RECENT BANKRUPTCY ARTICLES
BY ATTORNEY COLMENARES
By: Neil E. Colmenares, Esq.
Bankruptcy is everywhere. Bankruptcy affects everyone including, but not limited to, Debtors, Creditors, Lending Institutions, Accountants, Financial Analysts, Mortgage Brokers, Real Estate Agents, All Types of Lawyers, Potential Homebuyers, Owners of Real Property, The President of the Bank of Mom & Dad, etc. Therefore, an understanding of the Bankruptcy Code and the principals enunciated therein are essential for everyone. Bankruptcy law is extremely complex and, like other specialties, takes a significant investment of time to master. The purpose of this article is not to make you an expert in Bankruptcy law. This article is intended merely to apprise you of various misconceptions about Bankruptcy that arise every day. As with any area of the law, you should seek the advice of an experienced attorney before taking any action.
There are several misconceptions about Bankruptcy that everyone should be aware of. I will attempt to dismiss the most blatant misconceptions. Here is my Top 10 list of Common Bankruptcy Misconceptions.
1. The debtor[i] must be broke to file Bankruptcy. Nothing can be further from the truth. With limited exceptions, the only requirement to file for Bankruptcy is that the Debtor cannot pay their bills as they come due (sometimes referred to as financial distress). This makes sense when given some thought. If a person had to be broke to file Bankruptcy, that person would not be able to pay their attorney, which would lead to a proliferation of pro se Debtors which would clog the Courts and drive the entire Bankruptcy Court system insane.
Next, if the “broke” Debtor cannot file Bankruptcy, they would in all likelihood become public charges since they have nothing left to live on. To avoid this burden on the government, Congress has permitted “exemptions” to allow Debtors to keep a certain amount of property despite the Bankruptcy filing. For example, in New York a person filing for Bankruptcy is permitted a choice of either New York or Federal Exemptions.
New York Exemptions include $150,000 in equity in a home (depending on the county), $5,000 in cash, $4,000 in equity in an automobile as well as unlimited funds placed in a qualified 401K plan[i].
Federal Exemptions include $21,625 in equity in a home, up to $10,825 in cash, $3,450 in equity in an automobile as well as unlimited funds placed in a qualified 401K plan.
Finally, because individuals and businesses normally wait till they are broke to seek Bankruptcy advice, this unnecessary delay precludes options available to them, which may help them reorganize their finances and permit them to keep part or all of their property. For example, an individual normally waits until the day before a foreclosure sale to seek Bankruptcy advice where had they sought advice earlier; their chances of saving the property would have been greatly improved.
2. If an individual files Bankruptcy, his/her credit will be ruined and (s)he will not qualify for credit in the future. A blatant lie! The fact that an individual files for Bankruptcy will appear on the individual’s credit report for up to ten years. While this may seem draconian, this is not as bad as it may first appear.
First, if an individual is considering filing Bankruptcy, their credit is probably not that great to begin with. Filing Bankruptcy may be their best bet to “get good credit” again. Why you ask? The rationale is simple. When a Debtor files for Bankruptcy under Chapter 7 of the Bankruptcy Code and receives a discharge[i], a Debtor cannot receive another discharge under Chapter 7 for at least eight (8) years.
Lets pretend you are the head of a credit card company in charge of deciding to whom to extend credit and you have two identical applicants with one exception, one of the applicants filed Bankruptcy three months ago. Who would you extend credit to? Applicant #1 who never filed for Bankruptcy and who could file Bankruptcy at any moment after taking your money thereby discharging your debt? Or would you extend credit to Applicant #2 who filed for Bankruptcy three months ago and who recently received a discharge under Chapter 7 of the Bankruptcy Code thereby insuring that your loan cannot be discharged under Chapter 7 for at least the next eight (8) years?
The answer is simple, in the above hypothetical, the person who recently filed Bankruptcy is the better credit risk because an individual can receive only one discharge under Chapter 7 every eight (8) years. This, in reality results in the individual who filed Bankruptcy receiving dozens of new credit card offers within weeks of filing Bankruptcy!
3. If a person files Bankruptcy, they cannot buy a house in the future. Another lie! All banks are willing to take risks with people who filed Bankruptcy if they have enough security. This normally means a higher interest rate but remember the bottom line here: banks are looking to make money. If a person who filed Bankruptcy in the past applies for a mortgage and that individual has a sufficient down payment, banks will be tripping over themselves to give them a mortgage.
4. If a person owns a home and files for Bankruptcy, they will lose the house. Yes and no. An individual in the five boroughs of New York, Long Island and Westchester is allowed to keep the first $150,000 in equity in their homes above all liens and encumbrances despite the Bankruptcy filing (the exemption is $300,000 for married couples filing Bankruptcy together). This is called the “homestead exemption.” Lets look at a couple of common scenarios:
“The individual is current on the mortgage, there is little equity in the property and has a lot of credit card debt.” Let’s assume that the property is worth $650,000 and there is a mortgage of $500,000 on the property. In this instance, that individual can file for Chapter 7 and still keep their house.
