Chapter 7 Exemption Planning & Strategizing

Before I begin this blog post, I just want to assure you that asset cases (what is described below) are relatively rare in the State of Wisconsin due to fairly generous exemption options.  Just based on informal observation, I’d estimate that fewer than 5% of cases have non-exempt assets that could be administered by a trustee, and fewer still are actually administered.  I say this now so as to not induce panic.  Filing for bankruptcy does NOT necessarily mean that you will lose property.  It is certainly possible, but an experienced attorney can estimate with a reasonable degree of certainty whether your case might have an exemption issue during a free initial consult, before you’ve invested a single dime into bankruptcy.  And worst case scenario, you can always file under Chapter 13 and avoid losing assets altogether.  This article below applies to only a very small number of cases.
So, you’re getting ready to file Chapter 7 Bankruptcy.  You’re at your attorney’s office, and he’s punching his keyboard furiously – polishing off the last of the exemption math.  Then he turns to you and says, “You have $10,000″ in non-exempt equity.”
Perhaps you knew this was coming.  Perhaps this news came out of the blue.  Either way, you have non-exempt assets.  So what does this mean?
Well, if we’re going to get technical and grim about it, it means that you either have to cough up $10,000 to give to the Chapter 7 Trustee, or you have to be prepared to lose whatever asset(s) are exposed.
In reality, you’re not in nearly as much trouble as it looks like on paper.  Over the years, I have filed dozens of what appeared – on paper – to be an “asset case” – sometimes with thousands or even tens of thousands of dollars in non-exempt equity.  And in many cases, the trustee still filed an asset report.  Here are just some of the factors weighing on the trustee’s mind when he decides to pursue or abandon a non-exempt asset…
  1. How much is the trustee going to get paid?  The trustee retains a percentage of the assets he recovers for the work he must perform in distributing the assets.  If the only thing he can go after is $100, the costs of administration will far outweigh the mere pittance he will recover.
  2. How much are the creditors going to get paid?  $10,000 is a lot of money if the unsecured claims are only expected to be $25,000.  Even after administrative costs, creditors would still likely get paid over 33% of what is owed them.  But if you owe $200,000, the percentage is a lot less (less than 5%).
  3. How easy will it be to liquidate?  Is the trustee seizing money in a bank account?  If so, that is easy to convert and use to pay creditors.  But what if the exposed money is in household furniture and appliances?  Even if the trustee realized the full market value that you estimated your stuff to be worth, he still has to go through the process of selling the stuff, and that costs money.  And the likelihood of him selling your stuff for even a fraction of what you think it’s worth is still pretty low.
  4. Is the asset contingent?  Sec. 541 of the bankruptcy code describes “property of the estate” and includes contingent assets – or assets that you are entitled to possess, but do not yet possess.  There are tons of contingent assets.  Rights to tax refunds are the most common.  Unresolved lawsuits, inheritances, and residual income are all examples of possible contingent assets (depending on the specific circumstances).  Okay, so you have a lawsuit pending against someone else for $5,000.  Does that mean the trustee wants to hold open your case for months or years, waiting for it to resolve?  Sometimes he will, but often times, he won’t bother.

