We view negatively a person who files bankruptcy after running up credit cards debts to fund an extravagant lifestyle, but we are less judgmental about the unlucky person who incurs medical debt.  Apparently the three major credit reporting bureaus agree and have decided to remove these debts from their credit reporting.

Forbes Magazine has a break-down of the new rules:

  • Starting July 1, 2022, medical debt that’s been paid will no longer be included on credit reports from Equifax, Experian and TransUnion—even if it’s been on your report for several years.
  • In addition, the three credit bureaus are increasing the amount of time before medical debt in collections appears on your credit reports. That cushion is now six months but will be lengthened to one year.
  • If you’re in the process of negotiating or paying a medical debt, this can give you extra time to work with providers or collectors to find a mutually-agreeable payment solution.
  • Finally, beginning in the first half of 2023, the three consumer credit reporting agencies will no longer include medical debt in collections under $500 on credit reports.

Is this a good thing?

Well, for bankruptcy attorneys this is a bad development since we pull credit reports when preparing a bankruptcy petition.  We can’t list creditors we don’t know about, and clients seem overwhelmed when trying to remember all the medical creditors they owe.

There will be more unscheduled debts. That’s a bad consequence of this new practice.

The woke FICO score.

So, medical debts are no longer “debts” for the FICO score.  It would be harsh and oppressive to report . . . um . . . debts.  I mean, the wrong kind of debts.

Something tells me this is purely public relations.  My guess is there is another report bankers are viewing to tell the about the politically incorrect debts, like medical debts.  In fact, I know such reports are reviewed when bankers are deciding whether to extend credit.

For years the Credit Counseling industry has said that enrolling in a Debt Management Plan does not affect the FICO score, but I’ve heard bankers tell me that they know that people who enter these programs are several times more likely to default on a loan, so they do consider those programs as a “factor” when extending new loans.

The score ain’t the score anymore.

Debt management plans don’t reduce FICO scores, but it is a “factor.”

Medical debt is not debt.

2+2=5.

If a credit report does not accurately report a person’s debts–if the debt-to-income ratio is not really an accurate ratio–what good is the report?
I smell a rat.  Somehow, some way, those bankers still look at medical debts.

A credit score is supposed to inform us of whether you are a good credit risk. The higher the debt level, the higher the risk. More debts equate with more lawsuits and garnishments and potential loan defaults. How you acquired the debt really doesn’t matter, but apparently it does now.

What else shouldn’t be reported?

So what other debts will not be reported based on what is politically correct?  Should debts incurred by single moms be reported? Should debts of ethnic minorities be reported? Should debts owed by residents of low-income neighborhoods be reported? Isn’t all reporting of debt repressive?

 

Image courtesy of Flicker and CafeCredit.com

The Covid/19 pandemic has changed how we work forever, and bankruptcy practice is no exception.

Just two years ago this is what we did:

  • We met most new clients in person during office meetings.
  • Most cases were signed in person.
  • An 80-page bankruptcy petition was signed with ink signatures on paper.
  • Debtors attended a Section 341 Meeting of Creditors at the courthouse.
  • Agreements to reaffirm home and car loans were signed on paper and mailed to creditors.

All that changed in March 2020 when the pandemic forced courts to close down.  Since that time we have signed all cases electronically and meetings with the bankruptcy trustee (required under Section 341 of the Bankruptcy Code) have been conducted over the telephone.

Although many questioned whether telephone 341 meetings would be effective since the trustees cannot see the person testifying under oath, the general feeling is that little has been lost in the process.  Trustees seem to be as effective conducting telephonic exams as they are with live in-person examinations.

Some trustees have even said that telephonic meetings are actually better since fewer debtors miss the hearings due to work or family conflicts. They can call in during work hours and can attend even if they are sick.

I think some trustees are as delighted to avoid dressing up for hearings that stretch out all day in federal courthouses as are debtor’s counsel who frequently work from home.

The big news received this week is that the United States Trustee’s Office will be implementing  a new nationwide Zoom 341 hearing system to be unveiled in the next year.

Wow, this is really a big deal.  It means that in-person 341 hearings are permanently a thing of the past.  It also means the US Trustee’s office has carefully evaluated the effectiveness of remote hearings and have found them to be successful.

Zoom 341 hearings will offer several advantages over voice conference calls:

  • Facial Expressions: Trustees will be able to see the debtor’s testify and read their facial expressions.
  • Shared Screens:  Trustees will be able to share their computer screen with the debtor to bring attention to specific lines of the bankruptcy petition, tax returns, bank statements or other documents.  That rarely occurred during in-person hearings.
  • Waiting Rooms: Zoom technology allows meeting participants to be keep in an electronic waiting room until their meeting is up.
  • Meeting Queues: Zoom may allow participants to know how many cases will be called before their turn.
  • Muting Feature.  Whether meetings take place in person or on conference calls, trustees are frequently annoyed by folks who talk during other people’s hearing. Zoom technology may empower the trustees to mute all voices not involved with the case.

The obvious problem with Zoom meetings will be that some debtors will struggle with the technology.  Not everyone uses a smartphone or computer.  So there will probably need to be rules that allow low-tech debtors to call in on the phone.  Perhaps attorneys may need to file motions to allow such calls for those debtors.

No doubt, Zoom 341 hearings will create new complications and technology frustrations, but overall the move to Zoom hearings is a great advancement.

