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Wells Fargo Bank has admitted to opening millions of customer accounts and credit card accounts without customer authorization since 2005.  Stories have emerged of a bank gone wild where employees working in an intense sales culture felt pressured to open new accounts to meet sales quotas.

Wells Fargo has agreed to pay $185 million in fines to the Consumer Financial Protection Bureau.

So what happens when customers file bankruptcy on credit card accounts fraudulently opened without any authorization?  Naturally, Wells Fargo filed bankruptcy Proof of Claims with the court itemizing the amounts not legally owed.  And that reality leads to the next logical question:  Has Wells Fargo committed bankruptcy fraud for filing false proof of claims?

False Claims—18 U.S.C. § 152(4):

A person who…knowingly and fraudulently presents any false claim for proof against the estate of a debtor, or uses any such claim in any case under title 11, in a personal capacity or as or through an agent, proxy, or attorney;…shall be fined…, imprisoned…, or both.

It would be hard for Wells Fargo to argue that it has not “knowingly and fraudulently” presented false claims in bankruptcy proceedings since they authored the false debt.

HOW DOES A BANKRUPTCY ATTORNEY IDENTIFY FRAUDULENT WELLS FARGO CLAIMS?

A tougher question for bankruptcy attorneys is how they will be able to distinguish valid claims filed by Wells Fargo from the fraudulent claim.  All the claims look the same, so how do you tell the difference?

Most claims filed in bankruptcy cases do not attach copies of signed credit agreements, so it is unlikely that clients will be able to spot fraudulent claims either.  Signed credit agreements are becoming a thing of the past and it is extremely rare for a proof of claim to include a copy of a signed revolving credit card agreement.

The Wells Fargo scandal highlights a major problem with this new age of “inferred consent” in the credit card industry.  As the the industry has moved away from traditional signed credit agreements to modern methods of assent over the phone or internet, it becomes increasingly difficult for consumers to deny liability for revolving credit accounts.  Increasingly, credit card bill collectors sue not under traditional breach of contract legal theories but under Account Stated doctrines where liability is claimed because the liability is stated in monthly account statements.

So, if a Wells Fargo Proof of  claim does not attach copies of signed credit agreements, how can we be sure the debt is real?  How should debtor attorneys react to all Wells Fargo claims?  Should objections be automatically filed to every Wells Fargo claim until they can be verified?  If no written agreement can be produced, should it be assumed that the debt is invalid?  Should the bank be entitled to recoup the money loaned without interest under some type of Quantum Meruit or Unjust Enrichment theory?

This latest Wells Fargo scandal poses a major dilemma for Wells Fargo, bankruptcy attorneys and the court.   Generally speaking, the filing of a proof of claim is prima facia evidence of the validity of a debt.  Does that legal presumption belong to Wells Fargo claims going forward?

Dave Ramsey

The most famous name in the getting out of debt industry is Dave Ramsey.  As a young man Dave himself was in a pile of debt and wound up filing bankruptcy. The pain of that experience lead him on a quest to learn about personal finance and he began a career in advising others how to get out of debt.

I’m a talk radio/podcast junkie.  I don’t care what the topic is as long as it is interesting.  Dave Ramsey is the host of a nationwide talk show and it played on the radio as I was driving home.  So, as I counseled clients every day about how to file bankruptcy, I would listen to Dave on the way home explaining how to avoid it.  Gosh, was I doing my clients wrong by not teaching them the tough road out of debt that Dave advocated?

The hallmark of the Dave Ramsey system is a series of seven “Baby Steps” one takes to eliminate debt and build wealth.

  • Step 1:  Save $1,000 Emergency Fund.
  • Step 2:  Debt Snowball.  Pay off all debt.
  • Step 3:  Save 3 to 6 months of expenses.
  • Step 4:  Invest 15% of income in retirement.
  • Step 5:  Establish College Fund for children.
  • Step 6:  Pay off house.
  • Step 7:  Build Wealth and Give.

The Debt Snowball is the program to eliminate debt.  The basics of the program are as follows:

  1. List all debts from Smallest to Largest.
  2. Maintain minimum payments on all debts and get all debts out of default status.
  3. Devote all extra income to pay off the smallest debt first, regardless of whether that debt has a higher or lower interest rate.
  4. Reduce expenses, sell off unnecessary possessions, and take on part-time jobs to fund the debt snowball.
  5. Once the smallest debt is paid, move onto the next smallest debt and then the next smallest, etc., etc., until all debt (except the home mortgage) is paid in full.

Why pay off the smallest debt first instead of the debts with the highest interest rate?  Because, according to Ramsey, getting out of debt is 80% emotion and 20% head knowledge.

If it were about math, you wouldn’t have credit card debt. It’s not about math. It’s about behavior modification.

Paying off the smallest debt “fires you up!” says Ramsey, and that small success helps ignite an emotional reaction to kill off the remaining debts.  There is actually a lot of scientific fact to back up that claim, especially in the study of healthy habit formation.  Small victories do lead to bigger wins.

The challenge is you.  You are the problem with your money.

Ramsey focuses on “behavior modification” as the key to solving a debt problem.

