So many people buy into myths about bankruptcy with devastating consequences on their lives. This is a great report debunking five common myths:

In a prior post discussing dischargeability of a Dodge Durango Debt from a Divorce, I said that in the case, Howard v Howard, 2008-CA-001059-MR (June 12, 2009)(to be published) the Kentucky Court of Appeals addressed two important domestic support obligation issues. This post reveals that second issue.

As we saw before, Roy lost his argument that the deficiency judgment debt on his Dodge Durango was discharged through bankruptcy. As to his ex-wife Sondra, he remained responsible for the payments because it was agreed to and decreed through the divorce. That made it non-dischargeable as a domestic support obligation and so Sondra could pursue payment through contempt proceedings.

Now, Roy also had left a nice paying job as a federal prison guard claiming a medical reason. Apparently it was not a very good medical reason (or he failed to prove it up) because the trial court determined that his new employment at half his former wages was voluntary. Because it was deemed a voluntary reduction in pay, Roy was ordered to keep paying the same child support as before while earning half the amount of wages as before. He wouldn’t even be able to put gas in the tank of a Durango now.

In order to modify child support, the movant must show “a material change in circumstances that is substantial and continuing.” KRS 403.213. Judges have considerable discretion to decide whether a job change resulting in much less income is voluntary or involuntary. If it is voluntary then that person does not get a break on the child support.

But what if Roy really had a medical problem and could not longer work at the federal prison? Well, if his medical condition was legitimate, and it may have been, then there should have been a trail of documentation that was produced as evidence to the court. If Roy had that evidence, then he needed to pull it together and convince the judge. This is where it actually saves money in the long run to invest in having a good attorney. A good attorney would have either told Roy he was wasting his time because an ingrown toe-nail won’t convice the court, or she would have made sure the evidence was there.

Unfortunately, losing on the Durango Debt and losing on the reduction of child support did not end his very bad day. Roy also had to pay $500.00 towards Sondra’s legal fees. I mean no offense to any of my colleagues that may have represented Roy, and if Roy reads this I am sorry if it seems I am rubbing salt in the wounds, but had he invested in legal counsel knowledgeable in bankruptcy and family law, he could have saved a heap of money in the long run.

The Kentucky Court of Appeals just issued a decision directly related to family law and bankruptcy that shows why knowledge of both fields can be so important. In Howard v Howard, 2008-CA-001059-MR (June 12, 2009)(to be published) the Court addressed two important issues regarding domestic support obligations.

A domestic support obligation has a very broad definition under the bankrucpty code (11 USC 101(14A)) encompassing any debt owed to or recoverable by “a spouse, former spouse, or child of the debtor or such child’s parent, legal guardian, or responsible relative” including a “government unit”. This includes alimony (maintenance), child support, or other obligations arising out of a divorce or separation. The debt can be established through a separation agreement, decree or other order of the court. 11 USC 523(a)(15). For Kentucky Courts, it also includes a Dodge Durango debt.

In this case, Mr. Roy Shane Howard divorced his wife, but he agreed to, and was later ordered in the decree, to pay towards a deficiency judgment arising from the repossession of their Durango. The case does not say, but that repossession may have been the final straw that broke the back of their marriage. Some folks really love their Durangos.

Anyway, after the divorce, he listed this deficiency judgment as a debt in his bankruptcy and his ex-wife did not object to its discharge so he figured he no longer owed that debt. However, little did he realize that Kentucky Courts share jurisdiction with Federal courts to determine whether an obligation is discharged and the Court of Appeals wasn’t buying the argument that she had to object in the bankruptcy case. After all, the bankruptcy code declares such debts as non-dischargeable and spells out no special action required by the creditor.

This Court determined that Roy’s obligation in the divorce to pay part of the Durango deficiency was a domestic support obligation. While the bankrutpcy discharged the debt as to the original lender, it did not disturb his responsibility for the debt to Sondra, his ex-wife. In other words, the original creditor could not come after Roy for the debt any longer, but they could go after Sondra and Sondra could bring it right back around and get Roy for contempt in the divorce court. And that is exactly what happened.

So, if debts are an issue in a divorce proceeding, it is wise to plan carefully what will happen to those debts. Often, it is best for the each person to set aside the anger and honetly assess if they can pay those debts once the one set of living expenses becomes two separate households. If not, and they otherwise qualify for bankruptcy, then a joint bankruptcy may be the best option.

