By TARA SIEGEL BERNARD
Millions of consumers have fallen out of favor with the credit scoring gods.
Some lost their jobs or were just overwhelmed by mounting debt. Others got caught up in the real estate bubble or had major medical bills. Whatever the reason, the rising number of foreclosures, short sales, late credit card payments and the ultimate credit sin — bankruptcies — have left black marks on credit reports most everywhere.
So what can these people do to repair their credit?
The simple answer is to focus on the information that is used to generate the all-powerful FICO score — the measure used most frequently by traditional lenders to determine creditworthiness. Its scale runs from 300 points to 850 points; the higher the score, the better your credit standing. “FICO is still the 500-pound gorilla,” said John Ulzheimer, president of consumer education at SmartCredit.com. “In 2011, the best way to get credit from the mainstream lenders is to have a good FICO score.”
Consumers can hope that the banks will eventually consider alternatives to the traditional FICO score, which was developed by Fair Isaac Corporation and has been in wide use for about two decades. After all, as banks regain their appetite for lending, they will be looking for ways to differentiate between borrowers with the same scores, some of whom are temporarily struggling and others who chronically have trouble with money.
For now, though, the FICO score reigns. The best antidote to a poor score is time. Still, there are a half dozen ways to speed the process, or, at the least, avoid even more credit trouble.
What to Do
ASSESS YOUR SITUATION Before you even start to think about rehabilitating your credit, make sure that you can pay your bills on time and not do any more harm. If keeping up with your credit card bills is still an issue, then call the issuer, explain your situation and try to negotiate payments you can afford. Ask the issuer how that will be reported to the major three credit bureaus: Not paid as agreed, which can hurt your score? Or will the new terms say that you are now paying as agreed?
“You have to get in writing that this is what they agreed to do,” said Mechel Glass, director of education at CredAbility, a nonprofit consumer credit counseling agency. Ditto for other providers, like utility companies.
Then, assess all the damage by getting a free copy of your credit report from each of the three major credit reporting bureaus through annualcreditreport.com. Each of the major credit bureaus — Equifax, Experian and TransUnion — generate their own FICO scores based on the data they collect. Two versions of your FICO score are also available for $19.95 each, through myFico.com.
How far your credit score has fallen will depend on where it started, as well as the frequency and severity of your credit mistakes. If you had almost perfect credit, but because of the loss of a job your credit card bills ended up at a collection agency, you can expect to lose anywhere from 80 to 150 points from your FICO score. A short sale or foreclosure? Both, Mr. Ulzheimer said, “would turn a FICO 790 into a FICO 590 overnight.”
CLEAN UP YOUR SCORE Start with the low-hanging fruit. Let’s say you were late paying a bill from a company that no longer exists, or a bank that has since merged with a larger institution. If the credit reporting bureaus cannot verify the accuracy of that black mark, they are required to remove it. “Not only does it have to be correct, but it has to be verifiable,” Mr. Ulzheimer said.
Next, focus on paying off the loans — namely, credit cards — that will help give your score the most lift. Paying off a mortgage, a student loan or other installment debts, like car loans, feels good but that won’t necessarily do much for your credit score.
You also want to get your so-called debt utilization rate into good shape. FICO considers how the total amount of debt on each of your credit cards compares with your total available credit. The credit score “elite” — that is, people with FICO scores above 760 — typically don’t have debts that exceed 7 percent of their available credit. But if you are at 50 percent and can get the rate down to 30 percent, that will help.
LEAVE A NOTE Because prospective employers may pull a copy of your credit report, consider adding the equivalent of a doctor’s note to each of your reports explaining your hardship, like a job loss. All three major credit bureaus allow you to add a brief statement through their Web sites. FICO doesn’t consider these statements when formulating scores, however, so don’t expect it to sway lenders.
GET SECURED CARDS It will obviously be hard to get a traditional credit card when you have a poor credit history. Secured cards, if used strategically, can help nurse your credit back to health more quickly. These cards require you to put a set amount of money in a bank account, say $250 or $500, which is used as collateral. And the amount of available credit should be equivalent to the amount on deposit.
“What is the most predictive and powerful in your score are the things you’ve done most recently,” Mr. Ulzheimer said. “That cuts both ways. If you add a secured card and you pay it religiously and the balance is low, it will help your score a lot more quickly than if you do nothing.”
But read the fine print before signing up. Consumer advocates said some unscrupulous card issuers have charged the security deposit to the card. And be sure the issuer reports your payment information to the big three credit bureaus, since not all do.
Curtis Arnold, the founder of CardRatings.com, recommended two cards, both of which report payments to the big three: the Orchard Bank Secured MasterCard, which has an attractive interest rate of 7.9 percent, waives the annual fee in the first year and charges a moderate $35 annually thereafter. He also likes the Citi Secured MasterCard, largely because it offers an interest rate on the security deposit equivalent to an 18-month certificate of deposit, which he says is an industry first.
TALK TO A CREDIT UNION These institutions may be more willing to work with members who have checkered histories. Their offerings vary, but they may be more likely to consider alternative credit scores, offer free credit counseling or have products tailored for people with poor credit histories. “Certainly, many credit unions have credit builder or rebuilder loans, often structured as a loan with a built-in savings component so that a person gradually builds up funds that can act as partial collateral,” said Clifford Rosenthal, the president of the National Federation of Community Development Credit Unions, a trade association representing credit unions in low- and moderate-income areas.
