Tom Scott Law Indy

Bankruptcy Attorneys in Indianapolis Since 1980

Property & Asset Protection

Protecting Your House From Liquidation in a Bankruptcy

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If you own a home, Indiana law allows you to protect a portion of the equity in that home. A liquidation analysis determines what would be available for creditors after you deduct the cost of sale and other expenses.
We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including being “judgment proof,” protecting your house from liquidation in a bankruptcy, home equity exemptions, some benefits of filing a Chapter 13 “100% plan,” common reasons people file for bankruptcy, a deficiency balance on a debt, an example of how an ex-spouse can impact a bankruptcy, and conduit mortgage payments. Below is Part 1 of 2 of the transcript of that conversation.

Q: In regard to a person’s financial situation, what does it mean to be “judgment proof?”
Chris Holmes: Some people have too much debt and maybe they’re on Social Security or they have no income. Those individuals are what we call “judgment proof” because creditors can’t make them pay if they don’t have wages to garnish. A person’s take-home pay must exceed $217.50 per week before they can be garnished. In addition, some sources of income, like Social Security and veteran’s benefits, are exempt—off-limits—from garnishment. If those individuals don’t have any real estate or they have less than $10,250 in tangible personal property, there’s nothing a creditor can take from them to liquidate, to pay on the debt. Sometimes I tell people that they don’t even need me, if they have a strong enough stomach to withstand the calls, the letters, and being dragged into court periodically.
Jess Smith, III: On the other hand, I had a woman come in to see me recently and she hardly has any income, but her name is on the deed of an ex-boyfriend’s piece of lien-free real estate that is worth $90,000. Therefore, she had to pay 100% of her debts to protect that property. She said, “Well, I better go out and find a job first.” She was behind on her residence and thought she could get rid of her other debt and just keep her residence, but she found out her name is on this other piece of property.
CH: Sometimes people come to us, creditors are hounding them, and they don’t have the ability to pay them back. Most people would prefer to file a Chapter 7 bankruptcy and just wipe the slate clean, but we have to evaluate their home and compare it to what’s owed on it. If you own a house in your name only, Indiana law allows you to protect $19,300 of equity in that home. So let’s say you have an $80,000 house and you only owe $30,000 on it, so there’s $50,000 of equity. You can only protect $19,300, which leaves just under $30,700 of non-exempt equity. In a Chapter 7 bankruptcy, the trustee has the power to take that house, sell that house, pay the commission for the sale, give you your $19,300 equitable interest that’s protected, and use what’s left over to pay back some of your debt.
Q: So how do you avoid that?
CH: For those people, if they want to protect their house, I ask them if they have a rich relative or a retirement account or some resources to tap. We do what’s called a liquidation analysis to determine what would really be leftover for the creditors once you factor in the cost of sale and some other things. I had a case where a woman couldn’t afford to come up with money herself, but she had a rich uncle who stepped in and gave her a sum of money equivalent to what the trustee wanted to prevent him from taking and selling her house. Otherwise, what most people have to do is file a Chapter 13 bankruptcy plan to pay back to their creditors, over a three- to five-year period, as much or more money than they would have received had the house been taken and liquidated.
Q: Are they paying the full amount of the equity or a certain percentage on the dollar?
CH: What we can do is factor in not only the mortgage and the exemption, along with the cost of sale. We figure out how much would the trustee in a Chapter 7 have received for doing all of that work and liquidating—the trustee gets a percentage of every dollar they collect for the creditors—so we can subtract that amount out. What’s left over is a reduced amount that has to be paid or distributed amongst all of the creditors during that three- to five-year period.
Q: Are those all of the factors that go into the liquidation assessment?
CH: Sometimes there are some other things, like certain taxes that have to be paid first in a Chapter 7, so we factor that in, which reduces the amount even further that somebody would have to pay to protect their home from liquidation.
Q: In a general sense, would you say it’s better to file for Chapter 13 bankruptcy and keep your house rather than to file a Chapter 7 and lose your house?
CH: It depends on the debtor. Maybe they don’t even care. They might live in a terrible neighborhood and don’t like their neighbors, or they’re tired of raking the leaves and mowing the grass. It’s rare, but I’ve had a client who said, “Fine. Mr. Trustee, take my house, sell my house, and give me a check for my equity amount.”
Q: Tell me a little more of the specifics about this woman who had her name on the deed of her ex-boyfriend’s house.
JS: Her first issue is that, because she is between jobs, she is behind on the regular mortgage payments for her residence. She owned her own home and had a half-interest on this other house, so she was going to have to file a Chapter 13 to catch up on the overdue payments on her home. Then, when she lost her job, her car got repossessed, because she couldn’t pay for it. I don’t know which came first, the job loss or the repossession, but she just had the car repossessed and she thought she had a citable deficiency of about $15,000. In other words, after the car was repossessed and sold, they’re coming after her for that $15,000. I explained to her that because of the equity she has in the non-residential real estate, she would likely have to pay the deficiency on the car she just lost. So she said, “I understand that and I knew that, so I’ve got to get a job to make this all work.”
Q: Who owns the other half of that non-residential property?
JS: An ex-boyfriend that put her name and his name on the deed about 20 years ago when she had loaned him some money.
Q: So your recommendation to her was to not file for bankruptcy?
JS: Not until she has some cash flow that can fund a Chapter 13.
Q: Why did she want to protect the ex-boyfriend?
JS: I’m not sure, but she was very adamant that he should not lose that real estate because of her.
Q: Could she have taken a different, less-friendly approach regarding that other property?
JS: She could have filed a Chapter 7, but it wouldn’t help her cure the arrearage on her residence. We’ve agreed she’s going to eventually file a Chapter 13.
Q: Would you have to meet the best-interest-of-the-creditors test if she didn’t care if that other property was taken and sold?
JS: Yes, because a Chapter 13 trustee is not going to liquidate it. I have the same issue in another case I have in which a woman is in what’s called a “100% plan.” She has to pay everyone back, because she has $50,000 to $60,000 equity in a residence. In addition to that equity, she was also try to cure the arrears on it, because she had one health issue after another after another. The ongoing mortgage payments were being paid by the trustee, but she wasn’t making enough to do that and pay for the car she wanted to drive. She had visions that she was going to refinance the mortgage outside of the bankruptcy. So, I filed an amended plan that says we surrender our interest in the house, but we now want to pay for the car and pay the balance of the attorney fees, and chop the payment way down from about $1500 a month to $400 a month. I now have an objection from the trustee saying we haven’t met the liquidation test on the equity of the house.
Q: Even though she’s surrendering the house?
JS: We haven’t fought it out yet, but it drew an objection.
Q: What is the objection based on?
JS: Because she could sell her real estate and pay off the mortgage and there would still be money for other creditors creditors. That’s what the trustee said. At least on paper, there’s a ton of equity here. She has a son and his fiancé who’ve said they want to refinance it, but the trustee wants money for the creditors.
Q: For clarification, what exactly is a 100% plan?
JS: Every creditor that files a claim will get paid in full.
CH: So, in that Chapter 7 liquidation, there would have been enough money to pay back every single penny of all of the debt. In a Chapter 13, to prevent the sale of the house, you have to make sure that every single penny of that debt gets paid, to protect the equitable interest in the real estate. The benefit of the Chapter 13 then could be—because I’ve had people ask, “What benefit is it for me to file Chapter 13 bankruptcy if I have to pay back everybody in full?”—first of all, once they’re under the protection of the Chapter 13 bankruptcy creditors can’t call, can’t write, can’t sue, can’t garnish. Also, as soon as we file the case, no more interest can accumulate, no more late charges can be imposed or attorney fees assessed. And, those creditors have a window of opportunity—about four months from the date of the filing of the case—to file what’s called a Proof of Claim. So if somebody wants to get paid, they have to file a claim with the bankruptcy court before what’s called the bankruptcy Bar Date. If they don’t file a claim by that date, they don’t get any money.
Q: So, it puts the onus on the creditors to do something to get paid?
CH: Right. We had an extraordinary Chapter 13 case not too long in which we had a high-income dentist making enough money to pay everyone in-full. The total of her unsecured debt to be paid through the plan was around $106,000. So we came up with a plan payment that over 60 months she would pay every single penny of that debt, without any interest or late charges. But—and it’s the only time I’ve ever seen it happen—not one single creditor filed a claim. So, whereas she would have had to pay the entire $106,000 through this plan, she got out of the plan with a discharge on all $106,000 of debt and didn’t have to pay one penny on any of that debt, because not one of those creditors was on-the-ball enough or smart enough to file a claim.
Q: If there were no payments to be made, did the discharge come immediately?
JS: Actually, after payment of attorney fees and trustee fees; after the claims deadline.
CH: I had a Chapter 7 case in which the trustee decided the debtor had an asset that legally could not be protected, so the trustee wanted to take and liquidate it. The trustee sent out a notice to all of the creditors to file a claim, because there would be money available for them. Not one single creditor filed a claim, so the trustee sent out a second notice that said, “I’m going to have money for you if you file a claim.” Again, not a singular creditor filed a claim, so the trustee had no one for whom to collect some money, so he could not and did not take the property that had been subject to liquidation. The debtor got to keep the property, because for whatever reason, creditors did not file a claim. Those are anomalies, but when you do as many cases as we do, you see more and more of those kinds of unusual situations.
Part 2 of Conversation: Common Reasons People File for Bankruptcy

