Benefits of Bankruptcy

 

New Long Island case now permits lien-stripping that was previously impossible
 
One of the biggest problems that homeowners face in today’s recessionary economy is the loss in value to their homes.  It is not uncommon to see houses that have dropped 50% in value over the past few years, leaving many to wonder if it is even worthwhile to keep their home.

 

As such, many homes are “under water” or “upside down” meaning that the homes are worth less than the balance due on the mortgage.  In many cases, there are two mortgages and the home is worth less than the first mortgage, making the second mortgage totally unsecured.

 

Up until recently, there was little recourse available to consumer bankruptcy filers to eliminate mortgages that were underwater.  However, a new decision released last month has now changed all that, permitting cram-down of second mortgages in Chapter 7 bankruptcy cases.

 

What is a Cram-down in Bankruptcy?  Also known as a “strip-off”, a cram-down is when a debtor modifies the rights of a mortgagee, who is a secured creditor, by having the bankruptcy court strip off the secured status of the mortgage because there is insufficient value in the property to secure any part of it.

 

A cram-down removes the mortgage as a lien on the premises.

 

 

The existing state of the law has been that only Chapter 13 debtors had the unique ability to cram-down mortgages, and then, only the second mortgage.  Chapter 7 debtors did not have any ability to cram down any mortgage.

 

The reason for this is that the provision for cram-down is § 1322(b)(2), located in Chapter 13 of the Bankruptcy Code, which limits debtors from cramming down first mortgages.

 

 

On November 25, 2009, Central Islip Bankruptcy Judge Dorothy T. Eisenberg issued a decision permitting Chapter 7 debtors to cram-down second mortgages.  In re:  Mark T. Lavelle, et. al (09-72389-478, Eastern District of New York).

 

An unusual aspect of this case is that the debtors did not even file an application seeking to cram-down their mortgage – it fell in their lap.  The debtors are typical consumers residing in Levittown who sought Chapter 7 relief in April 2009.   They were represented by Long Island bankruptcy attorney Norman M. Mendelson, Esq.

 

The home was in the name of the husband and it was worth $400,000.  The balance owed on the first mortgage was $411,000 and the balance on the second mortgage was $9,900.  Both mortgages were held by Bank of America.

 

In May 2009, the mortgagee, represented by Steven J. Baum, P.C. filed a motion seeking relief from the stay on the second mortgage based on the fact that the debtor had no equity in the property.
 
However, the debtor defended that motion by filing opposition in the form of a cross-motion seeking to avoid the mortgagee’s lien on the second mortgage under Bankruptcy Code § 506(a), arguing that the creditor only had a secured claim to the extent of the value of its collateral, and an unsecured claim for the balance.

 

The debtor argued that even though this was a Chapter 7 case, the ability of the Court to modify wholly unsecured liens against a debtor’s residence in a Chapter 13 case under § 1322(b)(2) should be extended to Chapter 7 cases.

 

Judge Eisenberg, in a very complicated and complex, technically-worded decision which discussed two Supreme Court cases, first noted that the debtor’s motion should have been brought by adversary proceeding, but nevertheless permitted the debtor to proceed by motion, which she pointed out was “technically incorrect.”

 

 

The Court addressed the 1992 Dewsnup Supreme Court decision which held that a Chapter 7 debtor may not “strip down” a first mortgage to the fair market value of the property.   However, there is a difference between “stripping down” a mortgage and “stripping off” a mortgage.

 

Stripping-down refers to removing that portion of a mortgage that is unsecured, which is done pursuant to § 506.   On the other hand, “stripping off” is essentially cramming down a mortgage, which means removing its lien status altogether.

 

The Judge observed that since Dewsnup, the issue of whether wholly unsecured liens may be “stripped off”, as opposed to “stripped down”, has been a contentious issue between various bankruptcy and district courts and their respective Courts of Appeals.

 

Judge Eisenberg then discussed the 1993 Supreme Court case of Nobelman which barred Chapter 13 debtors from relying on § 506 to bifurcate an undersecured mortgage to secured and unsecured components.  (I wrote an article about Nobelman for the Suffolk Lawyer 16 years ago).
 
However, the Nobelman case only applies to situations where a portion of the mortgage remains secured, and the Supreme Court did not address situations where the mortgage is totally unsecured.   Consequently, debtors have been able to cram-down totally unsecured second mortgages in Chapter 13 cases.