ALTERNATIVE VERIFICATION There are other credit reporting agencies and services that — for a monthly fee, and sometimes a hefty one — will collect your payment history from sources that aren’t included in your traditional credit report or FICO score. At this point, however, most mainstream lenders base their decisions on the big three bureaus’ reports and FICO scores. So you’re better off saving your money. “All of those companies say they will report your accounts to a credit bureau, and they may be doing that,” Mr. Ulzheimer said. “But if it is not the big three, then who cares?”
This could change, of course, as banks become more willing to lend and potentially open to using other means to identify promising borrowers. Lenders may begin to consider rental payment histories, for instance. Or they may be willing to look at alternative credit scores that incorporate payment information that doesn’t show up on traditional credit reports.
Or perhaps one lender will permit so-called shoe box credit: Did you know that if you walk into a lender with a box stuffed with receipts proving that you paid your cable bill, for instance, that they are required to consider it? They aren’t obliged to give you a loan, but the regulation says they must consider the information.
What to Avoid
CREDIT REPAIR OFFERS You may have seen the advertisements for credit repair companies on the Web. “We really tell our clients to stay away,” said Ms. Glass, of CredAbility. One re-emerging scam, she says, involves companies that claim they can clean up your credit. Some companies manage to do this for a limited time by disputing all of your accounts, sending letters to the bureaus claiming the accounts aren’t valid. But after the credit bureaus validate the accounts and debts, they reappear on your report and your score will plummet again.
Legitimate credit repair companies exist, and they can assist in disputes. But there’s nothing they can do that you can’t do yourself at little cost. Besides, these companies often besiege the bureaus with letters, and the bureaus are allowed to ignore what they believe are frivolous disputes. Be wary of companies that do not disclose in writing that you can do these tasks free on your own, that guarantee results or that try to charge you before they perform any services.
CERTAIN CARDS Despite the tighter credit environment, Chi Chi Wu, a staff lawyer at the National Consumer Law Center, said the center was still receiving complaints about credit cards aimed at people with poor credit histories.
“These cards are pitched as a way to build credit, but with these kind of steep fees and high interest rates, there is a good chance they will hurt,” she said.
Copyright 2011 The New York Times Company. All rights reserved.
Monday, February 21, 2011
Friday, February 04, 2011
Jim Shenwick to talk on "Personal Bankruptcy: The Basics and Discharging Taxes in Bankruptcy"
The following is an outline of the talk Jim Shenwick will give to the New York Society of CPA's Small Firms Practice Committee on Monday, February 7, 2011.
Personal Bankruptcy: The Basics and Discharging Taxes in Bankruptcy
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
• 9.1% unemployment rate
• The effective unemployment rate is 17-18%
• The unemployment rate for recent college graduates is 20-21%
• $796.5 billion of revolving (credit card) debt as of November 2010
• The foreclosure rate is 11%
• 20-30% of homes are “underwater.”
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.
• A workout may be a less “negative factor” on your credit report than filing for bankruptcy (“FICO Score”)
• 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.
• Of all of the solutions to too much debt, Chapter 7 bankruptcy will have the most negative impact on credit reports and will lower FICO score.
• 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.
• 1.6 million Americans filed for bankruptcy in 2010.
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 § 341 meeting with attorney and Bankruptcy Trustee
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.
• 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 5 year plan (rather than a 3 year plan).
• If a debtor has too much debt under § 109(g) of the Bankruptcy Code (noncontingent, liquidated, unsecured debts of more than $360,475 and noncontingent, liquidated, secured debts of more than $1,081,400), 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 § 341 meeting with attorney and Chapter 13 Bankruptcy Trustee and attends hearing on Plan confirmation.
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.
• The filing fee for Chapter 11 is $1,039 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 November 1, 2010)
1 $45,548
2 $56,845
3 $67,292
4 $82,587
• Add $7,500 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. Dischargeability of Taxes in Bankruptcy
A. Certain “old income taxes” may be dischargeable if:
i. The tax return was filed more than two years prior to the bankruptcy filing (note that a return prepared and filed by the IRS is not deemed to be a filed return);
ii. The taxes are more than three years old;
iii. The taxes were assessed more than 240 days before the filing of the petition;
iv. There was no attempt to avoid or evade the taxes.
• Various events can toll or delay the calculation of these time periods, including a bankruptcy filing, a pending offer in compromise, failure to file a return, filing an amended return and requesting an extension of time to file a return.
If all of these conditions are met, the taxes are dischargeable in bankruptcy. Tax account transcripts from the Internal Revenue Service and the New York State Department of Taxation and Finance are needed in order to determine if the taxes are dischargeable.
B. Bankruptcy Litigation/Adversary Proceeding- The Debtor or the taxing authority can file an adversary proceeding (bankruptcy litigation) to determine if the tax debts are dischargeable. The Debtor can also enter into a payment plan with the taxing authority.
