Business Debt Exception to the Means Test

The means test only applies to individuals whose debts are primarily “consumer debts,” as opposed to business debts, pursuant to § 707 ofthe Bankruptcy Code.  Congress did not define the word “primarily,” but most courts have defined the word to mean more than half.  If more than 50% of the debtor’s debts are non-consumer debts or business debts, the debtor is automatically eligible to file for Chapter 7 bankruptcy without doing the means test, and the presumption of abuse does not apply,

What are consumer debts?  Section 101(8) of the Bankruptcy Code defines a consumer debt as “debt incurred by an individual primarily for a personal, family, or household purpose.”  Many bankruptcy courts have developed a “profit motive” test.  If the debt was incurred with an eye towards making a profit, then the debt should be classified as business debt.  Accordingly, a mortgage on an individual’s home would be considered consumer debt; however, if a vacation home were purchased for investment purposes and rented out, then the mortgage would qualify as business debt.  If an individual uses credit cards for consumer purchases, then those debts are consumer debts; however, if an individual used the credit card for business purposes, then in all likelihood that debt would be deemed business debt.  If an individual guaranteed a debt for a business obligation, that personal guaranty would be deemed business debt, as would the investment losses.

With respect to tax debts, a number of bankruptcy courts outside the Second Circuit have held that those debts are business debts.  See In re Brashers, 216 B.R. 59 (Bankr. N.D. Okla. 1998), which holds that the debtor’s income tax obligations do not constitute consumer debt, also see In re Westberry, 215 F.3d 589 (6^th Cir. 2000), which also holds that taxes are not consumer debt.  Taxes are not consumer debts, according to the Westberry Court for the following reasons:

I. Tax debt is incurred differently than consumer debt.  Consumer debt is incurred voluntarily and taxes are involuntary.

II. Consumer debt is incurred for personal or household purposes, while taxes are incurred for a public purpose.

III. Taxes arise from the earning of money, while consumer debts arise from consumption.

IV. Consumer debt normally involves the extension of credit from a credit card or from the seller of goods.

Notwithstanding the fact that business debt is an exception to the means test, if an individual files for Chapter 7 bankruptcy, their business debt exceeds their consumer debt and they do not have to take the means test, a creditor, the Office of the U.S. Trustee, or the Bankruptcy Trustee may move to dismiss the case if they find that the debtor was living an extravagant lifestyle (based on the details of their Schedule J expenses), and that if they reduced those expenses they could pay creditors a significant dividend via a Chapter 11 plan.  See In re Rahim and Abdulhussain, 442 B.R. 578 (Bankr. E.D. Mich. 2010).   

Notwithstanding the fact that this is a Michigan case, this author believes that this logic would also be applicable to cases in the Second Circuit and the Southern and Eastern Districts of New York.  In In re Rahim and Abdulhussain, the court held that under § 707(a) of the Bankruptcy Code, there is cause to dismiss a case for abuse of discretion, as well as under § 707(b) of the Code.  Relying on case law, the court held that Congress only intended to deny Chapter 7 relief to dishonest or non-needy debtors.  Relying on In re Krohn, the court held that among the factors to be considered is whether the debtor is needy is the debtor’s ability to repay debts out of future earnings.  The Sixth Circuit held that debtor’s continuing lavish lifestyle would support a finding of bad faith sufficient to warrant dismissal of a bankruptcy case under § 707(a), notwithstanding the fact that the individual’s debts were primarily business debts.  In In Re Rahim and Abdulhussain, the debtor’s monthly expenses exceeded $42,000, which the court described as extravagant and lavish.  The court indicated that the record indicated that the debtors had made no effort to reduce their expenses-they leased or owned expensive cars, owned property in Florida and sent their children to private schools.  Accordingly, the court dismissed the bankruptcy case.

NYT: Debt Collectors Cashing in on Student Loans

By ANDREW MARTIN

At a protest last year at New York University, students called attention to their mounting debt by wearing T-shirts with the amount they owed scribbled across the front — $90,000, $75,000, $20,000.

On the sidelines was a business consultant for the debt collection industry with a different take.

“I couldn’t believe the accumulated wealth they represent — for our industry,” the consultant, Jerry Ashton, wrote in a column for a trade publication, InsideARM.com. “It was lip-smacking.”

Though Mr. Ashton says his column was meant to be ironic, it nonetheless highlighted undeniable truths: many borrowers are struggling to pay off their student loans, and the debt collection industry is cashing in.

As the number of people taking out government-backed student loans has exploded, so has the number who have fallen at least 12 months behind in making payments — about 5.9 million people nationwide, up about a third in the last five years.

In all, nearly one in every six borrowers with a loan balance is in default. The amount of defaulted loans — $76 billion — is greater than the yearly tuition bill for all students at public two- and four-year colleges and universities, according to a survey of state education officials.

