What Happens to Your “General Unsecured Debts” in Chapter 7?

Your “left-over debts”—those which are neither secured by collateral nor belong to any of the special “priority” categories—often don’t drive the decision about whether to file Chapter 7 or 13. But you still need to know how these “general unsecured debts” are handled under these two options.

Your secured debts often are tied to your most important possessions—home, vehicles, and sometimes business equipment. So it’s understandable that your bankruptcy decisions will focus on how you can hold on to the collateral you need. And your “priority” debts tend to involve your most aggressive creditors and often can’t be discharged in bankruptcy, so these also grab our attention. And yet, in the list of all your creditors you probably owe “general unsecured debt” to more of them than the other two categories combined. So what happens to these “left-over debts”?

I’ll cover this for Chapter 7 today, and then for Chapter 13 in my next blog.

What happens to your “general unsecured debts” in a Chapter 7 case depends on two very different considerations: 1) “dischargeability,” and 2) asset distribution.

“Dischargeability”

This term refers to whether your creditor will dispute your ability to get a discharge–a legal write-off—of that debt. The vast, vast majority of “general unsecured debts” ARE NOT challenged and so they are in fact discharged. In the rare case that your discharge of the debt is challenged, you may have to pay some or all of that particular debt, depending on whether the creditor is able to show that you fit within some rather narrow grounds for “nondischargeability.” That would usually involving allegations of fraud, misrepresentation or other similar bad behavior on your part.

Asset Distribution

If everything you own is exempt, or protected, then your Chapter 7 trustee will not take any of your assets from you. This is commonly referred to as a “no asset” case. But if the trustee DOES take possession of any of your assets for distribution to your creditors—an “asset case”—that does not necessarily mean that your “general unsecured creditors” will receive any of it. The trustee must first pay off any and all of your “priority” debts, AND pay the trustee’s own fees and that of any liquidating agents or other professionals used. Only if any funds remain will the unsecured creditors get to share in these “leftovers.”

 

To summarize, in most Chapter 7 cases your “general unsecured debts” will all be discharged, preventing those creditors from ever being able to pursue you for them. Also in most cases, this category of creditors will receive nothing from you, as long as all your assets are exempt. Relatively rarely, a creditor may challenge the discharge of its debt. And if you have an “asset case,” the trustee may pay a part or—very rarely—all of the “general unsecured debts.” But these can happen only if the “priority” debts and trustee fees do not exhaust all the funds being distributed by the trustee.

 

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The Most Basic Concept in Bankruptcy: Debts

The most practical questions you likely have if you are considering bankruptcy is what it will do to each of your debts. Will you still owe anything to anybody? What about debts you want to keep like a vehicle loan or mortgage? How to handle special debts like income taxes and child support?

To understand bankruptcy you need to understand debts. One of the most basic principles of bankruptcy is that it treats all creditors in the same legal category the same as all the other creditors in that category. So the first step in understanding debts is to understand the three main categories of debts. Not everybody has debts in each of these categories, but lots of people do. At the end of this blog, you should be able to at least start dividing your debts among these three categories. From there, bankruptcy and how it deals with each of your creditors will start making more sense.

The three categories are “general unsecured debt,” “secured debt,” and “priority debt.”

Secured Debts

All debts are either secured by collateral or not. Whether or not a debt is secured is often very straightforward, such as with a vehicle loan in which the vehicle’s title specifies your lender as the lienholder. That lien on the title, together with the documents you signed with that lender, gives that lender certain rights as to that collateral, such as the right to repossess it if you fail to make payments.

In the case of every secured debt, there is a legally prescribed way to attach the debt’s collateral to the debt. In the case of the vehicle loan, the lender and you have to jump through certain hoops for the lender to become a lienholder on the title. If those aren’t done right, the vehicle might not attach as collateral to your loan.

Debts can be fully secured or only partially secured. If you owe $10,000 on a vehicle worth only $8,000, the debt is only partially secured—secured as to $8,000, and unsecured as to the remaining $2,000 of the debt.

