Being a judge isn’t a popular calling lately–at least during the Republican Presidential primary season. Courts are blamed for everything that ails society.

For example, Republican Presidential contender Rick Santorum laid out his view that the judicial branch of government is the least important branch.  He explains his view by stating:

Our founders intended for them to be the least consequential of the three branches of government . . . How do I know that for a fact? Because it’s Article III. Article I is Congress, Article II is the president and Article III is the courts. If it was the most important, they wouldn’t have put it third.

He apparently pulled out his pocket Constitution in support of the argument.  The late Senator Sam Ervin would have been proud–well, maybe not.

And as for the 9th Circuit Court of Appeals, Santorum is really fed up.  That Court, he says, should be shipped to Guam. I don’t know what the 9th Circuit Court of Appeals has done to deserve this, but I think it would certainly be unfair if we didn’t stop to ask the people of Guam if they want the 9th Circuit Court of Appeals. Don’t they have any say in this? Apparently not, according to Santorum.

But Santorum’s flawed–and downright bizarre–logic that the last mentioned is the least important got me thinking.

First, I wondered about where all that “checks and balances” stuff I learned about in Mrs. DeVore’s 8th grade civics class was going–apparently to Guam or some other place. Then I also wondered what this means for bankruptcy courts. Where do the bankruptcy courts fit in?

Clearly, bankruptcy courts are number 1 since they are Article I courts.  (Or do I say, “Bankruptcy courts are number I”?)

How do I know this? The U.S. Supreme Court said it in Stern v. Marshall.  Okay, we knew the Article I thing before that, but this decision really makes it clear. (Ignore the fact that the Supreme Court is an Article III Court and therefore part of the least important branch of government.)

“But Stern limits the jurisdiction of the bankruptcy courts,” you say.  True, but let’s not get bogged down in details.  I’m a glass-half-full kind of guy and think that bankruptcy judges should take some comfort in the fact that they are in first place in the “What-Branch-Matters-Most” contest.

So I say to bankruptcy judges: Hold your heads high! You really are number 1!

Postscript: Guam is, of course, a U.S. Territory. It also turns out that Guam is in the 9th Circuit already. Whether Guam should have more of the 9th Circuit than it already has will probably be fiercely debated during primary season among those candidates seeking to lead the free world. Still, it is the position of this author that Guam should be consulted prior to any changes being forced upon it it. Perhaps instead, the circuits should be changed so that, for example, the 9th Circuit switches places with the 6th Circuit, and so on. Of course, the question then becomes, do the Guamanians want the 6th Circuit?  If not, would anyone else want the 6th Circuit? Santorum may have opened up a real can of worms.

Still, Santorum’s views seem workable compared to those of Republican contender Newt Gingrich. Gingrich advocates sending U.S. Marshals to arrest judges–Article III judges, I’m sure, so bankruptcy judges relax!–and have them brought to Congress to justify their decisions in Congressional hearings. This can’t happen for a variety of reasons–most notably that we are not Nazi Germany–but still, it illustrates the point. 

We all know that individual tax returns are due on April 15 (or a day or two later if April 15 is on a weekend).  But Congress inserted a little tax time craziness into sections 1308 and 1307 of the new and drastically unimproved Bankruptcy Code of 2005.  Section 1308(a) states:

(a) Not later than the day before the date on which the meeting of the creditors is first scheduled to be held under section 341 (a), if the debtor was required to file a tax return under applicable nonbankruptcy law, the debtor shall file with appropriate tax authorities all tax returns for all taxable periods ending during the 4-year period ending on the date of the filing of the petition.

At first reading, this section appears to only be dealing with those returns the debtor “was required to file” prior to the 341 hearing or “First Meeting of Creditors.”  For example, if it’s February 5th, 2012, and I’m a debtor in bankruptcy, it can’t be said that I “was required” to file my 2011 return.  After all, the IRS gives me until April 15.

But like many provision of the Bankruptcy Code, this one’s a little murky.  And section 1308(b) provides:

(1) Subject to paragraph (2), if the tax returns required by subsection (a) have not been filed by the date on which the meeting of creditors is first scheduled to be held under section 341 (a), the trustee may hold open that meeting for a reasonable period of time to allow the debtor an additional period of time to file any unfiled returns, but such additional period of time shall not extend beyond—

(A) for any return that is past due as of the date of the filing of the petition, the date that is 120 days after the date of that meeting; or

(B) for any return that is not past due as of the date of the filing of the petition, the later of—

(i) the date that is 120 days after the date of that meeting; or

(ii) the date on which the return is due under the last automatic extension of time for filing that return to which the debtor is entitled, and for which request is timely made, in accordance with applicable nonbankruptcy law. [emphasis added].

Reading both 1308(a) and (b) together, along with a few tea leaves and tarot cards thrown in for good measure, we see that the requirement of 1308(a) applies even to returns not yet due. So if you haven’t filed your 2011 return, and your 341 hearing is scheduled for February 6, you’d better have  your return filed by February 5!

And what if I don’t file my return prior to my 341?

If you don’t, the trustee “may hold open that meeting for a reasonable period of time to allow the debtor an additional period of time to file any unfiled returns” as noted above.  At the very least, that holds up confirmation of your plan.  And if you have a not-so-friendly Chapter 13 trustee, she just might not hold the meeting open and instead proceed under section 1307(e), which provides:

(e) Upon the failure of the debtor to file a tax return under section 1308, on request of a party in interest or the United States trustee and after notice and a hearing, the court shall dismiss a case or convert a case under this chapter to a case under chapter 7 of this title, whichever is in the best interest of the creditors and the estate.

What this means is that, in our example, if you don’t have your return filed by February 5, the U.S. Trustee or a “party in interest” (i.e., pretty much anyone including your crazy ex-wife) may file a motion, and the court “shall dismiss a case or convert a case under this chapter to a case under chapter 7.”

This presents huge problems for self-employed debtors

For most W-2 employees, filing tax returns isn’t that big of an undertaking, assuming they get their W-2 from their employers in a timely fashion.  Still, getting the return filed by February 5, or even a few weeks later, can be difficult when the debtor may be dealing with issues in his bankruptcy case.

But for self-employed debtors, this requirement presents an impossibility.  Many self-employed debtors must first file corporate or partnership returns prior to filing their own individual tax returns.

Furthermore, holding the first meeting open accomplishes nothing. Trustees have the right to demand annual tax returns under section 521 or to require the debtor to furnish the trustee the last year’s return even after confirmation. After all, what’s the difference between a case filed on December 31 and one filed on January 1?  Why should one case be administered under the draconian requirements of 1308(a) and the other, filed a day earlier, escape these requirements?

But the IRS needs the returns to file their claims on time!

No they don’t. Governmental creditors already get 180 days to file claims because we assume the government can’t possibly do anything on time. So for that January 1 bankruptcy petition, the IRS has 180 days after that to file its claim–way beyond April 15.

Would the IRS really do this?

Yes, apparently it would.  The IRS Office of General counsel in North Carolina reminded bankruptcy lawyers in the South Carolina bar of this in a letter dated August 11, 2011–which, amazingly was signed by a staff attorney in “Group 1, business/self-employed.”   I say, “amazingly” because the IRS attorney signing this letter should know that there’s no earthly way debtors can pull partnership and corporate returns out of their ears in early February, then follow up with a quick 1040 filing.

Mom says just because you can doesn’t mean you should

There is nothing in the Code requiring the IRS to hassle debtors by filing unnecessary motions like this. As mom used to say, “just because you can doesn’t mean you should.”  Ditto for the IRS.  Searching the hills of North Carolina for illegal stills would be a better use of IRS resources.

And if they persist, there’s the 1040WAG

Okay, I just made that up.  But here’s what it is.  It’s a 1040 return where the debtor takes a wild-assed guess (hence the “WAG”) at what he should put down, then files it.  Voila, no more problems.  He then amends the return at a later date (filing a 1040X–there really is such a thing) when he obtains W-2s, other records, partnership returns, corporate returns, and so on. Problem solved!  This is, after all, what the government asked for.

Of course, this accomplishes nothing but allowing the debtor to assert compliance with a nonsensical rule which should not be enforced. Instead, it would be better if the IRS focused on its core mission–collecting taxes.

Postscript: On both a personal and professional level, I genuinely like the people I’ve come in contact with at the IRS on behalf of my clients.  I do, however, object to the Office of Division Counsel in North Carolina threatening debtors with dismissal for failing to do something which is impossible.  Chapter 13 bankruptcy is about paying creditors back, including the IRS.  The IRS should work to assist debtors to accomplish this goal, rather than threatening hard-working, honest Americans in the throes of the worst economy since the Great Depression.     

For one of the few decisions analyzing this issue, see In re French, Case No. 06-20066 (Bankr. E.D.W.I. 2006).  In addition, United States v. Novello, Case No. 08-2362-JAR, a U.S. District Court case in Kansas , is worth reading.  In Novello, the U.S. District Court reversed the Bankruptcy Court’s use of section 105 (allowing the court to issue any order necessary to carry out the provisions of the Code) to deny the IRS’s motion to dismiss the case.  After explaining that the Bankruptcy Court improperly used section 105–albeit in a common-sense fashion–the District Court admonished the IRS by stating: “In so ruling, the Court repeats the observations of the bankruptcy court in this case as well as in McCluney, that a motion to dismiss brought under § 1307(e) is discretionary and that once a return is filed soon after the motion to dismiss, that statute’s purpose has been fulfilled. The bankruptcy court was understandably frustrated by the tactics of the United States and the resulting inequity to the debtor. As the bankruptcy court noted, just because the IRS has the power to pursue such a motion does not mean it should seek to enforce it with “unwavering tenacity” under any and all circumstances. The United States has succeeded on appeal. Upon remand, however, it would behoove the United States to consider whether the gain incurred by continued pursuit of its motion to dismiss under the circumstances of this case comes at the cost of its goodwill with the bankruptcy court.”  Words of wisdom–sounds like something mom would say.

And for even more reading on this fascinating subject, see “Pre-Petition Tax Returns, Post-Petition Tax Payments, and Proper Characterization of State Tax Claims” by Texas Assistant Attorney General, Kimberly Walsh.

The debtor education course. It’s the second course required by the Bankruptcy Code–the ticket out of bankruptcy, at least if the debtor wants his discharge.

I confess I’ve always wondered what my clients thought of the course. Calling it a “course” is a bit much.  It only takes an hour or two, and there’s not much you can accomplish in that amount of time.  It’s more like a session.

I’ve had clients experience some really severe hardships–failed businesses, strange and unexpected medical problems, domestic problems, job losses, huge medical debts, just to name a few. So I’ve wondered if clients find the debtor education course, well, patronizing and insulting.  I’ve asked a few of them, and some do.

I got an email from a client recently who’d gone through three job losses in a short period of time, as well as some domestic relations craziness mixed in for good measure.  Her email about the debtor education course is–with her permission–reproduced below.  She writes:

“I have attached the last page displayed for that awful two hours of required federal course on bankruptcy. Obviously, it is intended as a cruel and unusual punishment in return for the act of declaring bankruptcy. There was nothing in it that was something I did not know. It is obviously intended for idiots who have never attend school, earned a penny, had a job, opened a checking account, heard of the financial market, held insurance of any kind, or made any other type of financial transaction on the face of the earth.

Perhaps those who demand these courses should take into account that some people declare bankruptcy not because they are financial idiots, but because they met unexpected financial demands. I do not believe there are courses which can be created to cover those instances – divorce, child custody, unexpected, unplanned major medical expenses.  I have met their stupid requirement.”

But you must see people who have been irresponsible with credit!

Yes, I have–and plenty.  But they all know that when they walk through my door.  This reminds me of my childhood friend and his dog, “Peanut.”  It was one of those little “wiener dogs,” a Dachshund.  When Peanut occasionally had “an accident” on the carpet in the basement, my friend’s mother would rub the little dog’s nose in it and yell at the dog.  This is the mental picture I get when I think of the debtor education requirement.  The Bankruptcy Code basically says, “you just messed on the rug you stupid little dog, and now you can pay to take a course so we can rub your nose in it.”

And there’s another side to the “irresponsible debtor” argument

The system focuses on the debtor.  Should the debtor be in a Chapter 13 instead of a Chapter 7?  Is the debtor hiding assets?  Are the debtor’s assets valued accurately? Fair enough. But just once I’d like a panel trustee or someone from the U.S. Trustee’s office jump up at a First Meeting and yell, “Why on earth did these credit card companies lend $90,000 to this couple earning only $50,000 a year?”  I’m sure they think it, but it would be fun to hear it–just once.     

Who’s got the MBA here anyway?

It’s ironic that the bankruptcy system expects Joe and Sally–many times with no college or financial education–to be so financially responsible when it’s perfectly content to have nincompoops running our financial institutions.  Folks with MBAs can destroy companies like Washington Mutual, Wachovia (bought by Wells Fargo to avert destruction), Merrill Lynch (bought by Bank of America on the eve of destruction back in 2008 and as the CEO bought an $87,000 area rug for his office), Lehman Brothers, AIG (if not for the bail out it received), and Bank of America (perhaps?–think Countrywide.)

The fact of the matter is that over the last 100 years, the Joe and Sallys of America haven’t done anything to cause depressions or recessions; it’s been the MBAs of the world who manipulate stock markets, commit fraud–think Enron or Worldcom–or otherwise wreak economic trouble. Read a book or two about the Great Depression if you have any doubts about this.  (Check out what National City Bank was up to back then!)  Now, as then, the blame for the mess we’re in can be laid at the feet of Wall Street.

