Category Archives: Debt Relief & Bankruptcy

AVOIDING JUNIOR MORTGAGES & CHAPTER 7

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Bank of America, N. A. v. Caulkett from U.S. Supreme Court (2015) currently is the defining case regarding avoiding junior mortgages in a bankruptcy filed under Chapter 7. It may not be the last word on this issue, but it does set forth the current law.

Caulkett held that a debtor in a Chapter 7 bankruptcy proceeding may not permit avoiding  junior mortgages under 11 U.S. Code §506(d) if the debt owed on a senior mortgage lien exceeds the current value of the collateral while the credi­tor’s junior claim is secured by a lien and allowed under §502 of the Bankruptcy Code (found in Title 11 of the U.S. Code).

CLOSER LOOK AT “SECURED” AND “UNSECURED” CLAIMS IN BANKRUPTCIES

Defining the term “secured claim” is not easy as context plays a large role in this. 11 U.S. Code §506 is the provision in the Bankruptcy Code that defines “[d]etermination of secured status.” However, case law interprets the meaning of statutes. Dewsnup v. Timm from U.S. Supreme Court (1992) defined a “secured claim” in §506(d) to mean a claim supported by a security interest in property, without any consideration of whether the value of that property would be suffi­cient to cover the claim.

The Supreme Court in Dewsnup concluded that an allowed claim (under §502) that is “secured by a lien with recourse to the underlying collateral . . . does not come within the scope of §506(d),” which could permit the debtor to avoid the lien on the collateral. However, there is a “secured claim” under Dewsnup because the claim is supported by a security interest in property, even though the value of that property is not sufficient to cover the claim. Furthermore, Caulkett states that a claim secured by a lien that also qualifies as an allowed claim under §502 cannot be voided under the Bankruptcy Code.

IMPACT OF NOT REQUIRING FILING OF A PROOF OF CLAIM IN A NO-ASSET CHAPTER 7

According to 11 U.S. Code § 502 (“Allowance of claims or interests”), a claim or interest – upon the filing of a proof pursuant to §501 of this Code – is deemed “allowed” unless a party in interest objects. As noted in In re Smoot from the U.S. Bankruptcy Court in the Eastern District of New York (2011), one can argue that, in a no-asset chapter 7 case, the adjudicative process for claims is not even invoked because claims need not be filed; therefore, a junior mortgage claim is going to be deemed allowed under 11 U.S.C. § 502(a).

Here, a filed proof of claim to determine if a claim or interest against the Debtor’s property should be allowed is not required. Whether or not any assets are available for distribution to general unsecured creditors is not an issue in such situations. Instead, the determination of whether a lien or interest against property is unsecured, leaving it disallowed as a secured claim, is made independent of the existence of assets to be distributed to the general unsecured creditors.

“ANTIMODIFICATION” PROVISION IN CHAPTER 13 & ITS NONEXISTENCE IN CHAPTER 7

The “antimodification” provision in (b)(2) of 11 U.S.C. §1322 does not apply regarding avoiding  junior mortgages that are wholly unsecured on a Chapter 13 debtor’s home. The Third Circuit decided that, because the U.S. Supreme Court in Nobelman stated that § 506(a) still applies and determines the “status” of a creditor’s claim, a wholly unsecured junior mortgage ceases to be a secured claim under the Bankruptcy Code and hence is not subject to the “antimodification” clause. However, because there is no similar provision in Chapter 7 of the Bankruptcy Code, this reasoning from the Third Circuit’s In re McDonald cannot be directly applied to the issue of avoiding junior mortgages in bankruptcies under Chapter 7.

LOOKING AT DIFFERENCES BETWEEN JUDICIAL LIENS & MORTGAGE LIENS

When entered of record, the judgment also operates as a lien upon all real property of the debtor in that county — in Pennsylvania, see 42 Pa.C.S. Sections 4303(a)(b), 1722(b), and 2737(3). Due to this, a judgment lien is called a general lien. Meanwhile, a mortgage lien is a specific lien that encumbers a particular piece of real property. Additionally, the Bankruptcy Code and related case law have defined these two liens quite differently, which can explain why they receive different treatment when the issue of avoiding junior mortgages comes into play.

