One of the oft-unspoken worries of my clients facing foreclosure or the need to seek bankruptcy protection is what they tell their children and family. But just as critical is the other side of this coin--the effect on children of financial trouble and the resulting disruption of their lives and expectations.
The January 31, 2011 New York Times published a heart-wrenching piece entitled Teacher, My Dad Lost His Job. Do We Have to Move? It illustrates the problem, from the viewpoint of schoolteaches. I recommend it. One of the points that emerges is that children have "eagle ears" and always know when their parents are in financial trouble, and their fears for the future are at least as great if not greater than those of their parents.
This underscores the advice I have given my clients who are parents: don't try to hide what is going on from your children, because it will only make matters worse for them and you. I advocate a carefully considered approach that can help them to understand what is happening as part of a family. See my article "What to tell the kids when financial problems loom large" for some helpful approaches and thoughts from a non-psychologist.
Monday, January 31, 2011
Saturday, January 22, 2011
When borrower files a Chapter 13 Bankruptcy, mortgage lenders barred from increasing monthly mortgage payments to restore mortgage escrow "cushion", Third Circuit says.
Very commonly, home mortgages have provisions that require the homeowner to pay, as part of their monthly payment, an additional monthly amount in escrow to cover taxes and insurance and certain other expenses. Under the federal law governing this, the Real Estate Settlement Procedures Act [RESPA], the lender can calculate this amount by estimating the future taxes and insurance over the next 12 months, and add an additional two months’ payment as a cushion. This total, essentially 14 months worth of payments, is then divided by 12 to come up with the monthly escrow dollars added to the mortgage payment. If a borrower does not make mortgage payments which include the escrow portion, the lender is entitled to increase the future payments to make up the resulting shortfall.
In In re Rodriguez, 2010 WL 5191428, the homeowners filed a Chapter 13 bankruptcy, and proposed to pay the mortgage arrears including the unpaid escrow amount through their bankruptcy plan. When the bankruptcy was filed, the lender had already advanced $3869.91 for taxes, insurance and other charges, and in addition was entitled to an escrow cushion of $1787.69. There were two possible ways the total escrow shortfall including the cushion could be paid. One was to include the full amount including the cushion as part of the arrears in the lender’s proof of claim. In that case, the cushion would have been restored by the time the borrowers had completed all their payments, along with repayment of the $3869.91 the lender had paid out pre-bankruptcy. The lender chose the alternative. It included in the arrears it asked to be repaid through the bankruptcy only the $3869.91 it has already paid out, and increased the borrowers monthly payment going forward to get back its cushion.
The borrowers filed a motion saying what the lender had done was an illegal attempt to collect from them a debt or claim, ie the "cushion" that was only collectible inside the bankruptcy process. The "automatic stay" imposed under 11 U.S.C. 362 prohibits (with certain exceptions not applicable in this case) post-bankruptcy collection on claims that existed when the bankruptcy was filed. The borrowers asked for sanctions against the lender.
The issue was thus whether the lender could collect the cushion directly from the borrowers outside of bankruptcy, or whether it had to collect inside the bankruptcy plan’s proposed payout. If the right to the "cushion" was a "claim" that was enforceable when the bankruptcy case was filed, what the lender had done was improper. The bankruptcy court and later the US District Court on appeal held that what the lender had done was legal and proper.
On further appeal, the Third Circuit reversed the lower courts. The lender argued that the right to collect the cushion was not a "claim" that had to be paid through the bankruptcy, because the escrow account was only an asset and not a debt. It pointed out correctly that if they had foreclosed and gone to sheriff sale, the borrowers would not have had to repay the cushion. Instead, the lender said, it was required only to collect through the bankruptcy what it had already paid out. The Circuit Court disagreed and held that under its broad view of what constitutes a "claim" that must be included for payment in a bankruptcy, the lender’s right to demand and collect the cushion was no different than its right to get back what it had paid out. Since both were enforceable rights that existed when the borrowers filed their bankruptcy, the lender had to collect its cushion by payments through the bankruptcy plan. It made no difference, the Court said, that this would force the lender in effect to give an "interest free" loan for the cushion amount during the time it would take to get paid up.