 

 

Judge Eisenberg, after utilizing a rather complex analysis, determined that the second mortgage was wholly unsecured (which means that § 506(a) does not apply), and that the plain meaning of § 506(d) required the lien to be voided.  The Judge went on to say that there was no logical reason that this result should be any different in a Chapter 7 context as opposed to a Chapter 13 situation.

 

Thus, the Judge voided the lien on the second mortgage.  Since this was a Chapter 7 case, the debt, now considered an unsecured debt, became totally discharged.  A big win for the consumer.

 

 

There is a record number of homeowners facing foreclosure, and there appears to be a groundswell of support by politicians, bankruptcy attorneys and consumer groups for a change to the Bankruptcy Code to deal with this.  As such, perhaps some judges, like Judge Eisenberg, are taking a position rooted in public policy that recognizes the existing problem.

 

Many provisions in bankruptcy law have favored the mortgagee and secured lender over the past two decades.  It now looks like the tides may be shifting in the other direction.

 

This case will likely result in a number of Chapter 7 cram-down proceedings being brought.  As the Judge put it:

 

“Arguments that debtors will benefit from possible windfalls, are not persuasive. Markets are uncertain, and it is not certain such a scenario will ever occur. Secondly, the creditors’ right to foreclose will not result in any present monetary gain for the creditor since there is no value in the property for them.”

 

“Bankruptcy is not intended to benefit either the creditor in securing a potential increase in property value, or the debtor. However, where the future is unknown, bankruptcy principles of giving the debtor a fresh start should apply.” 

 

 

If you have a Fannie Mae mortgage, are delinquent with your mortgage payments, and are headed towards losing your house in foreclosure, you may be able to get a temporary break.  A new program entitled, “Deed for Lease” permits homeowners to transfer the deed to their house to Fannie Mae and sign a one-year lease.  The program was just announced two days ago.

 

Why would Fannie Mae do this?    The foreclosure process is usually lengthy and time-consuming.  This program will permit families to stay in their homes (albeit for a limited period of time) and avoid the uncertainty of foreclosure.

 

However, the program is not for everyone.  There is a detailed application process and you must be approved.  Also, the program only applies to Fannie Mae mortgages.

 

Is the “Deed for Lease” program better than filing bankruptcy or engaging in foreclosure defense?      Only an experienced bankruptcy attorney can really help answer that question.  There are pros and cons with all options.  The “Deed for Lease” program means losing your home — for good.  On the other hand, filing a Chapter 13 bankruptcy enables the homeowner to cure the mortgage arrears over time and keep the home.

 

The program also guarantees a minimum one-year rental period, which also calls for a monthly rental payment.  However, defending a foreclosure proceeding (assuming that there is a reasonable foreclosure defense) can often provide the homeowner with an even longer period to stay in the home, during which time the homeowner does not make any rent, mortgage or real estate tax payments.  In the program, you would have to pay “market rate” for rent, which could be fairly pricey.  For a typical Long Island home, that could easily be $2,000 per month or more.

 

Finally, even if the program sounds good for you, there is no guarantee that you will be accepted into it, and the approval process can take some time — and all the while the mortgagee can continue a foreclosure proceeding.

 

Of course, if the bank takes back a deed in exchange for a lease, the homeowner is off the hook for any mortgage deficiency.  However, keep in mind that a Chapter 7 bankruptcy filing in New York would discharge such a deficiency.

 

If you’ve already filed for bankruptcy, you are not eligible for the program.

 

How do I know if I have a Fannie Mae mortgage?      Fannie Mae has a website that enables you to look up your property to see:  http://loanlookup.fanniemae.com/loanlookup/.

 

 

The mortgage servicer has to decide that the homeowner qualifies for a “deed in lieu of foreclosure.” Basically, borrowers who are in default on their loan voluntarily give the deed back to the lender, negating the need for a drawn-out foreclosure process. Traditionally this has been considered less damaging to the borrower than foreclosure, although both actions have severe effects on a borrower’s credit standing–and both result in loss of their home.

Borrowers-turned-tenants must be able to afford market rent on the home. That rent can’t exceed 31 percent of their monthly gross income, which must be documented.

