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Microsome at the German language Wikipedia [GFDL (http://www.gnu.org/copyleft/fdl.html) or CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0/)], via Wikimedia CommonsAn extravagant lifestyle was not enough to overcome the presumption that debts incurred prior to filing for bankruptcy, including tax debts, are dischargeable, according to the Ninth Circuit. Hawkins v. Franchise Tax Bd. of California, No. 11-16276, slip op. (9th Cir., Sept. 15, 2014). The court considered whether the debtor’s tax debt was not subject to discharge under the exception for “willful[] attempt[s]…to evade such tax.” 11 U.S.C. § 523(a)(1)(C). After noting that the question of the mental state required to prove a “willful attempt to evade tax” was a matter of first impression, it held that the statute requires proof that a debtor specifically intended to evade tax liability. The debtor’s spending prior to filing bankruptcy, while “lavish,” was not out of the ordinary for him, and the tax debt was therefore dischargeable in bankruptcy.

The debtor made a substantial amount of money in the technology industry. He was an early employee of Apple, which he left to found the software and video game company Electronic Arts (EA). In 1990, he left EA to run a newly-created EA subsidiary called 3DO, which was entering into the video game and console market. By 1996, his net worth was around $100 million. He sold much of his EA stock and invested in 3DO. The Ninth Circuit’s opinion describes a series of accounting techniques using offshore corporations in order to claim losses on the sales of EA stock.

3DO filed for Chapter 11 bankruptcy in 2003 and later converted the case to a Chapter 7 liquidation. The debtor never received any substantial payouts from the liquidation of the business. The IRS began challenging his tax shelters in the late 1990s, and in 2005 it and the California Franchise Tax Board (FTB) assessed a total balance of over $36 million in unpaid taxes, penalties, and interest. The debtor sold some real property and applied all of the proceeds to the IRS balance in 2006, and the FTB also seized some financial accounts. In September 2006, the debtor and his wife filed for bankruptcy. The IRS and FTB filed proofs of claim for $19 million and $10.4 million, respectively. Continue reading

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By Shahroozporia (Own work) [CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia CommonsA bankruptcy judge in Los Angeles granted the trustee’s motion to dismiss a Chapter 7 case, ruling that the debtors filed their bankruptcy petition in bad faith. In re Olen, No. 2:13-bk-38721, mem. decision (Bankr. C.D. Cal., Aug. 22, 2014) (PDF file). The trustee moved to dismiss the case on multiple grounds, including the claim that granting relief to the debtors would be an abuse of Chapter 7’s provisions. The court held that the debtors had not provided enough financial information to allow it to rule on the question of abuse. It then held that this same lack of information, combined with evidence of substantial consumer expenditures shortly before and after filing the Chapter 7 petition, supported a finding of bad faith.

The debtors, a married couple, filed a voluntary petition for Chapter 7 bankruptcy in December 2013. An amended schedule of unsecured debts identified five debts totaling $1,575,000, including at least one substantial judgment against them in Los Angeles Superior Court. They identified total after-tax income of about $4,500 per month, based on employment with a corporation that they wholly own and control. Their claimed monthly living expenses resulted in a negative monthly net income of approximately $10,000.

In the months prior to filing for bankruptcy, according to the court, the debtors spent significant sums on airfare, including round trips to Florida and Nigeria to visit each debtor’s parents, trips to New York and Massachusetts for other family events, and a trip to Dubai that was allegedly a layover during the Nigeria trip. They also paid about $1,200 for a “boarding and training” program for their two dogs during the Nigeria trip, and they claim to have paid off the loan on their Land Rover in the same month they filed for Chapter 7. Continue reading

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OpenClips [Public domain, CC0 1.0 (http://creativecommons.org/publicdomain/zero/1.0/deed.en)], via PixabayA federal district court in California considered a request to discharge federally guaranteed parent loans, which the debtors took out to pay for one of their children’s education. In re Mees, No. 2:13-cv-01892, order (E.D. Cal., Jul. 22, 2014). Student loan debt is not dischargeable in bankruptcy except in rare case of “undue hardship.” 11 U.S.C. § 523(a)(8). The bankruptcy court ruled that the parent loans were not dischargeable, applying the same legal standard used for student loans. The debtors appealed, arguing in part that the bankruptcy court erred in applying this standard. The district court considered this question but ultimately remanded the case to the bankruptcy court, finding that it applied the test incorrectly.

