I.          The Automatic Stay

I wrote:

Simply put, the automatic stay stays all actions by the debtor’s creditors against the debtor as a person (in personam), and against the property (in rem) of the debtor and of the bankruptcy estate that is created upon the filing of the papers.  In practical terms – with a few exceptions listed in § 362(b) – this means that creditors must stop all direct communications with the debtor, all attempts to collect money or other assets from the debtor, all lawsuits against the debtor, and all attempts to exercise control over the debtor’s (or the estate’s) property.  Willful violations of the automatic stay can be expensive mistakes because the debtor who successfully sues in the Bankruptcy Court under § 362(k) can collect damages including costs, attorney’s fees, and punitive damages.

Thus, the automatic stay provides some very important protection to a debtor who files for bankruptcy protection. 

II.        The Chapter 13 Codebtor Stay

If the debtor files under Chapter 13 there is another stay that is triggered that protects, not only the debtor, but also codebtors of the debtor.  Unsurprisingly, it is referred to as the codebtor stay, and it is found in 11 U.S.C. § 1301(a).  The portion I will focus on today is:

[A]fter the order for relief under this chapter, a creditor may not act, or commence or continue any civil action, to collect all or any part of a consumer debt of the debtor from any individual that is liable on such debt with the debtor . . .

Read the rest of this Bankruptcy Code section for its caveats. 

The issue of the codebtor stay arises most commonly when only one member of a married couple files under Chapter 13, perhaps because the nonfiling spouse doesn’t want to file, or is ineligible for a discharge because of a relatively recent previous bankruptcy.  The filing spouse must, of course, list the nonfiling spouse’s debts because of California’s community property law regarding “community debt”:

Except as otherwise expressly provided by statute, the community estate is liable for a debt incurred by either spouse before or during marriage, regardless of which spouse has the management and control of the property and regardless of whether one or both spouses are parties to the debt or to a judgment for the debt.

Cal. Fam. Code § 910(a).

Since the nonfiling spouse is a codebtor, the codebtor stay applies, meaning that the creditors cannot go after the nonfiling spouse.  There are exceptions.  Read the statute for details.

III.       Obtaining Relief Against The Violating Creditor

Given the intimate statutory connection between the automatic stay and the codebtor stay, the injured codebtor could try seeking the relief under 11 U.S.C. § 362(k), which provides:

[A]n individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages . . .

Note in particular, that the relief afforded by this subsection is not limited to the debtor, but extends to any injured individual.  See, e.g., In re Sommersdorf, 139 B.R. 700, 701 (Bankr. S.D. Ohio 1991) (awarding damages to the debtors for the creditor’s violation of the codebtor stay because the legislative histories of § 1301 and § 362 make it clear that both provisions were enacted to protect the debtor).

However, a court might object to an appeal to 11 U.S.C. § 362(k) because of its use of the phrase:  “. . . provided by this section . . .”, since § 362(k) makes no mention of § 1301(a), and § 1301 does not have a provision analogous to § 362(k).

Therefore, in the alternative, the codebtor should also seek relief under 11 U.S.C. § 105(a), which provides:

The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.  No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.

See, e.g., Patti v. Fred Ehrlich, PC, 304 BR 182 (E.D. Penn. 2003) (district court affirming of the bankruptcy court’s finding the creditor in violation of the codebtor stay, and awarding sanctions for civil contempt pursuant to 11 U.S.C. § 105(a)); In re Bertolami, 235 B.R. 493, 498 (Bankr. S.D. Fla. 1999) (granting the debtor’s motion for sanctions for violation of the codebtor stay).

Although I have limited my discussion to the application of the codebtor stay to the case where the codebtors are married to each other, its protection extends to any codebtor – even nonrelatives. 

If you have filed for Chapter 13 protection and a creditor is going after one of your codebtors, seek the advice of a good bankruptcy attorney to learn of your rights and options.

Some time ago I posted an article discussing the consequences of omitting a creditor in a debtor’s bankruptcy papers.  Recently, I had an interesting email exchange with a colleague, that explored the question in a bit more depth.  This post gives you that email exchange.  I hope you find it interesting.  In the interests of privacy I have changed any personal identifiers.

I.        The Question My Fellow Attorney Posed

We all know that per In re Beezley that failure to schedule a creditor in a no-asset Chapter 7 case does not affect the dischargeability of any debts.  This works both ways, in that debts that would be dischargeable (but for failure to schedule) are discharged, but also that debts that would NOT be dischargeable (such as DSO’s, certain taxes, etc.) are not discharged.  My question regards those types of non-dischargeable debts which are not self-executing, namely fraud claims (523(a)(2)).  Since these aren’t really non-dischargeable unless and until a court makes a finding of the requisite fraud, is there any time limit for a creditor to reopen the bankruptcy case to litigate the fraud claim if they weren’t scheduled?

The specific facts I’m dealing with are:  Debtor filed Ch. 7 and got their discharge.  Debtor failed to list a certain creditor.   Debtor later seeks to reopen Chapter 7 case to amend schedules and add creditor.  Court allows it for some reason, and debtor amends.  Creditor files lawsuit in state court against debtor claiming breach of promise and fraud for prepetition debts.

My bigger question is:  Am I “safe” to file an OSC re: contempt for violating section 524 or, per Beezley, was this debt not discharged?

II.       My Response

I offer my thoughts with a suggestion on the OSC motion.

A.          In Re Staffer

In re Staffer, 306 F. 3d 967 (9th Cir. 2002), is interesting because the original debt in question was alleged to have been incurred through fraud.  This fact would appear to implicate § 523(a)(2), and thus, through § 523(c), the 60-day bar of Fed. R. Bankr. Proc. 4007(c).

However, the debtor’s failure to schedule the debt put it into § 523(a)(3), avoiding § 523(c) altogether, and making applicable Fed. R. Bankr. Proc. 4007(b)’s provision (with emphasis added):  “A complaint other than under §523(c) may be filed at any time.”

