Articles Posted in Chapter 7

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Nicholas Eckhart [CC BY 2.0 (https://creativecommons.org/licenses/by/2.0/)], via FlickrChapter 7 bankruptcy enables qualifying debtors to pay down their debts by liquidating their non-exempt assets, followed by a discharge of many remaining debts. In order to qualify for a Chapter 7 discharge, debtors must demonstrate that they meet the criteria set out in the “means test,” 11 U.S.C. § 707(b). A trustee or creditor may ask the court to convert a Chapter 7 “liquidation” case to a Chapter 11 “reorganization” case for good cause, such as if they believe that the debtor does not qualify under the means test. Individual debtors rarely use Chapter 11, but a court cannot convert a Chapter 7 case to Chapter 13 without the debtor’s agreement. 11 U.S.C. § 706(c). A bankruptcy court recently ruled that a married couple could not file under Chapter 7 and essentially encouraged them to use Chapter 13 instead. In re Decker, No. A14-00065, memorandum (D. Alaska, Mar. 31, 2015).

The debtors in Decker have a complicated history of financial problems, as described by the bankruptcy court. Their adult daughter has required their ongoing support for medical problems and addiction recovery since 2009. The debtors began having serious issues with the Internal Revenue Service (IRS) in 2007, when it assessed deficiencies for the previous two tax years. Those debts have reportedly continued to accrue.

When the debtors filed their Chapter 7 petition in March 2014, they identified almost $426,000 in debts. Debts owed to the IRS included over $102,000 in priority debt and $81,000 in non-priority debt. The IRS filed a proof of claim for more than $204,000 in taxes, interest, and penalties. They also identified tax debts owed to the states of California and Alaska. The $35,000 in personal property identified in their schedules is all exempt or subject to liens.

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PublicDomainPictures [Public domain, CC0 1.0 (http://creativecommons.org/publicdomain/zero/1.0/deed.en)], via PixabayThe loss of a job is one of the biggest factors that lead people to file for Chapter 7 and Chapter 13 bankruptcy. State and federal programs exist to assist people who have lost their job and are looking for a new one. When losing a job puts a person in such financial distress that they must consider bankruptcy, the question emerges as to whether or not unemployment benefits constitute “income” for the purposes of a bankruptcy case. The short answer to that question is yes, it is considered income. The answer can be more complicated, however, when applied to specific parts of the bankruptcy process, like the Chapter 7 means test.

California, like most states and the federal government, maintains a system of unemployment insurance (UI). Employers pay into the insurance fund, which is available to pay temporary benefits to qualifying former employees. In order to qualify for benefits, individuals must have lost their job through no fault of their own, such as through a layoff; must have received a minimum amount of wages during an earlier 12-month period; and must be physically capable of working, willing to work, and actively seeking work. The amount provided through these programs is usually not much, but it at least keeps people from losing any and all income.

The general rule in bankruptcy is that unemployment compensation received through state or federal UI programs is included in a debtor’s income calculations. Chapter 7 bankruptcy cases rely on a “means test” based on a debtor’s “current monthly income.” A debtor whose “current monthly income” is greater than a certain amount, determined by a rather complicated formula, is not eligible for Chapter 7 bankruptcy. 11 U.S.C. § 707(b)(2). Some courts disagree on whether this income calculation includes unemployment compensation.

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American Advisors Group [CC BY-SA 2.0 (https://creativecommons.org/licenses/by-sa/2.0/)], via FlickrBusiness owners, entrepreneurs, and investors often create business entities as a means of protecting themselves from liability, as well as protecting their business or investment from their own liability. If an individual debtor has some form of individual liability for unlawful business activity, however, those activities may be considered a factor in the bankruptcy proceeding. This was the case in a claim brought by the U.S. Department of Labor (DOL) against a business owner accused of withholding employee retirement contributions in violation of the Employee Retirement Income Security Act (ERISA), 29 U.S.C. § 1001 et seq.