The Bankruptcy Code defines the judicial lien in Section 101(36) as those obtained by judgment, levy, or other legal or equitable processes. Under Section 522(f) of the Code, judicial liens that impair exemptions provided in bankruptcy law can be avoided so liens that fit this definition must be involved. On the other hand, mortgage liens are said to be “bargained for” and consensual, as opposed to judicial liens which are viewed as imposed by the legal system.

Mortgage liens are part of an agreement between lenders and borrowers. People are free to make deals that they later regret, and the government generally does not feel obligated to save them from themselves. This helps to explain why the opportunities of avoiding junior mortgages are more limited. Section 506, in conjunction with Section 502, sets forth the only mechanism in the Bankruptcy Code for seeking to avoid these liens while both methods of avoidance could be explored for avoiding judicial liens.

AVOIDANCE WHEN OBLIGATION IS SECURED BY MULTIPLE AGREEMENTS

When an obligation is secured by more than one agreement, the extinguishment of a debtor’s obligation under one agreement does not necessarily end all of the obligations. However, in In re Stendardo from Pennsylvania, the bankruptcy court concluded that any right the creditor had to attorney’s fees and costs under the note was extinguished once it entered judgment on the note.

The analysis did not end at this point, though. The court went on to hold that the rights created by the continuing lien of the secured creditor’s mortgage and its asset purchase agreement that also secured the debtor’s obligation were not extinguished until the creditor received payment. In addition, the court cited In re Clark Grind & Polish, Inc., 137 B.R. 172 (Bankr.W.D. Pa. 1992), which stated that a confessed judgment on the promissory note did not extinguish the independent provisions of the mortgage and the asset purchase agreement. Since the various debt instruments were not seen as relying on each other for their continued existence, when one ceased to exist, the others still remained in place.

DIFFERENT INTEPRETATIONS OF SECTION 506 IN CHAPTER 13 & CHAPTER 7

U.S. Bankruptcy Court for the Eastern District of Pennsylvania noted in In re Cusato that “a discharge extinguishes only the personal liability of the debtor [while] a creditor’s right to foreclose on the mortgage survives or passes through the bankruptcy.” While the debt that was owed by the mortgagor cannot be obtained from the mortgagor after a discharge, the mortgagee retains the ability to pursue a judgment against the property to obtain a foreclosure sale to satisfy the mortgage lien on the property. This highlights the importance of Section 506’s applicability, as it can result in a mortgage debt being treated as an unsecured debt that would be discharged at the completion of the bankruptcy case, which could be permitted in Chapter 13 bankruptcies. When this occurs, a mortgage lender has no recourse for seeking repayment.

Courts, in the belief that Chapter 7 debtors would reap a windfall if in personam and in rem liabilities were eliminated through the bankruptcy action, have read and applied laws such as 11 U.S. Code §506 more strictly in Chapter 7 cases. The idea that the impact is different for debtors in Chapter 7 versus those in Chapter 13 could be viewed as unfair, but it seems to stem from the belief that a Chapter 7 debtor can walk away from a discharge without paying any money to creditors while the debtor in Chapter 13 will repay some amount on debts under a Chapter13 Plan. However, the justification for differing treatment of debtors regarding avoiding junior mortgages that are wholly underwater and are not subjects to payments under either bankruptcy chapter could be questioned. However, at this point in time, while potentially questionable, it also is unquestionably the applicable law under these circumstances.

Can a Third Party File Bankruptcy for Another?

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A third party may be able to file a bankruptcy for someone else. For example, a Power of Attorney may be used to start a bankruptcy action party, but bankruptcy courts have limited the authority of individuals to take this step. The third party in this situation is the agent named by the principal (the would-be debtor in the bankruptcy) in the principal’s Power of Attorney (POA). Since the Bankruptcy Code does not prohibit a third party from taking this action but does require the debtor to be involved in the bankruptcy case, such a filing relies on factual determinations and legal interpretations by the Bankruptcy Court where the case was filed, which is the focus here.

