Wednesday, November 24, 2010

Dischargeability of taxes in bankruptcy

In these troubled economic times, we're getting calls from many potential clients who owe money to the IRS and other taxing authorities. They're seeking our counsel about whether their taxes are dischargeable in bankruptcy or a strategy for dealing with their tax liabilities. Some advice and strategies for the discharge of taxes in bankruptcy are provided below.

1. Trust fund taxes (money withheld from an employee's wages (income tax, social security, and Medicare taxes) by an employer and held in trust until paid to the Treasury) and sales taxes are not dischargeable in bankruptcy.

2. So called "old income taxes" for which (i) the tax return was filed more than two years before the bankruptcy filing, (ii) the tax was due more than three years before the bankruptcy filing and (iii) the tax was assessed more than 240 days before the filing of the bankruptcy petition can be discharged in bankruptcy.

3. Taxpayers should file their income tax returns on a timely basis, whether or not they can pay the tax that is due.

4. Never file a fraudulent tax return-fraudulently filed tax returns aren't dischargeable in bankruptcy.

5. If a taxpayer didn't timely file income tax returns for several years and then did a "batch filing" of returns for multiple years, the IRS or other taxing authorities can argue that these batch filings were "an attempt to evade or defeat the tax" and taxes for those years may not be dischargeable, according to both the Bankruptcy Code and case law.

6. A determination of what taxes may be dischargeable in bankruptcy begins with a review of a taxpayer's tax transcript, the types of taxes that are due and the dates the taxes were assessed.

Please note that the interrelationship of taxes and bankruptcy law is quite complex and requires experienced counsel. The general guidelines listed above should not be construed as legal advice for your particular circumstances. Anyone who has questions concerning the dischargeability of taxes in bankruptcy should contact Jim Shenwick.

Thursday, November 18, 2010

NYT: Deal Over Foreclosures Statys Out of Reach

By DAVID STREITFELD and NELSON D. SCHWARTZ

Changing the face of foreclosure in America will take some time, several state attorneys general said Wednesday, cautioning that an agreement with major lenders over revamped foreclosure practices was not imminent.

“We want to move as quickly as possibly but it has to be done right,” said Roy Cooper, the attorney general of North Carolina. “We have plowed this ground before.”

Ever since the law enforcement officials from all 50 states signed on last month to a highly publicized investigation of big mortgage lenders, there has been a public tug of war.

The banks, who have been subjected to bad publicity, have played down the investigation and want to see it end as quickly as possible. The state attorneys general, however, say that there is an opportunity to fundamentally change the way banks deal with defaulting borrowers so that more people can stay in their homes by modifying their mortgages, and that they will take the time needed.

“The large banks say they are doing everything they can to avoid foreclosure, but that is not the reality on the ground,” said Patrick Madigan, an assistant attorney general in Iowa who is a lead figure in the investigation. “The question is, Why?”

Mr. Madigan mentioned some theories, saying any or all could be true: “Is it the fact that the current servicing system was not designed to do large numbers of loan modifications, is it being understaffed, incompetence or the servicers having the wrong financial incentives?”

The major lenders are scheduled to appear on Capitol Hill on Thursday for the second hearing this week on their foreclosure procedures. The pressure to reach a settlement with the attorneys general will likely intensify after the hearing, which will be led by Representative Maxine Waters, a Democrat from California and outspoken critic of the mortgage lending industry.

But quick fixes are not likely, the attorneys general said. Richard Cordray, the Ohio attorney general who lost his bid for re-election this month, was hesitant to predict a significant outcome.

“Something will come of this, no question,” Mr. Cordray said of the inquiry. “The question is whether it will be a meaningful resolution that will make a real difference or a missed opportunity. It’s not entirely clear at this point.”

Some experts were willing to go even further, saying the lenders were impervious to change. For 18 months, the Obama administration has promoted modifications that would keep families in their homes over foreclosures that would kick them out. The programs have had some success but ultimately have done little to stem the tide.

“The banks’ act was to put their tail between their legs, act contrite before Congress and change nothing,” said Adam Levitin, an associate profesor of law at Georgetown University who testified before Congress on Tuesday and will testify again on Thursday.

The banks hope to buy off the attorneys general with money, perhaps to establish a compensation fund for victims, Mr. Levitin said. That, he said, would prevent attorneys general from “digging deeper and uncovering more rot in the mortgage system. My fear is that the banks’ calculus is correct.”

There were fresh reports on Wednesday that the foreclosure situation was deteriorating. Another 35,000 households entered foreclosure in October, the data company Lender Processing Service said, despite freezes instituted by lenders as they reviewed their practices. About 4.3 million households are either in serious default or in foreclosure.

