How Lien Stripping Differs From Lien Avoidance

The draft of a lien avoidance motion my paralegal presented me was garbled.  Lien stripping concepts sat next to a cite to §522.

I doubt my staff is alone in missing the critical differences between lien stripping under (or despite) §1322 and lien avoidance pursuant to §522(f).

So let’s try some compare and contrast on liens we want to excise.

Avoid liens that impair exemptions

Section 522(f) enables the debtor to eliminate, in whole or in part, liens that impair an exemption to which the debtor is entitled.

With an small exception, it is only judicial liens that may be avoided.  Tax liens are statutory, so they aren’t avoidable under § 522.

The exception to the rule confining avoidance to judicial liens is that for a nonpossessory, nonpurchase money lien on household goods, tools of the trade, or professionally prescribed health aids.  This exception is drafted to extract the debtor from the tentacles of finance company loans where the lender took a security interest in everything the debtor owned,  not because the collateral had value but because it was essential to the debtor.

Avoidance under §522 works in Chapter 7 and in Chapter 13.

Because the aim of the exercise is to see that the debtor gets the benefit of the available exemptions, a creditor with a judgment lien might find itself secured in part and avoided in part.  Once the debtor gets the full exemption, if there is equity remaining to which the lien attaches, it survives.

Lien stripping in Chapter 13

What we call lien stripping is exploiting the §1322 workaround.  Section 1322 prohibits the modification of a mortgage lien on the debtor’s principal residence.  But if there is no equity whatsoever for the mortgage lien to attach to, most circuits permit the lien to be voided in Chapter 13.

So, here we’re eliminating a voluntary lien.  It’s all or nothing:  either there’s some value to support the lien or there isn’t.  But see my post on settling disputes about value.

Up until recently, all circuits held that you could only strip voluntary liens in Chapter 13.  Then came Mcneal  in the 11th Circuit.

Then there’s 506

Section 506 is the utility player in Chapter 13.  This section defines an secured claim.  A claim is secured if there is value in the estate’s interest in an asset to which the lien can attach.

If there is no value for the lien to attach to, then it is not a secured claim and at the end of the Chapter 13, the lien is void.

For the purposes of §506, it doesn’t matter whether the lien is voluntary, statutory or judicial (so long as it isn’t a mortgage lien on a principal residence or a long term debt).  It’s gone at plan completion.

Clearer?

Image courtesy of automania.

Use All Channels to Educate Bankruptcy Debtors

teach clientsThe skill set of a consumer bankruptcy lawyer must include a healthy dose of  the skills of a teacher.

The client has to master any number of legal issues and procedures to make informed decisions about the case.  An effective lawyer has a plan for how to convey all those things the debtors need to know.

As the parent of children with learning disabilities, I learned that each person has a preferred learning style:  some learn best by seeing; others learn best by hearing; others by feeling; and some by movement.

And the indisputable fact is that individuals contemplating bankruptcy are generally not functioning at their best.

Stress makes us stupid

The challenge for a bankruptcy lawyer  to teach the client enough about bankruptcy to make the necessary decisions is daunting.

So, how to do it?

Many roads to wisdom

Maybe we don’t need to aim for “wisdom”.  Maybe it’s enough to convey sufficient information that the client can participate in the necessary decision making.

After all, there are lots of decisions to be made in filing a bankruptcy case.

Use each learning channel:

tell the client what they need to know, and,

give them written summaries of the material.

Different clients will pick up the information better in one fashion than another.

Put basic information on your web site.  Remind them of basic points when you meet.  Summarize important decision points in a letter.

Belt and suspenders, put the information in several forms and you increase the chances that your client absorbs the information.

When all else fails

Recall that there is a another learning channel:  some folks are tactile learners.

So I am often tempted slap them alongside the head, and pound the information in.  I try, however, to resist temptation….

More

What makes a bankruptcy lawyer great

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The Change We Need In Consumer Bankruptcy Practice

bankruptcy changes

The American Bankruptcy Institute under the leadership of retired Judge Eugene Wedoff is gathering input for a review of changes needed in consumer bankruptcy law.  I was privileged to offer my thoughts at NACBA’s 25th annual convention in May.

