The Two Roads of Bankruptcy

A Chapter 7 Bankruptcy is kind of like a road trip. It’s a trip on which all the players (the debtor, the debtor’s creditors, the case trustee, and the United States Trustee) get to embark. There are two roads to this trip: the debtor’s road, which pertains to the discharge, and the creditors’ road, which pertains to trustee’s administration of assets. The filing of a bankruptcy petition commences the beginning of the road trip. The trip is over, only after the parties have traveled all the way down both roads.

The Debtor’s Road: Obtaining a Discharge
This road is typically no longer than 105 days. It starts with the moment the petition is filed and usually concludes once the court enters a discharge order. Barring an objection, the court will automatically enter the discharge order about 67 days after the debtor’s 341 Meeting of Creditors. The 341 Meeting, is typically scheduled 4-5 weeks after the petition is filed. Hence the projection of 105 days.

In many cases, to earn the discharge, the debtor really only has to do a few things after the petition is filed: 1. submit certain documents to the Trustee (tax returns, bank statements, paystubs, etc.), 2. attend the 341 Meeting of Creditors, 3. and take a post-petition financial management course.

The 341 Meeting of Creditors is an important event in a chapter 7 bankruptcy case. Not only is it an opportunity for the trustee and any creditors to ask the debtor questions about its financial affairs, but it is also the point in the road trip where the two roads diverge. Starting with the first date set for the 341 Meeting of Creditors, the trustee, creditors, or the US Trustee will have 60 days to bring an action either objecting to the debtor receiving a discharge (known as a §727 action), or objecting to a creditor’s claim from being discharged (known as a §523 action). If no objection is raised in that 60 day period, the court will then go through its internal process of entering the discharge order (which takes about 7 days).

Now, with regards to §727 and §523 actions, a party in interest can request for an extension of time in which to bring its objection; and the court freely grants those requests. So the 60 day period CAN be extended if warranted. Further if a §727 action is filed, the court will naturally delay the entry of the discharge order until the outcome of the action is determined. If the objection is later overruled (which can be several, like 12-18, months later), the discharge will be entered. But if the objection is sustained, then the court will enter an order denying the debtor a discharge.

The Debtor’s Road will conclude when the Court either enters the discharge order or enters an order denying the debtor a discharge.

The Creditors’ Road: The Administration of Assets
The chapter 7 trustee is the individual appointed to administer the assets of the bankruptcy estate. It is one of the trustee’s duties to analyze the non-exempt equity of the bankruptcy estate and make a determination as to whether to liquidate the non-exempt equity. If the trustee chooses not to liquidate the non-exempt equity, the trustee will file what is known as a “No Asset Report” or a “Report of No Distribution.” Essentially this report is the trustee’s declaration that there is not a sufficient amount of non-exempt equity in the bankruptcy estate to make a meaningful distribution to the creditors. The filing of such a report typically concludes the Creditors’ Road. However, so long as the case remains open, the Trustee has the right to withdraw the No Asset Report, thereby reopening the Creditors’ Road.

Now, after inquiring with the debtor at the 341 Meeting of Creditors, the trustee might easily determine to file a No Asset Report. In some cases, however, such a determination may not be easily made. The trustee may simply wait to file the No Asset Report until after it has determined the size of the debtor’s tax refund. On the other hand, the trustee may choose to object to a debtor’s claim of exemption or initiate a lawsuit to avoid a certain pre-petition transfer in which the debtor voluntarily or involuntarily engaged. If successful, the estate may now have a sufficient amount of non-exempt equity for the trustee to liquidate.

If there is a sufficient amount of non-exempt equity, the trustee will notify the creditors that there will be a distribution and invite them to file a proofs of claim. The trustee also will begin the process of liquidating the assets in which non-exempt equity sits. Once time to file a proof of claim has elapsed, and the non-exempt equity is liquidated, the trustee will file its “Trustee’s Final Report” in which the trustee proposes how it will distribute the estate’s funds. Interested parties have 30 days to object before the Court approves the proposed distribution scheme. Once approved, the trustee will begin the process of distributing the funds.

After all the funds have been disbursed (and the checks have cleared the trustee’s bank account), then the Trustee will file a Final Accounting, in which the Trustee discloses how the funds were disbursed.
The Creditors’ Road will typically conclude when the trustee has filed either its No Asset Report, or its Final Accounting.

