Third Circuit Court of Appeals: Reckless disregard for truth may be enough to keep a debt from being discharged

When an individual debtor files a bankruptcy, creditors who were duped into extending credit based on a false statement, fraud or false pretenses can sue to keep that debt from being discharged, based on 11 USC 523(a)(2)(A). On July 23, 2015, the Third Circuit held in In re Bocchino that the creditor does not have to prove the debtor making the statement knew it was false. Instead it is enough if the statement was made with reckless diregard of its truth.

Mr. Bocchino was a stockbroker who recommended that his clients invest in two private placement stock purchases. He recommended both based on rumors and little or no actual investigation into what they were about, even though he was aware of facts that should have raised questions about their legitimacy. Both investments turned out to be fraudulent ventures. The principals of both companies were convicted. The investors lost their money. The SEC sued Bocchino and others for various violations of securities laws and got judgments against Bocchino for almost $179,000.00.

Mr. Bocchino then filed a Chapter 13 bankruptcy, and the SEC filed suit in the bankruptcy court asking it to find that the judgments were non-dischargeable. The Bankruptcy Court recognized that Bocchino believed his statements to investors were true, but held that his gross recklessness in not pursuing an independent investigation into the quality of the product he was selling was enough to prevent a discharge of the resulting liability. It was enough that as “an experienced stockbroker, he knew or should have known, that an independent investigation…was imperative”. On appeal, the Third Circuit agreed.

The Court also agreed that Bocchino could not rely on the fraud of the company principals to escape liability. Bocchino claimed that it was this fraud and not his lack of due diligence that caused his clients losses. The Third Circuit disagreed. Instead, the collapse of the investments was “neither abnormal nor extraordinary given Bocchino’s lack of due diligence” and that the “woeful state of the entities when Bocchino solicited the investments…the losses were manifestly foreseeable”. In other words, Bocchino was a substantial cause of the losses, which would not have occurred had he done his job.

This case addresses what had previously been an unsettled question in the Third Circuit. It eases the way for victims of fraud to preserve the collectibility of their judgments.

However, prompt action is critical. The ability to keep such debts from being discharged requires the filing of a bankruptcy lawsuit (called an adversary proceeding) within a relatively short time (usually about 90 days after the bankruptcy filing). Anyone in this situation should retain experienced bankrutpcy counsel right away.

NY Fed Study shows that for those drowning in debt, a bankruptcy results in a faster improvement in credit scores

A February 2015 study by the Federal Reserve Bank of New York looked at households in financial distress who are in or descending into insolvency,  and compared the results of their filing bankruptcy vs not doing so. Insolvency after the 2005 Bankruptcy Reform. Most of these households were facing lawsuits or collections, unpaid medical bills, and not enough money to pay these debts. Surprisingly, after a year to a year-and-a-half, those who filed bankruptcy had better credit scores and better access to credit!

Here is what the study found:

  • “both the balances in collection and the fraction of individuals with court judgments grow after insolvency for individuals who do not go bankrupt, whereas bankruptcy filing immediately stays collection efforts and court judgments”
  • individuals who filed bankruptcy had better access to new credit, opening “a larger number of new unsecured accounts.” NOTE: this does not account for how favorable or unfavorable the credit terms were. Most likely these are high interest credit card accounts. Because a bankruptcy discharge bars another bankruptcy discharge for 4-8 years, this makes sense,  as compared to those with unmanageable debt.
  • For those who were “newly insolvent… the individuals who do go bankrupt have lower credit scores than those who do not go bankrupt, which is consistent with them having a higher default risk”
  • BUT  by a year post-bankruptcy,  “the individuals who go bankrupt experience a sharp boost in their credit score after bankruptcy, whereas the recovery in credit score is much lower for individuals who do not go bankrupt. “

This coincides with what we have been saying for a long time. A bankruptcy may be a better option for those who are drowning in debt with no realistic prospect of turning things around. Either way, the goal is to get back to financial stability and financial health.

Too many people put off consideration of bankruptcy as an option, and end up making things worse for themselves and their families.

The starting point is a consultation with a qualified bankruptcy attorney who will take the time to help you review your budget and your options. Properly done, this easily takes an hour.

Whether or not bankruptcy is right for you, our firm is available to help.

 

Seniors in financial trouble recommended to consider using bankruptcy to help protect assets.