The housing market also showed fresh signs of trouble. CoreLogic, a data company, said Wednesday that home prices fell 2.8 percent in the last year. Earlier this week, another information company, DataQuick, said sales in the Southern California market had dropped 24 percent in October from last year.

“We agree with the attorneys general that a housing market recovery is vital to restoring economic growth, and the sooner we resolve the outstanding issues, the better,” said Lawrence Di Rita, a Bank of America spokesman.

For the banks, the immediate cost of halting foreclosure is not significant. Brian Moynihan, the chief executive of Bank of America, said it totaled $10 million to $20 million a month. Bank of America has frozen foreclosures in 27 states.

A far greater threat to the broader financial system is the possibility that investors will force financial institutions to buy back hundreds of billions of dollars in soured mortgages, according to a Congressional Research Service report prepared for Thursday’s hearing and obtained by The New York Times.

Loan buybacks could shift $425 billion in losses on mortgage-backed securities from the investors that owned them to the banks that helped originate or assemble the securities, according to the report, far more than most estimates floated on Wall Street.

“Loan buybacks have the potential to cause the banking system to become undercapitalized once again or to cause individual large banks to fail,” the report says, “even if that outcome is unlikely.”

While bank officials agree that a settlement with the attorneys general is not in the making anytime soon, they remain eager to put the controversy behind them. Bank of America’s reputation, in particular, was hammered last month as the uproar grew over claims that the industry had pursued foreclosures in cases where documents were lost, missing or barely reviewed before they were signed by bank officials, a practice known as robo-signing.

What is more, as the nation’s largest mortgage servicer — it handles roughly 14 million home loans, or one in five American mortgages — it has more to lose as the investigation drags on. The majority of its troubled portfolio was picked up in 2008 when it bought Countrywide, whose aggressive subprime lending practices made it a symbol of industry excess.

“What makes it a little more pressing for Bank of America is their level of exposure,” said Guy Cecala, publisher of Inside Mortgage Finance. “Whatever the issue is, Bank of America seems to have a target on its back from people looking to be compensated for losses.”

As the beneficiary of two government bailouts, both repaid, it has been eager to maintain good relations with regulators.

Representatives from Bank of America and the other main players in the mortgage servicing industry — Ally Financial, JPMorgan Chase, Wells Fargo and Citigroup — will testify at Thursday’s hearing. A top mortgage executive at Citi plans to testify that the company identified 14,000 foreclosure cases where errors may have been made, including 4,000 where a notary may have been absent when they were signed. The bank, which until now has defended its processes, still insists that in each case the original decision to foreclose was correct and that the paperwork will be refiled.

Mr. Levitin, the Georgetown professor, will argue in Thursday’s testimony that the business model at servicing giants like Bank of America and Wells Fargo “encourages them to cut cut costs wherever possible, even if this involves cutting corners on legal requirements, and to lard on junk fees and in-sourced expenses at inflated prices.” That results in foreclosure, rather than modification, being a better bet for servicers.

In removing such incentives, the attorneys general have the task of encouraging a new system that changes behavior. “We are trying to create a paradigm shift in the way foreclosures are handled,” said Mr. Madigan, the assistant Iowa attorney general.

Copyright 2010 The New York Times Company. All rights reserved.

Friday, November 12, 2010

Personal Bankruptcy in The Year 2010

The following is a talk on this topic given by James H. Shenwick, Esq. at the Douglaston Club on November 10, 2010.

I. Three types of personal bankruptcy

a. Chapter 11-This is the same kind of bankruptcy used by major corporations to reorganize. The primary reason that individuals file for Chapter 11 is that they have too much income and assets or they have debts that fall outside the statutory limits for filing a Chapter 13 bankruptcy.

b. Chapter 13-This is usually the type of bankruptcy individuals file when they want to reorganize their debts, if (for example), they have too much equity in their house. However, this means that the debtor will have to repay a portion of their debts, and their are limits on the amount of debt you can have to qualify for this type of bankruptcy (more on that later).

c. Chapter 7-the most common type of personal bankruptcy, this allows debtors to liquidate or discharge most (but not all) of their debts (again, more on what debts are dischargeable in Chapter 7 bankruptcy later).

II. Today’s market

a. The nominal unemployment rate is close to 10% [9.6% in September], while the real unemployment rate is closer to 18-19%.

b. The unemployment rate for recent college graduate is 20-21%.

c. We are seeing a record number of foreclosures–most of our personal bankruptcy clients who have purchased a home in the last three to four years are “underwater” (the owner owes more on the mortgages(s) then the home is worth).

d. 41.8 million Americans are on food stamps, and the White House estimates that number will soon rise to 43 million.

e. Are we in a “W” shaped economic pattern? If so, are we on a upward leg or a downward leg of the “W?”