Most financial people make the mistake of trying to show you the numbers, thinking that you just don’t get the math. I am sure that the problem with my money is he guy in my mirror.

A large part of the behavior modification is about daring to be radical–to sell your home and fancy car and to take on a part-time pizza delivery job–to drop out of society’s pressure to keep up with the Jones’.

Stop buying things you don’t need with money you don’t have to impress people you don’t even like.

It is hard to disagree with any of this.  This is sensible and old-fashion advice to getting out of debt.  Cut expenses.  Increase income.  List the debts and have a plan of attack.  Paying off debts from smallest to largest is also a valid strategy since getting out of debt does require a person to be “fired up” and focused.

The power of focus is what causes our Baby Steps to work . . . if you attack too many areas at once you don’t finish anything you start for a long time . . . That makes you feel that you aren’t accomplishing anything, which is dangerous.

The key weakness of the Debt Snowball program, however, is the requirement that you must be able to get all debts out of default status and maintain minimum payments on all debts during the plan.  Is that feasible? Can you really maintain minimum payments on all debts and get the delinquent debts current while you pound away at the smallest debt?  Yes, some folks just need to cut the cable bill and downsize their life to free up the necessary money to make this plan work, but that simply does not work for the vast majority of people I see on a daily basis.

So, if you squander a lot of money on foolish entertainment, cars, eating out, cell phones, etc., the Dave Ramsey program may work just fine for you.  Get on a financial diet and start paying off the debt.  Yep, that works . . . if you have the income.  But what if you don’t?  Then what?  What if 25% of your paycheck is being garnished and the judgments are stacking up one on top of another and the mortgage payment is behind on a house worth no more than what is owed?  How do you downsize that expense?

And what if you can’t get a second job to speed up the debt snowball?  What if your health, both physical and mental, is already taxed to the maximum?  What if getting a part-time job means abandoning your children and a stressed out spouse for another 20 hours a week?  Is that a smart decision?  Sure, you might become debt-free, but will you have a family left to come back to?

Dave Ramsey is a positive voice of reason and encouragement in the personal finance industry.  I like his attitude and enthusiasm.  Overall, I think we all should really pay attention to his message.  Stop lying to yourself and stop pretending to be somebody you are not.  Downsize your life, become debt free, and then realize the blessing of truly being a free person.  That’s a great message and goal.

But the Dave Ramsey program is not for everyone and it is just not feasible for too many.  If you are living beyond your means, try it.  But if you are already struggling after devoting every dime to stay out of debt and now you are draining your retirement or mortgaging your home to make minimum payments on debts, consider other options.

Image courtesy of Flickr and Bonnie Brown.

 

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There is a lot of chatter going on among Nebraska bankruptcy attorneys about reports of court hearings where debtors are being told they can keep a car even if they choose not to reaffirm the car loan as long as payments are kept current.

That’s news to me and many of my colleagues.  The Bankruptcy Reform Act of 2005 was supposed to end the Ride-Through option.  A “ride-through” is where a lender cannot legally repossess a vehicle even if the debtor does not sign a formal Reaffirmation Agreement as long as the loan was paid current.

A reaffirmation agreement is an agreement to pay a debt (typically a home or auto loan) listed in a bankruptcy case.  Reaffirmations basically pull a debt out of the bankruptcy and makes a debtor liable again for the payment.  Secured debts tend to be reaffirmed in Chapter 7 and unsecured debts almost never.  Clients tend to reaffirm their car loans because if they don’t the banks may repossess a vehicle regardless if the loan is paid current.

In contract to the reaffirmation agreement, a “ride through” gives the debtor the best of both worlds:  they keep the vehicle but are not liable for the debt in the event they can not afford future payments.  Keep the vehicle if you can afford the payments, but surrender it without being responsible for the debt if you cannot.  Everybody loved the ride through, except the banks.

BANKRUPTCY REFORM ACT ENDS THE RIDE-THROUGH?

Along comes the Bankruptcy Reform Act of 2005, and the bankers finally got what they wanted. The automatic bankruptcy stay rule was modified to ban the ride-through option:

11 U.S.C. 352(h)(1):

In a case in which the debtor is an individual, the stay provided by subsection (a) is terminated with respect to personal property of the estate or of the debtor securing in whole or in part a claim, or subject to an unexpired lease, and such personal property shall no longer be property of the estate if the debtor fails within the applicable time set by section 521(a)(2)—

(A) to file timely any statement of intention required under section 521(a)(2) with respect to such personal property or to indicate in such statement that the debtor will either surrender such personal property or retain it and, if retaining such personal property, either redeem such personal property pursuant to section 722, enter into an agreement of the kind specified in section 524(c) applicable to the debt secured by such personal property, or assume such unexpired lease pursuant to section 365(p) if the trustee does not do so, as applicable; and

(B) to take timely the action specified in such statement, as it may be amended before expiration of the period for taking action, unless such statement specifies the debtor’s intention to reaffirm such debt on the original contract terms and the creditor refuses to agree to the reaffirmation on such terms.

And with that 2005 amendment to the Bankruptcy Code, we all waived goodbye to the ride-through.  You want to keep that car?  Sign here please.