Let’s change the facts a bit. Let’s say the same house is worth $650,000 but the individual has a $400,000 mortgage on the property. After we take into consideration the $150,000 homestead exemption, the individual is left with $100,000 in non-exempt equity. If this individual files for Chapter 7, the Chapter 7 trustee[i] will sell the property and the individual will be given the first $150,000 from the proceeds of the sale. The point that needs to be emphasized here is that the individual will lose the house under Chapter 7 unless after the filing of the Bankruptcy the individual can come up with $100,000 to pay the trustee the non-exempt equity. These funds can come from a post-bankruptcy mortgage or a loan from family and/or friends.
Next example: “The individual is behind on their mortgage, there is substantial equity in the property and has lots of credit card debt.” In this example, assuming there is money left over each month after paying the regular monthly bills (the mortgage payment not including arrears, gas, electricity, food, etc.), if this left over money can satisfy the arrears on the mortgage over a period of not to exceed five years, the individual may be able to keep the house in under Chapter 13. Chapter 13 is quite complicated but its principle is simple. As long as the individual repays the debt, they can keep the property. This may be an oversimplification but the point to remember is there are options.
5. Taxes cannot be discharged in Bankruptcy. Wrong! Certain taxes are dischargeable in Bankruptcy such as certain personal income taxes that are more than three years old if certain requirements are met. As a general rule, fiduciary taxes are not dischargeable. The Bankruptcy Code’s provisions relating to taxes are quite complex and differ depending on the Chapter filed under but suffice it to say, certain taxes are dischargeable. Check out our website for the requirements to eliminate personal income taxes in Bankruptcy.
6. Student loans are non-dischargeable. Generally speaking this is true. However, like every other rule there are exceptions. If the Debtor can prove certain hardship, student loans can be eliminated in Bankruptcy. This is normally an uphill battle but certainly not impossible. Check out our website for the requirements to eliminate student loans in Bankruptcy.
7. An individual can file for Bankruptcy but not include certain creditors in the Bankruptcy. Wrong! One of the principles behind the Bankruptcy Code is to treat similarly situated creditors equally. When a Debtor does not list a creditor in their Bankruptcy and decides to pay that creditor back, that Debtor is prejudicing the other creditors. If a Debtor does this, the Court considers this fraud and the Debtor can risk losing their discharge and in extreme circumstances face jail time as well as a hefty fine. Don’t do it!
8. If I have to list all creditors in the Bankruptcy, I will end up cheating my mom by discharging the money she loaned me. Although a Debtor must list all their creditors in the Bankruptcy; in certain instances the Debtor can repay a creditor after the Bankruptcy is filed. This is commonly known as a “Reaffirmation.” All reaffirmations are subject to court approval. The reason most Debtors agree to pay back a debt they have no legal obligation to pay is to maintain an existing business relationship. In our example, the court would likely approve the reaffirmation if the Debtor lives with mom and worries that mom may throw him out.
9. I signed a piece of paper stating I cannot get rid of this debt in Bankruptcy and I am therefore stuck with it forever. This is yet another scare tactic. Although the Bankruptcy Reform Act of 2005 has modified this somewhat, there are state law remedies available. Consult with your Bankruptcy Attorney about these provisions.
10. I could lose my job if I file for Bankruptcy. If you lose your job, you can sue your boss! The law states that if an individual can prove that an employer fired an employee solely because the employee filed Bankruptcy, the employee can sue the employer. As a caveat, if the Debtor/employee looks for another job after the filing of the Bankruptcy, the potential employer can use the Bankruptcy filing as a factor (not the sole factor) in deciding whether to grant that individual employment.
As the above information indicates, there are lots of misconceptions about Bankruptcy. I strongly urge you to contact this office to schedule a consultation should you be in need of assistance.
For professionals who are reading this article, you are perhaps in the best position to advise your clients regarding their financial condition. Most individuals and business owners are in denial about their financial situation. It normally takes the intervention of a professional to apprise the Debtor they need help. This is analogous to a person with a physical illness. The sooner they seek help, the greater the chances for a speedy recovery. As professionals we have fiduciary duties incumbent upon us that can be at times overwhelming. If we exercise these duties responsibly and take care to advise our clients of potential problems and things they can do now to stave these problems off, we will be in their eternal gratitude as well as helping society as a whole. But if we fail, then we will continue to perpetuate derogatory stereotypes and have failed not only ourselves, but also our clients who have come to us for help.
[i] A “Trustee” is a person appointed by the Court to administer the Debtor’s estate. The Trustee’s main function is to sell the Debtor’s non-exempt property and use the proceeds to pay creditors.