Debtors will not need to take a day off work to attend routing meetings that generally last no more than a few minutes. Debtor attorneys may continue to evolve their remote office practices. Shared screens may actually cause the trustees to ask more penetrating questions by showing debtors documents that contradict their testimony.

The downside of Zoom 341 meetings?  Yep, everyone needs to start dressing up again.

 

Image courtesy of Flickr and Radiofabrik-Community

Does the income of a live-in girlfriend of five years count towards household income?  I read that question in an online chat discussion recently.

Here is the answer provided by a bankruptcy attorney: “No, her income will not be used to determine your household income unless you are attempting a modification and want to use her income as a contributor.”

That answer is completely wrong. In fact, that answer could lead this person to commit perjury on his bankruptcy schedules and may result in a denial of his bankruptcy discharge.

Important Questions:

There are important questions that must be answered to determine if the girlfriend’s income needs to be listed.

  • Do you share bank accounts with the girlfriend?
  • Do you own property together, such as a home or vehicle?
  • Are there children from this relationship?
  • Are  you a cosigner of debts with the girlfriend?

The bankruptcy schedules request that you report the size of the household and all household income.  That answer is not dependent on whether or not you are married.

Does the girlfriend’s income make  a difference?

Does it make a difference if you list the girlfriend’s income?  If not, list it.  The best approach is to list all household income.

If it does make a difference (for example, if listing her income makes you ineligible for Chapter 7), then you need to carefully examine the details of the relationship.

The concept behind Household Income:

There is a reason the bankruptcy schedules ask you to report all household income instead of just income of a married couple.  Obviously, the bankruptcy laws want full disclosure of all regular income of the household.  And if you fail to report all regular income of the household you could be found guilty of committing perjury on the bankruptcy schedules and your discharge my be denied.

But what is household income? If you have a roommate and share an apartment, do you have to list the roommate’s income? Do you have to list the income of your children or your parents living in the home?

The answer is it depends.  You have to carefully examine the nature and extent of the relationship.

I would list the income of a live-in girlfriend of five years if you share bank accounts, children, property and debts.  I would not list the income of a girlfriend who is just spending the weekend together.

The duration of the relationship matters.  The nature of the relationship (romantic versus non-romantic) matters.  Sharing bank accounts and property and cosigning debts matters.  Each case is unique.

Shared expenses:

Assuming you do not share bank accounts or children or property together (which is an altogether different article about lack of commitment!), you probably do share expenses.  So, if you only pay half of the rent and the girlfriend pays the other half, make sure you do not take credit for paying all the rent on the monthly expense schedule. In other words, only list your share of the expenses that you actually pay.

Common Fraud Issue:

When reviewing bankruptcy cases I notice that the failure to disclose all household income is quite common and easily detected.  I commonly see cases filed that list “Contribution from Boyfriend/Girlfriend” and then I notice several children listed as living in the home. When you live with your boyfriend/girlfriend and have children of the relationship living in the home, it is simply wrong to list contribution income.  Rather, the entire gross income should be listed on Schedule I of the bankruptcy Schedules and six months of gross income on the Means Test.

It simply boggles the mind to understand why the US Trustee does not pick up on this common failure to report household income more frequently.  It is too easy to avoid the requirement of reporting household income just because parents with minor children living together are not married, and attorneys who prepare schedules in this manner put their clients at risk for serious charges of perjury and possible denial of discharge.

 

Image courtesy of Flickr and davidmesaaz

The experience of reading a Supreme Court opinion on bankruptcy law is like having a two-year-old in a China shop—you just want them out before they break more stuff.  

The Supreme Court’s stumble through the City of Chicago v Fulton opinion is no exception to this rule.  

The City of Chicago, itself an entity on the brink of filing bankruptcy, was desperate for revenue, so in 2011 the City increased impound lot fees. Many low-income residents soon found it impossible to pay the fees to reclaim their vehicles. 

George Peake, one of the debtors in the case, drove a 2007 Lincoln MKZ 45 miles each day to and from work. When that car was impounded he owed $4,300 in impound fees, so he filed bankruptcy but the City of Chicago refused to release his car until he first paid $1,250. 

 THE AUTOMATIC STAY: 

Section 362(a)(c) of the Bankruptcy Code states that the filing of a petition stays “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate.” 

The debtors in Fulton claimed a violation of the stay occurred because the City of Chicago was “exercising control” over their vehicles by refusing to release them. 

The City of Chicago’s attorneys replied that they were not violating the stay since they were taking no affirmative action to change the status quo. Their attorneys argued that mere possession of property seized prior to bankruptcy was not a violation of the stay and that it had not duty to release the vehicles until the courts issued an order requiring a turnover. 

The debtors argued that the City of Chicago had an affirmative duty to release the vehicles once a request for the vehicles was made known. 

THE TURNOVER STATUTE: 

Section 542 of the bankruptcy code requires a creditor to release property as requested by the Trustee or as directed by the Court.   But obtaining a turnover order may take months to accomplish and is expensive, whereas filing a motion for violation of the automatic stay is relatively cheap and fast. 

THE RULING: 

By a unanimous 8-0 vote (Justice Barrett did not participate) the court ruled that the automatic stay of 362(a)(3) did not require the City to turn over the vehicles since the City was merely preserving the status quo.