But now our court seems to be saying something else.  Several bankruptcy attorneys report of hearings where the court is saying they can keep their vehicle as long as the loan is paid current.  Is the Ride-Through back?

STATE LAW:

It appears that Nebraska Statute 45-1,107 is the key law in question.

Consumer credit transaction; default; consumer’s right to cure.

(1) With respect to a consumer credit transaction, after a default a creditor may neither accelerate maturity of the unpaid balance of the obligation nor take possession of collateral, except voluntarily surrendered collateral, because of such default until twenty days after a notice of the consumer’s right to cure is given. The consumer shall have twenty days after the notice is given to cure any default by tendering the amount of all unpaid sums due at the time of the tender, without acceleration, plus any unpaid charges, or by tendering any other performance necessary to cure the default as specified in the notice of right to cure. Cure shall restore the consumer to his or her rights under the agreement as though the default had not occurred.

(2) With respect to defaults on the same obligation after a creditor has once given notice of the consumer’s right to cure, the consumer shall have no further right to cure and the creditor has no obligation to proceed against the consumer or the collateral.

Okay, so a consumer has 20 days to cure a default.  But how exactly does this law help when a car loan is not reaffirmed in bankruptcy?  There are no cases in Nebraska even mentioning this law. Most auto loan contracts contain a “bankruptcy clause” which states that filing bankruptcy itself constitutes a breach of the agreement.  How does one cure that type of breach?

Based on the complete lack of case law on this statute, it is very unclear that Nebraska state law permits a general ride-through option.

BACKDOOR RIDE-THROUGH

Perhaps the court is referring to something called a “Back Door Ride-Through.”  To qualify for a backdoor ride-through, a reaffirmation agreement must be filed with the court and the court must then disapprove the agreement.  By filing the reaffirmation agreement with the bankruptcy court, the technical requirements of §521(a)(2) and §362(h) are satisfied.  See Coastal Fed. Credit Union v. Hardiman, 398, B.R. 161, 166 (E.D.N.C. 2008); In re Baker, 390 B.R. 524, 532 (Bankr. D. Del. 2008); In re Blakely, 363 B.R. 225, 2230 (Bankr. D. Utah 2007).  See Debtor’s Dilemma: The Economic Case for Ride-Through in the Bankruptcy Code, Amber J. Moren,The Yale Law Journal.

A backdoor ride-through creates a binding nonrecourse loan subject to the automatic bankruptcy stay protection.

Why would a court deny a filed reaffirmation agreement?  Generally, if it appears that a debtor does not have sufficient income to justify the monthly expense or if the the loan balance significantly exceeds the value of the vehicle, a court may decline to approve a reaffirmation agreement.

Is the backdoor open in Nebraska?  Does a reaffirmation agreement filed with the bankruptcy court that is not approved give rise to a ride-through?  There is no written opinion stating this, but it would seem from reported court hearings that such an option may exist.

Image courtesy of Flickr and Anders Ljungberg.

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Nebraska is the 16th biggest state in the USA, but we rank 43rd in population density.  In fact, Nebraska has more cows than people by a ratio of 3 to 1.

Bankruptcy is a specialized area of laws these days, especially after enactment of the Bankruptcy Reform Act of 2005.  Attorneys in sparsely populated areas of the state generally do not handle bankruptcy cases, so our firm is routinely hired by clients throughout our big state.  (This is actually a wonderful aspect of practicing bankruptcy law since we get to know folks in every square inch of the state and learn about their communities.)

One challenge we face in a state that stretches 430 miles across is getting documents signed and returned in a timely fashion.  This is especially critical in bankruptcy cases since we must provide the court with a precise “snapshot” of a debtor’s financial situation on the day the case is filed.  Bank account balances change daily, average income calculations change monthly, and the list of debts owed changes constantly.

Like an astronomer looking at a distant galaxy through a telescope, we report of a scene that no longer exists.

Preparing bankruptcy petitions is like laying a foundation on moving soil or taking a vivid 35 mm snapshot of a speeding race car when the nearest camera is 3 days away.  It is hard to provide an accurate snapshot when the information is constantly in motion.  Like an astronomer looking at a distant galaxy through a telescope, we report of a scene that no longer exists.

The challenge is to get a list of debts, income and property signed and filed with the court before the information becomes outdated.  Bank account balances can vary by thousands of dollars in a matter of days and debtors may be penalized for providing the court with inaccurate information.  Receiving documents mailed to clients for signature may take up to two weeks.

Many clients do not have ready access to fax machines as that technology seems to be fading away.  To compound the problem, debtors demand their cases to be filed immediately to stop ongoing garnishments and foreclosure.  “Move fast!”, says the client.  “Be accurate!”, says the court.  It’s a tricky balance.

Once solution to this time/distance problem is to obtain electronic signatures.  Companies that offer digital signature services, such as DocuSign, allow attorneys to obtain virtually instantaneous signatures of any document.

Digital signatures are electronic signatures that are encrypted by computer technology, and encryption process protects the document from alteration.  A document that is signed digitally provides an assurance that it was signed by the sender and receiver without alteration.  Parties to a digitally signed document typically receive an executed copy of the document instantly.  A digital signature is similar to a notarized document or a document embossed with a seal to ensure authenticity.