[i] A discharge is a court injunction relieving the Debtor of the obligation to repay most debts and preventing creditors from collecting for same.
[i] For a complete list of exemptions for Debtors who are domiciled in New York, see the New York CPLR Sections 5205 and 5206, New York Debtor and Creditor Law Sections 282 – 285 and the New York Insurance Law Sections 3212 – 3213 and the United States Federal Exemptions located at 11 U.S.C 522.
[i] A “Debtor” is an individual or entity that owes money. The Bankruptcy Act of 1898 which was replaced by the Bankruptcy Code of 1978 substituted the term “Bankrupt” for “Debtor.” One of the reasons for this change in nomenclature was to help remove some of the social stigma involved in filing Bankruptcy. Remember, we are all Debtors.
In today’s economic slowdown, times are tight for almost everyone. It will be likely that you will have more than a few individuals come into your office who are experiencing financial difficulties. This article is designed to apprise the practicing professional of “red flags” to be aware of in advising clients. This article is not designed nor intended to make you a Bankruptcy Attorney. As with any area of the law, it is strongly recommended you seek the advice of a professional with many years of experience in the field.
The following list is what I consider to be the 10 most important signs you should be aware of that your client should consider filing Bankruptcy.
1) The client cannot pay their bills as they come due and/or is making minimum payments on credit card debt. This sounds obvious enough but its importance cannot be overstated. Other signs include borrowing from Peter to pay Paul, etc. An important point to remember is that the client does not have to be flat broke to file Bankruptcy. In fact, Bankruptcy merely requires financial distress. Finally, because individuals normally wait until they are flat broke to seek Bankruptcy advice, this unnecessary delay precludes options available to them which may help them reorganize their finances and permit them to keep part or all of their property. For example, an individual normally waits until the day before a foreclosure sale to seek Bankruptcy advice where had they sought advice earlier, their chances of losing the property would have been diminished significantly.
2) The client is in the process of a Credit Card Debt Consolidation Plan. This is one of the biggest scams going in the industry. It is the extremely rare situation that Credit Card Debt Consolidation actually works to benefit a Debtor. Here are five quick and dirty reasons why your client should consider Bankruptcy if they are in a “Debt Consolidation Plan.”
a) There is no cap on the amount of interest a Credit Card can charge you. That’s right, your Credit Card Company can charge you 1000% interest a day if they want to.
b) Your current interest rate can change at any time! When you read the fine print of your contract (and try to find all the other text it makes reference to) you will discover a brutal, deceptive and sleazy truth. The terms of your credit card (including interest) can be changed with 45 days notice, which normally comes in that fine print document which accompanies your monthly statement. So if you think you have a 4% interest rate on your credit card for as long as you have the card, think again!
c) If a creditor cancels some of your debt, you have to pay taxes on that amount! Cancellation of debt is a taxable event that requires you to pay taxes for that money. This does not apply if a person receives a discharge in Bankruptcy.
3) The Client is having their Wages Garnished and/or has frozen bank accounts. If this has happened, the Client in all likelihood had a judgment entered against them. If this is so, and the client owns a home, then the Client’s home now has a lien on it. At this point, Bankruptcy may be in the Client’s best interest to avoid the lien (get rid of) to the extent the lien impairs the homestead exemption. In New York, the homestead exemption is $125,000 ($250,000 for Joint Debtors). Regardless of whether the Debtor is a homeowner, the Bankruptcy process will stop the wage garnishment and “unfreeze” the Debtor’s bank accounts (limitations apply).
4) The Client is in foreclosure or is in danger of imminent foreclosure. We are all currently paying the price of the promiscuous lending practices of the credit industry. With limited exceptions, the entire industry is guilty of putting people into mortgages they cannot afford. Most people were drawn into mortgages they could not afford by unscrupulous lenders and brokers who, for example, did not advise the homeowner that they could not legally rent out the basement of their new home. Nor did they advise the homeowner that most properties will be vacant a certain amount of time of the year, etc. If the Client is in foreclosure, then Bankruptcy may be an option! There is a federal law that requires a mortgage company to stop a foreclosure action immediately upon filing Bankruptcy and gives the homeowner a chance to catch up on their mortgage payments in manageable monthly installments (restrictions apply). Under Chapter 13 of the Bankruptcy Code, individuals with steady incomes who want to pay their debts can do so with the protection of the Federal Court and without the harassment of collectors and attorneys (such as the law firm which commenced the foreclosure action). Special provisions apply to be eligible for Chapter 13.
5) The Client owes more on their home than their home is worth. In situations like this, there is a knee jerk reaction to try to have a “short sale.” The problem with this is that the amount of debt that is forgiven is considered taxable income (certain limitations apply). To avoid this and keep the homeowner in their home, the Client should consider Bankruptcy. The possibilities are too numerous to discuss in this article but one Bankruptcy option is worth mentioning. Lets say that the homeowner has two mortgages and the value of the house is less than the amount owed on the first mortgage. In this scenario, the homeowner can strip off (get rid of) the second mortgage in its entirety! As one would imagine, there are restrictions but it is certainly something worth looking into for the cash strapped homeowner.