Good Morning, I’m Cathy Moran.  I’ve practiced bankruptcy law in the Silicon Valley, in California’s Northern District, for 37 years.

I’ve been  a bankruptcy specialist, certified by the California State Bar Board of Legal Specialization, for 21 years.

I’ve divided my comments this morning into two general categories:  the specific and the systemic.  Both need change if bankruptcy is going to realize its potential to enable individuals to lead financially stronger lives.

Specific Changes

Student loans  

I’m sure you’ll hear from others much about student loan discharge and  the need for a better balance between the interests of student loan lenders and guarantors and the interests of borrowers.

Short of changing the test for the discharge of student loans, there are lesser changes which would aid borrowers in dealing with their loans.

  • One, recognize student loans as long term debt on which payments can properly be maintained through out the life of a Chapter 13 plan.  Allow separate classification of student loans in the plan.
  • Alternatively, permit debtors to continue to service student loans directly.  Where I practice, neither are presently permitted.  Instead we effectively require debtors to default on their student loans and incur significant collection costs in addition to the oft crippling loans themselves.

Use Chapter 13 to practice savings  

No credible financial counselor would craft a budget for a client that had them spending every penny they take in.  Yet that’s how our Chapter 13 calculation of monthly disposable income works.

The means test makes no allowance for routine replacement of household goods, the repair of appliances, much less the unexpected or catastrophic event.  Without an approved mechanism for an emergency fund, a bump in the financial road leads to plan defaults, the need for plan modification, additional attorneys fees, or dismissal.

Even when a family can get through 5 years without some unplanned expense, the system has missed an opportunity to build a saving habit.  Three or five years of practice at saving would be more powerful in the future lives of debtors than a one hour financial management class.

Retirement  

The bankruptcy system contributes to our national attitude that retirement will take care of itself.  That’s an exercise in wishful thinking.

Saving for retirement should be a reasonable and necessary living expense.  To conduct ourselves as though it isn’t is to perpetuate the hope that old age will take care of itself, magically.

Our current system allows only retirement savings where contributions are mandatory;  yet fewer and fewer individuals have the kind of employment that requires retirement savings.

Early plan payoff  

Chapter 13, as it operates, is divorced from financial common sense when it resists early payoff of Chapter 13 plans.

Whether by reason of improving finances or an unexpected windfall, or the willingness to reach into exempt assets to fund plan pay off, too many Chapter 13 trustees oppose early payoff.
What creditor would reject payment of $100 now, in favor of 10 future payments of $10.

Which is a segue way to attitudinal changes within the system.

Systemic Changes

Chapter 13 as serving time  

With a system  that exposes any improvement in circumstances to capture for the benefit of creditors, it becomes harder for counsel to pitch the advantages of Chapter 13 over alternatives.  Chapter 20 looks better.  Debt settlement which fixes the payment schedule at the outset look better.

The risks of Chapter 13 swallowing any improvement in the debtor’s financial situation are becoming disproportionate to the benefits of the shrunken Chapter 13 discharge.

Conditioning access increases costs disproportionately  

The misbegotten idea that consumers were flocking to bankruptcy in an irresponsible attempt to avoid paying their just debts has lead to the enormous increase in cost  of bankruptcy representation.

The means test, the need for supporting documents, and the threat of having to defend your need for bankruptcy against a taxpayer funded lawyer from the Office of the US Trustee with a prosecutorial mentality makes bankruptcy difficult for the unsophisticated or the stressed consumer.

My sense is that trustees feel their supervisors expect them to act as inquisitors.  Yet the statistics about “abusive filings” suggest this is a remedy without an ailment. We’ve just succeeded in pricing bankruptcy out of the reach of too many.

Fair compensation of counsel  

While the Code and pronouncements from the bench mouth the platitudes about compensating counsel for consumer debtors consistent with fees paid to lawyers in other fields, it doesn’t happen consistently enough to attract capable and committed lawyers to this field.

Court sanctioned “flat fees” are crafted not so much to pay the average value of services, but rather the minimum that a consumer case could cost.  Judges apparently fear overpaying the journeyman lawyer more than they do starving the capable out of the field.

