rise to a constitutional claim for forfeiture. “Our constitution lays out the terms and conditions a home-equity loan must include if the lender wishes to foreclose on a homestead following borrower default.” In other words, an equity lending violation is a shield not a sword, although how the sword is wielded is not made completely clear by Garofolo (or Wood). The court states that “we do not suggest Garofolo is not without recourse. Her remedy simply lies elsewhere – for instance, in a traditional breach-of-contract claim, in which a borrower seeks specific performance or other remedies contingent on a showing of actual harm.” [Emphasis added.]

With respect to the breach of contract claim, however, the Court held that she did not have a claim for forfeiture under a breach of contract theory as it was undisputed that she had suffered no actual damages as a result of the breach. (Although the holder did not send her a release in recordable form, the holder did file an actual release in the real property records so there was no cloud on her title.) The court noted that the 2003 amendments to 50(a)(6) included a change to the forfeiture provision “whereas forfeiture under the original version was arguably triggered whenever a lender ‘fails to comply with [its]obligations,’ the current version does not implicate forfeiture until a lender ‘fails to correct the failure to comply… by’ performance of a corrective measure.”

50(a)(6)(Q)(x) was amended in 2003 to set out the methods by which a lender or holder may correct the failure to comply. The amended statute provides:

Except as provided by Subparagraph (xi) of this paragraph, the lender or any holder of the note for the extension of credit shall forfeit all principal and interest of the extension of credit if the lender or holder fails to comply with the lender’s or holder’s obligations under the extension of credit and fails to correct the failure to comply not later than the 60th day after the date the lender or holder is notified by the borrower of the lender’s failure to comply by:

(a) paying the owner an amount equal to any overcharge paid by the owner under or related to the extension of credit if the owner has paid an amount that exceeds an amount stated in the applicable Paragraph (E), (G), or (O) of this subdivision;
[Paragraph (E) is the 3% cap on closing costs which is one of the more common violations. Paragraph (G) is the prohibition against pre-payment penalties. Paragraph (O) limits the interest rate to a “rate permitted by statute.”]
(b) sending the owner a written acknowledgement that the lien is valid only in the amount that the extension of credit does not exceed the percentage described by Paragraph (B) of this subdivision, if applicable, or is not secured by property described under Paragraph (H) or (I) of this subdivision, if applicable;
[Paragraph (B) is the 80% loan-to-value limitation. Paragraph (H) prohibits taking “any additional real or personal property other than the homestead” as collateral for the loan. Paragraph (I) prohibits taking an equity lien on ag exempt property.]
(c) sending the owner a written notice modifying any other amount, percentage, term, or other provision prohibited by this section to a permitted amount, percentage, term, or other provision and adjusting the account of the borrower to ensure that the borrower is not required to pay more than an amount permitted by this section and is not subject to any other term or provision prohibited by this section;
[This cure does not refer to any specific provision or prohibition.]
(d) delivering the required documents to the borrower if the lender fails to comply with Subparagraph (v) of this paragraph or obtaining the appropriate signatures if the lender fails to comply with Subparagraph (ix) of this paragraph;
[Subparagraph (v) is the provision that requires the lender to provide the borrower with copies of all documents signed by the borrower related to the extension of credit which were signed at closing. Subparagraph (ix) is the provision which requires the acknowledgment of value to be signed by the borrower and the lender.]
(e) sending the owner a written acknowledgement, if the failure to comply is prohibited by Paragraph (K) of this subdivision, that the accrual of interest and all of the owner’s obligations under the extension of credit are abated while any prior lien prohibited under Paragraph (K) remains secured by the homestead; or
[This one presents a problem. Paragraph (K) provides that a borrower may only have one equity loan at a time. The cure provision is that the lender must send the borrower a written acknowledgement that accrual of interest and all of the borrower’s obligations under the extension of credit (including making payments) are abated while any prior lien prohibited under Paragraph (K) remains secured by the homestead. But, assuming that the first lien equity loan is otherwise valid, then the first lien is not prohibited by Paragraph (K). The cure provision as drafted would seem to provide only a cure for a third lien equity loan. In short, the cure does not appear to match the violation.]
(f) if the failure to comply cannot be cured under Subparagraphs (x)(a)-(e) of this paragraph, curing the failure to comply by a refund or credit to the owner of $1,000 and offering the owner the right to refinance the extension of credit with the lender or holder for the remaining term of the loan at no cost to the owner on the same terms, including interest, as the original extension of credit with any modifications necessary to comply with this section or on terms on which the owner and the lender or holder otherwise agree that comply with this section.