Bankruptcy Closure
The Bankruptcy case will close once the longer of the two roads concludes. In a vast majority of cases, there are no objections to a debtor receiving a discharge and the trustee files a No Asset Report shortly after the 341 Meeting; thus allowing a case to close 105 days after the petition is filed. However, each case is different and if there is an objection to the debtor receiving a discharge, or if the trustee desires to liquidate non-exempt equity, then its not uncommon for the case to remain open for a longer period of time.

The most important take away, however is that the case does not close simply because the debtor received a discharge or because the trustee files a No Asset Report. The trip is over once the longer of the two roads of bankruptcy has concluded.

The Discharge

WHAT IT IS:

It’s the reason one files for bankruptcy relief….to obtain a discharge.  A discharge is a Federal injunction prohibiting the debtor’s creditors from ever attempting to collect from the debtor on account of a claim it had against the debtor at the moment the debtor filed its bankruptcy petition.  Essentially, it absolves a debtor of its legal obligation to repay debt the debtor had before it filed for bankruptcy relief.

WHEN IT HAPPENS:

A debtor’s discharge is effective when the bankruptcy court enters an order granting the debtor a discharge.”  In a chapter 7 case this typically occurs approximately 100 days after the the bankruptcy petition is filed.  In reorganization cases, that order is entered after the completion of the reorganization plan.

WHAT IS ITS SCOPE:

The discharge is very broad and affects credit card debt, medical debt, business loans/guarantees, and other various debts.  There are, however, some exceptions; not every debt is subject to the discharge:

  • Debts such as child support, alimony or spousal support are non-dischargeable (this may include childcare, school-related expenses, health insurance, and out-of-pocket medical costs).
  • Some taxes are non-dischargeable, while others may be discharged (depending on the age of the tax obligation, and whether the returns were timely filed).
  • Debts incurred due to fraud, or misrepresentations on financial statements/loan applications are non-dischargeable.
  • Debts incurred due to theft, breach of fiduciary duty, or embezzlement are non-dischargeable.
  • Debts incurred due to malicious and willful injury to another person or property are non-dischargeable.
  • Court fines are non-dischargeable.
  • Debts incurred due to the operation of motor vehicle while intoxicated are non-dischargeable.
  • Student loans are typically non-dischargeable.

These are just the more common exceptions; there are other exceptions that might apply, and if you are considering bankruptcy, you’ll want to discuss your circumstances with an attorney to see if any exceptions apply in your case.

Also, the scope of the discharge depends on the chapter the debtor files.  For instance if a debtor file a chapter 7, it may not discharge a debt incurred in a divorce decree (if such debt is not child-support, alimony or spousal support), but the debtor may discharge that obligation if the discharge is entered pursuant to chapter 13.  A debtor who is not an individual (but a corporation, or an LLC) may not receive a discharge in a chapter 7, but may receive a discharge entered pursuant to chapter 11.

Just because a debtor receives a discharge does not mean it cannot voluntarily repay the debt if it is so inclined.  While the debtor may not be under a legal obligation to repay it, it may desire to do so and the bankruptcy code allows it to.  A discharged debt cannot be revived, so one need to worry about only repaying a portion of the discharged obligation; simply paying a fraction toward the discharged debt does not revive the debt.

Now, the discharge simply discharges the debtor from having to repay the debt.  It does not affect any security interests a creditor may have in any collateral (such as a home or a car).  To alter the creditor’s security interest, the debtor must reorganize through one of the reorganization chapters (9, 11, 12, or 13) and have a reorganization plan confirmed by the bankruptcy court.  Therefore if a chapter 7 debtor discharges his home or car loan, the lender can still foreclose on the home or repossess the vehicle.  Hence the common inquiry from potential debtors: “Can I file bankruptcy and still keep my home? or car? ”  And typically the answer is: “Yes, you can.  If you are able.”

A discharge is automatically granted during the process of a bankruptcy proceeding.  And unless the court orders otherwise, all debts but those by code definition to be non-dischargeable will be subject to the discharge order….including car and home loans.  Thus, with regards to those debts, if a debtor takes no action after filing the bankruptcy petition, the debts will be discharged and car or home lenders will likely proceed with repossession or foreclosure.  However, a debtor can take affirmative action to except certain debts from discharge through a process called “reaffirming a debt.”  In a nut shell, this process involves the debtor and creditor signing a “reaffirmation agreement” in which the debtor agrees to remain liable for the balance owed on the car or home loan and the the lender agrees not to repossess the car or foreclose on the home so long as the debtor is not in default of the underlying loan agreement.  Essentially this allows the car or home loan to pass through bankruptcy.  The positive of this is that the debtor gets to retain the car or home.  Also reaffirmed debts will be disclosed on the debtor’s credit report, thus timely payments help improve a debtor’s credit post-bankruptcy.  The drawback is that should something happen to the debtor that prevents the debtor from paying the debt, the debtor cannot go back and use the discharge and a defense to having to pay the debt.  Additionally, a court will only allow a debtor to reaffirm a debt if the debtor can afford to do so; thus the debtor will need to show that even after reaffirming a debt it has still has positive income (at least $0.01) each month.