III. How can personal bankruptcy be of use?

a. 98% to 99% of our personal bankruptcy clients wind up filing for Chapter 7 bankruptcy for the “fresh start” of liquidating most of their debts.

b. In 2005, the New York State legislature increased the homestead exemption from the bankruptcy estate (the assets available to pay their creditors) to $50,000 per spouse. Most of our Chapter 7 clients can reaffirm their mortgages and keep their houses. And the homestead exemption may be increasing soon (more on that later in my talk).

c. Debtors can also reject unfavorable leases and guarantees through a Chapter 7 filing.

d. Congress radically revised and amended Chapter 7 personal bankruptcy laws by enacting the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). These changes include median income and means testing, where if an individual (single, married or with children) has income that exceeds a certain dollar amount, then the bankruptcy filing is considered an abuse of the system and facially they are not permitted to file Chapter 7 bankruptcy.

e. The first test under the revised code is whether a debtor exceeds the median income for their family size based on their state of residence. Pursuant to the 2005 amendments, a case where the debtor makes less than the median is presumed to be a non-abusive filing, and a below-median debtor may file for Chapter 7 bankruptcy. Effective March 15, 2010, the median income of a single person in New York State is $46,320. For a family of two, the income threshold for the Median Income Test is $57,902, for a family of three it is $69,174 and for a family of four it is $82,164. Add $7,500 for each individual in excess of four. Median income figures are periodically revised by the Census Bureau.

f. However, all is not lost for a debtor who exceeds his or her state median income threshold. If an individual’s income exceeds the median income for their respective state and family size, they may still be allowed to file for Chapter 7 bankruptcy if they pass the so-called “Means Test,” i.e. the results show that the bankruptcy filing is not a presumption of abuse under § 707(b)(7) of the Bankruptcy Code. The Means Test (officially known as Form 22A, “Chapter 7 Statement of Current Monthly Income and Means-Test Calculation”) is one of the most complicated calculations in the law. It consists of eight pages, and is similar to doing a 1040 tax return for an individual. The Means Test incorporates the debts that an individual has (both unsecured and secured (i.e. mortgages and car loans), taxes that they owe, and expenses specified by the IRS in its financial analysis standards–food, clothing, household supplies, personal care, out-of-pocket health care and miscellaneous (National Standards); housing and utilities (non-mortgage expenses), housing and utilities (mortgage/rental expense), with adjustments, transportation (vehicle operation/public transportation/transportation ownership or lease expenses)(you are entitled to an expense allowance in this category regardless of whether you pay the expenses of operating a vehicle and regardless of whether you use public transportation)–as well as many other factors.

g. Another requirement to file for Chapter 7 bankruptcy is that the Debtor’s monthly net income (their average monthly income less their average monthly expenses) must be zero or a negative amount.

h. Chapter 13 bankruptcy can useful for debtors who have unincorporated businesses that they want to keep. Like Chapter 7 debtors, Chapter 13 debtors can also exempt up to $2,400 in equity in a motor vehicle and $50,000 in equity in a principal residence from their bankruptcy estate.

i. However, § 109(e) of the Bankruptcy Code places limits who can qualify to be a debtor under Chapter 13. To qualify, a debtor must have regular income and noncontingent, liquidated, unsecured debts of less than $360,475 and noncontingent, liquidated, secured debts of less than $1,081,400.

IV. New developments.

a. New York bankruptcy exemptions may be about to undergo their biggest transformation in years. New York State Senate bill S.7034A and Assembly bill A. 8735A have been passed by the Legislature and are expected to be signed into law by Governor Paterson in the very near future.

The scope of the bill is very broad, but a few of the major changes are:

• The homestead exemption would increase from $50,000 to: $150,000 for the counties of Kings, New York, Queens, Bronx, Richmond, Nassau, Suffolk, Rockland, Westchester, and Putnam; $125,000 for the counties of Dutchess, Albany, Columbia, Orange, Saratoga, and Ulster; $75,000 for the remaining counties in the state.
• The motor vehicle exemption would increase from $2,400 to $4,000. If the vehicle was equipped for a disabled person, the limit would be $10,000.
• The aggregate individual bankruptcy exemption for cash, household goods and clothing would increase from $5,000 to $10,000.
• The New York Banking Department will publish cost of living adjustments to exemption amounts every three years commencing April 1, 2012.
• Debtors will now be able to choose whether to use the New York exemptions or the federal exemptions. This will be especially useful for Debtors who do not own a home, since the “wildcard” exemption in § 522(d)(5) of the Bankruptcy Code allows Debtors to exempt a significant amount of cash.