Borrowers cannot have 12 or more past-due payments on their mortgage. And they must have made at least three payments since the loan was first taken out–or since the last time it was modified. Borrowers can’t be in the process of declaring bankruptcy.

Rentals are for 12 months, with the possibility of an extension.

The home remains available for sale, subject to the terms of their lease. Renters remain responsible for maintaining the property.

Only primary residences qualify. Landlords may qualify if their tenant has been using the home as a primary residence.

Mortgages backed by the FHA, VA or other government agencies don’t qualify.

Borrowers who think they might qualify for the new rent-back program should talk with their mortgage servicers, who, in conjunction with Fannie Mae, will figure out if they qualify for a rent-back offer.

 

These days, almost everyone has a cell phone.  Should a typical consumer debtor filing bankruptcy on Long Island list their cell phone provider as a creditor for bankruptcy purposes?

 

Consumers Who Have Old Accounts with Deficiencies.   If you have an old bill on a closed account with a balance due, then there is no question.  This is a debt that you must include.   The entire obligation will be eliminated by the bankruptcy filing.

 

Consumers Who Have Active Accounts with Balances Due.   Consumers filing for personal bankruptcy are required to list all outstanding debts in the bankruptcy petition.  Thus, if you owe your cell phone provider a balance, even if you plan to keep the account, you must list them.  Doing so will enable you to discharge the balance owed.  Some cell phone companies may ask you to post a security deposit after the bankruptcy filing, but I observe that most providers are not asking for this.

 

What Happens to the Service Contract in Bankruptcy?   Chances are you are still in a service contract which requires that you pay a penalty if you cancel it before the end of the contractual period, which is typically two years.  Most consumers can benefit by canceling their cell phone contracts.  This would enable the consumer to not only eliminate their balance but remove their obligation to pay any early cancellation penalty. 

 

Here’s why:  Filing a Chapter 7 bankruptcy has the effect of terminating any “executory contract” which is one in which the parties are still performing it.  Cell phone contracts are executory contracts during the typical two-year contract period.  By including the cell phone provider as a creditor in the bankruptcy petition, the contract is automatically terminated, and any early cancellation penalty becomes a dischargeable debt just like the credit card debts.

 

Consumers Who Have Accounts that Are Totally Up-to-Date.   Consumers should list the cell phone provider as a potential creditor in the bankruptcy petition, even if no balance is owed.  Although the bankruptcy law has the effect of automatically terminating the cell phone contract, virtually all cell phone companies will continue service if the account is current, and will not pay any attention to the bankruptcy filing.

 

The advantage to you, the consumer, by including the cell phone company in the petition, even if you are current, is that you can later terminate the contract before the end of the typical two-year period, and not be responsible for the early termination penalty.

 

Special Note About Cell Phones for Later:   Since I’m talking about cell phones, please note that when you do eventually file for bankruptcy relief and later go to court for the meeting of creditors, you must leave your cell phone in the car.  The Central Islip Bankruptcy Court has a policy of not permitting any cell phones into the building.  If you arrive at court by public transportation, the U.S. Marshall will permit you to check your phone with them in the lobby.

 

 

Some taxes can be discharged in a personal bankruptcy filing.  The most common type of tax that consumers owe is back income taxes.  In certain circumstances, they can be discharged.  Most other types of taxes cannot be eliminated in bankruptcy.

 

What Taxes Are Dischargeable In Chapter 7 Bankruptcy?

There is a multi-prong test for determining whether income taxes can be eliminated in a personal bankruptcy filing and this test is rather detailed and complicated.

 

First Prong:  More than three years must have elapsed from the date that the tax return was “last due”.  Assuming that no extension request was filed, the income tax is “last due” on April 15th of the following year.  It does not matter that you may have filed the tax return a month earlier; the three-year  period starts running from the date the return was due — in this case April 15.  Extension requests have to be incorporated into the “last due” calculation as well.

 

Second Prong:  The tax return must have been actually filed at least two years prior to the date the bankruptcy petition is filed.  Thus, even if more than three years elapsed from the date the return was “last due”, there must be at least two years that elapsed since the date the return was actually filed, before the bankruptcy petition can be filed.

 

Third Prong:  More than 240 days must have elapsed since the date that the IRS “assessed” the tax obligation.  Tax assessments are tricky and IRS records and transcripts should be reviewed  to determine tax assessment dates.

