Kentucky Bankruptcy Law

Counsel with Care

Keeping the Homestead Safe in Bankruptcy: Chapter 7

This post will only apply to a narrow segment of people forced to consider bankruptcy – those who have a bunch of equity in their house along with a hefty debt in which their spouse does not have liability. Most often, this would be an entrepreneur whose business venture took a downturn.

I have discussed previously how Chapter 13 is a great mechanism for preserving one’s house if there are arrears to be dealt with or if there is excess equity beyond what can be covered by a homestead exemption. However, Chapter 13 is not for everyone. There are debt ceilings in a Chapter 13 that can operate to knock out business people who have personally guaranteed large amounts of unsecured business debt or even larger levels of secured debt. There also needs to be a somewhat predictable income upon which to base the budget and plan payment. This makes Chapter 13 difficult for people who may go months at a time without income due to the way their employment is structured, such as an entrepreneur.

Going into a Chapter 7, though, with excess equity in one’s house can be dangerous. Excess equity exists if there is a substantial value to the house even after subtracting the secured debt on it and the exemptions available. You see, a Chapter 7 trustee only makes about $60.00 per case unless they find non-exempt assets they can liquidate and distribute to unsecured creditors. The trustee gets a percentage of all such assets.

This brings us to the strategy that relies on a number of “ifs” being true. This strategy can be helpful (though certainly not a panacea): 1) If the Debtor is married and their spouse is NOT also indebted on the majority of debt so that they do not have to file also, 2) If the husband and wife share the home as tenants in the entirety (the deed gives then ownership “for their joint lifetimes with the remainder in fee simple to the survivor of them”), and 3) the Debtor has some exempt or non-estate resource to make a lump-sum offer to the trustee. The strategy is simply to go into Chapter 7 bankruptcy as an individual and then hope your spouse outlives you or you can make a deal with the Trustee.

The Trustee can seize non-exempt assets of the Debtor and liquidate them in a Chapter 7, but they must do this liquidating under state law. Kentucky law only allows a creditor (or Trustee) to sell the expectancy interest of a Debtor in real estate that they own as tenants in the entirety with a non-debtor spouse. The expectancy interest is that if they outlive their non-debtor spouse, then they have the entire undivided homestead as their own, but if their spouse outlives them then there is nothing – the entire undivided homestead goes to the surviving non-debtor spouse. So, the question becomes: “How much would someone pay for a chance that the non-debtor spouse dies first?” That amount, whatever it may be, is the actual value that the trustee would receive in selling the Debtor’s interest in the house.

In other words, a home owned in the way I described by a husband and wife cannot be stripped away from the non-debtor spouse. He or she is entitled to all of that home concurrently with the Debtor; it cannot be divided. A creditor cannot even get half the rents, if there were any. They can only obtain that expectancy – that chance that they may get it all. Because of that, many Trustee’s would be open to a reasonable lump-sum payment from the Debtor to retain their expectancy interest rather than risk coming up with a goose-egg by trying to sell what essentially amounts to a lottery ticket on the court house steps.

December 22, 2014 Posted by | Alternate Debt Relief, Assets, Bankruptcy, Business debt, Chapter 13, Chapter 7 | , , , , , , , , , | Leave a comment

Overcoming a “Presumption of Abuse” in Chapter 7 Bankruptcy

Overcoming the “presumption of abuse” in Chapter 7 bankruptcy is not always as daunting as it may sound. In order to qualify for an individual Chapter 7 one either must have predominantly business debts or qualify for it under a “means test”. The means test essentially looks at your household income for the six month preceding the month in which the bankruptcy is filed. Certain things can be deducted out of that income as well as certain standardized costs of living. Once the information has been run through the formula, a potential debtor either falls under the median income for their household size and state of residence, thus qualifying for a Chapter 7, or it does not.

One might be tempted to think that failing to fall under the median income is the end of the story and they cannot file a Chapter 7 (they almost always can still do a Chapter 13). This is true for the majority of persons where the presumption arises. However, it is not automatically the end of the analysis that your bankruptcy attorney should engage in. They need to also explore any changes in circumstances that would justify going into the Chapter 7 anyway.