Debts can be voluntarily or involuntarily secured. Examples of the latter are judgment liens on your home, IRS income tax liens on all your personal property, and a mechanic’s or repairman’s lien on a vehicle that’s been repaired and the repair bill not paid.

General Unsecured Debts

All debts that are not legally secured by collateral are simply unsecured debt. And “general” unsecured debts are simply those which do not belong to any of the categories of “priority” debts (discussed below). So general unsecured debts are the default category—if a debt is not secured and not a priority debt, it’s a general unsecured one. They include every imaginable type of debt or claim. Common ones include most credit cards, essentially all medical bills, personal loans without any collateral, bounced checks, most payday loans (although those sometimes have collateral), unpaid rent and utilities, balances left over after a vehicle is repossessed, many personal loans, and uninsured or underinsured motor accident claims against you.

Sometimes debts which were previously secured can become general unsecured ones, and vice versa. An example of the first: once you’ve surrendered all the collateral—such as a vehicle on a vehicle loan—any remaining debt is general unsecured. And an example of the second: a general unsecured medical bill can become secured after a lawsuit is filed against you and a judgment entered, resulting in a judgment lien attached to your real estate.

Priority Debts

Just like it sounds, priority debts are special ones that the law has selected to be treated better than general unsecured debts. In fact, there are very specific levels of priority among all the priority debts.

It’s all about who gets paid first (which often means who gets paid at all). This comes up in two main ways.

First, most Chapter 7 cases don’t involve the trustee receiving any of your assets for distribution to your creditors. But in those cases where there are non-exempt assets, the priority creditors are paid in full before the general unsecured ones receive anything. And the higher priority creditors are paid in full before the lower priority ones.

Second, in a Chapter 13 case, your formal plan has to show that you will pay all priority debts before the completion of your case, and then you must in fact do so before you are allowed to finish it.

The most common priority debts for consumers or small business owners are the following, in order starting from the highest priority:

• child and spousal support—amounts owed as of the time of the filing of the bankruptcy case

• the administrative costs of the bankruptcy case—trustee fees and costs, and in some cases attorney fees

• wages and other forms of compensation owed to employees—maximum of $10,000 per employee, for work done in the final 180 days before the bankruptcy filing or close of business, whichever was first

• certain income taxes, and some other kinds of taxes—some are priority but others are general unsecured if they are old enough and meet some other conditions

In the next blog I’ll get more into how debts in each category are treated in Chapter 7 and Chapter 13.

 

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Business Litigation Worth Fighting About in Bankruptcy

The closing of your business, followed by your personal bankruptcy filing, often ends threatened or ongoing business litigation against you. But here are three situations where that litigation could well continue regardless of the bankruptcy.

What is No Longer Worth Fighting About

Most debts or claims against you at the time of your bankruptcy filing are resolved for all legal purpose by the filing of your bankruptcy case. Now there is no longer any benefit for the creditor to initiate previously threatened litigation or to continue the pending litigation. If you filed a Chapter 7 bankruptcy case, most if not all of your business and personal debts which you want to discharge will in fact be discharged. The creditors will either receive nothing or will receive a pro rata portion of any of your non-exempt assets. If you filed a Chapter 13 case, your creditors will receive whatever your court-approved plan provides, often pennies on the dollar of whatever you owe. There is usually not much worth starting or continuing to fight about.

What IS Worth Fighting About

But there ARE some types of debts or claims that DO still need court resolution. In these situations the creditor or adversary would likely get permission from the bankruptcy judge to either continue the pending litigation or initiate it.

1) Determining the Amount of a Debt

If a debt or claim is being discharged in a no-asset Chapter 7 case, the amount of that debt makes no practical difference. But in an asset Chapter 7 case, in which the bankruptcy trustee is anticipating a pro rata distribution of assets to the creditors, the amounts of all the debts need to be determined in order for that distribution to be fair to all the creditors. Same thing occurs in Chapter 13 cases in which the creditors are being paid a portion of their claims but not in full, since the amount of any allowed claim affects the distribution received by all the creditors.