Digital signatures have been authorized in the United States by the Electronic Signature in Global and International Commerce Act of 2000, (ESGICA). 11 U.S.C. 7001.  The Nebraska Digital Signatures Act was enacted in 1998.  In short, these laws give digital signatures the same legal effect as a penned ink signature on paper (sometimes called “wet” signatures).

MAY A DEBTOR DIGIGALLY SIGN A BANKRUPTCY PLEADING?

Federal Rule of Bankruptcy Procedure 9011 governs signatures on bankruptcy documents.  The Nebraska bankruptcy court has a local rule 9011-1 regarding signatures as well:

  1. Petitions, lists, schedules and statements, amendments, pleadings, affidavits, and other documents which must contain original signatures or which require verification under Fed. R. Bankr. P. 1008 or an unsworn declaration as provided in 28 U.S.C. § 1746, shall be filed electronically and may include, in lieu of the actual signature, the signature form described in subsection C.
  2. The attorney of record or the party originating the document shall maintain the original signed document for all bankruptcy cases at least one year after the case is closed. In adversary proceedings, the parties shall maintain the original document until after the case ends and all time periods for appeals have expired. Upon request, the original document must be provided to other parties or the Court for review (Fed. R. Bankr. P. 9011 applies).

May a digital signature qualify as an “original signature” under Nebraska Local Rule 9011-1?  May a bankruptcy petition be digitally signed in Nebraska?

Some bankruptcy courts appear to require “wet-ink” signatures on bankruptcy pleadings, including the Southern District of Indiana, the Northern District of Oklahoma, and the District of Maine.  However, even in in these districts it is not perfectly clear that the courts require “wet-ink” signatures on paper or if the courts are merely speaking to the requirement that bankruptcy attorneys retain originally signed documents, whether in ink or digital format, for a period of years.  Courts seem to use the term “wet” signatures to mean “original signatures” while overlooking the fact that digital signatures may also be used original signatures as well, thus causing confusion.

The Nebraska local rule 9011-1 does not use the term “wet” or “wet-ink” in reference to signatures, nor does Federal Rule 9011.  So, in the absence of local rule explicitly requiring wet ink signatures on paper, it would appear that digital signatures do qualify as original signatures in Nebraska bankruptcy cases since both federal and state law validate digital signatures.  However, a prudent attorney will seek out clarification on this topic from the court before utilizing digital signatures in bankruptcy pleadings.

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BANKRUPCY COURTS SHOULD ALLOW AND PREFER DIGITAL SIGNATURES TO WET INK SIGNATURES ON PAPER

There are several reasons why bankruptcy courts should encourage the use of digital signatures:

  • Documents signed digitally cannot be altered.  Each page of the digital document is encrypted and stamped electronically.  If altered, such a document will display an error code to warn that unauthorized changes were made to the document.
  • Every page of the document is verified.  Unlike wet ink signatures on paper, it is not possible to attach altered pages to the signature page.  A wet ink signature on paper may be attached to 60 or more pages of bankruptcy pleadings, and there is no guarantee that the attached paperwork has not been changed.
  • Digitally signed documents are instantly sent to all parties who signed.  If the document is altered each party has evidence of the alteration.
  • Allowing digital signatures encourages attorneys to improve the accuracy of bankruptcy documents since signatures may be obtained instantaneously if errors are discovered.
  • Debtors get immediate full copies of what they signed.  This makes it difficult for them to claim ignorance of what they signed.

In short, allowing digital signatures improves the integrity of court documents. It supplies debtors with full copies of what they signed immediately.  It encourages attorneys to make last minute corrections and improvements to the documents.  Digital signatures essentially provide something similar to a document where every page has been signed and notarized.

Selfishly I confess that digital signatures would be more convenient to use in our practice, but it is clear that they offer a superior level of transparency as well.  The notion that wet ink signatures are more trustworthy is simply not supported by the facts.  Hopefully Nebraska can adopt a local rule confirming the propriety of using digital signatures on bankruptcy pleadings.

Image courtesy of Flickr and Leszek Leszczynski

A few weeks ago I wrote an article to warn plaintiff attorneys to be careful to ensure that their clients who have previously filed bankruptcy to ensure that all claims they have against third parties are reported on the bankruptcy schedules.  (Plaintiff’s Attorneys Beware: Your Client’s Bankruptcy Case is About to Sock You Right Between the Eyes)  Well,  . . .  it just happened to a lady in Minnesota. (See Cover v J.C. Penny Corporation, Civ No 15-515, District of Minnesota).

The significant aspect of this case is that the debtor, April Cover, failed to report a discrimination claim on her bankruptcy schedules but she did verbally tell the bankruptcy trustee about the claim.

Not good enough says the Minnesota court.  Actual verbal notice of a claim is not enough.  Audio recordings of the court meeting between the trustee and the debtor disclose that the discrimination claim was reported to the trustee.  There is no question that the debtor disclosed her claim, but without formally amending the bankruptcy schedules a debtor is legally barred from pursuing recovery in subsequent litigation.