Common Reasons People File for Bankruptcy

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Uninsured medical bills resulting in lawsuits and threats of legal action or garnishment are common reasons for bankruptcy these days. Divorce is also a reason for many bankruptcies—a high percentage of the people who file for bankruptcy protection are single mothers. In a Chapter 13 bankruptcy, a conduit case refers to making mortgage payments through the trustee.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including being "judgment proof," protecting your house from liquidation in a bankruptcy, home equity exemptions, some benefits of filing a Chapter 13 “100% plan,” common reasons people file for bankruptcy, a deficiency balance on a debt, an example of how an ex-spouse can impact a bankruptcy, and conduit mortgage payments. Below is Part 2 of 2 of the transcript of that conversation.

Q: With the economy turning around and the rate of bankruptcies dropping, what are the most common reasons people file for bankruptcy these days? Why are people getting into financial trouble?

Chris Holmes: It’s still uninsured medical bills resulting in lawsuits and threats of legal action or garnishment. The biggest percentage of people I see these days are single mothers on a limited income with children to support. They’re on a razor-thin budget and threatened with garnishment, while they’re barely getting by on 100% of their take-home pay, They can’t afford to lose 25% of their take-home pay through a garnishment, so they come in and seek protection from creditors through the bankruptcy court.

Q: Is credit card debt what’s causing their problems?

CH: I would say uninsured medical issues or an old cell phone bill or maybe a car got repossessed and there is a deficiency balance that the creditor is suing them for. Maybe the economy is better in the sense that the unemployment rate is relatively low, but all the jobs people are getting are such low-paying jobs that they aren’t being paid a living wage to really make ends meet. Then they’re on that razor-thin line with a budget that is just barely enough to survive on. If something unexpected happens there’s a threat of garnishment. If they let the garnishment happen, maybe they’ll be evicted or lose their car and can’t get to work. They’re just desperate to file bankruptcy.

Q: So it’s mostly people in a single-income-with-kids situation?

CH: It seems that way in many cases. Of course, divorce is always a big reason that people file for bankruptcy. People go their separate ways and somebody has been ordered to pay certain marital debt, but they can’t afford to do that, so they have to seek refuge in the bankruptcy court. Job loss is still a big cause of financial problems. I’m sure there are going to be some bankruptcies on the horizon when all of those Carrier employees get laid off.

Q: Have you seen any unusual circumstances in recent cases?

Jess Smith, III: I have a nasty hearing coming up soon. A woman received an offer to sell real estate. She had a divorce decree in which she owned the real estate only in her name and only her name was on the mortgage. But the divorce decree stated that if she were to sell the house, she would keep the first $60,000 and anything over and above that first $60,000 would be split between her and the ex-husband. In the interim, she filed for bankruptcy because she had other debt. He hasn’t paid child support to her in months. The house goes into foreclosure. I hire a Realtor and get permission to sell it—and we get an offer. By the way, we listed the ex-husband as a creditor in the bankruptcy, which basically states, “Speak up or forever hold your peace.” He never filed a claim. Instead, he hired a couple of lawyers and eventually his objection to the bankruptcy plan is overruled. He said, “If we get anything over and above $60,000, you can have that,” knowing that we’re not going to get there. So we had an offer to buy the house. The debtor would get to keep her exemption of $17,600 and as things stand there is presently around $15,000 that would go to the creditors who filed a claim. We had a motion out to approve the sale, but the ex-husband has objected to the sale—even though his name is not on the mortgage and he didn’t file a claim. I have to go before the judge next week.

CH: And the sale will not bear proceeds big enough for him to even get a half.

JS: Right. His objection is, “You should list the house for more money," even though there is a foreclosure pending and he is not current with his child support. I don’t know what kind of patience the judge will have for this gentleman, but I’ve got to bring the debtor into court and also have the Realtor state there will need to be $10,000 thrown into the house, to deal with radon and other things, and that this is the best offer we’re going to get. In the meantime, the foreclosure is actively proceeding to Sheriff’s sale.

CH: So, the payoff on the mortgage is constantly getting bigger.

JS: If we wait, it’s going to take money out of the hands of the other creditors who filed claims.

Q: Have you thought about throwing some his way to make his objection go away?

JS: Our client is an attorney, so when the case originally started we contemplated amending the divorce decree to bump up his position; to give him $5000 or $10,000, but her ex-husband wanted nothing of it. So, he started first with attorney John W. I call John, whom he never paid to file an appearance, but we had discussions and I said, “We’ll move you up the ladder and give you a secured position and give you some money. It wouldn’t be a lot, but it would be something as opposed to nothing.” He never paid John W. a retainer. Then, after we filed our second plan, the ex-husband hired attorney Jim Y. and after a couple of hearings I amended the plan and said, “We’ll give you one-half of anything over $60,000.” He didn’t pay Jim Y., but now on the day of the objection on the motion to sell, he paid attorney Eric R. some money and Eric filed an objection and handed off the files to attorney Keith G. So now I’m dealing with Keith. Then, my client, who is mad as heck, sent me an email saying that her ex-husband was at the house having someone service the air conditioner—and he doesn’t even own the house or have his name on the mortgage or deed. And she still lives there.

Q: He’s paying someone to service the air conditioner at her house?

JS: Yes. And then he asked, through Keith G., for permission to show the house to other people—despite the fact that I have a Realtor with an exclusive listing and a sale pending.

CH: So, he seems to think that she accepted a low-ball offer to move the property and deny him his fair share of the net proceeds.

JS: Yet, he hasn’t paid child support for seven months.

Q: What is the assessed value of the property compared to the sale price? Is it in the ballpark?

