Monthly Archives: October 2008

An Embarrassment of Riches

The Tenth Circuit BAP handed down a decision four days ago called, Weinman v. Graves (In re: Graves), 2008 WL 4649378, Nos. CO-08-038, 07-20569-ABC (10th Cir. BAP, Oct. 22, 2008); that is an absolute embarrassment of riches. Oh, and the fact that it provides a nifty new tool when representing debtors who are expecting a hefty tax refund and don’t have time to get it back before they file for Bankruptcy is just almost gravy.

The issue in Graves is whether or not a Chapter 7 Trustee can require turnover from the Debtors of a prepetition transfer to the IRS in the form of an application of a pre-petition tax refund to a post-petition tax year. In other words, the Debtors filed a tax return that would result in a large refund. The Debtors elected to have that refund applied to their next year’s tax liability. (Every year I see that box on my tax return and wonder who on EARTH would do that? Well, now I know — smart debtors.) The Trustee demanded turnover from the Debtors of that refund amount. The Debtors refused, and the rest is a wonderful BAP opinion.

Now, I am a little bit prejudiced. I am going to like any opinion that begins with:

This appeal exemplifies the concept that “you cannot get blood out of a turnip.”

Oh, and it gets better.

The official holding of the Court is:

Assuming, without deciding, that the pre-payment constitutes estate property as a contingent reversionary interest, this Court must decide wither the Bankruptcy Code empowers trustees to demand its turnover. We hold that it does not. Turnover is a remedy that is specifically limited by Section 542 to “property that the trustee may use, sell, or lease,” and is in the turnover target’s possession or control during the bankruptcy case. A contingent reversionary interest in funds held by another is simply not something that is in the debtor’s possession that can be turned over to the trustee.

Oh, please, “A contingent reversionary interest”? Would someone who paid attention in Property I please explain that to me?

Ok, so a Debtor can apply a tax refund to a post-petition year, and the Trustee can’t take it back from the Debtor. Why can’t the Trustee take it back from the IRS? Stay tuned for that and more fascinating tidbits from Graves.

By the way, if you are in the 9th Circuit (or just outside the 10th) be sure to read Nichols v. Birdsell, 491 F.3d 987 (9th cir. 2007) before getting too excited about Graves.


I Hate it When I am Right — well, sometimes

One of the more entertaining aspects of the 2005 Bankruptcy Reform bill is that it makes so little sense. Under the terms of the Means Test a Chapter 13 debtor whose gross income is over the median for his State is required to have a 5-year commitment period. A Debtor whose gross income is below the median for his State may have a 3-year commitment period. Notice, that this says gross income; it doesn’t say disposable income.

Now, I love to harp on the fact that the Means Test really has far more to do with what you spend your money on and what kinds of debt you have then with how much money you actually make. This is one area where that is not true. If your gross income is over median you have a five-year commitment period even if your Disposable Monthly Income and your Projected Disposable Monthly Income are both negative. In other words, if you are over median income, but you pass the Means Test and are not required to make any distributions to unsecured creditors and still choose to file a Chapter 13; you still have a five-year commitment period.

This makes no sense. If someone is filing a Chapter 13 to restructure secured debt, is eligible to file a Chapter 7 and chooses to file a 13; why should they have to spend five years in their 13 plan when they aren’t required to pay anything to their unsecured creditors? Why not let them reorganize their secured debt and get out? Because that would make sense, that is why.

So, smarter lawyers than I am came up with a reading of this statute that lets above median income debtors who still pass the Means Test get in and out of a Chapter 13 in less time. They decided that the commitment period wasn’t really a time period, it was a multiplier. Chapter 13 plans are generally formulated as a base plan where you agree to pay a certain amount that is calculated as being the monthly plan payment x the plan length. When you pay a base, you just pay the base and then you are done. So, clearly that was what this language contemplated. It was creating a base amount of the monthly payment times the number of months in the commitment period. If the Debtors can pay that amount in a shorter period of time, fine. After all, that cuts down on administration expenses and increases the chances of the debtors successfully completing the plan — except not a lot of courts have agreed that this is what the Statute says — probably because a five-year commitment period sounds like five years and not like times 60.

I understand the argument, I would never have thought of it; but I do understand it. I just don’t like it. I want my clients who are over median but who pass the Means Test to be able to file as short a plan as they can pay. I want them to get in and out. I want them to succeed. I don’t want them to get to year 4 and lose a job or develop a significant illness and wind up having to convert or dismiss. Unfortunately, so far the case law inside this Circuit has gone against the Debtors. The most recent decision is out of a Bankruptcy Court in Colorado, In re: Pfeiler, Bankruptcy Case No. 07-22817 SBB, decided Sept. 12, 2008. There is, currently, a case on appeal from the BAP to the Tenth, itself, that might address this issue. Even so, I don’t hold out great hopes — and I think it stinks.


