Articles Posted in Chapter 13

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A bankruptcy judge recently denied a debtor’s request to convert his case from Chapter 11 to Chapter 7, finding that he had not acted in accordance with his fiduciary duties throughout the case. Most individual debtors do not find Chapter 11 to be helpful. It is much more common for business bankruptcies and individuals with very large estates. In this case, the debtor is a professional hockey player. In re Johnson, No. 2:14-bk-57104, petition (S.D. Oh., Oct. 7, 2014). When he moved for conversion to Chapter 7, the court reviewed the course of the case and issued a 150-page order denying the motion and criticizing the debtor’s conduct. Johnson, op. and order (Feb. 26, 2016). The judge’s reasoning offers an idea of the concerns that courts address in Chapter 7 cases.

A key difference between the Johnson case and a Chapter 7 or Chapter 13 case is that the bankruptcy estate had no independent trustee. The debtor was acting as trustee when he moved for conversion to Chapter 7. In Chapter 11 cases, a trustee is only appointed if requested by a party in interest or the U.S. Trustee’s Office. 11 U.S.C. § 1104. If no trustee is appointed, the debtor serves in the capacity of trustee, with all the same fiduciary duties towards creditors and others. Under Chapters 7 and 13, the Bankruptcy Code states unconditionally that a trustee “shall” be appointed. 11 U.S.C. §§ 701, 1302.

Debtors are typically allowed to convert their case from one chapter to another if they meet various criteria established in the Bankruptcy Code. A Chapter 11 debtor can convert their case to Chapter 7, with several exceptions. A bankruptcy court may not convert a case to Chapter 7 if it finds that appointment of a Chapter 11 trustee would be in the estate’s and the creditors’ best interest, or if it “identifies unusual circumstances” indicating that conversion would not be in their best interest. 11 U.S.C. § 1112(b). A Chapter 7 debtor can convert their case to Chapter 11 or Chapter 13 with the court’s permission, after establishing cause. 11 U.S.C. § 707. A Chapter 13 debtor is far less constrained in converting a case to Chapter 7. 11 U.S.C. § 1307.
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Individuals and families may file for bankruptcy protection under Chapter 7, which focuses on liquidating assets and paying down debts in a short period of time. Or they may use Chapter 13, which allows debtors to pay down large portions of their debts over a period of several years and avoid unsecured debts. Deciding which to choose depends on each debtor’s individual circumstances. Some, but definitely not all, courts allow debtors to file a Chapter 7 case in order to pay down their debts and obtain a discharge of unsecured debts, followed shortly afterwards by a Chapter 13 case, which the debtor uses to “strip” one or more liens from their home. This process is informally known as a “Chapter 20” case.

What Is Lien Stripping?

Chapter 13 may be an appealing option for a debtor with an “underwater” second mortgage, meaning a mortgage with a principal balance that exceeds the debtor’s equity in their home, or the amount not covered by a first-priority mortgage. A debtor may be able to use Chapter 13 to avoid an underwater mortgage, a procedure known as “lien stripping.”

By law, a secured creditor’s claim is only “secured” to the extent that the amount owed is equal to or lesser than the collateral’s value—meaning that any amount over that value is considered unsecured debt. 11 U.S.C. §§ 506(a)(1), (d). A Chapter 13 plan may avoid unsecured debts. 11 U.S.C. § 1322(b)(2). The U.S. Supreme Court held earlier this year, however, that lien stripping is not permitted in Chapter 7 cases. Bank of America v. Caulkett, 575 U.S. ___ (2015).

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When a debtor files a bankruptcy petition, a bankruptcy estate is created that exists as a distinct legal entity. The court-appointed trustee has the authority to manage this estate, and the debtor’s non-exempt property becomes the estate’s property. Property obtained by the debtor after the filing date may also become estate property, depending on the circumstances and the chapter of the Bankruptcy Code that the debtor chooses. A debtor in a Chapter 13 case disputed the trustee’s claim to money received by inheritance more than 180 days after the filing date. In a decision that turned on principles of statutory construction, the Ninth Circuit Bankruptcy Appellate Panel (BAP) ruled that the inheritance was estate property. In re Dale, 505 B.R. 8 (9th Cir. BAP 2014).

