One of the fundamental requirements to confirm a plan in a Chapter 13 bankruptcy is that (unless creditors are paid in full) the Debtor must pay for the benefit of unsecured creditors his or her “projected disposable income” to be received in an “applicable commitment period” (36 or 60 months).  Since the enactment of 2005 Bankruptcy reform act, what “projected disposable income” means has been a matter of some dispute.  The Supreme Court has now put at least some of that dispute to rest.

In Hamilton v. Lanning, decided today (June 7, 2010), the Supreme Court held in an 8-1 decision that “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.”  In other words, rather than mechanically applying the calculation of “current monthly income,” which looks at the Debtor’s income for the 6 calendar months before the filing of the petition,  the court can take into consideration changes in income that have occurred or are known or virtually certain to occur at the time of confirmation.

In Lanning, the Debtor had received a buyout from her former employer which, when included in “current monthly income,” dramatically increased her income over what she was really making, and the mechanical approach would have resulted in her having to pay more into the plan than she possibly could afford.  Because after the buyout she was making wages well below the state median income, the Supreme Court held that this change in income could be considered in calculating her “projected disposable income.”

But this “forward looking” approach should not give the Court or the Trustee, or the Debtor, a blank check: as the Supreme Court stated, “a court taking the forward-looking approach should begin by calculating disposable income, and in most cases, nothing more is required. It is only in unusual cases that a court may go further and take into account other known or virtually certain information about the debtor’s future income or expenses.”

While the expense side of “projected disposable income” was not specifically before the Court, the Lanning opinion did state the court may consider changes in income or expenses when calculating projected disposable income.  But it is important to note what was said and not said.  The Lanning opinion requires a “change” in income or expenses, not a discrepancy between the expenses allowed on the “means test” and the Debtor’s actual expenses.   For debtors whose “current monthly income” is above the state median, many expenses are determined based on fixed allowances, not on what the Debtor really spends.   If the food and related items allowance (set by the IRS) is $1152 for the Debtor’s household size, but the Debtor only spends $500 on these items, he or she can claim the full allowance in calculating “projected disposable income.” The trustee should not be allowed to recapture that $652 and require that it be paid to creditors.  Conversely, if the Debtor spends $1500, he can still only claim the allowance.   Similarly, if the Debtor’s rent is $500 but the IRS allowed mortgage/rental expense is $1187, the Debtor can claim the full $1187 deduction.   As a result, for many debtors, the fixed “means test” numbers result in a more favorable result than reality as reflected on Schedules I-J (which helps offset the fact that certain other necessary expenses are simply not allowed as deductions on the “means test” calculation).    Because this is not a “change,” Lanning should not result in the IRS-allowed expenses being disregarded.

That said, the Lanning opinion could result in disallowance of deductions for secured debt payments where property is being surrendered or perhaps where liens are being stripped down or off, as those could be seen as “changes” in expenses.  But otherwise, unless there is a “change” in those expenses (such as secured debt payments) that are allowed as real numbers on the means test, the means test expenses should apply as written. 

Foreclosure or not?  I’ve been using the  f-word a lot here in my Summerville, South Carolina law office.  (That’s “foreclosure,” not the other f-word, by the way.)  And I’ve noticed a transition in attitudes among clients.  It’s gone from, “I don’t want foreclosure no matter what” to “let’s discuss what happens if my lender forecloses.”  I call this the “foreclosure option.”

Deciding to keep your home is certainly not a foregone conclusion.  Sometimes, it makes sense.  But at other times, it’s nothing more than slow financial suicide.  And sometimes it’s just not possible.  Perhaps HAMP (“Home Affordable Modification Program“) won’t work for you, or maybe you have an investment property, like a lot in a subdivision, that isn’t eligible for HAMP.

Clients have been doing the math. And when they don’t, I’ve been doing it for them so they can make intelligent decisions about whether to stop making mortgage payments.  Someone trying to save a house worth $250,000 when they owe $350,000 and can’t afford the payments needs a reality check.  They need to understand that if they started renting tomorrow, they’d have more equity in the rental house than in the home they want to save.  At least with the rental, they’re at zero equity, not negative $100,000!