C. “No Attempt to Avoid or Evade the Taxes” Standard-the IRS has heightened its scrutiny of the discharge of income taxes in bankruptcy, and their position (based on case law) is that if you spend too much money on luxury items, and/or pay other creditors ahead of the IRS, and/or make yourself judgment proof, then according to the IRS, those tax debts would not be dischargeable, and the IRS will commence an adversary proceeding (litigation in a bankruptcy case) to object to the discharge of these taxes. See Wright v. Internal Revenue Service, 191 B.R. 291 (S.D.N.Y. 1995); Haesloop v. U.S. (In re Haesloop), 2000 Bankr. LEXIS 1104, 2000 WL 1607316 (Bankr. E.D.N.Y. Aug. 30, 2000); Lynch v. United States, 299 B.R. 62 (Bankr. S.D.N.Y. 2003); Epstein v. United States, 303 B.R. 280 (Bankr. E.D.N.Y. 2004)
D. What taxes are not dischargeable?
• Recent taxes (2009 and 2010 tax years)
• Payroll, sales and other trust fund taxes (employee portion of FICA and FUTA, not the employer portion)
• Property taxes assessed within one year of filing
E. BAPCPA (2005) requirements for Personal Bankruptcy
i. Under BAPCPA, in addition to the list of creditors, schedules of assets, liabilities, income and expenses debtors must now provide:
a. A certificate of credit counseling;
b. Payment advices from employers received 60 days before filing (if any);
c. A statement of monthly net income and any anticipated increase in income or expenses after filing;
d. Tax returns or transcripts filed in the most recent tax year;
f. Photo ID; and
g. Social Security card
ii. Failure to provide the documents within 45 days after the petition has been filed (with a possibility of a 45-day extension) results in automatic dismissal of the case.
iii. Also new under BAPCPA, a debtor must have received pre-petition credit briefing (in person, by phone or internet) from an approved non-profit entity that outlined opportunities for credit counseling and assisted the Debtor in performing a personal budget analysis in the 180 days before filing a petition. Greenpath (http://www.greenpath.com), one of the approved credit counseling agencies, charges approximately $45. There are many other course providers besides greenpath, some with lower costs.
vi. Additionally, within 60 days after the first Meeting of Creditors, the debtor must also take a post-petition financial management course and file a certificate of completion with the Bankruptcy Court. The cost of this course from Greenpath is also approximately $45.
iv. The Bankruptcy Court may grant a waiver based on the Debtor’s sworn statement that they were unable to obtain the counseling services within five days of making the request and had to file immediately, but the waiver expires 30 days after the petition is filed.
v. The briefing is not required if the Bankruptcy Court determines that the Debtor is mentally incapacitated, physically disabled, or is an active member of the military in a combat zone.
F. What are the negatives of filing for Chapter 7 bankruptcy?
i. The filing stays on a person’s credit report for seven to ten years
ii. A debtor may only file for Chapter 7 bankruptcy every eight years (however, if a debtor files for Chapter 7, receives a discharge, and then gets into further financial trouble, they can file under Chapter 11 or 13 of the Bankruptcy Code).
VII. Chapter 13
A. What are the pros and cons?
i. Cons
a. The debtor is placed on an austerity budget and must pay their disposable income to the Chapter 13 Trustee on a monthly basis.
b. If the debtor is over the “median income,” then they must prepare a five year, 60 month plan. The shortest plans are generally three years.
c. The filing fee is $279 (which is $20 less then the filing fee for a Chapter 7 filing).
d. However, legal fees are greater than those for a Chapter 7 filing, since there are fees for preparing the plan, the hearing on plan confirmation, and the plan must be served on creditors and must be confirmable.
e. In the Southern District of New York, historically only 30% of Chapter 13 plans pay out over time.
f. Pursuant to §1322 of the Bankruptcy Code, first mortgages cannot be modified in Chapter 13. However, second mortgages can be modified and mortgages on investment properties and vacation homes can be modified.
g. The Chapter 13 Trustee receives a commission of 10% of the monies paid into a Chapter 13 plan.
h. With the increased New York State homestead exemption of $150,000 (for debtors residing in the New York metropolitan area), Chapter 7 can accomplish much of what can be accomplished with a Chapter 13 filing at a lesser cost to the Debtor.
ii. Pros
a. Chapter 13 allows the debtor to retain property that he or she would otherwise lose in a Chapter 7 liquidation (e.g. a car or a house with substantial equity)
b. A Chapter 13 debtor remains under bankruptcy court protection for the duration of the repayment plan (3-5 years)
c. Tax refunds are property of the bankruptcy estate and those monies must be transferred by the Debtor to the Chapter 13 Trustee
VIII. New York State Bankruptcy Exemptions
A. The most sweeping change in decades on what real and personal property is exempt from a debtor’s bankruptcy estate (the debtor’s property that can be distributed to creditors) in New York State took place last month. New York State Senate bill S.7034A and Assembly bill A. 8735A were signed into law by Governor Paterson on December 23, 2010. The new law became effective on January 22, 2011.
B. The scope of the bill is very broad, but a few of the major changes are:
i. The homestead exemption has increased 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; and $75,000 for the remaining counties in the state.
ii. The motor vehicle exemption has increased from $2,400 to $4,000. If the vehicle is equipped for a disabled person, the exemption is $10,000.
iii. The aggregate (combined) individual bankruptcy exemption for certain annuities and personal property under New York Debtor and Creditor Law § 5205(a) has increased from $5,000 to $10,000.
iv. The exemption for tools of trade (including professional instruments and library) has increased from $600 to $3,000.
v. The New York Banking Department will publish cost of living adjustments to exemption amounts every three years commencing April 1, 2012.
vi. Debtors are now 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-$1,150 plus up to $10,825 of any unused amount of the homestead exemption.
C. A debtor may also exempt:
i. An unlimited amount of rental or utility security deposits.
ii. 120 days of food.
iii. $7,500 of monies recovered for a personal injury.
iv. A qualified IRA up to $1,000,000.
A married couple filing jointly for bankruptcy can double the amount of the monetary exemptions listed above.