6) The Client is about to or is in the process of getting a divorce. It has been said that financial difficulties can put a tremendous strain on a relationship and is a leading cause of divorce. Once again, the Bankruptcy possibilities are limitless but I would like to talk about one Bankruptcy option in particular. Alimony, Maintenance and Support are non-dischargeable in Bankruptcy. That’s the bad news. The good news is that Property Settlements are dischargeable in Chapter 13 Bankruptcy! So if you have a client that is considering a divorce, perhaps a good piece of advice would be to structure the distribution of marital assets and liabilities as a Property Settlement. In doing so, the Property Settlement may be dischargeable in Chapter 13 Bankruptcy! As always, there are restrictions and Bankruptcy Judges can look beyond the labels put on certain settlements but is certainly something to keep in mind. Finally, Bankruptcy should always be considered a financial planning tool particularly for people about to get divorced.
7) The Client does not have health insurance, is underinsured, or is sick and will need treatment. The best thing that can be done here is to speak to a Bankruptcy attorney to discuss a long-term strategy for maintaining assets. It is a sad state of affairs that the wealthiest nation on earth requires its citizens to file Bankruptcy because of illness.
8- The Client is borrowing from exempt assets to pay dischargeable debts. For example, your Client keeps taking out pension loans, borrows from their 401K’s, etc. to pay credit card bills or to make ends meet. In this scenario, the best thing that can be done here is to speak to a Bankruptcy attorney to discuss a long-term strategy for maintaining assets. The Bankruptcy Code permits individuals to maintain certain assets despite filing Bankruptcy. These “certain assets” are known as exemptions. There are numerous policy reasons for having exemptions among which are to prevent individuals from becoming public wards. Speak to a Bankruptcy Attorney to discuss asset preservation.
9) The Client has signed numerous personal guarantees on business debts. A common example of this is when an individual owns a corporation and personally guarantees much of the corporations’ debts. Another common problem is when a corporation does not pay taxes and thereby leaves the principal or responsible officer, i.e. your Client, responsible to pay same. A Bankruptcy or at the very least Bankruptcy planning is needed at this juncture.
10) The client has excessive liens levied against their assets for everything from non-payment of credit card debt, tax liens, consensual and non-consensual liens, etc. The individual should consider bankruptcy. The Bankruptcy process and/or good pre-Bankruptcy planning can strip away those liens and help the individual save their assets.
This is a non-exhaustive list of “red flags” that should apprise the practicing professional that the Client should consider Bankruptcy or at the very least, speak with a Bankruptcy Attorney to consider asset preservation strategies. Remember, every situation is unique and must be approached with that in mind. The sooner a Client seeks Bankruptcy advice, the more likely that the Client will be able to preserve their assets.
In a recent decision of the United States Bankruptcy Court for the Eastern District of New York, the Court held that “We the People” engaged in the unauthorized practice of law, committed fraudulent, unfair and deceptive acts, and rendered services that had no value.*
The truth about “We the People” is that they are a typing service. “We the People” are not lawyers! Court documents do not have to be typed. Why pay several hundred dollars to someone to type forms? The motto “No Lawyers Save You Money” should be taken with a grain of salt. People end up losing their valuable assets by going to typing services instead of qualified lawyers. Their motto should be “No Lawyers Cost You A Lot More Money.” See the attached Court decision about one of the victims of “We the People.”*
With so much on the line, why go to someone who is not a lawyer to solve your legal problem. If you were in an accident, broke several bones and lying on the floor bleeding, would you call an herbalist? Of course not, a sane person would call a doctor. So if you have a legal problem, why go to someone who is not a lawyer to solve your legal problem?
It is my sincere belief that typing services like “We the People” have no value and do not benefit the hard working people whose money they take. Do not just take my word, look at the attached summary opinion by a Bankruptcy Judge stating that “We the People” render services that have no value.*
UNITED STATES BANKRUPTCY COURT EASTERN DISTRICT OF NEW YORK
In re: PHYLLIS GAFTICK, Chapter 7 Debtor. Case No.: 1-04-20061-dem
DECISION AND ORDER
On July 8, 2004, Phyllis Gaftick (“Gaftick”) filed a voluntary petition for relief under Chapter 7 of the Bankruptcy Code. On March 18, 2005, a joint application for Orders pursuant to Section 110 of the Bankruptcy Code (the “Application”) in which they sought sanctions against We the People of Sheepshead Bay, New York, Inc. (“WTP- SB”) and We the People Forms and Service Centers USA, Inc. (“WTP- USA”) (collectively, the “Respondents”). Specifically, the Movants sought an order: (1) directing WTP- SB and WTP- USA to disgorge (give back) fees pursuant to Section 110(h)(2); (2) directing WTP- SB and WTP- USA to cease conduct which amounted to the unauthorized practice of law; and (3) finding that WTP-SB and WTP-USA committed fraudulent, unfair or deceptive acts pursuant to Section 110(i).