Justice Alito, writing for the majority, states that if 362(a)(3) requires the City to turn over the impounded vehicles, then the turnover provision of §542 would become superfluous.

  • “Any ambiguity in the text of §362(a)(3) is resolved decidedly in the City’s favor by the existence of a separate provision, §542, that expressly governs the turnover of estate property.
  • “Reading “any act . . . to exercise control” in §362(a)(3) to include merely retaining possession of a debtor’s property would make that section a blanket turnover provision.”
  • “The better account of the two provisions is that §362(a)(3) prohibits collection efforts outside the bankruptcy proceeding that would change the status quo, while §542(a) works within the bankruptcy process to draw far-flung estate property back into the hands of the debtor or trustee.”

Justice Alito reasons that if the automatic stay requires a creditor to  release the vehicle, then the turnover provision of Section 542 is redundant and unnecessary.  For this reason, the automatic stay, according to the Court’s logic, does not require a turnover since “mere possession” is not an action to control.

I believe the Court’s reasoning is flawed and oversimplified.  The debtors in this case were not arguing that the the automatic stay required the turnover of the vehicles. Rather, they argued that the refusal to turn them over constituted a violation of the stay.

The filing of a bankruptcy petition changes the status quo. Mere retention is no longer mere retention–it is a violation.

Imposing penalties on a creditor that refuses to release collateral after a bankruptcy is filed does not make the turnover provision of Section 542 redundant.  Section 362 merely imposes penalties for violating the stay, but it does not actually require the turnover of property.  Section 542 does not impose penalties but can require the turnover of property. The provisions perform distinct but complimentary functions.  One does not obviate the other.

Imposing penalties on creditors that refuse to turnover seized collateral does not make the automatic say a de facto turnover provision (although such penalties will certainly encourage creditors to release collateral).

There will be times when a dispute exists as to the ownership of property, and the turnover provision of 542 addresses those questions, but the automatic stay does not.  The automatic stay of 362 and the turnover provision of 542 serve different but complimentary functions.

AFFECT ON NEBRASKA CASE LAW:

  • In re Griger, Nebraska Case No. 97-80017  Nissan Motor Acceptance repossessed debtor’s vehicle 7 days before Chapter 13 petition was filed. Nissan refuses to release the vehicle until the debtors pay the costs of repossessing the vehicle and the cost of transporting the vehicle back to Nebraska.  Judge Mahoney ruled that: “A willful violation of the automatic stay is not only triggered by malfeasance; nonfeasance on the part of a creditor may also be considered a willful violation of the stay under appropriate circumstances.
  • In re Sandra Mae Hoyle, Neb. Bkr. 96:701 (Bankr. D. Neb. 1996) (Mahoney, J.) (A judgment creditor must take affirmative action to obtain release of garnished funds). While a creditor is not under a time limit in returning property, a creditor must return the property within a reasonable period of time.”
  • In re Hill, Nebraska Bankruptcy Case 92-82086 : 11 U.S.C. §362 “prohibits actions against property of the debtor after a bankruptcy petition is filed. It does not require any notice by the debtor or court order. The injunction of Section 362 of the Bankruptcy Code is automatic. In re Knaus, 889 F.2d 773, 775 (8th Cir. 1989).”
  • Judge Mahoney imposed sanctions for failing to release the repossessed vehicle: “This creditor kept control of the vehicle notwithstanding the fact that it had received information, including a copy of an Eighth Circuit case, In re Knaus, which directed a return of property seized post-petition. The creditor did not consult an attorney but simply let the debtors stew until this Court, at a hearing scheduled on an emergency basis, specifically ordered the turnover of the property. The actions of this creditor are “appropriate circumstances” under which punitive damages can and should be assessed.”

All of these Nebraska cases are now thrown into question.  Do creditors have affirmative duties to release collateral or garnishments after a bankruptcy is filed?

NEW PROBLEMS EMERGING FROM COURT RULING:

Emboldened by the Supreme Court’s neutering of the automatic stay, creditors are now refusing to stop collection activities in a variety of settings.

  • Margavitch vs. Southlake Holding LLC:  In this case the creditor refused to issue a release of a garnishment of funds held in the debtor’s bank account.  There creditor said is was taking no action and there mere retention of the garnished funds was not a violation of the automatic say. The creditor claimed it was merely preserving the status quo.  The Pennsylvania bankruptcy court agreed and ruled no violation of the stay occurred.
  • Mark E. Stuart vs. City of Scottsdale.  The Ninth Circuit Bankruptcy Appellate Panel rules that no violation of the stay occurs due to mere retention of repossessed vehicles.

What about wage garnishments? Is it a violation of the stay to merely allow a wage garnishment approved by a court before the bankruptcy is filed to continue? Is there an affirmative duty of the creditor to release the garnishment?

I have no doubt the Supreme Court would say that is different, but why? How is it different? The creditor is taking no “action” to continue the garnishment, rather the creditor has set a process in motion that continues to garnish future paychecks.

What “action” has a creditor committed by not releasing the wage garnishment? Obviously, the creditor has taken no action, and that is the problem.  If you buy into the concept that the automatic stay may compel a creditor to take affirmative action in some cases, then Justice Alito’s logic completely unravels.  Why does a creditor that takes no action of any kind after a bankruptcy is filed be required to take affirmative steps to stop a wage garnishment process, but a creditor that maintains a process or retaining vehicles does not? The logic is flawed.