The only locations where Cover disclosed her EEOC claim—the audio file of the creditors’ meeting and communications between the trustee and her counsel— are unavailable to creditors. Hence, despite her later, oral disclosure, Cover failed to adequately amend her Petition, and she also failed to keep the trustee apprised of the status of her EEOC charge, or the existence of this action. In the Court’s view, Cover’s positions are clearly inconsistent.”

Given the court’s opinion, actual written notice to the trustee is also probably insufficient to protect a debtor from judicial estoppel in subsequent litigation.  It is not enough to send the trustee a letter to report claims not originally report or new claims occurring during the bankruptcy.  The Minnesota court declares that only formal amendments to the bankruptcy schedules are sufficient to protect a debtor’s claim.

This issue becomes confusing because the trustee, when informed of the claim, probably determined that the claim was exempt from creditor or trustee claims under Minnesota law.  However, even when a trustee is informed of the claim against a third party and elects not to claim it because of exemption laws, the claim must be formally reported on amended schedules to be preserved.

Plaintiff attorneys need to ask the following questions:

  • Has their client filed bankruptcy in the past?
  • Did the injury occur before, during or after the bankruptcy case?
  • If a claim occurred before or during the bankruptcy were the bankruptcy schedules amended?
  • Did the Chapter 7 trustee release his or her claim against the injury claim?
  • Was the PACER computer system checked to see if the client has filed bankruptcy?
  • Have you obtained a full copy of the bankruptcy schedules?
  • Is it too late to amend the bankruptcy schedules to report a missing claim?
  • Was the notice of the claim sufficiently detailed to put the trustee and creditors on notice?

I encourage Nebraska attorneys to contact this office if they have concerns about their client’s bankruptcy case.

Bomb

The more I think about the disastrous  consequences of two recent 8th Circuit Court of Appeals decisions regarding Judicial Estoppel the more alarmed I become.

This is a time bomb waiting to go off.  The 8th Circuit has ruled that debtors who fail to amend bankruptcy schedules to report claims against third parties that occur after the bankruptcy case was filed will not be able to recover damages in their future litigation.

Following the entry of a bankruptcy discharge, litigation related to unreported post-petition claims shall be subject to Summary Judgment dismissal under the legal theory of Judicial Estoppel.

Judicial estoppel is an equitable doctrine which “prevents a party from asserting a claim in a legal proceeding that is inconsistent with a claim taken by that party in a previous proceeding.” New Hampshire v. Maine, 532 U.S. 742, 749 (2001).

The 8th Circuit has ruled that a debtor’s failure to report new claims arising after the bankruptcy case was filed is basically a statement that no such claim exists, and if a debtor is saying that no such claim exists in one legal proceeding (i.e., the bankruptcy case) then it is inconsistent to say one exists in a future case.

The court’s reasoning is deeply flawed.  There is no provision in the Bankruptcy Code requiring debtors to report new claims that occur after a bankruptcy is filed.  And not reporting such a claim is clearly not the same thing as making an affirmative statement that no such claim exists.  Silence is not a statement. Nevertheless, the 8th Circuit has taken a punitive approach and the failure to report new causes of action will be fatal to recovering a settlement in future legal proceedings.

This is a significant ruling.  There will be tragic consequences.  Uninformed debtors will be denied rightful recoveries and their attorneys are going to be sued.

Imagine the case of a Chapter 13 debtor who is seriously injured in an auto accident 6 months before the end of a 5-year bankruptcy plan.  Assume the bankruptcy attorney never learned of the accident and the debtor never knew of the requirement to report such claims.  Imagine a year or two after the bankruptcy is completed and the debtor’s injury attorney receives a Summary Judgment motion since the bankruptcy schedules were never amended.  This is the type of disaster that now awaits plaintiff attorneys who fail to verify if their client was in a bankruptcy case.

Can you smell the legal malpractice case?  Who gets sued?  The Plaintiff attorney?  Absolutely.  The bankruptcy attorney?  Very likely if they had any knowledge or should have known of the claim.

HOW CAN PLAINTIFF’S ATTORNEYS PEVENT THIS DISASTER?

There is a simple procedure plaintiff’s attorneys can utilize to avoid this nightmare:  Check the PACER computer system to verify if their client has filed bankruptcy, and check the system again before the lawsuit is filed. Update your quality checklist to verify whether a bankruptcy is filed.

My experience is that plaintiff’s attorneys are generally annoyed when a bankruptcy attorney contacts them about the need to report their case to the bankruptcy court.  They are fearful that they may somehow lose control of their case or that the bankruptcy court will interfere with the process.  The opposite is true.  Reporting the claim will preserve the right to proceed with the case and will protect them summary judgment motions.

WHAT BANKRUPTCY ATTORNEYS NEED TO DO TO PREVENT UNREPORTED CLAIMS.

My office is instituting the following procedures to protect our clients from losing recovery for new injuries suffering during the bankruptcy case:

  • We have updated our information disclosure forms to warn clients of the vital need to report new claims against third parties throughout the term of their bankruptcy case.
  • We are contacting all existing clients to warn of this danger.
  • We are sending out regular correspondence to clients to remind them to report new claims.
  • We will conduct an exit interview when cases are about to close to discover unreported claims.