In this case, the violation – failing to return the cancelled note and sending a release in recordable form – does not fall within the scope of subparagraphs (a) through (e) so it must fall, if anywhere, within the scope of the “catchall” provisions of subparagraph (f). The Court held, however, that under the circumstances the catchall cure would not actually provide a cure. The lender could offer to pay or credit $1,000 but could not refinance the extension of credit as there was no longer any debt to refinance. Garofolo concluded “…if a lender fails to meet its obligations under the loan, forfeiture is an available remedy only if one of the six corrective measures can actually correct the underlying problem and the lender nonetheless fails to timely perform the relevant corrective measure.” [Emphasis added.]

The final paragraph of the opinion states:

The terms and conditions required to be included in a foreclosure-eligible home-equity loan are not substantive constitutional rights, nor does a constitutional forfeiture remedy exist to enforce them. The constitution guarantees freedom from forced sale of a homestead to satisfy the debt on a home-equity loan that does not include the required terms and provision – nothing more. Ocwen therefore did not violate the constitution through its post-origination failure to deliver a release of lien to Garofolo. A borrower may seek forfeiture through a breach-of-contract claim when the constitutional forfeiture provision is incorporated into the terms of a home-equity loan, but forfeiture is available only if one of the six specific constitutional corrective measures would actually correct the lender’s failure to comply with its obligations under the terms of the loan, and the lender nonetheless fails to perform the corrective measure following proper notice from the borrower. If performance of none of the corrective measures would actually correct the underlying deficiency, forfeiture is unavailable to remedy a lender’s failure to comply with the loan obligation at issue. Accordingly, we answer “no” to both certified questions. [Emphasis added.] [Unfortunately, Garofolo does not make clear the distinction between 50(a) and 50(c). More on this infra.]

My response to the Court’s summary:

First sentence: The terms and conditions applicable to home equity loans contained in 50(a)(6) are not “required” to be “included” in the equity loan documents (although most of them typically are included).

Second sentence: A borrower is protected from forced sale of a homestead if the loan “does not include the required terms and conditions – nothing more.”” The opinion suggests that defects in an equity loan are only a defense to foreclosure and not the basis for an affirmative claim against the lender, but… (Look at the fourth sentence).

Fourth sentence: Notwithstanding the holding that there is no constitutional violation or remedy, the court also stated that a borrower may seek forfeiture under a breach of contract theory but:
• only if one of the corrective measures contained in 50(a)(6)(Q)(x)(a)-(f) would actually cure the violation;
• and the lender fails to perform the applicable corrective action following notice from the borrower;
• and the borrower sustained actual damages as a result of the uncured violation.

Fifth sentence: If none of the corrective measures enumerated in the 50(a)(6)(Q)(x)(a)-(f) would actually correct the violation, forfeiture is not an available remedy.

The missing sentence: The Court states elsewhere that the borrower must be able to prove actual damages in order to invoke forfeiture under a breach of contract theory. Under the facts of the case, the borrower in Garofolo sustained no actual damages and has no remedy.

Because of the atypical fact in this case that the loan was paid in full prior to the instigation of litigation, the holding should be limited in its application. (Although I am primarily a debtor’s attorney, I have to agree with the result in Garofolo. The violation was highly technical and the borrower suffered no damages, actual or otherwise. A borrower shouldn’t get a “free house” under those circumstances.)

Wood is the follow up to Garofolo. Wood states:

The primary issue in this case is whether a statute of limitations applies to an action to quiet title where a lien securing a home-equity loan does not comply with constitutional parameters. The parties also dispute whether petitioners are entitled to a declaration that respondents have forfeited all principal and interest on the underlying loan. We conclude that liens securing constitutionally noncompliant home-equity loans are invalid until cured and thus not subject to any statute of limitations. We further hold that in light of this Court’s decision today in Garofolo [citation omitted], petitioners have not brought a cognizable claim for forfeiture. [Emphasis added.]

The determination that there is no applicable statute of limitations is a major change from prior case law which generally held that limitations accrues at closing if the violation was apparent at the time of closing. See, In re Priester, 708 F.3d 667 (5th Cir.2013); Schanzle v. JPMC Specialty Mortgage LLC, 2011 WL 832170 (Tex.App – Austin 2011); Santiago v. Novastar Mortgage, Inc., 443 S.W.3d 462 (Tex.App. – Dallas 2014); Estate of Hardesty, 449 S.W.3d 895 (Tex.App. – Texarkana 2014). [Judge Gargotta took an early lead on the limitations issue in In re Ortegon, 398 B.R. 431 (Bankr.W.D.Tex.2008), a case I lost. Somebody has to try the cases where we don’t know what the answer is.] The borrower did not have to be aware that the extension of credit violated 50(a)(6), as long as it was not concealed. For instance, if the closing costs exceeded the 3% cap on closing costs and that could be determined by doing the math on the HUD-1, the fact that the borrower was not aware of the 3% cap or how it was calculated does not delay limitations from running.