[T]he Court finds that the services the Respondents (We the People) rendered to Gaftick had no value and directs that (i) the Respondents disgorge Two Hundred Twenty-Nine Dollars ($229.00) to Gaftick under Section 110(h)(2) (ii) of the Bankruptcy Code. The Court further finds that the Respondents (We the People) collected a money order in the amount of Two Hundred Nine Dollars ($209.00) from Gaftick made payable to the Bankruptcy Court for the filing fee in connection with the Debtor’s bankruptcy petition and directs that WTP-SB and WTP-USA shall be fined, jointly and severally, Five Hundred Dollars ($500.00) for violating Section 110(g)(1) of the Bankruptcy Code. The Court finds that the Respondents (We The People) committed fraudulent, unfair, and deceptive acts when they (i) advertised that their bankruptcy services cost One Hundred Ninety-Nine Dollars ($199.00) when in fact their services cost Two Hundred Twenty-Nine Dollars ($229.00); (ii) charged Gaftick a fee of Fifteen Dollars ($15.00) for a process server although a process server was not used and (iii) deceived Gaftick into believing that she was required to have the Respondents photocopy her petition.
[I]t is well settled that “[t]he giving of legal advice and counsel, including instructions and advice as to the preparation of legal instruments, constitutes the practice of law.”
However, the act of simplifying the bankruptcy process and forms “leads to the exercise of judgment by the Bankruptcy petition preparers in how best to accomplish that result, which in turn inevitably crosses the line by giving potential debtors guidance and advice on how to fill out the forms.” In addition, these forms may also “lead a debtor to choose incorrectly how to treat his or her property.” An example of this occurred in the present case when Gaftick was led to claim her cash in her bank accounts as exempt, not realizing that this exemption pertained only to exempting a portion of the “earnings” she had received in the last sixty days.
Here, the Respondents’ legal advice to choose the exemption under NYCPLR §5205(d)(2) caused Gaftick to have to retain counsel to correct this error on her schedules, confused her creditors and caused them to question her integrity when this matter was revealed at the adjourned 341(a) meeting. It could have jeopardized Gaftick’s discharge if this error had not been caught and corrected in time. Accordingly, the Court finds that the services the Respondents rendered to Gaftick had no value to her.
DENNIS E. MILTON, United States Bankruptcy Judge
* This is a summary of this case. The full case can be downloaded online at,
By: Neil E. Colmenares, Esq.
Bankruptcy is booming in America! Each year seems to bring record consumer and business Bankruptcy filings. Bankruptcy, although considered a specialty, is quite broad in nature and affects almost every area of the law. Therefore, an understanding of the Bankruptcy Code and the principals enunciated therein is essential to everyone involved in the practice of law. Bankruptcy law is extremely complex and, like other specialties, takes a significant investment of time to master. The purpose of this article is not to make you an expert in Bankruptcy law. This article is intended merely to make the non-Bankruptcy lawyer aware of various issues that arise in various disciplines. Attorneys who practice in the areas of Personal Injury, Matrimonial, Landlord/Tenant, Criminal Law, Real Estate, Trusts and Estates, Business Law, Collections and Commercial Litigation matters should take special note of the Bankruptcy related issues in their practice.
The purpose of the Bankruptcy Code is twofold. First, the Bankruptcy Code is intended to give the honest but unfortunate debtor a fresh start. Secondly, the Bankruptcy Code provides a system of paying creditors via the liquidation of the debtor’s non-exempt assets or through a structured repayment plan. As one would imagine, these competing interests often collide with the force of a hurricane.
There are five chapters of the Bankruptcy Code. Starting with the most popular, Chapter 7 is a liquidation of the Debtor’s non-exempt assets. Chapter 13 is a repayment of all or part of the debts of an individual with regular income. Chapter 11 is a reorganization of a business but is also, though less frequently, available to consumer debtors. Chapter 12 is similar to Chapter 13 but available only to Family Farmers. Chapter 9 is the adjustment of debts of Municipalities.
Which Chapter of the Bankruptcy Code an individual files under should be carefully considered by an experienced Bankruptcy Attorney. Each Chapter has its pros and cons and one size certainty does not fit all. The importance of familiarity with all the Chapters of the Bankruptcy Code can not be over emphasized. Filing a Bankruptcy for a client without first explaining all their options under all the Chapters of the Bankruptcy Code can lead to court sanctions and a malpractice suit from the client!