The debtors, a married couple, filed a Chapter 13 petition in October 2011. In August 2012, the husband’s mother passed away, and he received about $30,000 in inheritance. At that time, the bankruptcy court had not yet confirmed a Chapter 13 bankruptcy plan. The debtors filed a declaration notifying the court of the inheritance in December 2012.

The trustee demanded that the debtors turn over the full amount of inheritance funds to the estate. In January 2013, he filed a motion to dismiss the Chapter 13 case, partly for failing to disclose the inheritance and turn over any non-exempt amounts. The debtors argued that the inheritance was not part of the bankruptcy estate. After a hearing in May 2013, the bankruptcy court ruled that the estate was entitled to the inheritance and ordered the debtors to turn over all funds to the trustee. The debtors appealed to the BAP.

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A bankruptcy court granted a Chapter 13 trustee’s motion to dismiss a debtor’s case and barred the debtor from further bankruptcy filings, in any district in the country, for a two-year period. In re Weik, No. 14-61298, mem. dec. (Bankr. D. Mont., Feb. 24, 2015). The trustee had argued that the debtor was ineligible for bankruptcy relief because of recent prior bankruptcy cases, 11 U.S.C. § 109(g)(1); that the debtor had abused the bankruptcy process; and that he was not seeking bankruptcy relief in good faith.

The debtor filed a Chapter 13 petition in approximately October 2014. According to the court’s ruling, he had previously filed at least nine bankruptcy petitions, mostly under Chapter 13:  five in Montana, two in Arizona, and two in Texas. Several of the cases had been dismissed by the court for delinquency in plan payments. A bankruptcy court dismissed the most recent prior case in April 2014 because of missed Chapter 13 plan payments.

At the hearing on the trustee’s motion to dismiss, the trustee called the manager of a self-storage business in Tucson, Arizona to testify. She stated that the debtor had entered into a month-to-month storage contract for three units at her facility in 2012 and continued to occupy all three units. He allegedly had not made a rent payment since January 2013, and as of January 2015 he owed more than $8,600. She testified that she had attempted to repossess his property under Arizona law, but the debtor filed each of his three most recent prior bankruptcy cases on the day she had scheduled a sale. The automatic stay prevented the auction each time.

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A California bankruptcy court recently ruled on a motion to lift the automatic stay in a Chapter 13 case by a company that purchased real property at a foreclosure auction. In re Richter, No. 6:14-bk-10231, mem. dec. (Bankr. C.D. Cal., Jan. 20, 2015). The purchaser sought to initiate an unlawful detainer proceeding, commonly known as an eviction, in order to take possession of the property. The debtor argued that he had a right of redemption under California law, which allowed him to recover the property by paying the amount owed to the lienholder. The court expressed sympathy for the debtor but ruled that his right of redemption had expired under both California law and the Bankruptcy Code.

The debtor owned a condominium in Palm Desert, California. Since it was part of a common interest development, the property was subject to covenants, conditions, and restrictions (CC&Rs) enforced by a homeowner’s association (HOA). When the debtor fell behind on assessments, the HOA commenced nonjudicial foreclosure. Under state law, a property owner has a 90-day right of redemption after the sale of a property in a nonjudicial foreclosure by an HOA. Cal. Civ. Code § 5715(b), Cal. Civ. Proc. Code § 729.035.

A trustee appointed by the HOA conducted a foreclosure auction in October 2013. The purchaser bought the property for $36,000, which more than covered the debtor’s $18,836 assessment arrearage. The foreclosure trustee notified the debtor of his 90-day right of redemption. On the last day of the redemption period, in January 2014, the debtor filed for Chapter 13 bankruptcy. According to the court, he intended to use the Chapter 13 bankruptcy plan to exercise his right of redemption. The HOA refused to accept his payments, however, arguing that the sale of the property was complete. The foreclosure trustee recorded the trustee’s deed in August 2014, perfecting the purchaser’s title. In October, the purchaser moved to lift the automatic stay.

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A bankruptcy court allowed Chapter 13 debtors to pursue an adversary claim against their loan servicer for unapproved fees. The debtors claimed that the loan servicer intentionally misapplied a lump sum payment intended to go towards their mortgage principal after the discharge. The court granted the debtors’ request for a preliminary injunction. In re Moffitt (“Moffitt I”), 390 B.R. 368 (Bankr. E.D. Ark. 2008) (PDF file). It dismissed the debtors’ non-Bankruptcy Code claims in two subsequent opinions, 406 B.R. 825 (Bankr. E.D. Ark. 2009) (“Moffitt II”) (PDF file) and 408 B.R. 249 (Bankr. E.D. Ark. 2009) (“Moffitt III”) (PDF file), but it allowed the remaining claims to proceed. The parties settled the dispute several months later.