Don’t get me wrong, I’m not saying everyone should just happily stop making mortgage payments.  There are many factors which homeowners must carefully analyze to determine if surrendering their homes to foreclosure makes good financial sense to them. Sometimes, it’s complicated.  At other times, it’s a no-brainer.

And What About the Morality of Allowing the Foreclosure?

The morality of the decision is a big issue for most people.  Sometimes, it’s simply impossible for clients to continue making payments, but sometimes they can make the payments but decide to quit paying anyway.  Recently, a client from Summerville, South Carolina came to see me about a mortgage on a lot.  He now owes more than $100,000 than it’s worth.  He’s paid over $50,000 in interest to the lender over the last five years.  And he’s not doing it anymore even though he could.  My job is to advise my clients of their legal rights, not kick them out of my office and tell them to keep paying no matter what.  Homeowners need to decide what they think is right for their unique situation and act accordingly.

For some, the decision to let the property go is easy.  They tried to work with their lender, but the lender wouldn’t help.  They may also believe that the lender allowed them to borrow more than they were capable of repaying.  Some also realize that allowing the foreclosure to occur isn’t a crime.  It’s not illegal, and it’s in their best interests, so they tell the bank to foreclose away.

For most people, though, they view their contract as a promise which must honored, and they agonize over the foreclosure option. They only “give the house back to the bank” when there are really no other workable options.  I’d say over 90% of homeowners fall in to this category.

There’s been a lot of discussion about the foreclosure option in the media lately.  Recently, The New York Times published an article entitled, “Owners Stop Paying Mortgages, and Stop Fretting.”  According to the article, some Florida homeowners used foreclosure to allow themselves to go to the steakhouse, “take their gas-guzzling airboat out for the weekend,” and “visit the Hard Rock Casino.”  This has some people crying foul, and it has my friend and colleague Jay Fleischman, a New York City bankruptcy lawyer, a bit peeved at The Times.

As Jay states in his recent blog post:

The real shame of this piece is that it’s not reflective of what people do when they fall behind on the mortgage.  Most people fight like hell to catch up, to get out from under the debt, and to do what is by all accounts the honorable thing.  They want to hold up their end of the bargain, and fail only because most lenders don’t have the same objectives. There’s a disconnect in the real world – consumers want to make it right, and lenders just don’t give a crap.  Because consumers are real people, and lenders are monolithic corporations with bureaucracies and levels between the font lines and the decision makers.  That’s the reality, but the New York Times went for the sensational.  Boo, hiss.

He’s got a point.  Jay deals with lots of people every day as do I.  And we both know in the vast majority of cases clients agonize over the foreclosure option and only decide to surrender their properties when (1) they just can’t pay, and (2) their lenders have refused to modify their loans.

And what Jay’s really troubled over is that Congress will get concerned that the American consumer will start behaving like Corporate America–just out for #1 and the “bottom line.” Oh, the irony!

We all know that Corporate America will avail itself of any legal means–and sometimes some illegal means–of propping up the bottom line.  Corporations breach contracts, deny legitimate insurance claims, and don’t hesitate to avail themselves of bankruptcy protection if it will help their bottom line. But if the American consumer starts that stuff, well then, Congress will start hearings in short order.  It’s a double standard.

Just remember the truth: Despite recent media attention, most people agonize over the foreclosure option and do their very best to keep their homes.

The other day I spoke with a young couple with a history.  The wife and her best friend had been friends since they were five years old.  They had grown up next to each other and were otherwise always together.  When the house next door came available for purchase (at the top of the market) the young woman purchased the home right next to her best friend.

Now, several years later and facing tough economic times, the young woman expressed to me that she didn’t want to file bankruptcy (based upon what she had heard from her friend), but was looking for alternatives due to mounting debt and loss of income.  She wanted to save the home because she just couldn’t leave her friend.  We discussed the consequences of leaving the home and keeping the home, and despite my best advice, she still wanted to keep the home.