Although there are some debtors who intentionally fail to report new claims because they fear they would have to pay the settlement over to the bankruptcy court, that is not the typical case.  The 8th Circuit’s decision to punish dishonest debtors will unfortunately be imposed on innocent debtors and plaintiff attorneys who are simply unaware of the duty to amend bankruptcy schedules.

Chapter 13 cases fade into the background of life once the payment plan is approved. It’s just another payment in our list of monthly bills.  Contact between debtors and their bankruptcy attorney commonly disappears once the payment plan is approved. Life resumes, and when bad things happen–like car accidents or work injuries–clients contact other attorneys to represent them in those matters. The need to report these new claims to a bankruptcy attorney they have not spoken to in 4 years is not obvious. This is what the 8th Circuit is not understanding. The failure to report new claims is generally not intentional. Why do I have to call my bankruptcy attorney when I get in a car accident? There is no obvious connection between the two events.

The rules have changed.  Beware.

Image courtesy of Flickr and Andrew Kuznetsov

Choices

What is the most effective solution to a serious debt problem?  Without a doubt, Chapter 7 remains the single most effective way to eliminate debt.  What is the success rate of chapter 7 cases?

In reviewing 172 cases filed by our firm since January 1, 2014, clients received a discharge in all but three cases.  Of those 3 cases where no discharge was entered, two of them converted to chapter 13 since their income was declared to be too high to be eligible for chapter 7 relief and they will receive a discharge when they complete their payment plan.  The remaining case was voluntarily dismissed after the client incurred significant unplanned medical bills during her case. After her case was dismissed she filed a new case and received a discharge.

To summarize, 100% of the clients who filed chapter 7 obtained bankruptcy protection, and 99% of the cases received a chapter 7 discharge.

There simply is no more effective way out of debt.  Chapter 7 relief is immediate.  The moment a case is filed a federal protection order comes into place that immediately stops garnishments, collection calls, lawsuits, and all other forms of collection.  On average, cases were discharged in 102 days.

Success Rate of Chapter 13:

A Chapter 13 case is a payment plan completed over 3 to 5 years.  A review of the first 210 cases filed in 2006 indicates that 58% of those cases were discharged. When you factor in that 19 cases were converted to chapter 7, the discharge rate increases to 67%. That is actually an amazing statistic considering that a dramatic overhaul of the bankruptcy law took effect in October 2005 and attorneys were working with an entirely new law.

The success rate of Nebraska chapter 13 cases  is significantly higher than the national success rate of 36% reported by law professor Katherine Porter in her article, The Pretend Solution: An Empirical Study of Bankruptcy Outcomes.  Much of that success is attributable to our Chapter 13 Trustee, Kathleen Laughlin, and the Nebraska bankruptcy court for making the process work.

The success rate of chapter 13 does not include those cases converted to chapter 7. So the real success rate may be higher depending how we define “success” in bankruptcy. Also omitted is a list of those cases dismissed the first time around but that were eventually refiled with a successful result.

Success Rate of Consumer Credit Counseling Debt Management Plans:

Measuring the success rate of Debt Management Plans (DMP) is difficult since, unlike bankruptcy court records, there is no public data to review.  However, a poll conducted by the National Foundation for Credit Counseling indicated that only 21% of the repayment plans were completed. To be fair, the poll indicated that another 21% withdrew from the repayment program to manage the payments on their own but there is no data as to whether they were successful. The chief stumbling block to the program is that the payments were not affordable.

Success Rate of Debt Settlement:

This is the darkest area of the debt management industry and there is no hard data available to show how many plans have been completed.  It is generally believed that the success rate of these programs is less than 10%.

Need help sorting out debt repayment options?  Click here for help.

Image courtesy of Flickr and Dan Moyle.

Ten

Ten years ago this month the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) became effective. The act was designed to make filing bankruptcy more difficult by requiring filers to provide more information to court trustees that supervise the process and by installing a mathematical formula to keep higher income debtors out of chapter 7.

Is the reform act at success? Hardly. Despite the fact that some changes in the law had the effect of supplying the court with more income information and imposed limits on repeat filers, the vast majority of changes were unnecessary and are detrimental to the process.

The Good Reforms:

  1. Limits on Repeat Filers.  The drafters of the reform act felt that some people file too often, especially on the eve a foreclosure sale. BAPCPA limited how often a person could file bankruptcy. Chapter 7 cases may only be filed once every 8 years and those individuals who have been debtors in several cases within the preceding year do not automatically get protection without seeking court review of their case.
  2. Forum Shopping.  Some states have generous exemption laws that protect a debtor’s property, while other states are more frugal. BAPCPA curtailed this process by requiring debtors to use the exemption laws of the state a they lived in the majority of the two years prior to filing bankruptcy.
  3. Homestead Exemption Limits.  Prior to BAPCPA, wealthier debtors moved to states with unlimited homestead exemptions (such as Texas and Florida) and protected their money by purchasing expensive mansions. BAPCPA put a cap on homestead exemptions.  Sorry kids, no moving to a beach house when daddy’s business goes down.
  4. More Income Documents Provided to Trustees.  Debtors must supply the bankruptcy trustee with their last two tax returns and 2 months of paycheck stubs.
  5. Bankruptcy Attorneys Responsible for Accuracy of Case.  The reform act holds bankruptcy attorneys to a higher standard and requires that they perform a due diligence investigation of the information reported instead of just taking the debtor’s word for its accuracy. Good attorneys always did this, but it is fair to say that the reform act has put a healthy amount of fear in the hearts of bankruptcy attorneys.  Many attorneys, including this one, now obtain background reports to ensure that all property and property transfers are reported.