Wood explains the holding in Garofolo, including the scope of that opinion.

Our opinion today in Garofolo clarifies the extent of the protections outlined in section 50(a), including a borrower’s access to the forfeiture remedy. Specifically, we hold in Garofolo that section 50(a) does not create substantive rights beyond a defense to foreclosure of a home-equity loan securing a constitutionally noncompliant loan, observing that the terms and conditions in section 50(a) “are not constitutional rights and obligations unto themselves.” We also clarify that “the forfeiture remedy [is not] a constitutional remedy unto itself. Rather it is just one of the terms and conditions a home-equity loan must include to be foreclosure-eligible. We explain that borrowers may access the forfeiture remedy through a breach-of-contract action based on the inclusion of those terms in their loan documents, as the Constitution requires to make the home-equity loan foreclosure-eligible. In Garofolo we interpret only section 50(a), which sets the terms home-equity loans must include to foreclosure-eligible. Section 50(c), on the other hand, expressly addresses the validity of any homestead lien, broadly declaring the lien invalid if the underlying loan does not comply with section 50. [Internal citations omitted.] [Emphasis added.]

50(a) provides, in relevant part: “The homestead of a family, or of a single adult person, shall be, and is hereby protected from forced sale, for the payment of all debts except: [a list which includes subparagraph (6) which describes home equity loans.] [Emphasis added.]

50(c) provides, in contrast: “No mortgage, trust deed, or other lien on the homestead shall ever be valid unless it secures a debt described by this section…” [Emphasis added.]

Although Garofolo is less than crystal clear that its holding is based on 50(a) as opposed to 50(a)(6), Wood makes clear that the distinction is between 50(a) and 50(c).

Although Garofolo and Wood may seem to say that a borrower may not bring a declaratory relief action regarding an alleged home equity defect, the actual holding is that a borrower may not bring a declaratory relief action based upon alleged constitutional violations. Both opinions make it clear that a borrower may bring an action for breach of contract if the loan is noncompliant and the lender/holder fails to cure after notice. This is significant as a claim for breach of contract gives rise to a request for attorney’s fees under Tex. Civ. Prac. & Rem. Code Sec. 38.001 and a claim for declaratory relief gives rise to a request for attorney’s fees under Tex. Civ. Prac. & Rem. Code Sec. 37.009. (I say “request” as both statutes are discretionary – the court “may” award attorney’s fees.)

What it the message for practitioners? If a potential client comes to you and you identify a home equity violation, you should draft a notice of violation letter for the client’s signature which identifies the violation with sufficient specificity for the lender to identify the violation, i.e., if the violation is charging more than 3% for closing costs, say that. You do not have to identify the specific statutory sub-paragraph. Do not take any further action during the 60 day cure period. Assuming the lender does not cure, you have a couple of options. Have the borrower default, wait until the lender files an application for foreclosure, then sue the lender for declaratory relief and breach of contract. (And injunctive relief if necessary to stop a foreclosure.) Alternatively, don’t wait for the lender to take action and file a preemptive declaratory relief/breach of contract action. In your pleading, make certain that forfeiture of principal and interest is requested under 50(c), not 50(a). The declaratory relief is that the loan is invalid under 50(c). The breach of contract claim is that the lender failed to cure the violation pursuant to 50(a)(6)(Q)(x)(a)-(e) after notice pursuant to 50(a)(6)(Q)(x).

This is way beyond the scope of this post, but home equity violations may give rise to other claims and causes of action. For instance, there may be claims for DTPA violations. Texas case law holds that a loan is not a “good’ or “service” and will not serve as the basis for a DTPA violation. If, however, the home equity violation is charging closing costs in excess of the 3% cap, one or more of those costs may be a good or service – an appraisal, a survey, a tax certificate……. – which might bring the claim under the DTPA. There may also be RESPA violations, FDCPA violations, FCRPA violation,… (I have seen all of these. This is not meant to be an exhaustive list.) I mention the DTPA in particular as it may give rise to treble damages. (And attorneys fees)

Lien Stripping

We just filed our first “lien stripping” case where we are attempting to strip off a wholly unsecured second lien from a house the debtor owns in Washington DC. The property generates positive cash flow after paying the first lien (which will help the debtor fund her plan), but not enough cash flow to pay the second lien. (The same analysis applies to property here in Texas, but I’m just giving you general info that might be relevant.)