After a very long discussion, it became apparent that the driving motivation was fear.  She was fearful that her friend would find out if she filed for bankruptcy.  She feared that her friend wouldn’t understand.  She feared that her friend wouldn’t be there for her.  All of these fears arose out of conversations between the two of them and opinions that were expressed in the past.

Filing for bankruptcy is a very personal financial decision, but many individuals seek out the opinions of others looking for options or support.  When it comes to making financial decisions that will alter our futures, we want the best advice out there.  Likewise, with the loss of so much wealth in this country over the last several years, we want the best possible advice on what to do going forward.  Yet, sometimes we to go the worst sources for information.

Often, the information seekers are met with supportive individuals (friends or relatives) who say un-supportive things, which leaves them more confused than ever before.  The question is why would typically supportive people say un-supportive things about a person’s decision to file for bankruptcy protection ?

I honestly believe that people fear change.  They fear changing their circumstances, but another fear lies within, and that fear may be even greater than the fear of change,  and that fear is the fear of others changing.  If someone else makes a change, it could have a positive or negative effect on the relationship, and therefore, they discourage the person seeking to make a change.  In other words, they feel threatened.

The idea of making good financial decisions which would change her and her young family’s lives going forward was not being considered.  She was fearful of what others would think and whether they would still like and accept her.  She never stopped to think about what would be best for her?  Or, what would be best for her family?

After speaking with this young woman, I realized that money and money problems are not as important to some people as what others may think of them having financial issues.  Unfortunately, money problems can happen to anyone, no-one is immune.

Owning your own business is part economics and part love affair.  Doing what you love for money is nearly every American’s dream.  But when love affairs go bad, we react emotionally.  That can be bad for business, particularly if you are on the verge of bankruptcy.

In a recent example, we learn that it’s dangerous to tell your supplier or banker things you can’t or won’t really be able to do.   If it doesn’t play out well, you might lose your fresh start options.

In this case, the business was heavily in debt to its main supplier of concrete.  And the supplier decided to cut off further supplies and require cash at time of sale instead of waiting for payment, after the business was paid for services to the ultimate customer.  This is often a death sentence for retail and contracting businesses since they often do not have the capital base to pay COD for everything.

Unfortunately, when negotiating with the supplier the business owner was desperate not to lose his business.  So he agreed to a payment plan and also promised he could make the payments because he would take nothing out of the business himself before paying off the business debts.  And the supplier began deliveries again.

As with many failed love stories, things did not go as planned and the business could not keep making payments and eventually the owner filed for bankruptcy.   But worse, the Court of Appeals held that the owner could not get out of the obligations owed to the supplier.  In part the court concluded that promising the near-impossible — to pay the business debts before taking out anything for himself — while somewhat unlikely in the circumstances, was not completely unbelievable.  So the supplier justifiably relied upon that (and other) representations in extending more credit.

There are a lot more lessons to be learned from this case — don’t co-mingle business and personal finances, don’t take the assets of one business to start another, and so on — but at the heart of it is a simple idea:  When you’re in trouble, it’s better to say nothing than too much.

If you can’t — or probably won’t — do what you are about to promise, don’t promise it.  Businesses fail.  That’s why bankruptcy was first turned into a remedy to help debtors rather than just creditors.  You can start over.  Don’t let your pride — and your love for your business — get in the way of your second chance.

When a confirmed Chapter 13  bankruptcy plan threatens to fail, the debtor needs to consider whether the plan can be modified to survive.  The debtor can seek a change in the amount of the monthly payment or the length of the plan.

Debtors who experience a change in financial circumstances often seem to freeze, to forget that they have a lawyer who is committed to the success of their plan.  They may never have heard that confirmed plans can be  changed to fit the current circumstances.

The Bankruptcy Code in Section 1329 provides that the plan can be modified to

(1) increase or reduce the amount of payments on claims of a particular class provided for by the plan;

(2) extend or reduce the time for such payments;

(4) reduce amounts to be paid under the plan by the actual amount expended by the debtor to purchase health insurance for the debtor

My charge to those in Chapter 13 is to contact their attorney just as soon as they see they won’t be able to make a payment on the plan on time.  Engage your attorney in looking for solutions to the plan.