In an attempt to recover money on the defaulted loans, the Education Department paid more than $1.4 billion last fiscal year to collection agencies and other groups to hunt down defaulters.

Hiding from the government is not easy.

“I keep changing my phone number,” said Amanda Cordeiro, 29, from Clermont, Fla., who dropped out of college in 2010 and has fielded as many as seven calls a day from debt collectors trying to recover her $55,000 in overdue loans. “In a year, this is probably my fourth phone number.”

Unlike private lenders, the federal government has extraordinary tools for collection that it has extended to the collection firms. Ms. Cordeiro has already had two tax refunds seized, and other debtors have had their paychecks or Social Security payments garnisheed. Over all, the government recoups about 80 cents for every dollar that goes into default — an astounding rate, considering most lenders are lucky to recover 20 cents on the dollar on defaulted credit cards.

While the recovery rate is impressive, critics say it has left the government with little incentive to try to prevent defaults in the first place.

Though there are programs in place to help struggling borrowers, the companies hired to administer federal student loans are not paid enough for lengthy conversations to walk borrowers through the payment options, critics say. One consequence is that a government program called income-based repayment has fallen short of expectations. Under the program, borrowers pay 15 percent of their discretionary income for up to 25 years, after which the rest of their loan is forgiven. But participation has lagged because borrowers are either not aware of the program or are turned off by its complexity.

“If people were well informed, how many defaults could be averted?” asked Paul C. Combe, president of American Student Assistance, a loan guarantee agency based in Boston. “We are hurting people here.”

For borrowers, the decision to default can be disastrous, ruining their credit and increasing the amount they owe, with penalties up to 25 percent of the balance.

Ms. Cordeiro, a single mother, dropped out of Everest College, a profit-making school, 16 credits shy of a bachelor’s degree. She said she could not get any more loans to finish. “I get these letters about defaulting, and I get them and throw them in the bin,” she said.

Jake Brock, who graduated in 2008 from Keuka College, a private liberal arts school in upstate New York, defaulted in May on a federally guaranteed loan of $8,000. With penalties and accumulated interest, the loan balance is now $13,000, he said. “I just fell behind and couldn’t dig myself out,” said Mr. Brock, who is 29 and owes a total of $100,000 in student loans.

There is no statute of limitations on collecting federally guaranteed student loans, unlike credit cards and mortgages, and Congress has made it difficult for borrowers to wipe out the debt through bankruptcy. Only a small fraction of defaulters even tries.

“You are going to pay it, or you are going to die with it,” said John Ulzheimer, president of consumer education at SmartCredit.com, a credit monitoring service.

 

The New Oil Well?

Business is booming at ConServe, a debt collection agency in suburban Rochester. The company recently expanded into a neighboring building. The payroll of 420 is expected to double in three years.

“There is great opportunity,” said Mark E. Davitt, the company’s president and founder.

Where some debt collection firms have made their fortunes collecting on delinquent credit cards or hospital bills, ConServe is thriving because of overdue student loans, a large majority of its business.

With an outstanding balance of more than $1 trillion, student loans have become a silver lining for the debt collection industry at a time when its once-thriving business of credit card collection has diminished and the unemployment rate has made collection a challenge. To recoup unpaid loans, the federal government, private lenders and others have turned to collection agencies like ConServe.

Mark Russell, a mergers and acquisition specialist, writing in the same trade publication as Mr. Ashton, the consultant at the N.Y.U. protest, suggested student loans might be a “new oil well” for the accounts receivable management industry, or ARM, as the industry is known.

“While the Department of Education debt collection contract has been one of the most highly sought-after contracts within the ARM industry for years, I believe it is now THE most sought-after contract within this industry, centered within the most sought-after market — student loans,” Mr. Russell wrote last October.

In 2010, Congress revamped the student loan program so that federal loans were made directly by the government. Before that, most loans were made by private lenders and guaranteed by the government through so-called guarantee agencies.

Of the $1.4 billion paid out last year by the federal government to collect on defaulted student loans, about $355 million went to 23 private debt collectors. The remaining $1.06 billion was paid to the guarantee agencies to collect on defaulted loans made under the old loan system. That job is often outsourced to private collectors as well.

The average default amount was $17,005 in the 2011 fiscal year. Borrowers who attended profit-making colleges — about 11 percent of all students — account for nearly half of defaults, while dropouts were four times as likely as graduates to default. A loan is declared in default by the Department of Education when it is delinquent for 360 days.

Borrowers are most often declared in default when they cannot be found. That is when the collection agencies take over. While some in the industry, like Mr. Ashton, worry about public revolt over aggressive collection tactics, there is no holding back at this point.

At ConServe, in a room of cubicles with college pennants lining the walls, collectors comb through databases and public records hunting for contact information for borrowers. If ConServe reaches a borrower who refuses to cooperate, the company considers garnisheeing wages or withholding a government check, which requires approval from the Department of Education.

