Traps for the Unwary Chapter 7 Bankruptcy Attorney

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1 Traps for the Unwary Chapter 7 Bankruptcy Attorney MSBA Consumer Bankruptcy Section Presented 1/24/18 Michael G. Wolff, Esquire Chapter 7 Trustee Definition Unwary Not cautious, not aware of possible dangers or problems Rule # 1- Make sure you get paid your legal fees before you file the case Fees not paid prior to filing the case are discharged. Provide the financial documents required by 11 U.S.C. Section 521 to the Trustee in advance of the scheduled meeting of creditors Avoid having your client receive a non compliance notice from the clerk or even worse, causing the meeting to be suspended and rescheduled to another date. These documents are needed by you to construct the Bankruptcy Schedules and the Form 22 means test They logically must be in your possession prior to drafting the bankruptcy documents. These documents; the last filed tax returns or transcripts, 60 days of pay advices or Local Form Q, and statements for each financial account open in the name of the Debtor as of the date of filing, must be provided to the Trustee. The Trustee is obligated to refer ineligible Debtors or unexplained disparities in the Schedules to the U. S. Trustee. Be prepared to explain disparities between the Schedules I & J and Form B-22 and bank balances at the Meeting of Creditors. Rescheduling of 11 U.S.C. Section 341(a) Meeting of Creditors - Local Bankruptcy Rule (d) - requires that a written request for postponement of a meeting of creditors be made to the Interim Trustee. The Meeting may be rescheduled to the Trustee s next available panel date, or as otherwise agreed. The request for postponement shall state the basis for the request and shall state whether any prior continuance requests have been made. The Local Rule also requires that the documents required by 11 U.S.C. Section 521 (Pay Advices or Local Form Q and Tax Returns) must be delivered prior to or with the request to the Trustee. Trustees will not agree to reschedule meetings due to schedule conflicts if this documentation has not been provided by the time of the request. In addition, Counsel must provide a certification that a Consent Motion has or will be filed with the court to extend the deadlines to file both an objection to discharge under 11 U.S.C. Section 727 and a motion to dismiss under 11 U.S.C. Section 707 (b)(3) until a date sixty (60) days after the rescheduled meeting of creditors, and to extend the deadline for the United States Trustee

2 to file a Statement of Presumed Abuse under 11 U.S.C. Section 704(b)(1)(A) until ten (10) days after the rescheduled meeting of creditors. Lastly, Counsel must file and serve on all parties on the matrix by mail or CM/ECF a Notice of the new meeting date and time, along with the consent motion, at least seven (7) days in advance of the rescheduled meeting, and must certify to the Court (with a copy to the Trustee and the U.S. Trustee) that said Notice has been given. Make sure the Debtor understands that proof of identity must be presented at the Meeting of Creditors- an original photo ID (Driver s License or equivalent and a Social Security Card) Explain to your client that the Meeting cannot proceed until the identity of the Debtor is verified and the Social Security number has to be full and not redacted and that the Debtor s tax return cannot be used. Failure to comply with this basic requirement will cause the meeting to be suspended and rescheduled to another date. Avoid Substantial Abuse Motions to Dismiss filed by the U.S. Trustee- miscalculated means tests for over median income debtors, failure to use allowed deductions, miscalculating income (seasonal income, severance, bonuses, etc.), and improperly classifying business debt as consumer debt, inability to explain disparity between Schedules I & J and Form B-22. Know the true value of the Debtor s assets- avoid your client s shock when the Trustee begins to liquidate or recover property. Control your client s expectations by fully explaining the role of the Trustee and the process of a liquidating Chapter 7 Bankruptcy. The Trustee is compensated on a commission basis for recovering assets for the benefit of creditors. Identify assets owed to the Debtor or are held in trust for the Debtor or could be recovered by the Debtor which are recoverable by the Trustee. Make sure that the Debtor s exemptions are calculated correctly- exemptions are claimed by each individual Debtor even if filing jointly with a spouse (except for marital property). Marital property is a tenancy by the Entireties (T/E) which can only be liquidated by the Trustee to satisfy the claims of the unsecured creditors of both the Husband and the Wife. The Internal Revenue Service is also permitted to collect what it is owed from one spouse from the T/E property. A Debtor can only exempt property of the Estate which as of the date of filing is a property right held by the Debtor. Remember a transfer of property and or payments made to third parties prior to filing the case cannot be claimed exempt by the Debtor. Make sure that your client understands what constitutes a preference and a fraudulent transfer and that they are fully disclosed in the Statement of Financial Affairs family, friends and insider creditors may be sued as a result of the bankruptcy filing by the Trustee to repay or return assets. 11 U.S.C Section 547 and 548 set out the requirements of what constitutes a