So, having an income above the median only creates a “presumption” that doing a Chapter 7 would be abusive of the bankruptcy process. This presumption can be overcome by a showing of a change of circumstances. For example, a sudden change in one’s health could decrease the current income or increase health costs that can be deducted from that income. Such a sudden event may not show up in the means test results for months since one is looking at a six month snapshot but, one may not be able to wait that long to file.

The way to overcome that presumption of abuse requires your attorney to prepare two extra documents. First, they should prepare a sworn statement for you to sign (an affidavit) that explains the change in circumstance that justifies overcoming the presumption. Second, they should prepare a mock means test showing what that change in circumstances would look like over time. These can be filed  concurrently with the petition.

The United States Trustee would look at these extra documents and make their own determination whether to pursue dismissal of the Chapter 7 or decline to pursue it. Even if the US Trustee declines to pursue the presumption of abuse dismissal, individual creditors could still pursue it, though they are unlikely to do so.

November 19, 2014 Posted by | Bankruptcy, Chapter 13, Chapter 7 | , , , , , , , , , , , , , | Leave a comment

The danger of short term loans on your house

You home is an incredible source of collateral for loans when there is equity (value minus debt secured against it), but there is also danger in using your home this way. There are still lenders who will do rather large, short-term loans secured against a private residence. These loans can be tempting because they often will provide for relatively low-interest loans. However, they can be dangerous. especially when they are balloon loans. Such loans are seductive because they have low monthly payments with a final huge payment due at the end.

I have seen these often used by people trying to get a business venture off the ground. However, people sign up for them for many reasons. The business folks are essentially betting on having a solid and very profitable business going in three to five years. I admire their confidence, but most businesses that survive take three years just to start making a modest return. And so, many find their balloon payment looming without adequate resources to cover the debt. Sometimes banks will roll it into a new loan, but there is no guarantee of this. Therefore, it is wise to talk to a lawyer who knows about bankruptcy prior to that maturity date.

Banks like loans against your personal residence because the revisions to the bankruptcy code back in 2005 gave special treatment to loans secured solely against one’s residence. Basically, 11 USC Section 1322(b)(2) prevents such loans from being modified in a Chapter 13 bankruptcy. Therefore, the only thing one can do is cure the arrears through the bankruptcy, but the underlying agreement remains intact. There is a nice little exception, though, found in 11 USC Section 1322(c)(2) for loans that come due DURING the Chapter 13. So, if one times things right and files a Chapter 13 BEFORE the last payment on your short-term loan is due, a Debtor CAN modify that loan to some extent.

The most likely use for this exception is to move the maturity date of the loan out for the duration of the Chapter 13 plan and thus provide for the cure of arrears on that loan. The Debtor still has to show that the lender is adequately protected, but that hurdle is usually overcome easily with real estate that is either holding its value or increasing in value. This is NOT a complete remedy, but it can buy more time for a Debtor to either find alternative financing that has no balloon payment or make those profits they hoped for that would cover the debt.

September 9, 2014 Posted by | Additional Debt, Adequate protection, Bankruptcy, Chapter 13, Financing, Foreclosure, Home Loan Modification, Home loan modifications, Plan, Plan payments, Planning, Pre-filing planning, Secured loan arrears, Security interests | , , , , , , , , , , , , , , , | Leave a comment

I cannot pay my bills, how can I afford an attorney?

Times remain tough all around despite signs of recovery. It is always true that folks looking to file Chapter 7 or Chapter 13 bankruptcy have a hard time affording legal help for the process. This has become even more difficult in recent times. This can often be worked around in a Chapter 13 where some attorney fees can often be paid through the plan itself. However, in a n0-asset Chapter 7 if attorney fees are not collected up front then they are discharged with every other unsecured debt.

Often, Debtors have continued paying debts that will be included in the bankruptcy and discharged. So, if time permits before filing, those funds can be directed instead toward attorney fees. It can also help to pay the court filing fees ($306) in four installments rather than all at once. This works because the court has the power to dismiss the Chapter 7 if all fees are not paid whereas attorney fees are not protected by the power of the court.

I have also taken the step of reducing my Chapter 7 attorney fees down to rock bottom while still providing all the same services. I have not done a formal survey but I suspect that if folks call around they may find someone who will quote less. However, I was recently told by one client who had called around that my fees were the lowest. I doubt it, but that is beside the point. The point is finding someone you trust and who will see you through the process of the bankruptcy rather than just preparing a petition and sending you on your way. If that costs a hundred dollars or so more, it will be a tiny fraction of the debt that will get discharged.