There’s a perverse twist here

The perversity is that we’re regulating Joe and Sally with “bankruptcy reform” and things like the debtor education course but giving Wall Street and corporate America a pass.  And it happened at about the same time.  Our “bankruptcy reform” (which, by anyone’s account was an attempt to increase regulation on ordinary Americans) occurred between 1998 and 2005.  At the same time, in 1999, Congress repealed the Glass-Steagall Act of 1934, the act which separated commercial banking from investment banking–the kind of banking where securities are underwritten and issued.  Congress also decided to leave the derivatives market unregulated, which led to the AIG mess and near financial Armageddon at the end of 2008.  The MBAs and corporate America–those with “financial education”–saw to it that the regulations put in place in 1930s during the Great Depression were swept aside. As financial regulation of Main Street increased, financial regulation of Wall Street decreased. (Watch “The Go Go 90s” to learn about how this happened.)

Maybe someone else’s nose should be rubbed in the mess for a change?

Most of us have an idea of what income is for federal or state tax purposes.   Wages are income, as are gains on the sale of stock.  Dividends and interest also qualify.   We know that.  It’s intuitive and easy to understand.

The classic definition of income is that it’s the return on labor or capital.  In fact, if you look through the kinds of things which are considered income in the Tax Code, the “usual suspects” appear in section 61: rents, interest, compensation, alimony, annuity, pensions, among others.

But then comes bankruptcy world

When we get to bankruptcy world, it’s not so intuitive.  Various things are income in bankruptcy world that the Tax Code would not consider income.  For example, an inheritance, a gift, child support, and disability payments–even those not taxed–are income for bankruptcy purposes.

The bankruptcy world definition of income I use is this: “anything that comes in.”  (Get it?  In….Come.)  If if hits your hands or your bank account, it’s income.  That gift from mom for $2000 to help you make ends meet, contributions to your household expenses, an inheritance, child support, you name it.  There are some exceptions to this rule, but you need to tell your bankruptcy lawyer about everything you’ve received so that “income” can be disclosed.

Don’t worry about the exceptions

There are some income sources which are not part of your CMI (“current monthly income”) such as Social Security and, depending on the views of your particular judge, unemployment.  Also, I don’t know of anyone who would consider all the money you’d received from the sale of an asset as income.  Only the gain would be income.  Most of the time, assets are never sold at a gain. Likewise loan proceeds would not be considered income.

But don’t worry about the exceptions.  Your job is to tell your lawyer everything.  Don’t exclude something just because it’s not taxed.  

Words are powerful.  The word “bankruptcy” carries enormous emotional baggage.  People hear it and immediately jump to conclusions.  “Failure,” “shame,” “irresponsibility,” “ruin” all come to mind.

Recently, I met with an elderly couple.  They had significant cash flow problems, and a Chapter 13 bankruptcy would benefit them greatly.  As I do with all prospective clients, I gave them the initial disclosures required by the Bankruptcy Code along with my “non fee agreement fee agreement.” I call it that because it’s simply a required agreement which says that their first consultation is free. It’s silly, but required by the Bankruptcy Code.

The reason they would not sign either document became immediately clear.  The first thing they said was, “We’re not here to discuss bankruptcy!”

And then Steve Jobs died a few days later

Admittedly, I’m shifting gears a bit, but bear with me.  We all know Steve Jobs passed away this past week.  I can’t add anything meaningful to the accolades others have deservedly heaped upon him.  I’ve got an iPhone, an iPad, an iPod, and, of course, an iMac.  We all know how good these products are and how much we love them and the way Apple supports them.  I also have work computers on which I run Windows 7, and Steve Jobs and the folks at Apple made Windows better as well–albeit indirectly.

When we think of Steve Jobs, we think of a lot of things.  Bankruptcy, however, is certainly not a word which comes to mind.  After all, Jobs and Apple have been a success.  Money has been made and investors paid–in heaps.

But What If Things Had Been Different?

In the 90s, Apple wasn’t the household name it is today.  Most believed that PCs would continue to dominate the market (I did) and that Apple would shrivel up and remain a tiny company with only a niche market.  What if Apple needed to file bankruptcy to stay alive while it reinvented itself?  Would it have filed bankruptcy–even with all the emotional baggage and stigma?  I think so.

One of the many insightful things Steve Jobs said is this:  “Your time is limited, so don’t waste it living someone else’s life.  Don’t be trapped by dogma, which is living with the results of other people’s thinking.  Don’t let the noise of others’ opinions drown out your own inner voice.”