3 preference or transfer. The payments and transfers made by the Debtor and the lack of disclosure of the transfer may cause the denial of a discharge. Make sure your client understands which debts are discharged and which ones are not - 11 U.S.C Section 523 sets out in detail the debts which are not discharged. The most common types of nondischargeable debts are certain types of tax debts, debts not disclosed in the schedules, secured debts, marital debts for child support or alimony, debts for willful and malicious injuries to person or property, student loan obligations, debts for personal injury or death caused by driving while intoxicated, debts owed to retirement plans, and debts for condominium or HOA fees. You should review consumer credit debts incurred by your clients to determine if there were debts incurred prior to filing which are owed to a single creditor in an amount over $ for luxury goods or services. Consumer debts incurred within ninety (90) days prior to filing are subject to a rebuttable presumption that they are nondischargeable. Cash advances aggregating more than $ obtained within seventy (70) days of filing are also presumed to be nondischargeable. Credit debts as outlined in 11 U.S.C. sections 523(a) (2), (4), and (6) (obligations incurred by fraud, false pretenses or a materially false financial statements) are not automatically excepted from discharge. Creditors must file an Adversary Proceeding and obtain a favorable ruling or the debts will be discharged. Review contributions to educational tuition savings 529 Plans, and the over funding of 401 K and Retirement Plans which may cause the contributions to be recoverable by the Trustee as avoidable transfers. 11 U.S.C. sections 541(b)(6) limits the contribution to tuition 529 plans to $6, seven hundred and twenty (720) days prior to the filing and to no contributions during the preceding 365 days. You should also confirm that the Debtor s profit sharing or retirement plans are qualified under Federal ERISA statutes as non qualified plans are not exempt. Analyze the Debtor s tax attributes -Tax Refunds Know what the Debtor is entitled to receive or what was received and spent post filing or the business debtor whose failed business created a tax loss forfeiting the Debtor s right to utilize Business Net Operating Losses (NOLs) carrybacks to generate refunds. It is possible that these refunds could have been claimed by the Debtor to pay debts and possibly avoid bankruptcy. Premature Filing Beware of filing the case before income tax debts become dischargeable obtain a tax transcript and review it. Be on the lookout for the Debtor s payment of another s debt - grandchildren emancipated children the payment of tuition, the non Debtor spouse s debts. Know when preferences and fraudulent transfers were made and are no longer recoverable by the Trustee. Explain the rules of abandonment 11 U.S.C. Section 554 sets out how and when property of the Estate is abandoned. In order for property of the Estate to be abandoned it must be scheduled by the Debtor. If scheduled, the property is then deemed abandoned back to the

4 Debtor when the case is closed. Assets that are not scheduled remain property of the Estate even after the case is closed. Personal injury claims which were not scheduled have been barred by the principle of estoppel when Debtors attempt to pursue injury claims after the Bankruptcy case closes. Estoppel can result in an absolute bar to the recovery of the claim of both the exempt and non exempt portions of the claim. The failure to disclose a claim could result in the loss of the Discharge and could be construed as a bankruptcy crime. Inheritance Make sure that the Debtor understands the rules related to inherited property. If a death occurs within 180 days of filing (regardless of when the inheritance is received) the inheritance becomes the property of the Chapter 7 Estate (subject to the exemptions of the Debtor). Failure to disclose an expected inheritance could result in the denial of or revocation of a Discharge. Divorce The impact of a divorce decree within 180 days of filing on a pending bankruptcy needs to be explained to the Client. A Divorce Decree will result in Tenants by the Entirety marital property being converted into Tenant in Common property retroactive to the day of filing. This may result in property which was previously not available for liquidation to become available. Marital debts are not dischargeable in Chapter 7 but there are some of those non support type debts that may be dischargeable in a Chapter 13 proceeding. Personal Injury the exemption claimed for a personal injury applies to the Debtor s pain and suffering but not the economic loss created by the injury. If the Debtor has substantial medical creditors and has a significant economic loss, it is the Bankruptcy Estate s claim to pursue not the Debtor s. If the claim is being pursued on behalf of the Debtor without notice and approval of the Trustee the Debtor is not the proper party and as such should not prevail. If the Debtor isn t the proper party then the principle of equitable estoppel may result in no recovery. If the Debtor didn t disclose the claim it could also result in no recovery and the revocation of the discharge. A harsh result that can be avoided by a full disclosure, cooperation with the Trustee and by obtaining the abandonment of the claim and procuring the Debtor s right to proceed. Failure to disclose and exempt a Pre Filing Claim - Bankruptcy Rule 1009(a) provides that a Debtor may amend the Schedules at any time prior to the close of the case and that such amendments are generally freely allowed. Of course, the Debtor s case may be re-opened to schedule the claim but a literal reading of the plain language of Bankruptcy Rule 1009(a), does not necessarily grant the Debtor the right to amend the Schedule C. The Court has long recognized that Rule 1009(a) is permissive, with amendments disallowed in limited instances if the Court finds bad faith by the debtor or where there is prejudice to creditors. The Debtor s failure to disclose a Claim if not found to be as a result of a lack of knowledge or understanding about his or her obligations and was not a matter of inadvertence, mistake or carelessness will result in the amendment being denied. The Court would then find that the untimely