July 1, 2013 Posted by | attorney fees, Bankruptcy, Chapter 13, Chapter 7 | , , , , , , , , , | Leave a comment

Delving Deeper: Where the tax code and bankruptcy intersect

My last post hit some highlights on tax debt from a presentation by Professor Williams at the 16th Biennial Judge Joe Lee Bankruptcy Institute. This post delves a bit deeper into a specific tax law I touched on in that last post. The tax code provision is 26 USC Sect 1398 and it applies specifically to Chapter 7 and Chapter 11 bankruptcy cases. It does not address Chapter 13 cases.

The main thrust of Sect. 1398 is to allow for a Debtor to make an election to treat their ordinary tax year as two separate, shorter tax years. The first tax year would go up to and include the day before a Chapter 7 or Chapter 11 is filed. The second tax year includes the filing date of the bankruptcy and runs through the remainder of the normal tax year. This does NOT happen automatically, so the Debtor must take affirmative action.

If a married couple file jointly, the Joint-Debtor may also make this same election, but again it has to be an affirmative step taken by the Joint-Debtor; the Debtor’s election does not automatically apply to the Joint-Debtor. The election of the Debtor and election of the Joint-Debtor must be made no later than the due date for filing the return for the first short year and it cannot be undone once made.

By making the election, income that is part of the bankruptcy estate is taxable to the estate instead of to the Debtor. An example of how this might matter for a consumer debtor is if the Debtor becomes entitled to an inheritance or lottery winnings during the 180 days after filing. These monies get pulled back into the estate and might not be exempt or only partially exempt. Without this election, the Debtor may be hit with taxes on monies they were not able to keep.

This tax code provision would most usually come into play for business related bankruptcy debtors. Even if the Debtor is an individual, they own a business entity that may not be exempt or only partially exempt. The revenue that business generates would be income to the estate to the extent that business entity is not exempt. This can occur through ongoing revenues of the business or liquidation. The Debtor, again, would not want to be liable for taxes on funds they cannot enjoy.

The 1398 provision does not, however, have any impact on tax debt arising prior to the filing of the bankruptcy and the vast majority of consumer debtors will never need to avail themselves of this election to split tax years. Business related debtors need to be mindful of this option when there are non-exempt assets. Businesses entering bankruptcy as an entity, rather than the individual owner, must remember this election.

June 12, 2013 Posted by | Bankruptcy, Business & small business, Business debt, Chapter 11, Chapter 7, Exemptions, Planning, Pre-filing planning, Tax Debts, The estate | , , , , , , , | Leave a comment

Tips for Tough Times #3

One of my repeated themes is to seek legal counsel early. This is a variation on the theme of seeking counsel when trouble first rears it head so that you can plan for the worst case eventuality. This post is geared towards those entrepreneurial spirits out there who are forging ahead with starting their own businesses. It takes an extra measure of courage to do this in this post-recession recovery period (I am not entirely convinced that we are post-recession, but let’s go with it). And, along with that extra measure of courage I recommend an extra measure of counsel.

For by wise guidance you will wage war, And in abundance of counselors there is victory. Proverbs 24:6 (NASB)

And, while starting a business is not as bloody as waging war, it is indeed a financial battle. So, I recommend getting counsel from a lawyer all the way from setting up the proper corporate entity to tips on financing that can save you down the road. While talking to a lawyer about your business idea may not be the most inspiring and motivating conversation, it can be a lifesaver for you finances. This is because lawyers are trained to think about and plan for worst case scenarios – those eventualities you do not want to contemplate. The conversation, then, may feel like it is taking wind from your sails. However, making sure the right documents are in place from the inception of your business all the way to how to sign on promissory notes can make a huge difference when times are tough.

March 15, 2013 Posted by | Bankruptcy, Business & small business, Financing, Planning, Pre-filing planning, Solo & Small Firm | , , , , , , , | Leave a comment

SMALL BUSINESS OWNERS: Backed into a corner

The economic situation we face has hit small business owners broadside and many are scrambling to figure out how to get relief. Developers who specialize in building upscale homes were particularly troubled by the 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 decreased and only now are increasing slightly. 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 personally? 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 over $21,600.00 per person; over $43,200.00 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.