A recent New York Times article,  Bankruptcy Can Help Seniors Protect Assets, NY Times, June 30, 2015, makes a point that I have been making for years. Those in or near retirement need to be concerned about preserving their ability to support themselves as they age, and that means protecting the assets that make self-support possible.

Instead, I have seen too many people deplete IRA’s or retirement accounts to pay creditors. These accounts are protected from creditors and in bankruptcy (special rules protect all IRA’s in New Jersey. In other states the protection is there but more limited). Social Security income is also protected. Using up retirement funds means there will be less income or resources to meet our personal or health needs as we age.

While paying debts is laudable, it is a fools errand if the result is to make one destitute, or to leave debts for our estate to clean up after we die. A concern over one’s credit score should be less of a concern: with a fixed income, seniors should not be borrowing money that may not be paid back.

The starting point, as always, is a clear headed look at the available income and necessary living expenses. If one can afford to pay the debts one has while having a reasonable cushion for the inevitable unexpected expenses, a debt management plan may be best.

Even here, be leery of firms that promise to settle all your debts for a fee. Non profit organizations should be preferred.

Whatever the situation, a careful review with a qualified bankruptcy attorney is always in order. Knowing the options available is a wise first move. Whether or not bankruptcy makes sense for you, knowing what is available provides a good baseline to evaluate other options, and the relative short-term and long term costs they involve.

Supreme Court rules that Bankruptcy Courts can enter final judgments in Article III controversies where the parties consent by act or deed

Earlier this year, our blog noted that this would be an exciting year for important rulings from the Supreme Court on several bankruptcy related fronts. Rulings have now started coming down.

In Wellness International Network Ltd v Sharif, decided May 26, 2015, the Court resolved what could have been the most serious challenge to the entire bankruptcy system. Both bankruptcy judges and U.S. Magistrates handle a large volume of disputes, such that, as the Court noted, “it is no exaggeration to say that without the distinguished service of these judicial colleagues, the work of the federal court system would grind nearly to a halt.”

The problem is that the Constitution vests the full power of the federal judiciary only in “Article III” judges who have lifetime appointment and salary protection. These judges are confirmed by Congress. Magistrates and bankruptcy judges serve limited terms and are appointed by the District and Circuit Court judges in their district. They serve at the pleasure of those judges and are delegated handling of certain types of matters. Bankruptcy judges have authority to hear and decide all matters coming before them in or arising in a bankruptcy case. That is a lot of decisions to make, folks.

There are certain types of disputes, however, that only Article III District Court judges may issue final rulings on.  Generally, these are claims and disputes that would have had an existence even were there no bankruptcy filing. Examples include common law contract disputes, or whether a transfer of property can be undone as a “fraudulent transfer”. For these types of matters, the Bankruptcy Court can hear the case, but can only issue “proposed findings of fact and conclusions of law” which the District Court must review all over again on the record in a “plenary” manner. This gives the loser in the bankruptcy court a much better chance of getting a “second bite at the apple”.  In Wellness, a creditor sued the debtor to grab the assets of an alleged family trust which the debtor had concealed, claiming the trust was a fiction and that the assets really belonged to the debtor and should be turned over to the trustee to be sold to pay creditors.

The Supreme Court held that the Bankruptcy Court had the authority to make a final ruling on this issue because Sharif had knowingly and voluntarily consented to its doing so. Here, it was argued, Sharif did not expressly consent by statements to the court below even though he had not objected and in fact had applied to the Bankruptcy Court for a ruling in his favor. But the Court ruled that consent may be implied, and pointed to a long history of that being allowed.

The decision was split, with 5 justices ruling with the majority, one justice agreeing in the result but not in the ruling on implied consent, and the remaining 3 dissenting.

Wellness makes clear that gamesmanship on this issue will not be allowed. If a party objects to the Bankruptcy Court making a final ruling in disputes that could have been litigated without any bankruptcy filing, it must say so and take affirmative action, or the objection is waived.

The opinion is well-reasoned and provides much needed guidance to the Bankruptcy Courts and those who practice there.

Filing bankruptcy? Your bank may freeze your checking account!

Most people filing a bankruptcy have money in one or more bank accounts. Under certain circumstances, and for one bank in particular, a bankruptcy filing could cause the accounts to be frozen by the bank, at least temporarily, despite the protections of the “automatic stay” the prevent creditors for taking control of a debtor’s property after a bankruptcy is filed.

