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Business Disputes that Get Dragged Into Your Bankruptcy Case

Creditors can challenge your ability to legally discharge your debts in a bankruptcy case. These challenges happen more so in bankruptcy cases filed to clean up after the close of a business. Avoid the creditor challenges for a cleaner case.

Bankruptcies filed after the close of a business seem to attract more creditor challenges to the discharge of debts for a number of reasons:

1. The amounts at issue tend to be larger, making litigation more tempting for the creditor.

2. Certain debtor-creditor relationships can become deeply personal, and so when things go badly, can turn very antagonistic. So in debts between ex-business-partners, or between a business owner and his or her financial supporter or investor, or the buyer and the seller of a business, the aggrieved creditor is more reluctant to let the debt be discharged without a fight.

3. For business owners trying to keep their businesses afloat, desperate times call for desperate measures, so they edge into risky behavior that exposes them to future challenge in bankruptcy court.

4. In these kinds of close creditor-debtor relationships, the creditor often knows something about the debtor’s risky behavior, making it more likely to be raised later in court.

On the other hand, when former business owners considering bankruptcy hear that any creditor can raise challenges to the discharge of its debt, they often feel that will inevitably happen in their case. But such challenges are in fact relatively rare, for the following legal and practical reasons:

1. The legal grounds under which challenges to discharge can be raised are relatively narrow. Instead of just proving the existence of a valid debt—as in a conventional lawsuit to collect on a debt—the creditor has to prove that the debtor engaged in behavior such as fraud in incurring the debt, embezzlement, larceny, fraud as a fiduciary, or intentional and malicious injury to property.

2. In bankruptcy, the debtor files under oath a set of extensive documents about his or her finances, and is also subject to questioning by the creditors about those documents and about anything else relevant to the discharge of the debts. When these documents, along with any questioning, reveal that the debtor genuinely has nothing worth chasing—as is most often the case—this tends to cool the anger of most creditors. Only the most motivated of creditors will be willing to throw the proverbial good money after bad in the hopes of getting nothing more than a questionably collectible judgment.  

So in a closed-business bankruptcy case we have these two opposing tendencies—more likely to have challenges to the discharge of significant debts, especially by certain kinds of closely related creditors, but these challenges are still relatively rare because of the narrow legal grounds for them and the financial practicalities involved. It is impossible to predict perfectly something that is largely outside of the control of the debtor. But a good bankruptcy attorney will give you good counsel about this, prepare your paperwork in the best possible way to counter any such challenges, and may even be able to defuse them before they are raised. A dischargeability challenge is very expensive to defend and can turn a relatively simple bankruptcy case into a very involved one. So avoiding one if possible, or positioning well for it if it is raised, are important reasons to have an experienced and conscientious bankruptcy attorney in your corner. That’s all the more true if you have reason to believe that any of your business creditors are in fact considering raising such a challenge.

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Will You Benefit from the Just-Completed $26 Billion Home Mortgage and Foreclosure Settlement?

The long-awaited joint federal-state settlement with the major banks for their alleged fraudulent documentation and processing of mortgages and foreclosures was announced on Thursday, February 9. Will it help you, and if so, how?

I interrupt my ongoing series on small business bankruptcy to answer your most immediate questions about this huge settlement.

1. Who is included in this settlement?

  • Only five big banks are currently signed on: Bank of America, Wells Fargo, J.P. Morgan Chase, Ally Financial and Citigroup.  Only mortgages owned and held by them are directly affected.  Negotiations continue with nine other mortgage servicers, which if successful could bring the total amount of money involved to $30 billion.
  • 49 states joined in the settlement; only Oklahoma did not.
  • Mortgages held by Fannie Mae and Freddie Mac—consisting of the majority of U.S. mortgages—are NOT covered.

2. What does this settlement resolve and what is open for further negotiation and litigation? In other words, what liabilities are the banks escaping from for their $26 billion?

