Debts That Survive Bankruptcy: Domestic Relations Obligations

Posted on February 3, 2012 by Lex Rogerson

confused domestic obligations in bankruptcyWritten by Lexington/Columbia Bankruptcy Lawyer, Lex A. Rogerson, Jr.

Congress has declared that debtors usually cannot get rid of domestic (family court) obligations in bankruptcy.

When Chase or Wells Fargo extends credit, they know there is a risk that the borrower will not be able to repay the debt.  They continue to make loans because, as a matter of business judgment, the interest and fees they charge make these transactions worth the risk.  But domestic creditors – spouses, former spouses, and children of the debtor – never get to make that choice, and the effect of non-payment of a domestic obligation is usually much more damaging than non-payment of a commercial debt.

Whether a family court obligation is dischargeable depends on the type of bankruptcy the debtor files and the nature of the obligation. 

In Chapter 7, it’s simple: no domestic obligations of any kind are dischargeable.  As long as the obligation is written into a divorce decree, family court order, or separation agreement, it survives.

It’s different in Chapter 13.  Support-type obligations – alimony, child support, and other payments intended to support the spouse, former spouse, or child – are not dischargeable.  But other obligations, including property division and related payments, are dischargeable.  Sounds simple enough, right?  It isn’t.

First of all, what the decree or agreement calls the obligation doesn’t necessarily govern: it’s the real purpose that matters.  Something can be called “rehabilitative alimony” when it’s really intended to equalize the division of property.

In addition, lawyers who draft separation agreements and courts that issue divorce decrees often set out obligations with no indication of their nature or purpose.  Take for example the couple from Orangeburg, whose divorce decree contains a “hold-harmless” paragraph requiring the husband to pay three joint debts – with no further explanation.  Was the husband required to pay the debts (1) so the wife could maintain a reasonable standard of living, or (2) because he got most of the marital property, or (3) because his misconduct caused the breakup of the marriage?  With #1, it’s probably “in the nature of support” and therefore non-dischargeable.  With # 2 or #3, it’s probably dischargeable.  But it’s usually hard to tell for sure.

The problem doesn’t just arise with the allocation of joint debts. 

Lots of other common obligations don’t fall neatly into the property category or the support category.  These include requirements to pay the other spouse a sum of money, to pay his or her attorney’s fees, to keep a life insurance policy in force, to sign over the tax refund, or to deed over the marital home.

There are literally hundreds of court opinions deciding whether particular obligations are “in the nature of support.”  Not all reach consistent results.  So when we advise clients whether a domestic obligation in is dischargeable in Chapter 13, we are necessarily dealing in probabilities rather than certainties.

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Debts That Survive Bankruptcy

Posted on January 15, 2012 by Lex Rogerson

girl riding bikeWritten by Lexington/Columbia Bankruptcy Lawyer, Lex A. Rogerson, Jr.

In most cases, discharging debt is a major, if not the sole, reason for filing bankruptcy.  You file bankruptcy to get a fresh start and get on down the road of life.

While bankruptcy can discharge most debts, there are important exceptions that can affect your decision of what chapter to use – and, in some cases, whether to file bankruptcy at all.

Several provisions of bankruptcy law have the effect of keeping debts alive after bankruptcy, at least in certain respects.  The most obvious of these is section 523 of the Bankruptcy Code, which sets out the explicit exceptions to discharge.  Congress has made the policy judgment that people simply should not be able to wipe out 19 special kinds of debts.  The most common examples are alimony and child support, other domestic relations obligations, most taxes, student loans, government fines, and damages for injuring someone while driving under the influence.

Additionally, debts associated with certain kinds of misconduct can be non-dischargeable if the creditor raises the issue during the bankruptcy case.  These kinds of misconduct include mis-handling funds the debtor held in trust; intentionally injuring others or their property; or obtaining money, property, or credit by fraud or misrepresentation.  Courts have uniformly held a debt is fraudulent and non-dischargeable if the debtor did not intend to pay the debt when he incurred it.

Other bankruptcy rules mean that certain aspects of a debt can survive.  For example, with most secured debts, such as mortgages and car loans, the creditor’s lien on the collateral (e.g., the house or the car) survives or “rides through” a bankruptcy case.  If the debt is not paid, the creditor can foreclose or repossess when the bankruptcy case is over even though it cannot sue the debtor for money.  If the debtor wishes to keep the collateral, therefore, he must continue to pay the debt.