I did a little research and lo and behold, the Southern District of Texas has a procedure for doing this, so basically I just followed/copied/misappropriated theirs. We are doing this by plan provision rather than an adversary. Rule 7001(2) defines adversary proceedings to include “a proceeding to determine the validity, priority, or extent of a lien…” The obvious goal here is to avoid the expense and delay of an adversary. One of the key issues between contested matters and adversaries is procedural due process. In addition to the notice required in the Southern District form, we also serve the registered agent or other appropriate corporate representative. (i.e the president of the bank.) We also serve a “Lien Stripping Notice” separate from the plan which basically says “Hey, you. Yes, you. We are trying to do bad things to you. Pay attention.”

 We had a confirmation hearing which has been re-set based upon an amended plan. At the hearing, our Chapter 13 Trustee and I made sure the judge  knew what I am trying to do. He did not “approve” this procedure, but he basically said give it a shot and we’ll see how it works. If the creditor objects to doing this by plan provision, we may have to re-file as an adversary, but if they don’t, it looks like it will work.


Michael Baumer

<p align=”justify”><a href=””>Law Office of Michael Baumer</a></p>

Bandi – Dischargeability under 523(a)(2)(A)

On June 12, the Fifth Circuit issued an opinion addressing the meaning of “a statement respecting the debtor’s or an insider’s financial condition” [and the distinction between non-dischargeability of debts under 523(a)(2)(A) and (B)]. In re Bandi, 2012 WL 2106348 (5th Cir.2012).

523(a)excepts from discharge any debt –

(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by –

(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition;

                        (B) use of a statement in writing—

                                    (i) that is materially false;

                                    (ii) respecting the debtor’s or an insider’s financial condition;

(iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably relied; and

(iv) that the debtor caused to be made or published with intent to deceive; …” [Emphasis added.]

In Bandi the debtors (two brothers) guaranteed a loan their corporation obtained from a friend. Prior to obtaining the loan, one of the brothers represented that he had purchased a home and both of the brothers represented that they had purchased a condominium project and an office building. They even took the friend (and his lawyer wife) on a tour of “their” office building. The brothers did not actually own any of the properties and admitted as much at trial. They argued that their statements were made with respect to their financial condition, so they did not fall within the scope of 523(a)(2)(A) and they were not in writing, so they did not fall within the scope of 523(a)(2)(B), either. The focus of the opinion is on the meaning of “a statement respecting the debtor’s or an insider’s financial condition.”

 The court held: “The term ‘financial condition’ has a readily understood meaning. It means the general overall financial condition of an entity or an individual, that is, the overall value of property and income as compared to debt and liabilities. A representation that one owns a particular residence or a particular commercial property says nothing about the overall financial condition of the person making the representation or the ability to repay the debt. The property about which a representation is made could be entirely encumbered, or outstanding undisclosed liabilities of the person making the representation could be far more than the value of the property about which a representation is made.” The court found that the false statements were not statements respecting the debtors’ financial condition within the meaning of 523(a)(2)(A) and the debt was non-dischargeable.

 I’m not sure I agree with the court’s definition. The Code does not say “the general overall financial condition” of the debtor – it says a statement “respecting” the debtor’s financial condition. My American Heritage Dictionary defines “respecting” as “In relation to; concerning.” “I own this office building” would seem to “relate to” my financial condition. This may just be one of those “bad facts make bad law” cases. The debtors got their friend to loan them $150,000, at least in part by “puffing.” It doesn’t seem fair for them to get away with it. The court fashioned a remedy so they didn’t. 

Michael Baumer


<p align=”justify”><a href=””>Law Office of Michael Baumer</a></p>

Discharge of taxes in bankruptcy

Ladies and Gents -

The Fifth Circuit just (1/4/12) issued an opinion that is going to change our world. (Or at least part of it.) In McCoy v. Mississippi State Tax Commission, 2012 WL 19376 (5th Cir. 2012), the court interpreted the hanging paragraph at the end of 523(a) which was added by BAPCPA. That paragraph provides:

For purposes of this subsection, the term “return” means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements.) Such term includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or a similar State or local law. [Emphasis added.]

The Fifth Circuit held that “applicable filing requirements” includes the requirement that a return be timely filed. If a “return” is not timely filed, it does not qualify as a “return” under 523(a). Congress has now defined “return” so that a real, actually filed return is not a “return” if it was filed so much as one day late. (Even if it was actually filed more than two years prior to the bankruptcy filing.) (If congress really wanted to change prior law, shouldn’t they have put the hanging paragraph at the end of 523(a)(1)(B)(ii) [instead of after the other 17 unrelated sub-paragraphs and sub-sub-paragraphs in 523(a)] or wouldn’t they have changed the existing wording of 523(a)(1)(B)(ii)? I am not arguing that the result is incorrect. It appears to be “correct” if you read all of this together. I am simply suggesting that this is one more example of a poorly conceived and/or drafted provision our “friends” in Washington left us with to sort out. Although McCoy involved state income tax returns, there is no basic difference between the Mississippi tax code and the Internal Revenue Code as far as filing requirements. (The Mississippi tax code also requires that returns be filed by April 15th.)