Usually disputes about the amount of a the claims are resolved in bankruptcy court, by the creditor or trustee objecting to a proof of claim filed by the creditor. But in relatively complex disputes, especially ones already pending in another court, , the bankruptcy court may allow the amount of the debt to be resolved in that other court.

2) Potential Insurance Coverage of the Debt

If a claim against the debtor is potentially covered by insurance, then often all the affected parties want the dispute to be resolved. Issues needing resolution include whether the debtor is liable for damages, whether those damages are covered by the insurance, and whether the policy limits are enough to cover all the damages or instead leaves the debtor personally liable for a portion. Examples include:

• vehicle accidents involving the business’ employees or owners, especially those with multiple drivers

• claims on business equipment damaged by fire or flood

• various business losses potentially covered by your business owner’s policy, such as an employee’s embezzlement, or an injury to a non-employee on the business premises

In these situations the bankruptcy court will likely give permission for the litigation to proceed outside of bankruptcy court, with appropriate conditions about not pursuing the debtor for any amount not covered by insurance.

3) Nondischargeable Debts

The biggest fights about business-related debts arise when a creditor or claimant argues that its debt or claim should not be discharged in the bankruptcy case. This challenge goes to the heart of the bankruptcy case—the debtor’s desire to get a fresh start without being burdened any longer by the debts connected to the failed business.

These discharge fights apply to both Chapter 7 and Chapter 13. In the past, Chapter 13 did not allow creditors to raise many of the kinds of challenges to the dischargeability of debts allowed under Chapter 7. But the major 2005 bankruptcy amendments for the first time opened the door in Chapter 13 to many of those same challenges. Because Chapter 13 is often a better solution for debtors who have closed a business (for example, it is often a better way to deal with certain business-related debts such as nondischargeable taxes), in the last few years there have been a significant number of dischargeability challenges by creditors in Chapter 13.

 

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A Big Benefit to Owing Lots of Business Debt: Skip the “Means Test” and Qualify for Chapter 7

If you owe more business debt than consumer debt, then you avoid not only the “means test” but also some other roadblocks to a successful post-business Chapter 7 bankruptcy case.

What’s the “Means Test” and Why it Matters?

Bankruptcy law says that if your income is more than a certain amount, you have to pass a “means test” to be able to go through a Chapter 7 case successfully. One way to avoid this “means test” is by having less income than the permitted “median family income.” But the “median family income” amounts are relatively low. If your income is at all above the applicable median amount, you have to go through the “means test,” with a significant risk of being forced into a 3-to-5-year Chapter 13 payment plan instead of three-month Chapter 7 “liquidation.”

Debtors with More Non-Consumer Debts than Consumer Debts

You can skip the “means test” altogether if your debts are NOT “primarily consumer debts.” This way you could be eligible for a Chapter 7 case even if your income is above the median level. Indeed, you avoid other kinds of “presumptions of abuse” as well, not just the formulaic “means test,” but also the broader “totality of circumstances” challenges. Congress has seemingly decided that if your debts are mostly from a failed business venture, you should be permitted an immediate Chapter 7 “fresh start,” regardless of your current income and expenses.

What is a “Consumer Debt”?

The Bankruptcy Code defines a “consumer debt” as one “incurred by an individual primarily for a personal, family, or household purpose.”

The focus is on the purpose for which you incurred the debt in the first place. If you made a credit purchase or took out the loan exclusively, or even mostly, for your business, then it may well not a “consumer debt.” That is a factual question that must be decided separately for each one of your debts.

“Primarily Consumer Debts”?

The Bankruptcy Code does not make this crystal clear, but generally if the total amount of consumer debt is less than the total amount of non-consumer debts, your debts are not “primarily consumer debts.” And then you do not have to mess with the “means test.”

