Kentucky Bankruptcy Law

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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.

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December 22, 2014 Posted by | Alternate Debt Relief, Assets, Bankruptcy, Business debt, 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

That Pesky Equity Line of Credit

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.

November 8, 2013 Posted by | Bankruptcy, Chapter 13, Exemptions, Foreclosure, Home loan modifications, Planning, Pre-filing planning, Property (exempt | , , , , , , , , , , , , , , | Leave a comment

Refinancing during Chapter 13: Do not shoot yourself in the foot!

A couple of days ago I wrote a post about refinancing your home loan during an active Chapter 13. In that post I addressed the issue of how such refinancing impacts your budget and plan payment. You need to think long-term in refinancing, because your will not be able to hold onto the savings from the lower mortgage payments. This is aggravating, but benign.

There is a much more sinister trap that refinancing can land you in. You need to be careful when looking at refinancing within an active Chapter 13 as to how to any existing arrears on the original loan are treated. If you are paying substantial arrears through the plan, but refinance, then those pre-petition arrears are most likely to be paid off with the new loan. Essentially, a lender with arrears is not going to release their lien to allow a new lien to take priority over theirs until all sums due are paid. This includes those arrears.

If that happens, then your plan payment is still going to be just as high or higher depending on your new loan payment. But, where a certain amount of those payments were going to pay off the arrears at zero (0%) percent interest, now you will be paying interest on the same arrears in the new loan. Not only that, but the percentage of your plan going to unsecured creditors will likely increase significantly. This may all be fine with you if your heart’s desire is to pay as much of your debts as possible. However, it needs to be a conscious decision rather than one your stumble into.

So, if you are paying $10,000 in arrears at 0% interest in the plan on the original loan and then refinance, the $10,000 arrears gets “paid” from the proceeds of the new loan. Your principal is now $10,000 higher than on the original loan, but your plan payment stays the same or higher. You essentially just cost yourself $10,000 plus interest. Your may not feel it, though, because the actual month to month cost remains relatively stagnant.

When looking at refinancing, it is best to look at all factors to make a wise decision: new interest rate and savings from that, length of time left on mortgage, amount of arrears in the plan, and how much additional interest you will pay if the arrears are then out of the plan and in the new note.

August 8, 2013 Posted by | Additional Debt, Bankruptcy, Chapter 13, Home Loan Modification, Home loan modifications, Plan, Plan payments, Planning, Secured loan arrears, Uncategorized | , , , , , , , , , | Leave a comment

Making a Second Mortgage Disappear

Well, I cannot actually make a second mortgage disappear, but I might be able to strip it off of your house and make it an unsecured debt instead of a secured debt. I mentioned this in my last post which you may want to look at if you are considering trying to save your house or let it go through foreclosure.

In a Chapter 13, one can “value” the amount of a secured debt under 11 USC Sect. 506. Essentially, when one files a Chapter 13 a secured debt is only secured up to the value of the property it is secured against. There are some exceptions which I will not go into. If you own a home and have a second mortgage, then that second mortgage might be completely underwater. That is, there is no equity left in order to secure the debt. If that is the case, it can be “stripped” off of the property and treated as an unsecured debt in its entirety.

However, if the lender can prove that there is even $1.00 worth of equity, the courts in the Sixth Circuit (such as Kentucky) will not strip the loan off; it has to be paid in full just like the primary loan. The rationale is that as one pays down the principal on the primary loan, more and more equity is realized to which that second loan can attach. So, they have made it an all or nothing sort of scenario.

July 23, 2013 Posted by | Bankruptcy, Chapter 13, Foreclosure, Plan, Security interests | , , , , , , , , , , | Leave a comment

Letting go is hard to do (or Home loan arrears)

We grow very attached to our homes. There is such a long heritage of home ownership being part of the American dream. Many who immigrated here long ago could have never attained to being a land owner and the new life in America created the opportunity and hunger for this hallmark of the gentry in the old country. This latest recession took a huge swipe at that American dream and one of the hardest parts of my job is helping a debtor realize when they just cannot hang onto their land.