Power of Attorney and State Law

With state law playing a large role in what powers can be granted through a POA and the language that is needed in the document, the courts that have interpreted the filing by a third party via a Powers of Attorney using similar ideas but oft times have reached divergent decisions. Pennsylvania is the primary focus here, but opinions from other states cannot be ignored as they are considered by courts during their decision making.

The principal for whom a Power of Attorney is drafted needs to have the language fit the law that will be applied in the individual’s state. If the agent is supposed to be able to file a bankruptcy for the principal, the Bankruptcy Court looks at the intent from the POA’s wording. At this point, a review of various approaches in different jurisdictions may give a clearer understanding of how the law evolves from jurisdiction to jurisdiction.

Interpretation Left to Bankruptcy Courts

As in Pennsylvania, the courts that have been responsible for determining what a given state’s law requires have been hesitant to prohibit the use of a Power of Attorney regarding bankruptcy in all circumstances. Fairness has been a concern that actually has resulted in positions from state to state that can support a given POA in one state while finding that it is not sufficient in another state. This can make the choice of law to be applied perhaps the most important decision in this area of law – in fact, this is a reason why a Power of Attorney should clearly indicate which state’s laws formed the foundation for the drafting of this legal instrument if it is to be used to file for bankruptcy by a third party.

Various jurisdictions over the years that have addressed the POA issue. There have been influential decisions from bankruptcy courts in Virginia, Missouri, and Pennsylvania. These will be highlighted to show how the issues has been approached by the federal judiciary and to demonstrate how the standards for what constitutes an acceptable document tend to differ, despite some commonalities overall.

Important Decisions from Virginia

A number of the opinions have been authored by judges within the Bankruptcy Court for the Eastern District of Virginia. A 1980 decision looked at when, during a bankruptcy action, an agent might be able to proceed in place of the principal. Specifically, In re Killett revolved around a third party seeking to appear at a reaffirmation and discharge hearing when the debtor, who was an active member of the Armed Services, was in England and was unable to return for this hearing. Section 524(d) of the Bankruptcy Code was at issue.

The Court pointed to its language stating that a debtor shall appear at this hearing. The law views “shall” as is a word that communicates a duty so that the individual has no choice about what must be done. However, despite this, the Bankruptcy Court noted that, as a court of equity, it had to weigh the facts to determine its decision, despite the use of “shall” within the Code’s provision. The Judge concluded that, under the circumstances that existed, the debtor would and could rely on the counsel of his attorney and allowed a third party to appear in the debtor’s place. The Court noted that “any loss of rights is on [the debtor].”

Subsequent cases from Virginia seemed to take a harder line against the use of Powers of Attorney in bankruptcy courts, however. These opinions – like In re Killett – often came from the Bankruptcy Court for Virginia’s Eastern District. 1981’s In re Raymond involved spouses in which only the wife was present at the time of filing. Since the husband had to be out of the area and could not be easily reached, the wife decided to file a bankruptcy on behalf of herself and her husband via a Power of Attorney in which he named her as his agent. The Court refused to permit this to proceed as it emphasized that bankruptcy is the personal exercise of a privilege – not a right – that has serious implications. The Court stated that, too often, a third party will abuse the POA in general and would not permit this to occur in bankruptcy actions.

Then, there was a 1990 case (In re Smith) from the same Bankruptcy Court, with another spouse seeking to file a joint bankruptcy case but, again, having to rely on a Power of Attorney to do so because the husband was physically disabled and could not execute the necessary documents. Again, the Court would not allow this filing. It also pointed to some considerations regarding third party filings, such as the lack of language in the document that set forth a specific power that authorized such a bankruptcy filing.

Notably, the Court would not point to the absence of this language for its denial and wrote that a guardian or a “next friend” could possibly file such a bankruptcy if a court with the necessary power issued an Order regarding this appointment and also included sufficient authorization to the third party filing. A “next friend” is someone who applies to a court based on an individual’s medical incapacity or minority.