Seemingly Consumer Debts May Not Be

Small business owner often financed the start-up and ongoing operation of their businesses with what would otherwise appear to be consumer credit—credit cards, home equity lines of credit and such. Given their purpose, these may qualify as non-consumer debts in calculating whether you have “primarily consumer debts.” This is definitely something to discuss with your attorney to consider how the local judges are interpreting this issue.

Unexpectedly High Business Debts Can Help

Sometimes business owners have business debts larger than they thought they had, which could push their non-consumer debt higher than their consumer debt. For example, if you had to break a commercial lease when you closed your business, the unpaid lease payments projected out over the intended term of the broken lease could be huge. Or your business closure may have left you with other hidden debts, such as obligations to business partners or unresolved litigation, with tremendous damages owed. The silver lining to these larger-than-expected business debts is that they may allow you to skip the “means test” and other grounds for dismissal or conversion to Chapter 13, allowing you to discharge all your debts through a Chapter 7 case when you could not have otherwise.

 

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Getting a Handle on Your Income and Business Taxes Through Bankruptcy While Your Business Forges Ahead

Could your small business survive and even thrive if you could just get better terms for payment of your back tax debts?

The owners of just about every struggling sole proprietorship have income and business tax problems. When you are barely scraping by, needing every dollar to pay the absolutely necessary keep-the-business-running expenses, you can find yourself unable to scrape together the money to make your estimated personal income tax payments each quarter. If you have an employee or two, it can be all too tempting to use the withheld payroll tax money for some critical business or personal expense instead of paying it over to the IRS. So even when business improves, once you fall behind with your taxes it’s terribly difficult to catch up, to be simultaneously paying both your current and past tax obligations. This especially true considering accruing late charges and interest, which can greatly increase the amount you must pay to catch up.

Add to the mix the IRS’ limited flexibility on payment terms for back taxes, plus its extraordinary collection powers against you and against your business and personal assets, and it’s no wonder that back taxes are often the most urgent problem for a business owner trying to figure out what to do.

If your business is a sole proprietorship in your name, or in your name and that of your spouse, a Chapter 13 case would very likely give you a series of advantages in dealing with your past due tax liabilities, while allowing your business to continue to operate. (If your business is instead in the form of a corporation, or if your debt amount is larger than a certain threshold, you may not qualify for Chapter 13 but instead need to consider Chapter 11 or other options, a discussion which is beyond the scope of this blog.)

A Chapter 13 bankruptcy could help your business survive by significantly reducing both your business and personal monthly debt obligations, and the tax debts themselves as well as the rest of your debts. As for the back taxes:

• some of the taxes or penalties may be written off (“discharged”) altogether;

• payments on the remaining tax debts would usually be stretched out over a much longer period than the taxing authorities would otherwise allow, thereby greatly reducing the amount you would need to pay each month; and

• ongoing interest and penalties usually stop accruing, so that the payments you make pay the tax debts off much more quickly.

So Chapter 13 almost always gives you both immediate month-to-month relief easing your business and personal cash flow, and long-term relief reducing what you must pay before you are tax debt free, and completely debt free.

 

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Oregon Foreclosures Likely Shifting to Judicial Process

Oregon foreclosures of residential properties will likely be shifting from nonjudicial to judicial process, and the shift has already begun with some servicers, namely Wells Fargo and its subsidiaries. Oregon is one of 24 states that provides a nonjudicial foreclosure process, which is how most delinquent residential mortgages are foreclosed since this has been a faster and cheaper process for lenders.

One reason for the shift to more judicial court actions is because judges have started blocking nonjudicial foreclosures for failure of lenders to record ownership history of the trust deeds, as required for nonjudicial foreclosure. The shift will mean that the process will possibly take longer to clear titles following the sheriff sales. It will also take lenders considerable time to review and shift gears on pending foreclosures. Lenders may decide the cost and time expense are worth more certainty with the judicial process.