I said there were two important domestic support obligation issues, but I will save the other one for the next post.

Timing is very important when considering bankruptcy and during the tax season one aspect of timing is when to file in regard to when one will be receiving their tax refund. This is one of those fact driven determinations where no one answer can be given in a general post like this, so be sure to consult with an attorney about your particular situation. What is surprising to many, though, is that even though they have not yet received their refund check, it is an asset of a bankruptcy estate. This is because they have already earned the money prior to filing a Chapter 7. So, if one files a Chapter 7 today and then receives their refund next week, the trustee can take that money to distribute to creditors.

Here is where making a decision on filing gets a little more complicated. Each person has certain exemptions they can use to hold onto property and assets through a Chapter 7 bankruptcy. If you have sufficient left over exemptions to cover your tax refund, then it does not matter if you file before or after receiving it. However, if you do not have spare exemptions, but you still really need to file a Chapter 7 soon, then it would be best to try and get that refund before filing.

Now, it becomes important to use that refund money carefully to keep from getting on the wrong side of the trustee or the bankruptcy code. The guiding idea is to use it for necessities for your family and NOT to pull one over on creditors. You cannot use it to buy luxury items (there is a specific dollar amount limit in the code) and you cannot use it to pay one creditor over others. You can use it to buy necessities. For example, stock up on food stuffs and if your clothes are getting threadbare, get a few items of clothing but be REASONABLE about it. If you have children, get them some school clothes if they actually need them. Do not get fancy clothes – just basic items. In doing this, you are basically converting non-exempt cash into exempt personal property. You could also use the refund to pay for the bankruptcy. AGAIN: Consult with an attorney regarding your particular situation and plan and do not blindly apply these general principles to your particular situation because there are limits to personal property or household items exemptions.

Adoption can be an expensive proposition and I have been asked on occasion if a person can do their adoption pro se (on their own and without a lawyer). Actually, this question tends to come up in family law matters in general far more than in other areas of law. I hear this question about self-representation even less often in bankruptcy where folks clearly are in dire straits financially. My response is typically yes, you can but . . .. Then I relate to them a show I saw on Discovery or TLC about a man who was out hiking and became trapped when a boulder rolled onto his arm. He would have died out in this ravine had he not amputated his own arm with a pocket knife (the tv show assured me this was a true story). Anyway, in this graphic and slightly grotesque story the man did what he had to do to survive, but it had to be exceedingly painful and extremely messy. Representing oneself in a family law matter can be just like that: exceedingly painful and extremely messy.

That answer seems to ring intuitively true for people in divorce situations, but many assume that since an adoption is a happy occasion and that judges love putting families together rather than tearing them apart, that one could handle it without a lawyer. The contrary is actually true. In the recent Kentucky Court of Appeals decision R.M. v. R.B., 2008-CA-001099-ME, (2009, to be published), the Court reminds us that “[b]ecause adoption is a statutory right, Kentucky Courts require strict compliance with the statutory procedures to protect the rights of natural parents.” The statutory framework for adoption contained in KRS 199 has many “if, then” kinds of provisions requiring careful navigation even by seasoned adoption attorneys. Because of this strict compliance requirment, adoption is the least likely area of family law where one should proceed pro se. At the very least, consult with an attorney that is knowledgeable in adoptions to see if there are any “boulders” in your particulare situation that need to be dealt with.

Here is a classic video from Saturday Night Live (NBC) (posted by danwho.net) that succinctly answers the question I’ve posed in the title of this post. Caution, if you are still feeling a little sensitive about your financial state, you may feel offended – but it certainly is not offered for that purpose. Also, while the video clip offers sage advise, it over simplifies many peoples’ dilemma. They did not get to the place of needing bankruptcy because of being irresponsible. Most people I talk to, the debt crept up little by little over time for reasonable things but then some unexpected event occurred that made the debt uncontrollable. Regardless, this clip is a funny reminder that bankruptcy does NOT cure financial problems; it only gives a fresh start that allows you to make the necessary lifestyle changes. This is extra important after a bankruptcy because, after filing a Chapter 7, you cannot file a Chapter 13 for four years and you cannot file another Chapter 7 for eight years. With no other relief in the immediate future, you either follow the advise from the clip or sink.