The full text of the new law can be found at:
http://www.nyeb.uscourts.gov/announcements/ExemptionsSummaryLaw.pdf
IX. Real Estate/Family Home and Personal Bankruptcy
Chapter 7 bankruptcy can be very effective for individuals with real estate in which they live that is “underwater” (where the fair market value of the property is less than the value of the mortgages to which the property is subject)
A. When we talk about real estate, we’re talking about houses, townhouses, co-ops and condos. In order to qualify for the homestead exemption, a debtor must reside in the property at the time the bankruptcy is filed.
As I mentioned earlier, last month New York State increased the homestead exemption to $75,000, $125,000 and $150,000 per Debtor (varying exemptions for different regions of the state), so a married couple under New York law can exempt $150,000, $250,000 or $300,000 of equity in a residence. Let’s look at a few examples of how residential real estate issues play out in a Chapter 7 bankruptcy filing.
Real Estate Scenarios:
For example, let’s take a look at a married couple considering filing for bankruptcy and the value of their property and mortgage(s) on their property.
FMV $600,000
Mortgage ($500,000)
Equity $100,000
In this scenario, the couple could file for Chapter 7 bankruptcy, discharge their unsecured debts, and keep their house, provided that they continue to make mortgage payments.
FMV $700,000
Mortgage ($500,000)
Equity $200,000
NYS Homestead Exemption ($150,000)
Non-Exempt Equity $50,000
In this scenario in a Chapter 7 bankruptcy, the Chapter 7 Trustee would sell the house and receive $50,000 for the equity above the homestead exemption (less costs and expenses), and that money would be used to pay the couple’s creditors. The Trustee would pay $150,000 to the Debtors at the end of their case as a result of their homestead exemption. Alternatively, the debtors could repurchase the house from the Trustee by buying the equity from the Trustee (redemption).
FMV $400,000
Mortgage ($500,000)
Negative Equity ($100,000)
In this scenario, the house has a negative equity of $100,000 and is “underwater” and would not be sold by the Chapter 7 Trustee. However, in order to keep the house, the debtor must reaffirm the debt to the mortgagee before the case is discharged and continue to make the payments on the mortgage, notwithstanding the fact that the value of the house is less than the amount of the mortgage.
Reaffirmation is governed by section 524(c) of the Bankruptcy Code, and requires that the debtor file an agreement with the court stating that he or she agrees to be legally bound to repay the otherwise dischargeable debt. The reaffirmation agreement must be filed 60 days after the meeting of creditors. The debtor’s attorney must file an affidavit stating that such an agreement will not be a hardship for the debtor. In the case of a pro se debtor, the bankruptcy judge will interview the debtor to ensure the agreement is voluntary and that it does not present a hardship for the debtor. In any event, the debtor may rescind the agreement up to 60 days after the agreement is filed with the court, or the case is discharged, whichever is later.
Here’s a question for all of you-Under these circumstances why would the couple want to retain the house?
Wouldn’t they be better off economically to file for Chapter 7 bankruptcy and let the bank make a motion for relief from the automatic stay so they can foreclose and obtain title to the house? This a personal decision for the debtors would have to make, which may include non-economic considerations that would lead them to want to keep a house that is $100,000 “underwater.”
Scenario: One spouse files for bankruptcy, the other spouse does not and the house has equity.
In a Chapter 7 bankruptcy, the Trustee may be able to sell the house. However, under New York State law due to “tenancy-by-the-entirety” protection, the house cannot be sold. The creditor can docket a judgment against the property, which is good for 20 years, and the home cannot be sold or refinanced.
Under this scenario, NYS law may provide more protection to the non-filing spouse than bankruptcy law. See §§ 363(h), (i), and (j) of the Bankruptcy Code when dealing with a scenario where one spouse files for bankruptcy, the other spouse does not and the house has equity.
Note that if the home is transferred from one spouse to the other, this a fraudulent conveyance.
Planning opportunity: If the couple divorces, the house may be transferred from one spouse to the other for no consideration, pursuant to New York State equitable distribution law.
In Chapter 7 bankruptcy, the factors to be considered as to whether the Chapter 7 bankruptcy trustee can sell the house are: (i) the equity in the property; (ii) the respective ages of the debtor and the spouse; and (iii) the burden to the non-filing spouse of having to leave the house (i.e. the impact on minor children).
Section 363(h) of the Bankruptcy Code deals with the conditions which must be met for a Trustee to sell a co-owner’s interest in property (whether owned as tenants in common, joint tenants or tenants by the entirety), which include:
1. Partition of the property between the bankruptcy estate and the co-owners is impracticable;
2. Sale of the bankruptcy estate’s undivided interest in the property would realize significantly less for the estate than the sale of the property free of the interests of the co-owners;
3. The benefit to the bankruptcy estate of a sale of the property free of the interests of the co-owners outweighs the detriment, if any, to the co-owners.
In Community Natl. Bank and Trust Co. of New York v. Persky (In re Persky), 893 F.2d 15 (2d. Cir. 1989), the Second Circuit Court of Appeals reviewed a bankruptcy filing in which only one of the co-owners was indebted to the bank and filed for bankruptcy relief. The Court found that:
• The Bankruptcy Court had the power to review the Trustee’s discretion to sell the property.
• The benefit to the bankruptcy estate should be analyzed from the standpoint of the sale of the nondebtor spouse’s entire interest in the property, including their possessory and survivorship interests, in determining whether the property should be sold.