The debtors filed a Chapter 13 petition in October 2004. They listed a first-lien deed of trust of $35,000 to their mortgage servicer, EverHome, which filed a proof of claim alleging a debt of over $36,000. It filed amended proofs of claim that progressively increased that number throughout 2005, claiming expenses like attorney’s fees and inspections. The debtors objected to the additional fees, but they also moved to settle and administer the case in order to use a personal injury settlement to pay off the Chapter 13 plan. Although the debtors wanted to continue to pursue the objection, the court ruled that it was moot and granted a discharge.

EverHome transferred the debt to America’s Servicing Company (ASC), which the debtors claim is an alter ego of Wells Fargo Bank, in late 2005. ASC submitted a payoff amount to the trustee of just under $10,000. In April 2006, the trustee paid that amount to ASC, and the debtors sent a personal check to ASC in the amount of $10,000, directing ASC to apply the funds to the mortgage principal. Instead, ASC applied the debtors’ payment to other fees, causing their mortgage “to go into complete disarray.” Moffitt I at 389. Continue reading

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Years after a debtor obtained a discharge of personal debt in a Chapter 7 bankruptcy proceeding, a mortgage lender with a second-lien mortgage sought to enforce its lien. A bankruptcy court ruled, over the debtor’s objection, that the lender was allowed to do so. In re Cusato, 485 B.R. 824 (Bankr. E.D. Pa. 2013). It ruled that an order issued during the bankruptcy proceeding, which held that the creditor’s claim was unsecured, did not avoid its lien. Bankruptcy law holds that a discharge only applies to a debtor individually, meaning that a creditor can still enforce a lien against property.

The dispute arose in late 2011, more than six years after the debtor obtained a Chapter 7 discharge, when the debtor applied for a reverse mortgage loan to prevent foreclosure by the first-lien mortgage holder. Springleaf Financial Services of Pennsylvania sent the title agent a letter claiming a second-lien mortgage. Although the debtor disputed Springleaf’s claim, she reportedly agreed to pay the claimed amount from the loan proceeds because she could not close on the reverse mortgage loan otherwise. The debtor obtained leave to reopen the Chapter 7 case and filed an adversary proceeding against Springleaf in May 2012, claiming that Springleaf had violated the statutory injunction against collecting discharged or avoided debt under 11 U.S.C. § 524(a).

Springleaf’s claim arose from a loan, secured by a second mortgage, made by its predecessor-in-interest in 2000. The debtor filed for Chapter 13 bankruptcy in November 2000. Several days later, she filed an adversary proceeding against Springleaf’s predecessor asking the court to avoid the second mortgage lien. The predecessor filed a proof of claim that December but never answered the adversary complaint. The court entered a default order in March 2001 classifying the claim as unsecured. Continue reading

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A federal district court affirmed a bankruptcy judge’s order converting a Chapter 13 bankruptcy to a Chapter 7 based on a finding of bad faith on the part of the debtor. In re Killian, No. 3:12-cv-03156, order (C.D. Ill., Sep. 30, 2013). Federal bankruptcy law allows a court to dismiss a case, or to convert it to a different chapter, for cause. The bankruptcy court found that the debtor failed to disclose, among other transactions, a transfer of cash that occurred just days before he filed his Chapter 13 petition, and held that he filed the petition in bad faith. It ordered a conversion to Chapter 7 to protect the creditors’ interests.

A debtor may wish to convert their case from one chapter to another for a near-infinite number of reasons, but this option is only available automatically once. The law specifically prohibits conversion of a case that has already been converted unless specifically set for hearing. 11 U.S.C. §§ 706(a), 1307(b). In a Chapter 13 case, the court can dismiss the case or convert it to a different chapter if a party in interest or the trustee makes a motion and shows cause. “Cause” may include material failures by the debtor to comply with court orders or the Chapter 13 bankruptcy plan, 11 U.S.C. § 1307(c), but may also involve a showing of the debtor’s bad faith. Marrama v. Citizens Bank of Massachusetts, 127 S. Ct. 1105, 1113-14 (2007).