5 amendments were made in bad faith and, for that reason, would not be allowed. The Trustee would then be free to prosecute the claim solely for the benefit of the creditors of the estate. Pre-Filing Considerations: Interview your client, review prior bankruptcy filings, insurance riders, divorce financial statements, separation agreements and court orders and other civil proceedings, probate estate inventory, trust documents, tax returns, appraisals, purchase receipts, lien searches, credit reports, federal & state tax returns or tax transcripts, review deeds and deeds of trust. Identify 90 day preferences Identify 1 year preferences Timing is everything : Identify fraudulent conveyances - (3 years under Maryland Law) Review payment history Identify undisclosed personal injury or other claims Advise your client against making post-petition transfers without obtaining Court approval The Benefits of a Chapter 7 Asset Case Most consumer cases end unceremoniously after the meeting of creditors as a no asset case, just waiting for the 60 day objection period to expire to obtain the Order of Discharge. The vast majority of cases end routinely as no asset cases. There are times that Chapter 7 cases are filed which are intended to be administered as asset cases. There are Chapter 7 cases filed which contain non exempt assets that a Debtor wants the Trustee to administer. For example; co-owned property where the co-owner won t cooperate with its liquidation (former spouse or disgruntled business partner, etc.). A Trustee is authorized to use 11 U.S.C. Section 363 to sell property of the Estate which is owned by the debtor and a co-owner. Sometimes this provision of the Bankruptcy Code benefits a Debtor by allowing movement past the obstacles which brought on the need for the Bankruptcy. In addition, sometimes there are priority and non dischargeable debts that will be paid by the funds garnered by the Chapter 7 Estate administration that will relieve the Debtor of liability. If it wasn t the original intention of the Debtor to give up assets, don t always run from the Chapter 7 Trustee just because it is discovered that the Debtor can t exempt all of the assets. Remember, a Chapter 7 case can only be dismissed after a Hearing and only when the Court

6 determines that the dismissal will be in the best interest of the creditors, a difficult standard to satisfy. If the Debtor chooses to convert the case to Chapter 13 the Debtor must have acted in good faith in the filing of the Schedules and in the dealings with the Trustee and must show that a payment plan would be feasible. Many Chapter 7 cases that convert to Chapter 13, rather than give up the assets in the Chapter 7, only languish in the Chapter 13 process to eventually return to Chapter 7. The time spent avoiding the Chapter 7 Trustee only delays receiving the discharge and delays the Debtor s fresh start. Analyze the Debtor s goals realistically. If the eligible Chapter 7 Debtor has to give up some assets to receive an order of discharge might turn out to be the best result for the client. Remember, in a Chapter 7, the Discharge, the ultimate prize, is awarded 60 days after the first scheduled Meeting of Creditors. The Debtor begins on the path to financial recovery after being provided the immediate fresh start. The alternative is to file or try to convert the case to a case under Chapter 13. In Chapter 13 the Chapter 7 liquidation test will still apply. The Debtor will have to propose a payment plan for a 3 to 5 year period based upon the value of all of the assets and the dictates of the means test. The process of gaining approval of a payment plan can be difficult and influenced by other post filing economic factors. The plan must still meet the Chapter 7 liquidation test and satisfy the Chapter 13 Trustee, the creditors and the Court. The plan must be fully executed before a discharge can be ordered. We all know that a lot can happen during a three to five year Chapter 13 plan before the discharge order can be obtained. The Chapter 13 Trustee is obligated to determine the liquidation value of non exempt assets as of the effective date of the plan pursuant to 11 U.S.C. Section 1325(a)(4) and may not exercise the same level of business judgment to compromise the value as would the Chapter 7 Trustee. The Debtor may be required to pay more to the creditors in a Chapter 13 than what a Chapter 7 compromise agreement will require. If the Trustee is not able to liquidate the non exempt asset it will be abandoned back to the Debtor when the case is closed. The Debtor should consider what the asset is that is not capable of being exempted and what its value will be in three to five years? The Trustee is permitted to exercise business judgment to allow the Debtor to retain personal property by making a payment arrangement with the Estate. The Trustee can exercise business judgment to compromise the Estate s claims or can pursue and recover the assets for the Estate. It is advised that you fully consider the benefits of Chapter 7 for the eligible debtor and keep an open line of communication with the Trustee. Another positive reason to recommend a Chapter 7 filing in an asset case, if the Debtor will owe taxes for the period before the case was filed, the Debtor can elect to bifurcate the calendar

7 year into two taxable years one pre-petition and the other post-petition. The pre-petition taxes owed are a priority debt, so it would be paid by the Trustee ahead of general unsecured creditors. To bifurcate a tax year, the Debtor must file an election under Internal Revenue Code Section 1398 (d) (2). To be timely, the election must be filed by the 15 th day of the 4 th full month after the filing of the bankruptcy. NOTES: