Articles Posted in Chapter 7

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The bankruptcy process helps people who cannot make all of their required debt payments with their available income. It allows them, in Chapter 13 cases, to create a manageable payment schedule, or to pay down their debts by liquidating assets in Chapter 7. At the end of the case, the court may grant a discharge of some or all remaining debts. Of course, payments on debts, such as mortgages, credit cards, and student loans, are not the only regular financial obligations people must maintain. Most people also have monthly bills for utilities, cellular phones and internet, and other services. People who do not own their homes must also pay rent, which can be a tricky aspect of personal bankruptcy.

A recent article in the Los Angeles Times described ways that tenants can “game” the eviction system. In addition to various courtroom tactics, the article mentioned bankruptcy as a means of delaying eviction. This only tells one small part of the story. If stalling an eviction is an individual’s primary goal, a bankruptcy filing is perhaps the least efficient way of doing it. The automatic stay in a bankruptcy case, 11 U.S.C. § 362, has the effect of staying any pending court case, including most evictions, but the relationship between bankruptcy and eviction under California law is much more complicated than that.

The legal term for eviction in California is an action for “unlawful detainer.” Cal. Civ. Pro. Code § 1161. A tenant commits unlawful detainer if they continue to occupy leased premises after the expiration of the lease, or if they default on their rent obligation and fail to vacate the premises three days after the landlord gives written notice with instructions on how to cure the default. The landlord must file a verified complaint alleging unlawful detainer and, if the eviction is based on a default, stating the amount of rent owed. Id. at § 1166. Eviction cases occur on a faster timeline than other lawsuits. The tenant must file an answer within five days of receipt of the complaint, or risk a default judgment. Id. at §§ 1167, 1169.

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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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“Lien stripping” is the process of eliminating some junior liens, such as a second mortgage, from real property during a bankruptcy case. Junior liens are, by definition, subordinate to senior liens securing a piece of real estate. The lien-stripping process essentially converts junior liens that are “underwater”—meaning that the fair market value of the collateral property is insufficient to cover the amount owed—from secured to unsecured debt, then voids the unsecured portion. 11 U.S.C. §§ 506(a)(1), (d). Lien stripping is generally available in Chapter 13 bankruptcy cases, but the U.S. Supreme Court ruled over twenty years ago in Dewsnup v. Timm, 502 U.S. 410 (1992), that it is not available in many Chapter 7 cases. Earlier this year, the court built on this ruling and disallowed lien stripping in all Chapter 7 cases. Bank of America v. Caulkett, 575 U.S. ___ (2015).

The priority of most liens is determined by the order in which the lien was recorded. A purchase-money lien is usually the first to be recorded, and is therefore known as the senior lien or the first mortgage. Additional liens secured by the property are known as junior liens, or the second mortgage, third mortgage, and so on. A junior lien is not entitled to repayment from the collateral property, such as in foreclosure, until all superior liens have been satisfied. If nothing is left, the lien becomes an unsecured debt.

If the amount of debt secured by a lien is greater than the fair market value of the collateral, that lien is said to be “partly unsecured” or “underwater.” A lien that is subordinate to an underwater senior lien is “wholly unsecured” or “wholly underwater.” The underwater portion of a lien is subject to lien stripping, meaning that portion of the lien becomes unsecured debt that can be voided. Lien stripping allows a debtor to convert a wholly-underwater junior lien into unsecured debt in its entirety under § 506(a)(1), then void it under § 506(d). This applies to “allowed” claims, defined as claims that are entitled to payment from the bankruptcy estate.
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A California federal district court ruled that fines assessed under a California law that allows employees to enforce state labor law as “private attorneys general” are not dischargeable in a Chapter 7 bankruptcy proceeding. Medina v. Poel, No. 1:14-cv-01302, order (E.D. Cal., Jan. 20, 2015). Federal bankruptcy law excepts certain fines and other penalties payable to a government entity from discharge. 11 U.S.C. § 523(a)(7). The debtor argued that any damages awarded in a lawsuit brought by an individual under the California Private Attorney General Act (PAGA), Cal. Labor Code § 2698 et seq., do not fit the definitions established in § 523(a)(7) and therefore should be subject to discharge. While the bankruptcy court agreed with the debtor, the district court reversed that holding, finding that PAGA provides for civil penalties that are excepted from discharge.

The creditor filed suit under PAGA against the debtor in state court in 2010 for alleged wage and hour law violations. PAGA allows employees to sue an employer for civil penalties for violations of state labor laws. The California legislature enacted PAGA in recognition of state officials’ inability to “keep pace with the sprawling and often ‘underground’ economy.” Medina, order at 5, citing Iskanian v. CLS Transp. Los Angeles, LLC, 59 Cal.4th 348, 379 (2014). It therefore decided to “deputize and incentivize employees uniquely positioned to detect and prosecute[] violations.” Id.