The advantages in keeping your Chapter 13 plan alive include keeping the automatic stay in place;  getting to discharge; and getting full value for the attorneys fees  you’ve already paid.

There are other options including dismissal, conversion and a hardship discharge.  You can’t tell which works best for you until you talk freely with your attorney.  Don’t put your head in the sand if times are tough.  Call your lawyer, gather up y0ur paystubs and your current budget information and get plannning.

]]> http://www.bankruptcylawnetwork.com/can-failing-chapter-13-plan-be-modified/feed/ 0 http://www.bankruptcylawnetwork.com/bankruptcy-lawyer-misconduct-listed-in-suspension-order/ http://www.bankruptcylawnetwork.com/bankruptcy-lawyer-misconduct-listed-in-suspension-order/#comments Tue, 11 May 2010 04:00:16 +0000 Craig Andresen, Minneapolis, MN, Bankruptcy Attorney http://www.bankruptcylawnetwork.com/?p=15334

A California bankruptcy court recently cited a catalog of misconduct in suspending a lawyer from practice and imposing a steep fine as a sanction for violating Rule 9011.

In re Tran, 2010 WL 1255617 (Bky.N.D.Cal. April 2, 2010), resulted in a thirty day suspension from practice before the bankruptcy court; a $7,500 fine, with $5,000 stayed if the lawyer refrained from filing any more cases without the debtors’ signatures; and disgorgement of the $2,400 in fees paid for the case.

The court found that bankruptcy lawyer Joel J. Margolis had filed bankruptcy papers which had not been signed by the debtors, and thus they contained numerous inaccuracies and omissions.  Among these were failure to list a 2008 Mercedes, a furniture store filled with furniture, real estate, and a $13,000 bank account.

The court also found that due to the recurring nature of the lawyer’s misconduct, the bankruptcy court needed to take immediate action to protect the public, rather than waiting for the State Bar to take action.  The lawyer’s wife was Vietnamese, and although not a lawyer, she was his principal assistant.  “Her main value [was] that she is Vietnamese,” the court noted, and the lawyer “advertise[d] in Vietnamese-language periodicals.”  The lawyer “has filed approximately 100 bankruptcy cases for Vietnamese clients.”  The court acted to prevent “the continuing victimization of the Vietnamese community.”

The court found that the lawyer had done the following:

He allowed his wife, a non-lawyer, to conduct the initial interview with the debtors, advise them as to the chapter they should file under, and prepare their schedules.  Margolis himself spent a total of only about 15 minutes, perhaps less, speaking to the debtors himself.  He completely abdicated his responsibilities to his clients, leaving them in the hands of untrained non-lawyers.

Worse, Margolis completely failed to instill in his own staff the importance of the schedules or the need for complete honesty and disclosure….  The debtors … got the idea that it was normal and expected that they conceal property they wanted to keep….  That led directly to the denial of their discharge.

Consequently, the court suspended the lawyer, imposed monetary sanctions, and set forth educational requirements to be met by the lawyer prior to filing any further bankruptcy cases.

Every chapter 7 or chapter 13 bankruptcy filing involves a creditors meeting which occurs about one month after the case is filed.  This meeting can unexpectedly become the perfect storm where, if enough of the wrong factors jell together, the debtor may blurt out the “forbidden reason” for spending down his or her bank accounts before the bankruptcy was filed.

This is where the debtor testifies, with the tape recorder capturing every word, sneeze or other sound, that he or she spent the money so the trustee wouldn’t be able to take it.  Then, the room will turn silent while the bankruptcy trustee slowly opens the U.S. Code laying on the table.  The trustee will turn the page to section 727(a)(2) of the bankruptcy code, which reads:

The court shall grant the debtor a discharge, unless … the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed … property of the debtor, within one year before the date of the filing of the petition….

This is the forbidden reason for spending down the bank accounts or other liquid cash prior to filing bankruptcy.  If the reason was to shield the money from the trustee or a creditor, the trustee has an excellent argument that the debtor should not receive a discharge in the chapter 7, or that the debtor’s chapter 13 plan was filed in bad faith.