The moment a Bankruptcy petition is filed, a “Bankruptcy estate” is created which consists of all legal and equitable interests of the Debtor that existed on the date the petition was filed. When a debtor files for Bankruptcy, an “automatic stay” goes into effect. This automatic stay, with exceptions, is immediate and stops all collection efforts on property of the estate. The purpose of the automatic stay is to give the Debtor “a breathing spell” from their creditors. The automatic stay is also meant to protect creditors by creating an orderly liquidation or repayment procedure which obviates the need for a race to the courthouse to collect outstanding debts. The automatic stay suspends creditors claims so that they may be administered by the Bankrupt estate. Finally, the automatic stay does not prevent collection of post-petition debts so long as collection is not from property of the Bankrupt’s estate.
As previously noted, there are exceptions to the automatic stay. These exceptions permit the excepted Creditor to go about their business as if the Bankruptcy Petition had never been filed. The United States Congress decided that certain “public policy” interests override the need for the automatic stay. These exceptions are so important that every practicing attorney should have familiarity with them.
Some of the most important exceptions to the automatic stay are as follows: commencement or continuation of criminal proceedings against the Debtor; the commencement or continuation of an action to establish paternity; the establishment or modification of an order for alimony, maintenance or support (as distinguished from property settlements); the collection of alimony, maintenance or support from property that is not property of the estate; the commencement or continuation of criminal proceedings against the Debtor; actions by a governmental unit to enforce its police or regulatory power for health, safety or welfare of the community.
So much for the automatic stay. Once the Debtor is in Bankruptcy, the Bankruptcy estate must be administered. This is accomplished in different ways depending on the Chapter of the Code the Debtor filed under. Each Chapter brings with it a myriad of possibilities and nuances that counsel should be aware of. The following is a brief synopsis of how cases are administered under the various Chapters.
Under Chapter 7, non-exempt assets are liquidated by a court appointed Trustee to pay creditors who have filed timely proofs of claims according to the priority set forth in the Bankruptcy Code. If a Creditor fails to file a timely proof of claim, they are prohibited from partaking in the estate! A word of caution is in order here. The knee jerk reaction to file a proof of claim should be avoided and careful consideration must be taken before filing a proof of claim. The filing of a proof of claim, generally speaking, subjects the creditor to the jurisdiction of the Bankruptcy Court. This jurisdiction may or may not have been present before the filing of the proof of claim. In certain cases, the filing of a proof of claim can, inter alia, waive a creditor’s right to a jury trial!
Administration of a Chapter 13 case is somewhat different than Chapter 7. In Chapter 7, anything acquired by the Debtor after the filing of the petition is not considered property of the estate. Under Chapter 13, on the other hand, until the final payment under the confirmed plan is made, all property of the Debtor acquired both pre-petition and post-petition are considered property of the estate. Under Chapter 13, the Debtor submits a plan of repayment for part or all of their debts over a period of not to exceed five years. Once the Bankruptcy Court “confirms” the Debtor’s plan, all creditors are bound by the plan regardless of whether the Debtor continues making payments under the plan!
Chapter 13 has some interesting features that the other Chapters do not. For example, there is a Co-Debtor stay that acts as a stay against the commencement or the continuation of a civil action against an individual that is liable with the Debtor. Chapter 13 also provides for a “Super Discharge” of debts that are otherwise non-dischargeable in a Chapter 7 proceeding such as debts resulting from a willful and malicious injury. Finally, Chapter 13 allows a Debtor to withdraw the petition. This is in contrast to Chapters 7 and 11 which require court approval.
Chapter 11 administration is time consuming and cumbersome. Unlike Chapter 13 where a Debtor submits a plan of reorganization to the court and can be confirmed over the objections of creditors, under Chapter 11, the Creditors must vote on a plan of reorganization before the plan can be confirmed by the Court. This often leads to innovative methods of negotiations between the parties.
The goal of a Bankruptcy is to receive a discharge. A discharge forever prohibits a creditor from collecting or attempting to collect discharged debts. The discharge injunction allows the honest but unfortunate debtor to realize their fresh start. Which debts are discharged depends on the Chapter of the Bankruptcy Code upon which the discharge was granted.
A discharge under Chapter 13 of the Bankruptcy Code, as stated supra, discharges debts that are otherwise non-dischargeable in Chapter 7 such as debts resulting from a willful and malicious injury. Under Chapter 7, certain debts are excepted from discharge such. This non-exhaustive list includes debts for certain taxes; debts that are in the nature of alimony, maintenance or support; debts for most student loans; debts for most fines, penalties, forfeitures or criminal restitution obligations; debts for personal injuries or death caused by the Debtor’s operation of a motor vehicle while intoxicated; some debts which were not properly listed by the Debtor; debts that the Bankruptcy Court specifically has decided or will decide are not discharged; debts for which the Debtor has given up the discharge protections by signing a reaffirmation agreement in compliance with the Bankruptcy Code requirements of debts.
