Content lost, rebuilding
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.
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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.
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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.
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 www.irs.gov/irm/part5/ 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.
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?)
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.
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?
- Contracts should be in writing.
- They should be written by “scribes.” (Modern translation: lawyers.)
- Don’t leave anything out. (Make sure all important terms are addressed.)
- Have it witnessed. (Modern translation: notarized?)
- Don’t harm the scribe or witnesses. (Modern translation: don’t shoot the lawyers.)
- A written contract is “better as evidence and best for avoiding doubt.” (Modern translation: the parole evidence rule.)
- “Do not suppress any evidence.” (Modern translation: tell the truth, the whole truth, and nothing but the truth.)
- 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?”)
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:
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:
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.