Tuesday, May 24, 2016

Personal Bankruptcy in 2016: What Can a Client Expect?

On May 18th, James Shenwick delivered a lecture on personal bankruptcy in 2016 to Deliberate Solos.



I.          Introduction

Why do people file for bankruptcy today?
     Credit card debts
     Business reversals and job loss
     Falling real estate values
     High housing costs
     Student loans
     Divorce
     Medical bills and illness
     Guaranties of debt

II.        Economic Conditions that are driving Personal Bankruptcy Filing
     4.9% unemployment rate
     The effective unemployment rate is 9.7%
     The unemployment rate for recent college graduates is 7.2%
     $935.3 billion of revolving (credit card) debt as of January 2016
     The foreclosure rate is 1.2%
     11.5% of homes are “underwater.”
     Student loans total approximately $1.4 trillion


III.       What can a person with too much debt do?

            A.        Do nothing-“Hope and Pray”
B.        Negotiate an “out of court” workout with creditors

Pros:
     Save the legal fees in filing a bankruptcy petition and the Bankruptcy Court filing fees (usual minor in comparison to the amount of debt a debtor has).
     A workout may be a less “negative factor” on your credit report than filing for bankruptcy (“FICO Score”). However chapter 13 (partial payment of debts) is better on a credit report than chapter 7 (discharge of debts)
     Psychological relief in not filing for bankruptcy and “embarrassment or failure factor.”

Cons: 
     You negotiate one creditor at a time-what if you can’t reach an agreement with all creditors-do you do the work?
     Who will do the negotiating-the debtor, a CPA or an attorney? (CPAs and attorneys will charge a fee for this work)
     The time and effort of drafting, revising and reviewing a Settlement Agreement, Release, Stipulation of Settlement or Stipulation of Discontinuance of litigation.
     Under § 108 of the Internal Revenue Code, debt relief is considered income and is taxable.  This is “phantom income” (Creditor will have to file a Form 1099R with taxing authorities)

C.        File Bankruptcy-Chapter 7, 11 and 13

IV.       Overview of the three types of personal bankruptcy

A.        Chapter 7-“Liquidation and Fresh Start”-the most common type of personal bankruptcy, this allows debtors to liquidate or discharge most (but not all) of their debts:

What debts are discharged in a Chapter 7 personal bankruptcy?
     Credit card debt
     Personal, business, automobile and real estate loans
     Lines of credit
     Medical bills
     Utility bills
     Personal and “good guy” guaranties-“good guy” guaranties are guaranties created for the leasing of commercial space.
     Chapter 7 bankruptcy will have the most negative impact on credit reports and will lower FICO score (however after receiving a chapter 7 discharge a debtor will be able to rehabilitate their credit and obtain credit
     Chapter 7 bankruptcy constitutes the vast majority of individual filings, and can be very helpful in dealing with many debtor/creditor problems that individuals have these days (90-95% of our bankruptcy filings are Chapter 7).
     Chapter 7 bankruptcy provides individuals who qualify to file under this chapter with a “discharge,” which can wipe out a significant amount of an individual’s debt. 
     Over 819,000 individuals and corporations filed for bankruptcy in 2015.

The Mechanics of a Chapter 7 Bankruptcy Filing
     Hire an attorney, provide data to attorney, bankruptcy petition is prepared, reviewed by client, filed with the Bankruptcy Court and Debtor attends one § 341 meeting with attorney and Bankruptcy Trustee
     The filing fee for a Chapter 7 bankruptcy is $335.

B.        Chapter 13- This type of personal bankruptcy provides for the reorganization of debts of an individual with regular income and allows them to retain real and personal property and business interests. 

     Generally used by a person who owns assets that would be liquidated in a chapter 7 bankruptcy such as a house with alot of equity, a business or some other type of valuable asset
     Under BAPCPA, individuals must file for Chapter 13 bankruptcy if they earn too much and fail the means test.
     Corporations may not file Chapter 13 bankruptcy.  Corporations may file Chapter 7 or Chapter 11 bankruptcy.