Moreover, the Ninth Circuit held that:  “[A] separate motion to reopen is not necessary when commencing an action for nondischargeability of a debt under Rule 4007(b) . . .” Staffer, at 969, so the creditor could have filed the adversary complaint without even reopening the case.

By the way, the Court didn’t reject the laches argument:  “[W]e agree with the BAP that the debtor may assert laches as a defense when Predovich’s complaint is filed.”  Id.  The Court’s focus on chronology dealt with the inapplicability of Fed. R. Bankr. Proc. 4007(c) rather than laches.

Next, to your question.

            B.         In Re Beezley

The Beezley Court held:  “If the debt is of a type covered by 11 U.S.C. § 523(a)(3)(B), it has not been discharged, and is non-dischargeable.”  In re Beezley, 994 F. 2d 1433, 1434 (9th Cir. 1993) (emphasis added).

Section 523(a)(3)(B) (with emphasis added) excepts from discharge any debt

neither listed nor scheduled under section 521 (a)(1) of this title, with the name, if known to the debtor, of the creditor to whom such debt is owed, in time to permit— . . . if such debt is of a kind specified in paragraph (2), (4), or (6) of this subsection, . . . timely request for a determination of dischargeability of such debt under one of such paragraphs, unless such creditor had notice or actual knowledge of the case in time for such timely filing and request . . .

The Beezley Court’s holding is expanded on in the concurrent opinion:

If the debt flows from an intentional tort “of a kind specified” in the relevant paragraphs [i.e., § 523(a)(2), (4), and (6)], the debtor’s failure to schedule in time to provide notice to the creditor of the need to seek an adjudication of dischargeability is conclusive (at least in the absence of actual knowledge of the bankruptcy on the part of the creditor).  The debt is not discharged.

Beezley, at 1437 (emphasis added).

In sum, an unscheduled fraud debt is not discharged, and amending the schedules after the 60-day bar date will not change that fact:

Reopening a case does not extend the time to file complaints to determine dischargeability.  Either the creditor had actual, timely notice of the [case] or he didn’t.  Amending the schedules will not change that.

Beezley, at 1437 (internal quotes omitted).

Therefore, your client’s amending of the schedules had no effect on the question of discharge.  If the debt was a fraud debt it was not discharged.

            C.       Limit Your OSC Motion To The Breach Of Promise Action

In light of the above discussion, I do not think that the creditor’s fraud action in state court is improper – though the breach of promise action clearly is – because the fraud portion of the debt was not discharged.  Therefore, the state court fraud action may be characterized as the legitimate vehicle for determining the liquidated value of the debt.  Consequently, I suggest that you limit your OSC motion to the impropriety of the breach of promise action and exclude the fraud action from its ambit.

III.     My Friend’s Follow Up Email

So if the debt on the fraud claim is not scheduled, then it is automatically non-dischargeable without ever filing a 523 action?

IV.     My Follow Up Response

If the unscheduled debt was incurred through fraud, then the holding in Beezley is that it was not discharged.  However, it seems to me that there are three options you should consider as a way to perhaps make the debt dischargeable, and therefore discharged.

First, the debtor could file a complaint under a combination of § 523(a)(3)(B) and Fed. R. Bankr. Proc. 4007(b) to get a determination of dischargeability.  Nothing in Rule 4007(b) restricts the filing of such a complaint to the creditor.  If you win, the debt is discharged.  Of course, you have to incur the costs and attorney’s fees to get the determination, so a cost/benefit analysis is necessary before proceeding down this path.  Moreover, there is no a priori guarantee of victory, so you might end up throwing money into the wind.

Second, you could fight the state court action.  If you win, then there is no debt to discharge.  Moreover, if the creditor’s action was genuinely without merit, after winning you could sue the creditor for filing a frivolous suit in the first place.  This approach also has the drawback of upfront costs and attorney’s fees, without any guarantee of recovering them if there is a subsequent suit for frivolous prosecution.  And once again, you might lose.  In addition, this approach may take much more time to resolve, as the state courts are very backed up these days.

Third, you could file the OSC motion without mentioning the specific state court causes of action – a sort of generic OSC motion – and hope that it dissuades the creditor from continuing the state court action.  Best case scenario:  you settle before the hearing on the OSC motion.  Worst case scenario:  the creditor correctly appeals to the holding in Beezley, or the judge, sua sponte, applies Beezley and sanctions you for filing a meritless OSC motion.

The success of this third approach obviously depends on the bankruptcy law sophistication, or lack thereof, of the state court action attorney.  The fact that the pending state court action has a breach of promise cause of action thrown in suggests that your opponent is unaware of Beezley, since under Beezley’s holding that debt was discharged.

I had a case a few years ago in which a state court attorney blew the 60-day bar (inapplicable in your case, of course) by staying a state court action without filing a § 523(c)  action in the bankruptcy court.  The attorney had a serious lack of bankruptcy law knowledge, which worked to my client’s advantage.

Rescission is a way for a borrower to get out of a mortgage that was fraudulently or deceptively originated.  For example, if the lender misrepresented the terms of the mortgage by failing to disclose a balloon payment, or the nature of the adjustable rate, or advised the borrower to inflate income to qualify for a larger loan – gasp! does this sort of thing ever happen? up until recently, all the time – the borrower may cancel the loan.

II.        The Legal Foundation For Mortgage Rescission

The main statutory vehicle for rescission is the Truth in Lending Act (“TILA”), 15 § U.S.C. 1601 et seq., and its regulatory partner, Regulation Z, 12 C.F.R. 226.31, et seq..  TILA and Regulation Z are complicated, so it is easy for a creditor to violate them.  The most common violations involve inadequate disclosures.  See 15 U.S.C. §§ 1638(a)-(b)(1) for some of the required disclosures.  Regulation Z has its own plethora of required disclosures.