 Literally one week after McCoy,(1/11/12) Judge Lief Clark issued an opinion in Hernandez, v. U.S., Adv. No. 11-5126C (Bankr.W.D.Tex.2012) which made the same analysis with respect to the Internal Revenue Code. He reached the same conclusion Judge King did in McCoy.

To make sure that the client’s tax returns were timely filed, you should probably order a “tax account transcript” for each year in question. (Your client can sign the form so you can order these.)

I am absolutely certain this is not the end of the dispute/discussion over this issue, but advise your clients appropriately. Just my opinion, for what it’s worth.

Michael Baumer

Austin, Texas

Federal Tax Liens in Chapter 13

I recently filed a Chapter 13 case and had an issue arise which I see occasionally that I thought might be of interest to the consumer debtor bar. In my case, the debtor lived in Travis County and owed the IRS taxes for several years, all but one of which would be dischargeable as “stale” taxes. The IRS filed a tax lien, but filed it in Williamson County, not Travis.

The improper filing creates a tax lien against the debtor, but not as against third parties, i.e., a judgment lien creditor, like a trustee in bankruptcy which has the status of a hypothetical judgment lien creditor under Section 544(a)(1) or a bone fide purchaser of real property under 544(a)(3).

This made a huge difference in my case because the debtors had significant equity in their home but did not have sufficient disposable income to pay the IRS claim. If the lien was “good”, they would have had to sell their home to pay the lien. Since the lien was unperfected as against the trustee, the claim became unsecured and they were able to pay significantly less than the amount of the claim. (And the IRS did the right thing and amended their claim so I didn’t have to file an adversary to determine the validity and priority of the lien.)

For a discussion of this issue, see the Internal Revenue Manual, Part 5, Chapter 17, Section 2, which can be found at Scroll down to 5.17.2 titled Federal Tax Liens and get the Service’s take.

The practice tip here is if you get a secured proof of claim from the IRS, don’t assume it is perfected. Check. Most counties have their real property records online now, so it is no great burden. I am not suggesting that this is a common situation, but this is not the first time I have seen it.

Michael Baumer


Law Office of Michael Baumer

Ethical Implications of Recent Supreme Court Consumer Bankruptcy Opinions

In the last year, the U.S. Supreme Court issued four opinions which addressed what appear to be fairly discrete questions of some practical import to consumer bankruptcy practitioners. Three of those cases have ethical implications which the Supremes either did not comprehend or did not attach much significance to.

 The first case, United Student Aid Funds, Inc. v. Espinosa, 130 S.Ct. 1367 (2010), involved a Chapter 13 in which the debtor filed a plan which proposed to pay his student loan debt in full through the plan, but without payment of interest. No one objected and the plan was confirmed. Approximately three years later, the creditor intercepted the debtor’s tax refund, the debtor moved to enforce the confirmation order, the creditor moved to set aside the order as void under FRCP 60(b), and eventually the case ended up before the Supremes. The court held that the order was not void because the court has jurisdiction to to hear student loan hardship discharge cases. The court further held that the creditor was not denied due process although it was not served with a summons and complaint (the creditor was served with a copy of the plan and filed a proof of claim in the case) because Rule 7011 requiring an adversary be filed is procedural, not jurisdictional. Result: debtor wins. Interest on the student loan debt is discharged.

 This case places a debtor’s attorney in the unfortunate position that he/she has conflicting duties to the court and to the client. Although the Supremes make it clear that the confirmation order never should have been entered (they refer to the “bankruptcy court’s error”), they nonetheless held that the provision was effective. As a debtor’s attorney I have an obligation to represent my clients zealously within the bounds of the law. Isn’t it my duty to try to get a plan confirmed that provides my client with the most relief possible? The obvious answer is that the relief granted to the debtor in Espinosa never should have been granted. (The relief granted was not within the bounds of the law.) I concede that point, but it was granted so – Which duty is higher – the duty to the court or the duty to the client? The Supremes at least recognized this issue in Espinosa. In the final paragraph of the opinion, the court states: “We acknowledge the potential for bad-faith litigation tactics. But expanding the availability of relief under Rule 60(b)(4) is not an appropriate prophylaxis. As we stated in Taylor v. Freeland & Kronz (citation omitted), “debtors and their attorneys face penalties under various provisions for engaging in improper conduct in bankruptcy proceedings. The specter of such penalties should deter bad faith attempts to discharge student loan debt without the undue hardship finding Congress required. And to extent existing sanctions prove inadequate to the task, Congress may enact additional provisions to address the difficulties United predicts will follow our decision.”