It is important to note that all of the above are pragmatic considerations for the Trustee.  That doesn’t mean that you will always get off the hook.  The trustees are also under considerable pressure from the U.S. Trustee to pursue worthwhile assets, and of course, they have a fiduciary duty to unsecured creditors.
Trustees are also human beings.  Understand that sometimes, the trustee’s decision to pursue or abandon an asset could be influenced by what kind of a day he is having and what kind of mood he is in.  For example, if he just landed a million dollar asset case earlier in the day, he probably doesn’t care too much about your thousand dollar case.  On the other hand, if you (believing that the trustee is going to screw you over and take things from you) treat the trustee with hostility and contempt – he might just exercise his full rights just to be vindictive.  Fortunately, trustees in our district are pretty good people and easy to get along with.
Younger trustees tend to scrutinize cases more to look for assets.  With age and experience, apathy tends to follow.  They know an asset case when they see one, and they don’t bother with the tiny cases.
So, what are some strategies you can use to retain as many of your assets as you can?
  1. Don’t try to hide any assets.  Anything not disclosed, if discovered later, cannot be taken as exempt – even if you had plenty of exemption to use.  And trustees WILL go after non-exempt assets, if for no other reason than to make an example of you and deter other people from lying to the bankruptcy court.  Learn from the mistakes of others.
  2. Believe it or not, I have learned that it’s actually better to over-estimate the value of your assets.  Trustees can usually tell if you’ve perhaps been a little too generous about their personal belongings.  They can also tell if you’re short-changing your schedules.  If they believe that is the case, they will scrutinize your schedules moreso, and perhaps hire their own appraiser.  If you thought you had problems with $1k in non-exempt equity, wait until the trustee gets real values and finds out that you actually have $10k exposed.  (It’s worth dispelling a common myth at this point.  Trustees do not actually come out to your home to look at your stuff.  But they can, and they will, if they have good reason to believe you have not been truthful on your schedules.)
  3. Check your exemption options.  For example, Wisconsin residents who have resided in Wisconsin for at least two years may choose between federal exemptions and Wisconsin state exemptions.  Each set has its own benefits and drawbacks, so debtors may select whichever set is most beneficial to them (though they may not mix-and-match).  Which exemptions you are entitled to depends on which state you currently reside in, and which state you have resided in during the past 730 days.  (We’ll discuss residency requirements and exemptions a different day.)
  4. You will have access to a variety of exemptions, which can only be applied toward certain types of property, and most of which have dollar limits to them.  To the extent the exemptions allow you to do so, leave exposed things that are hard for the trustee to sell, like furniture and appliances.  Cover up cash and cash-like items (aka liquid assets, such as bank accounts, whole life insurance policies, retirement accounts, tax refunds, stocks, and bonds).  Then cover up real estate and motor vehicles – yes, the trustee has to sell them, but they’re easier to sell.  Whatever is left – that is what you want to leave exposed.
  5. If there are assets secured by liens that you intend to surrender back to the bank, leave those items exposed, too.  The trustee can try to intervene in a repossession or foreclosure action if he chooses to.  But since you’re already resigned to losing the property, it’s no skin off your nose.  If you have a piece-of-junk snowmobile sitting in your backyard collecting rust that you could care less about – don’t waste exemptions on it if they can be better utilized elsewhere.
  6. Expose contingent assets.  These are things you don’t have yet, and it’s harder to miss things that you never had possession of in the first place.
  7. If the trustee is not willing to abandon assets completely, he is still likely going to be open to a settlement – particularly if you have left exposed contingent or hard-to-sell assets.  He doesn’t want to go through the hassle of administration, or leave a case open for months or years to collect a contingent asset.  He would much rather get a cash payment from you, in exchange for which, he will settle for less than what is exposed.  So, for example, let’s say you have $5k exposed in a car.  The trustee may settle for $3k and you get to keep the car.  Now, this isn’t Chapter 13, so you would be able to stretch payments out for 3-5 years.  In Chapter 7, if the trustee settles, he is going to expect payment pretty promptly.  Sometimes he may give you a month.  Sometimes 3-4 months.  The longest I’ve ever seen a payment plan for was 12 months, and that was for an extremely large asset (as I recall, $60-70k).