It is inaccurate to say the City of Chicago is “merely retaining” the vehicle.  Retention itself is a process, just like a continuing wage garnishments is a process.  Both require effort.

The Supreme Court has opened up a can of worms and a decade of litigation will now take place to figure out what the automatic stay actually stops.

 

Image courtesy of Flickr and Dave Nakayama

The Massachusetts Attorney General recently settled a major consumer fraud case against subprime auto lender Credit Acceptance Corporation.

The case is long and complicated, but the issue that caught my eye is the argument about the true purchase price of a vehicle.

For example, assume a dealer sells a vehicle for $10,000 and the buyer signs an 18% loan spread over 60 months at $253.93 per month.  Then, assume the dealer immediately sells the loan to a subprime lender for $8,000 cash.

What is the true purchase price of the vehicle? Is it $8,000 or is it $10,000.

FORM OVER SUBSTANCE

I would argue the true sales price is $8,000 because that is what the dealer actually received. In fact, I’m quite certain the dealer would report on its tax return that the vehicle was sold for $8,000.  And the financial records subprime lender probably reports that it acquired the loan for $8,000 as well.  So, isn’t that the true sales price?

But all the purchase documents state a purchase price of $10,000.  All the finance charges and disclosure statements say the cost was $10,000 and that the interest rate is only 18%.

If, however, substance rules over form, both the car dealer and the subprime lender have a major problem. The problem is that they are lying about the true sales price of the vehicle and the true interest rate being charged.  If the true sales price is $8,000, then the actual interest rate is actually 29%, not 18%.  And by failing to disclose the true interest rate, the dealer and lender have committed a violation of the Truth in Lending Act disclosure.

CHAPTER 13 BANKRUPTCY ISSUE

Determining the real purchase price of a vehicle also has importance in a chapter 13 case when the vehicle was purchased within 910 days of filing bankruptcy. Under Section 1325(a)(9) of the Bankruptcy Code, a debtor must pay a lender the current balance of the loan, even if the vehicle is worth less than the balance of the loan.

So it makes a BIG difference if the actual loan amount is $8,000 instead of $10,000.  It also makes a big difference if the true interest rate is 29% and not 18%.

The legal consequence of violating Nebraska laws on usury is that a creditor is entitled to no interest at all.  See Nebraska Statute 45-1024. (“If any amount, in excess of the charges permitted, is charged, contracted for, or received, the loan contract shall not on that account be void, but the licensee shall have no right to collect or receive any interest or other charges whatsoever.”)

Interest rates for installment loans in Nebraska are capped at 24% on the fist $1,000 and 21% on balances above 21%.  If Nebraska Courts rule that the true purchase price of a car is $8,000 and not $10,000, that automatically triggers a violation of these interest rate caps.

So, in theory, a debtor could propose to pay off the car loan at $8,000 and offer no interest to the creditor as a penalty for violating Nebraska Statute 45-1024.  That’s a big deal.

WILL THE COURTS BUY THE ARUGUMENT?

Our courts have routinely ruled that we apply the law to the facts at hand and disregard the forms of a transaction. Labels do not control.

  • Lease to Own Transactions:  The most common form over substance transaction we find is where a creditor tries to disguise a purchase in the form of a lease. Several years ago I litigated against a company called Cash In a Flash Inc. that disguised high interest rate title loans in the form of a lease.  The Nebraska bankruptcy court  and Nebraska Department of Banking ruled that the transactions were really loans and the lender had violated Truth in Lending disclosure requirements.
  • Reasonable Compensation:  Tax courts routinely take issue with business owners who evade payment of Social Security taxes by paying themselves artificially low salaries.
  • IRS Disguised Sales Rules: The IRS commonly recharacterizes transactions between partners under Section 707 of the Internal Revenue Code.
  • Time Sale Transaction:  “It appears quite clearly that the transaction was a loan to Jones disguised as a conditional or time sale with defendant as surety or guarantor. As such it is usurious and subject to the forfeiture of interest. See §§ 45–105 and 45–138(3), R.R.S.1943.” Midstates Acceptance v. Voss, 202 N.W.2d 822, 189 Neb. 411 (Neb. 1972).  Midstates Accceptance v. Voss, 202 N.W. 2d 822, 189 Neb. 411 (Neb. 1972)

But when it comes to the subprime auto lending two-step dance, our courts fail to confront the nonsense of these transactions.

Overcharging is not in itself usury

The Michigan bankruptcy court confronted this issue in the case of Allen-Morris v. Nicholas Fin., Inc. (In re Allen-Morris), 523 B.R. 532 (E.D. Mich. 2014).  In that case the debtor claimed that the auto dealership was inflating the price of the auto to disguise a usurious rate of interest (above 25%).  The debtor attempted to prove the hidden interest rate by relying on NADA and Kelly Blue Book values to prove the cars were sold at inflated prices.

The bankruptcy court disagreed, and on appeal the district court ruled  that “overcharging is not in itself usury.”  The court also stated that “even overcharging solely because a product is being sold on credit rather than for cash in not in itself usury.” However, the court also stated that the debtor did not allege that he was forced to purchase the vehicle at an inflated price to secure the loan, so perhaps the door is not completely shut on this argument.

LESSONS LEARNED: SHOP FOR THE LOAN BEFORE SHOPPING FOR THE VEHICLE

What I take away from this is that it is so important to shop for the auto loan before shopping for the vehicle itself.