Did you hear that?

“Don’t be trapped by dogma, which is living with the results of other people’s thinking.” Isn’t that exactly what these older folks were doing?  (“Bankruptcy means we’re ruined.”  “Bankruptcy means we’re a failure.” “Bankruptcy is immoral.”  “Bankruptcy will hurt our credit.”  “Bankruptcy is not an option.”)

We need another word!

I wish we could come up with another word for bankruptcy.  Companies do it.  It was “Kentucky Fried Chicken” and now it’s “KFC.”  (Fried is bad–emotional reaction averted.)  Maybe we could call it a “financial petition” or something like that?

In the meantime bankruptcy is bankruptcy.  And a rose by any other name is still a rose.  Don’t be trapped by dogma when it comes to your financial options.  Steve Jobs most certainly wouldn’t have been.

The Bankruptcy Code mandates that the debtor take a credit counseling course within 180 days prior to filing bankruptcy.  The course is one of the many useless hoops debtors must jump through prior to filing their bankruptcy petition.

If you really want to avoid bankruptcy, this “course” is not helpful

I, like any other bankruptcy lawyer I know, view bankruptcy as a last resort. I give my clients other options prior to suggesting bankruptcy–provided those options make sense for the client.  We discuss debt management plans (which occasionally work), doing nothing (generally not a good idea but an option), or debt settlement (many times a good bankruptcy alternative if the client has some financial resources).

I also suggest the client speak with a reputable agency here in Charleston, South Carolina area, Family Services of Charleston.  Family Services is a non-profit with an excellent reputation for helping consumer in Charleston.  Most other communities have similar non-profit agencies.  If you want unbiased information on bankruptcy alternatives, getting input from a local agency is a good idea. If you can address your financial problems without bankruptcy, they’ll set up a plan to help you.  And if your situation is severe enough to warrant bankruptcy, they’ll tell you that as well.

The mandated credit counseling course is very different

The course you must take to file bankruptcy is very different.  It’s usually a one-size-fits-all course telling you that you might be able to avoid bankruptcy by cutting back on your expenses, or by getting a debt consolidation loan, or by refinancing your house.

I know, you’ve thought of those options already, and they won’t work.  And therein lies the problem with the requirement.  It’s sort of like a non-smoking class for folks with lung cancer.  At the point you take the couse, you already know you’ve got financial cancer.  You probably know what caused it as well.  Most of my clients predictably view the course as patronizing and useless, and I agree with their analysis.  Most bankruptcies are caused by job loss, divorce, or medical problems. Clients feel horrible about their situation.  They don’t need their noses rubbed in the mess they’ve made.

Do it late and do it quickly

There’s really nothing to be gained from the “course,” except that you need the certificate to file bankruptcy. It’s your ticket in to the bankruptcy system.  Enter the information quickly, and get it over with.  However, don’t take the course until shortly before you are scheduled to file bankruptcy.  It’s only good for 180 days, and you don’t want to have to waste you time on this useless exercise again.

Bankruptcy Petition Preparers.  Should you hire one?

Let’s face it.  Folks with financial problems aren’t exactly flush with cash.

So it’s tempting to cut corners in purchasing legal advice and to opt for the services of a bankruptcy petition preparer. But as with most things, you get what you pay for.

Preparers really can’t–at least if they follow the law–do much of anything except serve as data entry clerks.

Most notably, they can’t:

• Give legal advice–including advising debtors whether to file or what chapter to file; or
• Advise debtors about what exemptions to claim (state, federal, or what state’s exemptions apply).

They’re also subject to state unauthorized practice of law statutes.  As the U.S. Trustee’s office states, “bankruptcy petition preparers can only type documents and must charge a reasonable fee.”  And you’re supposed to tell them what to type!

Section 110 of the Bankruptcy Code is devoted to them, the problems they cause, and what you can do if you’re harmed by one to get compensation for your damages–assuming, of course you can find the preparer and he’s collectible.

Interestingly, courts set a very low value on the services of petition preparers.  The Bankruptcy Court for the Eastern District of Michigan limits a preparer from charging more than $100 without filing a request with the court. Likewise, the Northern District of California limits preparer fees to $150, along with publishing guidelines specifying what a petition preparer may and may not do.   Numerous other courts have also limited compensation to similar nominal amounts.  Courts, therefore, don’t place much value on the services of bankruptcy petition preparers.  And bankruptcy judges have first hand knowledge of the quality and value of bankruptcy petition preparers work.