The state PAGA lawsuit was still pending when the debtor filed for Chapter 7 bankruptcy in August 2012. The debtor filed an adversary proceeding against the creditor. In a motion for summary judgment, the debtor claimed that any liability under the PAGA lawsuit was not excepted from discharge under § 523(a)(7), and that any liability had already been discharged by the general discharge issued by the bankruptcy court in June 2013. The bankruptcy court granted the debtor’s motion, and the creditor appealed to the district court. The two questions presented to the district court on appeal were whether the bankruptcy court erred in ruling that civil penalties under PAGA do not fall under the exception to discharge in § 523(a)(7), and whether the court erred in ruling that the creditor’s claims were already discharged.

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A bankruptcy court reopened a Chapter 7 case after granting a discharge on the debtor’s motion, although not for the reason stated by the debtor. In re Sullivan, No. 11-38246-A-7, memorandum (Bankr. E.D. Cal., Feb. 23, 2015). The debtor asked the court to reopen the case in order to amend the schedules to include one or more creditors who had not been included at the beginning of the case. The court held that amending the schedules was not necessary under the circumstances, but it also noted that the creditors may be able to claim an exception to discharge under 11 U.S.C. § 523. The court reopened the case in order to allow the creditors the opportunity to challenge the discharge of their debts.

The debtor filed a Chapter 7 petition on July 26, 2011. The case was determined to be a “no asset” case, so no proofs of claim were requested from the creditors. The trustee was not able to find any nonexempt assets to liquidate and filed a “no distribution” report with the court. No creditor objected to the trustee’s report. The court ordered a discharge and closed the case. Since the case was a “no-asset, no-bar-date-case,” Sullivan, mem. at 1, any dischargeable debt was discharged by the court’s order, whether or not the debt was included in the schedules or the creditor received notice of the case. See 11 U.S.C. § 727(b).

At some point after the discharge and closing of the case, the debtor moved to reopen on the grounds that the schedules did not include one or more creditors and needed to be amended. Since the discharge affected all creditors, not just the ones listed on the schedules, the court held that amending the schedules was not necessary. The court noted that a procedure exists for creditors who did not have the opportunity to object to discharge, but it held that amending the schedules would not address that issue.

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The story of a film producer who finds himself in a range of financial difficulties after poor performance at the box office is not unique to Los Angeles, but Hollywood probably gives this region more examples of this tale than most cities. One producer’s story, recently covered by the Los Angeles Times, describes just how difficult the entertainment business usually is, how easy it can be to lose money, and how many ways the personal bankruptcy process can become involved in the process. Bankruptcy can be helpful to the parties involved in these types of situations, but just like the movie business, it can also get very complicated.

The debtor in this case has what the Los Angeles Times calls a “showbiz pedigree.” His uncle was a well-known Hollywood producer, and his father-in-law was part of the production company that bought Miramax from Disney in 2010. He had some successes in the early- to mid-2000’s, such as the 2005 film Lord of War starring Nicolas Cage and Ethan Hawke. By 2008, however, he had amassed several “flops,” as well as films that were never released in theaters. His production company, which he formed with a former executive of the William Morris Agency, folded that year.

In early 2009, the debtor filed for Chapter 7 bankruptcy protection. In re Eberts, No. 2:09-bk-12534, petition (Bankr. C.D. Cal., Feb. 5, 2009). His Schedule F, the list of creditors with unsecured nonpriority claims, identified more than $7.7 million in debts. These included loans for both personal and business purposes, and personal guarantys of business loans. He received a discharge of debt from the court on March 15, 2013, although that was far from the end of the legal issues.
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A creditor objected to the discharge of a judgment for damages against the debtor in a Chapter 7 bankruptcy case under 11 U.S.C. § 523(a)(6), which prohibits discharge of debts resulting from “willful and malicious injury by the debtor.” The bankruptcy court granted partial summary judgment for the creditor, finding part of the damage award nondischargeable. The creditor appealed to the Bankruptcy Appellate Panel (BAP), arguing that the entire damage award should be excepted from discharge. The BAP vacated the bankruptcy court’s order and remanded the matter for further proceedings regarding how much of the judgment involved tortious action. In re Lawson, No. NC-14-1153, memorandum (B.A.P. 9th Cir., Mar. 23, 2015).

The debtor operates a winery in California’s Napa Valley under an assumed business name. He entered into a two-year master distribution agreement (MDA) with the creditor in May 2011, which gave the creditor the exclusive right to distribute the debtor’s wine in China. The BAP states that “signs of strain in the business relationship” soon became apparent. Lawson, mem. at 3. In May 2012, the creditor placed an order for Merlot and paid in full. It also placed an order for Cabernet, but the debtor canceled this order and, according to the BAP, refused to release the Merlot to the creditor unless it paid additional money for expenses related to the cancelled Cabernet order and underpayment for earlier orders.