The second case was Hamilton v. Lanning, 130 S.Ct. 2464 (2010), which involved a debtor who took a one time buyout from her previous employer. That income caused her income to be above the median for her state. She proposed a 36 month plan based upon her new job and the trustee objected contending that the Code requires mechanical application of the means test. The court rejected that position and held: “When a bankruptcy court calculates a debtor’s projected disposable income, the court may account for changes in the debtor’s income or expenses that are known or virtually certain at the time of confirmation.” This ruling should come as no surprise as the majority of the courts which have addressed this issue have reached the same result – holding that “projected” has to add something to “disposable income.” This is the one opinion of the four that does not raise any serious ethical implications. (You can’t advise your debtor to quit their job so they qualify. Right? Seems pretty straightforward to me.)

 The third case was Schwab v. Reilly. 130 S.Ct. 2652 (2010). In that case, the debtor had operated a restaurant before filing a Chapter 7. She claimed restaurant equipment as an asset and assigned a dollar value to the asset of $10,718 which fit within her allowable federal exemptions. The trustee obtained an appraisal of the equipment at $17,200 and moved to sell the equipment subject to the debtor’s claimed exemption. The debtor objected contending that because the trustee did not object to her exemptions, she was entitled to keep 100% of the value. The court disagreed holding that because the dollar value assigned to the asset by the debtor fit within the dollar range of the allowable exemption, the trustee was not required to object to the exemption to preserve the estate’s interest in any value in excess of the exempt interest. This is the case which has resulted in many debtor’s attorneys now including a provision in their Schedule C which states some version of “amount claimed is 100% of market value.”

 The problem with this is that it places the trustee in the position of having to at least consider filing an objection to exemptions where the debtor’s schedules include such a provision. This may not be an issue in the “typical consumer case” where the assets consist of basic household goods and a house and two cars. (Of course, how many of us have had clients who listed only minimal jewelry but show up in our office wearing something which was clearly not valued accurately?) It seems that the more common problem scenario for the trustee is the scenario that played out here. The debtor owns something other than basic household goods – inventory, equipment, etc – and assigns a value that fits within the allowable exemption amount (i.e., under the wildcard.) Is it just fortuitous that the value fits within the allowable amount, or did the debtor “lowball” the value to make it fit? The trustee in these cases may feel compelled to object just to preserve the estate’s interest and to get some opinion of value. (Which he is going to pay for out of the $60 he gets out of the filing fee.) I would suggest that if a judge catches a debtor’s attorney doing this on more than a few occasions, there should be serious consequences. (Both for the debtor and the attorney.)

 Finally, in Ransom v. FIA Card Services, N.A., 131 S.Ct. 716 (2011), the court was faced with the issue of whether a debtor gets a vehicle ownership expense on the means test for a vehicle which is not encumbered by any debt. The court concluded that the debtor does NOT get such an expense. For those of us in Texas, this reversed the holding of In re Tate, 571 F.3d 423 (5th Cir.2009). But if the debtor went out and got a title loan for, say, enough to pay the bankruptcy attorney’s retainer, then there would be a debt secured by the car and the debtor would get the full vehicle ownership expense for that vehicle even if the debt would be paid in only a few months. Of course, 526(a)(4) provides that a debt relief agency may not advise an assisted person to incur more debt in contemplation of filing bankruptcy or to pay an attorney for filing a bankruptcy, but the reality is that an attorney is not prohibited from telling his client “You do not qualify for Chapter 7 by a few hundred dollars and if you only had a title loan, you would qualify. I am not advising you to do that, I am just advising you of the fact that you do not currently qualify, but you would if…….” (Wink, wink.)

 The unfortunate effect of three of these four opinions is that it places the debtor’s attorney in the precarious position of balancing his duty of fully advising his client of all of their rights and responsibilities while maintaining his duty to the integrity of the system.

 Just thinking out loud. (Or is it shouting into the hurricane?)

 Michael Baumer


Law Office of Michael Baumer


The Fifth Circuit recently held that private employers may discriminate in hiring based on a bankruptcy filing. In re Burnett, 635 F.3d 169 (5th Cir.2011). The court distinguished between public employers which may not discriminate in hiring and private employers which may. Neither public nor private employers may discriminate with respect to persons who are already employed based solely on a bankruptcy filing. (The employer in Brunett was Stewart Title Inc. – another reason to not be fond of title companies.) The Fifth Circuit is in line with Rea v. Federated Investors, 627 F.3d 937 (3d Cir.2010).