There is an incestuous relationship between car dealers and subprime lenders. In the above example the car dealer is clearly selling the vehicle for $8,000, but the bill of sale says $10,000.  It is also clear that the dealer does not care if the buyer pays the $8,000 cash or if it is paid by the subprime lender. The case price is $8,000.

I suspect that most buyers would object to paying 29% interest on a car loan. But from what I can see, if your credit is hurting and you agree to finance a car at 18% interest, chances are you are really paying 29% but just don’t realize it.

Cash talks. When consumers walk onto a car lot with their loan already secured, they tend to negotiate lower prices.  Instead of paying $10,000 they negotiate the price down to $8,000.

Never depend on a car dealer to supply financing. Always shop the loan before shopping the car.

 

Image courtesy Flickr and Nicole Yeary.

 

 

 

 

 

 

Chapter 13 cases are three to five year payment plans.  Creditors receive a monthly payment based on a debtor’s ability to pay, the type of debts they owe, and the amount of unprotected property they own.

But how does one make the payment? Who do you pay?

Chapter 13 payments are paid to the Chapter 13 Trustee, typically an attorney appointed to oversee the bankruptcy case. In Nebraska that person is Kathleen A. Laughlin.

HOW DO YOU PAY THE CHAPTER 13 TRUSTEE?

There are only two ways to pay the Trustee:

  1. Money Order or Cashier’s Check.
  2. Garnishment of paycheck.

No other payment methods are allowed.  (Read this.)

What about payment in cash? Are personal checks allowed? What about paying via a debit card? Can you pay online? Can you set up an automatic payment?   What about BillPay services?

None of those payment methods are allowed.  And, to be honest, I just don’t understand.

WHY CAN’T AUTOMATIC PAYMENTS BE SET UP?

I wish I understood the answer to that question.  I really see no reason why an automatic payment cannot be set up.  In fact, the TFS company has established a program to facilitate automatic payments in chapter 13 cases.  Many chapter 13 trustees around the country use TFS, including Iowa.

What I do know is that automatic payments work. Clients who have the payment deducted from their paycheck complete their payment plans at a much higher percentage than those who do not.

But not everyone can have a payroll deduction, and that is a real problem. Many clients are self-employed. Many are underemployed and they do not earn enough from one job to make the payment.  Others have jobs where their employers look dimly on payroll garnishments thus causing employment issues.

SUMMARY

Working in our nation’s bankruptcy system for nearly 30 years, I can say that Nebraska has just about the best court system in the country. Really, there is something special about Nebraska’s system. Maybe it is because we are small population state and we just know each other better and cut through the red tape. Attorneys just don’t appreciate how great Nebraska’s bankruptcy judges and trustees are until they practice elsewhere.

But the lack of automatic payments in Chapter 13 drives me nuts. Come on Nebraska, we can do better than this!  Let’s automate!

 

 

May a person contribute to 401(k) retirement plan during a Nebraska Chapter 13 case?

THE RULE PRIOR TO 2005:

Prior to the Bankruptcy Reform Act of 2005 the answer was fairly simple: No.  Contributions to a 401(k) retirement plan are voluntary, and prior to 2005 it was commonly known that contributions were not “necessary” to the support of a debtor.

The maximum required length of a plan was only three years, so to deny this deduction was not a terrible burden on debtors.  No matter how high their income was, debtors only had to be in Chapter 13 for three years.

THE RULE AFTER 2005:

But that all changed in 2005 and now higher-income debtors are required to spend up to five years in Chapter 13. Monthly payments are now, in theory, determined by a Means Test based on income received during the prior six months.

The entire intent of the new law was to make filing bankruptcy more difficult and to force debtors to pay back a greater portion of their debts

But the new 6-month income test also contained a new deduction: qualified retirement plan contributions.  Debtors might have to repay more of their debts, but at least they could contribute to a voluntary retirement plan, or so it appeared.

CONFUSION OVER RETIREMENT PLAN CONTRIBUTIONS:

The problem with applying the Bankruptcy Reform Act of 2005 is that nobody really understands what it says. The language is confusing and it contains incomplete “hanging sentences.”

As a result, bankruptcy courts have crafted different interpretations of whether a debtor may contribute to a voluntary 401k plan during a Chapter 13 case.  (See In re Penfound, 6th Cir 2021)

FOUR INTERPRETATIONS ABOUT RETIREMENT CONTRIBUTIONS:

  1. Majority View–the Johnson View.  The majority of bankruptcy courts hold that a debtor may fund a 401k plan during Chapter 13 if the contributions are made in “good faith.”  Under this view bankruptcy courts look at all the relevant factors to see if the contributions are justified. Contributions must be reasonable in light of the debtor’s income, age, health, existing retirement balances, previous contribution percentages, the type of debt owed, and the amount of debt owed.  See Baxter v. Johnson (In re Johnson), 346 B.R. 256, 263 (Bankr. S.D. Ga. 2006).
  2. Priggee Interpretation: Debtors are never permitted to contribute to voluntary retirement plans during chapter 13. In re Prigge, 441 B.R. 667, 677 & n.5 (Bankr. D. Mont. 2010)
  3. Seafort-BAP Interpretation.  A debtor may continue to contribute to a 401k plan an amount they were contributing “at the time” the case was filed. In other words, you may not start contributing to a program after the case is filed.
  4. CMI Interpretation.  A debtor may only claim a monthly deduction for an amount equal to the average amount contributed in the six months prior to filing.