In some situations, the debtor may find it advantageous to reaffirm a debt.  The most common example is a car loan.  The bankruptcy code now says that if a debtor fails to reaffirm a car loan, the creditor can declare the loan in default even if the payments are current.  To avoid the risk that the creditor will repossess the car, my clients frequently chose to reaffirm, which means that particular debt is not discharged.

In a prior post, we explained which kinds of taxes can and cannot be discharged.  In future posts, we’ll discuss other kinds of debts that can’t be wiped out.  You can also check out this video put out by the U.S. Courts for an overview of this topic.

Photo Credit: Charleston Photographer Marissa DeMott of Hazel Eyes Photography.

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Avoiding Bankruptcy

Posted on December 10, 2011 by Lex Rogerson

avoiding bankruptcyWritten by Lexington/Columbia Bankruptcy Lawyer, Lex A. Rogerson, Jr.

Avoiding bankruptcy.  There can be a number of  potential reasons why someone with debt problems decides not to file bankruptcy.  Fairly often we’ll advise our Columbia area clients not to file – at least, not yet.

Sometimes it’s a matter of delaying for tactical reasons, and sometimes it’s just not a good idea flr that client.  But there are a few things someone in that position should do, and probably more things they should not do, whether or not they eventually decide to file.

  • Don’t run up unnecessary debt.  Sometimes paying off debts can seem so hopeless that a client says, “What the heck?  I’ll never get out of debt, so I might as well enjoy myself.”  This is dangerous thinking and can lead folks to incur debt they have no intention of repaying.  That’s not only dishonest, it can lead to the new debt being declared non-dischargeable if they do eventually decide to file bankruptcy.
  •  Pay mortgages and car loans first.  When creditors are hounding you, it can be tempting to pay the ones that are making life unpleasant now instead of the ones that can cause the biggest problems in the long run.  Unsecured debts such as credit cards, retail charge accounts, and finance company loans are usually dischargeable in bankruptcy, and it usually makes little difference whether they have been paid down after the debtor begins feeling financial distress.  By contrast, a mortgage company’s lien on a debtor’s home, or an auto lender’s lien on his car, is are usually affected relatively little by bankruptcy.  And keeping payments on these debts current can keep open some beneficial options if the debtor does decide to file.  So secured debts like these should almost always be the first priority.
  •  Pay non-dischargeable debts next.  Special debts like taxes, student loans, and family court obligations usually survive bankruptcy.  So if a client eventually decides to file, he’ll be glad if he has used whatever funds he had available to pay these kinds of debts rather than his dischargeable Visa card or Macy’s charge account.
  •  Don’t take out a second mortgage or home equity line to pay off debt.  The exemption laws allow all of us to protect a certain amount of the value of our homes – in South Carolina, the amount is a little over $53,000 per person.  So for most people, whose home has less than this amount of equity (or, if the home is jointly owned, twice this amount), unsecured creditors like the ones we were just discussing have no way to collect their debts out of the home.  But exemptions don’t apply against mortgages.  So if a debtor draws on the equity in his home by taking out a second mortgage or home equity line of credit (HELOC) in order to pay off debt, he is giving his creditors value out of his home that they could not otherwise reach – usually a very bad tactical decision.
  • Don’t give away or hide property.  When debt becomes a problem, some people decide they’ll simply put things they own into someone else’s name, wrongly believing this will protect the property.  This is dishonest, and it rarely works.  State laws allow creditors to recapture fraudulently transferred property from the recipient, and bankruptcy law allows a trustee to recover transferred property whenever the debtor does not get “reasonably equivalent value” in return.  What’s worse, once the trustee recovers the property, the debtor can’t claim an exemption in it, making the situation worse than before.  And to top it all off, this tactic can even prevent the debtor from receiving a discharge of any of his debts if he files bankruptcy.  So the cute trick of “selling” property to one’s brother-in-law for $50 can backfire big time.

 

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Bankruptcy Means Test and Falling Incomes

Posted on November 16, 2011 by Lex Rogerson

bankruptcy means test declining incomesWritten by Lexington/Columbia Bankruptcy Lawyer, Lex A. Rogerson, Jr. 