  • The claims against the banks that are released in this settlement are limited to mortgage servicing and foreclosure claims. Claims for a variety of other alleged wrongdoing are not covered and so remain open to being pursued by the federal and state regulators, investors, and homeowners. Claims that are NOT covered include those related to the securitization of mortgage-backed securities that were at the heart of the financial crisis, and those against or involving MERS (Mortgage Electronic Registration Systems).
  • Individuals’ rights to bring their own lawsuits or to be part of a class action against any banks for any claims are not affected by this settlement.
  • The settlement does not limit any potential criminal liability for any individuals or financial institutions; it provides no immunity from prosecution whatsoever.

3. How does the settlement help you if your mortgage is held by one of these five banks?

  • If you need a mortgage loan modification, these servicers will (finally!) be required to offer principal reductions, for first and second mortgages, to a value of up to $17 billion. This is where the bulk of the settlement funds are earmarked.
  • If you’re current on your mortgage but your home is worth less than the mortgage, $3 billion of the settlement is to provide refinancing relief.
  • If your home has already been foreclosed, $1.5 billion will be paid out by the banks as a penalty against them–around  $2,000 per homeowner–without you needing to show any damages or releasing any claims against the bank.

4. Where do you go for more information and to find out whether you will be helped in any of these ways?

  • Go to the new settlement website for current and upcoming information about it:

http://www.nationalmortgagesettlement.com

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Keeping It Simple in a Closed-Business Chapter 7 Case

Using a Chapter 7 case to clean up after closing down your business will be easy or not depending largely on three factors: business assets, taxes, and other nondischargeable debts. These three will usually also determine if you should be in a Chapter 7 case or instead in a Chapter 13 one.

Once you’ve closed down your business and decided to file bankruptcy, you may have a strong gut feeling about choosing the Chapter 7 option. After what you’ve been through, you just want a fresh, clean start. If you’d put years of blood, sweat and tears into trying to get your business to succeed, and then finally had to throw in the towel after resisting doing so for so long, at this point you likely feel like it’s time to put all that behind you. The last thing you likely feel like doing is dragging things along for the next three to five years that a Chapter 13 case usually lasts.

And you may well be ABLE to file a Chapter 7 case. The “means test” largely determines whether, given your income and expenses, you can file a Chapter 7 case. In my last blog I told you that you can avoid the “means test” altogether if more than half of your debts are business debts instead of consumer debts. But even if that does not apply to you, the “means test” will still not likely stand in your way, especially if you just closed down your business recently. That’s because the period of income that counts for the “means test” is the six full calendar months before your bankruptcy case is filed. An about-to-fail business usually isn’t generating much income.

But usually the question is not whether you are able to file a Chapter 7 case, but rather whether doing so is really better for you than a Chapter 13 one.

Many factors can come into play, but the following three seem to come up all the time:

1. Business assets: There are two kinds of Chapter 7 cases: “no asset” and “asset.” In the former, the Chapter 7 trustee decides—usually quite quickly—that none of your assets (which technically belong to your “bankruptcy estate”) are worth taking and selling to pay creditors. Either all those assets are “exempt” from the reach of the trustee, or are not worth enough for the trustee to bother. But with a recently closed business, there are more likely to be assets that are not exempt and are worth the trustee’s effort to collect and liquidate. If you have such collectable business assets, you will want to discuss with your attorney where the anticipated proceeds of the Chapter 7 trustee’s sale of those assets would likely go, and whether that is in your best interest compared to what would happen to those assets in a Chapter 13 case.

2. Taxes: Just about every closed-business bankruptcy seems to involve tax debts. Although some taxes CAN be discharged in a Chapter 7 case, most cannot. Chapter 13 is often a better way to deal with taxes. This will depend on the precise kind of tax—personal income tax, employee withholding tax, sales tax—and on a series of other factors such as when the tax became due, whether a tax return was filed, if so when, and whether a tax lien was recorded.

3. Other nondischargeable debts: Bankruptcies involving former businesses seem to get more than the usual amount of creditor challenges to the discharge of debts. These challenges are usually based on allegations that the business owner acted in some fraudulent fashion against a former business partner, a business landlord. or some other major creditor.  Such litigation, often started or at least threatened before the bankruptcy is filed, can turn an otherwise simple bankruptcy case into a long and expensive battle, regardless whether your case is a Chapter 7 or 13. But depending on the nature of the anticipated allegations, Chapter 13 may give you certain legal and tactical advantages over Chapter 7.