In Chapter 11 cases, a corporation does not receive a “discharge.” Rather, when the plan of reorganization is confirmed, the confirmed plan bounds all creditors by the terms provided for in the plan which may include less than full payment for outstanding debts. Finally, shareholders of a bankrupt corporation enjoy limited liability under state law from the corporation’s unpaid claims.
As the above mentioned information illustrates, Bankruptcy law is extremely complex and the practice thereof should be undertaken only by an attorney who has manifested a commitment to this complex area of the law. Former Judge Marvin Holland of the Eastern District of New York Bankruptcy Court, when speaking of non-Bankruptcy Attorneys practicing in Bankruptcy Court, said it most succinctly: the Bankruptcy Court is “occasioned by a small minority of lawyers who are ill- trained, unseasoned, unmotivated, and undedicated; lawyers who have practiced only in state courts and who blindly assume that procedure in this Court [Bankruptcy Court] is identical to that to which they are accustomed; lawyers with the temerity to represent a client in need before a court of highly-specialized jurisdiction and procedure without first having familiarized themselves with the basic fundamentals of bankruptcy practice.” In re: REFINE CONSTRUCTION CO., INC., 175 B.R. 827 at 831. The Attorney in this case was subsequently sanctioned. Id.
It is my sincerest hope that this article will help the non-bankruptcy attorney spot issues that arise in their respective practices and thereby avoid a possible court sanction or malpractice claim.
*The Bankruptcy Abuse and Consumer Protection Act of 2005 has changed a number of the provisions from the former Bankruptcy Code. It is suggested that you contact an attorney to discuss your specific situation.
Most mortgage brokers and bankers are under the false impression that bankruptcy has little or no effect on their practice. There could be nothing further from the truth! Brokers and bankers, more than almost any other profession, are directly affected by bankruptcy. Because so few are aware of the process, they end up losing a tremendous amount of business out of ignorance. This article has been written to familiarize lay brokers and bankers with the knowledge needed to identify when bankruptcy-related issues are before them and the appropriate action to take to earn their fee.
The bankruptcy process generally affects mortgage brokers and bankers in one of two ways:
The first general scenario is when a broker is considering or about to procure a loan for a potential homebuyer. In this scenario, the broker has worked diligently to procure the loan but, much to their chagrin, finds that the seller has fallen behind on the mortgage payments and is in foreclosure. When faced with this situation, most brokers/bankers normally cut their losses and run the other way, while chastising themselves for not having discovered this fact earlier. However, an astute broker/banker who has read this article will see an opportunity to earn a fee.
When faced with this situation, as a broker/banker, you are in a position to be levelheaded and make a decision that can save the day for everyone involved. If a modification, forbearance, refinance or a second mortgage is not possible or practical, bankruptcy may be an alternative.
Let’s assume that there is a foreclosure sale scheduled for the end of the week. Assume also, that there is a buyer ready, willing and able to purchase this home, but for various reasons cannot close on the property before the scheduled foreclosure sale date. On the advice of someone who has read this article, the financially distressed homeowner decides to hire a bankruptcy attorney to file a Chapter 13 bankruptcy. In doing so, the foreclosure process is stopped dead in its tracks. Although this may only be a temporary delay in the foreclosure process, this delay may be long enough to consummate the sale, prevent the financially distressed homeowner from losing their house and prevent you from losing a commission.
How does Chapter 13 do this? The filing of a Chapter 13 bankruptcy creates what is called an automatic stay on the foreclosure process. In plain English, this means the foreclosure process cannot continue unless one of several factors has been met. While a comprehensive lesson on the bankruptcy code is beyond the scope of this article, it is sufficient to say that no matter how the Chapter 13 bankruptcy turns out, the foreclosure, at a minimum, is delayed long enough to give the homeowner some breathing room. This breathing room can offer all interested parties an opportunity to come up with creative solutions to the issue at hand.
It should be noted that Bankruptcy Law is extremely complex and should be practiced only by an experienced bankruptcy attorney. No one should ever file a bankruptcy petition without the representation of an experienced bankruptcy attorney. Here is just one of the many reasons why:
Let’s say the homeowner goes to bankruptcy court without an experienced bankruptcy attorney and mistakenly files a Chapter 7 bankruptcy instead of a Chapter 13 bankruptcy. In this instance, if there is equity in the property, the trustee assigned to the Chapter 7 bankruptcy case will sell the house without the homeowner’s consent. This, it goes without saying, does not benefit anyone. And, the homeowner who filed the bankruptcy without an experienced bankruptcy attorney in an effort to save a few dollars on legal fees has lost the home that they have worked for their whole life and will be literally left out on the street in a relatively short time. Finally, the commission that you may have been entitled to as a broker or banker, will in all likelihood be lost forever. This is one of many common mistakes made by both lay people and non-bankruptcy attorneys when handling a bankruptcy case.