The United State Trustee’s Office frequently takes action against preparers.  Preparers are unlicensed, unregulated, uninsured and are often the subject of U.S. Trustee enforcement action.  For one example, read Craig Andresen’s post entitled, “Bankruptcy Petition Preparer Slammed by New Mexico Bankruptcy Court.”

Hiring a Bankruptcy Petition Preparer is a Really Bad Idea

I’ve been licensed as an attorney now for 18 years, and I’ve practiced law for 16 years.  (I worked as a judicial law clerk for the first two years.)  I’m licensed in two states, and, because of the strict requirements of the state in which I practice now–South Carolina–I had to take the full bar exam (multistate,  federal, and professional responsibility) and attend a three-day “Bridge the Gap” course prior to being admitted.  All this followed ten years of practicing law in Michigan, which, in turn, followed seven years of higher education–three of which were solely dedicated to the study of law.

Throughout my career, I’ve done a substantial amount of family law, criminal defense, and litigation.  I’ve also practiced bankruptcy law throughout my career and now solely practice in that area.  Bankruptcy law is–by far–the most legally complicated area of law in which I’ve practiced.  This is compounded by the bankruptcy “reform” act passed in 2005.  The law is poorly written–perhaps the most poorly written statute ever passed by Congress–and, consequently, is applied very differently from bankruptcy district to bankruptcy district and even sometimes differently by judges within the same district.  Bankruptcy law is complicated–very complicated.

Think About This

You stand the to gain the most from filing bankruptcy, not your lawyer, your trustee, or your bankruptcy judge.  (See “Bankruptcy Clients Make More than Bankruptcy Judges and Lawyers.”) Clients I see are discharging substantial sums of debt–most hundreds of thousands–some millions.  The real benefit goes to the client.  And even if you only have $20,000 of debt you’re discharging, getting rid of that debt is a huge relief.  Why hire a bankruptcy petition preparer who isn’t qualified to give you legal advice and who answers to no one?  Why try to save $1,000-$3,000 on legal fees (in most cases) when you’re trying to discharge many many times more than this in debt?  It makes no sense.

Hiring a bankruptcy petition preparer is a really bad idea.  And it’s not a cost-effective use of your hard-earned money.  Instead, hire an experienced bankruptcy lawyer to guide you through the process.

Explaining the differences between Chapter 7 and Chapter 13 bankruptcy can be difficult.  There are the obvious ones: Chapter 7 doesn’t involve payments to creditors, and Chapter 13 does.  And you can cure your mortgage arrears in Chapter 13 but not in Chapter 7.

And there are many others.

But what about the differences in the Chapter 7 and Chapter 13 trustees?

I found myself explaining this to a client the other day, and it just came out: “A Chapter 7 trustee is like a hungry wolverine,” I said.  “He only gets paid $60 a case, which might be enough to pay a staff member’s salary and nothing more.  To make money, he’s got to find assets so he can get a commission when those assets are distributed.  If he doesn’t he can’t make any money.”

The Chapter 7 trustee: The Wolverine

My wolverine metaphor sprang from watching the National Geographic documentary, “The Phantom Wolverine.”  The wolverine covers a large territory–up to 15 miles in a day–can kill animals several times its size, and has the ability to smell food through several feet of snow.  Yep, that’s our Chapter 7 trustee.  He’s paid by the case, and if he doesn’t find assets, he starves. 

This underscores the need to do your homework before you are in sight of the wolverine–err, I mean Chapter 7 trustee.  Once you file, it’s sort of like the mob, there’s (almost) no gettin’ out.  And this hungry animal will be all over your case.  Sniff, sniff.

The Chapter 13 trustee: The Koala?

I wanted to have this nailed down prior to writing this post, but I don’t–hence, the question mark.  So far, though, I’m leaning toward the Koala as the Chapter 13 trustee.  He stays in place, feeds off eucalyptus leaves, and doesn’t need to roam around for his food.  In short, he stays in his office and is fed a diet of close to $200,000 regardless of how many cases he administers or whether he finds assets. His job is the dream job of the bankruptcy system.  (I’m now day dreaming about it…)

But of course he can bite, so don’t play games with him, either.  Ever seen an angry Koala?

Why do I care?

You care because you might have a case where you have more assets than you can exempt (keep).  In Chapter 13, as long as you pay in that amount, less administrative costs of sale and the hypothetical Chapter 7 trustee’s fees and commissions, you can keep your kill–your assets, that is.   Chapter 7 offers no similar option.  Pay up or the wolverine is going to take it from you.