The issue of how fees for representation after plan completion but before discharge, such as lien stripping and Rule 3002.1, is without guidance or procedures.

The opportunity for a fresh start is unique and valuable in our economic system.  Access to a fresh start needs attention and support lest it become a platitude rather than a reality.

One Trait Makes A Bankruptcy Lawyer Great

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One trait makes a bankruptcy lawyers  stand out.

Bankruptcy forms promote the view that filing a case is just recording what the debtor owns and owes today.  If all you focus on is the here and now, you can assemble a bankruptcy petition.

But if there is one, uniform failing in average bankruptcy lawyers, it’s that they confine their attention to the here and now-what does the client have, owe, and earn.

Great bankruptcy lawyers take the broad view.  They look backwards and forwards from the filing date before uploading the petition.  Because bankruptcy rights and consequences flow from both the past and the future.

Let me count the ways this works.

Past events impact today’s petition

Our client’s present circumstances didn’t just pop up, overnight, like a mushroom.  They are the product of years of interlayered events.  The better we understand those events, the better we can advise the debtor.

  1. Means test income and Lanning :  does the 6 month look back income include a unique event, like a bonus, that won’t occur again?
  2. Preferences:  in the last 90 days, did they settle a suit, pay their student loans, make any transfer they don’t want undone?
  3. Transfers to insiders: in the last year-  if client has been repaying family loans, you don’t want them surprised when trustee sues their parents
  4. Conveyances to “protect” assets: move title from debtor to buddy, and debtor may have set buddy up for suit and imperiled their discharge
  5. Contributions to 529 accounts:  money contributed to government sanctioned college savings accounts within two years may be recoverable by trustee
  6. Interstate moves:  a move between states within two years of filing may drive exemption options
  7. Fraudulent transfers under state law:  the statute of limitations on fraudulent transfers where I practice is four years, and the trustee assumes the creditor’s rights to recover the transfer
  8. Tax filings: if there’s tax debt, it matters whether client got an extension of time to file return and whether tax day fell on the 15th, 16th, or 17th three years ago
  9. Transfers with intent to hinder, delay or defraud within 10 years: §  522(0) provides for reduction of homestead exemption for bad acts within a decade

So, you may have to get the client’s life story to see all the issues in their bankruptcy filing.

Events after filing matter, too

We’d like to think that things are locked down, right and tight, when the case is filed.  But some post petition events will augment the property of the estate in ways that don’t benefit the client.

  1. Inheritances–  541 expands the scope of property of the estate to assets acquired by testate or intestate succession.  Did you inquire about the health of client’s relatives and their succession instrument of choice?
  2. Additional debts if it’s likely that the debtor will accrue more debts, perhaps from ongoing illness, those debts won’t be dischargeable for years if you file a Chapter 7 prematurely
  3. Mortgage payment adjustments coming  a mortgage payment reset may affect the means test and the money available to fund a Chapter 13.
  4. Real estate appreciation  post petition appreciation belongs to the estate.  In a rising real estate market, you may need to compel abandonment of property before it becomes attractive to the trustee
  5. Tax refunds – a fraction of any tax refund for the year of filing may belong to the estate.  If the client is overwithheld, did you advise reducing withholding to eliminate refund come April?
  6. Expiration of limitations on sale  when prepetition options vest, or restrictions on sale of stock expire, the trustee may be able to sell something previously worthless.

The bigger picture yet

Going through bankruptcy can be a teachable moment:  if the client considers how he got here, a great bankruptcy lawyer may have thoughts for a sounder financial future.

The lawyer may ask:

  • Can you afford this house or this car in the long run?
  • Can you avoid taking on student loans that will cloud your future?
  • Can you utilize the financial discipline you used to survive this long to prepare for old age?

It’s not just filling out forms

The attorneys who see bankruptcy as “just filling out forms” set their clients up for unpleasant surprises.  It’s not easy or quick to extract all this information from a client who is stressed and self condemning.

Not easy, but the difference between adequate and great.