JS: The price offered is about $30,000 less than the assessed value, but here’s where it starts to get tricky: When the case started, they had a rental property. In addition, she fell behind in the mortgage payments on their house, because the husband moved out. I explained to her that if she didn’t get current on the mortgage payments for the house, it would have to be a conduit case. In the interim, the rental property went into foreclosure and a judgment lien was placed on that. So, we had to value the rental property low to get the lien avoided—and we got that lien avoided. But now the sale price is higher than what I initially scheduled the value of the property for, which is neither here nor there because the judgment lien holder from the rental property had their opportunity to object and they disclaimed any interest in the real estate and the foreclosure.

Q: You used the phrase “conduit.” Can you explain what that is in relation to a mortgage and bankruptcy?

JS: Conduit means if you file a Chapter 13 and you want to keep your house, and you’re behind on the mortgage payments when you file the case, the ongoing future mortgage payments get made through the trustee, who then disperses it to the mortgage company. Not only the ongoing payments, but the pre-filing arrearage also goes through the trustee.

CH: In the past, you would just cure the arrearage on the mortgage in the plan, then people would resume their regular mortgage payments outside of the plan, directly to the creditor, starting the month after the date of filing. But now the judges have decided that if the debtor is more than one month behind, then they have to make those regular monthly mortgage payments through the Chapter 13 trustee, which debtors and debtors’ counsel don’t really like.

JS: The reason for that is because for years we used to have arguments with the mortgage company about ongoing mortgage payments and whether they were made on time or not. Huge amounts of time were spent accounting and keeping track of payments. I guess the theory is that if the debtor is more than one month behind then they were going to miss some payments along the way.

CH: At the end of the old plan, invariably the mortgage companies would say, “You didn’t pay every single penny and you’re not current on the mortgage.” Now there is either a hearing or the trustee files a notice stating that a debtor is current, which gives the mortgage company an opportunity to say, “Yes, they’re current,” or “No, they’re not current.” The judge would then decide whether or not they really are behind, based on all of those payments that should have been made through the plan.

JS: Typically, the trustee, as the neutral party, has a record of dispersing three to five years of payments to the mortgage company.

CH: With variable interest rates, or the changes in taxes and escrow, those mortgage payments are fluctuating. Every six months, or 12 months, debtors receive an escrow analysis stating that the property owner’s taxes went up, so the mortgage company would have to bump up the mortgage payments a little bit to make up for that additional that would have to be paid in taxes. Or the homeowner’s insurance rate goes up and the mortgage company would have to escrow a little bit more for that increased insurance premium. We don’t see variable or adjustable interest rates much anymore.

Part 1 of Conversation: Protecting Your House From Liquidation in a Bankruptcy

Means Test Helps Determine Filing For Chapter 7 or Chapter 13 Bankruptcy

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The bankruptcy means test was established by congress as a standard method of calculating the disposable monthly income of a debtor, to help determine the amount paid to the trustee of a Chapter 13 bankruptcy plan.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including the means test, the differences between Chapter 7 and Chapter 13, how divorce and child support can affect bankruptcy, and the discharge process. Below is Part 1 of 4 of the transcript of that conversation.

Q: In a Chapter 13 bankruptcy, how is a debtor’s monthly plan payment amount determined?

Chris Holmes: In a Chapter 13 bankruptcy case, the general rule would be that the debtor must pay to the Chapter 13 trustee all of their disposable monthly income. So, we craft their budget to show how much their projected monthly income will be—gross income minus taxes—and then we calculate what they pay for rent, utilities, food, clothing and all of their living expenses. So, income minus expenses, whatever that difference is, that’s the primary way of determining the monthly plan payment. The bankruptcy code says a debtor must turn over all of their disposable income to the Chapter 13 trustee for the benefit of their creditors. And then, as long as they’re not already paying off 100 cents on the dollar, that’s what they have to pay.

Q: How do factors such as everyday expenses figure into determining what a debtor’s disposable income ends up being?

CH: Whatever their real expenses are or there are some IRS standards that we use on occasion. Obviously, a family of eight has expenses that are greater than a family of three. Jess and I have been doing this for so long, we understand, after putting thousands of budgets together, how far you can push the envelope on a food budget, for example, for a family of four. We know that if we go beyond a certain amount—a sort of comfort zone—that the trustee gives us some pushback and says, “Wait a minute. $1200 a month for two people?” So, for example, they can’t be going out to St. Elmo’s Steakhouse every night for dinner. They have to be reasonable in their budget. We’ve learned over time what a reasonable budget is, based on the household size.

The general rule of whatever is left over goes to the trustee was thrown out the window in a recent case we handled, because the husband had a job and the wife was disabled. She received Social Security benefits. Their combined income, including those Social Security disability benefits, exceeded their living expenses by $660 per month. Before the bankruptcy code changed back in 2005, and really up until just recently, their plan payment would have been $660 a month. However, in this case, our associate attorney Andrew DeYoung said we are only going to offer $250 per month. The concern was that the trustee would ask, “What about the other $410?” However, Andrew understood that there is an area of the law developing where judges have decided that because Social Security benefits are exempt—off limits to creditors—and that they don’t count in the means test that determines household income.

Q: So, Andrew was subtracting the disability payments from the means test equation?

CH: The wife collected about $1600 a month in Social Security benefits. Andrew was just arguing that not all of the couple’s disposable income should be turned over to the trustee, because the disability benefits are intended to provide the wife with a safety net, in case her health deteriorates or an unexpected medical situation arises.

Q: In this case, had both the husband and wife declared bankruptcy?

CH: Yes, it was a joint case. When the trustee asked why I only offered a $250 monthly payment, I stated there is some existing case law that suggests creditors cannot claim bad faith or abuse when debtors do not turn over all of their disposal income, because some of it—not all of it; just the disability benefits—is exempt from creditors. The trustee stated she was also familiar with that case law, so she dropped that disability income from the plan and, to our clients’ pleasure, accepted the $250 per month offered. I asked her if any Indiana judges had ruled on this type of situation or if there are any related 7th Circuit Court of Appeals cases. She stated not to her knowledge. The precedent for this is from some other jurisdiction where crafty bankruptcy lawyers have made this argument and evidently those judges have agreed, so she’s basically taken a position that maybe it isn’t money that she can demand from the debtors.

Q: You mentioned a family of four, which obviously includes children, and a related comfort zone of credible monthly expenses. Is there any entertainment budget that you can justify as not part of that family’s disposable income?

CH: There’s two things. There’s the means test, which looks at average monthly income over the past six months before filing. There’s also certain IRS standards for housing and food and whatever. If I refer to the computer program we use, I can look at how much is deemed to be reasonable for a four-person household. So sometimes when my clients don’t do a really good job on their budget, I’ll go to the means test and use the IRS standards to fill in a blank. Also, if a debtor shows too much money left over, and I know they really don’t have it, I’m going to find some place to use up that money, so they’re not too rich for a Chapter 7 bankruptcy. There are standards for what you can put into the different slots within a monthly household budget.

Q: Where do you find the means test you mentioned?

CH: It’s something that congress established, but our computer program provides all of this information, which is periodically updated. In Indiana, there’s currently a medium income for a one-person household of $43,422.

Jess Smith, III: The medium income varies from state to state.

CH: That’s the starting point. So if I have a family of four and their household gross income per year was less than $74,584, they immediately pass this test. The test is designed to determine if someone has an ability to pay back a significant percentage of their debt through a Chapter 13 plan.

Q: What happens if they fail the test?

CH: They’re ineligible perhaps for a Chapter 7, so we tell them that if they want relief from the bankruptcy code, they’ve got to file a Chapter 13 and offer this disposable income to their creditors.