A conversion by the court in such a case should serve “the best interest of the creditors.” Killian, order at 11. Most personal bankruptcies are filed under either Chapter 7 or Chapter 13. Each offers distinct advantages depending on an individual debtor’s circumstances. From a debtor’s perspective, a Chapter 13 case could safeguard certain assets that a trustee might sell in a Chapter 7 case. Creditors, however, might want to convert a Chapter 13 case to a Chapter 7 if the debtor has not made a full disclosure of all assets. A creditor could then ask the court to find that a previously-undisclosed asset is non-exempt. Continue reading

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A decision by the U.S. Supreme Court in United Student Aid Funds, Inc. v. Espinosa, 130 S. Ct. 1367 (2010), has reportedly prompted a review of various Chapter 13 bankruptcy procedures. The court affirmed an order discharging student loan debt, but only because the creditor failed to object or appeal properly. The Judicial Conference Advisory Committees on Bankruptcy and Civil Rules published a set of proposed amendments to the Federal Rules of Bankruptcy Procedure this summer that could modify how parties to a bankruptcy give notice of an adversary proceeding, how debtors give notice of a Chapter 13 plan, and how creditors make objections.

Federal law prohibits bankruptcy courts from discharging student loan debt unless it finds that the debtor would experience “undue hardship.” 11 U.S.C. §§ 523(a)(8), 1328(a)(2). In United Student Aid, the debtor filed a Chapter 13 plan that included repayment of the principal of his student loan debt, followed by discharge of the accrued interest at the close of the case. The creditor filed a proof of claim that included the total amount of the debt, but did not object to the plan. After the bankruptcy court confirmed the plan without entering a finding of “undue hardship,” the creditor still did not object.

Several years later, the creditor attempted to collect the unpaid interest. The debtor asked the bankruptcy court to order the creditor to cease and desist collection action, and the case made its way to the Supreme Court. The creditor argued that the order discharging the debt was void because the debtor did not serve the creditor with a summons during the original case, and also because the bankruptcy court did not make a finding of undue hardship. In a 9-0 ruling, the Supreme Court ruled for the debtor. It held that both of the points raised by the creditor might constitute legal error, but that the creditor should have raised those points in an objection to the bankruptcy plan or an appeal of the bankruptcy court’s order confirming the plan. Continue reading

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A federal judge sentenced a Chapter 13 debtor to fifteen months in prison in December 2013, following his conviction of one count of bankruptcy fraud in April. Federal prosecutors accused him of failing to disclose assets, including lease contracts on residential real property that he owned in Houston, Texas. U.S. v. Chaker, No. 4:12-cr-00168, indictment (S.D. Tex., Mar. 22, 2012). The purpose of the debtor’s failure to disclose the leases, the government claimed, was to defraud the property’s secured creditor, who had been preparing to foreclose on the property. The court, when pronouncing the sentence, reportedly noted the importance of the “reliability of those who petition for bankruptcy relief.”

The debtor, who resides in Beverly Hills, California and Las Vegas, Nevada, filed for Chapter 13 bankruptcy on March 6, 2007 in the U.S. Bankruptcy Court for the Southern District of Texas. According to the indictment, the debtor failed to disclose two details regarding his assets and liabilities. First, he had reportedly formed a limited liability company (LLC) in Nevada in 2005. He opened two business checking accounts for the company that year, and he registered it as a foreign LLC doing business in Texas in 2006. Second, the indictment stated that the debtor purchased residential real property in Houston, Texas in 2004, claiming on the loan application that he would use the property as his primary residence. He reportedly leased the property to others under two lease agreements in 2005 and 2006.

The indictment charged the debtor with one count of bankruptcy fraud under 18 U.S.C. § 157, alleging that he made “false or fraudulent representations” to the bankruptcy court and the trustee. He fraudulently failed to disclose “Income from Other Employment or Operation of Business,” it claimed, by omitting information about his interest in the LLC. He also failed to disclose the prior lease agreements on the residential property, and allegedly made a false representation to the court at a hearing on March 26, 2007, that he had not leased the property before January 2007. The indictment further alleged that the debtor sought to defraud the mortgage lender by using the automatic stay to postpone foreclosure, which the lender had scheduled for the same day the debtor filed his Chapter 13 petition. Continue reading