In the last two years, household incomes have generally fallen in South Carolina, pulling a cruel switcheroo on many distressed middle-income families at a time when the economy makes avoiding bankruptcy especially difficult.

An early but pivotal stage of the means test requires us to determine whether our clients’ household income is above or below the median family income for their family size here in South Carolina.  The answer can influence whether Chapter 7 is an option for those clients and how much and how long they must pay toward their debts if they file Chapter 13.

The bankruptcy laws provide for periodic updates to the median income figures we must use to compare against debtors’ income.  During normal times, when incomes are increasing, this rule helps debtors, much like a cost-of-living increase helps retirees.  But the decline in median incomes since their peak late 2009 has put a bankruptcy law squeeze on the most productive working people that compounds the economic squeeze they face every day.

In South Carolina the median income for a household of one, as applied beginning November 2009, was $39,191.  Two years later, it had fallen to $36,660, a decrease of 3.9%.  Middle-sized families showed larger declines, topped by three-person households, where income decreased by 8.1% during the same two years.  In early 2010, a couple from Irmo who had two children and an annual income of $65,000 were slightly below median.  Now they are above.

So the means test is now hitting harder on middle-sized families with middle incomes–the people who pay their taxes and play by the rules, and the segment of the population that has made America great.

The irony is that the means test can actually be beneficial for those in higher income brackets who file Chapter 13.  In calculating how much they must pay their creditors, they can deduct certain fixed amounts of allowed expenses–including auto, home, and medical expenses–that may be more than they actually spend.  We take advantage of that idiosyncracy when we represent upper-income clients, but it’s not fair to the folks in the middle.

Aside from the political lessons these facts teach, the practical lesson for those in financial distress is that it is even more important than ever to consult a bankruptcy lawyer who is experienced in applying the means test and thoroughly knows the complex legal precedents on how it works.

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What if I Fail the Means Test?

Posted on November 12, 2011 by Lex Rogerson

failing the means testWritten by Lexington/Columbia Bankruptcy Lawyer, Lex A. Rogerson, Jr.

If you “fail” the mean test, this results in a presumption of abuse.  You still may be able to file Chapter 7, but trying to do so becomes a little more complicated.

The bottom line of the means test is a dollar figure we call disposable income.  It’s the difference between our client’s household income (based on the last 6 months) and expenses (based on a hybrid of fixed allowances and actual expenses incurred).  If the figure is either negative (a deficit) or a surplus of less than $118 per month, no presumption arises.  If the figure is $195 or more, it is presumed that a Chapter 7 would be abusive.  If the figure is in between, abuse is presumed if the monthly disposable income, extended over five years, would pay 25% or more of the client’s unsecured debt.

If the presumption arises, there are two kinds of situations where the client might still receive a Chapter 7 discharge.  First, the Bankruptcy Code itself allows for a few special circumstances that can rebut, or overcome, the presumption of abuse.

The examples stated in the law are serious illness and military service, and there certainly could be others.  For example, the courts are about evenly divided whether the need to repay a non-dischargeable student loan is a special circumstance.  But all agree that any circumstance the debtor asserts must cause increased expenses or decreased income, and the client must not have any reasonable alternative about the change occurring.

Second, there can be factors that may not strictly fit the mold of special circumstances but that, practically speaking, make a finding of abuse unlikely.  The classic is unemployment.  If a couple had good income for most of the last six months, but one of them has been out of work for a good while, it would be surprising to see the US Trustee move to dismiss their case.

If the court ultimately finds it would be abusive for the debtors to remain in chapter 7, they have two alternatives.  They can convert to Chapter 13 and pay as much as possible toward their debts, usually for five years, or they can allow the case to be dismissed.  Fortunately, our clients so far  have avoided being faced with that choice.

When figuring the likely outcome of an abuse issues like these, it’s often as important to know the behavior of the various actors involved as it is to know the law.  For this reason, you should select a bankruptcy lawyer that is not only book-smart but concentrates on bankruptcy law sufficiently to be experienced in the trenches.

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What’s the Bankruptcy Means Test?

Posted on November 7, 2011 by Lex Rogerson

means testWritten by Lexington/Columbia Bankruptcy Lawyer, Lex A. Rogerson, Jr.