Q: What happens if that disposable income figure turns out to be zero or just a couple of dollars?

CH: They really wouldn’t flunk the means test in that case. There’s an algorithm in the computer program that looks at what’s left over at the end of the month and what their debt is, and it figures out if you have an ability to pay back a certain percentage of that debt. The program indicates whether they’ve flunked or passed the test; it shows if you’re eligible for a Chapter 7. Sometime you can get around that, because we’re looking at income over the past six months. If the debtor has just lost a job and no longer has that income, we can override the test in a way, or at least show this special circumstance—they’re now destitute and don’t have any money—they’re not required to pay back some of this debt when clearly they don’t have an ability to do that.

Q: So that inability to pay back the debt determines whether you file for Chapter 7 or Chapter 13?

CH: Right. Most people will file for Chapter 7, wipe the slate clean, not make any monthly payments, and be done in three to four months. In Chapter 13, it’s three to five years where they’re making this monthly payment to a Chapter 13 trustee who then divvies up the money amongst the creditors in a certain way. Some people do Chapter 13 because they need it to save a house, to pay taxes, or do some other creative things, but there’s a small percentage of people who are required to file Chapter 13 because they are too rich to just wipe the slate clean. It’s not fair; it’s consider an abuse of the bankruptcy code for somebody who makes $100,000 to just get rid of all their debt.

Q: So that medium income is the number that determines whether you makes too much money?

CH: Right. It’s a starting point. If they’re below that number, they pass automatically. If they’re above that number, then we have to do this more-comprehensive test that looks at not just gross income, but where all of that money goes. Taxes, insurance, rent, food, utilities, car payments, student loans—all of those things. Then, after you plug in all of these numbers, the program shows a green happy face if you pass or a yellow unhappy face if you fail.

Bankruptcy Means Test

There’s a case we filed in which we received the green happy face. We filled in the debtor’s average monthly income and then on the next page it totals it up to $62,580. The median income for a family of this size is $62,431. So, because their combined income was a little bit above the median income, I had to go through the program and fill in additional fields, for example car payments and mortgage payments. There are certain standards, for example for a two-person household with two cars it’s $424 per month for gas, oil, and routine maintenance on a vehicle. At the very bottom of this test, in this particular case, we come up with this number for Disposable Monthly Income, which we call “DMI” and here it’s “minus $371.” So, clearly in this case they don’t have any money left over. That’s why the program gives us the green happy face, because it concluded that even though their income is above median income, because of all of their expenses, there is no money left over for the creditors. So they qualify for Chapter 7. Now if this had been a yellow unhappy face, and the DMI had been a significant positive number, then we would have to say to the debtor that the case would get thrown out or threatened with dismissal, so we just know that we have to file as a Chapter 13. Then they’re in this plan for 60 months, five years, to pay back as much of their debt as possible.

JS: And there are certain things that are not deductible on a Chapter 7 means test that are deductible on a Chapter 13 means test.

Q: Such as?

JS: Such as retirement account contributions or 401(k) loan repayments. Going back to the Social Security issue, the code says that, if you have a habit of making retirement contributions, you’re supposed to be able to continue those under this means test. Then you put your budget together going forward. Our associate Andrew DeYoung had a case where he tried to schedule the ongoing contributions, because she had done them within the six months. But he received a creditor objection and Judge Graham said, “I’m not going to allow you to keep socking away this kind of money while paying very little on your debt.

CH: Even though they’re in a Chapter 13, they get credit for it.

JS: Correct. She had a very low Disposable Monthly Income number under the means test, but when it came before the judge, the judge said this doesn’t pass the smell test. If the client were to appeal, maybe the client would have won, but the client didn’t have the resources to appeal.

Q: Was it because the IRA contribution was too high?

JS: It was substantial. Plus, evidence came out that the debtor worked for a university. If she contributed some phenomenal amount of money, her employer would match it with about 20% of the contribution. So this woman was trying to put away $9000 to $10,000 a year, hoping to get another $3000 to $4000 match. It was not the trustee who objected, it was an individual creditor who had loaned the debtor money and who spent enormous resources objecting to the proposed plan. I don’t know that every judge would have sided with the creditor, but this particular one did.

Q: So the judge threw out the IRA contribution entirely or forced her to lower the payment?

JS: She was in a Chapter 13, so the plan Andrew offered met the means test. But the creditor started objecting with old law—pre-2005 case law—and Andrew and I did not believe the creditor could win because it was such old case law.

CH: But it was an extraordinary amount of her income that she was contributing.

JS: Yes, it was about 15%, so a substantial portion of her income was being deferred.

CH: I’ve told people that if their contribution is 4%, or 6%, or even 8%, that no one is going to squawk. But if it’s 10% or more, that’s probably where it wouldn’t pass the smell test.

JS: In this case, the debtor was trying to only pay about $7000 on over $100,000 debt, so the judge said, “You’re not going to walk out of here with a fat 401(k).”

CH: This case illustrates the situation where you go to law school and think the law is black and white. You’re going to learn how to solve problems and there are definite rules. But the law is actually shades of gray. It’s almost never black and white. One judge might say, “That seems reasonable,” and another judge might say “It’s unreasonable.” It’s unpredictable, especially in state court law, where you go to one county and have one judge rule one way, then you go to another county, with the exact same facts, and another judge might rule a different way. Clients always ask, “Can you predict the results?” But that’s next to impossible, because you just don’t know how that judge on that day is going to interpret those facts in light of the law. Sometimes I’ve had judges where it was not what they knew that I was afraid of, it was what they knew that just wasn’t so. They thought that they knew the law, but they didn’t and they interpreted the law improperly. But you can’t go to the judge and imply they’re wrong. The only way you can do that is to appeal and most people we represent don’t have the financial ability or resources to appeal a decision, because that’s really expensive and time-consuming. The case mentioned earlier is a good example of the gray shades of the law and it’s fluidity, because by offering a plan with only a $250 monthly payment, instead of $660 a month, Andrew saved our client $24,600 over the life of the five-year plan.

Part 2 of Conversation: Differences Between Chapter 7 Bankruptcy and Chapter 13 Bankruptcy

Part 3 of Conversation: Divorce and Child Support Can Impact a Bankruptcy

Part 4 of Conversation: Being Discharged From Bankruptcy

Differences Between Chapter 7 Bankruptcy and Chapter 13 Bankruptcy

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The primary difference between a Chapter 7 bankruptcy and a Chapter 13 bankruptcy is that a Chapter 7 bankruptcy can eliminate debt in a period of three to four months compared to the three to five years it takes to complete a Chapter 13 plan. Under certain circumstances, a Chapter 13 bankruptcy can be converted into a Chapter 7 bankruptcy.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including the means test, the differences between Chapter 7 and Chapter 13, how divorce and child support can affect bankruptcy, and the discharge process. Below is Part 2 of 4 of the transcript of that conversation.

Q: For a debtor, in terms of moving forward with your life after you declare bankruptcy, what are the differences between between Chapter 7 versus Chapter 13? How does that affect your credit score or your standing in the financial world?

Jess Smith, III: In the short-term, a Chapter 7 is probably more advantageous, because when you’re in a Chapter 13 there’s always the risk that you won’t complete the plan and you’ll become eligible to convert it to a Chapter 7. Therefore, you can add debt to your bankruptcy that accrue from the time you file your Chapter 13 to when you convert to your Chapter 7. That makes lenders nervous about extending credit to you while the Chapter 13 is open, because they could take a hit.