III.       Rescission Of Non-purchase Money Loans

For a non-purchase money loan such as a refinancing or a HELOC, the lender must also provide notice – two copies to each borrower (thus, if the borrower has a multiple personality disorder with more than two personalities, then some of the personalities will have to share) – that the borrower may void or “rescind” the loan within three business days of the transaction.  However, the right to rescind can be extended well beyond three days if the lender fails to give adequate disclosure.  The relevant language from Regulation Z states:

When the creditor has failed to take the action necessary to start the three-day rescission period running, the right to rescind automatically lapses on the occurrence of the earliest of the following three events:

• The expiration of three years after the occurrence giving rise to the right of rescission.

• Transfer of all the consumer’s interest in the property.

• Sale of the consumer’s interest in the property, including a transaction in which the consumer sells the dwelling and takes back a purchase money note and mortgage or retains legal title through a device such as an installment sale contract.

Thus, the borrower could have three years to rescind the mortgage contract!

IV.       From Secured To Unsecured Status

Rescission of the mortgage voids the lender’s security interest in the property, and converts the debt to unsecured status.  The lender is required to return the interest portion of the mortgage payments it received, and the borrower must return the amount borrowed, minus principal already paid.  The borrower may, of course, need to take out a new loan to get the money to repay the principal, but if the rescinded loan’s terms were onerous, the borrower may be able to get a loan with better terms.  Since the early loan payments are mostly interest, this means that the borrower could effectively enjoy a three-year interest-free loan.

Outside of bankruptcy the rescinding borrower has to pay back the money received from the lender.  In bankruptcy the debtor can rescind the mortgage, thus rendering the debt unsecured, and then modify or discharge the debt as part of the bankruptcy.

As you might expect, rescission is not self-executing (the Lord High Executioner in Gilbert & Sullivan’s operetta, The Mikado, would undoubtedly sympathize) and requires court intervention.  Therefore, to successfully rescind a mortgage and treat it as an unsecured debt in bankruptcy, the debtor must convince the judge that TILA and Regulation Z really were violated by the lender.

V.        Rescission In Chapter 7

The successful Chapter 7 debtor could in theory rescind a mortgage, thus converting it to unsecured status, and discharge it in a Chapter 7 bankruptcy – in essence, getting a free house out of the process.  However, in practice this is rare.  Indeed, in Yamamoto v. Bank of New York, 329 F. 3d 1167 (9th Cir. 2003) the Ninth Circuit held that a court – bankruptcy or district – had discretion to condition rescission on the return of the principal.  And if the TILA action is unsuccessful, the lender may file a lawsuit to recover costs and attorney’s fees, alleging that the TILA action was frivolous.  It is worth noting that while a court can condition rescission on return of principal, it is not required to.  See, e.g., Botelho v. US Bank, N.A., 692 F. Supp. 2d 1174 (N.D. Cal. 2010).

Of course, in the highly unlikely event that the debt is discharged in its entirety and the debtor gets a “free house”, the nonexempt equity would be liquidated by the Chapter 7 Trustee for the benefit of creditors.  Sorry – no free lunches here.

VI.       Rescission In Chapter 13

How does this play out in Chapter 13?  In theory the debtor could rescind, and deal with the now unsecured debt through the Chapter 13 plan; perhaps paying a relatively small percentage of the debt over the life of the plan, and discharging the remaining balance upon receiving a Chapter 13 discharge.  Unfortunately, in practice things are not quite so easy.  Two obvious problems conspire to make rescission a potentially weak Chapter 13 tool.

A.        The Sudden Surge In Nonexempt Equity

First, after the rescission the debtor may suddenly have a great deal of nonexempt equity in the property.  This can create a problem due to the Chapter 7 liquidation test for Chapter 13.  This Chapter 13 plan requirement, which is found in 11 U.S.C. § 1325(a)(4), specifies that the plan must repay the general unsecured creditors at least the amount they would have gotten if the nonexempt assets had been liquidated in a Chapter 7 bankruptcy.  Therefore, mortgage rescission could end up forcing the debtor to make impossibly large plan payments.

B.        Too Much Unsecured Debt For Chapter 13

Second, since rescission converts the previously secured debt to unsecured status, the debtor’s unsecured debts may exceed the Chapter 13 unsecured debt limit of $360,475 found in 11 U.S.C. § 109(e), thus rendering the debtor ineligible for Chapter 13 relief.

C.        Rescission:  The Lien Strip Alternative

In spite of the negatives just mentioned, rescission may provide a way to strip off a second mortgage, even if it isn’t wholly unsecured – i.e., when a Lam motion (discussed in my last post) can’t be done.  In other words, if rescission is available it can provide a way around the bifurcation prohibition of Nobelman v. American Savings Bank, 508 U.S. 324 (1993) discussed in my previous post.

Thus, if the debtor is underwater, but not sufficiently to strip off a HELOC through a Lam motion – i.e., there is some house behind the HELOC – the debtor may still be able to use rescission to strip off the second if the lender violated TILA and Regulation Z.

There are forensic experts who, for a fee, will review your client’s mortgage to determine whether a TILA lien strip is possible.  However, their services are not free, so impecunious clients may be reluctant to pay for them in the absence of a guarantee of success – which an attorney obviously cannot give.

I.          Lien Stripping On The Debtor’s Primary Residence

First the bad news:  In Nobelman v. American Savings Bank, 508 U.S. 324 (1993) the U.S. Supreme Court held that an under-secured – i.e., “partially secured” – mortgage on the debtor’s primary residence is protected up to the full amount of the debt in the sense that the unsecured portion cannot be stripped off.

Now the good news:  Any wholly unsecured mortgage on the debtor’s primary residence can be stripped off and treated as if it were ordinary general unsecured debt.  Thus, a second mortgage can be stripped off, put into the Chapter 13 plan, and paid off at the same percentage as the other general unsecured debts – which is usually a small percentage.  This means that the debtor can have the second mortgage extinguished in five years, after having paid only a small percentage of that mortgage.

The authority for this lien stripping is In re Zimmer, 313 F.3d 1220 (9th Cir. 2002), though the vehicle used is usually called a Lam motion after In re Lam, 211 B.R. 36 (B.A.P. 9th Cir. 1997).