Dwight Vigna, director of the department’s default division, says the government does not give up easily. If a vendor like ConServe has not found a borrower in six months, the department turns the case over to another collection agency.

In fiscal 2011, the department wrote off less than 1 percent of its loan balance, for such things as death or disability of a borrower.

“We never throw anything away,” Mr. Vigna said.

 

Lying in Wait

Arthur Chaskin, a disabled carpenter, can attest to the government’s long memory.

Since he left college in the late 1970s, Mr. Chaskin has largely ignored his student loans — until June, when a federal judge ordered him to turn over $8,200.

Mr. Chaskin had borrowed $3,500 in federally guaranteed student loans to attend Northwestern Michigan College, a community college. He did not graduate. The federal government sued him in 1997, but over the next 15 years he made only five payments.

Last January, a lawyer in Michigan working on contract for the government was alerted to a credit check for Mr. Chaskin. The lawyer filed a garnishment order and discovered a brokerage account with nearly $20,000 that Mr. Chaskin said he had opened with disability checks.

By the time the government caught up with him, Mr. Chaskin owed more than $19,000 in accumulated interest and penalties, but the judge reduced the amount to $8,200 after Mr. Chaskin pleaded for a break.

“If you wait long enough, you catch people when their guard’s down,” said the lawyer, Charles J. Holzman, who was rewarded with more than 25 percent of Mr. Chaskin’s payment.

Government officials estimate they will collect 76 to 82 cents on every dollar of loans made in fiscal 2013 that end up in default. That does not include collection costs that are billed to the borrowers and paid to the collection agencies.

While the government’s estimates take into account the uncertainty of collecting money over long periods, some critics say they don’t go far enough.

A 2007 academic study, for instance, estimated that the recovery rate was closer to 50 cents on the dollar.

“The reporting standards that the government imposes on themselves are far weaker than what they require of private institutions,” said Deborah J. Lucas, a finance professor at the Massachusetts Institute of Technology and an author of the study.

Over all, collections on federally backed student loans were $12 billion in the last fiscal year, 18 percent higher than the previous year. Of that, $1.65 billion came from seizures of government checks like tax returns and $1.01 billion was collected by garnisheeing borrowers’ wages. More than $8 billion of defaulted loans, however, were consolidated or rehabilitated.

Some borrowers say they do not see a path out of default, because they are sick, unemployed or facing so much debt they cannot imagine any way to pay it off. Some have defaulted on private student loans, too.

Patrick Writer of Redding, Calif., received a certificate in computer programming in 2008 from Shasta College, a community college. But he graduated in the midst of the financial crisis and has not been able to find a job as a programmer. He defaulted on $12,000 in federally backed loans in 2009.

“If you can’t make your utilities and your rent, your student loan payments are almost goofy, inconsequential,” said Mr. Writer, who is 57.

But Mr. Writer said he had come to realize what it meant to have a student loan that was guaranteed by the federal government. “It’s the closest thing to debtor prison that there is on this earth,” he said.

 

A Bias Toward Default

Jill Shockley, 36, of Rockford, Ill., owes more than $50,000 in federally guaranteed and private student loans, some of which are in default. A nursing school dropout, she said her loan servicer, Sallie Mae, asked her to come up with $600 a month to keep three of her federal loans from going into default. But she said she did not have enough money.

“I barely clear $30,000 a year,” she said. “I have rent, a car payment, insurance. They say maybe I should borrow from relatives.”

On paper, there are few good reasons struggling borrowers should go into default, or stay there, since there are many programs to help them keep up with payments. In addition to income-based repayment, there is forbearance for temporary financial woes and different types of deferment for issues like unemployment, military service and economic hardship. But the challenge of creating the right incentives — and getting collectors and debtors to embrace them — has bedeviled Congress and the Department of Education.

Critics say the result has often been contradictory incentives that provide little help to struggling borrowers. For instance, loan servicers are paid $2.11 a month for each borrower in good standing, but only 50 cents a month for borrowers who are seriously delinquent, too little to devote much time to them.

Guarantee agencies are paid a default aversion fee, equal to 1 percent of the loan balance, if they prevent a borrower from going into default. But the same agencies get paid much higher fees for collecting or rehabilitating a defaulted loan.

And debt collectors are rewarded primarily for collecting as much as possible, not for making sure a borrower can afford the payments, critics say.

Introduced in 2009, income-based repayment was supposed to help change that by allowing borrowers with high levels of debt but modest incomes to make relatively small payments over a long term. But many borrowers were never told about the income-based option, and many others have been frustrated by the onerous requirements. So far, 1.6 million borrowers have applied for income-based repayment; 920,000 are active participants and another 412,000 applications are pending.