And then there’s the practical aspect of dealing with the Chapter 13 trustee.  She doesn’t have any personal stake in your assets. She’s not getting a commission or attorneys fees when she finds them or administers them.  She wants you to pay in what’s required, and she’ll leave you alone.  Most importantly, if you don’t like the deal she’s proposing, you can get out–dismiss your case.  (See “Chapter 13 Bankruptcy and the ‘Mulligan Rule’” for more information this.)

Being in bankruptcy for five months instead of three to five years is appealing, but you need to keep in mind the differences between the chapters and, perhaps most importantly in many cases, the difference between the trustees.

Yes, you read it right.  This is about giving creditors advice about reaffirmation agreements.  It just might be a first here at Bankruptcy Law Network.  But it’s occurred to me that creditors deserve some help from time to time.  So why not?

The reaffirmation provisions are hopelessly flawed

Before 2005 reaffirmation was simple.  The debtor signed a relatively short form if he wanted to reaffirm a secured debt.  The form had plenty of disclosures on it. It worked just fine for over two decades.

And then came the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”).  Whoever you hired (yes, you, you did this) to monkey around with section 524 (that’s the Code section dealing with the reaffirmation provisions) was just plain clueless, completely lacking the most basic understanding of consumer bankruptcy law.

Undue hardship

The crowning jewel of section 524 is the concept of “undue hardship.”  Under the new, 2005 rules, undue hardship is presumed to exist where the debtor’s expenses exceed his income.

Let’s think about that for a minute. We know the following: (1) Reaffirmation only applies to Chapter 7 bankruptcy, (2) debtors which have “disposable income” left over are, generally speaking, expected to file Chapter 13 reorganization plans so they can pay back their creditors, and, therefore, (3) it logically follows that in almost all Chapter 7 cases the debtor’s expenses exceed his income.  This is why the debtor is in Chapter 7 in the first place!  For example, if a debtor has $5,000 of income and $4,500 of expenses, that debtor won’t be in Chapter 7.  He’ll be in Chapter 13 because he can pay his creditors $500 a month.  The bottom line here is this: There’s an undue hardship in virtually every Chapter 7 filed!

Rebutting the presumption

This requires the debtor to show (1) that circumstances have changed since filing bankruptcy and that the “undue hardship” no longer exists, or for (2) the attorney to certify that the debtor can make the payments, along with an explanation from the debtor as to how those payments can now be made.  Oh, and if the lender is a credit union, none of this matters.  I guess consumers don’t need as much protection against credit unions?

Two obvious problems

First, requirement one–that the debtor’s circumstances have changed–just isn’t realistic in the overwhelming majority of cases.  How often would any debtor’s income or expenses materially change in the few short weeks between filing and signing the reaffirmation agreement?  Pretty much never.  It’s just a really dumb idea to even expect it.

Second, many lawyers–myself included–refuse to sign the certification stating: “A presumption of undue hardship has been established with respect to this agreement. In my opinion, however, the debtor is able to make the required payment.” How can I certify that this agreement does not impose an undue hardship on the debtor when the debtor’s expenses exceed his income?  Remember, the folks who re-wrote section 524 defined “undue hardship” as a situation where expenses exceed income.  As Illinois bankruptcy lawyer Andy Miofsky explains:

Because of this certification requirement, attorneys across the country often refuse to sign reaffirmation agreements on the basis that they are not in a position to determine whether the debtor can make the future payments, and therefore do not want to assume liability for certifying the ability to repay a debt. The act does not require an attorney sign the agreement, but if the attorney does sign, then the signature must include the certification.

So because neither of these two things happen with much frequency, reaffirmation agreements usually don’t get entered.  But because the debtor signed the agreement, he’s done everything that’s required of him, and the creditor can’t repossess the collateral–almost always the debtor’s car.

Perhaps the best-known case on this issue is In re Husain, 364 B.R. 211 (Bankr. E.D. Va. 2007).  Husain and other cases allow “back door ride through” where the debtor attempts to reaffirm but can’t because the presumption of undue hardship can’t be rebutted, or where the debtor’s attempt to reaffirm is otherwise frustrated.  Put simply, because the debtor signed the reaffirmation, he did what the Code requires, and the creditor can’t repossess the collateral.

The result of the ill-fated tinkering with section 524 is that debtors enter into reaffirmation agreements far less frequently and that courts, now being required to approve reaffirmation agreements when not “certified” by the bankruptcy lawyer, almost never approve them.

So what’s a creditor to do?  (I was just waiting for you to ask.)