The key element in a Lam motion is to show that the second mortgage is 100% unsecured.  To do this the debtor must establish that the current balance on the first mortgage is greater than the value of the house.  If there is even one dollar of house value behind the second mortgage, the lien cannot be stripped.  As a consequence, if the value of the house is very close to the current balance on the first, the holder of the second mortgage will put up a fight over the value of the house.

It is important to get an unbiased appraisal – not from the debtor’s friend or relative – from an appraiser who is willing to sign a declaration under penalty of perjury regarding the value of the property.  This is important because the appraisal by itself, without the declaration, is inadmissible hearsay.

One cautionary note is in order:  When the debtor strips off a second, the second becomes an unsecured debt for plan purposes.  This means the unsecured debt will now be much larger than what was originally listed in Schedules E and F.  The result could render the debtor ineligible for Chapter 13 relief if the unsecured debt now exceeds the $360,475 limit found in 11 U.S.C. § 109(e).  Therefore, before stripping off the second be sure that you won’t end up destroying the entire Chapter 13 bankruptcy.

II.        Lien Stripping Other Than On The Debtor’s Primary Residence

A Chapter 13 debtor is permitted to modify the rights of secured creditors as long as the collateral is not the debtor’s primary residence.  See 11 U.S.C. § 1322(b)(2).  For example, the debtor can modify the terms of an under-secured  mortgage on rental property.

However, unless the creditor agrees otherwise, the debtor must pay the entire modified debt in equal monthly payments over the life of the plan  – which, as we have already seen, in Chapter 13 cannot exceed sixty months .  This requirement makes it unlikely that most debtors will attempt to modify a mortgage on rental property in a Chapter 13.

In my next post I’ll discuss another way to strip off a second mortgage in Chapter 13:  rescission.  Stay tuned.

Chapter 13 plans typically last either three or five years, with five years being the statutory maximum.  See 11 U.S.C. § 1322(d)(1)(C) and (d)(2)(C).  Each month during the pendency of the plan the debtor sends a plan payment to the Chapter 13 Trustee assigned to the case.  The Trustee in turn sends payments to the creditors according to the terms of the confirmed plan.  At the end of the plan any remaining scheduled unsecured dischargeable debt is discharged.

One attractive feature of Chapter 13 for the debtor wanting to keep collateral securing a debt is the chance to catch up on the payments.  For example, the debtor can use the plan to pay off a mortgage arrearage over the life of the plan, rather than having to immediately become current as in a Chapter 7 bankruptcy.

Another benefit is that the debtor does not have to surrender any nonexempt assets:  the debtor gets to keep everything.  Why?  The short answer is because in the plan the debtor makes monthly payments to pay creditors.  However, as we shall see, the value of the debtor’s nonexempt assets provides a starting point for the size of the monthly plan payments.

How much are the monthly payments?  In order to answer that question we need a little background.  In particular, we must observe that a Chapter 13 plan must satisfy three basic criteria.  These three criteria contain the essence of 11 U.S.C. § 1322.

I.          The Three Basic Requirements Of A Chapter 13 Plan

A.        The Chapter 7 Liquidation/Best Efforts Test For Chapter 13

The plan must ultimately pay the general unsecured creditors  at least as much as they would have received had the debtor done a Chapter 7.  See 11 U.S.C. § 1325(a)(4).  Huh?  I thought that in a Chapter 7 all dischargeable debts were simply erased.  Doesn’t that mean that the creditors get nothing?  Not quite.  If the debtor has nonexempt assets, the Chapter 7 Trustee will seize and sell them for the benefit of the unsecured creditors.  Thus, the bare minimum the Chapter 13 plan must pay out over its lifetime is the lesser of:  (a) 100% of the total unsecured debt, and (b) the dollar value of the nonexempt property.

1.        Listing Assets

One of the many things included in a set of personal bankruptcy papers is a complete listing of everything the debtor owns – even down to the clothes on the debtor’s body.  Schedule A is where real property is listed and Schedule B is where personal property is listed.  All of the assets are then divided into exempt and nonexempt categories.  In a Chapter 7 bankruptcy the debtor keeps everything that is exempt, while the Chapter 7 Trustee seizes and sells any nonexempt property for the benefit of creditors.  This loss of nonexempt property in Chapter 7 is one reason why some debtors decide against seeking Chapter 7 relief.

In contrast to Chapter 7, in a Chapter 13 bankruptcy the debtor keeps all assets – both exempt and nonexempt.  However, we still list everything and divide it into exempt and nonexempt categories so we can determine the dollar value of the nonexempt assets.  That dollar value is the amount that would have been paid to the general unsecured creditors in a Chapter 7 bankruptcy, and it becomes the starting point for the total Chapter 13 plan payout to those creditors.

2.        Exempting Assets

11 U.S.C. § 522 has the Bankruptcy Code’s exemption table.  However, § 522(b)(3) permits a debtor to use a given state’s exemption table if the debtor is eligible to use that state’s table.  California has two tables:  one for homeowners with equity in their primary residence  – the homeowner’s equity exemption cannot be used to exempt rental property – and the other for renters and homeowners with no equity.

One benefit of using the renter’s table is the availability of the “wild card” exemption , which gives the debtor an additional $23,250 worth of exempting power over the other categories.  This exemption is particularly useful in exempting cash, stocks, bonds, and cars.  The car exemption – which can only be used on one vehicle – in the renter’s table is only $3,525, and only $2,725 in the homeowner’s table.  Therefore, for most Chapter 7 debtors the wild card is essential in protecting cars.

Note:  You cannot mix and match the tables.  It’s either the federal table, the homeowner’s table, or the renter’s table, for the entire case.

3.        Application To Chapter 13

After exempting as much of the assets as possible, compare the dollar value of what’s left – the nonexempt property – with the value of the general unsecured debts.  Whichever is less is the starting point for the Chapter 13 plan – the bare minimum that must be paid out to the general unsecured creditors over the life of the plan.

B.        The Fairness/Disposable Income Test For Chapter 13

The plan must be fair.  Don’t you just love vague terms in law?  Well, it turns out that this is one time we can make the term “fair” very precise.