 

Other Issues to Consider:  The IRS has the right to object to efforts to discharge tax debts if they feel that the taxpayer filed fraudulent returns, willfully attempted to evade taxes, or engaged in a pattern of tax evasion.  Also note that even if you can eliminate federal tax obligations that you ow to the Internal Revenue Service, they may still have a lien on your assets if the IRS obtained a federal tax lien.  I will address this issue in a future post.

 

 

It is generally necessary to obtain a determination from the bankruptcy court.  This, unfortunately, can be more involved than the bankruptcy itself, as it often entails actually suing the IRS in an “adversary proceeding”, which is a federal lawsuit brought within the bankruptcy case, and heard before the bankruptcy court judge.  However, since tax debt is often substantial, it is usually worth the investment.  For more information on adversary proceedings, see A Primer on Adversary Proceedings .

  

 

The same bankruptcy rules that apply to the IRS also apply to state tax obligations.

 

 

Most other types of taxes cannot be discharged in a bankruptcy proceeding.  These include withholding taxes, fiduciary taxes, excise taxes, and sales taxes.  Remember, income taxes, in general, that are less than three years old, cannot be eliminated in bankruptcy.

 

Discharging taxes in bankruptcy can be rather complicated.  Getting advice from an experienced bankruptcy attorney who has actually brought tax dischargeability proceedings is important if you have significant tax obligations.

 Husband Used Bankruptcy to Eliminate Debt Fraudulently Incurred by Deceased Wife
 
One of my most interesting Long Island Chapter 7 bankruptcy cases was a number of years ago.  It involved an 80-year-old widower who learned some incredible, disturbing and unfortunate secrets about his wife’s finances while she was on her deathbed.

 

By using some creativity and the filing of a consumer bankruptcy case, I saved the day for my client.

 

Filing Bankruptcy Proved to Be the Ideal Solution to an Unusual Problem
 
Just a week after his wife had died, the widower, accompanied by his adult children, consulted with me about a very serious debt problem he had only discovered two weeks prior.
 
His deceased wife, also 80 years old, had been in the hospital, diagnosed with a terminal disease.  When the widower walked into her hospital room to pay her a visit a week before she died, he caught her trying to shove some papers under her covers.  These were credit card bills and lawsuit papers.
 
Wife, Unbeknownst to Husband, Incurs Substantial Debt in His Name
 
As it turned out, for years, the wife, who had handled all of the family’s finances, opened numerous credit card accounts in the husband’s name by forging his signature.  She did not tell him about this.  She had all the credit card bills sent to a post office box.
 
Just a week before she died, the husband learned that not only was he obligated to pay over $60,000 to credit card companies for debts he had absolutely nothing to do with, but several of the credit card companies had even commenced litigation against him.  The widower wanted to know what to do.
 
Although we discussed disputing some 15 different accounts, or defending the various suits that had been brought in state court, I decided that the easiest and most efficient way to resolve the problem would be to file a Chapter 7 bankruptcy.
 
Using Bankruptcy to Resolve the Problem
 
The tricky aspect of this case was that the debtor-husband owned his entire Locust Valley home free and clear of all liens, far exceeding the homestead exemption.  The unprotected home did not concern me because my strategy was to totally eliminate all creditors. 

 

I prepared the bankruptcy petition and listed the various credit card accounts totaling $60,000, but indicated that each and every credit card debt was disputed.
 
The bankruptcy court assigned the Chapter 7 case to Long Island bankruptcy trustee Kenneth Kirschenbaum.  He almost fell off his chair at the meeting of creditors when he learned that there was a valuable house that was almost totally non-exempt.  Keep in mind that at the time of filing, the homestead exemption was only $10,000 and the house was worth several hundred thousand dollars.  The trustee immediately began salivating over the prospect of administering a nice asset case.
 
However, I told the trustee, “not so fast, Cowboy” (or words to that effect).  I explained the situation and said that I would be filing an application for a “bar date” in which creditors would be notified that they have only so much time to file claims.  I then told the trustee that I would be filing objections to every filed claim.
 
Trustee Can’t Administer Bankruptcy Estate and Debtor Gets Discharge
 
Well, it turned out that even though there were 15 creditors, only six of them filed claims. (Remember, this was many years ago when creditors often neglected to file claims).  I then successfully objected to every claim, on the ground that the husband did not incur them.
 