In a June memo, President Obama wrote that “too few borrowers are aware of the options available to them to help manage their student loan debt.”

Education officials say there are changes in the works that could help struggling borrowers and perhaps reduce the default rate, which they attribute to the sluggish economy and dismal results among profit-making colleges.

Under proposed regulations, debt collectors would be required to offer borrowers an affordable payment plan. And, the department vows to do a better job of publicizing income-based repayment, including telling borrowers about the plan before they leave college.

In addition, borrowers will be able to apply for income-based repayment online rather than going through their loan servicer. Monthly payments will be reduced to 10 percent of discretionary income, down from 15 percent.

But efforts to change the incentive structure for guarantee agencies have stalled. And the Obama administration’s efforts to impose new regulations on profit-making colleges were initially watered down and then significantly weakened by a federal court judge.

“We’re trying to balance two priorities, working with students who have fallen on hard times while trying to be good stewards of the taxpayers’ dollar,” said Justin Hamilton, a Department of Education spokesman. “We’re always going to be in a process of continuous improvement.”

Lindsay Franke, of Naugatuck, Conn., is among the borrowers taking advantage of income-based repayment. While her monthly payment is now lower, Ms. Franke, who is 28 and has a master’s degree in business administration from Albertus Magnus College, said the program had not changed a crushing reality: she still owes too much money and makes too little to pay it off. A marketing coordinator for a law firm, she filed for bankruptcy last year because she could not afford her mortgage, car payment and student loans. She lost the house, but still owes $115,000 in student loans, both private and federal. Under income-based repayment, she pays $325 a month on her federal loans; she also pays $250 a month on her private loans. 

“I will never have my head above water,” Ms. Franke said. 

Copyright 2012 The New York Times Company.  All rights reserved.

NYT: Last Plea on School Loans: Proving a Hopeless Future

By RON LIEBER

PLAIN CITY, Ohio — It isn’t easy to stand up in an open courtroom and bear witness to the abject wretchedness of your financial situation, but by the time Doug Wallace Jr. was 31 years old, he had little to lose by trying.

Diabetes had rendered him legally blind and unemployed just a few years after graduating from Eastern Kentucky University. He filed for bankruptcy protection and quickly got rid of thousands of dollars of medical and other debt.

But his $89,000 in student loans were another story. Federal bankruptcy law requires those who wish to erase that debt to prove that repaying it will cause an “undue hardship.” And one component of that test is often convincing a federal judge that there is a “certainty of hopelessness” to their financial lives for much of the repayment period.

“It’s like you’re not worth much in society,” Mr. Wallace said.

Nevertheless, Mr. Wallace made his case. And on Wednesday, nearly six years after he first filed for bankruptcy, he may finally get a signal as to whether his situation is sufficiently bleak to merit the cancellation of his loans.

The gantlet he has run so far is so forbidding that a large majority of bankrupt people do not attempt it. Yet for a small number of debtors like Mr. Wallace who persist, some academic research shows there may be a reasonable shot at shedding at least part of their debt. So they try.

Before the mid-1970s, debtors were able to get rid of student loans in bankruptcy court just as they could credit card debt or auto loans. But after scattered reports of new doctors and lawyers filing for bankruptcy and wiping away their student debt, resentful members of Congress changed the law in 1976.

In an effort to protect the taxpayer money that is on the line every time a student or parent signs for a new federal loan, Congress toughened the law again in 1990 and again in 1998. In 2005, for-profit companies that lend money to students persuaded Congress to extend the same rules to their private loans.

But with each change, lawmakers never defined what debtors had to do to prove that their financial hardship was “undue.” Instead, federal bankruptcy judges have spent years struggling to do it themselves.

Most have settled on something called the Brunner test, named after a case that laid out a three-pronged standard for judges to use when determining whether they should discharge someone’s student loan debt. It calls on judges to examine whether debtors have made a good-faith effort to repay their debt by trying to find a job, earning as much as they can and minimizing expenses. Then comes an examination of a debtor’s budget, with an allowance for a “minimal” standard of living that generally does not allow for much beyond basics like food, shelter and health insurance, and some inexpensive recreation.

The third prong, which looks at a debtor’s future prospects during the loan repayment period, has proved to be especially squirm-inducing for bankruptcy judges because it puts them in the prediction business. This has only been complicated by the fact that many federal judicial circuits have established the “certainty of hopelessness” test that Mr. Wallace must pass in Ohio.

Lawyers sometimes joke about the impossibility of getting over this high bar, even as they stand in front of judges. “What I say to the judge is that as long as we’ve got a lottery, there is no certainty of hopelessness,” said William Brewer Jr., a bankruptcy attorney in Raleigh, N.C. “They smile, and then they rule against you.”

Debtors themselves struggle with testifying in their undue hardship cases. Carol Kenner, who spent 18 years working as a federal bankruptcy judge in Massachusetts before becoming a lawyer for the National Consumer Law Center, said that one particular case stuck in her mind.