There are two possibilities:  either (1) the plan proposes to pay back 100% of the general unsecured debt over its lifetime, in which case the plan is by definition fair, or (2) the debtor must devote 100% of his or her projected disposable monthly income to the plan.  The bankruptcy concept of projected disposable monthly income is a bit complicated.  I’ll discuss it in a future post.  For now, just think of it as the money left over each month after subtracting taxes and reasonable living expenses from gross income.  As a shorthand, I’ll call it DMI.

C.        The Feasibility Test For Chapter 13

The plan must be feasible.  The basic idea here is that the plan must satisfy the first two requirements (i.e., the Chapter 7 liquidation test and the fairness test), leave enough for the debtor to live on, and treat certain special creditors they way they are entitled to be treated.  This “definition” is, admittedly, less than satisfying.  The following three simple examples illustrate what can go wrong, and lead to plan infeasibility.

Example 1:

Suppose the debtor’s nonexempt assets are worth $60,000 and the debtor’s general unsecured debt is $100,000.  Then according to the Chapter 7 liquidation test the debtor must pay at least $60,000 to the general unsecured creditors over the life of the plan.  For simplicity assume the plan will last sixty months.  This translates into plan payments of $1,000, plus Trustee fees (usually 11 percent), for a total of say $1,110 per month.  Suppose in addition that the debtor’s DMI is $500, meaning that the debtor has a total of $30,000 (= $500 × 60) to pay into the plan over the requisite five years.  Then the debtor has insufficient income to support the plan.  The plan is infeasible.

Example 2:

As in the previous example, suppose the debtor’s DMI is $500, meaning that in a five-year plan the debtor can pay at most a total of $30,000.

Suppose further that the debtor has a $60,000 income tax liability that is a priority debt .  Then the tax liability must be paid in full  over the life of the plan, unless the taxing authority agrees to be paid less.

However, since the debtor can only pay $500 per month for a total of $30,000, the plan is infeasible.

Example 3:

Suppose, once again that the debtor’s DMI is $500.

Suppose further that the debtor is behind on his or her mortgage payments by $30,000.  The debtor can put the mortgage arrearage into the plan and spread the paying off of it – in full, of course – over the plan’s five years.  See 11 U.S.C. § 1322(b)(3).  However, the debtor must also pay the contract interest rate.  See 11 U.S.C. § 1322(e); cp. Till v. SCS Credit Corp., 541 U.S. 465 (2004).  Therefore, even if we ignore Trustee fees – though you can be quite certain that the Trustee will not do so – this means that the debtor must pay more than $30,000 just to cure the arrearage over the life of the plan.  Unfortunately, in a five-year plan at $500 per month the debtor would only be able to pay a total of $30,000.  Therefore, the plan is infeasible.

II.        Conclusion

This post has just scratched the surface of Chapter 13.  And the post has elided over some significant complications in the three factors discussed.  The reality is too complicated for a person without an attorney.  If you’re interested in Chapter 13 as a way to deal with overwhelming debt, don’t go it alone.  Contact a good bankruptcy attorney to take you through the process.

Can you really get that bankruptcy legally removed from your credit report? If only it were so easy.

After bankruptcy you’re looking to rebuild your credit. That’s understandable because you want to be able to get financing for a car or a new home at some point.

You do some searching online, or maybe you get a letter in the mail from a reputable-looking company that promises to remove that pesky bankruptcy from your credit report immediately. Your bankruptcy lawyer told you it would show up on your credit report for ten years.

Remember grandma, who said that if something sounds too good to be true then it likely is.

The Fair Credit Reporting Act governs the information on your credit report, and exists to ensure accuracy of information. Note that it does not mention anywhere that you’ve got to like what’s showing up – just that it’s correct.

If you file for bankruptcy, that’s a fact. There’s nothing that will change it. You can rail against the system, but it’s not going to provide solace or lead to a different outcome.

Disputing The Bankruptcy On Your Credit Report

The Fair Credit Reporting Act does, however, give you a mechanism for disputing inaccurate information on your credit report. When you send in a dispute letter to the credit reporting agency, they’ve got a responsibility under the law to investigate. If the information can’t be verified within thirty days, it must be removed.

So here’s the trick that many “credit repair companies” use. They send in a dispute letter demanding removal of the bankruptcy as well as anything else you don’t happen to like. If the information is verified, another letter goes out. On and on until someone fails to verify the information, or the credit reporting agency gets sick and tired of being bothered.

At that point, the company proudly shows you that the information is gone.

Sounds Sweet, Right?

Not so much. First of all, you’ve got a company making inaccurate and fraudulent statements to a third party. I’ve never seen a consumer prosecuted, but it doesn’t pass the smell test to me.

Second, you forget that most credit information is updated every 30-90 days. So that negative information is sure to come back at some point.

Third, you’re paying a company to write letters for you. Do you really have that much spare change sitting around that you can afford to throw cash out the window on a futile and dishonest endeavor?

The (Not So) Bad News

The bankruptcy is going to stay on your credit report for up to ten years, and there’s nothing you can do about it. But the truth is that nobody cares – even your future creditors.

Credit is largely a matter of recency. What you did last month is more important than what you did last year assuming, of course, that you’ve done good things in the more immediate past. Set to work on adding good information to your post-bankruptcy credit report and you’ll be just fine.

Jay S. Fleischman is a bankruptcy lawyer who concentrates in helping people fight back against debt collection harassment after bankruptcy. He has never seen a credit repair company that can successfully eliminate accurate information, and hates seeing people get taken for a ride.

Image credit:  cybertoad

I.          Debt Collector Abuses

A.        Whole Lotta Collectin’ Goin’ On

In the February 16, 2012 Los Angeles Times, Jim Puzzanghera reported on the recently formed Consumer Financial Protection Bureau and noted:

Debt collection has been second only to identity theft in consumer complaints to the Federal Trade Commission in recent years. The bureau estimated that 30 million Americans have debts in the collection process.

