Chapter 13 trap for the unwary: not listing a creditor in time could mean you still have that debt to pay when the case is over!

In every bankruptcy, a debtor is required to certify that all creditors have been listed. We always caution our clients to include everyone to whom they MIGHT owe money. That way everyone who could sue them to collect a debt gets notice of the bankruptcy and there is no question that all dischargeable debts in fact do get discharged.

All too often, after filing new potential creditors need to be added. But waiting too long to do this can be a serious mistake.

Not listing a creditor risks that later on, that creditor will pursue lawsuits or collection efforts. In the Third Circuit (where New Jersey and Pennsylvania are located), the typical “no asset” Chapter 7 case (where there is nothing distributed to creditors) results in a discharge of all debts that could have been listed and discharged.

But in Chapter 13 cases, it is not so easy. First, any debt not listed will not be discharged. Second, and potentially worse, not listing everyone accurately at the outset could mean that the omitted creditors cannot file a claim in the Chapter 13 case. This means the debtor will be left with this debt still having to be paid when the case is over.

This is a major trap for the unwary. It happens because in a Chapter 13 case, all claims must be filed by a “bar date” set at the start of the case. Late filed claims are not allowed, even if the creditor did not find out about the bankruptcy until after the deadline had passed. And if the creditor cannot file a claim to share in plan payment, then that creditor’s debt does not get discharged, unless the Chapter 13 case is converted to Chapter 7.

Note this could be the result of not listing the creditor, or not providing a proper address. As debtor’s counsel we urge all our clients to get us as accurate an address as possible so this does not happen.

On the other side of the coin, this rule can ensure some degree of fairness to the creditors who did not receive timely notice of the bankruptcy (either by official notice or from other sources of information). We always urge creditors to act right away and investigate as soon as they hear or learn about a bankruptcy filing by someone who owes them money. But if through no fault of their own, they did not learn about it in time to file a claim that will be allowed, there is some recourse.

How debt buyers and creditors get judgments when they do not have a right to sue, and what you can do about it

Most bad consumer debt is sold off to “debt buyers” who make a good living buying bad debt for pennies on the dollar then collecting it. As a recent New York Times article points out, these creditors have been able to get judgments on debts that are too old to sue on. Worse, when the judgment debtors tried to stop this practice by a class action lawsuit, they were thrown out of court because of a clause in the original loan agreement that forced all disputes into arbitration. Courts have rejected the argument that by going to court themselves, the debt buyers waived their right to rely on this clause.  “Sued Over Old Debt, and Blocked From Suing Back” 12-22-2015

There are some important take-aways here.

  1. Read the credit agreements and understand what you are agreeing to. Some credit cards give you a limited time to “opt out”. Arbitration looks simple and less expensive, but in fact you may be giving away important rights.
  2. Keep your own records of what you have paid or charged. You may need them later.
  3. When faced with collection, demand proof and keep good records of all contacts, letters or communications. Debt collectors are required to provide proof of the debt if you ask in writing. Because they have bought the debt in large bulk purchases, they likely do not have the original documents.
  4. Watch the statute of limitations. In New Jersey, creditors have 6 years from the date of the last payment after default in which to sue. Even a $1 payment after that time has passed could start the clock running all over again.
  5. If sued, seek legal advice and seriously consider filing an Answer IN WRITING, FILED WITH THE COURT. YOUR ANSWER MUST BE IN THE HANDS OF THE CLERK BEFORE THE STATED DEADLINE EXPIRES. Calling the collection attorney does not protect your rights. A qualified attorney can advise you about the rights and defenses you have. These might include
    1. Plaintiff does not own the debt and is not qualified to sue me.
    2. Plaintiff is not entitled to use the courts to sue me. (In New Jersey out of state businesses must file certain reports in order to sue in our courts)
    3. The statute of limitations has expired. (See above and check the law in your state)
    4. If Plaintiff is owed money, the amount claimed is wrong. (This will require production of account records and possibly the loan agreement. You need to carefully assemble your records to show what you think is due)
    5. NOTE,  THESE ARE ONLY EXAMPLES: you are entitled to demand proof, but you may not have a valid claim to the above defenses or you may have other rights and defenses. Always seek legal advice and assistance, even if it is only a consultation.
  6. When dealing with debt collectors, keep careful written records of who contacted you, when and how, and what they said. You may have a counterclaim against the debt collector, but again, proof is key. Do not hesitate to record the conversations, but be sure to tell them, at the beginning of the recording, that you are recording. Not doing this can result in criminal liability in your state or the state where the caller is at.

For many people, debt collection is more likely to be a symptom of bigger problems. You should consult with a qualified attorney about how you can use Chapter 7 bankruptcy to discharge debts you cannot afford to pay, or Chapter 13 to pay what you can afford over time.

Bankruptcy courts: foreclosure is not time-barred until 6 years after last payment due date specified in the mortgage or note

Last year, one of our bankruptcy judges ruled that once a mortgage lender waited more than 6 years from declaring a default and demanding the entire balance due (“accelerating the loan”) the statute of limitations specified in the Fair Foreclosure Act barred any later foreclosure suit. At the time, many of us thought the result, contrary to the adage that “no one gets a free house”, was surprising.

Many thought this would provide a windfall as they escaped foreclosure. Alas, that ruling, in Specialized Loan Servicing LLC v Washington, was reversed on appeal. 2015 US LEXIS 105794. The District Court, in a persuasive and well-thought out opinion, showed that the statute setting 6 years to foreclose actually stated that the time began to run on the maturity date set out in the loan documents. Acceleration of the loan is not mentioned there or elsewhere in the Fair Foreclosure Act. Moreover, another statute, governing the time to sue on negotiable instruments, did specify that the time ran from default. From this, the District Court concluded that, since the New Jersey Legislature knew how to make a time period run from default, its choice not to do so in setting 6 years to sue under the Fair Foreclosure Act was deliberate.

More recently, another bankruptcy judge, newly-appointed Jack Sherwood, came to the same conclusion in another well-reasoned decision. Hartman v Wells Fargo Bank NA, 2015 Bankr. LEXIS 2783 (Bankr DNJ 2015)

Oh well, for those hoping for a free house it was nice while it lasted.

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.


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.

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.


Recognized Quality & Experience