The debtors, a married couple, took out federally guaranteed parent loans for their son, the older of two, to pay for his college education. Parent loans, known as PLUS Loans, typically have a much higher borrowing limit and might be used to cover any gaps in financial aid available directly to the student. Unlike a student loan co-signed by parents, the student is not liable on a PLUS loan. No payments are due until the student completes or leaves school.

The debtors’ son never completed his degree. The balance of the parent loans is about $35,000. By the time of the court’s ruling, both of the debtors had been unemployed for substantial periods of time:  three years for the husband and 30 years for the wife. Their younger son is still a minor. The debtors filed for Chapter 7 bankruptcy in September 2011. They filed an adversary proceeding several months later, seeking discharge of the parent loans. The bankruptcy court ruled against them, citing the three-prong test for determining “undue hardship,” known as the Brunner test after Brunner v. New York State Higher Educ. Svcs., 831 F.2d 395 (2d Cir. 1987). Continue reading

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By Viriditas (Own work) [CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0) or GFDL (http://www.gnu.org/copyleft/fdl.html)], via Wikimedia CommonsA creditor filed an adversary proceeding in a Chapter 13 bankruptcy case, seeking an exception from discharge based on alleged fraud and willful and malicious injury. The creditor had been involved in a business venture with the debtor and made numerous allegations of accounting irregularities and financial misrepresentations. After a bench trial, at which the plaintiff-creditor presented expert testimony from a forensic accountant and a certified public accountant, the bankruptcy court held that the plaintiff did not meet his burden of proof under either claimed exception to discharge and ruled in favor of the defendant/debtor. In re Olsen, No. 2:13-bk-60733, memorandum (D. Mont., Aug. 28, 2014).

The facts of the case might be best summarized as a business venture where the parties had different understandings of the business relationship. The defendant was the majority shareholder of Human Interactive Products, Inc. (HIPinc), a “business incubator” engaged in a wide range of activities, known as as “profit centers,” under different trade names. HIPinc had a system, including accounting methods, for evaluating the performance of its profit centers.

The plaintiff, a native plant restoration specialist, approached the defendant about starting his own business in 2006. He accepted an offer of employment with HIPinc as “Operations Manager/Senior Restoration Ecologist” with a venture called Great Bear Restoration (GBR). The defendant would be his supervisor. The plaintiff did not contribute any capital towards GBR but received a salary from HIPinc. Continue reading

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By Jennifer Pahlka from Oakland, CA, sfo (LOL Just divorced. And no, that's not my car.) [CC-BY-SA-2.0 (http://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia CommonsA debtor moved to dismiss her Chapter 7 bankruptcy case after the trustee sought to use half of a $5,000 monthly payment she received from her ex-spouse to pay creditors. The trustee claimed that half of the monthly payment, which was the debtor’s only reported source of income, was actually an asset under the terms of the divorce decree and was therefore part of the bankruptcy estate. The bankruptcy court granted the motion and dismissed the case. The Bankruptcy Appellate Panel (BAP) reversed, finding that dismissal of the case would prejudice the creditors. In re Grossman, No. NV-13-1325, memorandum (BAP 9th Cir., Feb. 4, 2014) (PDF file).

The central issue for the debtor was whether $2,500 of the $5,000 payment she received every month from her former spouse was spousal maintenance, which is an exempt form of income under bankruptcy law, or part of her share of the marital estate, which is a non-exempt asset. The settlement agreement between the debtor and her former spouse stated that she was entitled to $390,000 from the former spouse. He paid her $30,000 upon signing the agreement and began making monthly payments of $2,500 on February 1, 2005. This is known as an “equalization payment.” The full amount should be paid by 2017. He sends her an additional $2,500 per month, which all parties in the bankruptcy agree is spousal maintenance.

The debtor filed a Chapter 7 petition in April 2013. She did not include the equalization payment in the Schedule B list of personal property, nor did she include a copy of her divorce decree. She reported $5,000 per month in spousal maintenance income in the Statement of Financial Affairs. After receiving a copy of the divorce decree, the trustee claimed that the equalization payment was an asset of the bankruptcy estate that could be sold to pay creditors. Continue reading

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By Valugi (Own work) [CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia CommonsAn article published earlier this year in The Week tells the story of a professional debt counselor who filed for bankruptcy. His account is notable, as he candidly admits, in part because it seems odd for someone who makes a living advising other people about their debt to find himself unable to pay his own debts. The moral of the story, to the extent that any real-life story has a “moral,” is that financial difficulties can happen to anyone. It is not always the result of some major crisis and, despite some lingering negative perceptions in our culture, it is not necessarily brought on by laziness or irresponsibility. Someone might do everything exactly right, but things still don’t always work out. This person’s story offers a glimpse of how filing for bankruptcy is not a cause for shame or an admission of failure, but a useful tool that allows people to get a fresh start.