The debtor had a history of hospitalization for mental illness but testified that she did not suffer from depression at all. “She was so mortified about the desperation of her situation that she was committing perjury on the stand,” Ms. Kenner said. “It just blew me away. That’s the craziness that this system brings us to.”

Debtors also stretch the truth in other directions. In 2008, a federal bankruptcy judge in the Northern District of Georgia expressed barely disguised disgust in deciding a case involving a 32-year-old, Mercedes-driving federal public defender with degrees from Yale and Georgetown. With nearly $114,000 in total household income, the woman’s financial situation was far from hopeless, despite her $172,000 in student loan debt.

No one keeps track of how many people bring undue hardship cases each year, but it appears to be under 1,000, far less than the number of people failing to make their student loan payments. In its most recent snapshot of student loan defaults, the Department of Education reported that among the more than 3.6 million borrowers who entered repayment from Oct. 1, 2008, to Sept. 30, 2009, more than 320,000 had fallen behind in their payments by 360 days or more by the end of September 2010. About 10.3 million students and their parents borrowed money under the federal student loan program during the 2010-11 school year.

One reason so few people try to discharge their debt may be that such cases require an entirely separate legal process from the normal bankruptcy proceeding. In addition, those who may qualify generally lack the money to hire a lawyer or the pluck to file a suit without one.

Nor is the process quick, since the lender or the federal government often appeals when it loses. And even if clients can pay for legal assistance, some lawyers want nothing to do with undue hardship cases. That’s the approach Steven Stanton, a bankruptcy lawyer in Granite City, Ill., settled on after trying to help David Whitener, a visually impaired man who was receiving Social Security disability checks. The judge was not ready to declare him hopeless and gave him a two-year “window of opportunity” to recover from his financial situation, saying he believed that Mr. Whitener had the potential to obtain “meaningful” employment.

Mr. Stanton did not see it that way. “It’s the last one I’ve ever done, because I was just so horrified,” he said. “I didn’t even have the client pay me. In all of the cases in 30 years of bankruptcy work, I came away with about the worst taste in my mouth that I’ve ever had.”

Those who do go to court face the daunting task of arguing against opponents who specialize in beating back the bankrupt.

They will often square off against Educational Credit Management Corporation, a so-called guaranty agency sanctioned by the government to handle a variety of loan-related legal tasks, from certifying students who are eligible for loans to fighting them when they try to discharge the loans in bankruptcy court.

 

On its Web site, the agency paints a picture of how much of a long shot an undue hardship claim is, noting that people “rarely” succeed in discharging student loan debt.

Some academic researchers have come to a different conclusion, however. Rafael Pardo, a professor at the Emory University School of Law, and Michelle Lacey, a math professor at Tulane University, examined 115 legal filings from the western half of Washington State. They found that 57 percent of bankrupt debtors who initiated an undue hardship adversary proceeding were able to get some or all of their loans discharged.

Jason Iuliano, a Harvard Law School graduate who is now in a Ph.D. program in politics at Princeton, examined 207 proceedings that unfolded across the country. He found that 39 percent received full or partial discharges.

His assessment of E.C.M.C.’s view of the rarity of success? “I think that’s wrong,” he said. While his sample size was small and he agrees that it’s not easy to prove undue hardship and personal hopelessness, his assessment of bankruptcy data suggests that as many as 69,000 more people each year ought to try to make a case. And they don’t necessarily need to pay lawyers to argue for them, as he found no statistical difference between the outcomes of people who hired lawyers and those who represented themselves.

Dan Fisher, E.C.M.C.’s general counsel, said it had no opinion on whether more borrowers should try to make undue hardship claims. As for the “rarely” language on its Web site, he said the company stood by its assertion that it was uncommon for an undue hardship lawsuit to end in a judgment discharging the loans in its portfolio.

Sometimes, getting any judgment is a challenge, as judges may delay a decision if the case seems too close to call or there is a possibility that the facts may change reasonably soon.

Radoje Vujovic, a North Carolina consumer bankruptcy lawyer, for instance, had more than $280,000 in student loan debt and just $23,000 in annual income.

When Judge A. Thomas Small, a federal bankruptcy judge in the eastern district of North Carolina, examined the case in 2008, he decided to wait two years before rendering final judgment, given that Mr. Vujovic thought his law practice might grow. “Must the cost of hope be permanent denial of discharge of debt?” Judge Small asked in his written opinion. “The answer to that question cannot be an unequivocal ‘yes.’ Hope is not enough to end the inquiry and, ironically, permanently tip the scales against a struggling debtor.”

The Department of Education, unhappy with the two-year delay, appealed before the period was up and persuaded a higher court to overturn the ruling. “I would stand by my decision,” Judge Small, who is now retired, said in an interview. “If you’re forced to make that decision, all you have is speculation, and speculation is really not good enough to overcome the burden of proof.”