The bankruptcy code contains provisions dealing with employment discrimination by public and private employers in Section 525 as follows:

(a) Except as provided in the Perishable Agricultural Commodities Act, 1930 . . . a governmental unit may not deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise, or other similar grant to, condition such grant to, discriminate with respect to such a grant against, deny employment to, terminate the employment of, or discriminate with respect to employment against, a person that is or has been a debtor under this title or a bankrupt or a debtor under the Bankruptcy Act, or another person with whom such bankrupt or debtor has been associated, solely because such bankrupt or debtor is or has been a debtor under this title or a bankrupt or debtor under the Bankruptcy Act, has been insolvent before the commencement of the case under this title, or during the case but before the debtor is granted or denied a discharge, or has not paid a debt that is dischargeable in the case under this title or that was discharged under the Bankruptcy Act.

(b) No private employer may terminate the employment of, or discriminate with respect to employment against, an individual who is or has been a debtor under this title, a debtor or bankrupt under the Bankruptcy Act, or an individual associated with such debtor or bankrupt, solely because such debtor or bankrupt—

(1) is or has been a debtor under this title or a debtor or bankrupt under the Bankruptcy Act;

(2) has been insolvent before the commencement of a case under this title or during the case but before the grant or denial of a discharge; or

(3) has not paid a debt that is dischargeable in a case under this title or that was discharged under the Bankruptcy Act.

Subsection (a) dealing with discrimination by governmental units was contained in the 1978 Bankruptcy Code. Subsection (b) dealing with discrimination by private employers was added in 1984. Both prohibit termination of employment or discrimination of employment based solely on a bankruptcy filing, but there is a small but apparently significant variation in the language of these two provisions. (a) prohibits denying employment based on a bankruptcy filing, but (b) does not. The courts have relied on this difference in holding that a private employer may deny employment based on a bankruptcy filing while a governmental unit may not.

An issue common to both sections is that they prohibit discrimination based “solely” on a bankruptcy filing. Employers will rarely identify a bankruptcy filing as the reason for terminating employment when a general assertion of insubordination or not being a team player will suffice (and is much more difficult to disprove.) Even if an employer does identify a bankruptcy filing as an issue in employment discrimination, as long as it is not the only issue, 525 is presumably not violated.

Law Office of Michael Baumer

Lessons in Islamic Law – Contract Law

The other day, I was reading something in the Tao Teh Ching which reminded me of something I read once in the Quran and I was looking for that and came across the following passage. In case anyone cares, I am not a Muslim, but I never trust what anyone else tells me the Quran says (or the Bible, either), so I read the actual book to see what it really says. Anyway, this is what the Quran says about contracts. (More particularly, promissory notes.)


O believers, when you negotiate a debt for a fixed term,

draw up an agreement in writing,

though better it would be to have a scribe write it faithfully down;

and no scribe should refuse to write as God has taught him,

and write what the borrower dictates,

and have fear of God, his Lord, and not leave out a thing.

If the borrower is deficient of mind or infirm,                                         

or unable to explain, let the guardian explain judiciously;

and have two of your men to act as witnesses; but if two men

are not available, then a man and two women you approve,

so that in case one of them is confused the other may remind her.

When the witnesses are summoned they should not refuse.

But do not neglect to draw up a contract, big or small,

with the time fixed for paying back the debt.

This is more equitable in the eyes of God,

and better as evidence and best for avoiding doubt.

But if it is a deal about some merchandise

requiring transaction face to face,

there is no harm if no contract is drawn up in writing.

Have witnesses to the deal, and make sure

that the scribe or the witness is not harmed.

If he is, it would surely be sinful on your part.

And have fear of God,

for God gives you knowledge,

and God is aware of every thing.

If you are on a journey and cannot find a scribe,

pledge your goods against the loan;

and if one trusts the other,

then let him who is trusted

deliver the thing entrusted, and have fear of God, his Lord.

Do not suppress any evidence,

for he who conceals evidence is sinful of heart;

and God is aware of all you do.



So what are the important principles here?

  1. Contracts should be in writing.
  2. They should be written by “scribes.” (Modern translation: lawyers.)
  3. Don’t leave anything out. (Make sure all important terms are addressed.)
  4. Have it witnessed. (Modern translation: notarized?)
  5. Don’t harm the scribe or witnesses. (Modern translation: don’t shoot the lawyers.)
  6. A written contract is “better as evidence and best for avoiding doubt.” (Modern translation: the parole evidence rule.)
  7. “Do not suppress any evidence.” (Modern translation: tell the truth, the whole truth, and nothing but the truth.)
  8. I have no intention of going here, but two women equal one man, at least for witness purposes, so “if one of them is confused, the other may remind her.”  (Modern translation: if you are discussing this with a woman you might want to still talk to you in the future, you should preface the discussion with “Can you believe this?”)