1. Send the debtor’s lawyer a letter explaining that while the bankruptcy discharge will relieve the debtor of liability on the loan, the lien remains.  This calls the debtor’s intention to the fact that cars aren’t just given away, and that the lender will repossess the vehicle if payments are not made as required.

2. Repossess the vehicle if the debtor is more than 30 days late.  Keep the debtor on a short leash.

3. Quit wasting time sending out these agreements, and quit pestering debtors and their lawyers to get them signed.  Most of the time they won’t get entered anyway, so why bother?  And if they do and the debtor later defaults, the odds of collecting anything from the debtor–likely jobless at that point–are miniscule.

4. Reassign insolvency staff members dealing with this craziness to more productive uses–modifying loans, for example, thereby lowering losses from needless defaults and repossessions.  (We all know if the car is repossessed a huge deficiency will result, and now that the debt is discharged, the creditor will take a huge loss.)  If you can’t use staff in this capacity, send them to the mortgage modification department, because those folks lose virtually every piece of paper they ever touch.  They could really use some help.

5. Realize that any increased losses from failing to obtain to get the occasional reaffirmation agreement entered will be offset by not needlessly paying employees to waste time with this process.  To quote a friend of mine: “I have one expense, and it’s people.”  You run a business, and I don’t care if you’re the CEO of Ford Motor Credit or a country lawyer like I am, payroll and employee benefits are your number one expense.  There’s just no way that staffing up to deal with the reaffirmation madness is cost-effective.

6. Do NOT repossess a vehicle just because the debtor failed to sign a reaffirmation agreement. That’s just plain stupid and almost always guarantees that you’ll have a loss.  (See #2 for how to deal with this situation.)  Ford Motor Credit is the most notorious lender with this policy, and it’s a really bad one.  My guess on this one is that the guy who decided to rename the Ford Taurus the “Ford 500″ got transferred over to finance and had a heavy hand in this policy.  See Reaffirmation Agreements: “Let them Eat Steel” (Parts One and Two) on just what a bad idea this is.  Any debtors reading this post should read these, too.

7. You’ve got good lobbyists, but make sure they don’t hire the same folks to revise section 524 next time around.  For all the money you’ve spent on this legislation, you really deserve better.

Postscript: For debtors wanting a detailed explanation of their rights and obligations regarding this issue, see my four-part post on reaffirmation agreements on the Charleston Bankruptcy Blog by clicking here.

You have financial problems and you’re not sure you want to file bankruptcy.  The first thing you need to know is this: That’s okay!

Why should you know for sure that you need to file bankruptcy?  If you haven’t met with a bankruptcy lawyer, how would you possibly understand what bankruptcy has to offer?

Feeling bad about “not knowing” really doesn’t make sense.  And it also doesn’t make sense to cancel or postpone your bankruptcy consultation.  Not knowing is the whole reason to find out about your options.

And there are other issues as well.

I cringe when clients come in to see me having postponed meeting with me for several months and then report all the really self-destructive things they’ve done because, until recently, “we didn’t know if we wanted to file bankruptcy.”  Here are some examples I see in my practice here in Charleston:

• I kept paying my credit cards by using my IRA or 401(k) funds. This is a horrible idea because these funds are exempt from creditors and the bankruptcy trustee.  It’s like flushing money down the toilet.  And remember, you’ll need these funds some day.
• I kept paying on a home I could not afford.  These clients have been needlessly throwing away money for several months as well.  Why continue paying large payments on a home you can’t afford and in which–almost always–there is no equity?
• I paid mom back.  After all, I can’t stiff my own mother! This is another bad idea.  Paying mom (or dad, or other relatives) back prior to filing bankruptcy causes problems for them, which are all avoidable.
• I transferred property into my dad’s name so I could protect it from creditors.  This is a fraudulent transfer and could result in you not getting your bankruptcy discharge or getting dad sued, or both.
• I took some cash advances on my credit cards to get by.  This is yet another bad idea that could get you sued for fraud, or, at the least, delay your bankruptcy filing by several months.
• I used my equity line to pay my credit cards.   Now you’ve exchanged dischargeable, unsecured debt and turned it into secured debt, which must be paid if you want to keep your home.  I’ve had clients who have done this only to come in a year or two later needing to file bankruptcy anyway.
• And there are many others!

The point here is that it’s perfectly fine not to know.  Just realize that there are many other things you don’t know and that before you make decisions–many of which will have unpleasant consequences–you should consult a bankruptcy lawyer.  A good bankruptcy lawyer doesn’t “sell” bankruptcy; instead, he’ll help provide good options for your financial problems.  Sometimes, that means filing bankruptcy, but many times it doesn’t.  Find out your options before making any decisions.