I’ll expand on these three one at a time in my next three blogs. From them you will be able to get a much better idea whether your business bankruptcy case should be in a Chapter 7 or not, and if so whether it will likely be relatively simple or not.

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Massive Mortgage Settlement Finally Coming Together

The multibillion-dollar deal, more than a year in negotiations between the biggest home mortgage servicers on one side and the states’ attorneys general and federal agencies on the other, may be just days from being finished. The deadline for each state’s attorney general to decide whether to sign was Friday, February 3, but that has now been extended to Monday, February 6.

This settlement is to resolve allegations about an extensive series of foreclosure and mortgage loan-servicing abuses that came to light in the summer and fall of 2010. State and federal officials have since then been negotiating an agreement with five major mortgage servicers. It would provide some very specific mortgage relief to homeowners and would establish strict requirements for how banks could conduct foreclosures. The negotiations have gone back and forth, with various proposals being floated, resulting in very public displays of protest by various bank-friendly sets of attorneys general on one hand and by other more aggressive attorneys general on the other. A settlement now looks imminent, in large part because of the timing of the current election cycle, as well as the dire need for progress on the never-ending home foreclosure front —and because this has dragged on for so long.

Since this story is evolving every day, I’m going to provide you with a few recent news articles about it, introducing each one to help you decide if you want to look at it.

This USA Today article gets right to what we all care about, “Who benefits from possible $25B mortgage settlement?”  It’s actually a good summary—in a Q&A format—of the likely terms of the settlement and its effects on homeowners and the housing market. Some of the questions include: “How might the $25B be spent?” “Who will get [mortgage] principal reductions?” “How tough are the potential settlement terms on the banks?

“Mortgage deal would give states enforcement clout” from Reuters addresses the concern “that banks have not adequately followed through on prior settlements, a concern that has pushed government negotiators to establish more forceful enforcement mechanisms in this deal than have been used in the past.” So this deal gives the states, along with a separate “monitoring committee,” the power to go to court to enforce the terms of the settlement and to ask for penalties of up to $5 million per violation.

And if you want to get a taste of how complicated these negotiations have been on the technical side (without even accounting for the intense political pressures), here is a letter dated January 27, 2012 from the Nevada Attorney General to the officials who have been spearheading the settlement. In the letter, she asks for written answers to 38 questions so that her state can decide whether or not to sign on to the settlement. It’ll make your head spin. Don’t say I didn’t warn you.

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In a Chapter 7 Case, “The Only Thing We Have to Fear is Fear Itself”

There’s a lot you can do to help make your “straight bankruptcy” Chapter 7 case a straightforward one, but one thing you can’t control is your creditors’ reactions to it. You know that creditors can sometimes try to prevent you from discharging (legally writing off) your debts, so naturally you worry about this. Here’s why you shouldn’t worry.

Let’s first be clear that I’m not talking here about the kinds of debts that simply can’t be discharged, and don’t require any creditor objection for that to happen—for example, back child and spousal support, many taxes, and criminal fines. Instead I’m talking about the right of any creditor to object to the discharge of its debt, under certain limited circumstances.

You might figure that if your creditors have ANY chance to object to the discharge of their debts, it would jump at the chance to do so. Or at least enough of them would object to cause you trouble. But that is NOT what happens. Most Chapter 7 cases go through with NO creditor objections at all. Well, why not?

1. The legal grounds for creditors’ objections are quite narrow. They need to have evidence that the debt was incurred through your fraud or misrepresentation, arose out of a theft or embezzlement, as a result of your intentional injury to a person’s body or property, or was related to other similar bad acts. So creditors don’t object to the discharge of their debts simply because most of the time no such facts exist.

2. Even within such narrow grounds, relatively common situations such as bounced checks or the use of credit not long before filing bankruptcy can be seen as fraudulent, so creditors can object to these kinds of debts. But even in these situations, creditors often do not bother to object because they decide it’s not worth “throwing good money after bad”—spending more money for their staff time and attorney fees in the hopes of first getting a bankruptcy judge to agree with them, AND then still needing to get you to repay the debt.