Thirty million!  Wow!  That’s one-tenth of the entire U.S. population.  So it’s not just my clients who are facing debt collection agencies and their corrupt and abusive tactics.  And given the volume of complaints it appears that abuses by debt collectors are widespread – it’s not just a few bad apples.

B.        We Don’t Need To Obey No Stinkin’ Laws

Mr. Puzzanghera reported:

“It will improve things immensely because most debt collectors are operating in an either illegal or amoral way,” said Bill Bartmann, chief executive of debt collection company CFS II in Tulsa, Okla., who has been a longtime critic of some industry practices.

The debt collectors know they’re doing wrong, but do it anyway because the devil makes them do it.  Oops.  I meant to say that they view the occasional pesky lawsuit filed by an abused debtor or government agency is just part of the cost of doing business.  In fact:

One of the nation’s largest firms, Asset Acceptance, agreed to pay a $2.5-million civil penalty in January to settle a Federal Trade Commission lawsuit for misrepresentations in dealing with consumers, including failing to disclose when a debt was too old to be legally collected.

As a bankruptcy attorney I see abuse by collectors all the time.  It’s nice to see that someone with governmental authority sees it too.

C.        Pssst:  Wanna Buy A Discharged Debt?

One fascinating abuse involves the marketing of discharged debts.  Debt collectors buy and sell debts that were discharged in bankruptcy.

As you might have guessed, such debts are called zombie debts because they eat brains – oops, I mean because they come back to life after they died.

What can be done?  If a debt collector attempts to collect a discharged debt from you, file a motion to reopen your case to sue the collector for violating the discharge injunction of 11 U.S.C. § 524(a).

D.        Violations Of The Automatic Stay

Filing for bankruptcy protection triggers the automatic stay of 11 U.S.C. § 362(a), which, inter alia, stays all attempts to collect on prepetition debts.  Most of the time collection agencies abide by the stay, but recently I have seen an increase in stay violations.  Garnishment of wages, sending the debtor bills, and the like – all postpetition (I.e., after the bankruptcy petition is filed), and after clear notice of the filing – are happening with alarming frequency.  The collectors must be making enough money collecting in this fashion because, as I said before, my suits are just the nuisance cost of doing business.

II.        Corruption In The Sheriff’s Department

One shocking repeat offender is the Sheriff!  I have seen multiple wage garnishments after a given bankruptcy filing, even in the face of clear notice.  And the Sheriff simply refuses to return the funds garnished postpetition in spite of the fact that federal law requires it.  Indeed, I have even had the Sheriff refuse to return garnished funds after I produced an order signed by a bankruptcy judge ordering the return of the money!

Since sovereign immunity with regard to the automatic stay has been waived in 11 U.S.C. § 106(a) – this provision was upheld by the U.S. Supreme Court in Central Va. Community College v. Katz, 546 U.S. 356 (2006) – the Sheriff’s behavior is without excuse.

The Sheriff’s department has recently been in the news over the beating of inmates.  And the deputies union is fighting tooth and nail to prevent investigators from seeing the personnel files of the deputies who participated in the beatings.  Perish the thought that investigators would be permitted to see incriminating evidence against corrupt cops.  Apparently, there must be a deputy/Sheriff privilege that I didn’t learn about in law school.

I wonder if the deputies union is familiar with this language from the Sheriff’s website:

As Sheriff of our nation’s largest county serving ten million people, my responsibility for public safety requires constant action, innovation, strong core values, cutting edge technology, positive political partnerships at the federal, state, and local level.  Also required is a daring to be different, no fear of criticism, transparency regarding our mistakes, full respect and cooperation with the media, and big ideas.

If the Sheriff’s department sees nothing wrong with beating inmates, it’s not all that surprising that they see no reason to comply with federal bankruptcy law, and nothing wrong with stealing garnished funds.  It looks like the corruption has infected large swaths of the department.  After all, a little leaven leavens the whole lump.

III.       The Anti-Constitutional Supreme Court Justice

Speaking of troubling words and deeds from on high, the Los Angeles Times recently reported that U.S. Supreme Court

Justice Ruth Bader Ginsburg traveled to Egypt and Tunisia with her daughter to celebrate the “Arab Spring” on a trip arranged by the State Department. She raised eyebrows when she told an Egyptian interviewer she would not recommend America’s “18th century” Constitution as a model, pointing to the South African Constitution as more fitting for a new democracy.

The New York Times expanded on Justice Ginsberg’s recommended constitutional reading list to the Egyptian audience:

In a television interview during a visit to Egypt last week, Justice Ruth Bader Ginsburg of the Supreme Court seemed to agree. “I would not look to the United States Constitution if I were drafting a constitution in the year 2012,” she said. She recommended, instead, the South African Constitution, the Canadian Charter of Rights and Freedoms or the European Convention on Human Rights.

And lest you think the Los Angeles Times and the New York Times took Justice Ginsberg out of context, you can watch the entire interview to see for your self.

Hmmm.  One of the nine Supreme Court justices has such a low opinion of the U.S. Constitution that she prefers the South African Constitution, the Canadian Charter of Rights and Freedoms, and the European Convention on Human Rights instead.  It makes me wonder how that position informs her constitutional reasoning when she authors the opinions of that august court?  Shouldn’t there be some requirement that a Supreme Court justice be pro-U.S. Constitution?

What was that sound, Justice Ginsberg?  It was freedom of speech being dashed on the rocks of the European Convention on Human Rights:

Europeans lack an American-like First Amendment, which means they can be punished for expressing the “wrong” opinions. But Europe’s war on free speech should serve as a warning to Americans about the perils of complacency. Indeed, the Obama administration says it intends to “strengthen federal hate crimes legislation, expand hate crimes protection by passing the Matthew Shepard Act, and reinvigorate enforcement at the Department of Justice’s Criminal Section.” Some politicians have also expressed support for re-imposing the Fairness Doctrine, which would effectively censor the opinions of tens of millions of Americans.

Moreover, the New York Times warns that

Europe’s suppression of free speech is guaranteed to spawn and incubate precisely the kind of bigotry and sectarian violence it is intended to prevent.