Advanced Lien Stripping Information

One of the great tools that Chapter 13 Bankruptcy provides for homeowners is the possibility of stripping off a wholly unsecured mortgage.  What does that mean?  Well, claims are generally only “secured” to the extent that there is equity in collateral for the claim to attach.  So, let’s pretend John Doe owns a house worth $120,000, has two mortgages with balances of $150,000 and $50,000.  The balance on the first mortgage is greater than the value of the house.  Therefore, the property has zero equity for the second mortgage to attach to.
If it were any other type of debt, the first mortgage would only be secured up to the value ($120k secured, $30k unsecured.  But the bankruptcy code’s anti-modification provision at 11 U.S.C. § 1322(b)(2), however, ensures that the first mortgage company will be treated as completely secured.
If there is so much as one dollar of equity in the property, there is something for the second mortgage to attach to, and the anti-modification provision would apply to the second mortgage, too.  But in cases where the property is “underwater” before we even look at the second mortgage, then the second mortgage is completely unsecured and could be stripped under 11 U.S.C. § 506(d).
That was, at least, until the 7th Circuit issued its decision last July: Ryan v. United States (In re Ryan), 2013 U.S. App. LEXIS 13710 (7th Cir. Ill. 2013).  Without getting into the technicalities, the court in Ryan opined that § 506(d) could be read separately from § 506(a).  § 506(a) says that a claim is only secured to the extent there is equity available to attach to.  § 506(d) permits the avoidance of a lien that is not an allowed secured claim.  The court said that the former didn’t necessary create a “disallowed claim” – which effectively abolished § 506(d) as a mechanism for stripping off unsecured mortgages.
This has left practitioners with the question of whether liens could still be stripped, and if so, how.  As of September 20, 2013, only three decisions were published that referenced the Ryan case – all in Illinois.  One of them mentions the possibility of another mechanism for lien stripping, but is silent as to that mechanism.
I have had one lien stripping case since Ryan, and that one settled out of court.  The approach I used was to stick with § 506(a), which allows my client to assert that the junior mortgage company does not have a valid secured claim.  Then, I switch from § 506(d) to § 1322(b)(2) which allows modification of two types of claims: secured claims except ones secured solely by your principal residence, and unsecured claims.  If the judge rules that the claim is unsecured, then invoking 1322(b)(2) to modify their claim should be no problem.
So we’re not avoiding the lien, we are modifying the claim.  The plan should contain language that asserts that the junior mortgage lender would retain their lien in the property and have an unsecured claim in the bankruptcy, but upon successful completion of the plan and discharge, the lien would be satisfied.
Since this approach has already yielded one settlement, I am confident this is the correct approach.  However, until there is a published judicial opinion on the matter, we proceed in this area of law cautiously.
So, you wanna try to strip your unsecured junior mortgage?  Here’s some things you need to know…