NEBRASKA’S RETIREMENT CONTRIBUTION RULE:

There is no Nebraska or 8th Circuit case exactly on point, but it appears that Nebraska follows the Good Faith rule of Johnson.  A reasonable retirement contribution is allowed.

Counsel for the Chapter 13 Trustees often speak about a higher-income debtor’s level of retirement contributions.  Objections are raised on “good faith” grounds instead of technical arguments. However, when presented with a case involving a high-income debtor who offers to pay very little to unsecured creditors while making significant contributions to their own retirement plan, is is common for the trustee to object to the debtor’s budget.

OBSERVATIONS AND FINAL COMMENTS:

It is extremely common for debtors to liquidate or to stop contributions to a retirement plan before bankruptcy.  The vast majority of people I meet do not realize that retirement funds are shielded from creditor claims and they feel a strong moral duty to liquidate their savings to pay debts.

The other observation is that liquidating a retirement plan to pay debts rarely provides enough funds to pay back all the debt. At best only a portion of debt is paid and income taxes and penalties frequently consume nearly half of the funds withdrawn. Rarely does it make sense to use retirement savings to pay debts.

Those who do use retirement savings to pay debts suffer a tremendous blow. They forfeit decades of savings they can never restore.

When it becomes clear that filing bankruptcy is necessary, a debtor should cease to pay unsecured debts (credit cards & medical bills) and they should consider contributing to a retirement program prior to filing bankruptcy.  Bankruptcy courts may balk at contributions to 401k plans if those contributions were not being made prior to filing a case.

Most debtors wait too long to visit a bankruptcy attorney. By the time they do visit one they have wiped out savings that would have been fully protected in the bankruptcy case.

The lack of retirement savings is often a strong factor in deciding to file bankruptcy. Although a young person may learn a hard but valuable lesson in paying back debts incurred foolishly, those in their middle years are running out of time to save up for retirement.  Filing bankruptcy enables a person to protect the retirements they have saved so far and frees up future income to devote to that purpose. Bankruptcy has as much to do with planning for the future as it does in cleaning up the past.

 

Image courtesy Leigh Blackall & Flickr

 

A new Nebraska bankruptcy court opinion (In re Torres) answers the question of whether a debtor may hold a vehicle title in trust for another person who provided the funds to purchase the vehicle.

In Torres, the debtor’s sister lived in Mexico and she transferred $42,970 to the debtor’s bank account to purchase a 2020 Hyundai Palisade.  The vehicle was titled only in the debtor’s name.

The chapter 7 trustee demanded a turnover of the vehicle, but the debtor objected claiming that he merely held the vehicle in trust for his sister.

There was no written agreement between the debtor and his sister.  The parties stipulated that the sister did not intend to make a gift to her brother but that the funds were transferred to purchase a vehicle for the sister’s use.  Apparently the sister intended to come to Nebraska for medical treatment but was unable to due to Covid-19 travel restrictions.  It’s not clear why the sister’s name was left off the title.

THE LAW: 

Nebraska statute 60-140 governs the ownership and acquisition of motor vehicles:

No person acquiring a vehicle from the owner thereof . . .  shall acquire any right, title, claim, or interest in or to such vehicle until the acquiring person has had delivered to him or her physical possession of such vehicle and (a) a certificate of title or a duly executed manufacturer’s or importer’s certificate with such assignments as are necessary to show title in the purchaser, (b) a written instrument as required by section 60-1417, (c) an affidavit and notarized bill of sale as provided in section 60-142.01, or (d) a bill of sale for a parts vehicle as required by section 60-142.

That seems very conclusive. No person shall acquire any “right, title claim or interest” without possession of the vehicle and a title, a written instrument, or a bill of sale.  Something must be in writing.

THE RULING:

Judge Kruse ruled that “any equitable interest Ms. Torres asserts in the vehicle cannot defeat the trustee’s powers under 11 U.S.C. § 544. This court previously refused to recognize the equitable ownership interest of a non-debtor whose name is not noted on a motor vehicle’s certificate of title. See In re Farrell, Case No. BK19-80282, 2019 Bankr. LEXIS 1949 (Bankr. D. Neb., June 28, 2019).”

The court focused on Nebraska Statute 60-140.  “No person shall acquire any right title claim or interest of any person in or to a vehicle . . . unless there is compliance with this section.”

In Torres there was no writing between the debtor and his sister. Case closed. The sister had no interest recognized under Nebraska motor vehicle title law.

In re Farrell

In the Farrell opinion Judge Saladino relied on the Strong Arm power of Section 544 to allow the chapter 7 trustee to void the interest of a non-debtor spouse in a motor vehicle.  In Farrell the debtor’s mother purchased a vehicle for the debtor and his wife, but the title was only recorded in the debtor’s name. On the bankruptcy schedules the debtor claimed a one-half interest in the vehicle and stated that his wife held an equitable interest in the other half.

Bankruptcy Code Section 544 is called the Strong Arm Power because it allows a chapter 7 trustee to avoid any interest in a judicial or unrecorded lien in property of the debtor.

Importantly, in the Farrell opinion Judge Saladino ruled that Nebraska case law does recognize an ownership interest in a motor vehicle not listed on the vehicle title.