As for the Canadian Charter of Rights and Freedoms championed by Justice Ginsberg, the Boston Globe observed:

The laws as they were written were a recipe for censorship, and the meal has now been cooked.  Worse, the legal restrictions on free speech have contributed to a climate where freedom of thought and speech is considered a disposable value. During a 2008 case examining a white supremacist, a lead investigator for the Human Rights Commission was asked what value she gave to the freedom of speech. She responded: “Freedom of speech is an American concept, so I don’t give it any value. It’s not my job to give value to an American concept.’’

Finally, check out the South African Constitution.  Do a search on “speech” or “freedom of speech” and you will find that freedom of speech is available for “Cabinet members, Deputy Ministers and members of the National Assembly” (section 58), “Delegates to the National Council of Provinces” (section 71 – see also sections 66 and 67), and “Members of a provincial legislature and the province’s permanent delegates to the National Council of Provinces” (section 117).  Notice anyone left out?  Everyone who is not a cabinet member, government minister, or elected official is left out in the cold.

As for freedom of the press, here’s Amnesty International’s take on recent developments in South African law:

The South African parliament’s approval of a draconian secrecy bill which could see journalists and whistleblowers in prison for investigating state wrongdoing is a worrying development for the country, Amnesty International said today.  The bill, which could see journalists facing up to 25 years in prison for publishing information which state officials want to keep secret, was overwhelmingly approved in parliament, with 229 votes to 107.

If Justice Ginsberg is thoughtful enough to opine on the advisability of using the South African Constitution, the Canadian Charter of Rights and Freedoms, or the European Convention on Human Rights over the U.S. Constitution only after having read these documents and seeing their provisions in practical application, then what on earth is her view of the First Amendment’s freedom of speech and freedom of the press provisions?  If she is not alone on the Court in holding these views, the future does not bode well for freedom of speech and freedom of the press in America.  Stay tuned.

By the way, although some articles on that site are ghost-written, I really did write the article.

I.          Discharging Taxes In Bankruptcy

There are two possible scenarios:  discharging taxes in a bankruptcy other than a completed Chapter 13 plan, and discharging them through a completed Chapter 13 plan. 

A.        Discharging Taxes Other Than In A Completed Chapter 13 Plan

To discharge an income tax debt in a Chapter 7, 11, or 12 bankruptcy, or through a Chapter 13 hardship discharge without completing the plan, the tax debt must satisfy three requirements.

1.        File Bankruptcy Three Years From The Due Date Of The Return

The day you file your bankruptcy papers must be more than three years after the date your return was due – with extensions.  For example, if the tax year in question is 2007, then the date your return was due, with extensions, was October 15, 2008 – not April 15, 2008.  Therefore, to satisfy this requirement you can’t file the bankruptcy papers before October 16, 2011.  Notice that this requirement does not focus on whether you actually filed the return, just on when the return was due.

If you’ve looked at 11 U.S.C. § 523(a)(1) – the subsection dealing with the non-dischargeability of tax debt – you might wonder where I got this three-year requirement.  The wording of that subsection:

A discharge under section 727, 1141, 1228 (a), 1228 (b), or 1328 (b) of this title does not discharge an individual debtor from any debt—

(1) for a tax or a customs duty—

(A) of the kind and for the periods specified in section 507 (a)(3) or 507 (a)(8) of this title, whether or not a claim for such tax was filed or allowed;

(B) with respect to which a return, or equivalent report or notice, if required—

(i) was not filed or given; or

(ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition; or

(C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax;

makes no mention of this three-year requirement.  This requirement comes from the reference in the underlined portion to 11 U.S.C. § 507(a)(8), which focuses on:

. . . a tax on or measured by income or gross receipts for a taxable year ending on or before the date of the filing of the petition— (i) for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition . . .

2.        Two Years From The Date Of Filing The Return

You must have actually filed a legitimate, non-fraudulent return for the tax year in question at least two years before you file your bankruptcy papers.  This is what 11 U.S.C. § 523(a)(1)(B) quoted above is all about.  Continuing with the previous example, for you to be able to file bankruptcy papers on October 16, 2011, you must have actually filed the return no later than October 15, 2009.  By the way, if the IRS or FTB files a “substitute for return” on your behalf because you never filed a return, then you can’t satisfy this requirement.  The moral:  file your returns each year.  You never know when that might come in handy.

3.        Two Hundred Forty One Days After The Assessment

The third requirement to get rid of the tax debt focuses on the date the taxing authority assessed the tax debt – i.e., entered it into its records as a legitimate tax debt that you owe.  If you’re going to get rid of the debt, then they cannot have assessed the tax debt during the 240-day window immediately prior to your filing the bankruptcy papers.  Thus, in the previous example, if you wanted to file your bankruptcy papers on October 16, 2011, the taxing authority cannot have assessed the tax after February 18, 2011.  This particular requirement can be problematic because the 240-day clock is tolled during an offer-in-compromise, plus 30 days, and during any time in which a stay of proceedings against collections in a prior bankruptcy was in effect, plus 90 days.  See 11 U.S.C. § 507(a)(8)(A)(ii).  In applying this third requirement, you can determine the appropriate chronology by reviewing your tax transcript, which you can order from the taxing authority.  Then file 241 days after the assessment.

In sum, an income tax debt that satisfies all three of these requirements is dischargeable under any chapter.  However, things are less stringent in a non-hardship Chapter 13 discharge.

B.        Discharging Income Taxes In A Completed Chapter 13

There are two ways you can receive a Chapter 13 discharge.  First, you can receive a non-hardship discharge under 11 U.S.C. § 1328(a) by making all of your Chapter 13 plan payments.  Second, you can receive a hardship discharge under 11 U.S.C. § 1328(b), without making all of the plan payments, if:  (1) you become unable to complete the plan due to circumstances beyond your control, (2) you have repaid your general unsecured creditors through the plan at least as much as they would have received if you had done a Chapter 7 liquidation, and (3) modification of your plan is not practicable.