Chris Holmes: I always tell people you’re in a case for three to four months under Chapter 7. Your done and you can do whatever you want. In a Chapter 13, you can’t borrow money without permission of the trustee or the judge. As Jess pointed out, debts that are incurred after the filing of the case, if they change their mind and switch to a Chapter 7, they can be thrown into the mix for discharge.

Q: So what would be the circumstance in which someone could switch from a Chapter 13 to a Chapter 7?

JS: A loss of income is the primary one.

CH: People start out and maybe they’re too rich. they make $100,000 a year and can pay back some of the debt. Then their job goes overseas and they’re making $10 an hour; income plummets; no money left over for the creditors; case is no longer feasible. And so we switch to a Chapter 7, dispense with the monthly payments, and just wipe out the rest of the debt.

JS: Another reason someone might want to start as a Chapter 13 and contemplate having the option of a Chapter 7 later is that you have people with substantial medical issues. Perhaps they have a few creditors coming after them now, where they need that protection. But they don’t want to file Chapter 7 now, because they know they’ve got medical issues within the next eight years that are going to crop up. Some of them will go into a Chapter 13, to establish a payment plan with those existing creditors, knowing that if a medical calamity happens before the Chapter 13 is done they can convert to a Chapter 7 and add those debts.

CH: It’s kind of a way to insure against uninsured events over this three- to five-year period, so if something terrible happens—they run up $50,000 of uninsured medical debt and they can’t afford to pay it—the law says we can switch from a Chapter 13 to a Chapter 7 and move those debts. Generally speaking, when you file the case, you’re going to list the debts prior to that date. In a Chapter 13 or a 7, you can’t add debts thereafter. Unless you switch it from a Chapter 13 to a Chapter 7, so that deadline before which debts can be added moves up to the date of conversion to a Chapter 7. So, all of those debts incurred in-between, that otherwise a debtor would have been stuck with, are added to the list.

Q: It seems as if wiping out debts completely under Chapter 7 is a more drastic financial transaction. Does that affect your credit score more negatively than filing a Chapter 13?

CH: You would think that someone filing under Chapter 13 who is paying back some of the debt would get some kind of credit for that. But my understanding is that a bankruptcy is a bankruptcy is a bankruptcy to most creditors, whether it’s a Chapter 13 or a Chapter 7. People don’t get credit, in a sense, for paying back some of their debt through a Chapter 13 plan.

JS: Not until the Chapter 13 discharge, but while you’re in it you get no positive benefit from it.

CH: No one is going to pat you on the back and say, “You’re paying back some of your debt, here I’ll give you more money.”

JS: At the end, if it shows you paid your mortgage on time and you paid your car off in full, you’ll get credit for those things. But your not going to get a boost for running into a Chapter 13 as opposed to a Chapter 7. Not in the short-term, no.

Q: But in the long-term?

JS: Potentially, yes.

CH: I tell people that supposedly debts stay on your credit reports seven to 10 years.

JS: Usually from petition date.

CH: So being in a Chapter 13 for three to five years, as opposed to a Chapter 7 for three to four months, won’t stay on your record any longer.

JS: A Chapter 13 will actually come off the credit report sooner. A Chapter 7 will be up there for up to 10 years; a Chapter 13 for about seven years.

Q: So an advantage to completing a Chapter 13, in the long-term, is that it will help you establish better credit sooner?

JS: Potentially. But in the short-term it’s the same.

CH: People always ask, “What’s a bankruptcy going to do to my credit rating?” Well, if you’ve got $50,000 of credit card debt, $30,000 of medical bills, and people are suing and garnishing and hounding you, your credit worthiness is already shot. In a weird sort of way, when you get a discharge in bankruptcy, you wipe that slate clean. You can’t file another bankruptcy for eight years, but if you have decent income and no debt, I would imagine that one’s credit worthiness is going to be enhanced by wiping the slate clean. We have debtors who tell us that just weeks later they start getting inundated with car loan applications, even though they’re in a bankruptcy. I assume that’s because the creditors are sophisticated enough to know they can’t file another bankruptcy and they can’t add any post-filing debt to the bankruptcy. So, any car loan after the filing can’t be added; they can’t file another Chapter 7 for eight years, and they’ve got decent income and they know all of this debt is going to be wiped out, a new loan can’t be discharged. I assume that’s why they are aggressively marketing to those people.

Q: So, you can’t file another Chapter 7 for eight years after having filed a Chapter 7?

CH: Date of filing plus eight years.

Q: How about if you file for Chapter 13, then complete that 60-month plan and the bankruptcy is discharged?

JS: If you file a Chapter 13 first and complete it, you can file a Chapter 7 six years after your Chapter 13 filing date, under certain circumstances. If you file a Chapter 7 first and then you file a Chapter 13, it has to be four years after your Chapter 7 filing to be eligible for a discharge. We have people who file them so close together they’re not eligible for any discharges. They complete an umbrella, so they can get their things sorted out. With an umbrella, the creditors are told to stay, while the debtor makes some sort of a payment plan. We have people complete those payment plans and then they still have to deal with the debt, because it wasn’t discharged. But, in the interim, that period of the five-year window, they’re able to live their lives and try to get their affairs in order.

CH: Or we put them in one of these bankruptcies just long enough until finally it’s been long enough to file a bankruptcy from which they can get a discharge. So, we let the case be dismissed and then re-file when it’s been long enough.

JS: I just placed someone into a Chapter 13 where basically the primary purpose was that her main debt was student loans. She made about $70,000 salary and, based on her household size, she could file a Chapter 7. But the student loan creditor said, “You owe us over $100,000, so we’re going to administratively garnish 15% of your wages. And she said, “No you’re not. I’m going to file a Chapter 13 and I’m going to pay you $500 a month for the next five years, so I can get my kids out of the house.” Otherwise she knew that 15% was going to have her end up being evicted, because it was too much of her income.

CH: Another reason we do Chapter 13 filings is because student loans are nondischargeable. If, for example, the debtor has other problems and the student loans is just too burdensome, we put them in a Chapter 13, so they can keep the student loan creditor at bay for five years. Meanwhile they can resolve some other cash issues or save their house or do whatever they need to do. But then, of course, because it’s nondischargeable, down the road that student loan is still there. Chances are that what was paid to the student loan through the five year plan won’t cover the interest that accumulates, so that student loan is probably going to be bigger. But at least they can get rid of all their other financial problems and then they can focus on the student loan at the end of five years. Hopefully at that time the money that was in the plan to solve other problems will be there to solve the student loan five years down the road.

JS: We refer to that as a Chapter 26. That’s when you get through your first Chapter 13 and shed everything but the student loan, and then if you’ve got all of the kids out of the house, maybe you’re in another Chapter 13 where your student loan is your only creditor and you try to knock it out during the second five-year plan.

Q: So, regardless of whether you file Chapter 7 or Chapter 13, student loans are not dischargeable?

JS: Correct. By and large, with rare exceptions.

Q: And that’s the same for federal taxes?

CH: Well, no. Taxes are a little different, although that gets complicated, too. But, generally speaking, if the taxes are less than three years old, you’ve got to pay them back. Taxes more than three years old may be dischargeable, but then you have to worry about whether there is a federal tax lien. Some of the tax might have to be paid back. I’m about to file a case for a debtor who had some taxes owed for 2012. The clock didn’t start ticking until April 15, 2013, because taxes are always due by April 15 the following year. So, I said to her, “Look, you’ve got all of these taxes owed for 2012; we don’t have to file your bankruptcy sooner than later. Let’s wait until after April 15, 2016, so they’ll be more than three years old and then maybe those 2012 taxes will be treated just like a credit card or medical bill, and be totally wiped out.” The threat was that in the interim, unbeknownst to me, the IRS filed a tax lien, which would make some of the tax payable. The hope is that the tax is going to fall off as a dischargeable debt.