The appeals court sent the case back for the lower courts to determine whether the lender had wilfully violated the automatic stay and could be sanctioned for doing so. However, it is unlikely given the novelty of the issue and their previous rulings for the lender that any sanctions are going to be imposed. Judge Sloviter filed a dissent pointing out that the decision improperly gave RESPA's procedures and requirements short shrift, and that the lender had in fact acted entirely as this law allowed. Whether in another court RESPA will be given precedence with a different result remains for the future.
Nevertheless, this decision is important guidance for lenders and borrowers alike. In Chapter 13 cases, the borrowers must stay current after bankruptcy on their mortgage payments if they want to keep the home. Any increase in those payments decreases the amount they have left to pay out under their bankruptcy plan, and can sink an otherwise feasible plan. Borrowers and their bankruptcy attorneys should always examine and question escrow calculations and demands by lender for repayment to make sure the amounts are correct. This decision makes that process easier and more predictable for both borrowers and lenders.
This decision also underscores how broad is the universe of "claims" that can be discharged in bankruptcy. The Court cited and relied on its previous ruling in In re Grossman’s Inc. 607 F.3d 114 (3d Cir. 2010) that a "claim" exists where the circumstances upon which a right to payment arises predated the bankruptcy, even though the right to collect or sue on that right might come sometime in the future and even though the creditor might only later be able to determine who owed it. The Grossman’s case is still the subject of controversy and in certain cases can be the result of enormous practical and legal difficulty. (Think of the person whose right to sue for injury is discharged because the accident happened before the bankruptcy but its effects including pain, suffering or disability become apparent only years later and long after the bankruptcy) However, in this case, we think the Third Circuit properly applied its principles to achieve certainty and uniformity of treatment.
In In re Rodriguez, 2010 WL 5191428, the homeowners filed a Chapter 13 bankruptcy, and proposed to pay the mortgage arrears including the unpaid escrow amount through their bankruptcy plan. When the bankruptcy was filed, the lender had already advanced $3869.91 for taxes, insurance and other charges, and in addition was entitled to an escrow cushion of $1787.69. There were two possible ways the total escrow shortfall including the cushion could be paid. One was to include the full amount including the cushion as part of the arrears in the lender’s proof of claim. In that case, the cushion would have been restored by the time the borrowers had completed all their payments, along with repayment of the $3869.91 the lender had paid out pre-bankruptcy. The lender chose the alternative. It included in the arrears it asked to be repaid through the bankruptcy only the $3869.91 it has already paid out, and increased the borrowers monthly payment going forward to get back its cushion.
The borrowers filed a motion saying what the lender had done was an illegal attempt to collect from them a debt or claim, ie the "cushion" that was only collectible inside the bankruptcy process. The "automatic stay" imposed under 11 U.S.C. 362 prohibits (with certain exceptions not applicable in this case) post-bankruptcy collection on claims that existed when the bankruptcy was filed. The borrowers asked for sanctions against the lender.
The issue was thus whether the lender could collect the cushion directly from the borrowers outside of bankruptcy, or whether it had to collect inside the bankruptcy plan’s proposed payout. If the right to the "cushion" was a "claim" that was enforceable when the bankruptcy case was filed, what the lender had done was improper. The bankruptcy court and later the US District Court on appeal held that what the lender had done was legal and proper.
On further appeal, the Third Circuit reversed the lower courts. The lender argued that the right to collect the cushion was not a "claim" that had to be paid through the bankruptcy, because the escrow account was only an asset and not a debt. It pointed out correctly that if they had foreclosed and gone to sheriff sale, the borrowers would not have had to repay the cushion. Instead, the lender said, it was required only to collect through the bankruptcy what it had already paid out. The Circuit Court disagreed and held that under its broad view of what constitutes a "claim" that must be included for payment in a bankruptcy, the lender’s right to demand and collect the cushion was no different than its right to get back what it had paid out. Since both were enforceable rights that existed when the borrowers filed their bankruptcy, the lender had to collect its cushion by payments through the bankruptcy plan. It made no difference, the Court said, that this would force the lender in effect to give an "interest free" loan for the cushion amount during the time it would take to get paid up.