The most common way this plays out is when a home owner has done all they can to stay on top of debts in the face of dwindling resources. They seek out a home loan modification to stave off financial devastation. Most lenders, though they are not required to do so, insist that the home owner stop making payments while they “process” the paperwork. This creates a bind, though, because almost no one sets that money aside to cure the arrears in the event the modification fails. And, once that payment is missed, then lender has the right to accelerate the mortgage and foreclose.

Chapter 13 is a great tool to save a home because it forces the lender to allow arrears to be paid, without additional interest, over 60 months. But, they home owner debtor must show they can afford the payments needed to pay the ongoing loan obligation PLUS pay enough plan payments to cure the arrears. There comes a point for each debtor where the arrears simply surpass their ability to catch them up in that 5 year window. When this point is reached, I am forced to give them the news that they cannot revive their home; it is too late. Some receive the news and surrender to the inevitable and others refuse to believe they are out of options.

The important thing to do if you have arrears mounting on your home loan debt, is to get solid bankruptcy counsel early on. When you allow time for planning, the chances of saving the home are maximized.

June 26, 2013 Posted by | Bankruptcy, Chapter 13, Foreclosure, Home Loan Modification, Property (exempt | , , , , , , , , , | 1 Comment

Not so mobile home and Chapter 7

A decision in the Bankruptcy Court for the Eastern District of Kentucky highlights a mistake made too often in Chapter 7s where the debtor lives in a mobile home. In Kentucky, mobile homes are not terribly mobile and often remain in place  for decades. So, the name “mobile home” is a bit misleading. The legal term for mobile homes is “manufactured home” which also seems silly because all homes are manufactured in one way or another. Anyway, mobile homes get physically fixed to the land and people stop thinking of them as titled property such as cars, boats, trucks and trailers. However, they are titled. Even though physically fixed to the land, they may not be legally affixed to the land.

Now, when one files a Chapter 7, everything they own and everything they owe goes into an estate. They pull things back out by using exemptions and reaffirming secured debts. Often debtors keep their homes because they have enough exemption to cover the equity in their home and are able to pay the secured debt payments (the mortgage) when all their other debts are discharged. Each person can claim almost $23,000 in homestead exemption using the Federal exemptions. So, if you own a home worth $120,000 and you owe $100,000 secured on the house, then you can use the exemption and keep the house by reaffirming the $100,000 secured debt with the remainder exempted.

Here is where the problem comes in for mobile homes. The only way a loan is secured against a mobile home is on the title as described in KRS 186A.190. Actually, there is one other way, but it involves surrendering the title and filing stuff with the county clerk and effectively converting the mobile home into a house from a legal standpoint. Anyway, most people do not do that. So, if there is a defect with the security interest on the title, then the loan is not perfected and cannot be reaffirmed. That may leave a very HIGH amount of equity in the mobile home requiring exemption.

If the mobile home is also on land that you own, then you have the challenge of applying the homestead exemption to your land and then also hoping you have sufficient exemption to cover the value of the mobile home. If the title has not been surrendered and the mobile home affixed to the land legally, then you must exempt two separate assets: the land and the manufactured home. If the home has been affixed, you are in far better shape because it is one asset, but you still must make sure the loan is properly secured.

Like in In re Owens, 09-62087 (Bankr.E.D.Ky., 2010), if the title is defective in regards to the security interest, then you could lose your home. In other words, if there is a problem with the title then you may have no secured loan to reaffirm and not enough exemption to cover the difference. Then, the trustee will keep the mobile home, sell it (if you can’t come up with money to redeem it), and distribute the proceeds to all unsecured creditors. If you live in a mobile home, be sure that your bankruptcy attorney examines the title and makes sure that any security interest is properly in place.

The bottom line is that if your home is a manufactured home and you are looking at bankruptcy, make sure your attorney does a thorough check as to the title, security interest, and exemption issues.

April 22, 2013 Posted by | Bankruptcy, Chapter 7, Discharge, Exemptions, Foreclosure, Planning, Pre-filing planning, Property (exempt, reaffirm or surrender), Security interests, The estate | , , , , , , , , , , | Leave a comment

No need to fear 13 (Chapter 13 that is)

Many people in debt feel overwhelmed when looking a filing a chapter 13. As much as five years of plan payments seem daunting and having to seek approval of incurring new debt seems intrusive. However, a Chapter 13 bankruptcy can often accomplish goals for people who a Chapter 7 cannot. One of the most frequent of these goals is for the debtor to keep their home even though they are behind on payments. To take some of the mystery and fear out of Chapter 13 plans, let’s look at what it takes for a Chapter 13 plan to be confirmed (approved) by the court.