  1. The equation depends on the value of the home and the balances owed on each mortgage.  The latter is rather simple to obtain.  A recent billing statement from the mortgage company will do.  Otherwise, the proof of claim that the mortgage company files in your bankruptcy case can be relied on (though that may not come for several weeks or months after your case is filed, and holding off on filing the adversary could delay confirmation of the plan.
  2. Evidence of the value of the home is much more difficult, since value is subjective.  As my mom was fond of telling me when I grew up – “something is worth only what someone else is willing to pay for”.  I like to get three pieces of evidence – the most recent property tax assessment, a recent appraisal (from an independent third party, no more than 6 months old), and a recent CMA (comparative market analysis).  If all three numbers are less than the balance of the first mortgage, then my client is in good shape.  If the house is in foreclosure and both mortgages are held by the same company, it is likely that the foreclosure complaint alleges a value.  Since the plaintiff in the foreclosure is the defendant in the lien strip, you can use their own number against them.
  3. Nothing prevents the mortgage company from disputing the value with their own appraisals.  If a contest develops, the judge will have to make a determination as to value.
  4. You will need to get copies of each mortgage from the Register of Deeds’ office, plus all assignments of the mortgage.  If the mortgage has been transferred from one lender to another, it is important in the adversary proceeding to serve the summons and complaint to the correct creditor.  Rule 7004 of the Federal Rules of Bankruptcy Procedure applies for serving the summons and complaint.
  5. Just because you get a bill from Bank of America doesn’t mean that they hold your mortgage.  There are several roles involved with a mortgage.  There is the holder of the note – the note is what entitles the holder to payment on the debt.  There is the holder of the mortgage – the mortgage is what entitles the holder to foreclose a property in event of default under the note.  Then there is the mortgage servicer, who merely accepts and processes payments.  The servicer is the entity that most homeowners are familiar with because the servicer is who they interact with.  However, the servicer is not the proper entity to serve the summons and complaint to (though they are the proper recipients of a qualified written request under RESPA to find out certain information, including the note and mortgage holder).  Under the UCC, the note and the mortgage are supposed to be held by the same entity, and most of the time, that is what you will find.  However, in the heydey of MERS (Mortgage Electronic Registration Systems) the mortgage and note were often separated.
  6. Obtaining all of the mortgages also helps to establish rank and priority.  The first mortgage holder is usually the one first recorded.  A first mortgage that is refinanced after a second mortgage has been recorded could lose its priority status if it does not have a valid Subordination Agreement.  Why does this matter?  Take my original example.  If the property is worth $120k, and instead has a first mortgage of $50k and a second mortgage of $150k, then there is $70k equity for the second mortgage to attach to, and it cannot be stripped.
  7. If you are successful in stripping your lien, the judgement must be filed and recorded with the Register of Deeds’ office.  The judgement should also reference the legal description of the property.
  8. Debtors may wish to employ the services of a title company to ensure that the judgment is properly recorded.
  9. There had been a split in judicial opinion about whether a debtor had to be entitled to a discharge in order to strip a lien (the so-called Chapter 20 scenario, in which someone files a Chapter 7, gets a discharge, then files a no-discharge Chapter 13 to strip a lien).  The case law was veering in the direction of saying ‘yes’ you did have to have a discharge.  The Ryan opinion pretty much settles that question as a firm ‘yes’ – at least in the 7th Circuit.
  10. A copy of the discharge should be served upon the mortgage company or their attorney upon successful completion of a Chapter 13 Plan.  It may also be advisable to attach a copy of the discharge with the judgment that will be filed and recorded with the Register of Deeds’ office.

Final BAPCPA Anniversary Reminder

Tomorrow is the 8 year anniversary of BAPCPA.  At this time, everyone who filed a Chapter 7 bankruptcy case right before the law changed in 2005 is eligible to re-file a Chapter 7 bankruptcy case (assuming no other bankruptcy case has been filed since then, and assuming that you meet the income requirements – if you do not qualify, Chapter 13 may still be a viable option of relief for you).
I know this may seem a little corny, but we are nothing if not that, here at Holbus Law Office!  To commemorate this milestone, we will have a birthday cake – and any clients or prospective clients who stop in tomorrow can have a piece for free.

Shut-Down Update

Previously, we were informed that the Federal Court System would have money through today, and would be losing staff effective this upcoming Tuesday (with Monday being Columbus Day).  It appears now that the furloughs have been delayed another 3 days.  So there should continue to be no interruption to court services through the end of next Thursday.
This is from the Bankruptcy Court (Eastern District of Wisconsin) website:

The Bankruptcy Court will remain open during the government shutdown.  All hours, proceedings and deadlines remain in effect as scheduled, unless otherwise advised.  Case Management/Electronic Case Files (CM/ECF) will remain in operation for the electronic filing of documents with the Court.  After October 17, 2013, employees will be in non-pay status, and we will reassess and provide further guidance as necessary.  Thank you for your patience and cooperation.

Anecdotes – nondisclosure of assets, perjury, and bankruptcy fraud

From a press release last week from the Madison division of the FBI.
Bonnie Block of Lancaster was sentenced to two years probation and a $1,000 fine for failing to disclose $10,750 she held in a bank account on the date her bankruptcy case was filed and for lying about how she spent the money when questioned about it.
Two years probation and a $1,000 fine, by the way, was hardly the maximum that she could have faced for her crime.  She could have been imprisoned for up to 5 years, and the fine could have been a lot more.
The bankruptcy court denied her discharge.  Additionally (the press release doesn’t detail this, but I have it on good authority from a former trustee in that district), she ended up having to turn over the hidden funds.
Now, I can’t speak as to the totality of the exemption math in her case.  But it is likely that she would have been able to protect almost half of that money if she had disclosed it and used state exemptions.  (Federal exemptions may well have protected even more.)  Or she could have gone the Chapter 13 route.  Instead, she lost the entire amount, attorney fees for representation in the bankruptcy, attorney fees for representation in the criminal proceedings, her discharge, the fine, plus the criminal mark on her record.
Lesson of the story: no matter how bad you think something might be in bankruptcy, lying and getting caught is going to be MUCH WORSE.  Always be honest with your attorney and disclose all of your income and assets.