A married couple filing jointly for bankruptcy can double the amount of the exemptions listed above.

b. Student loans are not usually dischargeable in bankruptcy, but the House of Representatives is currently considering H.R. 5043, the “Private Student Loan Bankruptcy Fairness Act of 2010,” which would allow debt from private loans issued by for-profit lenders to be dischargeable in bankruptcy. H.R. 5043 is currently in the House Judiciary Committee. A similar bill, S. 3219, the “Fairness for Struggling Students Act of 2010,” is currently under consideration in the Senate’s Judiciary Committee.

Wednesday, November 10, 2010

Preference Actions

Here at Shenwick and Associates, we have noticed an uptick in preference actions. For those of you who are not familiar with bankruptcy jargon, a preference action is an adversary proceeding (litigation) commenced by a Chapter 7 bankruptcy trustee or a Chapter 11 debtor seeking the return of monies that were paid by the company to a creditor, generally within 90 days of the bankruptcy filing. If the creditor is an "insider" (i.e. a relative, or, in the case of a company, a director or officer), the look back period (also known as the "preference period") for a preference action is one year.

Many clients ask what strategies are available to avoid preference actions. Some potential strategies are as follows:

1. If a customer or client owes money, and those monies are past due, attempt to have the bill paid by a third party.

2.Attempt to have a third-party guarantee payment of the debt.

3. The ordinary course of business defense -- the more ordinary the payment, the less likely the payment will be considered a preferential transfer. Additionally, if the terms of an invoice are net 30 days, and the invoices are 90 or 120 days past due, have the customer or client pay more recent invoices and avoid payment of the 90 or 120 day invoice.

4. The small payments exception-Under §§ 547(c)(8) and (c)(9) of the Bankruptcy Code, which were added as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Trustees may not avoid a transfer: (1) in a case filed by an individual debtor whose debts are primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $600; or (2) in a case filed by a debtor whose debts are not primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $5,850 (as of April 1, 2010).

5. Attempt to shed your insider status prior to receiving payment if you will be deemed an "insider" under § 101(31) of the Bankruptcy Code.

6. Remember that if you ship goods to a debtor during the preference period and are not paid for those goods, those goods are deemed new value and decrease the amount of the preferential payments.

If you have questions regarding preference or fraudulent conveyance actions, please do not hesitate to contact Jim Shenwick.

Monday, November 08, 2010

NYT: Robo-Signing at Companies That Buy Consumer Debts

By David Segal

When Michael Gazzarato took a job that required him to sign hundreds of affidavits in a single day, he had one demand for his employer: a much better pen.

“They tried to get me to do it with a Bic, and I wasn’t going — I wasn’t having it,” he said. “It was bad when I had to use the plastic Papermate-type pen. It was a nightmare.”

The complaint could have come from any of the autograph marathoners in the recent mortgage foreclosure mess. But Mr. Gazzarato was speaking at a deposition in a 2007 lawsuit against Asset Acceptance, a company that buys consumer debts and then tries to collect.

His job was to sign affidavits, swearing that he had personally reviewed and verified the records of debtors — a time-consuming task when done correctly.

Sound familiar?

Banks have been under siege in recent weeks for widespread corner-cutting in the rush to process delinquent mortgages. The accusations have stirred outrage and set off investigations by attorneys general across the country, prompting several leading banks to temporarily cease foreclosures.

But lawyers who defend consumers in debt-collection cases say the banks did not invent the headless, assembly-line approach to financial paperwork. Debt buyers, they say, have been doing it for years.

“The difference is that in the case of debt buyers, the abuses are much worse,” says Richard Rubin, a consumer lawyer in Santa Fe, N.M.

“At least when it comes to mortgages, the banks have the right address, everyone agrees about the interest rate. But with debt buyers, the debt has been passed through so many hands, often over so many years, that a lot of time, these companies are pursuing the wrong person, or the charges have no lawful basis.”

The debt in these cases — typically from credit cards, auto loans, utility bills and so on — is sold by finance companies and banks in a vast secondary market, bundled in huge portfolios, for pennies on the dollar. Debt buyers often hire collectors to commence a campaign of insistent letters and regular phone calls. Or, in a tactic that is becoming increasingly popular, they sue.

Nobody knows how many debt-collection affidavits are filed each year, but a report by the nonprofit Legal Aid Society found that in New York City alone more than 450,000 were filed by debt buyers, from January 2006 to July 2008, yielding more than $1.1 billion in judgments and settlements.

