Here I am dead and my ex-wife (ex-husband) got all of my retirement!?

It is common for a Separation and Property Settlement Agreement to be reached in a divorce situation where retirement benefits are divided up. When one spouse’s retirement is split up and a portion is given to the other spouse, family law practitioner’s know that a Qualified Domestic Relations Order (“QDRO”) is required in addition to the agreement document. However, due to off-setting of funds, one spouse generally has a retirement account that remains unmolested and sometimes each spouse keep their retirement wholly as their own through negotiations. In this latter situation, a QDRO is not required and so they are rarely prepared and entered with the court and the plan administrator. A recent Supreme Court of the United States (“SCOTUS”) decsion, KENNEDY, executrix of the ESTATE OF KENNEDY, DECEASED v. PLAN ADMINISTRATOR FOR DuPONT SAVINGS AND INVESTMENT PLAN et al., Decided January 26, 2009(available here at Findlaw) points out the danger assuming the divorce’s settlement agreement wraps up loose ends regarding retirement accounts.

In the Estate of Kennedy case, Husband and Wife entered into an agreement where Wife gave up her interest in Husband’s savings and investment plan (“SIP”) that was governed by the Employee Retirement Income Security Act of 1974 (“ERISA”). The divorce was granted and the settlement was accepted by the courts. Husband’s attorney did not see the need for a QDRO and Husband assumed that was that and never changed his designation of beneficiary with the SIP administrator. When Husband died, the SIP administrator disbursed the remaining funds to ex-Wife. Everybody else got a bit peeved over this and sued in Federal District Court because it involved a question of federal law under ERISA.

Without getting too far into the analysis, SCOTUS decided to keep things simple and straightforward for plan administrators: either you do a QDRO or you change your beneficiary. The plan administrator is to look to the documents of the plan under ERISA to determine where the money goes avoiding complicated inquiries into a person’s intent. While a QDRO is an exception to this that could require the administrator to look outside of the plan documents, such an inquiry would be limited.

The lesson here is that if your are able to keep your retirement accounts intact through a divorce, you cannot rely on the divorce settlement agreement to direct those funds upon your death. You must either change your designated beneficiary, or have a QDRO entered – changing your beneficiary is by far the simplest and least costly of those options. Family lawyers need to provide their clients with follow-up directions at the end of a divorce to tie up loose ends such as changing beneficiaries for retirement accounts.

Justifying additional rent to pass the means test

To file a Chapter 7 bankruptcy (where your unsecured debts and secured debts where you are giving up the collateral are discharged), one must “pass” the means test. The means test is for persons who have primarily consumer debts (as opposed to business debt) and it can be passed in two ways. The easiest way to pass the means test is to have a household income for your family size that is less than the median for the region in which you live. For example, for a family of four (two parents and two children) in Kentucky, the median income right now is $63,097.00. If your family income is less than that then you can file a Chapter 7 without a presumption of abuse arising.

The other way to pass the means test, if your income is higher than the median, is to go through and show what secured debts on property you wish to keep are costing you and to claim various other living expenses. Many of the expenses are standardized for each region in the IRS guidelines. If after going through the math your disposable income is over $167.00 per month, the presumption of abuse arises (there are some wrinkles to this that I won’t get into right now, but if your disposable income is under $100.00 then you are pretty safe).

There are some other complexities to this that I mention here, but I will save the details for other posts. First, it is not completely accurate to say you have to pass the means test to file a Chapter 7; one can always file a 7 but if you do not pass the means test, then there is a presumption that your filing is an abuse of the bankruptcy system and you will have to prove otherwise to remain in the 7 and receive a discharge. Second, whether or not your debts are primary consumer debts can be an issue to argue in court. Third, who gets counted as being in your family or not is not defined in the bankruptcy code. Fourth, there are a number of issues about secured debts that need to be explored. Lastly, whether you file jointly with a spouse or as an individual can also have a bearing on filing. Given those
variations that need closer attention, the basic idea remains that if you pass the means test, then you can file a Chapter 7 and most likely get debts discharged.