The difference in federal income tax dischargeability between the non-hardship and hardship discharges lies in 11 U.S.C. § 523(a)(1)(A) quoted above.  That provision does not apply to a completed Chapter 13 discharge.  Thus, the three-year and 240-day rules do not have to be met.

II.        Making The Shortened Tax Year Election

A.        Splitting The Tax Year In Two

If you file a bankruptcy under either Chapter 7 or 11, you can split the year you file into two shortened tax years.  The enabling statute is from the Internal Revenue Code:  26 U.S.C. § 1398(d)(2).  If you choose this election, the first shortened year begins on January 1, and ends on the day before you file the bankruptcy papers.  The second shortened year begins on the bankruptcy filing day and ends on December 31.

If you make this election, then any tax you owe for the first shortened tax year becomes an allowable claim against your bankruptcy estate, as a claim arising before your bankruptcy filing.

If you don’t make the election, then the IRS can’t collect any of that year’s income tax liability from the liquidation of any nonexempt assets in your bankruptcy estate.  However, the IRS can certainly collect the tax from your postpetition earnings – i.e., the money you make after you file your bankruptcy papers.

B.        You Have To Have Nonexempt Assets To Make The Election

An important limitation to splitting the tax year in two is the requirement you have nonexempt assets.  These assets are, of course, available to pay your creditors – including the IRS – in your bankruptcy.

If you have some nonexempt assets, and if you have a tax liability for the prepetition portion of the year, then it makes sense to make the election.  This is because the tax liability for the first shortened year is a prepetition claim that will be paid, at least in part, from the proceeds of the liquidation of your nonexempt assets – which you wouldn’t get to keep anyway.  Consequently, your effective personal tax obligation for the year is reduced by the amount paid through the bankruptcy estate liquidation.

III.       Conclusion

The interaction between income tax law and bankruptcy law is vast and extremely complex.  To get a more complete picture of the interaction between tax law and bankruptcy law, and its application to your circumstances, please discuss your case with a knowledgeable Los Angeles and Orange County bankruptcy lawyer.

I.          The Five Exceptions To Cancellation Of Debt Income Tax

When a creditor forgives a debt you owe, the forgiven debt is usually credited to you as income for tax purposes.  The typical scenario these days involves the loss of a home in a foreclosure or a short sale.

Due to a provision in California real estate law, if the lender comes up short after the sale, it cannot come after you for the deficiency.  Instead, it will report the loss to the IRS and the Franchise Tax Board (“FTB”).  When it does, it will send you a 1099-C Form, listing the amount of debt it had to cancel.  This is your cancellation of debt income, and it’s taxable unless it falls within five exceptions listed in the Internal Revenue Code, and incorporated into the California Revenue & Taxation Code.

Those five exceptions are:

• the discharge – i.e., the debt forgiveness – occurred in a bankruptcy,

•the discharge occurred when you were insolvent,

•the indebtedness discharged was qualified farm indebtedness,

•in the case of a taxpayer other than a C corporation, the indebtedness discharged was qualified real property business indebtedness, or

•the indebtedness discharged was qualified principal residence indebtedness which was discharged before January 1, 2013.

For the first exception to apply, you have to have filed the bankruptcy before the debt was forgiven.  That way the debt is discharged in the bankruptcy.  If the debt is forgiven before you file the bankruptcy, then at the point of forgiveness the identity of the creditor changes from the bank to the taxing authority, and the debt you have is a tax debt instead of a mortgage debt.  Tax debts are usually not dischargeable in bankruptcy, so you could be out of luck.  (I’ll discuss the dischargeability of income tax debt in bankruptcy in my next post.)

For the second exception to apply you have to still be insolvent immediately after the debt was forgiven.  To illustrate what could go wrong, let’s use an example.  Suppose just before a foreclosure sale on your home your total debt was $525,000 – of which $500,000 was your mortgage debt.  And suppose your assets including the house were worth $450,000, with the house being worth $300,000.  At that point you would certainly be insolvent because the value of your debts ($525,000) exceeds your liabilities ($450,000).  However, insolvency for the second exception is measured after the sale, not before.  Thus, if the house sold for its market value of $300,000, and the bank forgave the post-sale shortfall, then after the sale your assets would be in value $150,000 (= $450,000 – $300,000), and your liabilities would be $25,000 (= $525,000 – $500,000).  This would mean that the value of your assets ($150,000) would be greater than your liabilities ($25,000), so you would no longer be insolvent – and you would be ineligible for the insolvency exception.  Ouch.

The third and fourth exceptions generally do not arise in the typical consumer bankruptcy case.  Therefore, if you think you might be eligible for either of them, consult a competent tax professional.

The final exception sunsets on January 1, 2013, and was enacted in response to the current housing mess.  If you lost your principal residence – this one does not apply to a rental property – and the debt that was forgiven was the original purchase money debt, then the amount forgiven after the sale does not get added to your gross taxable income.  Unfortunately, if you refinanced your home, and later lose the property, the debt forgiven would not qualify for this exception – unless you could prove to the taxing authority’s satisfaction that every penny of the refi went into home improvement.

If the forgiven debt does not fall within the ambit of any of these five exceptions, prepare for a tax hit.

II.        Filing The Tax Return

Suppose you were smart and filed for bankruptcy protection before the debt was forgiven.  Then the debt was discharged in a bankruptcy, so you don’t get the tax hit.  But the taxing authority won’t know that the debt was discharged in bankruptcy.  Contrary to what you see in the highly entertaining Bourne movies, the federal and California governments, and in particular, the IRS and the FTB, are not omniscient.

Therefore, when the taxing authority receives the 1099-C from the (former) creditor, it will assume that the cancelled debt should be credited to you as income.  To obviate this problem you should include the one-page Form 982 with your tax return – both state and federal – and check box 1 a because the debt was discharged in a title 11 case; title 11 of the U.S. Code being the U.S. Bankruptcy Code.

You may wish to consult a tax professional to help you complete your tax returns.

If you’re close to losing a home in foreclosure, or expect to have a creditor forgive a debt you owe, hire an expert los angeles bankruptcy attorney to help you before it’s too late.  Good luck.