The debtor was the sole member and manager of a limited liability company (LLC) organized in Massachusetts. The LLC operated a weight loss business through a Jenny Craig franchise at eight locations around New York state. It established a retirement plan and trust for its employees in 2012, with the debtor named as the plan’s fiduciary and trustee. Employees funded the plan through contributions withheld from their paychecks. The debtor was responsible for transferring the withheld amounts to the employees’ retirement plan accounts.

The DOL claimed that the debtor failed to transfer a total of $8,646.00 to the plan during pay periods in 2012 and 2013. Under ERISA, funds withheld from an employee’s paycheck for the purpose of contributing to a retirement plan automatically become an asset of that plan, and the plan’s trustee has a fiduciary duty to remit those funds to the plan promptly. The debtor, according to the DOL, violated ERISA by failing to transfer those funds to the retirement plan. Continue reading

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Fotocitizen [Public domain, CC0 1.0 (http://creativecommons.org/publicdomain/zero/1.0/deed.en)], via PixabayThe Ninth Circuit Court of Appeals recently issued a series of rulings addressing the rights of Chapter 7 debtors to the funds in their bank accounts. In re Mwangi (“Mwangi I”), 764 F.3d 1168 (9th Cir. 2014); In re Mwangi (“Mwangi II”), No. 14-15265, slip op. (9th Cir., Oct. 21, 2014). The debtors, a married couple, claimed exemptions on several bank accounts and sought sanctions against the bank when it refused to lift an administrative freeze. The appellate court held that the accounts remained part of the bankruptcy estate until the deadline for creditors to object to the debtors’ claimed exemptions had passed, and then the accounts re-vested in the debtors. Since the alleged automatic stay violation occurred before re-vesting, the court held that the debtors lacked standing. Only the trustee has standing to bring claims to protect assets in the bankruptcy estate.

The debtors filed for Chapter 7 bankruptcy in August 2009. They held four accounts at Wells Fargo Bank at the time with a total balance of about $17,000, which they did not claim as exempt in their original Schedule C. Wells Fargo runs an automated computer program that compares the names of new Chapter 7 cases to those of account holders. It put an administrative freeze on all four accounts shortly after the debtors filed their petition and notified them by mail. It also notified the trustee, who instructed it to hold the funds until further instructions, or until 31 days after the creditors’ meeting.

About a week after the filing date, the debtors filed an amended Schedule C that claimed exemptions in 75 percent of the value of the four accounts, citing a state law that exempts that amount of disposable earnings. Nev. Rev. Stat. § 21.090(1)(g). They asked Wells Fargo to lift the freeze on the accounts, which it refused to do without the trustee’s agreement. Continue reading

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Vladimir Makovsky [Public domain], via Wikimedia CommonsThe Bankruptcy Code provides individuals and families with several options when they need to file a bankruptcy petition, and it allows them to convert a case from one chapter to another in certain circumstances. A federal appellate panel in California recently considered an interesting question:  if a debtor converts a case from Chapter 11 or 13 to Chapter 7, what happens to income earned after the petition but before conversion? It would belong to the bankruptcy estate under Chapters 11 or 13, but to the debtor under Chapter 7. The court ruled that it reverts to the debtor once the case is converted from Chapter 11 back to Chapter 7. In re Markosian, 506 B.R. 273 (B.A.P. 9th Cir. 2014) (PDF file).

By filing a bankruptcy petition, a debtor creates a legally distinct “bankruptcy estate.” A court-appointed trustee has the right to make certain decisions about estate property and the duty to manage the estate responsibly. In general, any property that a debtor owns when he or she files a bankruptcy petition becomes part of the estate. 11 U.S.C. § 541. In Chapter 11 or 13 cases, property acquired and earnings received for services rendered by the debtor, including salary or wages, also become part of the bankruptcy estate until the case is dismissed, converted, or closed. 11 U.S.C. §§ 1115, 1306.