“Nebraska case law makes clear that “while the certificate of title act provides the exclusive method for the transfer of title to a vehicle, it is not conclusive on the issue of ownership[.]” Hanson v. Gen. Motors Corp., 486 N.W.2d 223, 225 (Neb. 1992) (citing Alford v. Neal, 425 N.W.2d 325 (Neb. 1988)). The bankruptcy court has observed that the certificate of title statute’s applicability may not be as broad as initially appears: “The Nebraska Supreme Court recognized that the purpose of § 60–105 is to prevent fraud or misrepresentation, and recognized that there are circumstances where, although § 60–105 would apply by its terms, the circumstances may not be within the intended purview of the statute.” In re Mueller, 123 B.R. 613, 615 (Bankr. D. Neb. 1990) (interpreting the predecessor statute to § 60-140).”

How can we reconcile Judge Saladino’s opinion in Farrell which does recognize an ownership interest in a motor vehicle that does not appear on the vehicle’s title with Judge Kruse’s opinion in Torres that “no right, title, claim or interest” may exist without compliance with 60-140?

Judge Saladino, quoting Hanson v Gen Motors Corp says an ownership interest may exist apart from the vehicle title. Judge Kruse says it does not. We have a conflict of opinions here.

Resulting Trusts:

In Farrell the debtor did not argue that he held his wife’s interest in trust. (“Mr. Farrell has not suggested that he holds the vehicle in trust for his wife, so § 541(d) need not be addressed further here.”)

Why is that significant?  It is significant because if the vehicle was held in trust then it would not be part of the bankruptcy estate and the Strong Arm power of Section 544 would not apply.

It is clear under the Hanson v Gen Motor Corp opinion that Nebraska recognizes that an ownership interest may exist even if it is not recorded on a vehicle title.  Nebraska statute 60-140 is not conclusive.  Judge Saladino says exactly that in Farrell.

In Torres Judge Kruse specifically finds that Nebraska law recognizes resulting trusts, but he finds that Nebraska that statute 60-140, however, does not allow a resulting trust in a motor vehicle. What Judge Kruse does not explain is why the Hanson v Gen Motors Corp case does not apply. We are left to wonder.

Burden of Proving Existence of Resulting Trust:

Judge Kruse explains that the existence of a resulting trust must be established by clear and convincing evidence.  That is a high standard.

In Torres there was no written trust agreement between the debtor and his sister. There was no writing of any type at all to prove the existence of a trust.

Based on the evidence presented, I think the Court got it right in Torres, but we now have a conflict in case law about whether Nebraska law allows a resulting trust in a motor vehicle that will have to be resolved in a future case.

 

 

 

 

 

 

 

 

 

 

 

 

Image courtesy of Flickr and Greg Gjerdingen

The 8th Circuit Bankruptcy Appellate Court (BAP) has issued a new opinion baring excessive attorney fees involved in the use of bifurcated fee arrangements in Chapter 7 cases. See In re Allen, No 20-6023.

The United States Trustee, the agency that polices bankruptcy cases, objected tot he excessive attorney fees charged by William Riding in two chapter 7 cases filed in Missouri.

The attorney offered his clients two payment arrangements:

  • $1,500 for a traditional chapter 7 case where all fees are paid before the case is filed.
  • $2,000 fee payable in 12 monthly installments after the case was filed.

Both debtors chose second option to pay fees after the case was filed.

BANKRUPTCY LOANS: FRESH START FUNDING LLC.

In both cases the attorney used a company called Fresh Start Funding LLC to finance the case. Under the Fresh Start program the attorney was paid $1,500 for each case and he sold his unpaid receivable to Fresh Start to collect from the debtor in monthly payments.  Fresh Start would earn $500 for financing each case over 12 months.

Essentially, the debtor is taking out a $1,500 loan with an effective interest rate of 57%.

REASONABLENES OF ATTORNEY FEES

The bankruptcy court found that both chapter 7 cases were relatively simple and routine. No complex issues were involved and both debtors received a discharge of their debts.

Since the attorney performed the exact same duties in these bifurcated fee arrangement cases as are performed in a traditional pay-upfront case, the court deemed the extra $500 charge excessive. The Bankruptcy Appellate Panel agreed and denied the extra $500 finance charge but allowed the attorney to be paid the standard $1,500 fee.

THE GLARING FRAUD NOT ADDRESSED BY THE COURT: THE AUTOMATIC STAY VIOLATION

What completely amazes me about this opinion is why the court did not address the obvious fraud this fee arrangement involved:

On May 21, 2020, Mr. Ridings filed a chapter 7 petition and creditor matrix on behalf of Mr. Allen. The schedules, statement of financial affairs, and disclosure of attorney’s fees were filed forty-four minutes later. Mr. Allen received his discharge September 23, 2020.

Forty-four minutes later!!  The Schedules, Statement of Financial Affairs, and the Means Test were filed forty-four minutes later??

What this means is that all of these forms were actually prepared BEFORE the case was filed. This fee arrangement in the Allen case was clearly a fraud.

The entire concept of a bifurcated fee arrangement is that this work is prepared  AFTER the case is filed. That is why attorneys, in theory, are allowed to be paid after the bankruptcy is filed.  Attorneys are allowed to collect post-petition payments because the bulk of the legal work is supposedly performed after the case is filed. But in this case ALL the work was obviously prepared before the case is filed since it was filed only 44 minutes later.