The same way that you wouldn’t go to a dentist when you’re having chest pains, you should never go to anyone who is anything short of a bankruptcy expert when you need bankruptcy counseling. Real estate law is not the same as bankruptcy law. And any lawyer who has a long laundry list of practice areas is, more likely than not, confirming the old cliché, “Jack of all trades, master of none.” When there is so much on the line, you cannot afford to have anyone but an experienced bankruptcy lawyer handling your case.
Let’s examine the other side of the coin. Say you are the bank that holds the mortgage in the above hypothetical case. You have now learned that an automatic stay has gone into effect that prohibits you from continuing the foreclosure process. What do you do now? For too many of the smaller lenders, this normally means going to the foreclosing attorneys who for the most part are not bankruptcy experts and who waste valuable time figuring out what to do. For starters, they should advise you that any actions taken to continue the foreclosure are usually void and can lead to contempt charges being levied against you. At this point, you should immediately file a “proof of claim” and depending on the bankruptcy chapter filed, you may need to file a motion to lift the automatic stay and/or an objection to confirmation. Let’s take each of these steps one at a time.
The first thing that the mortgagee should do is file a proof of claim. A proof of claim permits you to receive money from the trustee (a court appointed person in charge of distributing the bankruptcy estate) in the event that there is any money to be distributed. Failure to file a proof of claim forbids you from receiving any money from the trustee even though you may be entitled to it. For example, in the previous hypothetical case where the homeowner accidentally filed a Chapter 7 bankruptcy, if there is any equity that the trustee would distribute to which you may be entitled; your failure to file a proof of claim precludes you from receiving any of that money. There are a hundred other reasons to file a proof of claim but this is the most important.
Next, you may need to file a motion to lift the automatic stay. Making a motion to lift the automatic stay will allow you to continue the foreclosure process should that be in your best interests. When a person files for bankruptcy, a bankruptcy estate is created which encompasses all of the property that the debtor has an interest in. Most importantly to you as the mortgagee, this includes the property on which you hold a mortgage. Without making a motion to lift the automatic stay, you cannot continue to foreclose.
The bankruptcy court will allow you to continue the foreclosure process only under certain conditions. The most common is what is called “lack of adequate protection.” Adequate what? Here again, an analogy is in order. Think of an ice cube. Imagine it to be an exact size. This ice cube represents your interest in the property. If after the filing of the bankruptcy, this ice cube shrinks in size, you as the mortgage holder are not adequately protected. The bankruptcy court could either lift the automatic stay or give you something else to make your “ice cube” the same size it was just before the bankruptcy filing.
To illustrate, some examples of lack of adequate protection include failure to pay post-bankruptcy filing mortgage payments or not satisfying pre-bankruptcy filing mortgage arrears. In these instances, the bankruptcy court will usually lift the automatic stay to allow you to continue the foreclosure process and may in certain circumstances, give you a replacement lien on some of the debtor’s other property to get your ice cube back to size. The possibilities here are endless, but suffice it to say, prompt action after the filing of the bankruptcy will minimize if not eliminate any risk to your interest in the debtor’s property.
One more caveat-foreclosure attorneys are not bankruptcy attorneys. The same principles described above for selecting a bankruptcy attorney for a homeowner applies equally to lenders. Generally speaking, foreclosure attorneys are swamped with work and do not possess anything past a basic understanding of bankruptcy law. Once again, you should select a bankruptcy attorney who practices predominately, if not exclusively in Bankruptcy Law. Remember, every delay costs you money.
Finally, if the homeowner has filed either a Chapter 13 or a Chapter 11 bankruptcy, you may need to file an objection to confirmation. A little primer is in order here; Chapter 13 and Chapter 11 bankruptcies are reorganizations that in essence mean the homeowner proposes a plan to pay back their debts within the parameters set forth in the bankruptcy code. If this proposed plan does not take into account all of your rights and you fail to object, you have, for the most part, waived your rights. Once again, the possibilities here are endless but the point to remember is to know your rights and protect them.
In closing, remember that both debtors and creditors have rights. This means you must know these rights to protect your interests. If you are unaware of these rights or fail to take affirmative steps to protect your interests, you can lose a tremendous amount of your investment, not to mention your fees. I hope this article helps and enables you to grow your business, and seize the opportunities that others do not see.
Neil E. Colmenares, Esq. is a Bankruptcy Law attorney and a principal in the New York-based Law Offices of Neil E. Colmenares, P.C. He writes articles on the complex area of Bankruptcy Law for various professional organizations, has taught continuing legal education courses to other attorneys on Bankruptcy Law and is a frequent lecturer for government-sponsored programs teaching entrepreneurs how to form and maintain businesses.
*The Bankruptcy Abuse and Consumer Protection Act of 2005 has changed a number of the provision from the former Bankruptcy Code. It is suggested that you contact an attorney to discuss your specific situation.