That left a bankruptcy estate that contained a very significant non-exempt asset — the house — but with not one single claim that could be paid.
 
Trustee Kirschenbaum, who was not too happy, had no choice but to close the case as a “no asset” case because there were no creditors who he could pay.  The debtor, meanwhile, received his Chapter 7 discharge, kept his home, and eliminated all of the headaches caused by his wife’s secret financial life.
 
By thinking out of the box, I utilized an unorthodox solution to an unusual debt problem and achieved a great result for my client.

 

The next storm to hit the housing market will be caused by the wave of defaults on pay-option adjustable rate mortgages according to an article in the Wall Street Journal yesterday.

 

The problem is part of the sub-prime mortgage meltdown.  Between two and four years ago, an incredible number of homeowners took out pay-option adjustable rate mortgages (ARM), especially here on Long Island.  A very large number of our clients who own homes have such mortgages.

 

Now, with these mortgages starting to reset to much higher rates and exorbitant monthly payments, many homeowners will be unable to afford them any longer.  There can actually be a flood of defaults.  Many Long Island communities have a great majority of homeowners who refinanced their homes with ARMs. 

 

The rate of delinquencies and foreclosures on ARMs is extremely high, in large part because so many of these homes are underwater and have no equity.

 

 

The Long Island bankruptcy attorneys in our firm meet with homeowners on a regular basis who are facing this dilemma.  Fortunately for them, they have various bankruptcy options.

 

With some, we recommend Chapter 7 bankruptcy which enables them to stay in the home for a period of time without having to make any payments.  Then, they can move out and not have to worry about any deficiency obligation on the mortgage, as that is discharged in the bankruptcy proceeding.

 

With other clients who may have several mortgages, we may recommend Chapter 13 bankruptcy as there is a mechanism in that type of bankruptcy to eliminate the second mortgage if he house has lost a great deal of value.

 

For those Long Island homeowners in financial difficulty, it makes sense to quickly meet with an experienced Long Island bankruptcy attorney.

 

 

For ages, buyers of real estate were told that they should always stretch financially when buying their first home.  However, the recent resettling of the real estate market has blasted that maxim out of the water.  As a consequence of that good-natured, but ill-conceived advice, hundreds of thousands of Americans now have homes with no equity at all and are considering bankruptcy as a way out.

 

An article in the New York Times last week (Seven New Rules for the First-Time Home Buyer) said that too many people bought too much house for too many years.  Although our country’s financial system almost collapsed because of the sub-prime mortgage meltdown, the article suggested that consumers should share some of the responsibility.

 

Unfortunately, few home buyers anticipated such significant corrections with real estate values.  They also were blinded to the excited sales pitches of mortgage brokers and real estate sales agents about exotic mortgages that reset to rates that can become unaffordable.

 

A very large number of Long Island home buyers fell victims to this home buying euphoria and are now paying the price — something I see daily in my Long Island bankruptcy law practice.

 

Now, financial planners and economists are rejecting the idea that first-time home buyers should get as much home as they can afford.  The Times article spells out some new, common-sense guidelines that home buyers must consider, like placing a down payment of at least 20%, and not spending more than 35% of pre-tax income on the mortgage payment, including real estate tax and liability insurance.

 

The purchase of a home, once thought to be a no-brainer as far as being a safe investment, must now be approached cautiously.

 

For those home buyers that have found themselves in an untenable real estate situation, combined with excessive debt, bankruptcy can often provide a solution to getting out of a bad real estate home investment and getting a fresh new financial start.  We have helped many Long Island homeowners do just that with Chapter 7 bankruptcy.

 

 

There have been some massive job layoffs in this deep recession, even for professionals and upper level executives.  Consequently, many recently-laid off workers are being forced to rethink their professional identities, their personal relationships and how they will manage their existing debt.

 

The current financially-plagued economy seems to be sparing no one.  Even white-collar workers with advanced degrees, working at prestigious companies, are not immune.  Anyone can lose a job.  Wall Street firms have not been kind; advertising and retail are suffering greatly, and many question the viability of garment industry jobs remaining in New York.