The good news for borrowers subject to the judicial foreclosure process is they will now have a judge to hear their complaints, if they challenge the filing. This right is currently unavailable unless a lawsuit is filed by the borrower to stop a nonjudicial process from continuing forward. However, under a judicial foreclosure, if homeowners don’t challenge a filing, the lenders could get a sale date more quickly and possibly expedite the process. It also does not require the recordation of beneficiary history, so it can result in cleaning up any messy title situations the lender may face. This means a defaulting borrower will need a good defense in order to realistically challenge a judicial foreclosure, but the court will have to make a decision before the foreclosure can happen. There could be more opportunities for workouts and settlements too.

One huge risk is that, currently, Oregon law protects homeowners from being pursued by lenders for their losses for homes that sold for less than the balance on the loan. However, if a lender pursues judicial foreclosure, if someone moves out of the home before the foreclosure complaint is filed, they could lose this protection and may be personally liable for the deficiency. (This problem is going to be fixed by a new law that goes into effect soon). Homeowners will also lose the right to cure, which gives them up to 5 days prior to a nonjudicial auction sale date to pay the missed payments and lender fees to end the foreclosure; but they will gain the right of redemption under the judicial process which gives them up to six months to repurchase the home for what it sold for at the foreclosure sale. This could mean homes will be vacant for longer periods and be difficult to immediately resell.

 

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Irony by Perjury Adds Insult to Injury: from Lender Robo-signing to Foreclosed Homeowners Begging for Scraps from the National Mortgage Fraud Settlement

Homeowners who lost their homes to foreclosure may need to commit perjury to get restitution payments though the settlement.  That would be the deepest kind of insult on injury.

In the last blog, I explained what a homeowner who lost a home to foreclosure (from 2008 through 2011) will have to assert to get his or her small share of that $1.5 billion pot of money:

1. “Borrower lost the home to foreclosure while attempting to save the home through a loan modification or other loss mitigation effort.”

2. “Servicer errors or misconduct in the loss mitigation or foreclosure processes affected the borrower’s ability to save the home.”

While these may seem superficially sensible, in practice they are very troublesome, especially because the statements must be made under penalty of perjury.

As to the first statement, what “other loss mitigation effort” “to save the home” will be considered sufficient to be able to make that statement? Must that effort have continued right up to the foreclosure date to be considered to have “lost the home to foreclosure while attempting to save the home”?  How is the former homeowner to know whether he or she can make this statement truthfully?

The second statement is even more of a problem. How can the former homeowner know whether “servicer errors or misconduct in the loss mitigation or foreclosure processes affected the borrower’s ability to save the home”? The robo-signing of foreclosure documents—mortgage servicers’ false assertions made under oath by the thousands—were only discovered through borrowers’ attorneys’  aggressive discovery efforts during litigation. In this nationwide settlement, the five banks are not admitting ANY wrongdoing or liability. (For example, see the non-admission clause in the Federal Release, Exhibit F in the Wells Fargo settlement documents, paragraph F on page F-11, which is page 232 of the 315 pages of those documents.) Presumably the banks are not now going to start admitting wrongdoing on a case-by-case basis so that borrowers can answer this statement accurately.

So to receive the restitution payment a former homeowner will have to sign a statement under penalty of perjury affirming the truthfulness of one statement that is so vague as to be in many situations meaningless, and the truthfulness of a second statement the accuracy of which is unknowable.

There may yet be a partial solution, to at least the first required statement about the extent of borrowers’ efforts to save the home. The claim form to be sent out to the borrowers’ by the yet-undesignated Settlement Administrator may give enough guidance about this. A tentative 3-page claim form has been prepared by the Monitoring Committee for possible use by the Settlement Administrator. It may create a bright line between qualifying and non-qualifying borrower efforts. We don’t know yet because although this tentative claim form is being made available for companies applying to become the Settlement Administrator (the application deadline is April 30, 2012), it is not being released to anyone else.

But even so, I see no conceivable way that the second statement about “servicer error or misconduct” can be made known to the borrowers in order for them to be able to assert that under penalty of perjury. The banks are not going to admit to wrongdoing as to two million or so homeowners in direct contradiction of their non-liability assertion in the settlement documents.