Part 1 of Conversation: Means Test Helps Determine Filing For Chapter 7 or Chapter 13 Bankruptcy

Part 3 of Conversation: Divorce and Child Support Can Impact a Bankruptcy

Part 4 of Conversation: Being Discharged From Bankruptcy

Divorce and Child Support Can Impact a Bankruptcy

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Divorce is one of the major causes of bankruptcy. If your divorce agreement includes child support payments, your ex-spouse can play a significant role in determining whether or not your bankruptcy will be discharged.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including the means test, the differences between Chapter 7 and Chapter 13, how divorce and child support can affect bankruptcy, and the discharge process. Below is Part 3 of 4 of the transcript of that conversation.

Q: Have you been dealing with any unusual circumstances recently?

Jess Smith, III: I have a gentleman who completed his Chapter 13 plan; he made all of his payments and was getting ready to file his motion for discharge. However, his ex-wife objected to it because he fell behind—not on his post-petition child support—on his share of the uninsured medical expenses for the child. She had taken him back to the divorce court and got a judgment against him for not paying his share of those medical expenses, which is classified as a domestic support obligation. She objected to his discharge under Chapter 13.

Chris Holmes: Before anyone can get a discharge under Chapter 13, they have to certify they have paid every single penny of child support that came due after the filing of the case up until the day of discharge. In this poor guy’s case, he had paid every single penny of child support, but then because that other expense—which is in the nature of child support—had not been paid, it became an issue. Child support is not just the weekly amount that’s paid, sometimes people are ordered to pay a percentage of medical and dental and optical expenses. Evidently, he didn’t pay his fair share, so she sued him and got a judgment against him.

JS: She filed a contempt on him in the divorce court. She also filed an objective to his bankruptcy discharge.

Q: If he was denied a discharge, would that mean his personal liability on all of those other debts would still be there?

JS: The bankruptcy judge waited to see if he was going to make any headway on it. No resolution was made, so the judge said to the debtor, “Either I’m dismissing this case or you might be able to convert to a Chapter 7 and there might be ramifications of that or not.” So, we converted to a Chapter 7 and we got his discharge. So, all of his other debts were discharged, but he did not get a Chapter 13 discharge, In this case, it was really of no consequence, because he was not paying taxes in the plan.

I’ve got another case in which the debtor had a Chapter 13, with taxes being paid in the plan. He also owed his ex-wife child support and he estimated that he owed her $5000 of child support. So the ex-wife got notice of the bankruptcy and was given a claims form. She never filed a claim. So, eventually the trustee was sitting on this money and he paid the taxes first. Then he said to the debtor, “We’ve got this $5000; you better file a claim for your ex-wife, otherwise I’m going to have to disperse it to Visa and MasterCard, and you won’t receive any child support credit for it.

CH: The ex-wife hadn’t file a claim and if you don’t file a claim you can’t get paid through a Chapter 13 plan.

JS: About a year and a half ago, I filed a claim for the ex-wife and I put the state court divorce number—the Indiana Support Enforcement and Tracking Number. Instead of sending the money directly to the mother, the debtor scheduled a flat $5000 payment and we had it go through the state address where they basically put that money onto a Visa debit card. The trustee pays it through the Indiana Child Support Collection Unit. In the meantime, he’s having his regular support deducted out of his wages. We’re getting close to the plan length, so we tell the debtor that he needs to come in to sign off that he is current. He says, “My kids are 19 and they’re still yanking it out of my check.” I ask, “Are you current or are you not?” So he hired me to find out why they are still taking out child support from his wages. I went to the state court, pulled 17 years worth of records, and did a hand audit. There were periods within those years during which he would miss eight months at a time, and despite the fact that he continued to pay support beyond the child’s 19th birthday, his estimate of what he owed his ex-wife was way low.  I created a spreadsheet that accounted for every nickel of child support he ever paid and then told him that he still owes about $5900, even after the recent $5000 payment. I tell him that I can’t file the certification for his Chapter 13 discharge, because it would be a false representation of his bankruptcy. For him to get a Chapter 13 discharge, he has to certify to the bankruptcy court that he has paid all post-filing and all pre-filing child support, unless there was an order in the state court to the contrary stating he doesn’t have to do it.

CH: He has to swear, under the penalties for perjury, that he has paid every single penny of child support from the date of filing to the date of discharge.

JS: The bottom line is I tell him we can’t do this. Meanwhile, the child is 19, so we file a motion to emancipate the child and determine an arrears. There’s a hearing set in June. Basically, I’ve talked to the ex-wife and she said, “I don’t care about the medical expenses, but I want every support payment that’s due. I’m not going to hold up his discharge, but I want my money.” What had happened is when he swore to me that he had paid everything, I filed a motion to terminate his withholding order. His employer received a copy of it, but with no order from the state court they just quit paying the ex-wife. She hasn’t received any money in about four months. But she says, “I want every nickel that is due to me, but I’m not going to hold up his discharge.” I then talked to the bankruptcy court and asked if they had ever had a case like this. They said, "No," and that we should make up a waiver form, have the mother sign it. and the judge will set up a hearing and grant the discharge, because the mother is not objecting to the discharge going through despite the fact that he has not technically complied with the bankruptcy code. If the mother did contest it, just like the other case, the judge would say, "I can’t grant the discharge."

Q: What would have happened if the mother contested the case and forced the judge to actually say, "I can’t grant the discharge."

JS: This particular debtor has only been in the bankruptcy about three years. I would probably put him back into the bankruptcy to stretch the plan out and pay it. But, I don’t want to do that because the trustee charges a fee on the money she collects to disburse to the state, so I’ve got the waiver worked out.

CH: That would be a remedy, if he had the luxury of stretching it out.

JS: If he had more time. We probably have about 16 months left now to delay, but I’m not going to go there.

CH: If it was a five-year plan, we couldn’t extend it. If she objected, the only other option would be to convert to a Chapter 7.

JS: If we converted to a Chapter 7, he would have to deal with some potential past issues in his particular case where he wouldn’t get the same benefits.

CH: Otherwise, he would be out of a bankruptcy without a discharge. So, if he only paid ten cents on the dollar on all of his debt, he would still owe his creditors the remaining 90%, plus interest and whatever late charges are nondischargeable.

JS: They could have closed the case without a discharge. It’s one of those gray areas. There’s no black and white in the code to deal with that issue. We have to kind of make it up as we go and see if the judge will bite on it.

CH: We’ve been doing this a long time. I’ve been doing nothing but bankruptcies since October 1997, when I joined Tom Scott, and Jess started focusing on bankruptcy shortly thereafter. There are attorneys out there who dabble in bankruptcy and there are lots of young lawyers right out of school. I can’t believe that without the experience that there is any way they render as effective legal representation to their clients as we do, because we’ve been there, we’ve done that, and we’ve seen so many strange situations.

In addition, we have the background to relate bankruptcies to other law. There are people who get out of law school now and just go straight into bankruptcy, not knowing how it impacts family law, personal injury, taxation, and other issues. Jess and I are both diversified lawyers. We started out as general practitioners, where we did criminal, divorce, probate, and everything that came through the door—we figured out how to do it.