 

According to studies by organizational psychologists, white-collar men tend to experience unemployment differently.  For them it is sometimes difficult to adapt and find a job to provide income if that income is significantly less.  Grappling with joblessness inevitably entails surrendering an idea of who they are.  Negative emotions abound.  I’ve previously written about the Eight Steps to Cope with Emotional Issues During Bankruptcy  as well as The Emotional Side of Debt and Bankruptcy .

 

To those who qualify, bankruptcy can often provide a solution for eliminating substantial debt.  This usually has a very positive effect on the psyche, eliminating a large source of anxiety and depression.

 

The bankruptcy option should be discussed and considered well before the raiding of 401-K and other retirement accounts.  (See Are Pensions Protected in New York Bankruptcy Cases? ).

 

In my Long Island bankruptcy law practice, I frequently see clients who previously earned six-figure incomes.  Bankruptcy can provide an opportunity for a fresh new financial start and remove some of the pressure of finding new employment.

 

When you’re down in the dumps and being attacked by the enemy with seemingly no way out, you need a superhero to come to your rescue.  Think of bankruptcy as that superhero — a fictional character with extraordinary powers and abilities dedicated to doing acts of public good.

 

You know the picture:  You’re in over your head and drowning in credit card debt.  The banks not only seem to be indifferent, but sneer at you and call you incessantly, even though you’ve got no financial ability to make payments.  They threaten to sue you and may have even done so already.  Your bank account is about to be frozen and your wages garnished.  WHAT CAN YOU DO?

 

Simple.  CALL BANKRUPTCY MAN !.  Sure, there is no Bankruptcy Man superhero, but I have to tell you that hundreds of my Long Island bankruptcy clients over the years have probably thought so of me.

 

An experienced bankruptcy attorney can quickly analyze a case (faster than a speeding bullet?)

 

Then he can file the bankruptcy petition with the bankruptcy court electronically, right from his desk (able to leap tall buildings with a single bound?)

 

And by filing the petition he can obtain an immediate and very powerful stay against the evil creditors (more powerful than a speeding locomotive?)

Finally, he seeks to have the bankruptcy court issue an order of discharge, forever eliminating credit card debts (fighting for truth, justice and the American way?)

  

Seriously, bankruptcy is a very powerful federal law that can protect a consumer who files bankruptcy in good faith and give that consumer the opportunity for a fresh new financial start by eliminating credit card debt.

 

For another bankruptcy superhero, see the comic strips about BAPCPA Man.  I just spoke with its creator, my friend, Steven Horowitz, and I will be posting one of his latest strips tomorrow.

 

If the severity of the recession affecting Long Island can be measured by the number of electric utility bill delinquencies owed to the Long Island Power Authority, then Long Island has been hit very hard.

 

LIPA recently reported that there is now a record amount owed by customers who have been unable to pay their electric bills.   Apparently, this figure has been rising steadily over the past two years.

 

As of the end of 2008, 157,217 residential customers were late in paying their LIPA bills.  This number jumped to 165,900 as of May 31, 2009, representing a total amount of $121 million in arrears.

 

The shear amount of late utility payments is probably an accurate barometer of the Long Island economy.

 

 

I personally witness the extensive amount of LIPA arrears daily as I meet client after client in my Long Island bankruptcy practice.  Although I don’t keep such statistics, I’d say almost half of my bankruptcy clients have LIPA utility bills that we include in their bankruptcy petitions.

 

Fortunately, utility bills such as LIPA are dischargeable in personal bankruptcy proceedings.  By law, the utility company cannot terminate service merely because the customer has sought to discharge the utility bill. 

 

 

First, LIPA gives the customer a warning by mail.

 

Then, LIPA gives more warnings and makes phone calls to the customer over the next two months.  However, LIPA will not terminate service and shut off power until there are at least three months of non-payment.  This is an option of last resort.

 

Most customers will seek to work out some kind of payment arrangement.  Even by paying a small amount, the customer can usually maintain electric service.

 

If the customer cannot work out a satisfactory payment arrangement with LIPA, then LIPA will terminate service.  In May, LIPA shut off service for 2,150 nonpaying customers.

 

Even if a customer has entered into a payment arrangement or is on a budget, all electricity bill balances can be discharged in bankruptcy.  Even filing a bankruptcy the day before a scheduled termination will prevent the termination from occuring.