The Bankruptcy Code and the means test does allow for “Other Necessary Expenses” to be claimed. 11 U.S.C. 707(b)(2)(A)(ii). One couple attempted to use this provision to claim a rent expense of $1,500.00 which was $658.00 over what the IRS quidelines stated. In re Shinkle, 382 B.R. 85 (Bankr. E.D. Ky. 2008). Unfortunately, the Shinkle’s made over $83,000.00 for their family of two and so they could only pass the meanst test if they could justify this additional rental expense. They attempted this by arguing that Ms Shinkle had to live in Boone County, Kentucky due to her work, that they planned to purchase this home once they obtained financing, and that they had been a family of four until recently and it would cost too much to move. The United States Trustee did not agree and argued that they simply wanted to live in a more expensive place and shift the cost to their creditors. In this instance, the Trustee won and the Shinkle’s either had to convert to a Chapter 13 or have their bankruptcy dismissed.

The case, In re Shinkle, does give some illumination to the kinds of additional rent expenses that might count. The Court mentions a Colorado case, In re Scarafiotti, 375 B.R. 618, 631 (Bankr.D.Colo.2007), where additional living expenses were justified because the debtor’s child had mental health issues that could best be addressed in a particular school. Another case the Court points to was In re Graham, 363 B.R. 844, 847 (Bankr.S.D.Ohio 2007) where the debtor husband had to move hundreds of miles away for employment, but debtor wife had to remain behind due to custody arrangements with her other children. Bascially, the bankruptcy courts are going to look to for some really special circumstance, such a serious medical problems or some other very unusual happenstance, to justify additional rental expenses in the means test. It cannot be the sort of scenario where the debtors have some readily available alternative, but choose to stay where the rent is higher due to personal preference or to avoid inconvenience.

Philosophy of practice in bankruptcy

My philosophy of practice comes through in most of my posts. Sometimes I am more direct about it like in this post on why I am a counselor at law rather than an attorney at law. As my practice in bankruptcy law grows, I thought it timely to express a few direct thoughts regarding my philosophy of practice in this area. As I alluded to here, I want to help decent, hard working people overwhelmed by debt get a fresh start. I also want to help people who have dug themselves into a hole, but who wish to learn how to live lean in the future. Conversely, I do not want to enable people with harmful habits to continue in a cycle of debt. To that end, I practice differently than many high volume consumer bankruptcy lawyers.

When you call to get assistance, you will talk to a lawyer rather than support staff. It will be either myself of one of the other two attorneys in the firm. This does mean a little bit of phone tag occurring, but it is worth the extra effort. When you come in for an appointment, you will meet with myself or the other attorney you spoke with at the firm. We will talk about your situation and you will get actual feedback about your overall circumstance and the best approach. Of course, once the detailed information comes in, some revisions to the plan will occur, but you will hear about those revisions from an attorney rather than a secretary or paralegal. When you go to court, you will already be familiar with the attorney who will be there with you and he will have prepared you for what is going to occur.

This contrasts to many bankruptcy specialty firms in that most of your interactions in those firms is with support staff. In some situations, you may not even meet with the attorney who will represent you until the meeting of creditors. This raises the question of how we can do this when our competitors are maximizing low cost support staff. I can answer that question easily enough: we charge a bit more than those firms. The fee is not so much higher that you will notice the difference, especially since the attorney’s fees are a drop in the bucket for the amount of debt that will be irradicated, but you will feel the difference of personal attention as you go through the process.

That brings me to the second way my philosophy of bankruptcy practice expresses itself. We plan from the very beginning for you to achieve a discharge. For Chapter 13s, we plan from the start to have a plan of repayment that gets approved and works. You will find some few practitioners that are more concerned about having a high number of filings and less concerned with the end result. We are concerned about the end result, and would rather do fewer filings. We care about this because it is the right thing to do and because it is a good way to do business. That is to say, it will bring more wealth to us in the long run than doing a high volume business.