Part 1 of Conversation: Means Test Helps Determine Filing For Chapter 7 or Chapter 13 Bankruptcy

Part 2 of Conversation: Differences Between Chapter 7 Bankruptcy and Chapter 13 Bankruptcy

Part 4 of Conversation: Being Discharged From Bankruptcy

Being Discharged From Bankruptcy

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When a Chapter 13 bankruptcy plan has been completed by a debtor, a few steps remain before the bankruptcy is officially discharged. The discharge process includes the filing of the Notice of Plan Completion by the trustee, along with the filing of two forms by the debtor: the Debtor’s Certification of Eligibility for Chapter 12/13 Discharge and the Motion for Entry of Chapter 12/13 Discharge. If the debtor has a mortgage, additional forms are required.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including the means test, the differences between Chapter 7 and Chapter 13, how divorce and child support can affect bankruptcy, and the discharge process. Below is Part 4 of 4 of the transcript of that conversation.

Q: If you’ve filed Chapter 13 and you’ve made all of your payments on-time to the trustee over the course of the three- or five-year plan, what is the next step for the debtor to ensure that everything is legal and the bankruptcy is discharged?

Jess Smith, III: The trustee files a Notice of Plan Completion. Copies of this notice are e-mailed to anyone who receives electronic notification in the case. The debtor then signs a motion for discharge (Motion for Entry of Chapter 12/13 Discharge) and a document stating they’re eligible (Debtor’s Certification of Eligibility for Chapter 12/13 Discharge).

Q: Does the debtor need to go back to their lawyer?

Chris Holmes: Yes. Our paralegal, Margaret, takes care of all of that. She prepares these documents; the debtor comes in and signs them; and we file it. Generally, the debtor receives an order granting discharge.

JS: Typically, the trustee has received all of the money from the debtor and dispersed it out to the creditors. There is one other thing that they sometimes do. If there is real estate involved and the trustee had made any distribution to the creditors whatsoever, the trustee files what’s called the Notice of Final Cure Payment, to which the mortgage companies have a duty to respond, to state they think that the debtor is current on the mortgage or not current on the mortgage. It’s kind of a final chance for the mortgage company to speak up before a Chapter 13 discharge.

CH: We used to have these problems where we’d have people in Chapter 13s and we thought they’d paid all of their mortgage payments and were caught up on what they were behind. They’d get their discharge and then they’d get a notice from the mortgage company stating, for example, they were still two months behind, which would cause all sorts of problems. So the courts came up with this procedure to have the trustees state their belief that the mortgage is current, which shifts the burden to the creditor to come into bankruptcy court and prove otherwise.

JS: Or, the mortgage company would tack on fees, hide the ball, and not tell anybody until discharge. All of sudden they would say, “Well, we charged you $3000 to monitor your bankruptcy. You owe us next week or we’re going to foreclose.”

Q: That’s in the past?

JS: That’s in the past.

Q: So if a debtor has completed the 60-month plan; they’ve paid the trustee on-time each month; they’ve paid their mortgage on-time each month; the trustee will send a notice to the mortgage company?

JS: Yes. And to the debtor.

Q: The debtor takes that notice and brings it back to their lawyer?

CH: We get a copy, so we know at the same time.

Q: So when you receive a copy of the notice sent to the debtor that states they’re eligible for discharge, a paralegal in a bankruptcy law office will do what with that notice?

JS: There are two different documents. The first is the Notice of Plan Completion, which deals with the payments and disbursements to creditors. The second document is the Notice of Final Cure Payment, which strictly relates to the mortgage lenders. When the trustee sends the Notice of Plan Completion, the debtor has to move for discharge. When the trustee sends the Notice of Final Cure Payment, there’s a burden on a mortgage company to file a response, usually within 30 days, stating whether the mortgage is current or not. If a mortgage company doesn’t file one, usually the trustee sets a hearing.

CH: First of all, the debtor gets a discharge, so the rest of the debt that wasn’t paid is wiped out—rendered null and void. And if there’s not a controversy about whether the mortgage is current, there’s an order stating it’s current. That gives the debtor a fresh start, so that the next month they don’t have to worry about the mortgage creditor saying, "Wait a minute. You still owe us $500." When the order is issued, the mortgage company can’t foreclose.

Q: So, if there’s no mortgage, the law office receives a copy of the Notice of Plan Completion. At that point, the law office automatically…

CH: …generates a document to be signed by the debtor that we then file to get them the discharge.

Q: And if there is a mortgage, do you wait 30 days to see if you’ve received back anything from the mortgage company?

JS: Let me give you an example. Normally the mortgage company will say, “We agree the trustee has paid everything that was owed pre-petition,” and either, “We agree they are current,” as of the date they file the response or they say, “No, we disagree and they owe four months of payments,” as an example.

Q: And if the mortgage company ignores the Notice of Final Cure Payment?

JS: If they ignore it, the trustee sets a hearing.

Q: Normally, if the mortgage is current, will the mortgage company respond back as soon as they receive the notice?

JS: Right, But let’s say they either blow it off or they say the debtor is delinquent. If they blow it off, the trustee is going to set a hearing to get an order from the judge.

Q: Does the debtor have to go to the hearing or just the mortgage company?

JS: Typically, you want the debtor there. Here’s an example: In this particular case, the trustee said, “We’ve paid everything we should pay and we think the debtor is current.” But the mortgage company said, “Well, we agree that you paid what was owed prior to filing, but we did an escrow analysis eight months ago, and didn’t tell anybody, and the debtor’s escrow is now short by $700.” So the trustee said there needs to be a hearing on the matter, because it’s not his fault. The trustee was caught in a position of wondering if he needed to go extract money from Visa and MasterCard to pay it on the mortgage, because the mortgage company messed up. We had a couple of hearings on this matter and the mortgage company backed off of its position, stating we’re not going to get the money through the plan. But the judge said that if that mortgage company truly advanced the money, it’s entitled to reimbursement, so you need to work out an agreement. So, we worked out an agreement that states the debtor has six months after the bankruptcy is done to cure the escrow shortage by paying one-sixth of the delinquent amount directly to the mortgage company. As long as the debtor does that, the mortgage company can’t foreclose.

CH: The mortgage creditor has an affirmative duty to tell the trustee how much the regular monthly mortgage payment is to be paid through the plan, so the trustee knows how much to send. Evidently in this case, the mortgage company neglected to say that it needed to increase the payment to make up for that shortfall. The mortgage payment has principal and interest, plus it escrows every month for one-twelfth of the annual taxes and insurance premium.

JS: This was a mess where, after the trustee had made the payments every month for five years, when the case was getting ready to close, the mortgage company sent a letter to the debtor stating, “You need to start making these payments and here is the account number, per the proof of claim.” So the debtor started sending the payments, but they weren’t getting cashed. We finally got to the bottom of it: the account number had changed but the mortgage company did not tell that to anyone. There was a lot of incompetence by this mortgage company.

Part 1 of Conversation: Means Test Helps Determine Filing For Chapter 7 or Chapter 13 Bankruptcy

Part 2 of Conversation: Differences Between Chapter 7 Bankruptcy and Chapter 13 Bankruptcy

Part 3 of Conversation: Divorce and Child Support Can Impact a Bankruptcy

Accruing Post-Petition Interest on Unpaid Federal Taxes (Interview Part 3 of 3)

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Penalties for unpaid federal taxes are still dischargeable when filing for bankruptcy, but they will accrue post-petition interest that is owed to the IRS. Debt limit amounts have changed for Chapter 13 cases, as of April 1, 2016.

Editor: We recently discussed the changes in the bankruptcy laws with Christopher Holmes, Jess M. Smith, III, partners at Tom Scott & Associates, P.C., along with associate attorney Andrew DeYoung. Below is Part 3 of 3 of the transcript of the conversation.