Money in the bank is an asset of a bankruptcy estate which comes under the control of the trustee. But debtors are entitled to exempt a certain dollar amount of that money and keep it. Technically, the exemptions do not receive final approval until at least 30 days after the First Meeting of Creditors is closed, which will not happen for at least 60 days after the bankruptcy is filed.

Most bank loan agreements have provisions allowing the bank to “setoff” a debt in default against money the bank holds. (ie take the money to pay or pay down the debt that is owed). One would think that a bankruptcy filing would make this illegal, but years ago the US Supreme Court said that it was ok for a bank to “administratively freeze” a debtor’s checking or bank account for a short while, as long as the bank acted promptly to get bankruptcy court approval by a motion to lift the automatic stay. Thus, we tell our clients who happen to owe Bank A money to move their money out of that bank before filing bankruptcy.

A few years back, Wells Fargo Bank as a nationwide policy has started a program to check the accounts of any customer who files bankruptcy. If the total amounts on deposit exceeds a certain amount (I am told it is between $3500 and $5000), they immediately freeze the account and notify the trustee. I am told this started because a trustee successfully sued Wells Fargo for letting a debtor empty a bank account after a bankruptcy filing, taking money that was not the debtor’s to keep.

Most, but not all, courts have so far backed Wells Fargo up on this, but the practice is troubling. Supposedly, there is no harm because the trustee will promptly check out the account and authorize a release of the funds if they are properly exempt. Many trustees applaud the practice, citing cases where hidden bank accounts or under-reported account balances were revealed.

For the hapless but honest debtor, the practice can be traumatic. Suddenly, they have no money. Checks may start bouncing (and of course there are the resulting bank fees!). The trustee may be away or slow to react. Or unwilling to release the funds for one reason or another. Meanwhile, many people have automatic payroll deposits into their account. If the account is frozen this money becomes unavailable. Since earnings from personal services post-petition are not estate property, at least in Chapter 7, this means that the bank freeze has unlawfully seized money that the debtor is unquestionably entitled to. What about joint accounts or convenience accounts? In New Jersey, the money in a joint account generally belongs to the account holder that put it there. So does that mean that the non-debtor spouse has his money frozen too? A convenience account is an account where the debtor is the named account holder for someone else, typically an elderly or infirm relative. Same problem.

One bankruptcy court in New York has ruled that the Wells Fargo freeze violates the automatic stay. I am told this is on appeal.

Until the courts can get this right, people filing bankruptcy need to be aware, fully informed and prepared to avoid these problems.

Heading for bankruptcy? Paying your children’s college expenses could create “clawback” headaches for them and their college

Many parents in financial difficulty still place a priority on helping their children with tuition and other college expenses. While this is entirely understandable, parents who pay colleges for their adult children could be creating problems for both their children and the colleges if they later file for bankruptcy protection.

Recent reports in the Wall Street Journal and elsewhere have exposed a growing trend: bankruptcy trustees are suing colleges to “claw back” money paid by parents in bankruptcy. This has led the colleges to seek payment from the students, or to withhold transcripts until the money is repaid. It has even spawn a proposed bill in Congress to prevent bankruptcy trustees from filing such suits.

The underlying legal theory for such “claw-back” suits is not that novel. Trustees have the right and indeed the obligation to pursue getting back money or property that a debtor in bankruptcy has “fraudulently” transferred, so the money can be made available to pay creditors (and to pay the trustee and his attorneys). The payment need not have been done with actual intent to defraud creditors. It is sufficient if it was made without the parent/debtor getting “reasonably equivalent value” in return for what is paid, and if the payment was made at a time the parent was insolvent or unable to pay current or anticipated debts.

In essence, the trustees argue, the parents paying the college education expenses of an adult child are making a gift to that child. Gifts are by definition not made for “reasonably equivalent value”. They take away money that could have been used to pay the parent’s creditors.  Love and affection are not considered “reasonably equivalent value”.

If the parent takes out a loan or co-signs a student loan for the child but all the money goes to the child or her college, the effect is the same. It is still an avoidable gift.

Ironically, if the parent making the payment is required to do so under a divorce settlement incorporated into a divorce decree, the problem disappears. Why? Because the parent has a legal duty to pay that is enforceable by the divorcing spouse, and by making the payment the parent is relieved of part of that obligation. This is no different than when one pays a debt that is owed. The corresponding reduction in debt creates reasonable value in exchange.