Problems with this torrent of litigation are legion, according to the Federal Trade Commission, led by Jon Leibowitz. The agency issued a report on the subject, “Repairing a Broken System,” in July. In some instances, banks are selling account information that is riddled with errors.

More often, essential background information simply is not acquired by debt buyers, in large part because that data adds to the price of each account. But court rules state that anyone submitting an affidavit to a court against a debtor must have proof of that claim — proper documentation of a debt’s origins, history and amount.

Without that information it is hard to imagine how any company could meet the legal standard of due diligence, particularly while churning out thousands and thousands of affidavits a week.

Analysts say that affidavit-signers at debt-buying companies appear to have little choice but to take at face value the few facts typically provided to them — often little more than basic account information on a computer screen.

That was made vividly clear during the deposition last year of Jay Mills, an employee of a subsidiary of SquareTwo Financial (then known as Collect America), a debt-buying company in Denver.

“So,” asked Dale Irwin, the plaintiff’s lawyer, using shorthand for Collect America, “if you see on the screen that the moon is made of green cheese, you trust that CACH has investigated that and has determined that in fact, the moon is made of green cheese?”

“Yes,” Mr. Mills replied.

Given the volume of affidavits, even perfunctory research seems impossible. Cherie Thomas, who works for Asta Funding, a debt buyer in Englewood Cliffs, N.J., said in a 2007 deposition that she had signed 2,000 affidavits a day. With a half-hour for lunch and two brief breaks, that’s roughly one affidavit every 13 seconds.

Executives at debt-buying firms say they have systems to ensure the accuracy of their affidavits. Robert Michel, chief financial officer at Asta Funding, says his company hires outside lawyers to read over affidavits, then has staff employees check their work.

“The people who work in this area are well trained, and they know that when they sign a statement they have to follow certain procedures,” he said. “They know what they are doing.”

He added that the pace of affidavits filed by Asta had dwindled since 2007 and was now closer to “several hundred” a day, rather than 2,000.

Even if debt buyers purchase the requisite information directly from a bank, it may be flawed. Linda Almonte oversaw a team of advisers, analysts and managers at JPMorgan Chase last year, when the company was preparing the sale of 23,000 delinquent accounts, with a face value of $200 million. With the debt sold at roughly 13 cents on the dollar, the sale was supposed to net $26 million.

As the date of the sale approached, Ms. Almonte and her employees started to notice mistakes and inconsistencies in the accounts.

“We found that with about 5,000 accounts there were incorrect balances, incorrect addresses,” she said. “There were even cases where a consumer had won a judgment against Chase, but it was still part of the package being sold.”

Ms. Almonte flagged the defects with her manager, but he shrugged them off, she says, and he urged her and her colleagues to complete the deal in time for the company’s coming earnings report. Instead, she contacted senior legal counsel at the company. Within days, she was fired. She has since filed a wrongful termination suit against Chase.

A Chase spokesman declined to comment, citing the pending litigation.

The majority of lawsuits filed in debt collection cases go unanswered, which is why most end with default judgments — victories for creditors that allow them to use court officers or sheriffs to garnish wages or freeze bank accounts, among other remedies.

There is a persistent argument about why so few consumers respond in these cases. Consumers often know they owe the debt and conclude that fighting about it is pointless, said Barbara Sinsley, general counsel at DBA International, a trade group of debt buyers.

Lawyers for consumers, on the other hand, contend that few debtors ever learn about the legal action until it is too late, often because the process server charged with alerting them never actually delivered a notification. In those instances when a consumer hires a lawyer, the consumer often prevails.

“I’ve lost four and I’ve taken about 5,000 cases,” said Jerry Jarzombek, a consumer lawyer in Fort Worth. “If the case goes to trial, I say to the judge, ‘Your honor, imagine if someone came in here to give eyewitness testimony in a traffic accident case and they didn’t actually see the crash. They just read about it somewhere. Well, this is the same thing.’ The debt buyers don’t know anything about the debt. They just read about it.”

Every plaintiff’s lawyer and consumer advocate in this field has a theory about why there has been so much fury over mortgage paperwork abuses but so little about debt collections. The stakes in collections cases are smaller, and of course, debt buyers were never given a taxpayer bailout.

“But what people don’t realize,” said Daniel Edelman, a plaintiff’s lawyer in Chicago, “is that the mortgage issue and debt collections are intimately connected. The millions of default judgments out there — you better believe that’s one reason that homeowners can’t afford their homes.”

Andrew Martin contributed reporting.

Copyright 2010 The New York Times Company. All rights reserved.