3. One of the reasons why sensible creditors decide not to object even when they think they might have the legal grounds to do so is that they risk being ordered to pay your attorney’s fees to defend against their objection. That can happen if the judge thinks that “the position of the creditor was not substantially justified.” So creditors risk not only paying for their own costs to object, but also paying for your costs in fighting the objection.

So that’s why most creditors just write off the debt and move on.

But there ARE two exceptions.

1. Leverage: If a creditor thinks it has a decent case against you—such as with a string of bounced checks or a debt incurred shortly before the bankruptcy was filed—it may well object to the discharge of the debt knowing that YOU can’t or don’t want to pay attorney fees in fighting it, EVEN if you have a decent defense. So they’ll raise the issue in the hopes of forcing you to enter into a settlement quickly.

2. Axe to grind: If you have someone you owe money to who is simply very mad at you, so that your bankruptcy filing really aggravated him or her, then this creditor might be looking for an excuse to hurt you back. Ex-spouses and ex-business partners are the most common. Irrational anger by those types, not reined in by the financial realities, probably causes the messiest objections.

To reduce any anxiety you have about any of this, talk it over thoroughly with your attorney. If you have any concern about how you incurred any of your debts, or if someone has threatened you with any trouble if file bankruptcy, lay it all out. Often, your fear will not be justified. And if there are potential problems, being up-front about it may enable your attorney help reduce the risks.

A final bit of good news: creditors have a very limited time to raise objections: generally 60 days after the Meeting of Creditors. So, if whatever assurances given by your attorney still doesn’t stop you from worrying in the meantime, you’ll at least know that you can stop worrying after that date.

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When Chapter 7s Are Not So Simple

The goal of most Chapter 7 cases is to get in and get out—file the petition, go to a simple 10-minute hearing with your attorney a month later, and two months later get your debts written off. Mission accomplished, end of story. And usually that’s how it goes. So when it doesn’t go that way, why not?

Four main kinds of problems can happen:

1. Income:  Under the “means test,” If you made or received too much money in the 6 full calendar months before your Chapter 7 case is filed, you can be disqualified from Chapter 7. As a result you can be forced instead into a 3-to-5 year Chapter 13 case, or have your case be dismissed altogether—thrown out of court. These results can sometimes be avoided by careful timing of your case filing, or by making changed to your income beforehand, or if necessary by a proactive filing under Chapter 13. Or sometimes it’s worth fighting to stay in Chapter 7 by showing that it is not an “abuse” to do so.

2. Assets:  In Chapter 7, if you have an asset which is not “exempt” (protected), the Chapter 7 trustee will be entitled to take and sell that asset, and pay the proceeds to the creditors. You might be happy to surrender a particular asset you don’t need in return for the discharge of your debts, in particular if the trustee is going use the proceeds in part to pay a debt that you want paid, such as a child support arrearage or an income tax obligation. But instead you may not want to surrender that asset, either because you think it is worth less than the trustee thinks or you believe it fits within an exemption. Or you may simply want to pay off the trustee for the privilege of keeping that asset. In all these “asset” scenarios, there are complications not present in an undisputed “no asset” case.

3. Creditor Challenges to Discharge if a Debt:  Creditors have the limited right to raise objections to the discharge of their individual debts, on grounds such as fraud, misrepresentation, theft, intentional injury to person or property, and similar bad acts. In most circumstances the creditor must raise such objections within about three months of the filing of your Chapter 7 case. So once that deadline passes you no longer need to worry about this, as long as that creditor got appropriate notice of your case.

4. Trustee Challenges to Discharge of Any Debts:  If you do not disclose all your assets or fail to answer other questions accurately, either in writing or orally at the hearing with the trustee, or if you fail to cooperate with the trustee’s investigation of your financial circumstances, you could possibly lose the ability to discharge any of your debts. The bankruptcy system is still largely, believe it or not, an honor system—it relies on the honesty and accuracy of debtors (and, perhaps to a lesser extent, of creditors). So the system is quite harsh towards those who abuse the system by trying to hide the ball.