According to Dave Landry’s piece in The Week, he and his wife married just after graduating college, when they had $40,000 in student loan debt between them. He admits that they lived beyond their means for a few years, accumulating $20,000 in credit card debt on top of the student loans. The birth of their first child caused them to cease their “jet-setting ways,” but they needed a bigger place to live. After the birth of their second child, they upgraded to a larger house, one that Landry admits was bigger than they absolutely needed. This occurred around the time of the recession of 2008, resulting in a $100,000 loss on the sale of their first house.

With the benefit of hindsight, it might seem easy to look at this story and identify mistakes. Life never works like that in real time, though, and much like doctors who neglect their own health, a debt counselor can overlook important issues. People grow accustomed to a certain lifestyle and may not recognize changing circumstances until they have already gone deeper into debt. “A certain lifestyle” does not even have to mean extravagance. It might simply mean taking vacations every year, or eating out several times a week, or any other activities or expenses that push the boundaries of their income. Continue reading

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Ron's Log [CC BY-ND 3.0 (http://creativecommons.org/licenses/by-nd/3.0/)], via ipernityThe city of San Bernardino, California is in the process of preparing a bankruptcy plan in its ongoing bankruptcy case. While a Chapter 9 case, applied specifically to municipalities, might have some superficial similarities to an individual’s Chapter 13 bankruptcy case, cities and towns typically have issues that differ from both personal and business bankruptcy cases. The city is currently considering removing its ban on medical marijuana dispensaries, which would provide new sources of tax revenue. This is legal for cities and counties under California law, but it still conflicts with federal drug laws. In personal bankruptcy, individual debtors may be able to find a higher-paying job, take additional jobs to supplement their income, or go back to school to improve their job prospects. A debtor risks criminal penalties by disclosing income derived from illegal activity in a bankruptcy case, but he or she also risks revocation of the bankruptcy discharge if he or she fails to disclose that income.

San Bernardino filed for Chapter 9 bankruptcy in 2012, and it is still working on its exit plan. The city attorney proposed medical marijuana dispensaries in July 2014 as a means of increasing revenue, and the matter went to the full City Council in mid-September. Voters in California passed Proposition 215 in 1996, which amended the state Health and Safety Code to exclude individuals from state drug laws if they possess small amounts of marijuana with a valid doctor’s prescription. Senate Bill 420, enacted in 2003, further defined the scope of the program and created a system of identification cards for medical marijuana patients.

A 2009 California Supreme Court ruling required all of the state’s counties to participate in the program. Cities, however, are not obligated to allow dispensaries to operate within their jurisdictions. Oakland became the first city to tax marijuana sales in 2009, and others have followed. San Bernardino’s city attorney cited Palm Springs, which has about one-fifth the population of San Bernardino but brings in about $500,000 per year from its ten-percent marijuana tax. Continue reading

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J.M. Gandy (Uploaded by User:Merchbow) [Public domain], via Wikimedia CommonsA bankruptcy court dismissed adversary proceedings brought in a Chapter 13 case, in which the debtors sought to strip off junior liens held by the U.S. government for loans issued through the Small Business Administration (SBA). In re Brisco, 486 B.R. 422 (Bankr. N.D. Ill. 2013). The SBA had junior liens on two properties owned by the debtors:  their residence and a rental property. The SBA did not file proofs of claim for either lien by the deadline established by the Federal Rules of Bankruptcy Procedure (FRBP), and the court held that this prevented it from valuing the SBA’s liens as requested by the debtors. The debtors objected, arguing that the SBA’s failure to file proofs of claim apparently shielded their liens from avoidance, but the court noted that the Bankruptcy Code allows a debtor to file a proof of claim on a creditor’s behalf.

The debtors owned two properties: their residence, which was appraised at $135,000 and had a first-priority lien held by JPMorgan with a secured claim of $161,064.57, and a rental property appraised at $100,000, with a first-priority lien and secured claim by JPMorgan of $213,829. The SBA had junior liens on both properties and secured claims of $25,800 and $25,700, respectively. The court entered a judgment reducing the amount of JPMorgan’s secured claim on the rental property to its value of $100,000, with the remaining $113,829 becoming an unsecured claim under 11 U.S.C. § 506(a).