The appeals court sent the case back for the lower courts to determine whether the lender had wilfully violated the automatic stay and could be sanctioned for doing so. However, it is unlikely given the novelty of the issue and their previous rulings for the lender that any sanctions are going to be imposed. Judge Sloviter filed a dissent pointing out that the decision improperly gave RESPA's procedures and requirements short shrift, and that the lender had in fact acted entirely as this law allowed. Whether in another court RESPA will be given precedence with a different result remains for the future.
Nevertheless, this decision is important guidance for lenders and borrowers alike. In Chapter 13 cases, the borrowers must stay current after bankruptcy on their mortgage payments if they want to keep the home. Any increase in those payments decreases the amount they have left to pay out under their bankruptcy plan, and can sink an otherwise feasible plan. Borrowers and their bankruptcy attorneys should always examine and question escrow calculations and demands by lender for repayment to make sure the amounts are correct. This decision makes that process easier and more predictable for both borrowers and lenders.
This decision also underscores how broad is the universe of "claims" that can be discharged in bankruptcy. The Court cited and relied on its previous ruling in In re Grossman’s Inc. 607 F.3d 114 (3d Cir. 2010) that a "claim" exists where the circumstances upon which a right to payment arises predated the bankruptcy, even though the right to collect or sue on that right might come sometime in the future and even though the creditor might only later be able to determine who owed it. The Grossman’s case is still the subject of controversy and in certain cases can be the result of enormous practical and legal difficulty. (Think of the person whose right to sue for injury is discharged because the accident happened before the bankruptcy but its effects including pain, suffering or disability become apparent only years later and long after the bankruptcy) However, in this case, we think the Third Circuit properly applied its principles to achieve certainty and uniformity of treatment.
Monday, January 17, 2011
Navigating the Means Test- Recent Supreme Court decisions show that timing may be everything and the answers are not simple
Bankruptcy Courts have long disqualified debtors from getting relief under Chapter 7 (where payments are not required but assets worth more than liens and exemptions can get sold to pay creditors), forcing them into a Chapter 13 repayment plan where they had a meaningful ability to pay something to their creditors. Before 2005, this determination was based on the debtors’ budget. If the monthly net income was not sufficient after deducting reasonable and actual monthly expenses (which could and often did include home mortgage payments and reasonable car loan payments) to yield a meaningful "disposable income" then there was no problem. However, when these figures showed that the debtors had disposable income sufficient to pay a meaningful amount over 36 months to creditors, they faced a "substantial abuse" dismissal motion. Usually, the Chapter 7 Trustee would alert the United States Trustee (a branch of the Department of Justice charged with overseeing various aspects of the bankruptcy process), who would then file such a motion.
In 2005, Congress changed all this to address what it thought were abuses of the system, by adding the "Means Test." Basically, if your gross household income (other than Social Security and a few other types of income) put you in the top half of households your size, in your state, then the trustees and the courts were directed to apply a complicated formula based on that used by the Internal Revenue Service in its determination how much people who owed back taxes could afford to pay. If that formula yielded a calculated disposable income over a specified dollar limit, then you did not qualify for Chapter 7 and had to file under Chapter 13. In Chapter 13, you have to pay your unsecured creditors the dollar amount derived from the Means Test each month for 5 years.
There are many aspects of this Means Test, and its application in each case is potentially complex. Many aspects were far from clear, and the courts have wrestled with the issues presented. In the past 12 months, the U.S. Supreme Court has answered two questions about this.
Timing is Important: No car loan or lease = no vehicle ownership deduction.
In January 2011, the Court held in Ransome v FIA Credit Services that a debtor who owned a car free and clear could claim a means test deduction only for the costs of operation, and also claim a separate deduction for the costs of ownership. These are two separate deductions in the means test formula. Until this decision, courts were divided on why there were two deductions and what they meant, and people who owned a car or two free and clear were claiming both deductions. The Supreme Court found that the "Costs of Operation" deduction is for items like gas and repairs, but the "Costs of Ownership" is based on an average loan or lease payment, and so does not apply where a car is owned free and clear.