You might wonder whose fault it would be it such a disaster were to actually happen.

Fortunately, this terrible scenario need never happen, because all the bankruptcy lawyer has to do is to carefully explain section 727 to every bankruptcy client before the case is filed, and before any spend-downs occur.

The point here is not that once the debtor knows about the forbidden reason announced in section 727, the debtor will testify untruthfully about his or her motives for spending down the funds.  Rather, the point is that the debtor will take especial care to testify truthfully about the reasons for the spend-down, and he or she will avoid citing the forbidden reason out of carelessness, without giving the true reasons.

For example, it ought to be obvious that the debtor bought groceries and clothing before the bankruptcy filing because her family really did need to eat, and they really did need some clothes to wear, and the debtor has been buying those things her whole life without any motive of defrauding creditors.  Similarly, the debtor caught up on house payments just before the bankruptcy filing because the family really did live in the house, and without making those payments the mortgage company would eventually see them living in the streets.

The bankruptcy lawyer’s having explained the exemption laws to the debtor doesn’t alter the fact that the debtor had solid, sufficient reasons for spending the funds in the manner he or she did just before filing bankruptcy.  And, when the debtor knows what section 727 says about the forbidden reason, the debtor certainly won’t be spending money before the bankruptcy filing in the manner described there.

In bankruptcy, an Individual Retirement Account (IRA) is usually protected from creditors.  But a controversy has been brewing over protection for an IRA when it is inherited from another person.

This should not be controversial and the 8th Circuit‘s Bankruptcy Appellate Panel (BAP) doesn’t think it’s that complicated either. When you establish an IRA, you can provide for it to be paid to someone else upon your death. If that person is not a spouse, there are complex tax rules that allow for the funds to be sheltered in their own separate account but that do require for the beneficiary to start taking distributions soon afterward.

The distribution of the IRA has nothing to do with age or employment status, as a retirement plan normally might.

And that’s where the issue has arisen.

Some bankruptcy courts concluded that federal exemptions require that an IRA be funded by the debtor’s own retirement funds and be created and tax sheltered under Sec. 408 of the Tax Code.  Since an Inherited IRA is created under Sec. 402 (although tax sheltered by Sec. 408) and the funds used to create the IRA were not the debtor’s own retirement contributions then they are not protected in bankruptcy.

The bankruptcy appeals court disagreed.  Instead of looking subjectively at who contributed the funds and whether they were “retirement funds” of the debtor, the Bankruptcy Appellate Panel concluded an objective analysis should be applied.

The federal bankruptcy exemption only requires it be “retirement funds” — which they were when contributed –  not that they specifically have been funded by the debtor with his or her own funds.  To do otherwise would virtually delete a provision of bankruptcy law that also protects IRA accounts when funded by rollover money from another IRA.

The other crucial factor is that an Inherited IRA is sheltered from tax under the same provisions as a regular IRA.  It is irrelevant that the debtor will have to take early distributions since the exemption itself does not make an exception for those situations. In reality, this makes sense.

Congress amended the bankruptcy law in 2005 with mostly anti-consumer provisions.  But one pro-consumer provision of the U.S. Bankruptcy Code protected IRAs and retirement fund assets.  And it did so broadly — creating only a cap of $1 million and even this cap can be waived by a court in the “interests of justice.”  Congress even took the unusual step of — for the first time — trampling on states’ rights by forcing protection for IRAs even where the states did not do so on their own (in so-called “opt-out” states).

While an Inherited IRA is not itself created with retirement money taken from the debtor, it is standard financial planning advice to take into account potential inheritances.  Reasonable consumers who have good reason to expect a large inheritance may quite rationally spend funds they would otherwise save if they know they will receive a nest egg from a wealthy cousin’s own estate at some point.  It would make sense to spend more to, for example, pay for a child’s education at a better college than sock the tuition away in an IRA and send the kid to community college — while also expecting to inherit a large fund in the future.