So here’s the moral irony:

1. The banks were accused by the federal government and 49 states of a long list of allegations of serious wrongdoing which take 10 pages to detail (see pages F-2 through F-11 of the Federal Release in the settlement documents referred to above). These allegations include fraud and misrepresentations of numerous kinds, including in the form of many thousands of perjured documents submitted to courts over an extended period of time. The banks do not admit to any of these allegations or to any resulting liability.

2. Now the banks have negotiated with the governmental entities to pay restitution for their extensive alleged wrongdoing, and in particular to homeowners who’ve already lost their homes to foreclosure. But as a precondition to receiving that restitution, these former homeowners will in many cases be faced with a moral dilemma: can they sign a statement under penalty of perjury asserting that their “ability to save the home” was affected by “servicer errors or misconduct” when they do not know whether such errors or misconduct happened as to their mortgage, and if so whether it had any effect on their “ability to save the home.”

3. Because the “Monitoring Committee” has made clear that the “Settlement Administrator” will not be required to get documentation from borrowers about their statements on the claim forms, borrowers are seemingly being encouraged to make statements that will in many cases be vague and factually unverifiable, while asserting the truthfulness and accuracy of those statements under penalty of perjury.

4. The banks, having admitted to no fault, having paid their modest penalty, and having foisted this moral conundrum onto the foreclosed borrowers, can now wash their hands entirely of the matter. They no longer care how each borrower handles the matter since the pot of money does not change. The money just shifts out of the hands of the perhaps more carefully honest borrowers who disqualify themselves by admitting that they cannot swear to the fact that they lost the property because of lender wrongdoing.

5. Thus this settlement process has lowered borrowers—through circumstances almost entirely outside their control—to the moral level of the original robo-signers: “just sign here and don’t worry what the statements say or what they mean.”

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Update on the Cash Distribution to Foreclosed Homeowners from the National Mortgage Fraud Settlement

What qualifies you to receive the $1,500 to $2,000 restitution payment for losing your home to foreclosure? More clues have just become available.

 The “largest consumer financial protection settlement in US history,” the $26 billion national mortgage fraud settlement, was announced with great fanfare in February. More than a month later, on March 12, 2012, the details of the settlement were finalized and hundreds of pages of settlement documents were signed and finally made public. But all those pages still did not at all make clear how a person whose home was foreclosed will qualify to get the money.

To remind you about this, most of the money in this settlement is earmarked for current homeowners for loan modifications, refinances, and other ways to help them hold on to their homes. But just shy of $1.5 billion is for those who’ve already had their homes foreclosed. That’s the subject of this blog.

This part of the settlement applies only to:

  • foreclosures that occurred during the calendar years 2008 through 2011
  • mortgages held or serviced by Bank of America, Wells Fargo, J.P. Morgan Chase, Ally Financial/GMAC and CitiGroup and their affiliates
  • mortgages on which at least 3 payments were made and the property “was not abandoned by the homeowner or condemned prior to the time of the foreclosure sale” 
  • “owner-occupied, one-to-four unit” residence in all states except for Oklahoma, which is not participating in this settlement

Find out if your mortgage is included in this settlement pool by going to the special settlement website for the banks’ toll-free phone numbers and websites.

But once you are in this pool, what further conditions, must you meet to get the money? The initial settlement documents last month surprisingly did not make this clear. They just stated that “cash payments” from the $1.5 billion fund would be provided to borrowers whose homes were foreclosed during the 2008 through 2011 period and “who submit claims arising from the Covered Conduct [the alleged mortgage servicing and foreclosure fraud]; and who otherwise meet criteria set forth by the State members of the Monitoring Committee.”

So if you are a foreclosed homeowner, do you only get the settlement money if you can show your foreclosure happened because of your bank’s alleged misconduct? Has the “Monitoring Committee” provided any more information on this or any other criteria to be used?