What this means is that you may be better off filing your bankruptcy while you still owe payments on that car, and not after you have paid it off. This of course penalizes those who prudently kept their debts lower. But that is how the Court reads the Means Test. Again, "timing is everything". The question remains what happens if your car is paid off sometime shortly after your bankruptcy is filed, and the result may be that you then might have to pay more. But especially if you are able to qualify for Chapter 7, having the deduction is better than not. While we do not recommend running out to borrow money that you cannot afford, the important message is to get qualified advice early and do not wait.
Income going up or down? Courts CAN be flexible in helping out; the Means Test is not always a rigid formula, but this might cut both ways...
While Ransome made things harder for people seeking bankruptcy relief, an earlier decision can help out. In Hamilton v Lanning, 130 S.Ct. 2464 (2010), the Supreme Court held that in calculating disposable income under the Means Test, a court may consider changed circumstances that are known or virtually certain by the time the court has to consider whether to approve a debtor’s proposed plan. There, the Means Test income figure, based on all income received during the 6 months before the bankruptcy filing, was substantially inflated due to a one time buyout payment. With that figure included, the monthly average based on that prior 6 months was well above what the debtors’ real income was going to be going forward. The debtors proposed a plan payment based on their real income going forward. Rejecting a rigid formulaic approach, the Court held that bankruptcy courts in these situations could look to the reality of the situation.
This case gives some hope to those unfortunate people who need bankruptcy relief, but based on the Means Test formula strictly applied would not be able to pay what the formula dictates. However, this can cut both ways. Arguably, the person who was unemployed during the past 6 months but now has a good and steady job may face the argument that she can afford more than the Means Test requires.
The message? The Means Test is very much an individual thing and the results are not always exactly what the formula might dictate. Getting the right advice and counsel from a qualified and experienced bankruptcy attorney is critical. Again, sooner rather than later.
Caveat: Every case is different, and individualized advice is critical. Trying "self help" in dealing with the complexities of the Means Test is ill advised.
In 2005, Congress changed all this to address what it thought were abuses of the system, by adding the "Means Test." Basically, if your gross household income (other than Social Security and a few other types of income) put you in the top half of households your size, in your state, then the trustees and the courts were directed to apply a complicated formula based on that used by the Internal Revenue Service in its determination how much people who owed back taxes could afford to pay. If that formula yielded a calculated disposable income over a specified dollar limit, then you did not qualify for Chapter 7 and had to file under Chapter 13. In Chapter 13, you have to pay your unsecured creditors the dollar amount derived from the Means Test each month for 5 years.
There are many aspects of this Means Test, and its application in each case is potentially complex. Many aspects were far from clear, and the courts have wrestled with the issues presented. In the past 12 months, the U.S. Supreme Court has answered two questions about this.
Timing is Important: No car loan or lease = no vehicle ownership deduction.
In January 2011, the Court held in Ransome v FIA Credit Services that a debtor who owned a car free and clear could claim a means test deduction only for the costs of operation, and also claim a separate deduction for the costs of ownership. These are two separate deductions in the means test formula. Until this decision, courts were divided on why there were two deductions and what they meant, and people who owned a car or two free and clear were claiming both deductions. The Supreme Court found that the "Costs of Operation" deduction is for items like gas and repairs, but the "Costs of Ownership" is based on an average loan or lease payment, and so does not apply where a car is owned free and clear.
What this means is that you may be better off filing your bankruptcy while you still owe payments on that car, and not after you have paid it off. This of course penalizes those who prudently kept their debts lower. But that is how the Court reads the Means Test. Again, "timing is everything". The question remains what happens if your car is paid off sometime shortly after your bankruptcy is filed, and the result may be that you then might have to pay more. But especially if you are able to qualify for Chapter 7, having the deduction is better than not. While we do not recommend running out to borrow money that you cannot afford, the important message is to get qualified advice early and do not wait.
Income going up or down? Courts CAN be flexible in helping out; the Means Test is not always a rigid formula, but this might cut both ways...