In two adversary proceedings brought against the United States, the debtors asked the court to rule that the SBA’s liens were wholly unsecured under § 506(a), and to strip the liens off the two properties under 11 U.S.C. §§ 506(d) and 1322(b)(2). The United States moved to dismiss for failing to state claims on which the court could grant relief, in large part because of the absence of proofs of claim. Secured creditors are not required to file a proof of claim, but if they choose to do so, the deadline for a governmental unit is set by FRBP 3002(c)(1). If the creditor does not file a proof of claim, the debtor may do so for them under 11 U.S.C. § 501(c). Continue reading

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The automatic stay in a bankruptcy proceeding is intended to freeze the bankruptcy estate at the moment the debtor files a petition in order to allow the bankruptcy trustee to deal with the estate’s property as efficiently as possible. By Kurtis Garbutt (http://www.flickr.com/photos/kjgarbutt/15420116119) [CC BY 2.0 (http://creativecommons.org/licenses/by/2.0)], via Wikimedia CommonsFederal law excludes some proceedings and obligations from the automatic stay, however, for a variety of reasons. If a debtor is obligated to pay spousal maintenance or child support, or is involved in a legal proceeding in which those are at issue when a bankruptcy petition is filed, the automatic stay could negatively affect people who rely on the debtor for support. The automatic stay therefore does not apply to spousal maintenance and child support obligations. A divorce case usually involves more than just maintenance and support, however, so it can be difficult for bankruptcy courts to determine which parts of an order are subject to the automatic stay. A California district court recently addressed this issue in a dispute between a debtor and his soon-to-be ex-wife. In re Cohen, No. 2:14-cv-08939, civ. minutes (C.D. Cal., Oct. 5, 2015).

The Bankruptcy Code allows an exception to the automatic stay with regard to state court proceedings “for the establishment or modification of an order for domestic support obligations.” 11 U.S.C. § 362(b)(2)(A)(ii). Congress added this provision specifically to protect spouses, ex-spouses, and children of debtors from losing needed support during a bankruptcy proceeding. Bankruptcy courts also have rather wide discretion to determine whether or not a particular obligation in a divorce proceeding is a “domestic support obligation.” Federal bankruptcy law, rather than state family law, guides the court’s determination. Cohen at 8. As a result, a bankruptcy court may conclude that an agreement or order is not covered by the automatic stay under § 362(b)(2)(A)(ii), even if it does not specifically provide for spousal maintenance or child support, if the court concludes that a recipient needs support. Id.

The debtor’s wife (the “Wife”) filed a petition for divorce in Los Angeles County Superior Court in October 2008. The court signed and entered an agreed order (the “Order”) in March 2012, ordering the debtor (the “Husband”) to make monthly spousal and child support payments. The Husband filed for bankruptcy in June 2013, and the automatic stay halted many aspects of the divorce proceeding, including the division of property and the divorce itself. The parties agreed that most marital assets became the property of the bankruptcy estate.

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By Broderick, Thomas [CC0], via Wikimedia CommonsThe moment a debtor files a bankruptcy petition, the automatic stay takes effect. ‘Access’ or ‘use’ to the automatic stay is one of the primary benefits and reasons a person would consider filing a bankruptcy, whether via Chapter 7 or a Chapter 13. It basically provides an ‘umbrella of protection’ on all of a Debtor’s assets. This means that no party or creditor can repossess or foreclose on such assets once the bankruptcy has been filed. Bankruptcy courts can lift the automatic stay upon the motion of a creditor or other party-in-interest, if/where such creditor is able to convince the court to do so. A California district court recently ruled on a creditor’s motion to lift the stay with regard to ongoing litigation in state court. The court considered 12 factors established by case law to determine whether to lift the stay. In re Roger, No. 5:14-cv-02515, civ. minutes (C.D. Cal., Oct. 13, 2015).

A bankruptcy court, upon a motion by a party-in-interest, notice, and a hearing, can lift the automatic stay “for cause,” which gives the court very broad authority. 11 U.S.C. § 362(d)(1). Bankruptcy courts in the Los Angeles area have adopted a set of 12 factors to consider, known as the Curtis factors after In re Curtis, 40 B.R. 795, 799-800 (Bankr. D. Utah 1984). See also In re Plumberex Specialty Products, Inc., 311 B.R. 551, 560 (Bankr. C.D. Cal. 2004). A bankruptcy court must evaluate the impact on the bankruptcy estate, and the bankruptcy proceeding itself, of whatever action the party requesting relief from the automatic stay wants to take.

The court’s decision in the Roger case involved a creditor’s appeal of the bankruptcy court’s denial of its motion to lift the automatic stay. The creditor had a pending lawsuit against the debtor and others in state court, involving two loans, their associated security agreements, and several claims that collateral attached to the loans belonged to various trusts.

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