H.R. 200, the Helping Families Save Their Homes in Bankruptcy Act of 2009, offers hope for distressed homeowners and is currently pending a vote by the House of Representatives. One of the most useful provisions of this bill, found in Section 4, would allow for judicial modification of loans mortgaged (secured) against ones principal place of residence. In fact, this bankruptcy tool could prove powerful enough to allow many to avoid filing Chapter 13 in order to save their home.

Currently, banks and other lendors have little incentive to renegotiate their loans with homeowners because they know that such secured home loans are not modifiable within bankruptcy. That is to say, if you are like most distressed homeowners your income is too high for a Chapter 7, your home is your largest debt, and your are thinking about a Chapter 13 primarily to save your home. Once in the Chapter 13 you are bound to the same terms on your home loan as got you into trouble before bankruptcy. So, negotiating with a lendor secured on your home pre-bankruptcy is much like David walking up to Goliath but without his sling and stones – all David can do is ask “pretty please” while Goliath just rolls over top of him. Sure, there have been some lendors who have offered short term accommodations for homeowners in trouble, but these accommodations have done little more than buy a few months reprieve against the inevitable foreclosure.

H.R. 200, on the other hand, puts that sling and stones back into David’s hands. If it becomes law, then lendors will be forced to calculate what terms they will end up with if the homeowner goes into bankruptcy and thus, it will make them more prone to negotiate terms to allow the homeowner to avoid bankruptcy. H.R. 200 would allow a home loan to be modified in substantial ways: 1) adjustable rate interest can be frozen during the repayment plan, 2) adjustable interest rates can be converted to a fixed rate, 3) the length of the loan can be extended by a number of years, and most importantly 4) allow for the secured part of the loan to be repaid while loan amounts over the value of the home are stripped down (treated as unsecured debts). One other substantial benefit to this legislation is Section 5 which limits fees and charges that can accumulate on the loan during bankruptcy.

I refer to the fourth item from Section 4 as “most important” because it directly impacts situations where the principal balance on loans secured by the house is greater than the value of the house itself. In days long past, one rarely saw this kind of “upside down” debt because lendors would not extend credit beyond the value of the home and home values generally rose each year. More recently, lendors loaned beyond the value of the homes and many home values have subsided. Without H.R. 200, a person entering Chapter 13 with a home valued at $100k but debt secured on that home of $125k would have to repay $125k. With H.R. 200 as law, he or she would only have to repay $100k and the remaining $25k would be treated as unsecured debt and potentially discharged at the end of the Chapter 13 plan.

Since lendors would know these various modifications would occur if the homeowner filed Chapter 13, you can imagine they would be inclined to cut a deal that preserved more of their interest but still made life feasible for the homeowner. One could argue that if the overhaul of the Bankruptcy Code in 2005 had not taken away that ability to “strip down” secured home loans, we might not be facing such a huge foreclosure crisis today. Home loan banks and other lendors are opposing this legislation and so it is crucial that you let your Senators and Representatives know where you stand on this bill.

When faced with bankruptcy, people hate to turn away from family that have helped them. The natural and common thing to do is try and repay those family members instead of other debts or to protect family assets by giving them away. This very human reaction may be understandable, but under the law it is not forgivable. Such transfers can create real problems for yourself and for the family you were trying to help.

The bankruptcy code provides for a trustee over a Chapter 7 estate to go after assets transferred prior to the filing of a Chapter 7. These transfers can take the form of favorable repayment of one (or some) debts over others or in the form of a gift. A favorable repayment may constitute a “preference” and a gift may qualify as a “fraudulent conveyance (or transfer)”. When the person receiving the preferential payment or the gift is a family member, the bankruptcy code is especially tough. The trustee can go after preferences made up to a year prior to the filing of the bankruptcy if made to an “insider”. Family members are insiders by definition. Trustees can go after fraudulent transfers (gifts) to insiders made two years prior to filing under the bankruptcy code. However, one cannot rely on that two year period because the bankruptcy code also has a “strong arm” provision that allows trustees to use state law to go after preferences and fraudulent transfers. In Kentucky preferences are treated the same, but the reach back period for fraudulent conveyances to insiders is five (5) years prior to the filing date.