One indirect consequence of our approach is that we may lose or even turn away business. This is similar to what happens in my family law practice and divorces. So many people get divorces believing it will improve their life and make them happier only to discover they brought their problems with them into a new relationship (that is not to say there are some egregious behaviors that warrant such a drastic step as a divorce, only that it rarely solves most of the issues). The same is true with bankruptcy. Getting the fresh start will bring only momentary relief if the same lifestyle and practices that contributed to the financial crisis continue (again, some situations are the result of sudden, unexpected job loss or a medical crisis and do not reflect harmful habits). So, in both circumstances, I counsel those seeking assistance in steps to take to address the root issues rather than just getting the decree or the discharge (and no, I do not mean that I give therapy sessions; just practical insights to ponder and sometimes I might encourage one to seek out therapy). Of course, some people only want an attorney to just get the job done, much like one wants a plumber to just unclog the sink. Of course, your sink may just get clogged again if you do not listen to your plumber’s sage advise about what not to put in that sink. If that is your inclination though, you would be more comfortable going to one of the high volume firms.

Learning to live lean

Bankruptcy is certainly an option when one lands in a bad spot due to unexpected life events. In fact, it is better for society for such a person to use the bankruptcy system to get a fresh start and become a productive citizen again relatively quickly rather than be dragged through a series of disheartening collection actions. However, bankruptcy does not really help those persons who do not learn from their economic woes how to live leaner. A tiny minority of people used Chapter 7s followed immediately by Chapter 13s and then began that process again as soon as possible to basically live off of credit for as long as possible. This tiny number of persons lead to reforms in the bankruptcy code that kept one from filing a Chapter 13 until four years after filing a Chapter 7 and prevented a repeat Chapter 7 for eight years. It also lead many to feel ashamed or embarrassed to file bankruptcy. For those who make no changes in their spending practices, the fresh start of bankruptcy will be short lived and they may end up in worse shape because of the timing limits for filing again.

It is those persons who feel embarrassed that I most want to help, because they are likely to learn to live lean to avoid ever being in that predicament again. They are the people who call and are most concerned about whether their name will be in the paper. They want to live within their means, but the costs of living crept up on them or some crisis precipitated unmanageable debt. For them, they can start living within their means if only that can break out of the bondage of overwhelming debt first.

One example of living lean is described in this post about cable television bundled with phone and other services: “Personal Soap Box”. While the post indirectly refers to cutting costs, it is helpful in explaining one way that a deal that sounds cost saving in the beginning can end up costing more in the long run. It also indirectly reminds us that cable television is not a necessity of life; cable TV is a luxury, not a utility like we have been trained to believe.

Bankruptcy is not something to be embarrassed about for basically responsible adults. The numbers of those who will be filing bankruptcy is going to grow larger and larger over the next year and most of those people are folks who wish to honor the debts they incur (as I pointed out in this post, the Jubilee system was a precursor of modern bankruptcy). Bankruptcy is merely the most efficient way for society to address overwhelming debts and keep such people as productive members who can continue to be consumers of goods and services, thus keeping the economy rolling along. But, especially in today’s economy, we must all be determined to live leaner and, if necessary, allow the bankruptcy system be our teacher.

SMALL BUSINESS OWNERS: Backed into a corner

The economic situation we face have hit small business owners broadside and many are scrambling to figure out how to get relief. Developers who specialize in building upscale homes are particularly troubled by this recession. Although home sales in the Lexington and Bluegrass area remain more stable than much of the country, folks appear to be shying away from building those half-million to million dollar abodes. These builders are proving especially vulnerable to what I describe below because they rely so heavily on secured loans. However, other small businesses are finding themselves in the same circumstances. The vulnerability of which I write is having one’s personal residence secured against primarily business loans.