If you’re reading here, I’d like to think you’re a member of the Lake Wobegon Bar Association, where all the lawyers are above average.  Cheers.

More

How to educate your client

Where to start when you encounter a problem

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Ensure You Understand Insurance In Bankruptcy

 

man with magnifying flickr anderscismoSometimes, issues that you’ve just skimmed over burst forth in bunches, demanding attention.

Lately, that issue in my bankruptcy cases has been insurance.

Because its treatment varies so, we need to be asking more pointed questions of clients about both insurance policies and the debtor as beneficiary.

Unmatured life insurance

Starting with exemptions, §522(d)(7) makes an unmatured life insurance policy exempt without limit.

So, the insurance element of a policy owned by the debtor is exempt whether it insures the life of the debtor or someone else.

Life insurance cash value exempt

The loan value, or accrued dividend, on a life insurance policy is exempt up to $8000.  §522(d)(8).

But here come qualifiers:  it has to be owned by the debtor. And it has to insure the life of the debtor or someone on whom the debtor is dependent.

If the client has insurance with cash value on a business partner, a parent, or their kids, it doesn’t fall into this exemption category.

Means test deducts term insurance on breadwinner

For means test purposes, premiums on life insurance is an allowable deduction from current monthly income.

But again, it must be term insurance (don’t want any disguised saving going on here) and it must insure the life of  the debtor.

That may leave a gap if the debtor is dependent, or the debtor’s household is dependent, on the wages of a non debtor spouse.

Insurance proceeds exemption

A different set of rules apply if the death of the insured preceded the bankruptcy filing and we’re dealing with death benefits.

The income stream from a life insurance policy is exempt if the debtor was the dependent of the decedent on the date of death.  §522(d)(11)(C).

The exemption is limited to the amount necessary for support for the debtor and the dependents of the debtor.

This, of course, opens the nasty issue of what is “necessary for support”:  is it beans and rice, or beefsteak?

Insurance a post filing exception

We’re fond of saying that bankruptcy deals with a snapshot of the debtor’s assets on the date of filing bankruptcy.

But that glosses over the exceptions to the rule:  the bankruptcy estate includes inheritances (used loosely); marital settlement agreements; and life insurance benefits to which the debtor becomes entitled within 180 days of filing.

Insurance proceeds payable directly to the debtor on account of a death in that 180 day window become assets of the estate, subject to the exemptions we’ve already examined.

Dig deeper

We’ve looked at exemptions from the perspective of the federal bankruptcy exemptions.  If those exemptions aren’t available in your state, you need to search out the treatment of both the policy and any proceeds provided in state law.

Twice recently, my clients have owned key man insurance on a former business partner. In my cases, the business was defunct.  If operating, perhaps there is an argument that the debtor was indirectly dependent on the partner, or there wouldn’t have been a need for the insurance.

A current client acquired, at the suggestion of his financial advisor, expensive life insurance on his children.  I’m not seeing any exemption possibilities there other than the grubstake exemption.

Then, finally, a client was the beneficiary of his mother’s life insurance, which was payable to him for the purpose of providing a culturally traditional funeral.  Sorry, said the bankruptcy trustee:  if it’s payable to you, it’s grist for your creditors.

As Arthur Conan Doyle has Sherlock say:  These are much deeper waters than I had thought.

Image courtesy of Flickr and Andercismo

Hammered By Rule 3002.1

To my mind, Rule 3002.1 is the most powerful, most under-utilized tool in our tool box.

And its power is coming to the fore as Chapter 13’s filed in 2011 and 2012 wind to a close.

Don’t let your home-owning client leave Chapter 13 without a determination that they are current

Or, if they are not current, without a plan for addressing the default.

Rule spotlights mortgage balance

During the case, the rule requires timely notice to Chapter 13 debtors and their counsel of payment changes and the addition of fees to a loan balance.

The debtor has an opportunity to challenge the change or the fee before the court.  So, disputes can be ironed out before the bankruptcy court, before there’s a post petition crisis.

But the real punch is at the end of the case when the trustee “shall” file and serve a notice of final cure payment and inform the creditor of its obligation to respond to the notice.  If the trustee fails to serve the notice, the debtor may do so.