There are four tests that a Chapter 13 plan has to pass in order to be confirmed. First, since debtors often turn to a 13 to save a house with past due payments, the Chapter 13 plan has to account for full repayment on these arrears. In the Eastern District of Kentucky, past due amounts of any secured debt, such as house payment arrears, must be paid through the plan. Your ongoing house payment can usually continue to be paid directly (outside the plan) to the creditor so that you are not also paying the trustee commission on top of the interest. So, if your regular house payment is $1000.00 per month and your loan won’t be paid off for five (5) plus years, you keep paying the creditor directly. But, if you owe $12,000.00 in past due payments on that same house, you will have to pay $12,000.00 into the plan over the course of those sixty (60) months (or $200.00 per month plus trustee’s commission).

Now, lets say you own a car and only have twenty-four (24) months left on the debt. Since this will be paid in full during the duration of the plan, you will either have to pay the entire amount through the plan or make a step up in your plan payment when it is paid off outside the plan. Since you will have to make that step up in payment anyway, you might as well look at paying the entire thing through the plan UNLESS your current interest rate is less than around 6%. So, the first test is that all secured debt is accounted for by the plan with all arrears paid through the plan. I am calling this the “first” test not because there is any particular order, but because most people’s highest priority is keeping their house.

The second test is the “disposable income” (a.k.a. “projected disposable income”) test. Basically, the debtor accounts for their average income (current monthly income) each month and subtracts out their reasonable living expenses. This takes the debtor looking back in time and seeing what they spend on food, clothing, recreation, and various other items. Determining reasonable expenses is probably the place where there are the most challenges by trustees to the plan. If you report expenses that are substantially over the norm for most people living in your region with the same household size and similar income, then your plan will draw challenges. However, if your expenses are in the realm of reasonable, whatever is left over after you subtract these expenses from your income is the disposable income.

The debtor is expected to pay their disposable income into the plan. If your proposed plan payment is substantially less than your disposable income, your plan will not get confirmed. If it is higher than your income minus expenses, then it might also be challenged because the plan has to be feasible that you can actually pay it.

The third test is very straightforward: If you owe priority income tax debt (some tax debt cannot be discharged – this is priority tax debt), then the plan payment must be sufficient to pay all the priority taxes in full through the plan. Federal income tax debt can still accrue 4% interest through the plan and Kentucky tax debt 5%. However, penalties are halted.

Fourth, unsecured creditors in the Chapter 13 must get paid at least as much through the plan as they would have gotten had you filed a Chapter 7. If in a hypothetical Chapter 7 all of your assets were covered by exemptions creating a “no asset” bankruptcy, then your Chapter 13 does not have to pay anything to unsecured creditors (some districts expect at least a small percentage of unsecured debt to be paid, but zero (0%) percent plans have been approved occasionally in Kentucky). Alternatively, if your home (or other asset) that you are wanting to keep has equity that could not be covered by exemptions, then the amount of equity left “exposed” has to be paid to unsecured creditors over the life of the plan.

Let us use the same example as above where a $12,000.00 arrears existed and add that $6,000.00 of equity in the home was left exposed (not covered by exemptions). In this scenario the debtor would have to pay $100.00 more than the $200.00 per month. The $200.00 covers the arrears and the $100.00 takes care of the “liquidation test” and pays the exposed $6,000.00 equity. Now, we have a $300.00 per month payment plus the trustee’s commission.

One has to look at all four tests in concert because if the disposable income is only $150.00 per month but the plan demands $300.00 per month, the Debtor needs to come up with a way to make that $300 payment feasible or make a tough choice of surrendering the home. If, though, the disposable income is actually $400.00 per month but the other tests demand only a $300.00 plan payment, then $400.00 will be the plan payment.