The next friend would have to be in possession of evidence (usually an opinion letter) from a licensed, qualified physician to show medical incapacity. Then, the Bankruptcy Court would require the next friend to have the all of the information needed to file a bankruptcy; after this party filed the petition, schedules, and related forms, the Court would proceed with the naming of a guardian (who could be the next friend) to handle the remainder of the case. These decisions did not appear to view a Power of Attorney as sufficient by itself to justify a third party filing.

Other State Courts Also Have Looked at POAs

Courts continued to struggle with the issue of a Power of Attorney being sufficient to allow third party filings. For example, In re Harrison, a 1993 bankruptcy case from Florida, stated that a Power of Attorney could provide authority for a bankruptcy filing in unusual circumstances, such as someone in the service during an active conflict, or in a hospital, or in a state of incapacitation. The court went on to note that a non-debtor cannot be granted authority to sign a verification under oath unless this person has personal knowledge of the facts involved. This is due to Rule 9011 of the Federal Rules of Bankruptcy Procedure, known as the “certification rule.” The Court scheduled a hearing about the possibility of sanctioning the third party for signing the statement that verified facts known only by the debtor.

Courts throughout the United States have continued to struggle with the effect of the Power of Attorney in the context of a bankruptcy filing. Before getting to Pennsylvania, a few other decisions show how what begins as a similar perspective can lead to further confusion among the federal bankruptcy courts. Vermont was the source for an opinion from 2001 that bears similarity to the reasoning found in some leading Pennsylvania cases. The Bankruptcy Court in In re Curtis decided that an agent can file for relief for a debtor under 11 U.S.C. Section 109 but required something more than a simple general Power of Attorney.

In this case, the debtor actually came forward to oppose the agent’s action after the latter filed the petition. The Court’s decision was that the agent lacked authority from the time of the original filing because the Power of Attorney did not include specific language that permitted the bankruptcy filing or allowed the agent even to pursue any litigation or legal proceeding while it had language involving business transactions, gift giving, and other matters. The authority on which the third party relied was seen as too general, resulting in the case’s dismissal. Courts commonly discuss the requirement of “specific language” in such cases, but the problem is practice is that different courts have different ideas about what words are specific enough to be necessary words.

Then, In re Eicholz, a decision from the Western District of Washington state in 2004, opined that, under Rule 9001(c) of the Federal Rules of Bankruptcy Procedure, an agent can file for bankruptcy on behalf of the principal under appropriate circumstances. The language within the Power of Attorney again was crucial to whether or not a bankruptcy filing was within the POA’s scope. Here, the language had to expressly grant authority to start a bankruptcy action. Otherwise, the principal had to ratify the third party’s actions, which looked at the passage of time as well as the acceptance of a benefit from agent’s act or the assumption of an obligation imposed by this act.

One last opinion before reviewing how Pennsylvania is consistent with the overarching idea about the need for specific language comes from the middle of the country. In re Sapp from the Northern Division of Missouri’s Eastern District in 2011 looked at a joint bankruptcy in which the wife was found to be mentally incapacitated and physically disabled (which was defined to mean that she would be prevented from participating in the case in person, by phone, via the internet, or in any other manner). While the case actually involved a guardianship, the Court still stated in this decision a Power of Attorney could not justify a third party filing a bankruptcy action unless the POA specifically set out the agent’s power to file for bankruptcy for the principal. Again, the exact language that would meet this standard did not appear.

Pennsylvania: Third-Party Filings and Powers of Attorney

As noted previously, Pennsylvania decisions are basically consistent with the reasoning found in other jurisdictions. The Bankruptcy Court for the Eastern District of Pennsylvania has two decisions that date back to the 1980s but remain important even now. 1987’s In re Zawisza dealt with a Chapter 13 action filed by a “next friend” and determined that a next friend or guardian ad litem could pursue a bankruptcy under appropriate circumstances.