Getting judges out of the speculation business, however, would require a new law or an entirely new standard, possibly from the United States Supreme Court. Neither appears likely anytime soon.

In the meantime, Doug Wallace, the blind man in Ohio, is nearing the end of his long wait for a ruling.

In December 2010, C. Kathryn Preston, a federal bankruptcy judge in the southern district of Ohio, tried to assess Mr. Wallace’s hopelessness by pointing to expert testimony that blindness does not necessarily lead to an inability to ever work again. But she also noted that because he lived in a rural area, he faced significant transportation obstacles. So she set a new court date for Sept. 5, to give him “additional time to adjust to his situation.”

The question for Mr. Wallace then became what sort of adjustments he was supposed to make aside from a court-ordered $20 monthly loan payment. His routine has not changed much. Aside from hernia surgery a few months ago, his days consist of sitting close to the television (he can just make it out through one eye that still has a bit of vision) and regular trips to the gym with his father. His college diploma hangs on the living room wall, and at night he sleeps underneath it on the couch of the rental house he shares with his father and sister.

Mr. Wallace’s sister, a community college student, is sometimes around during the day while his father works at a Honda factory. There are few visitors. “I’ve got friends around here, I’m sure, but they’ve got lives for themselves,” he said. “So I don’t really bother them.”

The judge did not explicitly order him to move closer to a training center, and his lawyer, Matt Thompson, said that doing so would set him up for certain failure. “I don’t think there is anyplace he could go in central Ohio and live on $840 a month,” he said.

Logistics aside, Mr. Wallace said that it was hard to imagine his overall situation ever improving and wondered who would hire a blind man in this economic environment.

“Do I think I’m hopeless?” he said. “Well, yeah, I mean, by looking at it you would think I am hopeless. Like it won’t get better for me.”

Copyright 2012 The New York Times Company.  All rights reserved.

Non-bankruptcy strategies for troubled real estate

In these demanding financial times, many clients of Shenwick & Associates are seeking to modify troubled real estate loans without filing for bankruptcy. As we have discussed in prior e-mails, many alternatives exist in bankruptcy to deal with troubled real estate loans. Now we will look at strategies to deal with troubled real estate loans outside of bankruptcy.

If an individual owns real estate and the property is underwater (the fair market value of the property is less than the outstanding liens encumbering the property (mortgages, home equity lines of credit, etc.)), and/or the owner/borrower of the property is having difficulty making mortgage payments, there are a number of options or strategies that the owner/borrower may want to discuss with their lender(s):

1. Many banks take the position that they will consider hardship issues with borrowers unless the loan is in default (the loan payments are past due). The consequences of being in default from loan payments range from lower credit scores for the owner/borrower to the lender commencing a foreclosure action on the property, which may be irreversible. The issue of whether a borrower should default on a loan is an extremely important decision, and should be discussed and analyzed with an accountant and/or attorney.

2. Short Sale. A short sale is a sale of the property which will net less than the amount required to pay off the principal amount of the loan on the property. In these difficult times for real estate, many banks are more amenable to approving short sales than they used to be. The first step in this process is to find a buyer for the property, then enter into a contract of sale with a special rider provision that discloses to the purchaser that the property will only be sold if the short sale is consented to by the seller's bank. Another issue that must be addressed in the short sale is relief of indebtedness income. This topic was addressed in this prior post, but there are tax consequences when the property is sold for less than the balance of the mortgage, which must be discussed with the owner/borrower's accountant and/or attorney. However, if the bank will approve the short sale, then this will allow the seller to sell the property, with some impact on his or her credit report and tax consequences; however, the net result is that the seller longer has to worry about a property that is underwater.

3. Another strategy is to ask the bank to do a "workout." The borrower may ask the bank to reduce the principal amount of the loan, decrease the interest rate or lengthen the term of the loan to reduce the amount of the monthly payments. In order to do a workout with a bank, the borrower must show a hardship. It is this attorney's experience that many banks are loathe to reduce the principal amount of the loan, and if the loan has been packaged and sold to investors, then it is more difficult for the bank to do a workout.

4. Deed in Lieu of Foreclosure. If a loan is in default and the property is underwater, then the borrower may ask the bank to do a "deed in lieu of foreclosure." Under New York law, in lieu of a foreclosure, the owner of the property can agree to deed the property to the bank. Again, there are tax consequences and credit implications in this strategy, and the bank will only agree to take back the property if they truly believe that there are no sellers available to purchase the property. An issue that often comes up in deeds in lieu of foreclosure is what happens to the deficiency–that is, the difference between the value of the property and the amount of the loan. The bank may require the seller to pay all or some portion of that deficiency over time.