While Ransome made things harder for people seeking bankruptcy relief, an earlier decision can help out. In Hamilton v Lanning, 130 S.Ct. 2464 (2010), the Supreme Court held that in calculating disposable income under the Means Test, a court may consider changed circumstances that are known or virtually certain by the time the court has to consider whether to approve a debtor’s proposed plan. There, the Means Test income figure, based on all income received during the 6 months before the bankruptcy filing, was substantially inflated due to a one time buyout payment. With that figure included, the monthly average based on that prior 6 months was well above what the debtors’ real income was going to be going forward. The debtors proposed a plan payment based on their real income going forward. Rejecting a rigid formulaic approach, the Court held that bankruptcy courts in these situations could look to the reality of the situation.
This case gives some hope to those unfortunate people who need bankruptcy relief, but based on the Means Test formula strictly applied would not be able to pay what the formula dictates. However, this can cut both ways. Arguably, the person who was unemployed during the past 6 months but now has a good and steady job may face the argument that she can afford more than the Means Test requires.
The message? The Means Test is very much an individual thing and the results are not always exactly what the formula might dictate. Getting the right advice and counsel from a qualified and experienced bankruptcy attorney is critical. Again, sooner rather than later.
Caveat: Every case is different, and individualized advice is critical. Trying "self help" in dealing with the complexities of the Means Test is ill advised.
For more articles like this on bankruptcy, please visit our sites at:
Saturday, January 15, 2011
Banks Loosening Purse Strings- not entirely good news for the future.
The Wall Street Journal reports that U.S. Banks are rediscovering consumer debt, and making 3.7% more new consumer loans in the third quarter of 2010. This includes car loans, and 36 million new credit cards.
WSJ, Jan 15, 2011 "Banks Loosen Purse Strings" "Among so-called near-prime borrowers with credit scores of 620 to 749, the approval rate jumped to 83% from 70%. In addition, down-payment requirements have loosened, and "there are plenty of resources for financing..." Id.
This is good news for banks, whose profits are rebounding. And a healthy banking and financial sector is good for all of us. We came scarily close to another Depression when the credit system closed down during 2008. But have we all learned the lessons of that crisis and what led to it?
The underlying problems that got us there are still with us. To use Elizabeth Warren's phrase, is there a "cop on the beat" to police and control abusive and uncontrolled lending practices and securitization of loans? In the 19th century, this country followed a "wild west" laissez faire approach to regulating markets and economy. We had booms and busts, major depressions and bank failures. We should not be surprised when a return to that same approach leads to similar results.
A regulatory system that ensures that borrowers have clear and easily understandable disclosure of important loan terms and risks is neither unfamiliar to us nor detrimental. Truth in Lending disclosures for consumer loans has been with us for over 30 years. Why not have the same for home mortgages? For car and small business loans? Can we get away from the "word barf" (as Elizabeth Warren recently called it) in loan documents that confuses and conceals the true costs and risks of these important commitments?
But disclosure is only part of the solution. Borrowers have to learn from past mistakes, both theirs and that of others. Far too many of my clients simply did not understand or chose to ignore the basic principles of money and money management. Many forgot that "money does not grow on trees". Many were desperately trying to hold onto the middle class dream that we baby-boomers grew up with. As the middle class has been squeezed over the past 30 years, and as the marketing of spending and borrowing against the future to pay for it, they got in over their heads. There is a lot of blame to go around.
Our system is oriented to consumer spending and borrowing. It is so easy for people to believe they have matters under control when they have easy access to credit card debt. Many people tell me they have things under control because they think they can pay the minimum payments on what turns out to be a large load of high interest credit card debt. And indeed, it is very easy to feel comfortable having borrowed a few thousand dollars that only cost $80.00 per month. But people then continue to borrow more and more and the debt load mounts until one day they can wake up with the $50,000 plus credit card debt that seems typical nowadays. Easy access to easy credit is what led to the real estate bubble. It has led to another looming crisis, in student loan debt. But that is a topic for another day.
Efforts are underway to try to educate people about the basics of money management and credit. I have not seen that our schools always appreciate how very important this basic life school is to the welfare of their students. Sadly, most people I see know more about how their computer works than how their money and debt works.