Generally, in New Jersey, parents do not have a legal obligation (absent a divorce situation) to support their children after they achieve the age of majority or become “emancipated”.

There are ways around this problem for parents in financial difficulty. One option is to file bankruptcy first, then pay the college expenses out of future income or assets that are protected in bankruptcy (such as pensions or profit sharing plans),  after the bankruptcy is over. But for most people in this situation, they and their children need to have a sober and honest discussion about what is practical and in every one’s best interests in the long run.

Careful planning and advice of qualified professionals is a must. These are difficult decisions and should be thought through carefully as part of a broad based plan for getting a “fresh start”. With years of trustee and bankruptcy experience, we have the ability to help distressed parents sort it all out.

Inherited IRA’s are not part of a bankruptcy estate in New Jersey, Bankruptcy Court holds

In a personal  bankruptcy of an individual, money and assets held in certain qualified trusts  are “excluded” and do not become part of the Debtor’s bankruptcy estate that, if not exempted, becomes available for sale by a trustee to pay creditors. Qualified pensions are a common example. Excluded assets need not be exempted to be retained by the debtor in bankruptcy.

As we previously reported, in 2014 the Supreme Court in Clark v Rameker held that under Wisconsin law, an inherited IRA was not an IRA that would fit into the generous federal exemption for IRA’s. The reason was that unlike normal IRA’s the money in these accounts could be access and used at any time without tax penalty. At the time, we questioned whether this would hold true in New Jersey, which has a statute protecting inherited IRA’s from claims of creditors or a bankruptcy trustee. N.J.S.A. 25:2-1(b).

On February 25, 2015, New Jersey Bankruptcy Judge Michael Kaplan held in In re Andolino,  2015 Bankr. LEXIS 577, that an inherited IRA is excluded from the bankruptcy estate. Clark, he held, did not address this issue. Under New Jersey law, any “qualified trust” is protected, and includes any “trust created, qualified or maintained” under section 408 of the Internal Revenue Code.  Since the IRA which Mr. Andolino inherited was a qualified trust when created, and remains so even after he inherited it from his mother, it cannot be included in a bankruptcy estate.

The opinion has been submitted for publication, so it should become persuasive if not binding on other New Jersey Bankruptcy courts. Since the reasoning and the statutory basis are clear, logical and persuasive, we expect most courts at least in New Jersey will follow it.

Credit Reporting Agencies promise to make it easier to correct credit report errors.

Our credit reports are our financial reputations, and are for that reason very important. Unfortunately, mistakes and errors are far too common. Even though there is a well established process for people to correct errors in their credit reports, the Big Three credit reporting agencies have made the process frustrating and overly-bureaucratic for those who could not afford a lawyer. This was the subject of an investigation by the New York Attorney General that has now led to a settlement. http://www.nytimes.com/2015/03/10/business/big-credit-reporting-agencies-to-overhaul-error-fixing-process.html?_r=0. 

As detailed in the March 10, 2015 report in the New York Times, Equifax, Trans Union and Experian will replace their largely automated (and frustrating) dispute resolution process with a staff of specially trained individuals. Most importantly, they have agreed to put a 6 month hold on adverse reports concerning medical bills. This is a recognition that these are more commonly the subject of a billing dispute rather than non-payment.

The AG investigation found that the existing process was often ineffective in correcting legitimate errors. Creditors reporting a bad debt were given deference in the investigative process, resulting in improper automatic rejection of claimed errors.

We hope these changes will make it easier for people to correct their credit reports. However, we still recommend that any inquiries and disputes be followed with a letter detailing the problem. If a proper correction does not occur within 30 days, a lawyer should be consulted.

We suspect that where an attorney gets involved, the response from the credit reporting agencies will be escalated to a higher level.

Annual monitoring of your individual credit report is always a good idea. (For New Jersey residents, a free credit report is available once a year through www.annualcreditreport.com) While no one can eliminate a truthful adverse credit record (at least until 7 years after it goes to “charge off” or collections), what is there should still be accurate.  In fact, we recommend that our bankruptcy clients check their credit reports after a bankruptcy discharge to make sure that none of the discharged debts show anything other than a zero balance due.

