Month: June 2014

What is the “Bankruptcy Estate”?

Last week, I had a client who had just recently filed for bankruptcy under Chapter 7.  Her intention was to reaffirm on her mortgage so that she could retain her home.  When she contacted her creditor to make arrangements for the reaffirmation agreement, she heard an automated message that sent her into a panic.
She called my office to ask me what they meant.  I set-up a conference call with the number she had called so we could both listen to the message together.  The number turned out to be a special number that people who had filed bankruptcy were supposed to call, and the automated message warned the callers that all of the client’s assets were part of the bankruptcy estate.
Technically, there was nothing inaccurate about the automated message.  When a debtor files for bankruptcy, all of their assets do indeed become part of the bankruptcy estate.  The problem was how the message was worded, and the fact that the message made any reference to the bankruptcy estate at all.  The message was worded in such a way (and in retrospect, I think it was done so intentionally) to prey on the relative naiveté of a typical debtor in bankruptcy and cause unnecessary panic.
First of all, most people filing for bankruptcy struggle with making distinctions between assets and debts, and  understanding the difference between disclosing a debt and having a debt discharged.  In fact, most people refer to it as “including or not including” debts, and they think that including a debt is synonymous with disclosure and discharge, when in fact, it is not.
So, as a result of that common misconception mixed with the cryptic automated message, my client believed that her mortgage lender was telling her that she had forfeited her home in the bankruptcy.  She hadn’t, of course.  But that brings us to today’s topic.  What is the “bankruptcy estate”?
The bankruptcy estate is one of those concepts that most people remain oblivious to because – in 99% of cases – its effects are not readily observable.  It’s a sort of behind-the-scenes concept, but one that plays a very crucial role in bankruptcy.
When a bankruptcy case is filed, all assets of the debtor (including real estate, motor vehicles, personal property, financial accounts, and legal ownership interests of all other kinds) become property of the bankruptcy estate (with a few exceptions).  This is laid out at 11 U.S.C. § 541.
The reason most debtors are unaware of this is because there is very rarely any manifestation of this transfer.  Debtors retain physical possession of all of their assets, including the ability to use and dispose of said assets (although technically, because of the bankruptcy estate, they are not supposed to dispose of assets – this is really only relevant when it comes to larger assets).
The bankruptcy estate is analogous to a probate estate, which is the legal entity or “thing” that owns the stuff of a dead person until the probate process runs its course and the assets of the decedent have been passed on to his/her heirs.
In fact, the existence of the bankruptcy estate is one of the key components necessary to making the automatic stay function at all.  One of the reasons that your creditors cannot garnish wages and repossess vehicles or foreclose property while a bankruptcy case is pending is because – technically – the assets are not yours, but instead they belong to the bankruptcy estate.  And there they will remain while the case is pending, which allows the trustee and the court to review your finances without the interruption of creditors going after assets.
The existence of the estate is also a necessary component to allow the trustee to liquidate assets that may be non-exempt.
In most cases, assets are never seized by the trustee, and so the client remains blissfully unaware that although they retain possession and use of their stuff, that their stuff is technically not theirs.
But fear not!  Like a probate estate, a bankruptcy estate is not permanent.  After the case is no longer pending, the bankruptcy estate is dissolved and ownership interests revest back upon the original owner (you).  Again, it’s very unceremonious, and chances are you’ll never notice that anything actually happened.  In Chapter 7 cases, the revestment typically happens at the same time you receive your discharge.  In Chapter 13, it can happen either at discharge or at confirmation of the plan (and there are strategic reasons to choose one over the other, in terms of legal protections).

Morality of Bankruptcy and Overcoming Unnecessary Guilt

For most people – bankruptcy is seen as an option of last resort.  In fact most people won’t consider bankruptcy at all, even if they really really need to file.  Those who finally decide to file bankruptcy often must first make peace with their own guilt and decades of conditioning.  Many of my clients express massive apprehension about filing for bankruptcy.  “In my family,” they often say, “we were taught that if you incur a debt, then it’s your responsibility to pay the debt.”
Certainly, most of us can identify with that sentiment.  And there’s nothing wrong with it… unless – of course – it is treated as a moral absolute.
Moral absolutes are a dangerous thing.  Absolutism ignores any possible extraordinary circumstances that might warrant a behavior that is otherwise discouraged, and denies people the right to consider such factors in their decision-making.  For instance – many people would agree in a moral absolute against taking someone else’s life.  But many other people would argue that even killing may fall into a moral grey area where self-defense is concerned.  If something as serious and final as death can have moral grey areas, then certainly there must be exceptions and circumstances that warrant bankruptcy.
One person – preparing to file for bankruptcy – expressed the following…