In the 25-plus years I’ve been helping people file bankruptcy here in the Columbia area, one of the biggest changes has been the advent of the means test, designed to limit the number of people who can take advantage of the simplest form of bankruptcy, Chapter 7.

In the late 1990s, when Congress first started trying to “reform” the Bankruptcy Code, one of its main focus areas was abuse of Chapter 7.  Representatives of banks and other lenders argued that many people file this form of bankruptcy, which does not require payments to unsecured creditors, when they could afford to pay a meaningful portion of their debts.

Since 1984, bankruptcy judges have had the power to dismiss Chapter 7 cases for “substantial abuse.”  Courts had developed a substantial body of law for determining when debtors were abusing the system.  But the lenders thought this standard gave judges too much discretion:  a judge in California might think a debtor with $150 more income than expenses should be granted a discharge, while another judge in Maine might dismiss the case of a debtor with $50 of surplus.  The lenders argued there should be a standardized test to determine when a debtor should be bounced out of bankruptcy based on his income.

The lenders won that argument in 2005, when Congress enacted the so-called Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”).  One of the most important provisions of BAPCPA was a mathematical formula to determine when a Chapter 7 case would be presumed to be abusive–a means test.

The means test is a sort of modified monthly budget, involving a calculation of income and–sometimes–expenses.  In my office, we carefully work through this formula with the client using information he provides.  It works like this.

On the income side, we begin by averaging the client’s household income over the last six months.  At that point, the test divides people into two groups.  If the household income is less than the median family income for households of the same size, the client “passes” the means test.  The court will not presume he would be abusing the system if he  files Chapter 7.

If the client’s income is above median, we then proceed to the expense side of the formula–what we call the full means test.  At this stage, we deduct certain expenses from the client’s income in order to determine whether he is operating at a significant surplus.

In some categories, such as the housing, household expenses, and automobile expenses, we can deduct fixed allowances, regardless of what the client actually spends.  In other areas, including taxes, support payments, child care, and telecommunications, we can deduct the actual amount of expense he incurs.

We then add up all these expense categories, producing a total that is a hybrid of allowed and actual figures.  If the client’s income exceeds this expense total by more than a certain threshold amount (calculated by another formula), it’s presumed a Chapter 7 would be abusive. That doesn’t mean Chapter 7 is automatically off limits.  It does mean we need to look carefully at any special circumstances that may allow the client to file Chapter 7.

The means test is important, but it’s also complicated.  It requires that the debtor’s attorney be informed and experienced in applying the rules.  In assisting those considering bankruptcy, we believe our clients have a right to expect us to guide them through the means test accurately and to advise them how the result affects their bankruptcy options.

 

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Chapter 13 and the Means Test

Posted on November 4, 2011 by Lex Rogerson

means test in bankruptcyWritten by Lexington/Columbia Bankruptcy Lawyer, Lex A. Rogerson, Jr.

The means test is found in Chapter 7 of the Bankruptcy Code and was primarily intended as a screening mechanism for Chapter 7 cases.  However, it plays a significant role in Chapter 13 as well.

To recap, in Chapter 13, the debtor files a plan for paying toward his debt for three to five years by making a single fixed payment each month through a Chapter 13 trustee.  The payments must be sufficient to catch up with any amount the debtor is behind on mortgages, to pay off car loans and other short-term secured debts in full, and to pay some dividend – usually a few cents on the dollar – on unsecured debts. The debtor is required to devote all his disposable income to the plan for the entire length of the plan.

When we run the means test, we first determine whether the client’s income is above or below median for his household size.  In Chapter 13, this question determines the “applicable commitment period” – how long the plan must last.  Those whose income is below the median for their household size must pay in for at least three years, but they can pay for up to five years if necessary to accomplish the purposes of the plan (for example, to catch up on the mortgage or to pay off past due taxes).  Above median clients must pay for five years, period.

For above median clients, the means test also affects the required plan payment, at least provisionally.  The bottom line of the means test is a dollar figure we call disposable income.  Usually the client must pay that much each month toward his unsecured debt, in addition to payments to secured creditors.  However, if future changes in income or expenses are known or reasonably certain, the plan payment can be adjusted to account for them.