Hedge Funds and Mortgage Modifications

Hedge funds are warning mortgage companies against modifying mortgages. Well, no kidding. Gee, and to think, the New York Times thought this was NEWS. Hello?

According to the New York Times (link above if you want to read the original), at least two hedge funds are sending letters to banks warning them of the banks’ contractual obligations to the investors (i.e., the hedge funds) who own the bonds and related securities collateralized by pooled mortgages. These letters supposedly warn the banks that the hedge funds might “take action” (I assume that is a polite euphemism for sue) if the banks participate in government backed plans to renegotiate delinquent mortgage loans. The hedge funds are concerned about protecting their investments. They bought bonds backed by mortgages with variable (read high) interest rates. Their cash flow, and ultimately total investment value, will be reduced if the interest rates on those mortgages is reduced — or the principal balance — or the monthly payment.

According to the New York Times this “saber-rattling highlights the conflicting interests of various players in the mortgage arena. . . . ” Well, yes.

Let’s go back to basics:

  • Mortgage pools are governed by Master Pooling and Servicing Agreements, these agreements set out each parties rights, liabilities and options;
  • Most Pooling and Servicing agreements include some provisions for modifying mortgage loans; one of the problems traditionally with getting mortgages modified (even FHA loans that have regulations requiring certain kinds of modifications) has been actual or perceived restrictions in the Pooling and Servicing agreements;
  • The servicer is the player who calls the shots, but the Servicer’s interest is for the Servicer to make money — which isn’t necessarily the same thing as for the investors to make money;
  • When the initial bailout provision was being negotiated in Congress, there was a provision to allow modification of mortgages in chapter 13 Bankruptcy included in an early draft, the banks screamed bloody murder; they made it pretty clear that they would just about not have a bailout than have that.

Now, the funny part of the article is at the end:

Officials at Braddock, a hedge fund based in Denver, said they were not against loan modifications per se but that they wanted to make sure renegotiations conformed to the contracts governing mortgages securities, which are backed by thousands of home loans. The most restrictive servicing contracts limit how many and what kinds of modifications mortgage firms can pursue. Other contracts allow the firms to pursue modification more freely if doing so will minimize overall losses. (Punctuation errors in the original.)

Ok, so before a bank — or even better the Treasury as part of its asset buyback plan — can modify a mortgage, an employee will have to identify the pool the mortgage is pooled into, obtain a copy of the Master Servicing and Pooling Agreement (a huge, densely written, pile of legalease in most cases), read it, understand it and stay within its terms. Uh huh, and these people are being paid how much?

Kind of what I thought.

Let’s stop kidding around. If we are going to start modifying mortgages to address the foreclosure rate, we have to have the authority to go outside the scope of the Pooling and Servicing Contracts. The only way that I know of to do that is by modifying Section 1322(b) of the United States Bankruptcy Code.


Capital One and Discharged Debts

Capital One has been caught by the U.S. Trustee’s office in Massachusetts.  They have been caught filing Proofs of Claim (i.e., a request for payment stating that they have a valid claim against the Debtor and are entitled to be paid) in Chapter 13 cases requesting payment for debts that had already been discharged in a preceding Chapter 7 case.

Sorry, but that pretty much qualifies as lying, cheating and stealing.  Furthermore, filing a false claim is punishable by a fine of up to $50,000 and some serious jail time.

So, what punishment has the U.S. Trustee suggested for Cap One?

They have to give the money back.  Yep, they filed false claims — thousands of them — and they have to give back the money they were paid on those claims.   Oh, and they have to hire an independent auditor to make sure that they do.

This is set out in a proposed settlement agreement, which is announced on the U.S. Trustee’s web page if anyone wants to read it.  The settlement has not yet been approved by the Court — and I hope that it won’t be.  It certainly does nothing to dissuade this kind of conduct in the future.  Nor does it do much to change the U.S. Trustee’s Office’s reputation for being a bit pro-creditor.

I think I need to get more aggressive about pursuing discharge violations.


Bankruptcy and THEN Short Sale? Why?

A couple of times a year clients who are surrendering a house in a bankruptcy call me wanting to know if the lender will still do a short sale on the property. Almost always they have been approached by some third party who tells them how much he wants their house, but it is such a wonderful place that he is just sure it will sell for more than he can manage at Sheriff’s Sale. Won’t they please arrange a short sale with their lender so he can be sure and get the house?