5. Purchase of the Mortgage. Another strategy is for the owner of the property to have a friend, family member or investor approach the bank and purchase the defaulted or troubled mortgage loan at a discount.

There is no perfect fit or solution to many troubled real estate purchases; however, the owner/borrower needs to be flexible, and oftentimes one of the above strategies can help ameliorate the problem. Before a borrower undertakes one of these strategies, they should consult with their accountant and an experienced real estate/workout attorney, such as Jim Shenwick.

New York Times: Problems Riddle Moves to Collect Credit Card Debt

By JESSICA SILVER-GREENBERG

The same problems that plagued the foreclosure process - and prompted a multibillion-dollar settlement with big banks - are now emerging in the debt collection practices of credit card companies.

As they work through a glut of bad loans, companies like American Express, Citigroup and Discover Financial are going to court to recoup their money. But many of the lawsuits rely on erroneous documents, incomplete records and generic testimony from witnesses, according to judges who oversee the cases.

Lenders, the judges said, are churning out lawsuits without regard for accuracy, and improperly collecting debts from consumers. The concerns echo a recent abuse in the foreclosure system, a practice known as robo-signing in which banks produced similar documents for different homeowners and did not review them.

"I would say that roughly 90 percent of the credit card lawsuits are flawed and can't prove the person owes the debt," said Noach Dear, a civil court judge in Brooklyn, who said he presided over as many as 100 such cases a day.

Last year, American Express sued Felicia Tancreto, claiming that she had stopped making payments and owed more than $16,000 on her credit card.

While Ms. Tancreto was behind on her payments, she contested owing the full amount, according to court records. In April, Judge Dear dismissed the lawsuit, citing a lack of evidence. The American Express employee who testified, the judge noted, provided generic testimony about the way the company maintained its records. The same witness gave similar evidence in other cases, which the judge said amounted to "robo-testimony."

American Express and other credit card companies defended their practices. Sonya Conway, a spokeswoman for American Express, said, "we strongly disagree with Judge Dear's comments and believe that we have a strong process in place to ensure accuracy of testimony and affidavits provided to courts."

Interviews with dozens of state judges, regulators and lawyers, however, indicated that such flaws are increasingly common in credit card suits. In certain instances, lenders are trying to collect money from consumers who have already paid their bills or increasing the size of the debts by adding erroneous fees and interest costs.

The scope of the lawsuits is vast. Some consumers dispute that they owe money at all. More commonly, borrowers are behind on their payments but contest the size of their debts.

The problem, according to judges, is that credit card companies are not always following the proper legal procedures, even when they have the right to collect money. Certain cases hinge on mass-produced documents because the lenders do not provide proof of the outstanding debts, like the original contract or payment history.

At times, lawsuits include falsified credit card statements, produced years after borrowers supposedly fell behind on their bills, according to the judges and others in the industry.

"This is robo-signing redux," Peter Holland, a lawyer who runs the Consumer Protection Clinic at the University of Maryland Francis King Carey School of Law.

Lawsuits against credit card borrowers are flooding the courts, according to the judges. While the amount of bad debt has fallen since the financial crisis, lenders are trying to work through the soured loans and clean up their books. In all, borrowers are behind on $18.7 billion of credit card debt, or roughly 3 percent of the total, according to Equifax and Moody's Analytics.

Amid the surge in lawsuits, credit card companies are facing scrutiny. The Office of the Comptroller of the Currency is investigating JPMorgan Chase after a former employee said that nearly 23,000 delinquent accounts had incorrect balances, according to people with knowledge of the investigation.
Linda Almonte, a former assistant vice president at JPMorgan, claimed in a whistle-blower complaint that she had been fired after alerting her managers to flaws in the bank's records.

The currency office, which oversees the nation's largest banks, is also broadly looking into the industry's debt collection efforts, focusing in part on the documents included with lawsuits. A spokeswoman for JPMorgan declined to comment.

The Federal Trade Commission is working with courts across the country to improve the process for pursuing borrowers who are behind on their credit card payments, mortgages and other bills. In a recent review of the consumer litigation system, the commission found that credit card issuers and other companies were basing some lawsuits on incomplete or false paperwork.

"Our concerns center on the fact that debt collection lawsuits are a pure volume business," said Tom Pahl, assistant director for the F.T.C.'s division of financial practices. "The documentation is very bare bones."

The lenders disputed the suggestion that they file lawsuits that include flawed or inaccurate documentation.

"We look at account records in our system to individually verify the accuracy of information before affidavits are filed and testimony is given," said Ms. Conway, the American Express spokeswoman, who declined to comment on specific borrowers.

The industry has faced similar criticism over practices stemming from the housing crisis. Amid a surge in foreclosures, state attorneys general accused the banks of using faulty documents without reviewing them and improperly seizing homes. In February, five big banks agreed to pay $26 billion to settle the matter.