March 8, 2013 Posted by | Bankruptcy, Marital Assets | , , , , , , | 1 Comment

Saving One’s Home: What can be done with junior liens?

Many people who own a home have more than one loan secured against their residence. These junior liens (a consensual lien against real property is also called a mortgage) may be home equity lines of credit, business loans where the lender insisted on a personal residence as security, judgment liens, and so on. Judgment liens can be “stripped off” (the security interest ended) in either a Chapter 7 or Chapter 13 if it cuts into the debtor’s exemption. 11 USC Sect 522(f)(A). However, voluntary liens (one the debtor consented to) are more challenging.

The Sixth Circuit Court of Appeals made clear that voluntary security interests against real estate in this neck of the woods (including Kentucky) cannot be stripped off in a Chapter 7. In re Talbert, 344 F.3d 555 (6th. Cir. 2003). They stuck with the pre-code rule that “real property liens emerge from bankruptcy unaffected.” Id. at 561. This case focused on the role of 11 USC Sect. 506 which provides for the determination of a secured debt status.

So, if the only way to save your home is to get rid of (strip off) a second or third mortgage, you must file a Chapter 13 bankruptcy. However, the relief provided in a 13 is limited as well. If the loan is secured solely against the debtor’s real property which is also their principal residence, then the loan cannot be modified. 11 USC Sect. 1322(b)(2). The one exception to that takes us back to 11 USC Sect. 506: If the loan is completely underwater – that is, if there is zero equity in the property for the security interest to attach to (and I mean not even $1), then even such a loan can be stripped off and treated as wholly unsecured debt in the Chapter 13. When home prices were dropping consistently, this was a more common occurrence but it still happens.

What can be done with junior loans where there is some equity to which their lien attached? Well, this is where your bankruptcy attorney needs to take a careful look at the promissory notes, mortgages, and secured property. In an interesting case coming out of Ohio, the Sixth Circuit took a look at the meaning of the words “only”, “real property” and “principal residence” and found that they all three must come together for the 1322 protection to come into play. The In re Reinhardt, 563 F.3d 558 (6th. Cir. 2009) case involved a loan secured against a mobile home and the real property upon which it sat. Most would see that as real property which is the principal residence, but under Ohio law, the mobile home was personal property. Just like in Kentucky, that mobile home only became real property (affixed thereto) when the title was surrendered and the proper documents filed with the County Clerk.

Because the Reinhardt’s never surrendered the title of the mobile home, the loan was secured BOTH in the real property and an item of personal property. Therefore, the terms of the loan could be modified by the Chapter 13 plan. Basically, this means that the loan could be valued under 11 USC Sect. 506 and split into a secured claim and an unsecured claim. The part that was secured (equal to the value of the property at the time of the filing) would be paid in full (not necessarily in the plan though) and the rest would be paid pro-rata as with all the other unsecured debts. The other place where it is common for a loan to be secured against both one’s principal residence real estate and other property is with business loans. These lenders often want security in the home and in any assets of the business. However, this makes those loans vulnerable to modification (cram down).

Be sure that you bankruptcy attorney takes a careful look at all the factors that come into whether a secured debt with a lien against your home can be stripped off or crammed down.

February 13, 2013 Posted by | Bankruptcy, Chapter 13, Chapter 7, Exemptions, Foreclosure, Home loan modifications, Plan, Plan payments, Planning, PMSI (purchase money), Pre-filing planning, Property (exempt, Secured loan arrears, Security interests, The estate | , , , , , , , , , , , , , , , | Leave a comment

Special Concerns for Small Business Owners

These last years of recession afforded me the privilege of consulting with a number of small business owners. There are special concerns for the small business owner facing a debt crisis and so finding someone with experience in this area is paramount. Few small business owners would be good candidates for a Chapter 11 bankruptcy because of the expense involved, but it is wise to consult a practitioner that has a grasp of Chapter 11 issues even when looking at a Chapter 7 or possibly a Chapter 13.