One of the good things about Chapter 13 is that through looking at these tests, the debtor is often faced with making decisions about what expenses can be reduced in order to come up with a plan that can be confirmed. The result of that process is that they sometimes realize there is no way to hang on to an asset, such as a home, with their income. Sometimes, though, they learn how to live within a budget which is feasible and which lets them keep important assets. Either way, Chapter 13 pushes debtors to live within their means far better than a Chapter 7.

April 17, 2013 Posted by | Bankruptcy, Chapter 13, Foreclosure, Plan, Plan payments, Planning, Pre-filing planning, Secured loan arrears | , , , , , , , , , , , , , | Leave a comment

Curing Post-Petition Arrears and Other Fun Stuff

Last Friday I posted about the ability to cure post-petition arrears that may arise on a secured debt paid outside the Chapter 13 plan, such as falling behind again on house payments. It can be done, but there are a couple of things you and your attorney need to keep in mind.

First, if you are raising your plan payments in order to effect the cure of the new arrears, there should be no problem. However, if you are attempting to keep your plan payments the same but just force unsecured creditors to receive a smaller pro-rata share of the plan’s distributions, you may have a fight on your hand. The creditors or the trustee will likely look at the whole picture and see what exactly caused the new arrears to determine whether or not to fight the matter.

Second, and this is important, the trustee is still only going to distribute to the creditor what their last claim lists as the arrears. If you get the modified plan approved, but the creditor never amends their claim to show the new arrears amount, it will not get paid. You really do not want to pay extra into your Chapter 13 plan to cover arrears only to end up arguing at the end of the bankruptcy as to whether they are still owed or not. So, your attorney will have to follow-up with the creditor to make sure the claim is amended or, eventually, file an amended claim for them (which is not preferred).

December 3, 2012 Posted by | Bankruptcy, Chapter 13, Plan, Plan payments, Secured loan arrears | , , , , , , , , , | Leave a comment

Chapter 13 and Post-Petition Arrears

In my prior post, I warned Debtors to be aware of payments made outside the Chapter 13 plan on certain secured debts and to make it a priority to stay current on those debts. Unfortunately, unexpected expenses can hit anyone as well as job losses or other income decreases. So, sometimes a Chapter 13 Debtor will be forced into a tough spot of whether to make a house payment or not. If this happens, all is not lost.

First, if the expense or income drop is beyond the Debtor’s control and it is ongoing, then the Chapter 13 should be modified to reflect the new circumstances. It may even be necessary to re-evaluate if the home can still be saved within the Chapter 13. But, if this is one of those out of the blue events and the Debtor can soon be back on track, then the question becomes whether brand new, post-petition arrears can be cured (caught up). Again, this usually arises when one is trying to save their home by way of the Chapter 13 (see this prior post). So, I will focus on post-petition home loan arrears, especially since there are special protections for these creditors in the Code.

First, let me explain what is special about home loans. Under 11 U.S.C. Sect. 1322(b)(2), the Chapter 13 plan cannot modify the rights of secured creditors where the loan is secured only by a principal residence. This is targeted to fit all your ordinary home loan situations. Creditors have argued that this provision stops Chapter 13 plans from forcing them to allow post-petition arrears to be cured. However, 11 U.S.C. Sect. 1322(b)(5) says that “any” defaults while the case is pending so long as the final payment on the whole loan is not due until after the Chapter 13 ends (technically after when the last payment in the Chapter 13 is due). I suppose creditors may misunderstand the “notwithstanding paragraph (2)” language to mean the opposite, but in truth, it makes it very clear that 1322(b)(2) does not preclude curing post-petition arrears.

It is no surprise, then, that the Eastern District of Kentucky Bankruptcy Court ruled just this last June, 2012, that Debtors could cure post-petition arrears that developed (See In re Cable, 11-70169 entered June 19, 2012). So, if you fall behind a little in your Chapter 13 on your home loan or other secured loan paid outside the plan, then it is vital you let your attorney know right away so the plan can be modified. Whether it will work or not depends on how much the new arrears will raise your plan payment.

But, this is not the end of the story…

November 30, 2012 Posted by | Automatic Stay, Bankruptcy, Chapter 13, Foreclosure, Plan, Secured loan arrears | , , , , , , , , , | 1 Comment