The bankruptcy law happens in this case to be keeping up with the flexibility of good financial planning.  And so too is the very efficient 8th Circuit BAP. See, In re Nessa ___ B.R. ___, #10-6009, (8th Cir.BAP 4/9/10)

When a client is considering filing for Chapter 13 bankruptcy, one of the first questions I’m asked is, “What will my Chapter 13 Plan payment be”? I almost always answer, “I don’t know yet.” Why? Because of the complex way plan payments are determined.

There is a four-part test. Unfortunately, after running all of the tests, you pick the one resulting in the highest payment.

Test No. 1: The Means Test. The Means Test was first imposed by Congress as part of the 2005 Bankruptcy Code Amendments. It replaced the case-by-case evaluation of actual ability to pay with an arithmetical formula that often has nothing to do with the debtor’s actual ability to pay. Almost universally panned as a failure, this test is nevertheless a legal requirement that must be complied with. I can’t tell you what the Means Test requires as a payment until after I’ve crunched all of the numbers, something I can’t do at the initial consultation.

Test No. 2: The Chapter 7 Liquidation Analysis Test. If your unsecured creditors would receive money from the sale of your non-exempt assets were your case a Chapter 7, they have to get at least as much through your Chapter 7 Plan. For example, if you have $20,000 in net, non-exempt, equity in your house, the Chapter 13 Plan would have to provide for at least $20,000 in payments to your unsecured creditors.

Test No. 3: The Disposable Income Test. Take your net income (after taxes and other allowable deductions). Subtract your allowable expenses. If the number is positive, that’s what you have to pay your creditors on a monthly basis. Sometimes called the “I Minus J Test,” because Schedule I lists income and Schedule J expenses, this test comes closest to reflecting your actual ability to make the Chapter 13 Plan payment. The interaction between the Means Test and the Disposable Income Test were the subject of the 2010 Supreme Court decision of Hamilton v. Lanning.

Test No. 4: The Required Payments Test. You have to pay administrative expenses, such as legal fees and Chapter 13 Trustee commissions, in full through the Chapter 13 Plan. You have to pay all priority debt, such as domestic support obligations and certain taxes, in full. You have to pay the amounts necessary to cure mortgage and car arrearages. Add all these up, and that’s the minimum that must be paid under the Plan.

Note that tests 1 and 4 have nothing to do with your actual ability to pay.

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Filing bankruptcy means listing all your debts, even those you eventually plan on repaying after bankruptcy, like debts to relatives or your mortgage and car payments.

As I tell my clients, you need to list anyone in the Milky Way Galaxy to which you owe money.  That means even those who think you owe them money when you actually don’t.  (We call those debts “disputed” and list them that way.)

You can’t pick and chose which debts you’ll list anymore than you can pick and choose which assets you’ll list.

One of the most important things to realize about filing bankruptcy is that you must provide accurate information to your bankruptcy lawyer.  Remember, she may know a lot about your case, but ultimately, it’s up to you to make sure your bankruptcy paperwork it accurate.

And failing to list a debt can lead to pretty painful consequences.  First, the debt may not get discharged.  This is especially true in a Chapter 13 bankruptcy or a Chapter 7 bankruptcy in which the trustee has assets to distribute to creditors.

Second, even if you catch the error later, you may have to file a motion to reopen your case to add the creditor if you discover the error after the case closes.  Some bankruptcy courts–like ours here in South Carolina–don’t require you to reopen the case.  But many do.  And that leads to more costs and fees for you.

Remember that just because a debt is discharged in your bankruptcy doesn’t mean you can’t pay that debt back.  The key is waiting until after your case is over.  If you want to pay someone back, you can.  In fact, the Bankruptcy Code specifically allows this.  Section 524(f) provides that “[n]othing contained in [this section] prevents a debtor from voluntarily repaying any debt.”  You have the U.S. government’s blessing.

So there’s nothing wrong with paying creditors back, even if you file bankruptcy.  But that doesn’t mean you don’t have to list them.  As with anything else in your bankruptcy schedules, you represent that you they are correct under penalty of perjury.  Accuracy is required, and lack of accuracy can cause you big problems during your case–and afterward.