“Bankruptcy isn’t something I wanted to do, and I avoided it as long as I could – probably longer than I should have.  But I’ve come to terms with it.  Simply put, I made mistakes.  Every person on this planet makes mistakes.  We are all faced with choices, and we have no way of predicting how the future will unfold.  Should I change jobs?  Should I buy this car?  Should I consider this surgery?  Every choice we make has consequences, and there’s no way to know for sure that we’re making the right choice.  All that we can do is live and learn, and try our best not to repeat the same mistakes in the future.”

And sometimes, it’s not even about making mistakes.  Even the most cautious among us can be brought down by events beyond our own control.  Most bankruptcy filers experienced some catastrophic event – a major medical expense or automotive repair – that made bankruptcy unavoidable.  Through no fault of their own, circumstances (and by extension, their debt) snowballed out of control.
There’s nothing wrong with parents teaching their children to be responsible, and to pay back debts that they have incurred.  Nor is there anything wrong with children wanting to live up to that ideal.  But life rarely goes according to plan.  When circumstances warrant, people have a duty to themselves.  There’s a huge difference between intentionally screwing your creditors and doing what it takes to put food on the table.  Don’t deny yourself a valuable tool such as bankruptcy.

Inherited IRAs

Last week, the U.S. Supreme Court issued a decision in Clark v. Rameker (a case from the Western District of Wisconsin), holding that an inherited IRA is not a retirement account for the purpose of the federal retirement funds exemption.
In its ruling, the court distinguished inherited IRAs from traditional IRAs, noting that the heir can never invest additional funds into the account, heirs are required to draw money from the account (even in advance of their own retirement), and heirs can draw the entire amount to be used for any purpose without penalty.
As a result of this decision, holders of inherited IRAs seeking bankruptcy protection will have to claim alternate exemptions (such as the federal wildcard exemption) or use Chapter 13 to protect the funds if there are not enough exemptions to protect the account.

How having your wages garnished could lead to a free bankruptcy.

A lawsuit has been filed against you.  Your wages have been garnished.  You decide that you can’t stay ahead anymore, and you decide to file for bankruptcy.
If the amount of your wages that have been garnished in the 90 days prior to filing bankruptcy exceeds $600, then it constitutes a preference under 11 U.S.C. § 547(b).  If the trustee lays no claim to the funds, the whole amount garnished in the 90 days prior to filing bankruptcy can be recovered under § 522(h).
Okay, admittedly, this isn’t a ‘free bankruptcy’ so much as it is a reimbursement (and likely only a partial reimbursement, depending on the recoverable amount relative to the costs to file bankruptcy).  Also, the money being reimbursed was your wages anyway, but since there was a legal garnishment, most people are simply appreciative to get it back.
But what about a real free bankruptcy?  Again, it would be a reimbursement, but there are ways to make creditors pay for your bankruptcy out of their funds (not yours) if they knowingly violate the automatic stay.  You are entitled to recover actual damages (for example, any wages actually garnished after your case was filed) no matter what.  But if you can prove that the creditor knowingly violated the stay, punitive damages can be awarded, too, and that can potentially reimburse you in full for the cost of bankruptcy.