To repeat: most of the time, Chapter 7s are straightforward. No surprises. That’s especially true if you have been completely honest and thorough with your attorney during your meetings and through the information and documents you’ve provided. In Chapter 7 cases for my clients, my job is to have those cases run smoothly. I do that by carefully reviewing my clients’ circumstances to make sure that there is nothing troublesome, and if there is, to address it in advance in the best way possible. That way we will have a smooth case, or at least my clients will know in advance the risks involved. So, be honest and thorough with your attorney, to greatly up the odds of having a simple Chapter 7 case.

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THE Goal of Bankruptcy: Discharge of Your Debts

Most—but not all—debts are written off, or “discharged,” in a bankruptcy case. Is there a simple way to know what will and what will not be discharged?


As part of getting a fresh start for the new year, I’m covering the most basic concepts about bankruptcy in the first few blogs of the year. And there is nothing more basic than bankruptcy’s main purpose, getting a fresh financial start through the legal discharge of your debts.

Both kinds of consumer bankruptcy can discharge debts. But most Chapter 13s tend to have other purposes as well, and the discharge usually occurs only 3 to 5 years after the case is filed. In contrast, most Chapter 7 “straight bankruptcy” cases are filed for the sole purpose of discharging debts. And in most Chapter 7 cases, all debts that the debtors want to discharge are discharged, and it happens within just three months or so after your case is filed. So I’m focusing in this blog on Chapter 7 discharge of debts.

So is there a simple way of knowing what debts will and will not be discharged in a Chapter 7 case?

Sorry. Not really.

I can give you a list of the categories of debts that can’t, or might not, be discharged (and will give you that list in a couple paragraphs), but some of those categories don’t have clear boundaries, and some depend on whether a creditor is going to challenge the discharge and how a judge might rule.

But why can’t it be simple? Because in the political tug of war between creditors and debtors over the last few centuries, there have been lots of compromises, leaving us today with a bunch of hair-splitting rules about what debts can and can’t be discharged.  Believe it or not, the original bankruptcy laws in England did not even include ANY discharge of debt, since bankruptcy was originally designed as a procedure to help creditors collect from debtors.

But I’m making it sound a lot worse than it is in practice. Here’s what you need to know:

#1:  All debts are discharged, EXCEPT for those that fit within an exception.

#2:  There ARE a lot of exceptions, BUT if you are thorough and candid with your attorney you will almost always know whether you have any debts that may not be discharged. Surprises are rare.

#3:  Some debts are never discharged, NO MATTER WHAT: for example, child or spousal support, criminal fines and fees, and withholding taxes.

#4:  Some debts are never discharged, but THAT’S ONLY IF the particular debt fits certain conditions: for example, income taxes, depending on conditions like how long ago the taxes were due and the tax return was filed; and student loans, as long as conditions of “undue hardship” are not met.

#5:  Some debts are discharged, UNLESS timely challenged by the creditor and resulting in a ruling by the judge that the debt meets certain conditions involving fraud, misrepresentation, larceny, embezzlement, or intentional injury to person or property.

#6:  A few debts (used to be many more) can’t be discharged in Chapter 7, BUT can be in Chapter 13: for example, divorce debts other than support.

The bad news: as simple as I would like to make it, determining what debts aren’t dischargeable is simply not simple. But there’s more good news than bad. First, for many people all the debts they want to discharge WILL be discharged. Second, an experienced bankruptcy attorney will be able to predict quite reliably whether all of your debts will be discharged. And third, if you have troublesome nondischargeable debts, Chapter 13 is often a decent way to keep those under control. More about that in my next blog about simple Chapter 13.

 

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Avoid the “Presumption of Fraud” for Using Credit Cards during the Holidays

Paying for the holidays with credit cards, even at a relatively modest amount, can mean that you will have to pay back those purchases if you file a bankruptcy. That could happen even if at the time you made those purchases you fully intended to repay that credit—in other words, even if you weren’t planning to file a bankruptcy.

The Bankruptcy Code contains some very specific rules about the consequences of using credit to buy “luxury goods or services” during the months before filing a bankruptcy.