The mechanics of the Chapter 13 means test vary somewhat from the Chapter 7 formula.  The most obvious example is that, in calculating Chapter 13 disposable income, the debtor can deduct  contributions to retirement plans such as 401(k)’s and payments on loans against such plans.  Chapter 7 debtors cannot.

So while the means test cannot exclude people from filing Chapter 13 as it sometimes does in Chapter 7, it can impact how much and how long our clients must pay.

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Is Bankruptcy Really the Last Alternative?

Posted on November 2, 2011 by Lex Rogerson

bankruptcy is one option in ColumbiaWritten by Lexington/Columbia bankruptcy lawyer, Lex A. Rogerson, Jr.

Last weekend I heard a Columbia radio advertisement for a debt adjustment service.  Aiming his message at those with out-of-control debt, the announcer said, “Don’t file bankruptcy – that should be your last choice!”

Is that good advice?  Well, as with most oversimplifications, the answer is yes – and no, depending on the circumstances.

For sure, bankruptcy should not be your first choice.  There are substantial disadvantages–the cost in attorney’s fees and filing fees, the damage to your credit, and the effort it takes to make all the required disclosures.  For these reasons, I never suggest someone take the decision to file bankruptcy lightly.

The best alternative is to pay your debts as promptly as possible.  If successful, this strategy preserves your credit standing, which can be tremendously important even if you never again intend to rely on debt.

Another alternative is to try adjusting your debts by yourself, directly with your creditors.  This approach can limit somewhat the damage to your credit.  But creditors often won’t compromise their accounts unless you are seriously in default, and by then your credit may already be badly damaged anyway.  And if a creditor writes off a part of the debt, this amount can represent taxable income.  You will get a 1099 the following January, and the IRS will be looking for that income on your tax return.

What about working with a debt adjustment service?  Many credit adjustment bureaus charge large fees and can deliver only modest help in the amounts and terms of your debts.  And frankly, some of these services, especially some for-profit agencies, are simply rip-offs.  Overall, I have rarely seen non-bankruptcy debt workouts succeed.

What if you just can’t pay your debts and a workout does not seem feasible?  At this point, you might want to get some competent advice from a bankruptcy professional – before letting some things happen that can damage you in the long run.  It’s possible to wait too long before considering bankruptcy.

A prime case in point: Ed and Sally from Aiken* consulted me last year.  Several months earlier, in an attempt to avoid bankruptcy, they had taken out a home equity loan and drawn heavily against it to pay some credit cards.  This approach worked for a while, but now the debts were again too much to handle.  Sadly, I had to tell them they had exchanged dischargeable credit card for mortgage debt we could not wipe out.  Given their numbers, we could have protected all the equity in their home from the credit card issuers, but now that equity was irretrievably lost to the home equity lender.  In short, they waited too long to see me.

Another example: Will from Newberry came to see me a couple of months after his Visa card issuer sued him and obtained a judgment.  In South Carolina, a judgment is automatically a lien against any real estate the debtor owns in the county where it is entered.  Because Will owned no real estate other than his home, and because the equity was within the state homestead exemption, we could file a fairly simple motion to make sure the judgment creditor could never actually have the home sold.  But this motion doesn’t automatically remove the judgment from the public record.  If someone searched the county land records, the judgment would appear a valid lien on his home.  State law provides a procedure for canceling the judgment, but that procedure requires a year’s wait, separate civil action, and additional fees and expenses.  Again, Will waited a little longer than he should have, and things happened that were not easy to fix.

So while one should certainly not file bankruptcy without a serious evaluation of the alternatives, it is possible to wait too long.  A bankruptcy consultation is usually not expensive–we usually charge $50 to $150–and sometimes it may be better to look at those alternatives sooner rather than later.

*           To preserve confidentiality, all identifying information on clients, including their residences, is fictionalized.  However, the fact situations are based on actual cases.

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What Happens to Judgments in Bankruptcy?

Posted on October 26, 2011 by Lex Rogerson

judgments in columbia--bankruptcyWritten by Lexington/Columbia bankruptcy lawyer, Lex A. Rogerson, Jr.

What happens to judgments in bankruptcy?

I spoke with a client from Columbia last week who had three judgments on record against her. As I told her, one of the best reasons for considering bankruptcy is a special option the Bankruptcy Code gives us for dealing with judgments.