It is often espoused from the court that bankruptcy is for the honest, but unfortunate debtor.  Thus if a debtor fails to be forthcoming with information, or misleads the bankruptcy court, the trustee, or its creditors a debtor may be denied a discharge, or have his discharged revoked.  This is not something that any debtor wishes to have happen to him or her.  In such an event, the debtor can likely lose what non-exempt equity it may have and still be obligated on the debts it attempted to discharge in bankruptcy.  Further the debtor cannot go back to the court later in life and attempt to discharge the same debts.  Thus it is vital for a debtor to be honest and forthcoming with information about its financial affairs so to not risk the denial or revocation of a discharge (not to mention its a Federal felony to commit bankruptcy fraud!).

National Data Center (Chapter 13 Case Information)

The National Data Center is a non-profit outfit that assists  Debtors, Debtors attorneys, Creditors and Creditors attorneys by providing up to date information regarding the particular chapter 13 case in which the Debtor, Creditor, or attorney may involved.

This is a great service for both Debtors and their attorneys alike.  The process is rather simple and after 4 easy steps, a debtor has a plethora of information available to him at his fingertips.

Step 1:  Enter Your Case Information.  When signing up with the NDC.org, the Debtor will need his case information on hand.  The 341 Notice of Meeting of Creditors is really all that is needed as it contains the Debtor’s name, case number, trustee, and Trustee State.

Step 2: Security Questions.  All the Debtor needs to do here is answer a couple questions like, what is his mailing address? From a list provided, select a creditor of the debtor.  Rather simple if you ask me.

Step 3: Create an account.  This requires the creation of a username and password and the entry of an email address.

Step 4: Terms and Conditions.  In order to use this service the Debtor must accept NDC’s terms and conditions.

And by completing these simple steps, the debtor will have at his fingertips information like:

– payments received by the Trustee

– disbursements made by the Trustee

– amounts paid to particular a creditor

– funds the Trustee has on hand

– claims filed by creditors

….and much more.  Check it out for yourself.

The 341 Meeting of Creditors

It happens in EVERY case.  11 USC 341(a) provides that the US Trustee shall convene and preside at a meeting of creditors.  Typically in chapters 7 and 13, in Idaho at least, the US Trustee schedules the meeting of creditors and appoints a standing trustee to preside over the meeting; in a chapter 11, however, the US Trustee will convene and preside over the meeting.

In the Chapter 7 context, I see the Meeting having two primary purposes.  First, it is where the Debtor stands up and physically appears to support his bankruptcy petition and verify, or explain, its contents.  Second, it provides an opportunity for the Trustee to inquire into the breadth, or scope, of the bankruptcy estate.

With regards to the first purpose, this involves the Trustee verifying the Debtor’s social security number and a picture ID.  Subsection 341(d) also requires the Trustee to apprise the Debtor of:

(1) the potential consequences of seeking a discharge in bankruptcy, including the effects on credit history;

(2) the debtor’s ability to file a petition under a different chapter of this title;

(3) the effect of receiving a discharge of debts under this title; and

(4) the effect of reaffirming a debt, including the debtor’s knowledge of the provisions of section 524 (d) of this title.

This is basic, rudimentary stuff merely required as a formality for the US Trustee to verify the person at the Meeting of Creditors is the actual person who filed bankruptcy and the consequences of seeking a bankruptcy discharge.

The second prong of the Meeting has an entirely different goal:  $$$$$$!  The Trustee is looking for money…..well, non-exempt equity and avoidable transfers that she can convert into cash.

While the focus of the Trustee’s inquiry varies, it’s almost always geared assisting her in determining whether there is any non-exempt equity to liquidate for the benefit of your unsecured creditors, or any pre-petition transactions she can avoid (i.e., reverse).