Don’t Fear Chapter 13 Bankruptcy; In Fact, It May Be the Better Option

In the past, I’ve written about how people refuse to consider bankruptcy as a tool to help them get out of financial trouble based on rumors and myths that are – frankly – untrue.
For example, many people are afraid to file for bankruptcy because they have heard from someone else that they will lose their house, their car, or their tax refund.  And while it certainly is true that some people lose those things in bankruptcy, the circumstances required for that to happen are actually pretty rare.  Furthermore, those circumstances are almost always identifiable in advance.  Meaning, a competent attorney can tell you if you’re at risk of losing any of these things at the initial consultation, before you pay the attorney a single penny.  And if that wasn’t enough – even if those circumstances do exist, they are avoidable given proper strategy.
So, if you’re struggling financially, it doesn’t hurt to consult with an attorney to get the facts about bankruptcy so you can make an informed decision.  Don’t disregard the option until you know exactly how it will affect you.
Today, however, I want to delve into the mysterious world of Chapter 13.  Even if someone has accepted that bankruptcy is something that they need to do, many people are deathly afraid of Chapter 13.  They hear “3-5 year repayment plan” and they assume that means that they have to pay all of their debt back, and if they’re filing for bankruptcy, why on earth would they want to file Chapter 13?
Like many myths and rumors, there is some basis in reality.  For instance, yes, Chapter 13 does involve making payments on debts, and yes, the plans usually last from 3-5 years.  But very few people end up paying back all of their debt.  In fact, some people end up faring better in Chapter 13 than they would have in Chapter 7.
How?  Well, let’s consider a typical Chapter 7 case.  Family of four (mom, dad, son, and daughter) have a combined household income of $60,000.  They have a mortgage, two car loans, and let’s say $40,000 in credit card and medical debt.  They qualify for and file a Chapter 7 bankruptcy.  They make no payments to the trustee.  But are they still paying on debt?  Well, yes – they decided to reaffirm their home and car loans.  So, they’re still making monthly payments.  Chapter 7 didn’t wipe out all of their debts.  But it did wipe out the $40,000 in credit card and medical debt.  Is this family happy?  Yes.  Could they have been happier in Chapter 13?  Maybe.  It depends on the circumstances.
For instance…
  1. What if they had two mortgages, and they were already underwater with just the first mortgage?
  2. What if their vehicles are older and worth next to nothing, but they still have huge balances on them?  Or high interest rates?
  3. What if they have massive tax debts, child support obligations, or student loans?

In Chapter 13, we can do special things that we can’t do in Chapter 7.
For instance…
  1. If there is no equity for which a second mortgage to attach to your house, we might be able to get rid of the second mortgage.
  2. We can cram-down vehicle loans so that you pay what the car is worth instead of the actual balance.  We might also be able to reduce your interest rates on the auto loan.
  3. While taxes, child support, and student loans cannot be discharged in bankruptcy, they can be handled in Chapter 13 bankruptcy, which means you will exit bankruptcy with less debt, and while paying 0% interest on many of these debts.

In essence, most people who would qualify for Chapter 7 bankruptcy would get the same level of discharge of their unsecured debts in a Chapter 13, PLUS they would enjoy a few additional benefits that they could not have gotten in Chapter 7.  In the above example, the debtors still get a discharge of their $40k in credit card and medical bills, whether they file Chapter 7 or Chapter 13.  They also still must pay on their house and cars, whether they file Chapter 7 or Chapter 13.  But at least in Chapter 13, they got to pay less on their house and car loans, due to lien stripping and cram-downs.
In the interest of full disclosure, people who qualify to file Chapter 7 but choose to file Chapter 13 may end up paying some of their unsecured debt back.  This can be due to a variety of administrative concerns (interest-bearing priority and secured debts are paid before unsecured debts; rounding numbers; commitments of tax refunds; claims coming in lower than anticipated; etc.).  But an experienced and knowledgeable Chapter 13 bankruptcy attorney can help you minimize the amounts paid to unsecured creditors.  And even if the unsecured creditors do get some money (more than the $0 they would have gotten in Chapter 7), the other benefits of Chapter 13 could vastly outweigh any nominal amounts paid on unsecured debts.
It is also true that some Chapter 13 debtors end up paying back all of their debt.  This is because either their income to debt ratio is too high to permit a discharge, or there is some other circumstance in the case that requires it.  Why on earth would someone file bankruptcy just to have to pay it all back?
Again – it’s important to realize that while a discharge is the main benefit of bankruptcy, it is not the only benefit.  Even in a “100% Chapter 13 Plan”, the debtor still enjoys reduced or no interest rates (in this district, all debts receive 0% interest with the exception of tax liens, property taxes, auto loans, and other secured loans).  Bankruptcy also bestows the automatic stay, which prevents wage garnishment, utility shut-offs, repossessions, foreclosures, harassment, and other invasive debt collection tactics.  In short, you get to pay back the debt on your terms – in a structured manner – with court protection.