And here’s where it gets interesting.  The creditor’s failure to respond properly to the notice is grounds for deeming the mortgage current.

And, the creditor’s failure to have given timely notice of “fees, expenses, and charges” added to the loan balance can bar introduction of evidence by the creditor.

Pretty powerful stuff.

In one of my cases last year, the creditor ate $62,000 in post petition advances on the loan because it botched the response to the trustee’s notice. And the lender paid the debtor’s attorneys fees to boot.

Had the creditor gotten the response to final cure payment right, they probably would have lost anyway, because the lender hadn’t given notice of the taxes it was advancing throughout the case.

Mine your files

A case now on my desk is simpler:  over the five years of the plan, the lender filed only one notice of fees, expenses, and charges for about $50.  But its response to the trustee’s notice has two defects:

  • The $7000 in fees, expenses and charges isn’t supported by timely notices.
  • The response fails to detail the nature and the timing of the claimed expenses.

Unless the creditor can show that $6950 in fees was incurred in the last six months, such that a notices under subsection (c) is still timely, I’d suggest that claim is dead in the water.

I’d bet that more often than not, servicers have not complied with the rule and, further, can’t tell a cogent story about what the debtor owes at case end.

And if the lender concurs that the loan is current, you want a record of it.  Nothing like a little claim preclusion, eh?

More to follow

I expect to explore Rule 3002.1 further in weeks ahead here.  So often, our clients filed Chapter 13 to save their home.  Yet sloppy mortgage servicing and client inattention can sabotage that effort.

Join me in vowing:  not on my watch.

Corporate Bankruptcy: So We Can Start Over

5304492399_805a329467_zThou shalt not file bankruptcy for a corporation.

It’s almost a commandment from on high in my practice.

But for every rule, there is an exception and the man sitting in front of me called on the exception.

He wanted, (or really “needed”) to stay in the same line of construction work.  But business was bad, there was a supplier suing the corporation, and then there was that pesky, state corporations law.

The duties of corporate officers

Hearken back to law school and Corporations.  Officers and directors owe the corporation a duty of loyalty.  They must not usurp corporate opportunities nor compete against the corporation.

My normal advice to business folk when a corporation needs to fold is to simply close the doors, liquidate any assets, pay the most important bills to the extent possible, and move on.

A corporation won’t get a discharge in Chapter 7.  If there are few assets, the trustee will probably close the case immediately following the 341 meeting.  So, the automatic stay won’t give a bankrupt corporation much breathing room.

Not much to be gained in a corporate 7.

My concern on these facts was that closing the doors on the corporate business, and reopening as a proprietorship, in the same line of work, using the same phone number, and the same small nest of tools would be subject to attack by the unpaid vendor.

Either, the claim would be that the individual had misappropriated the corporate assets and opportunities for himself, to the detriment of creditors, or that the new business was really just the alter ego of the failing corporation.

Bankruptcy as corporate funeral

The threat of breach of the duty of loyalty or alter ego claims fade if the corporation files Chapter 7.

Bankruptcy is a clear signal that the business, if not the corporation, is dead.  The bankruptcy court publishes the obituary.

A bankruptcy trustee conducts the final services.  With some ceremony, the business is interred.

The shareholder is left free from claims that going into business in the same line of work breaches his duty to the old corporation.  There is clearly no corporate business remaining.

Tidying up the corporate assets

Assuming that the trustee closes the corporate case as a no asset case, we will still have to dispose of the business effects of the corporation.

I will propose that the shareholder buy from the corporation, post bankruptcy, any tools or equipment useful in his new endeavor.  The purchase price goes into the corporate bank account.  A bill of sale will document the transaction.

If the phone number is actually in the name of corporation, rather than the individual as sometimes happens, we can either try to switch it to the individual’s new business name, or leave a recorded message on the old number referring callers to a new number.

This approach should make clear to creditors that the old entity is gone.  The no asset report establishes that there was nothing there.  The real live human being who needs to put food on the table is free to start over.

In this case, breaking my rule had a good outcome.

Image courtesy of Flickr and John Taylor