Stay tuned…

Even the big guys are guilty of making matters worse through denial-Detroit’s bankruptcy experience is an object lesson for many others

As you know the City of Detroit filed a Chapter 11 bankruptcy, and after a lengthy and expensive process, is emerging from Chapter 11, ostensibly with its finances in order and its future brighter. A recently reported interview with the now-retired bankruptcy judge who handled the bankruptcy suggests that in the years leading to its bankruptcy, Detroit’s city fathers fell victim to a common malady, namely desperation and denial, and that this led to expensive mistakes.

According reports of an interview given by Judge Steven Rhodes, the city made an expensive and ill-considered deal to try to fend off  the pension default that ultimately was a major impetus to its bankruptcy filing. The suggestion is that the City would have been better off had it simply bit the bullet earlier.

This syndrome of denial and “kicking the can down the road” is, in my experience, all to common, and leads to desperate and ill-considered attempts to stop the inevitable bankruptcy.

A common example is the business owner who borrows money against her home (or from the IRS by not handing over employee withholding trust funds) to keep a failing business alive. To be sure, saving a viable business and carrying it through a temporary rough patch is not a bad thing. The problem is that too often, there has been no effort to find out what is causing the problems, and no effort to deal with those problems.

Another face of this is the refusal to even consider the option of bankruptcy as an alternative until quite late in the game. Sometimes by the time this is considered, the situation has gone from bad but cureable to desperate and incurable.

Our advice to business owners is to always consider all the options, and to do so earlier rather than later. An early bankruptcy might solve critical problems that will only get worse and save the business, whereas later matters have gotten out of hand, and the once-saveable business is doomed.

Individuals are just a guilty of this. I cannot count the number of times I have seen couples  whose solution to mounting credit card debt caused by income that was not enough to cover their spending was to borrow against home equity or emptying retirement accounts.  The underlying problem is still there, and like Detroit, they are just “kicking the can down the road”

The lesson of Detroit is that financial problems do not get solved unless one gets to the source. Short term solutions, such as borrowing more money to meet a cash flow deficit, just delays the inevitable and makes matters worse.

It is never too soon for people or businesses in financial trouble to engage in careful and broad based planning. All choices and options should be considered.

A proposed New Years resolution: review finances and plan ahead; if bankruptcy might be an option, do not ignore it

Most businesses and individuals we see have plodded along for years with mounting unresolved financial problems. Too often, through a lack of careful thought and planning, they make matters worse. So herewith our modest proposal for the new year:

1. Do a year-end review of what your earnings were and where they went. If it was a good year, will that continue? What will be different this year coming up? Do we have to adjust our spending?

2. Look at what may have caused trouble last year, and work out a plan how to avoid it happening again. If bad luck or a bad call has put you or your business in a bind, work out a plan to get out of the bind. Maybe the plan involves paying down debt. Maybe a bankruptcy or other debt relief should be considered as an option of last resort.

3. Do a budget, or cash flow projection, so you have some idea what has to be spent each month, and what will be coming in. Many people avoid this for several invalid reasons:

a. “We don’t have exact figures for all our expenses”. Folks, the numbers do not have to be exact. Give it your best guess. Then with those figures in place, you can compare them to what is actually being spent.

b. “Those expenses do not come up every month-how are we supposed to put a number on them?” Examples are auto repairs, medical expenses, equipment repairs or replacement, home repairs. The trick is to look back and figure out how much is spent over a longer period, say a year, then convert that to a monthly figure. Most people know how often they have to replace tires on a car and what that costs. Say the figures here are $500.00 every 3 years. The monthly figure is 500/36 or $13.90 per month. The goal is get a working figure in place for planning purposes.

c. “My income is never the same” Response here is the same as above. Put together an average. Some months will be better, some worse. So long as you stick to the plan, over time it all works out.

d. “I know I am in trouble…why do I have to do this? It’s depressing.” What is depressing is being out of control. A budget is the first step in a plan, and a plan is the first step in taking back control of your life. No matter than you are running short each month. At least you know where you are, and can know what needs to be done to set things right.

4. Develop a plan and consider all alternatives. Bankruptcy is a choice that few want to make, but it is an alternative to learn about. Whether or not it is something you do, knowing what is involved and how it works for you can avoid your making things worse needlessly.

All these are tasks you need not do alone. Advice from qualified professionals may be the best money you spend. Talk to your accountant. Assemble the needed records. Talk to a qualified bankruptcy specialist not just about bankruptcy, but also some ways to avoid it.

 

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