The Trustee already has the information provided in the bankruptcy schedules and so her inquiry may be founded on that information.  The Trustee also has access to public records so she may inquire with the Debtor regarding any information she finds in her public record search that may be consistent or inconsistent with the information in the schedules.  Additionally, someone may also have tipped off the Trustee with insider information of the Debtor that the Trustee finds interesting (i.e., an ex-spouse or a disgruntled ex-business partner).

It is not uncommon for the Trustee to request documentation for her review prior to the Meeting of Creditors.  This may include, among other things, bank statements, promissory notes, deeds of trusts, security agreements, vehicle titles,  tax returns, divorce decrees, or pictures of assets.  Should the debtor fail to timely provide the requested information, the Trustee may continue the meeting.

In the Chapter 7 realm, this is usually the only meeting that the Debtor will attend during his case.

In the Chapter 13 context, there is a third prong to the 341 Meeting of Creditors.  Because a chapter 13 requires the debtor to pay into the plan all his disposable monthly income, the Trustee is behooved by inquiring into the debtor’s income and expenses going forward.

 

Property of the Bankruptcy Estate | Bank accounts

Client: Are the funds in my bank account property of the estate?
Attorney: Well….that depends.

It depends on whether the funds are the clients.  It depends on whether the client’s children’s funds are in a “UTMA” account labeled as such.  It depends on whether the client shares a bank account with another individual or entity.  It depends on whether the client has deposited his funds into the account.  It just depends on the facts and circumstances of the client’s particular situation.

But simply put, if the debtor deposits his wages in his bank account, which is his and his alone, then chances are yes, the funds in the account are property of the bankruptcy estate.

It is important to note that it is the funds in the bank account as of the Petition date that are property of the estate, not the funds in the debtor’s check register after all outstanding checks clear.  This is a big distinction. Granted it is not likely as much an issue nowadays with POS and ACH transactions so prevalent in our spending, but it certainly something the debtor must know when filing.

In fact, I bet Mr. And Mrs. Wolfe were not so aware of this little distinction when they filed their bankruptcy Petition.  In their case, they had timely filed their 2011 Federal income tax return on October 15, 2012.  They included with their tax return a check for $8,360, the amount of their 2011 tax liability; they had borrowed the funds from their acquaintance, Larry.  The IRS received the returns and deposited the check on October 19, 2012.  The Wolfe’s then filed their chapter 7 bankruptcy petition on October 22, 2012.  Then, on October 23, 2012, the IRS check cleared their bank account, debiting $8,360 from the account.

The Trustee subsequently sought from the debtors, the $8,360 they had in their bank account as of the Petition date.  (It should be noted that due to the source of the funds, a loan, there appears to be no applicable exemption for the debtors to claim to protect the funds from administration by the estate.)  The Debtors protested.  And Judge Pappas issued a written decision on the matter.

The Court held that the funds in the bank account became property of the bankruptcy estate the moment the Wolfe’s filed their bankruptcy petition.  That at that moment, they were still in control of the $8,360 in their bank account because they could have withdrawn all the funds in cash, transferred the funds to a different account, issued a stop-payment on the check, or close the account.  And that because they had control of the funds during the pendency of the case, they had a duty to preserve those funds and turn them over to the trustee if and when so demanded.

The last thing any debtor wants after declaring bankruptcy is the bankruptcy court issuing a $8,000 money judgment against the debtor.  So when attorneys and clients discuss the timing of a bankruptcy petition, the attorney needs to ask, and the client needs to advise, as to the status of any outstanding checks.  Though the check this case involved over $8,000, which may appear unusual; it is not uncommon for debtors to have mortgage payments upwards of $1,500 – $2,000 that may be outstanding.  It might just be better to wait until those checks clear before filing.  If waiting is not an option, then it is advised take out cashier’s check or money orders and mail those out prior to filing.

 

EDIT (1/10/2014):

The 9th Circuit filed an Opinion yesterday that affirms Judge Pappas’s reasoning in the Wolfe case.  In facts very similar to the Wolfe’s the issue was not whether the funds in bank account were property of the estate, but whether the defendant must have possession of property of the estate at the time the Trustee brings his motion for the turnover of said property.  In a rather short 13 page decision the 9th Circuit held that possession of property of the estate at the time the Trustee’s motion is filed is not necessary for the Trustee to succeed on the matter.  The Court opined that to hold otherwise would allow any defendant of such an action to simply transfer the property to avoid liability to the estate.