The Bad Aspects of the Reforms:

  1. Cost of Bankruptcy Skyrockets.  The cost of filing bankruptcy immediately doubled when BAPCPA was enacted, and for good reason.  Attorneys must gather substantially more information to prepare the case, they must prepare six-month income calculations and investigate the debtor’s financial condition much like an auditor.
  2. Means Test.  To keep higher income debtors out of Chapter 7 and to establish a nationwide standard of how much debt had to be repaid in Chapter 13, BAPCPA created a mathematical formula based on a debtor’s last six months of income. In practice, however, the Means Test has been a disaster to administer.  The central defect of the test is that most debtors do not have consistent income in the six months prior to filing bankruptcy. It is common that debtors have lost a good paying job just shortly before filing bankruptcy, so the six-month average does a poor job to forecasting what the debt they can really repay.  Conversely, some debtors were unemployed for a substantial time prior to bankruptcy but obtained a higher paying job just before filing. Past income is often a poor predictor of what future payments should be, but the Means Test is built on this faulty foundation. In addition, some types of income are not counted as income on the means test, such as Social Security income, so the test is often passed by debtors who really should fail.  Lastly, the means test favors secured debt so higher income debtors with big homes and fancy cars commonly pass the test while debtors who denied themselves such luxuries find they fail the means test.  Because of its complexity and poor drafting, bankruptcy courts struggle to establish a uniform method to apply the test.  The Means Test has failed its basic purpose and should be abolished.  Those who claim the means test has reduced the number of bankruptcies being filed are dead wrong.  Bankruptcy filings are down because the general rate of participation in the workforce is down.
  3. Mandatory Credit Counseling.  The drafters of the reform act require debtors to take a credit counseling class prior to filing bankruptcy and another course before the case is completed.  The idea here is that if people would just spend a little time getting the facts about budgeting and money management, perhaps fewer folks would file bankruptcy. This sounds nice, but as practiced this credit counseling is generally worthless.  Most of the courses are completed online and debtors just click through a series of mundane questions.  No real counseling is occurring.  Tragically, less sophisticated debtors without access to the internet are unable to get the credit counseling completed and, consequently, their homes are being lost to foreclosure and their paychecks are garnished. Thousands of debtors have lost their homes to foreclosure because bankruptcy attorneys are unwilling to meet with debtors whose homes are scheduled for sale until they complete the credit counseling class prior to meeting them.  Requiring a family who faces the humiliation of filing bankruptcy to learn about money management is just pouring salt in an open wound.  A single mom earning $9 per hour doesn’t need a credit counseling class–she needs housing, education, health insurance, child care and a higher paying job.
  4. Private Student Loan Discharge.  Prior to BAPCPA, a debtor could discharge a private student loan but not federally guaranteed loans.  The reform act now protects private student loans from discharge, and as a result there has been an explosion of debtors saddled with unmanageable student loan debt.  Private student loans are the single worst debt in America.  College financial aid departments steer students to these dangerous loans without any real discussion of the burden this will place on graduates and their families. Students are often unaware of the significant differences in repayment terms between federally guaranteed loans which offer income-based repayment plans and private loans which do not.  BAPCPA has created a monster student loan debt nightmare for millions of America’s young families and for the parents who foolishly co-signed these loans.
  5. Extended Duration of Chapter 13 Plans.  Prior to BAPCPA a chapter 13 case could be completed in 3 years.  Debtors with above-median incomes are now required to remain in chapter 13 for 5 years so that, in theory, they can repay more of their debt.  In reality, this change has decreased the success rate of chapter 13 payment plans and it also causes higher income debtors to load up on secured debts–especially car loans–prior to filing their case.  Debtors tied up in 5 year cases are not buying homes, cars, furniture, etc., and the economy as a whole takes a hit by taking these consumers out of the market.  Five year payment plans are too long.

Image courtesy of Flickr and Woodleywonderworks.

Going out of Business

I still remember being in the bankruptcy meeting room waiting for my client’s turn to see the Chapter 7 Trustee.  What I saw was a classic mistake made by young and inexperienced bankruptcy attorneys.

Trustee:  So how long have you owned the painting supply business?

Debtor: About 8 years.

Trustee: I see that you rent the store space and that you value the business equipment at $5,000, is that right?

Debtor: Yes, that’s correct.

Trustee: Are you owed accounts receivables?  Do customers owe you money today?

Debtor:   Yes.

Trustee: How much do they owe?  What is the total?

Debtor: About $15,000.

Trustee: And your inventory of paint, how much is that worth?

Debtor: About $10,000 to $15,000.

Trustee: Okay, and my understanding is that you are a sole proprietor.  You are not incorporated.  Is that correct?