The debtors in Markosian, a married couple, filed a Chapter 7 bankruptcy petition in February 2009. The trustee moved to dismiss the case for abuse under 11 U.S.C. § 707(b), claiming that the debtors had enough income to pay their debts. In response, the debtors converted the case to Chapter 11. While Chapter 13 is much more common among individuals and families, the Bankruptcy Code sets upper limits on the amount of debt a Chapter 13 debtor can have. Currently, Chapter 13 is not available to debtors whose secured and unsecured debts exceed $1,149,525 and $383,175, respectively. 11 U.S.C. § 109(e), “Revision of Certain Dollar Amounts in the Bankruptcy Code Prescribed Under Section 104(a) of the Code”, 78 F.R. 12089 (Feb. 20, 2013). Continue reading

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By VISALIA2010 (Own work) [CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia CommonsA California bankruptcy judge recently ruled on a series of motions in a Chapter 7 case, including an effort by the debtors to have their residence declared exempt under California law and a motion by the court-appointed trustee to compel them to turn the property over to him. The trustee alleged that the debtors undervalued the residence in their original schedules, that they did not heed his warnings about the type of exemption they were claiming, and that the amended schedules they filed were not filed in good faith. He sought turnover of the property because he had already entered into a contract to sell it. The court ruled in the trustee’s favor. In re Gutierrez, No. 12-60444, mem. decision (E.D. Cal., Jan. 29, 2014).

The debtors filed a Chapter 7 bankruptcy petition in December 2012. Their Schedule A listed a residence in Visalia, California valued at $127,748, with two mortgages totaling $115,050. They claimed the equity of $12,698 as exempt, using California’s “wild card” exemption defined in Cal. Civ. Pro. Code § 703.140(b)(5). They claimed five other assets as exempt, with a total claimed value of $17,927. At the creditors’ meeting in January 2013, the trustee told the debtors that the residence had more equity than they claimed and was therefore more than they could claim under the “wild card” exemption. He “implicitly suggested” that they look at other exemptions allowed by California law. Gutierrez, mem. dec. at 3.

About a week later, the court issued a notice to creditors to file proofs of claim, meaning it anticipated the sale of assets by the trustee. The court entered a discharge without objection that April. The trustee moved for leave to hire a real estate broker in July. The debtors’ only response was to file a motion to convert the case to Chapter 13. The court granted the motion for sale. It authorized the trustee to sell the residence for $165,000, significantly more than the value claimed by the debtors. It denied the debtors’ motion.

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By Although (English Wikipedia) [Public domain], via Wikimedia CommonsA debtor’s withdrawal of money from a bank account less than a year before filing for Chapter 7 bankruptcy resulted in the denial of a discharge of debt, based on a bankruptcy court’s finding of fraudulent intent. The debtor claimed that he withdrew the money because of concerns about a creditor’s methods of collection. The Bankruptcy Appellate Panel (BAP) for the Ninth Circuit Court of Appeals affirmed the ruling. In re Haag (“Haag I”), Nos. AZ-11-1661, AZ-11-1662, AZ-11-1663, memorandum (BAP 9th Cir., Sep. 27, 2012) (PDF file). The Ninth Circuit also affirmed, rejecting the debtor’s arguments that the court should consider his good intentions regarding the creditor’s allegedly questionable collection practices. In re Haag (“Haag II”), No. 12-60074, memorandum (9th Cir., Aug. 20, 2014).

The debtor was the sole owner of an engineering company called HTI, Inc. that had a line of credit with Northwestern Bank (NWB). In mid-2007, the housing market collapsed, and the company was not able to generate enough revenue to pay the debt. After an unsuccessful attempt to sell the business, the debtor surrendered all of HTI’s assets to NWB in late 2008. He informed the bank that he intended to file for Chapter 7 bankruptcy, and that his only sources of income were IRAs, social security, and unemployment.

In early 2009, the debtor received federal and state tax refunds totaling almost $250,000. He deposited “some or all” of the funds, Haag I at 5, into a personal checking account at the Bank of Tucson. He withdrew $120,000 in cash from that account in July 2009 and placed it in a safety deposit box that he had jointly rented with his wife at another bank. About three weeks later, NWB obtained a judgment against the debtor in a Michigan court, based on his personal guaranty of business debts, for approximately $1.7 million. The bank obtained a domesticated judgment in Arizona, where the debtor resided, in February 2010. The debtor filed for Chapter 7 bankruptcy the following month. 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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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