Ok, so the proposal is, I think your house is worth more than I am willing to pay, so I want you to run interference with the mortgage company to help me get it for less money than the mortgage company would probably wind up with at Sheriff’s Sale.

Hmmmm, colluding with a 3rd party to try and create a scenario where your mortgage company ends up getting less from their collateral than they would otherwise be entitled to. Why is it that these people all think this is such a wonderful idea?

The answer to that question is actually pretty simple. The people who propose these schemes know that losing a house in foreclosure has an incredible emotional toll. Even people who have already filed for Bankruptcy will go to great lengths to feel like they didn’t really lose their home in a foreclosure. In most cases these people are so desperate to feel better about their situation that I cannot convince them that simply helping this nice man out isn’t the right thing to do.

So, what do I tell them? Simple. I simply remind them that this negotiated short sale will be post-petition. If the buyer were to decide after the fact that there was some defect in the property that hadn’t been properly disclosed, the client would still be liable for those damages; because the actions took place after their bankruptcy was filed. Oh, I also tell them that they will have to get permission from the Court for the sale, they might have to go to Court and see THE JUDGE, and I will charge them an additional fee for doing the extra work. If the first two arguments don’t work, that third one always does.

It is taking calls like these that remind me how emotional foreclosure really is, and how desperate people are to think that if they just help this nice man who called, then they aren’t really the kind of person who loses a house in foreclosure. Being reminded of that occasionally makes me a better lawyer.


Military and the Means Test

The Means Test is becoming even more optional.  Yesterday, the President signed into law the National Guard and Reservists Debt Relief Act of 2008.   The basic effect of this act is to make the Means Test, the centerpiece of the 2005 Bankruptcy Reform Act, inapplicable to certain members of the National Guard, Reserves or disabled veterans.

The basic effect of this act is to exempt from the Means Test requirements certain people who file for bankruptcy within 540 days of the time in which they return from active duty in a combat zone.

Quite honestly, I expect this to have very little practical application and make virtually no difference in the relief available to most returning service members.  However,  it is one more chip in the Means Test armour.

As far as I can tell, the Means Test has done very little other than to drive up the cost of filing for bankruptcy and increase the paperwork and record keeping necessary.  Once you learn how to play it, it doesn’t really change eligibility for Chapter 7 relief for more than a handful of people

There are already two large exceptions to the Means Test.  The first is that Social Security benefits aren’t included in income for purposes of the Means Test.  The second is that if the Debtor’s debts are primarily non-consumer, then no Means Test is required.  This exception is very interesting, because it doesn’t say if the Debtor’s debts are primarily business debts — it says non-consumer.  Well, taxes have been held to be  non-consumer debt.  So, now, people with failed businesses whose debts are primarily non-consumer and people whose debts are primarily tax debt and National Guard, Reservists and disabled veterans returning from a combat zone are all exempt from having to complete the Means Test.

By the way, the actual provisions of the National Guard and Reservists Debt Relief Act of 2008 are very specific and quite detailed.  Before making any conclusions about which cases it will or will not apply to, be sure to read the actual Statute.  Oh, and the Act takes effect in sixty days.

If you use this successfully, let me know.


Bankruptcy — Where Landlords Fare Better than Homeowners

Every time I hear on the news how concerned Congress is with helping homeowners save their homes in foreclosure, I have to change the channel. The only thing worse is when I hear how eager mortgage companies are to modify loans to help homeowners.

Ok, so I am a bleeding-heart, liberal bankruptcy lawyer. I’m supposed to react this way., however, is supposed to be conservative, fiscally-sensitive, pro-establishment and utterly Republican. So, what happened there this morning? Ann Woolner wrote a nice, little op-ed piece for called, Buy a Beach House for Shelter When Going Bankrupt. This Editorial is about the disparate treatment that owner-occupied real estate gets in the Bankruptcy Code over other Real Estate. For my purposes the primary Statute Section is 1322(b)(2).

The basic idea is that in most of the Bankruptcy Code you can effectively strip a secured claim down to the value of the underlying asset. You then only have to pay the asset’s value (with interest, of course) in order to keep the property. Traditionally, this was used to great effect by consumers with cars on which they were seriously underwater. That has pretty well stopped as a result of some changes to the Code in 2005. However, real estate can still be crammed down if you owe more on it than it is worth — but only if it is not the Debtor’s primary residence. If the debt is secured solely by an interest in real estate that is the Debtor’s primary residence, the loan terms cannot be modified in anyway. Residential mortgages are the ultimate sacred cow in the Bankruptcy Court.

To quote Ms. Woolner:

A speculator with slum properties all over the city, who owns a place in Manhattan and a house at the Hamptons, gets better treatment under bankruptcy law than a salaried worker’s family with only one, modest bungalow.