Why should this attorney be allowed to collect a dime for services that were clearly prepared pre-petition?

Why did the 8th BAP not discuss this obvious fraud and automatic stay violation? Why should this attorney be allowed to collect a dime for services that were clearly prepared pre-petition?  How is this not a violation of the bankruptcy stay that prohibits the collection of payments for services rendered pre-petition?

MESSAGE TO FRESH START FUNDING: YOU WILL NOT BE PAID, GO AWAY

The message to Fresh Start Funding and other bankruptcy fee lenders is clear: You will not be paid in the 8th Circuit (which includes Nebraska, Iowa, Missouri, South Dakota, North Dakota, Minnesota, Arkansas and Oklahoma bankruptcy courts.)

In these cases the debtor got what they needed–an affordable payment plan to file bankruptcy. The debtor’s attorney got paid $1,500 which is his standard fee. But Fresh Start Funding will not be allowed to collect the $500 financing fee.  In other words, get lost, you won’t be paid in the 8th Circuit.

A case is pending in the Nebraska bankruptcy court on this exact issue, and it is now abundantly clear how the Court will rule.

 

Image courtesy of Flickr and Rachel Kramer Bussel

 

 

I’ve received ten of these emails in the past year from the Babbs Law Firm based in Orlando, Florida:

“Good morning Attorney Turco,

 My name is Terrylle, and I am reaching out on behalf of the Babbs Law Firm in Orlando, Florida. I found your name looking for lawyers in the Southern District of Iowa for possible establishment of a local counsel relationship with our outside law firm. The Babbs Law Firm does foreclosure defense in Florida and Washington, DC, but has recently expanded to serve homeowners nationwide. The Babbs Law Firm is looking for attorneys to serve as local counsel, or co-counsel, in many jurisdictions around the country.  I’m contacting your firm to find out if your firm might be interested in working with Babbs Law Firm as cases arise in your area. If we have a need to serve a client in your area, we want to have local counsel, or co-counsel, lined up and ready to go.”    

I really had no idea who Sam Babbs was until I saw a new case issued by the South Carolina bankruptcy court imposing sanctions on the Babbs firm.

There has been an avalanche of these types of cases issued throughout the county in recent years and almost all of them involve a highly entrepreneurial attorney who markets bankruptcy services through the internet.  Bankruptcy law is particularly suited for this type of advertising since bankruptcy petitions are fairly generic and the process of preparing a case can be standardized much like Henry Ford did with the assembly line.

The fact is, successful bankruptcy attorneys do create assembly lines.  Smart attorneys should create streamlined preparation methods. They should automate the process to achieve a standard level of excellence for every case prepared.

So it comes as no surprise that our field increasingly sees regional or national firms entering local markets. They advertise well. They are internet savvy. They use telephone salespeople to quickly sign up new customers. Necessary documents can be faxed or emailed or uploaded to a central case preparation factory anywhere in the world.

But these new firms lack one thing: a local attorney to represent clients at the bankruptcy court hearing.

The challenge for these high-tech law firms is to figure out how to create a network of local counsel to show up at court. Warm bodies are needed, and, quite frankly, that is about the only qualification required.

The results of this spoke-and-wheel legal structure is predictable.

  • Clients get lost in the shuffle. They don’t know the name of the attorney who represents them.
  • Local counsel rarely meets the client prior to the bankruptcy court hearing.
  • Bankruptcy petitions are prepared by staff in the central national office.
  • Petitions are prepared by non-attorney staff who lack any courtroom experience and who are compensated by the number of cases prepared instead of the quality of the cases.
  • Communications with the firm are limited to telephone calls with no one person or team assigned to the case. You talk to a new person on the phone every time.
  • Petitions are frequently bare-boned and lack important details to explain the case to the court trustee.

Read the entire Babbs case and all these shortcomings are revealed.

What these national firms don’t  seem to understand is that they have their organizational structure backwards.  The key to a successful national firm is not centralized operations but empowerment of the local counsel.

A national firm should used its centralized powers of technology, advertising, organization and finance to empower local counsel.

A smart national firm should immediately route new customers to speak with local attorneys. Instead keeping costs down by hiring the cheapest local attorney to show up in court, national firms should seek out enterprising local attorneys  who want a partner to handle advertising, technology, accounting and routine management duties so that they can focus on their role of representing clients. Talented local partners do not just want a token payment for being a warm body. They want ownership of their work and profits.

A savvy national firm that empowers its local partners would have a multiplier effect. The national office could answer phones and provide extra paralegal services and provide a template for standardized excellence in service. When times are busy the national office could inject extra personal to prepare cases. When times are slow a national office could tap local counsel to help out other local counsel in busier regions.

A national firm that focuses on making the local partner successful by enabling them to provide superior service is the blueprint for success. But this cannot be achieved if the national leader thinks like a fast food franchisor.

In my firm all new clients speak to an attorney who is then assigned their case for the duration of the matter. We work in teams, and a paralegal is partnered with each attorney to provide clients with an attorney/paralegal team that follows them through every step of the case. You always know who handles your case.  This is the most expensive way to structure a bankruptcy firm, but it also produces the highest quality of work and client happiness.

I’m not interested in being a warm body for the Babbs firm. No self-respecting attorney would.