• Noneconomic factors should be considered when analyzing the detriment to the nondebtor spouse of a sale of the property.
Section 363(i) of the Bankruptcy Code provides that in a Chapter 7 bankruptcy, if the property is to be sold, the debtor’s spouse may purchase the estate’s share of the property.
Pursuant to §363(j) of the Bankruptcy Code, the Chapter 7 Trustee must distribute to the debtor’s spouse the proceeds of the sale (less costs and expenses), but not including any compensation of the Trustee, in accordance with the ownership interests of the non-filing spouse and the bankruptcy estate.
Pursuant to § 363(k) of the Bankruptcy Code, the mortgagee may also bid on the house and, if they’re successful, they may offset their secured claim against the purchase price of the house.
Mortgage Arrears and Chapter 7 Bankruptcy
The above scenarios assume that the debtors are current on their mortgage. If the debtors were not current, then the mortgage arrears would need to be cured in order to keep the house during Chapter 7 bankruptcy.
A. How does a debtor deal with mortgage arrears?
i. Negotiate with the lender prior to the bankruptcy filing.
ii. Negotiate with the lender after the bankruptcy filing for payment plan for the arrears. Pursuant to Bankruptcy Code § 524, a debtor must reaffirm within 60 days from the date of the first scheduled meeting of creditors. Once the reaffirmation is executed, unless the agreement is rescinded, the debtor is liable; if they default on the mortgage in the future after reaffirmation, the mortgage debt is not dischargeable.
iii. Loss mitigation in the Southern District of New York (see Section IX below)
iv. Conversion of a Chapter 7 case to a Chapter 13 case, pursuant to Bankruptcy Code § 706.
v. Abandon the house to the mortgagee pursuant to the Chapter 7 filing, if you can’t work out a payment plan with the lender.
X. The Southern District of New York’s Loss-Mitigation Program
A. In response to a growing number of mortgage defaults and foreclosures, the U.S. Bankruptcy Court for the Southern District of New York (NYSB) adopted Loss Mitigation Program Procedures in January 2009, which were revised in December 2010. A full description of the program is at: http://www.nysb.uscourts.gov/pdf/lossmit/RevisedLossMitigationProcedures.pdf
B. “Loss mitigation” includes the full range of solutions that can prevent either the loss of a Debtor’s property to foreclosure, increased costs to the lender, or both. Loss mitigation commonly consists of the following general types of agreements, or a combination of them: loan modification, loan refinance, forbearance, short sale, or surrender of the property in full satisfaction of the mortgage.
C. Use of the NYSB Loss Mitigation Program Procedures requires that: (1) the individual must reside in the Southern District of New York (which includes the counties of New York, Bronx, Westchester, Rockland, Putnam, Orange, Dutchess, and Sullivan) and (2) loss mitigation can only be requested for an individual’s primary residence. Loss Mitigation is available for cases assigned to select judges in the U.S. Bankruptcy Court for the Eastern District of New York (which includes the counties of Kings, Queens, Richmond, Nassau and Suffolk).
D. Parties are encouraged to request loss mitigation as early in the case as possible, but loss mitigation may be initiated at any time.
Conclusion:
• Fortunately, in this environment where many people have lost their jobs, have too much debt or own real estate that has depreciated in value have options-generally an “out of court” workout or a bankruptcy filing.
• Pre-bankruptcy planning is often times necessary and clients should consult with their CPA and an experienced bankruptcy attorney as soon as possible.
Jim Shenwick
Visit the Shenwick & Associates website: jshenwick.googlepages.com, which has detailed information regarding personal bankruptcy.
Please call or e-mail Jim Shenwick with any questions at (212) 541-6224 or jshenwick@gmail.com
Personal Bankruptcy: The Basics and Discharging Taxes in Bankruptcy
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
• 9.1% unemployment rate
• The effective unemployment rate is 17-18%
• The unemployment rate for recent college graduates is 20-21%
• $796.5 billion of revolving (credit card) debt as of November 2010
• The foreclosure rate is 11%
• 20-30% of homes are “underwater.”
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.
• A workout may be a less “negative factor” on your credit report than filing for bankruptcy (“FICO Score”)
• 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.
• Of all of the solutions to too much debt, Chapter 7 bankruptcy will have the most negative impact on credit reports and will lower FICO score.
• 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.
• 1.6 million Americans filed for bankruptcy in 2010.
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 § 341 meeting with attorney and Bankruptcy Trustee
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.
• 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 5 year plan (rather than a 3 year plan).
• If a debtor has too much debt under § 109(g) of the Bankruptcy Code (noncontingent, liquidated, unsecured debts of more than $360,475 and noncontingent, liquidated, secured debts of more than $1,081,400), 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 § 341 meeting with attorney and Chapter 13 Bankruptcy Trustee and attends hearing on Plan confirmation.
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.
• The filing fee for Chapter 11 is $1,039 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 November 1, 2010)
1 $45,548
2 $56,845
3 $67,292
4 $82,587
• Add $7,500 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. Dischargeability of Taxes in Bankruptcy
A. Certain “old income taxes” may be dischargeable if:
i. The tax return was filed more than two years prior to the bankruptcy filing (note that a return prepared and filed by the IRS is not deemed to be a filed return);
ii. The taxes are more than three years old;
iii. The taxes were assessed more than 240 days before the filing of the petition;
iv. There was no attempt to avoid or evade the taxes.