Two and a half months after the February 9 announcement of the settlement, there is still no definite answer to the first question. And the second question? The 14 state attorneys general on the “Monitoring Committee” has curiously not directly told foreclosed homeowners anything more about the qualifying criteria, apparently because that will be the job of the “Settlement Administrator.” But in the last few days this Committee HAS indirectly provided some important clues about the criteria through its release of two documents:

The RFP states the following:

Borrower Certifications:

In addition to the baseline eligibility criteria listed above, eligible claimants must also complete a claim certification form in which they certify under penalty of perjury to the following:

  • Borrower lost the home to foreclosure while attempting to save the home through a loan modification or other loss mitigation effort.
  • Servicer errors or misconduct in the loss mitigation or foreclosure processes affected the borrower’s ability to save the home.

But those two requirements are not clear either. What would be considered an adequate attempt by the borrower to save the home? For example, if you simply made a number of unsuccessful attempts to get the lender to respond to phone messages—would that be enough? And how are you going to know when a bank’s misconduct “affected” your ability to save the home when the bank is providing you that kind of information and not admitting anything? Indeed, in this entire multi-billion dollar settlement the banks are not admitting to a single act of misconduct!

The First Addendum—released just a few days ago on April 20—gives some further clues, albeit maddening ones. Here is a pertinent question from the Addendum and the Monitoring Committee’s response:

Question #12: Will the Settlement Administrator be required to request and review documentary proof from claimants who submit claim certification forms in order to determine eligibility?

Answer: No. Other than reviewing the claim certification forms to ensure that claimants properly made the required certifications, the Settlement Administrator will not be required to request and review documentary proof from claimants in order to determine eligibility.

So to receive the settlement money, it looks like you as a foreclosed homeowner will have to sign a claim form stating under penalty of perjury that the foreclosure occurred in spite of you efforts to save the home, AND the foreclosure occurred because of the bank’s “errors or misconduct”—which you may well have no way of knowing about. But, it looks like you will not need to provide any documentation to verify your statements. It is unclear whether information will be provided by your bank to the Settlement Administrator which might contradict your statements—for example asserting that you did not attempt to contact the bank to try to save the home. And if that occurs, there’s also no indication how such disputed facts would be resolved.

Stay tuned here, and on the settlement website, for answers to these continuing ambiguities.

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Dealing with Accusations of Business Fraud through Bankruptcy

When a small business fails, its owner or employer is sometimes accused of causing or hastening that failure through fraud or intentional bad behavior. If that person is already considering filing a bankruptcy to deal with the financial fallout of the closing of the business, how are those accusations going to be handled in that bankruptcy case?

A bankruptcy filed after the failure of a business tends to be more acrimonious than in a straight consumer bankruptcy because:

• The relationship between debtor and creditor is often more personal and intense—such as between business partners, between a key employee and the owner, or between the owner and investors who were friends or a relatives. So the failure is taken more personally, and the person who lost money is more likely to feel a sense of betrayal.

• The business context often provides many all-too-convenient opportunities for the debtor to bend the rules or behave underhandedly, especially “when desperate times call for desperate measures.” On the other hand, actions that the debtor took in good faith at the time may simply look inappropriate in hindsight.

• There is often more money at stake, money which these kinds of creditors can less afford to lose than a conventional commercial creditor. So it’s harder for these creditors to just write it off and walk away.

So if you have been accused by a former business partner, investor, or similar business creditor of some sort of business fraud, or fear that you will be so accused, does this mean that you should avoid filing bankruptcy? Of course you will want to discuss a serious matter like this very thoroughly with your bankruptcy attorney, perhaps in consultation with your business or litigation attorney if those accusations have already ripened into a lawsuit against you. But, interestingly, there are a set of practical reasons why those kinds of accusations often go away, or at least are reduced in seriousness, when you file a bankruptcy.

1. Automatic stay

The filing of your bankruptcy case stops, at least temporarily, any litigation against you already in process, and prevents a lawsuit from being filed or any other collection action to be taken against you. This pause in the action at least gives your adversary the opportunity to consider whether continuing to pursue you would truly be worthwhile.