The creditor filed suit against the debtor in California state court after it lost two major contracts in China. An arbitrator found that the debtor was liable for conversion of the Merlot order, breach of the MDA, and breach of the covenant of good faith and fair dealing. The court confirmed the arbitrator’s award of over $222,000 in compensatory and punitive damages, attorney’s fees, and costs.

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A bankruptcy court ruled in favor of the Chapter 7 trustee in an adversary proceeding to deny a discharge. In re Clark, No. 12-00649, Adv. No. 13-06042, mem. dec. (PDF file) (Bankr. D. Id., Feb. 12, 2015). The trustee alleged multiple grounds under 11 U.S.C. § 727(a), which prohibits a discharge of debt in a Chapter 7 proceeding if a court finds that a debtor has committed any of a lengthy list of types of misconduct. A trustee or creditor may object to discharge under this provision. The court found that the trustee had met his burden of proof to establish fraudulent transfers, insufficient recordkeeping, false statements, and violations of an injunction.

The debtor filed for bankruptcy under Chapter 12 of the Bankruptcy Code, which applies to people who make a living as farmers or fishermen, in March 2012. His initial Chapter 12 petition provided very little information, according to the court, and subsequently filed schedules did not offer much more clarity. He reportedly included some assets, such as checking accounts in the name of a limited liability company (LLC), in which he claimed no ownership interest.

The bankruptcy court held a hearing in May 2013 on whether to convert the case to Chapter 7 due to fraud by the debtor under 11 U.S.C. § 1208(d). This is somewhat similar to provisions allowing a court to convert a Chapter 7 case to Chapter 11 or Chapter 13 for “abuse.” 11 U.S.C. § 707(b). The court converted the case to Chapter 7 and appointed a trustee.

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The Bankruptcy Code prohibits the discharge of debt in Chapter 7 cases if the debtor transferred property out of his or her own name, with fraudulent intent, less than one year before filing a petition. 11 U.S.C. § 727(a)(2)(A). This is known as a “lookback period.” The Bankruptcy Appellate Panel (BAP) in Pasadena, California ruled earlier this year on the following question. Is this one-year lookback period a “statute of limitations,” which a court can adjust if a creditor shows good cause, or a “statute of repose” that bars claims after one year without exception? It ruled in the debtor’s favor, holding that a transfer of real property more than a year before filing a Chapter 7 petition does not prevent discharge. In re Neff, 505 B.R. 255 (BAP 9th Cir. 2014) (PDF file).

The case involves a total of three successive bankruptcy cases. The debtor filed a Chapter 13 petition in March 2010, but the court dismissed it one month later for failure to attend the creditors’ meeting. He filed a second Chapter 13 petition in June 2010. In March 2008, he had executed a revocable living trust and a quitclaim deed conveying a piece of real property (the “Property”) to the trust. The deed was not recorded, however, until April 7, 2010, while the first Chapter 13 case was still pending. The court noted this fact during the second Chapter 13 case, and the debtor signed a deed conveying the Property back into his name in August 2010.

The creditor was a patient of the debtor’s dental practice who had obtained a judgment for $310,000 in a malpractice lawsuit. He moved to dismiss the debtor’s second Chapter 13 case for bad faith in September 2010, based in part on the transfer of the Property to the trust. The debtor agreed not to oppose the motion to dismiss if he was not barred from filing a Chapter 7 case, so the court dismissed the Chapter 13 case. Continue reading

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The trustee in a Chapter 7 bankruptcy case filed a motion for partial summary judgment seeking to avoid two transfers that occurred shortly before the debtors filed their bankruptcy petition. The court held one of the transfers, the sale of real estate for less than the market price, was fraudulent under federal and state law. In re Chu (“Chu I”), No. 12-00986, Adv. Pro. No. 12-90091, mem. decision (D. Haw., Jun. 5, 2014). The court also denied a motion for summary judgment brought by the trustee in another adversary proceeding that sought to deny the Chapter 7 discharge based on the same transfers. In re Chu (“Chu II”), No. 12-00986, Adv. Pro. No. 13-90056, mem. decision (D. Haw., Jun. 5, 2014).

The debtors, a married couple, filed for Chapter 7 bankruptcy in May 2012. The wife had purchased real property in 2001 for $600,000. About three months before filing bankruptcy, she had transferred the property to her two sons for $5,000 in cash and the assumption of a $400,000 debt she allegedly owed to a friend. The trustee challenged the real property transfer and also challenged the $400,000 debt because of a lack of any record of payments made by the debtors.

During the bankruptcy proceeding, the trustee demanded that the sons return the property to the estate. The sons did so, and the trustee was able to sell it for $710,000. The trustee moved for partial summary judgment, asking in part that the court find that the real estate transfer was fraudulent under 11 U.S.C. § 548(a)(1) and the Uniform Fraudulent Transfer Act, HI Rev. Stat. § 651C et seq. See also CA Civ. Code Sec. 3439 et seq.
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