• Various events can toll or delay the calculation of these time periods, including a bankruptcy filing, a pending offer in compromise, failure to file a return, filing an amended return and requesting an extension of time to file a return.
If all of these conditions are met, the taxes are dischargeable in bankruptcy. Tax account transcripts from the Internal Revenue Service and the New York State Department of Taxation and Finance are needed in order to determine if the taxes are dischargeable.
B. Bankruptcy Litigation/Adversary Proceeding- The Debtor or the taxing authority can file an adversary proceeding (bankruptcy litigation) to determine if the tax debts are dischargeable. The Debtor can also enter into a payment plan with the taxing authority.
C. “No Attempt to Avoid or Evade the Taxes” Standard-the IRS has heightened its scrutiny of the discharge of income taxes in bankruptcy, and their position (based on case law) is that if you spend too much money on luxury items, and/or pay other creditors ahead of the IRS, and/or make yourself judgment proof, then according to the IRS, those tax debts would not be dischargeable, and the IRS will commence an adversary proceeding (litigation in a bankruptcy case) to object to the discharge of these taxes. See Wright v. Internal Revenue Service, 191 B.R. 291 (S.D.N.Y. 1995); Haesloop v. U.S. (In re Haesloop), 2000 Bankr. LEXIS 1104, 2000 WL 1607316 (Bankr. E.D.N.Y. Aug. 30, 2000); Lynch v. United States, 299 B.R. 62 (Bankr. S.D.N.Y. 2003); Epstein v. United States, 303 B.R. 280 (Bankr. E.D.N.Y. 2004)
D. What taxes are not dischargeable?
• Recent taxes (2009 and 2010 tax years)
• Payroll, sales and other trust fund taxes (employee portion of FICA and FUTA, not the employer portion)
• Property taxes assessed within one year of filing
E. BAPCPA (2005) requirements for Personal Bankruptcy
i. Under BAPCPA, in addition to the list of creditors, schedules of assets, liabilities, income and expenses debtors must now provide:
a. A certificate of credit counseling;
b. Payment advices from employers received 60 days before filing (if any);
c. A statement of monthly net income and any anticipated increase in income or expenses after filing;
d. Tax returns or transcripts filed in the most recent tax year;
f. Photo ID; and
g. Social Security card
ii. Failure to provide the documents within 45 days after the petition has been filed (with a possibility of a 45-day extension) results in automatic dismissal of the case.
iii. Also new under BAPCPA, a debtor must have received pre-petition credit briefing (in person, by phone or internet) from an approved non-profit entity that outlined opportunities for credit counseling and assisted the Debtor in performing a personal budget analysis in the 180 days before filing a petition. Greenpath (http://www.greenpath.com), one of the approved credit counseling agencies, charges approximately $45. There are many other course providers besides greenpath, some with lower costs.
vi. Additionally, within 60 days after the first Meeting of Creditors, the debtor must also take a post-petition financial management course and file a certificate of completion with the Bankruptcy Court. The cost of this course from Greenpath is also approximately $45.
iv. The Bankruptcy Court may grant a waiver based on the Debtor’s sworn statement that they were unable to obtain the counseling services within five days of making the request and had to file immediately, but the waiver expires 30 days after the petition is filed.
v. The briefing is not required if the Bankruptcy Court determines that the Debtor is mentally incapacitated, physically disabled, or is an active member of the military in a combat zone.
F. What are the negatives of filing for Chapter 7 bankruptcy?
i. The filing stays on a person’s credit report for seven to ten years
ii. A debtor may only file for Chapter 7 bankruptcy every eight years (however, if a debtor files for Chapter 7, receives a discharge, and then gets into further financial trouble, they can file under Chapter 11 or 13 of the Bankruptcy Code).
VII. Chapter 13
A. What are the pros and cons?
i. Cons
a. The debtor is placed on an austerity budget and must pay their disposable income to the Chapter 13 Trustee on a monthly basis.
b. If the debtor is over the “median income,” then they must prepare a five year, 60 month plan. The shortest plans are generally three years.
c. The filing fee is $279 (which is $20 less then the filing fee for a Chapter 7 filing).
d. However, legal fees are greater than those for a Chapter 7 filing, since there are fees for preparing the plan, the hearing on plan confirmation, and the plan must be served on creditors and must be confirmable.
e. In the Southern District of New York, historically only 30% of Chapter 13 plans pay out over time.
f. Pursuant to §1322 of the Bankruptcy Code, first mortgages cannot be modified in Chapter 13. However, second mortgages can be modified and mortgages on investment properties and vacation homes can be modified.
g. The Chapter 13 Trustee receives a commission of 10% of the monies paid into a Chapter 13 plan.
h. With the increased New York State homestead exemption of $150,000 (for debtors residing in the New York metropolitan area), Chapter 7 can accomplish much of what can be accomplished with a Chapter 13 filing at a lesser cost to the Debtor.
ii. Pros
a. Chapter 13 allows the debtor to retain property that he or she would otherwise lose in a Chapter 7 liquidation (e.g. a car or a house with substantial equity)
b. A Chapter 13 debtor remains under bankruptcy court protection for the duration of the repayment plan (3-5 years)
c. Tax refunds are property of the bankruptcy estate and those monies must be transferred by the Debtor to the Chapter 13 Trustee
VIII. New York State Bankruptcy Exemptions
A. The most sweeping change in decades on what real and personal property is exempt from a debtor’s bankruptcy estate (the debtor’s property that can be distributed to creditors) in New York State took place last month. New York State Senate bill S.7034A and Assembly bill A. 8735A were signed into law by Governor Paterson on December 23, 2010. The new law became effective on January 22, 2011.