Chapter 13 bankruptcy is a good solution for individuals with:
     A lot of home equity
     Expensive cars
     A valuable lease
     A business they want to keep
     If a debtor’s income is greater than the median income for their state and household size, they will have to file a five year plan (rather than a three year plan).
     If a debtor has too much debt under § 109(g) of the Bankruptcy Code (as of April 1, 2016, noncontingent, liquidated, unsecured debts of more than $394,725 and noncontingent, liquidated, secured debts of more than $1,184,200), they do not qualify for Chapter 13.
     Chapter 13 bankruptcy will have an intermediate impact on credit reports and FICO score compared with Chapter 7 bankruptcy and an “out of court” workout.

The Mechanics of a Chapter 13 Bankruptcy Filing
     Hire an attorney, provide data to attorney, bankruptcy petition and Plan is prepared, reviewed by client and filed with the Bankruptcy Court, Debtor attends one § 341 meeting with attorney and Chapter 13 Bankruptcy Trustee and attends hearing on Plan confirmation before the Bankruptcy Judge.
     The filing fee for a Chapter 13 bankruptcy is $310.


C.        Chapter 11- Reorganization (for wealthy individuals or a corporation) or liquidation. 
     The primary reason that individuals file for Chapter 11 is that they have too much income or assets or they have debts that fall outside the statutory limits for filing a Chapter 13 bankruptcy.
     An individual Chapter 11 is modeled on a chapter 13 bankruptcy but allows  more flexibility to the Debtor
     The filing fee for Chapter 11 is $1,717 and legal fees are in excess of $10,000

V.        “BAPCPA” and Personal Bankruptcy Basics

A.        In 2005, Congress radically revised and amended Chapter 7 personal bankruptcy laws.  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. 

B.        Median Income.  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.

Family size
New York State Median Income (effective April 1, 2016)
1
$49,086
2
$62,451
3
$72,074
4
$88,747

     Add $8,400 for each individual in excess of four. 
     Median income figures are periodically revised by the Census Bureau.
 
C.        Means Test-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) (Local Standards)–as well as many other factors.      It is similar to preparing an “offer in compromise.”

D.        However, with proper planning, most individuals or couples whose income exceeds the median income can still pass the Means Test and will be allowed to file for Chapter 7 bankruptcy, notwithstanding the legislative intent of the changes under BAPCPA, which was to try and minimize the number of individuals who could file for Chapter 7 bankruptcy and force them to either not file for bankruptcy or to file for Chapter 13 bankruptcy.

     If an individual’s debts are primarily business debts, then the Means Test does not apply.
     The data that is used to calculate the Means Test is a six-month rolling look back at the debtor’s income and expenses.  Accordingly, if a debtor is self-employed, an independent contractor or a salesperson, they may be able to earn less and therefore pass the Means Test.
     If a debtor is married and living with his or her spouse who is not filing for bankruptcy, the non-filing spouse’s income and expenses must be included in the Means Test.
     Failing the Means Test means that a Chapter 7 filing would be deemed presumptively abusive under § 707(b)(2)(A) of the Bankruptcy Code.  However, a debtor can rebut the presumption of abuse by showing special circumstances.
     Similarly, if a debtor’s after tax income is greater then expenses, the debtor has monies to make some payment to creditors, and a Chapter 7 filing would be presumptively abusive under the “totality of the circumstances” test in §707(b)(3) of the Bankruptcy Code.


VI. Student Loans
A.    Student loans, both public and private student loans are non-dischargeable under Bankruptcy Code section 523(a)(8) unless the debtor can qualify for a “hardship discharge”
B.     The seminal case in the county on hardship discharge is Brunner v. New York State Higher Education Services Corp., a 2nd Circuit Court of Appeals case which held that in order to qualify for a hardship discharge a debtor must show 1. that they made a good faith effort to repay their student loans (they made some payments before the hardship arose), 2. the hardship will continue during the term of the loan (10 to 15 years) and 3. As a result of the hardship they will not be able to repay the loan and maintain a “minimal” standard of living
C.     This is a difficult standard for debtors. They generally must have a severe physical or mental disability, they will need to hire an expert (doctor or psychologist who will testify at trial) and they will need to commence an adversary proceeding (bankruptcy litigation) at a cost in legal fees and expert witness fees in excess of $10,000.
D.    As of late many judges, law professors and lawyers have criticized Brunner, but it is still the law
E.     There have been proposals to allow student loan defaults to be addressed in chapter 13 bankruptcy filings.

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