The errors in credit card suits often go undetected, according to the judges. Unlike in foreclosures, the borrowers typically do not show up in court to defend themselves. As a result, an estimated 95 percent of lawsuits result in default judgments in favor of lenders. With a default judgment, credit card companies can garnish a consumer's wages or freeze bank accounts to get their money back.

In 2010, Discover sued Taryn Gregory for more than $7,000 in credit card debt. Ms. Gregory, of Commerce, Ga., had fallen behind on her bills, but said she had accumulated only $4,000 in debt.
After the suit was filed, Ms. Gregory, a 41-year-old child care assistant, asked Discover for proof of the balance. The resulting documents, which were reviewed by The New York Times, have inconsistencies. One statement, for example, says it was produced in 2004, but advertisements on the bottom of the document bear a 2010 date.

The lawsuit against Ms. Gregory is still pending. Discover declined to comment. Judges have also raised concerns about witnesses and affidavits.

In May, Michael A. Ciaffa, a district court judge in Nassau County, N.Y., challenged the paperwork signed by a Citigroup employee in Kansas City, Mo. He found that one document "has the look and feel of a robo-signed affidavit, prepared in advance," according to court records. The case is still pending.

Emily Collins, a spokeswoman for Citigroup, said: "We continually review the effectiveness of our controls and policies for credit card collections, and ensure that affidavits are validated for accuracy and signed by Citi employees with knowledge of the client's account. Citi Cards has a range of programs to support our clients who may be facing financial difficulty, and we make every effort to work with our clients to prevent delinquency."

A review of dozens of court records showed that the same employee signed documents in cases filed against borrowers in three other states. In one lawsuit in Seattle, the employee attested in an affidavit in May that a customer, Vickie Sawadee, owed $14,000 on her Citigroup credit card. Although Ms. Sawadee was behind on her payments, she said she does not owe the full amount. She hired a lawyer to defend her case.

Many judges said that their hands are tied. Unless a consumer shows up to contest a lawsuit, the judges cannot question the banks or comb through the lawsuits to root out suspicious documents. Instead, they are generally required to issue a summary judgment, in essence an automatic win for the bank.

"I do suspect flaws," said Harry Walsh, a superior court judge in Ventura, Calif. "But there is little I can do."

Copyright 2012 The New York Times Company.  All rights reserved.

Signatories to a Proof of Claim

Here at Shenwick & Associates, one of the most common things we do for clients is the filing of proofs of claim in bankruptcy cases. We have written extensively before about proofs of claim here and here, but essentially a proof of claim is a written statement setting forth the creditor's claim against the debtor and filed with the Bankruptcy Court (or, in certain "megacases" with many creditors, the Debtor's claims agent).

Recently, a question arose about who could sign a proof of claim. A client wanted to file a proof of claim on his mother's behalf, and had a durable power of attorney for his mother. Was that sufficient? Could we sign it on her behalf, since we had been retained, but did not hold a power of attorney on her behalf?

Rule 9010(c) of the Federal Rules of Bankruptcy Procedure provides:

"Power of Attorney. The authority of any agent, attorney in fact, or proxy to represent a creditor for any purpose other than the execution and filing of a proof of claim or the acceptance or rejection of a plan shall be evidenced by a power of attorney conforming substantially to the appropriate Official Form. The execution of any such power of attorney shall be acknowledged before one of the officers enumerated in 28 U.S.C. §459, §953, Rule 9012, or a person authorized to administer oaths under the laws of the state where the oath is administered."

So it is clear that attorneys may sign proofs of claim without the need for a power of attorney. In re Roberts, 20 B.R. 914, 917, n. 2 (Bankr. E.D.N.Y. 1982) also supports the proposition that an attorney may sign a proof of claim, citing to Collier on Bankruptcy (one of the leading treatises on bankruptcy law), which says that a "separate power [of attorney] is not necessary for the filing of a proof of claim."

However, although attorneys may sign proofs of claim, that doesn't mean that they should. In In re Duke Investments, No. 10-36556, 2011 WL 2462681 (S.D. Tex. June 17, 2011), the Court almost disqualified an attorney who had signed his client's proof of claim. The Court refused to disqualify the attorney from representing his creditor-client in the chapter 11 case because the attorney was not a "necessary witness" to the merits of the claim, but the Court admonished attorneys against signing clients' proofs of claim in the future because of the risk that the attorney may become a necessary fact witness at his client's trial. The Court instead recommended attorneys have their clients sign the proof of claim. Following the Court's advice will allow attorneys to completely protect themselves from being disqualified as a necessary fact witness under similar facts. Attorneys should take notice of the holding in Duke when considering the obligations and duties owed to clients and avoid the potentially harmful but common practice of signing their clients' proofs of claim.

For more information about proofs of claim and preserving your rights to payment in bankruptcy, please contact Jim Shenwick.