If you use a credit card—or any other type of consumer credit—to buy at least $500 of consumer “luxury goods or services” through any single creditor within the 90 days before filing bankruptcy, there is a “presumption” that the debt incurred this way is nondischargeable—that it can’t be legally written off.

Don’t be fooled by the word “luxury” in that rule. That means anything not “reasonably necessary.” Arguably anything not used for survival in not “reasonably necessary.” So even modest Christmas and holiday gifts could be considered “luxuries” for this purpose.

Similar rules apply to the use of cash advances, except that the trigger dollar amount is $750 per creditor, and the period of time is within 70 days before filing bankruptcy, with the same “presumption” that the debt would not be dischargeable.

You may be thinking that these rules only create presumptions, which can be defeated. So that you can still discharge these kinds of debts by showing that you in fact you had every intention of paying them at the time you used the credit. Yes, that true, in theory but not likely in practice. First, coming up with that kind of evidence—proving your intent at some point of time in the past– is usually not easy. And second, and more important, the high cost to bring that kind of evidence to court usually makes trying to do so not worthwhile. Usually the amount of attorney fees it costs you to fight the issue is more than the amount being fought about.

What all this means that if during the holidays you use a credit card or other consumer credit exceeding these dollar limits, and then file bankruptcy within the applicable 70-day and 90-day periods, most likely you will still have to pay for whatever credit was incurred during those periods. You can avoid these presumptions by waiting to file the bankruptcy until after those periods of time have expired, but that’s not always possible. At best you’ll delay getting your bankruptcy filed, and so will delay the eventual resolution of your financial problems. And even if you wait, the creditor can still try to show your bad intention. Avoid all this by not using your credit cards and/or lines of credit whenever there is a sensible chance that you’ll have to file a bankruptcy in the near future.

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Avoiding Judgments that Can Really Hurt You, and Hurt Your Bankruptcy

Many judgments against you don’t matter once you file a bankruptcy. But certain ones are very dangerous. How can you tell the difference?

Letting a creditor get a judgment against you after it has sued you can sometimes result in that debt not being written off (“discharged”) in a later bankruptcy case. Or that debt may instead become much more difficult to discharge, even if eventually it is. But in the meantime it can turn an otherwise straightforward case into one much more complicated. 

So how can certain judgments make a debt not dischargeable? Because of a basic principle of law which says that once one court has decided an issue, another court must respect that decision. The theory is that litigants should only get to use court resources once to resolve a dispute. Once a court decides an issue, it’s been decided (except for the limited exception of appeals to a higher court).

But as I said, most judgments by creditors are NOT a problem in bankruptcy. That’s because most creditor lawsuits are about only one thing: whether the debt is legally owed. A judgment that establishes nothing more than that can generally be discharged in a subsequent bankruptcy.

The judgments that are dangerous are more complicated. They arise in lawsuits in which the creditor is alleging that the person owing the debt incurred it in some fraudulent or inappropriate way. If the judgment clearly establishes that’s what happened, then the bankruptcy court later has to accept that decision. If the wording of the lawsuit and judgment shows that the behavior was of the kind that the bankruptcy laws say results in the debt not being discharged, then without further litigation the bankruptcy court would rule the same way.

These cases can get complicated because often it’s not clear precisely what the previous lawsuit decided, or whether what was decided meshes closely enough with the dischargeablility rules of bankruptcy. There’s also the question whether the matter was “actually litigated” if the person against whom the judgment was entered did not appear to defend the lawsuit or did not have an attorney.  In other words you may or may not be able to get your day in bankruptcy court depending on whether in the eyes of the law you really already had your day in the prior court.

This risk of losing your chance to defend your case in bankruptcy court can be avoided by not waiting until after a judgment has been entered against you to see a bankruptcy attorney. That is especially true if the allegations against you involve any bad behavior other than not repaying the debt. As a general rule, if you get sued by any creditor you should see an attorney, even if you don’t plan on fighting the lawsuit and hiring an attorney for that purpose. That allows you to find out if the lawsuit could lead to a judgment making the debt not be dischargeable in a bankruptcy. And if so, you would then still have to option of filing the bankruptcy to prevent such a harmful judgment from being entered, instead of being stuck with it once you file a bankruptcy later.

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