B. The scope of the bill is very broad, but a few of the major changes are:
i. The homestead exemption has increased 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; and $75,000 for the remaining counties in the state.
ii. The motor vehicle exemption has increased from $2,400 to $4,000. If the vehicle is equipped for a disabled person, the exemption is $10,000.
iii. The aggregate (combined) individual bankruptcy exemption for certain annuities and personal property under New York Debtor and Creditor Law § 5205(a) has increased from $5,000 to $10,000.
iv. The exemption for tools of trade (including professional instruments and library) has increased from $600 to $3,000.
v. The New York Banking Department will publish cost of living adjustments to exemption amounts every three years commencing April 1, 2012.
vi. Debtors are now 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-$1,150 plus up to $10,825 of any unused amount of the homestead exemption.
C. A debtor may also exempt:
i. An unlimited amount of rental or utility security deposits.
ii. 120 days of food.
iii. $7,500 of monies recovered for a personal injury.
iv. A qualified IRA up to $1,000,000.
A married couple filing jointly for bankruptcy can double the amount of the monetary exemptions listed above.
The full text of the new law can be found at:
http://www.nyeb.uscourts.gov/announcements/ExemptionsSummaryLaw.pdf
IX. Real Estate/Family Home and Personal Bankruptcy
Chapter 7 bankruptcy can be very effective for individuals with real estate in which they live that is “underwater” (where the fair market value of the property is less than the value of the mortgages to which the property is subject)
A. When we talk about real estate, we’re talking about houses, townhouses, co-ops and condos. In order to qualify for the homestead exemption, a debtor must reside in the property at the time the bankruptcy is filed.
As I mentioned earlier, last month New York State increased the homestead exemption to $75,000, $125,000 and $150,000 per Debtor (varying exemptions for different regions of the state), so a married couple under New York law can exempt $150,000, $250,000 or $300,000 of equity in a residence. Let’s look at a few examples of how residential real estate issues play out in a Chapter 7 bankruptcy filing.
Real Estate Scenarios:
For example, let’s take a look at a married couple considering filing for bankruptcy and the value of their property and mortgage(s) on their property.
FMV $600,000
Mortgage ($500,000)
Equity $100,000
In this scenario, the couple could file for Chapter 7 bankruptcy, discharge their unsecured debts, and keep their house, provided that they continue to make mortgage payments.
FMV $700,000
Mortgage ($500,000)
Equity $200,000
NYS Homestead Exemption ($150,000)
Non-Exempt Equity $50,000
In this scenario in a Chapter 7 bankruptcy, the Chapter 7 Trustee would sell the house and receive $50,000 for the equity above the homestead exemption (less costs and expenses), and that money would be used to pay the couple’s creditors. The Trustee would pay $150,000 to the Debtors at the end of their case as a result of their homestead exemption. Alternatively, the debtors could repurchase the house from the Trustee by buying the equity from the Trustee (redemption).
FMV $400,000
Mortgage ($500,000)
Negative Equity ($100,000)
In this scenario, the house has a negative equity of $100,000 and is “underwater” and would not be sold by the Chapter 7 Trustee. However, in order to keep the house, the debtor must reaffirm the debt to the mortgagee before the case is discharged and continue to make the payments on the mortgage, notwithstanding the fact that the value of the house is less than the amount of the mortgage.
Reaffirmation is governed by section 524(c) of the Bankruptcy Code, and requires that the debtor file an agreement with the court stating that he or she agrees to be legally bound to repay the otherwise dischargeable debt. The reaffirmation agreement must be filed 60 days after the meeting of creditors. The debtor’s attorney must file an affidavit stating that such an agreement will not be a hardship for the debtor. In the case of a pro se debtor, the bankruptcy judge will interview the debtor to ensure the agreement is voluntary and that it does not present a hardship for the debtor. In any event, the debtor may rescind the agreement up to 60 days after the agreement is filed with the court, or the case is discharged, whichever is later.
Here’s a question for all of you-Under these circumstances why would the couple want to retain the house?
Wouldn’t they be better off economically to file for Chapter 7 bankruptcy and let the bank make a motion for relief from the automatic stay so they can foreclose and obtain title to the house? This a personal decision for the debtors would have to make, which may include non-economic considerations that would lead them to want to keep a house that is $100,000 “underwater.”
Scenario: One spouse files for bankruptcy, the other spouse does not and the house has equity.
In a Chapter 7 bankruptcy, the Trustee may be able to sell the house. However, under New York State law due to “tenancy-by-the-entirety” protection, the house cannot be sold. The creditor can docket a judgment against the property, which is good for 20 years, and the home cannot be sold or refinanced.
Under this scenario, NYS law may provide more protection to the non-filing spouse than bankruptcy law. See §§ 363(h), (i), and (j) of the Bankruptcy Code when dealing with a scenario where one spouse files for bankruptcy, the other spouse does not and the house has equity.
Note that if the home is transferred from one spouse to the other, this a fraudulent conveyance.
Planning opportunity: If the couple divorces, the house may be transferred from one spouse to the other for no consideration, pursuant to New York State equitable distribution law.
In Chapter 7 bankruptcy, the factors to be considered as to whether the Chapter 7 bankruptcy trustee can sell the house are: (i) the equity in the property; (ii) the respective ages of the debtor and the spouse; and (iii) the burden to the non-filing spouse of having to leave the house (i.e. the impact on minor children).