Here is the general scenario which appears over and over again: Small Business Owner (SBO) goes to the bank to get a loan to either purchase a business or purchase a new asset, such as land to develop. The bank is glad to lend money to SBO after looking over the business proposal and sets up a time to close the deal. SBO drops by the bank and is told, by the way, granting this loan is contingent upon SBO giving their personal guaranty on the loan AND granting a security interest against their personal residence for the full value of the loan. Now, not all banks wait until closing to announce this, but a few persons I have talked with stated they had no idea they would have to put their own house up until they showed up at the bank. At that point, the whole business deal was dependent on getting that loan soon. Due to time constraints, SBO acquiesces to the security interest. “After all,” they think “the debt is primarily secured by the land owned by the business which will increase in value.” And there is the kicker.

Land values have not been increasing and so many of the loans are “under water”; that is, the land providing the primary security interest end up bringing less than the amount of the loan. The SBO faces having any excess debt of that business loan remain against their personal property. As the banks know, now the SBO cannot simply let their business fail while remaining safe in their home; they must navigate the personal debt gauntlet as well. Has their income been low enough to file a Chapter 7? Do they have sufficient income to even qualify for a Chapter 13, and if so, could they fund a plan? Could they afford a Chapter 11 and would it bring the relief they need peronally? Throughout all those considerations the main question is: can I keep the home that I have worked so hard for so that my family has a home?

Unfortunately, there is often no clear course where I can confidently tell them that, “yes, you will keep your home.” If they have a primary debt that secures the home close to the allowed homestead exemption (currently $20,200.00 per person; $40,400.00 for a married couple), and their income is low enough, then they may be able to reaffirm on that home purchase loan and strip off the business debt. It is a different analysis if the business debt is secured first against the developed lot and secondarily by the builder’s personal residence which would otherwise have over $100k in equity. That means they have far too much equity for a Trustee to ignore when the debt securing so much of it is contingent. In other words, depending on the value of that developed lot, they may have $100k in equity or they may have zero equity and anything in between. Those details often do not become defined until after the bankruptcy has been initiated. They could attempt a Chapter 13, but their plan must still show that the unsecured creditors would do just as well or better than in a Chapter 7.

There are a few points I wish to highlight with the scenario I have briefly outlined: 1) Do your best, if you are a SBO, to avoid letting your personal residence secure a business loan; 2) If you do not have the clout or leverage to avoid using your residence as collateral entirely, negotiate limiting the amount of the personal guaranty to a manageable level if your business did fold; 3) Consult with an attorney, preferrably one familar with bankruptcy law, before signing on the dotted line any deal that directly involves the assets of your family; 4) Remember that bankruptcy can be far more complicated for a Small Business Owner, so if you find yourself facing a debt crisis, seek out an attorney that will meet with you personally and discuss all aspects of your financial and family situation. Pre-deal planning with an attorney is so much more cost efficient than bringing one in after the crisis.

Timing of Chapter 13 after a Chapter 7 Bankruptcy

The Sixth Circuit Court of Appeals clarified a timing issue related to filing a Chapter 13 following the filing of a Chapter 7 (some used to refer to this as a Chapter 20 super discharge). The bankruptcy code requires four years to pass between filing a Chapter 7 and then getting a subsequent discharge in a Chapter 13, but the question has been whether the four years is measured from discharge date of the 7 to the filing date of the 13 or the more generous filing date to filing date. The Sixth Circuit has declared it to be from the filing date to filing date.

A debtor cannot discharge their debts in another Chapter 7 for eight years after an initial Chapter 7. In Kentucky, as the Sixth Circuit’s decision implies, one measures this from filing date to filing date and disregards the discharge date.

Now I want to highlight a subtle point: the bankruptcy code prevents there from being a discharge in a Chapter 7 or a Chapter 13 if that bankruptcy is filed within the timeframes outlined above. The code does not prevent a debtor from filing another bankruptcy. This this means that if you file Chapter 7 and receive a discharge of debt and then get behind on your houseparent three years after the filing date of the 7, you can file a Chapter 13, but you will not be able to receive a discharge of debt. Some debtors use this as a means of buying some breathing room to catch up on their house payments. Whether the filing of a Chapter 13 for such a purpose constitutes a good faith action is a topic for another post.