To begin with, let’s define our terms.

A judgment is the end product of a lawsuit.  If someone sues me and wins the lawsuit, the court will enter a final order declaring that I owe a specific amount of money.  That order is called a judgment.

There are other kinds of judgments as well – a court might dismiss a lawsuit, issue an injunction, or require someone to turn over property.  But when we talk about judgments, we are usually referring to cases where the court decides the loser (called the judgment debtor) owes money. The reason may be that the debtor has borrowed money or taken someone else’s property or injured someone in an auto accident, but the result is a money judgment.

A money judgment has several legal effects.  First, unless it is appealed or rescinded (and the grounds for these are very narrow), it is a final, binding declaration that the debtor owes the dollar amount stated.

Second, the judgment is automatically a lien on any real estate owned by the debtor in the county where it is recorded.

Third, the judgment can give the creditor the right to seize property of the debtor, including items other than real estate, for up to ten years.  Certain property is exempt from seizure, including in South Carolina up to $53,375 in value in a home, $5,350 in a car, and $4,275 in household goods.

This is where the special bankruptcy option for judgments comes in.  If you own a home in, say, Lexington or Aiken and file bankruptcy after someone has obtained a judgment there against you, you can “avoid” (cancel) the lien that judgment has created on your home, as long as your equity does not exceed the $53,375 homestead exemption.  In most situations, this means the judgment can never be enforced against your home or anything else you may ever own.  So even if someone has obtained a judgment against you, it may not be too late to wipe out that debt.

If you’re going to file bankruptcy, it’s still better to do that before a creditor gets a judgment.  While a lien avoidance can make a judgment unenforceable, the bankruptcy court does not remove the judgment from the county court records.  So unless you take an additional step after your bankruptcy is over, a title search on your home would make it appear that the judgment is still a valid lien.  This could, for example, complicate selling or refinancing your home.

You almost always have 30 days after you are served with lawsuit papers before the creditor can get a judgment.  If you are considering bankruptcy and are sued, you should make your decision quickly and get your lawyer the information necessary to file before the judgment is entered.  But if you can’t, the situation isn’t necessarily hopeless.

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Taxes and Bankruptcy (Part Two)

Posted on October 21, 2011 by Lex Rogerson

propety taxes and income taxesWritten by Lexington/Columbia bankruptcy lawyer, Lex A. Rogerson, Jr.

In “Taxes and Bankruptcy (Part One)”, I discussed the 3/2/240 rule for discharging income taxes in bankruptcy.

Here in part two, I’ll give you some examples of how this rule works.

Tax liens and some specific examples of how these rules work

If the IRS or the state department of revenue files a tax lien, that lien attaches to all property owned by the debtor without regard to exemptions he might claim to protect property from a commercial creditor.  Even if the underlying tax is dischargeable, the tax lien passes through bankruptcy and remains enforceable unless the tax is paid.

So how does all this affect bankruptcy strategy? 

Let’s look at an example.

Say a couple from Irmo owe $20,000 in federal income taxes, evenly divided between the 2007 and 2008 tax years.  For each year, they filed their returns in February of the following year, and the IRS has never assessed any additional taxes beyond what was shown on the returns.

If bankruptcy is otherwise advisable, we might wait until April 2012 and then file a Chapter 7 case for these folks so that the 2008 taxes would be dischargeable in addition to the 2007 taxes, which already are.

By contrast, let’s say a woman from Orangeburg owes the same $20,000 in federal income tax for 2007 and 2008, but she did not file these returns until about a year ago.  Under Rule #3, neither year’s tax is dischargeable.  We may advise the client to consider filing a Chapter 13 case and paying the taxes, along with some portion of her other debts, over a period of three to five years.

The Chapter 13 case would prevent the IRS from levying on her wages or filing a lien that could cloud the title to her home.  Interest and penalties would stop adding up, and the repayment terms may be more favorable than under an installment agreement with the IRS.

In most cases, the debtor can pay the tax debt in full, and thereby prevent any of the tax debt from following her after her case is over, even if she pays her general unsecured creditors a few cents on the dollar.

If you’ve got tax debt you can’t pay, discussing your options with a bankruptcy lawyer is a wise move.  He can help you understand what you can and can’t do with tax debt through the bankruptcy system.

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