I would hope that the caution people have exhibited recently, curtailing new debt and trying to save more, will continue. This country will need more and more of this in the coming decades. If not, we crisis we may be just emerging from will not be the last.
WSJ, Jan 15, 2011 "Banks Loosen Purse Strings" "Among so-called near-prime borrowers with credit scores of 620 to 749, the approval rate jumped to 83% from 70%. In addition, down-payment requirements have loosened, and "there are plenty of resources for financing..." Id.
This is good news for banks, whose profits are rebounding. And a healthy banking and financial sector is good for all of us. We came scarily close to another Depression when the credit system closed down during 2008. But have we all learned the lessons of that crisis and what led to it?
The underlying problems that got us there are still with us. To use Elizabeth Warren's phrase, is there a "cop on the beat" to police and control abusive and uncontrolled lending practices and securitization of loans? In the 19th century, this country followed a "wild west" laissez faire approach to regulating markets and economy. We had booms and busts, major depressions and bank failures. We should not be surprised when a return to that same approach leads to similar results.
A regulatory system that ensures that borrowers have clear and easily understandable disclosure of important loan terms and risks is neither unfamiliar to us nor detrimental. Truth in Lending disclosures for consumer loans has been with us for over 30 years. Why not have the same for home mortgages? For car and small business loans? Can we get away from the "word barf" (as Elizabeth Warren recently called it) in loan documents that confuses and conceals the true costs and risks of these important commitments?
But disclosure is only part of the solution. Borrowers have to learn from past mistakes, both theirs and that of others. Far too many of my clients simply did not understand or chose to ignore the basic principles of money and money management. Many forgot that "money does not grow on trees". Many were desperately trying to hold onto the middle class dream that we baby-boomers grew up with. As the middle class has been squeezed over the past 30 years, and as the marketing of spending and borrowing against the future to pay for it, they got in over their heads. There is a lot of blame to go around.
Our system is oriented to consumer spending and borrowing. It is so easy for people to believe they have matters under control when they have easy access to credit card debt. Many people tell me they have things under control because they think they can pay the minimum payments on what turns out to be a large load of high interest credit card debt. And indeed, it is very easy to feel comfortable having borrowed a few thousand dollars that only cost $80.00 per month. But people then continue to borrow more and more and the debt load mounts until one day they can wake up with the $50,000 plus credit card debt that seems typical nowadays. Easy access to easy credit is what led to the real estate bubble. It has led to another looming crisis, in student loan debt. But that is a topic for another day.
Efforts are underway to try to educate people about the basics of money management and credit. I have not seen that our schools always appreciate how very important this basic life school is to the welfare of their students. Sadly, most people I see know more about how their computer works than how their money and debt works.
I would hope that the caution people have exhibited recently, curtailing new debt and trying to save more, will continue. This country will need more and more of this in the coming decades. If not, we crisis we may be just emerging from will not be the last.
Tuesday, January 11, 2011
Lessons from some businesses that didn't make it in 2010
The New York Times recently posted a fascinating article about some businesses that closed in 2010:
How Six Companies Failed to Survive 2010 . We have been counselling small businesses for years how to avoid this fate. See our article: Avoiding Business Bankruptcy
Some of the lessons from the stories these six companies are:
How Six Companies Failed to Survive 2010 . We have been counselling small businesses for years how to avoid this fate. See our article: Avoiding Business Bankruptcy
Some of the lessons from the stories these six companies are:
- Be careful how quick you expand, and if you borrow money to do it, look carefully at your assumptions. A good year or two does not guarantee a rosy future.
- Before you make a major move like this, get qualified and experienced legal advice and help from an accountant with small business expertise.
- To run a successful business, you have to be able to tolerate, if not love, the day to day work that needs to be done.
- If you have the next great idea, remember that someone else will likely think of it too or copy your approach. And if they are better financed or quicker to develop the product, you may be the big loser. It's not just a new idea that counts. More importantly, do you have something special that others cannot easily get for themselves? Without these "barriers to entry", the risks of a start-up enterprise are substantially greater.
- Sometimes "stuff happens". If you don't have the reserves to survive, or a lot of luck or solid financial backers, your time in business could be cut short.
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