Q. What else is new in bankruptcy law?

Chris Holmes: Some of our clients have received letters from the IRS. We thought certain taxes or certain penalties or certain interest on taxes were going to go away, upon discharge. But now the IRS is coming after people—after discharge—for non-dischargeable penalties and interest on taxes that were fully paid through the Chapter 13 plan. In the good old days we would tell people that once you’re done with that Chapter 13 plan, you’re done with the IRS; you’re done with the Indiana Department of Revenue; you have no more tax worries. Now we’re finding out that is not always true, depending upon when the tax returns were filed. So, in affect, the IRS is punishing people for not filing their tax returns in a timely fashion. So, if tax returns are not timely filed and they’re filed within two years of the filing of a bankruptcy case, those taxes are not dischargeable nor are the penalties and interest thereon. Previously, you would throw those taxes in the plan, pay them in full, and then the penalties and interest would be discharged.

Jess Smith, III: Now they’re boarding up the penalties, but accruing post-petition interest.

CH: So the penalties are still dischargeable; it’s just the interest that’s still accumulating, and will be there at the end of the road. So, now we get these calls from our clients saying, "Hey, what’s going on? I got this letter from the IRS," and we have to give them the sad news that when the law changed back in 2005, there was a provision in there that allows the IRS to collect these interest charges on debts that were otherwise fully-paid through the plan.

Andrew DeYoung: Starting April 1 of this year, and this only relates to Chapter 13 cases, the debt limits are going up. That means the amount of unsecured debt that you have is increasing about $10,000. Debtor’s going into bankruptcy are able to have another $10,000 owed out and still will qualify for a Chapter 13 case. It’s now $394,725, up from $383,175. For secured debt, the amount is now $1,184,200, up from $1,149,525. It changes every three years and it can be found in the Federal register if you use the code words "109(e)" or "Chapter 13 debt limit." 

CH: It’s pretty rare that someone would have debts of that amount.

AD: One case that we worked on the debtor had purchased some vacant real estate in Florida, when the market was doing very well. He purchased the property for roughly $300,000 to $350,000 per parcel. The value then went down to under $50,000 per parcel. We ran up against the debt limits on that issue. We were luckily able to negotiate with the creditor to work a solution in the Chapter 13, but if the creditor had not agreed to work with us we would not have been eligible for a discharge in Chapter 13 because the secured debt of the debtor was too high. In a case I’m working on now the problem is where the debtor has student loans totaling $370,000. The rest of their unsecured debt is not very high, but with the debt limits only around $390,000, absent an agreement with the Department of Education, we’re not eligible for a Chapter 13.

CH: The consequence would be that they have no choice but to resort to a Chapter 11, which is primarily designed for corporations and individuals with really, really complicated situations — and those cost a whole lot more for attorneys fees and court costs.

AD: In talking to the U.S. trustee, I was advised two days ago that you would be a fool to take a Chapter 11 for under $10,000 (as the attorney fee), which in comparison to our Chapter 13 fee would be a total fee over 60 months of $4000. $10,000 up front in one sum or $4000 over 60 months is quite a big difference.

CH: It’s rare, but once in a while you get a debtor who has that kind of debt, and then you have to really go into how much the really totals out to be. You think it might be a certain amount, but the hope is that it falls under those thresholds so you can just barely make it into a Chapter 13.

Part 1 of Interview: What’s New in Bankruptcy Law in Indiana

Part 2 of Interview: Property You Can Protect When You File for Bankruptcy

Property You Can Protect When You File for Bankruptcy (Interview Part 2 of 3)

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Retirement accounts are exempt from creditors when filing for bankruptcy, but an inherited IRA is not. A recent ruling extending the time to cure arrearage might help you save your house after a tax sale.

Editor: We recently discussed the changes in the bankruptcy laws with Christopher Holmes, Jess M. Smith, III, partners at Tom Scott & Associates, P.C., along with associate attorney Andrew DeYoung. Below is Part 2 of 3 of the transcript of the conversation.

Q: Can you mention some of the things you can protect and some that you cannot protect when filing for bankruptcy?

Chris Holmes: Real estate. If it is your residence, you can protect up to $19,300 of equity. If it’s a joint filing and the property is owned jointly by a husband and wife, they can protect up to $38,600. Sometimes, when only one of them files, the property owned by a husband and wife is totally off limits to the creditors. That comes in handy sometimes.

Q: Based on cases you’ve dealt with, what are examples of the types of property people will include in their bankruptcy filing?

Jess Smith, III: The cash value of life insurance polices.

Andrew DeYoung: 401k accounts. IRA accounts. It can be as general as the clothing on your back. It’s what the exemptions apply to.

CH: But inherited IRAs are not exempt.

JS: It’s complicated and that’s why you should consult with an attorney.

CH: In general, retirement accounts—IRAs, 401Ks, defined benefit pension plans—are exempt, off-limits, no matter how much money is in there. But there was a recent decision where someone inherited a person’s IRA. The person who had the IRA died; someone inherited the IRA. The person who died could have protected that in its entirety from his or her creditors, but when it was inherited by the recipient—the debtor— it wasn’t off-limits to the creditors. It became subject to being taken and liquidated for the benefit of the debtor’s creditors.

Q: Was this decision a case you worked on or a precedent-setting case?

CH: It was a precedent-setting case in the 7th Circuit Court of Appeals in 2013, Clark (debtor) v. Rameker (trustee), in which a decision was made by the judges that an inherited IRA is not exempt in certain circumstances. (ed., The Supreme Court affirmed this decision by unanimous vote in 2014: Funds held in inherited Individual Retirement Accounts are not “retirement funds” within the meaning of 11 U.S.C. §522(b)(3)(c) and therefore not exempt from the bankruptcy estate.)

JS: And there was the case of someone buying a new car on the eve of bankruptcy to protect the lien, or affecting the lien. If the creditor does not affect the lien on the title, sometimes the trustee can take the car itself.

CH: Right. I recently had a case where right before the people came in to sign the paperwork, just two days before, they went out and bought two cars. So I had to change the paperwork and their list of creditors, but then the problem was that we had to know for certain that the creditor had put their lien on the title to each vehicle—and they had to do that within 30 days of whenever the people got the car. Otherwise, in a Chapter 7 bankruptcy, or even in a Chapter 13, the trustee could void the lien, take the car and liquidate it. Unless we did something else to prevent that, we would have to wait 91 days from the transfer of the title to file the bankruptcy. Otherwise, it creates what’s called a “preferential transfer.” With that situation, a trustee could set aside that preferential transfer and try to confiscate and liquidate that car.

There is another recent precedent-setting case that has changed in bankruptcy law. Previously, when a house had been sold by the county treasurer for delinquent taxes, the debtor had one year to redeem the property—pay the taxes plus a rate of interest—to keep the house from going to the tax sale purchaser. In the bad old days, we would have to tell people, "You’ve got to file a Chapter 13 bankruptcy before the tax sale to get the benefit of the three- to five-year Chapter 13 plan, to cure that real estate tax arrearage and save the house. If the tax sale had occurred, we couldn’t use a Chapter 13 plan to give them three to five years to cure that problem. They still had this one-year statutory redemption period, but luckily one of our judges, Judge Carr, ruled that you can now use a Chapter 13 plan after the tax sale has taken place to force everyone to back off for three to five years, to give that debtor ample time to cure that arrearage. So that is a new development we can use to save houses after tax sales.

Part 1 of Interview: What’s New in Bankruptcy Law in Indiana

Part 3 of Interview: Accruing Post-Petition Interest on Unpaid Federal Taxes