2. More difficult to make a case against you

That pause is valuable because your bankruptcy filing changes the rules of the game, mostly in your favor. When you file your bankruptcy, you make it harder for your creditor to win against you. It’s no longer enough to merely establish that you owe him or her some money. Once you file bankruptcy, for the debt not to be discharged the creditor must also establish that the debt is based on one of a relatively narrow set of facts involving fraud, misrepresentation, embezzlement or theft, fraud in a fiduciary capacity, or an intentional and malicious injury to person or property.

3. Proof of your true finances

The documents you are required to file under oath in your bankruptcy case should show your angry creditor, and maybe more importantly his attorney, that even if the case against you was successful, you have no pot of gold with which to pay a judgment. Most sensible people do not like “spending good money after bad”—paying thousands of dollars to their attorney only to get a judgment that could never be collected, or only so slowly that the additional expense would simply not be worth all the risk and effort.

So, notwithstanding the tendency for small business-spawned bankruptcies to be more contentious, filing such a bankruptcy can create decisive advantages for you if you are being pursued for an alleged business fraud—you decrease your opponent’s odds of winning and increase his costs of pursuing you.

 

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Protecting Yourself When Your Business Has to Throw in the Towel

If you’re seriously considering closing down a struggling business, you are likely very concerned about personal damage control: how do you end the business without being pulled down with it?

My last blog was about saving your business through a Chapter 13 case. I can explore that option with you when you come in to see me, but let’s assume here today that either before or after talking with me you’ve made up your mind to close the business. And let’s keep it simpler by assuming that your business is or was a sole proprietorship, as I did in the last blog, and that you truly need bankruptcy relief because of the totally unmanageable size of the debts.

Lots of considerations come into play, but let’s focus on two main ones—assets and debts—in looking at three options: 1) a no-asset Chapter 7 case, 2) an asset Chapter 7 one, and 3) a Chapter 13 case.

No-Asset Chapter 7 for a Fast Fresh Start

After putting so much effort and hope into your business, once you accept the reality that you have to give up on it, you understandably may just want to clean up after it as fast as possible. And in fact a “straight bankruptcy” may be the most consistent with both your gut feelings and with your legal realities.

IF everything that you own—both from the business and personally—fits within the allowed asset exemptions, then your case will likely be relatively simple and quick. A no-asset Chapter 7 case is usually completed from start to finish in about three months. And if none of your assets are within the reach of the trustee, there is nothing to liquidate and distribute among your creditors. The liquidation and distribution process can take many additional months—or even years, so avoiding that streamlines a Chapter 7 case greatly.

But this assumes that all your debts can be handled appropriately in a Chapter 7 case—the debts that you want to discharge (write off) would be discharged and those that would not are ones that you either want to or are able and willing to pay. The debts you want to pay may include secured debts like vehicle loans and mortgages; debts you are able and willing to pay may include certain taxes, support payments, and perhaps student loans.

Asset Chapter 7 Case As a Convenient Liquidation Procedure

If you do have some assets that are not exempt, that alone may not be a reason to avoid Chapter 7. Assuming that those are assets that you can do without—and maybe even are happy to be rid of, such as if they came from your former business—letting the bankruptcy trustee mess with them instead of you doing so may be a sensible and fair way of putting the past behind you.

That may especially be true if you have some debts that you would not mind the trustee paying out of the proceeds of selling your non-exempt assets. You can’t predict with certainly how a trustee will act and how much if any would trickle down to which creditors, but this is something to keep in mind with this option.

Chapter 13 to Deal with the Leftover Consequences

Even if you’d prefer putting your closed business behind you quickly, there may be fallout from that business that a Chapter 7 would not deal with adequately. For example, if the business left you with substantial tax debts that cannot be discharged, non-exempt assets that you need to protect, or a significant mortgage arrearage, Chapter 13 could sometimes save you thousands of dollars and provide you protection from and a better way of dealing with these kinds of creditors. Deciding between Chapter 7 and 13 when different factors point in different directions is where you truly benefit from having an highly experienced bankruptcy attorney help you make that delicate judgment call.

 

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