Debtor:  Yes, that is correct.

Trustee:  Okay, well I’m going to claim your inventory and accounts.  I want you to stop operating the store now and deliver the keys to my office.

And just like that, the business was over.

The tragic thing is, neither the bankruptcy attorney nor the client thought this would happen.   They thought the business was safe because the business owed way more in debts than it had in assets.  In truth, the business did owe a lot of debt for rent, supplies, utilities, taxes, etc, but none of that mattered.

When you are a sole proprietor there is no such thing as a business being separate from you. You are the business.  The business assets are your assets.  In your mind you think of the business as a separate creature, but it is not.  The “business” is nothing more than a collection of assets and debts that is combined with your personal property and debts.  There is no distinction.

Now consider how this case would have turned out had the business owner incorporated the business prior to bankruptcy.  Instead of owing a painting supply business the debtor would have owned stock in a company that operated a painting supply business.  The corporation would have owned the business property and the corporation would have owed the various debts.  Since the debts of the company would have exceeded the value of the business assets, the stock of the company would have been worthless.  The business would have been safe from the Chapter 7 Trustee since the company’s stock would have had a negative net worth.  The trustee could not “cherry pick” the business assets.

There is a key difference between owning a business individually and owning stock of a company that operates a business.

SHOULD YOU INCORPORATE YOUR BUSINESS PRIOR TO FILING BANKRUPTCY?

Some businesses are so simple that there is no need to incorporate.  A home daycare may not have very many assets to protect (but watch out for receivables).  Some businesses are simple personal service businesses, so incorporation may not be necessary.  But if the business owns significant assets or if substantial inventories or receivables exist, it is probably best to incorporate the business prior to bankruptcy.

Transferring assets to a new company on the eve of bankruptcy can be a dangerous activity. Chapter 7 trustees have special powers to undue property transfers, so incorporating a business is not a simple solution.  It is best to hire a very seasoned corporate attorney to set up the new business.  You may want to delay the bankruptcy filing until the current inventory and receivables are gone and new inventory and receivables are built up in the new corporation.  You need to be counseled by an attorney who is familiar with the bankruptcy law of Fraudulent Conveyances and Insider Preferences.

If you own a business that supports your family and need to file bankruptcy, slow down.  Make sure you don’t lose your business in the bankruptcy process.  Consider the safer Chapter 13 alternative if you sense too much risk in the quick but dangerous Chapter 7 case.

Image courtesy of Flickr and Marius Watz.

 

Medical Bills

Medical debts account for nearly 62% of all bankruptcy cases filed according to a Harvard study.  The actual number may be even higher since medical debts turn into credit card debts and mortgage debts as people try to pay off debt collectors.  Although some medical debts are incurred when a person is temporarily uninsured, many are a result of ongoing  medical conditions that continue throughout the bankruptcy case.

It is amazing to see how much medical debt can be acquired even when a person has insurance.  Some deductibles are high and it seems like most consumers do not know how to respond when the claim is denied. Many treatments are not fully covered and medical supplies for diabetes and other conditions are just not covered very well under most policies.

This problem is especially heightened when new medical debts are incurred during a bankruptcy case.  Generally speaking, bankruptcy cases only cover those debts you owe on the day the case is filed.   Although Chapter 7 cases are completed in about 100 days, a Chapter 13 case can last up to five years and it is common for debtors to incur substantial new medical debts during the case.

What can you do when new medical debts are incurred during a bankruptcy case?

  1. Convert the case to another bankruptcy chapter.   Chapter 13 cases can be converted to Chapter 7 in most cases.  Some special rules apply, but if you were eligible to file chapter 7 on the day the chapter 13 case was filed you probably can convert the case to chapter 7 now and add all the new medical debts.
  2. Dismiss & Refile.  I have seen cases where a client suffered significant medical debt a few weeks after filing a case.  You do have the right to dismiss the current case and start over.
  3. Negotiate the Debt.  While you are in the middle of a bankruptcy case a creditor cannot garnish wages or bank accounts.  Some chapter 13 cases last for up to five years.  Since creditors prefer not to wait, request a discount on the amount owed in exchange for a payment now.

Converting a case from chapter 13 to chapter 7 can create problems if car and loans have not been paid in full or if the chapter 13 plan deeply discounted the interest rate of the car loan.  It is common for chapter 13 plans to reduce interest rates from 18% down to 5.25%.  (Secured auto debts in chapter 13 cases only pay the Prime Rate plus 2%).  So, when a case converts to chapter 7 the benefits of the chapter 13 plan vanish and the auto lender may demand the loan be made current at the original contract rate.  Be careful in assuming that the car is safe when you convert the case.  Sometimes it is wise to call the auto lender before converting the case to see what the new payment will be or if a large cure payment must be made.

When chronic medical problems exist and health insurance coverage is spotty, it is generally wise to file chapter 13 to take advantage of the ongoing protection from medical creditors.  If major surgeries are planned in the near future, perhaps it is best to start the bankruptcy as a chapter 13 case with the idea of converting to chapter 7 later just in case some of the medical bills are not covered by insurance.

Image courtesy of Flickr and Chuck Olson.