Property of the Bankruptcy Estate

**This article should be considered an incomplete article until further notice. The intent with this article is to establish a general article about property of the bankruptcy to which subsequent articles discussing the different specifics of property of the estate may refer. **

By definition, property of the bankruptcy estate includes: All legal and equitable interests of the Debtor in property as of the commencement of the case. 11 U.S.C. § 541(a)(1). When explaining this definition to a prospective client, I typically start with the paraphrase: Anything you can point to, whether you can see it or not, and say, “that is mine,” or “that should be mine,” or “that will be mine” is property of the bankruptcy estate.

The bankruptcy code broadly defines property of the estate with a few narrow exceptions. For instance one exception to property of the estate, found in § 541(b)(1), is any power the debtor may exercise solely for the benefit of an entity other than the debtor, i.e., a debtor’s fiduciary power under an express trust, or his managerial powers pursuant to his employment.

Whether an interest is property of the estate, at the moment the Petition is filed, is not left to the discretion of the debtor, trustee, or even the court. It is an objective determination based upon whether the asset falls within the definition in § 541(a).

There is often the question of whether a certain asset is property of the bankruptcy estate. While Federal law (i.e., Bankruptcy law) determines whether such asset of the debtor is property of the estate, state law determines whether the asset is property of the debtor.  So if state law recognizes the property being of the debtor, then Federal law will determine whether such property of the debtor is property of the estate.  Conversely, if state law does not recognize an asset as being property of the debtor, then there is no property of the debtor for Federal law to determine as property of the estate.

There is much to be discussed with regards to property of the estate.  And Debtors need to understand what constitutes property of the estate as their ignorance could put their discharge at risk.  When the debtor understands how broad the definition actually is, the debtor is better prepared for his bankruptcy.

Is that an Heirloom in My Room?

What is an heirloom?  Is a gift from Mom an heirloom?  What about a gift from Grandma?  What if the gift was simply an ordinary aluminum boat you could pickup at Cabela’s?

Well, there are two criteria that must be met for an asset to be deemed an heirloom:

1. the asset must be subject to multi-generational transfers, and

2. must possess unique characteristics that differentiate it from other similar items, such as antiquity, novelty, or history.

The exemption statute at issue here, Idaho Code § 11‐605, provides:

(1) An individual is entitled to exemption of the following property to the extent of a value not exceeding seven hundred fifty dollars ($750) on any one (1) item of property and not to exceed a total value of seven thousand five hundred dollars ($7,500) for all items exempted under this subsection:

* * * *
(c) Family portraits and heirlooms of particular sentimental value to the individual.

“An heirloom is “an item of property which has passed through at least one generation before it became property of the debtor.” In re Hearn, 97.1 IBCR at 22.  Stated another way, in order to achieve heirloom status, more than one generational transfer of the item in question is required.” In re Merrill, ID BK Case No. 12-40663-JDP, (Sept. 24, 2012).

“If this initial burden is met, the debtor must then show that the property has some characteristics of uniqueness that differentiate it from other similar items, such as antiquity, novelty, or history.” Id.

In the Merrill case, which only focuses on the first element, the Debtors’ son had purchased a boat from an aunt before he died intestate.  The Debtors took possession of the boat with the intention to pass it to their grandson when he reaches the age of majority.  Thus the boat really only passed from the Debtors’ son to the Debtors (the Court apparently did not consider the purchase of the boat a “generational transfer”).  So while this transfer between the Debtors’ and their son involves multiple generations (two), the asset must pass through at least one generation, not simply passed to one generation.  Thus at least 3 generations must be involved. 

“Even if this transfer from a descendant to an ancestor could be considered a passing of property from one generation to another, in the heirloom analysis, it represents but a single generational transfer, not the multi‐generational passing required by the case law in this District.” Id.

Thus a gift from Mom will not suffice as an heirloom.  I do not believe a gift from Grandma would suffice either – though I’m sure someone will try to argue that skipping a generation suffices as passing through it.

The two cases cited by Merrill appear to address only the first element, and not what constitutes sufficient “history” for an asset to have unique characteristics.  And I have not personally researched the issue, but I would surmise that if an asset satisfies the first element of an heirloom, then it likely has sufficient intrinsic history and sentimental value to meet the second element.  But again, that depends on the asset and the facts of each generational transfer – as I don’t think the issue is so clear with an aluminum boat Grandpa bought at Cabela’s 10 years ago and is now in the Debtors’ possession.

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