Government Shut-Down & Effect on Bankruptcy

Now that the federal government shut-down is a reality, I wanted to address some common questions people might have about the government shut-down.  This is an elaboration of my previous post.
First, everyone should bear in mind that this is a federal government shutdown.  Services provided for by state and local governments should remain unaffected, except to the extent they rely on federal money or resources.  Also, the entire government does not shut down.  “Essential personnel” are retained to continue operating certain critical aspects of the federal government, though they do so without pay until Congress provides funding.
We are told that the judiciary has funds to continue operating for approximately 10 business days (until about 10/15/2013) without any noticeable effect on services.  This is the first government shutdown in about 18 years, so specific details are not yet known.  If the shutdown continues for long, I will continue to post updates as we learn of them.
Q:  Can I still file for bankruptcy?
A:  Yes.  Bankruptcy filings are done electronically through an automated online system.  Unless and until we are told otherwise, there should be no interruption here.  What I am not certain of is whether the technical staff will be retained as essential personnel beyond 10/15/2013.  The electronic case filing system could go down (as computer systems are prone to do from time to time).  Also, the queues for the 341 calendars have to be entered manually.  If that service is suspended, then to comply with the scheduling rules, filings could potentially be blocked.
Q:  I already filed for bankruptcy.  Will my 341 hearing be canceled or rescheduled?
A:  We expect the 341 hearings to continue without interruption for the next 10 days.  During these 10 days, hearings held in non-government locations, or state/local government locations should certainly not be affected.  Therefore, hearings at Green Bay City Hall, the Green Bay State Office Building, Sheboygan County Courthouse, Winnebago County Courthouse, and Wittman Airport – should not be affected.  Hearings in federal buildings (such as the U.S. Courthouse in Milwaukee) could be relocated.  Beyond the 10 days, we are less certain.  Panel trustees are not government workers, but private individuals.  We believe hearings will continue, but the message we received from the U.S. Trustee has cast some doubt over that.
Q:  Will judges continue to hold hearings?
A:  Judges’ pay is guaranteed by the Constitution, so they will continue to work.  However, their staff can only be retained to tend to essential work, and the staff won’t be paid until the shutdown ends.  We expect that currently scheduled hearings will continue uninterrupted.  It is unclear how judicial services will be affected going forward, beyond 10/15/2013.  We expect there to be certain scheduling delays.
After October 15, 2013, we certainly do expect non-essential services to be cut-off – particularly anything that requires entry into a federal building.  The judges and UST are expected to be reduced to a skeleton staff.
Q:  How will the economy be affected by the government shutdown?
A:  The shutdowns in 1995-1996 (a total of 26 days) cost approximately $1.5 billion to the government, which is about $2 billion in today’s dollars.  Current estimates are that this shutdown will cost $300 million per day – so this shutdown is shaking out to be about 5x more expensive per day.  The actual cost will, of course, depend on how long the shutdown lasts.  As for the rest of the economy, there will be an impact.  Government contracts and spending with private corporations does account for a substantial portion of our economy.  Decreased spending will have a ripple effect.  Potentially, businesses that rely heavily on government work could be forced to lay off their employees, which would decrease consumer spending and ultimately affect other industries, as well.  Also bear in mind that there are some 800,000 federal employees now not working and not getting paid.  Though they will get paid after the shutdown ends, they are in the meantime, effectively unemployed, so there will be some immediate effects on consumer spending.  This will all stifle economic growth.  Source: Bloomberg.