Now, there are a lot of parts of the Bankruptcy Code that don’t seem to make a lot of sense. Some of them are downright contradictory, and some of them are just of questionable policy. What makes this particular provision so gut-wrenchingly awful is that when the original bailout bill was being negotiated (you know, the one where the Treasury was going to buy toxic waste bonds, the one before the equity positions in banks bailout) some of the more sensible members of Congress wanted to change Section 1322 and let homeowners use the Bankruptcy Courts to reduce the principal value of their mortgages down to the value of the property. Basically, the bank and mortgage lobby told Congress they would pretty much rather not have a bailout than have that.

Oh, well. I guess I’m just not sophisticated enough to understand. After all, I never invested in completley unregulated insurance contracts insuring the lower tranches of multi-layer bonds secured by mortgages based on completely falsified loan files. So, what do I know about finance.


Spouses and Co-debtors

Occasionally, I need a good, old-fashioned slap upside the head. Here is the scenario. Client is married, but files a Chapter 13 Bankruptcy without her spouse joining her. The electric bill is delinquent at the time the case is filed. I didn’t realize until later that the electric bill was only in the non-filing spouse’s name. Utility company terminated service post-petition with actual notice of the bankruptcy filing.

So, what’s the problem? It isn’t the debtor’s bill, it is her husband’s. She isn’t liable for it — right?


Husband and wife shall be jointly and severally liable for debts incurred on account of necessaries furnished to either spouse unless otherwise provided by law or court order. 43 O.S. 209.1

This little gem of a statute, coupled with the utility company’s policy not to let the spouse establish new service in her own name until the prior account has been settled; and, of course, the Bankruptcy Code’s extension of the Automatic Stay to co-debtors in a Chapter 13 case, is about to make my office a little more interesting. It is the first case I know of to make these arguments in Oklahoma. I will keep you informed.


Bankruptcy Myths

This is pretty good, not perfect; but pretty good.

Twelve Myths about Bankruptcy

I would add to the first myth that there are several pretty darn prominent Oklahomans who have filed for Bankruptcy and nobody has noticed until they did something else really stupid and a Journalist decided to see what else they had been up to.

Number 10 is almost true. Frankly, a lot of taxes are completely dischargeable in a Bankruptcy. There is not, however, a special kind of Bankruptcy known as a “Tax Bankruptcy”. That goes in the same rumor mill with the “Medical Bankruptcy”. There are four different kinds of Bankruptcy that may be filed by an individual — Chapters 7, 11, 12 and 13. Any one of them may be used to discharge taxes or medical debt or credit card debt or just about anything else.

Ok, so it could have been better; but 10 out of 12 isn’t bad. Check it out.


The Automatic Stay and Criminal Prosecution

A very interesting case has come down out of the Bankruptcy Court for the District of Massachusetts. It is Bartel v. Walsh, et al (in re: Bartel); Adv. No. 06-1161. The opinion is dated October 10, 2008 — so, this is nothing if not timely.

The main issue in Bartel is whether or not the exception from the automatic stay for criminal prosecution is absolute. Basically, the Debtor in Bartel argued that this exemption should not apply if the actual motive behind the criminal prosecution was to collect a debt. In support of his argument the Debtor argued provisions from the Federal Civil Rights Act, the Massachusetts Civil Rights Act, the 13th Amendment to the U.S. Constitution and abuse of process. Personally, I thought that the 13th Amendment Argument was downright inspired.

The Debtor in Bartel was a general contractor, and there are sufficient differences between Massachusetts and Oklahoma law regarding general contractors and client funds that I don’t expect to ever see a case just like this one. (Although, for a similar set of facts, but very different law, where I got my butt kicked at the Oklahoma Supreme Court see, In re: Harris, 2002 OK 35, 49 P.3d 710.)

Where I see this kind of issue is with hot checks. I have always told my clients, as this case supports, that a bankruptcy filing discharges the civil liability for hot checks; it does not discharge the criminal liability. In other words, the merchant to whom they wrote the checks can’t sue them; but the D.A. can still put them in jail. On the other hand, I have never actually seen a case where a D.A. has brought a bogus check charge after a Bankruptcy filing. In some cases the reason for that is the restrictions in Oklahoma Statute on what actually constitutes a bogus check — but not all cases.

To my mind the really interesting part of this case is the non-bankruptcy aspect. I will be interested to see if the Debtor pursues some kind of abuse of power or civil rights action against the prosecuting attorney.

Debtor is fortunate to be represented by one of the most dedicated and creative counsel out there. It will be interesting to see how this plays out.