Ordinarily, the small business owner’s personal finances are tied to the business finances in such a way that an individual Chapter 7 or Chapter 13 is necessary, even if most of the debt belongs to the business. In other words, just filing a Chapter 11 or Chapter 7 on the business almost always leaves the business owner still personally liable on the debt. The practitioner, then, must analyze whether both a business and an individual bankruptcy is necessary. If only a business entity needs to enter bankruptcy, then things remain fairly straightforward. If an individual (or joint for married folks) bankruptcy is required, then what will come of the business?

Very often the small business owner wants to keep their business up and running through the entire individual bankruptcy. Sometimes there are practical reasons behind this, but many times it is more of a sentiment. The small business owner understandably becomes very attached to the business entity. It is very common for the small business owner to have a hard time differentiating between themselves and the business because they have put so much work and care into it that it becomes an extension of themselves. Solid legal counsel can help you figure out just what the risk is of keeping the entity as a going concern versus letting is dissolve or filing a business bankruptcy.

One key factor the attorney must analyze is the value of the business. To do this, the assets, including accounts receivables, must be valued and any secured debt tied to those assets must be ascertained. Furthermore, is there transferable goodwill or a client list with substantial value? Is this a sole owner business or are there multiple owners? If multiple owners, how readily transferred are the debtor’s shares? Once a best estimate of the value is derived, the attorney must see if there are sufficient exemptions to cover the non-encumbered value (equity). If the value can be exempted, then the attorney must determine the likelihood of challenge by the trustee based on the nature of the business and help the small business owner decide what level of risk they are comfortable with. If the value cannot be exempted fully, then the lawyer should help sort out what a Chapter 13 plan payment would look like given the unique set of facts involved or if there is a source of funds to buy the non-exempt interest back from the trustee.

Depending on the option the owner/debtor chooses there are a number of other considerations to take into account beyond these basic ones listed. However, one thing is almost assured, unless the business is shut down or bankrupted too, a Chapter 7 will last one to two years rather than five to six months. The Chapter 13 would not be extended beyond its normal time frame, but that is three to five years.

February 11, 2013 Posted by | Bankruptcy, Chapter 11, Chapter 13, Chapter 7, Planning, Pre-filing planning, Property (exempt, Redeem / Redemption, Security interests, The estate | , , , , , , , , , , | 1 Comment

Small businesses and the bankruptcy estate

I wrote a while back about strategies for dealing with debt for the small business owner. I will get more focused here about a key issue involved in a business related individual bankruptcy. As I explained in that previous post, most small business owners who become insolvent are forced into a personal bankruptcy even though most of the debt belongs to their business because of the owner’s personal guarantee. I refer to these as business related bankruptcies even though it is actually the individual person who files.

For an oversimplification, when someone files a bankruptcy, everything they own (with some exceptions) goes into an estate under the control of the trustee. The individual then uses exemptions to reach into the estate and keep certain property. Now, the issue in focus is what happens to the business when the owner files. Although the business itself is not in bankruptcy, the owner’s interest in that business goes into the bankruptcy estate the moment the bankruptcy is filed. And, there is only a small exemption for business equipment and tools of the trade so most exemption must come from the “wild card” exemption of 11 USC Sect. 522(d)(5). So, if the company has many assets, accounts receivables, ongoing contracts for work, inventory, or transferable goodwill, the owner may not be able to exempt it all. That creates a real problem and a potential battle over the real value of the owner’s interest or the forced sale of the interest.

Ordinarily, the owner’s interest is actually very small or zero due to debt load or because most of the company’s value is tied to the owner’s personal efforts. However, there is little reason to tempt such complications when there is another option. The best practice in such situations is to wind down the business and dissolve it administratively just prior to filing the bankruptcy. Then, immediately after filing the bankruptcy, create a new Limited Liability Company or S-Corp and begin doing business as a new entity. While the trustee could attack the new company as an alter-ego of the first, there is a strong disincentive because now the trustee has to first win through on an alter-ego theory and then still argue over the value.

There are many details involved in the winding down of the old and the starting up of the new business including how bank accounts, accounts receivables, contracts and employees are all handled. So, it is best to get in with a bankruptcy attorney that is versed in these types of business related bankruptcies early on to give adequate time to plan and prepare.

February 6, 2012 Posted by | Bankruptcy, Chapter 7, Exemptions, Planning, Pre-filing planning | , , , , , , , , | Leave a comment