Section 363(h) of the Bankruptcy Code deals with the conditions which must be met for a Trustee to sell a co-owner’s interest in property (whether owned as tenants in common, joint tenants or tenants by the entirety), which include:
1. Partition of the property between the bankruptcy estate and the co-owners is impracticable;
2. Sale of the bankruptcy estate’s undivided interest in the property would realize significantly less for the estate than the sale of the property free of the interests of the co-owners;
3. The benefit to the bankruptcy estate of a sale of the property free of the interests of the co-owners outweighs the detriment, if any, to the co-owners.
In Community Natl. Bank and Trust Co. of New York v. Persky (In re Persky), 893 F.2d 15 (2d. Cir. 1989), the Second Circuit Court of Appeals reviewed a bankruptcy filing in which only one of the co-owners was indebted to the bank and filed for bankruptcy relief. The Court found that:
• The Bankruptcy Court had the power to review the Trustee’s discretion to sell the property.
• The benefit to the bankruptcy estate should be analyzed from the standpoint of the sale of the nondebtor spouse’s entire interest in the property, including their possessory and survivorship interests, in determining whether the property should be sold.
• Noneconomic factors should be considered when analyzing the detriment to the nondebtor spouse of a sale of the property.
Section 363(i) of the Bankruptcy Code provides that in a Chapter 7 bankruptcy, if the property is to be sold, the debtor’s spouse may purchase the estate’s share of the property.
Pursuant to §363(j) of the Bankruptcy Code, the Chapter 7 Trustee must distribute to the debtor’s spouse the proceeds of the sale (less costs and expenses), but not including any compensation of the Trustee, in accordance with the ownership interests of the non-filing spouse and the bankruptcy estate.
Pursuant to § 363(k) of the Bankruptcy Code, the mortgagee may also bid on the house and, if they’re successful, they may offset their secured claim against the purchase price of the house.
Mortgage Arrears and Chapter 7 Bankruptcy
The above scenarios assume that the debtors are current on their mortgage. If the debtors were not current, then the mortgage arrears would need to be cured in order to keep the house during Chapter 7 bankruptcy.
A. How does a debtor deal with mortgage arrears?
i. Negotiate with the lender prior to the bankruptcy filing.
ii. Negotiate with the lender after the bankruptcy filing for payment plan for the arrears. Pursuant to Bankruptcy Code § 524, a debtor must reaffirm within 60 days from the date of the first scheduled meeting of creditors. Once the reaffirmation is executed, unless the agreement is rescinded, the debtor is liable; if they default on the mortgage in the future after reaffirmation, the mortgage debt is not dischargeable.
iii. Loss mitigation in the Southern District of New York (see Section IX below)
iv. Conversion of a Chapter 7 case to a Chapter 13 case, pursuant to Bankruptcy Code § 706.
v. Abandon the house to the mortgagee pursuant to the Chapter 7 filing, if you can’t work out a payment plan with the lender.
X. The Southern District of New York’s Loss-Mitigation Program
A. In response to a growing number of mortgage defaults and foreclosures, the U.S. Bankruptcy Court for the Southern District of New York (NYSB) adopted Loss Mitigation Program Procedures in January 2009, which were revised in December 2010. A full description of the program is at: http://www.nysb.uscourts.gov/pdf/lossmit/RevisedLossMitigationProcedures.pdf
B. “Loss mitigation” includes the full range of solutions that can prevent either the loss of a Debtor’s property to foreclosure, increased costs to the lender, or both. Loss mitigation commonly consists of the following general types of agreements, or a combination of them: loan modification, loan refinance, forbearance, short sale, or surrender of the property in full satisfaction of the mortgage.
C. Use of the NYSB Loss Mitigation Program Procedures requires that: (1) the individual must reside in the Southern District of New York (which includes the counties of New York, Bronx, Westchester, Rockland, Putnam, Orange, Dutchess, and Sullivan) and (2) loss mitigation can only be requested for an individual’s primary residence. Loss Mitigation is available for cases assigned to select judges in the U.S. Bankruptcy Court for the Eastern District of New York (which includes the counties of Kings, Queens, Richmond, Nassau and Suffolk).
D. Parties are encouraged to request loss mitigation as early in the case as possible, but loss mitigation may be initiated at any time.
Conclusion:
• Fortunately, in this environment where many people have lost their jobs, have too much debt or own real estate that has depreciated in value have options-generally an “out of court” workout or a bankruptcy filing.
• Pre-bankruptcy planning is often times necessary and clients should consult with their CPA and an experienced bankruptcy attorney as soon as possible.
Jim Shenwick
Visit the Shenwick & Associates website: jshenwick.googlepages.com, which has detailed information regarding personal bankruptcy.
Please call or e-mail Jim Shenwick with any questions at (212) 541-6224 or jshenwick@gmail.com
Thursday, February 03, 2011
Jim Shenwick to speak on "Personal Bankruptcy: The Basics and Discharging Taxes in Bankruptcy" on 2/7
Jim Shenwick will be speaking on "Personal Bankruptcy: The Basics and Discharging Taxes in Bankruptcy" to the New York State Society of CPA's Small Firms Practice Committee on Monday, February 7th. The meeting is from 8:45 - 10:00 am at 3 Park Ave., 18th Floor(the receptionist will have the room assignment). For further information or registration, please call (212) 719-8300.
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