Law Office of Michael Baumer

Totality of the Circumstances under 707(b)(3)


Around Thanksgiving, The UST and I tried two 707(b) cases in front of Judge Mott. He took them under advisement and announced his rulings on December 22. He made lengthy recitations of findings of fact and conclusions of law on the record, but apparently will not be publishing these as opinions. If you are going to try one of these cases, you might want to get a transcript as it will provide valuable insight into how he approaches these issues.


The first case was:


Hufstedler 10-11769


In this case the debtors are in their mid-50s with one dependent child. They both work for the state and have for several years so income is fairly secure. Their combined gross income is $109,000 per annum. Just prior to filing, Mr. Hufstedler purchased a term life policy with a death benefit of $100,000 with a monthly premium of $151. Mr. Hufstedler already had term life coverage of approximately $300,000. (Mrs. Hufstedler has approximately $500,000 in term coverage, but it has been in place for several years and the UST did not object to that expense.) He and his wife also purchased long term care insurance with a monthly premium of $431. Although both of the debtors have some medical issues (they both take blood pressure medicine and he takes cholesterol medicine and is a diabetic), their conditions have not materially changed recently and are manageable with medication. The stated reason for these purchases was looking forward and trying to provide for the family in the event one of their medical conditions grew worse.


Judge Mott initially held that long term care insurance is not “health insurance” as contemplated by 707(b)(2)(A)(ii)(I) so it would not be an allowable expense on line 34 of the means test.


He went on to conclude that the long term care insurance was not a “reasonably necessary expense at this time”, because there was no apparent immediate need and the insurance could be purchased 5 years later (at the end of a hypothetical Chapter 13) for only an additional $91 per month.


Finally, he concluded that the long term care was not a “special circumstance” under 707(b)(2)(B)(i). He recited several cases which opine that special circumstances require something “unforeseeable or beyond the control of the debtor” or “out of the ordinary or exceptional in some way” or for which “there is no reasonable alternative” or disallowing the expense would “result in demonstrable economic unfairness prejudicial to the debtors.”


On the debtors’ side, he did hold that homeowners insurance required under a deed of trust was allowable as a reasonable and necessary expense on line 42 of the means test. (Payments on secured claims.) Although the insurance expense is not really a payment on a secured claim, if the debtor fails to provide the insurance, the lender can purchase single interest coverage insurance and charge the expense to the debtors. (HOA dues were not an issue in this case, but the same analysis should apply.)


He also concluded that the debtors’ cell phone expense was “not particularly excessive.” The UST objected to this expense largely (it seems) because just prior to filing the debtors upgraded their phones when they renewed their service contracts. (Most of us have nicer phones than the debtors.)


The UST also objected (somewhat vaguely) to the debtors’ out of pocket medical expenses which are much higher than normal. I’m not faulting the UST – this is always an issue because medical expenses fluctuate significantly and are not fixed like a house or car payment. Deciding on a specific monthly dollar amount is an imprecise exercise, at best. Although Judge Mott expressed some concern that the expenses might be overstated by some amount, he concluded that the UST had not met its burden in proving the actual amount so the amount listed in Schedule J was allowed.


The second case was:


Babb 10-11551


Mr. Babb is a commercial property manager/developer with Lincoln Properties. Between 2006 and 2010, his income decreased from over $400,000 to approximately $115,000. He is $47,000 over median. He qualifies for Chapter 7 under 707(b)(2). The issue in this case was whether allowing him to obtain a discharge was an abuse under the “totality of the circumstances” under 707(b)(3).


The problem in this case was the house payment. PITI totaled $7600 per month which was roughly equal to his current monthly net income and, although he was optimistic that some deals which had been on hold were moving forward, he could not say with any certainty that his income would increase in the near term. The house payment was 5.5 times the IRS standard. A modification on the first lien is in process, but neither the first or second liens was current. The liens total $1,020,000 and the house is valued at $950,000 (which might be optimistic given current market realities.)


Although Judge Mott accepted the fact the housing expense was not an issue when the home was purchased in 2006, he concluded the expense is “unreasonable and excessive in light of their current circumstances.”


FYI, in both cases he gave the debtors 30 says to convert to another chapter or the cases will be dismissed.


Michael Baumer

Law Office of Michael Baumer

by Michael Baumer