Two situations recently came to me that point out the need for caution. In the first situation, a person borrowed from a close relative to put into a business. They intended to pay this relative back in a lump sum from a retirement account, but then it began looking like a Chapter 7 might be imminent. This would have created a double impact: first, exempt funds that would have ridden through the bankruptcy would have been converted to non-exempt funds and second, the trustee would have pulled that large lump sum payment back into the estate from the relative. From those reclaimed funds, the trustee would pay himself a percentage and the rest would have gone to unsecured creditors. This is a good example of a preferential payment within a year of bankruptcy to an insider. The retirement would be gone and the relative would remain largely unpaid (they would be treated the same as any other unsecured creditor and recieve cents on the dollar).

The second situation involved a person who had racked up considerable unsecured debt and had their personal residence secured to the hilt, but they owned several acres in another state free and clear of any lien. It was important to this person to retain the out of state land because it contained a family cemetary. They wanted to give the land to someone else to keep it in the family. Unfortunately, this would have been a fraudulent conveyance and the land would be taken and sold by the trustee with proceeds going to unsecured creditors. The cemetary itself would likely be protected and the family could still access it, but ownership of it and all the surrounding acreage would leave the family. With a five (5) year reach back in Kentucky anyone would be hard pressed to plan for hard financial times well enough to preserve such an asset, but this example highlights the importance of sitting down with a bankruptcy practitioner who will help devise a comprehensive plan. In this scenario and with other factors beyond the limits of this posting (such as the age and health of the debtor), delaying bankruptcy by using this land as collateral to obtain enough funds to live on would be a wise alternative.

In my last post I discussed a general strategy for going further into debt in the event of a crisis such as lost employment or major illness. I want to clarify that the intent is not to figure out how to “trick” the system; rather, the intent is to be shrewd in surviving tough times. While some folks will misuse the suggestions, my hope is that honest folks, who want and plan to repay their debt if possible once they get back on their feet, will use the information to plan for worst case contingencies.

Given that preface, another temptation to avoid during tough times is raiding retirement accounts to make ends meet. Much like the strategy of maximizing your homestead exemption, leaving retirement accounts intact maximizes your assets across a bankruptcy. In a Chapter 7, retirement funds, such as a 401k, are exempt and so you emerge after the discharge with your retirement whole. Taking funds out (unless you meet qualifying events such as age, etc.) not only converts exempt funds into non-exempt, but you will also likely incur a ten percent (10%) federal tax penalty for early withdrawal. So, if you have unsecured credit available to you during a crisis, it is best to use that resource to pay for necessities than dipping into your retirement.

It is human nature: we often wait until the last possible moment (or later) to seek help we need. This goes for medical issues, retirement planning, home repair, etc. It is doubly true for legal matters. This is unfortunate because lawyers can be so much more effective (and less expensive) acting preventively rather than reacting to a crisis. Consulting an attorney practicing in bankruptcy law can benefit one whether filing is imminent or a distant possibility.

One example of the benefit of a proactive use of an attorney is evident during tough financial times. Many people are experiencing layoffs in our present economy. During these times, it is tempting to dip into retirement savings despite tax penalties or deplete one’s home of any remaining equity. While these offer lower initial costs of obtaining financing compared to higher interest credit cards, they may be incredibly costly in the long run.

An individual in Kentucky can claim up to $20,200.00 in a homestead exemption and a married couple can claim $40,400.00 in a Chapter 7 bankruptcy. So, if you have much more than that exempt amount in equity in your home, it is smart to obtain a loan secured on your property to make ends meet while searching for work. However, if possible, you do not want to borrow past that exemption threshold. For example, if you are married and your home is worth $150,000.00 and you owe $80,000.00 on it, you could borrow up to $30,000.00 more secured on the residence to live on, but it might be better to use higher interest credit cards beyond that. By doing so, you have your house sufficiently mortgaged to make it nearly certain that you can reaffirm on those loans in a Chapter 7 and thus keep your house. Also, you have maximized the amount of equity you can exempt and have at your disposal after the Chapter 7 is filed. The unsecured credit would then be discharged.

To make sure this is kept in perspective though, you must be able to afford the payments on the loans secured by your house subsequent to a Chapter 7 filing for this to work. You also do not want to run up debts on luxury or fluff items – this strategy is for the necessities of food, clothing, shelter, and medical care. Of course, this is a strategy for temporary events beyond your control, such as being laid off or suffering a major injury, where you expect things to turn around in a matter of several months. Because of all these complexities, the general suggestions I am offering need to be applied to your specific situation. The facts in your situation may call for a very different strategy so it is worthwhile to invest in preventive legal counsel.