However, In re Sullivan from 1983 focused on the use of a POA, making it more relevant here. The situation involved a monk who was a Pennsylvania domiciliary but would be in Holland for approximately five years. Meanwhile, he faced financial difficulties in Pennsylvania, which led him to give his brother a Power of Attorney that contained a specific right to sell his real property. Unfortunately for the monk, the language was limited to this action and did not mention bankruptcy. Despite this, the brother – as the monk’s agent – filed a Chapter 7 bankruptcy on behalf of the monk to prevent further deterioration of his financial position. In response, the Bankruptcy Court dismissed this filing because the limited POA that existed did not provide legal authorization for a third party filing. From Holland, the monk amended his Power of Attorney to include a specific grant for his agent to pursue personal bankruptcy on his behalf.

The brother now was authorized to do whatever the unavailable principal could do if he were personally present. Furthermore, in addition to filing the bankruptcy that originally was to be dismissed, the agent also could attend the §341 Meeting of the Creditors in his brother’s place, despite the mandate in the Bankruptcy Code that the debtor must attend this meeting. Being that the Bankruptcy Court is a court of equity, the decision from the Eastern District of Pennsylvania permitted the monk’s agent to attend the meeting while the monk was deemed unavailable due to his five-year commitment in Holland.

Thoughts about the Power of Attorney & Bankruptcy in PA

This case probably sets forth the best blueprint for an agent’s use of a Power of Attorney to file a bankruptcy in Pennsylvania. The POA needs to have specific language that authorizes the agent to file an action under the Bankruptcy Code. The principal also must be unavailable. The cited case involves a debtor who is unable to be physically present to pursue relief under the Code.

Although no definitive statement can be made with absolute certainty, the bankruptcy courts in Pennsylvania are likely to seriously consider and, quite possibly, permit a third party to pursue a bankruptcy for the principal using a Power of Attorney containing language specifically authorizing such a filing under very specific circumstances. These would include debtors who can be proven to be mentally incapacitated or physically unavailable (either due to a significant physical disability or due to inaccessibility). The reasoning behind this is that this facts would prevent meaningful (if any) participation by the debtor and also would amount to a denial of due process if a third party with authority (e.g., through a valid POA) would be prohibited from pursing this matter.

Limited Liability Company & Personal Debt in Pennsylvania

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The Limited Liability Company (LLC) is a creation of state law. Depending on the state, the applicable law may be more business friendly, as it is in Delaware and Nevada, for example. However, Pennsylvania is not in this category, and its laws – like those of states with similar views of business – tend to be less specific in certain areas. This ambiguity means that many of the laws applicable to LLCs can be interpreted differently by different courts. The result is that, at the moment, how certain situations will be handled is somewhat of a guessing game. When looking at financial difficulties of a member of the company, the impact on the LLC itself can be difficult to predict right now.

Single Member and Multiple Member LLCs

As will be seen, Pennsylvania provides more direction and clarity for a Multiple Member Limited Liability Company (MMLLC) than it does for the Single Member Limited Liability Company (SMLLC). Both will be reviewed in the context of the law that was enacted in 2016 to provide some idea of where a member in the LLC stands when this individual or another member suffers from a financial downturn.

Look to State Laws Regarding LLCs Currently

One must bear in mind that, while federal law can preempt state law, this does not as yet apply to a member of an LLC. Federal bankruptcy law does not have any provisions that deal with LLCs specifically so this has left bankruptcy courts faced with issues regarding these entities to handle these matters on an ad hoc basis.

The LLC is becoming an increasingly popular type of business entity because of its hybrid nature. It is a pass-through entity in terms of income in the same way that a partnership is. Meanwhile, like the corporation, it generally is viewed as a separate entity, which serves to protect from liability for the business’s debts. Due to the increasing popularity, this area of law is likely to become more uniform in the future, as federal law adjusts to the changing landscape. At the moment, though, state law controls for the most part so one must consider where to establish the business – and also needs to realize that, if the LLC operates in multiple states, no state is bound to apply the law of a different state to a legal dispute that arises in its jurisdiction.

What is a Member?

Before looking at SMLLCs and MMLLCs, one should understand some definitions that are important for a Limited Liability Company. While an organizer often is employed to form the LLC and the operating agreement may specify that it will be run by a manager instead of its members (15 Pa.C.S. Section 8847), the member of the LLC is the most important component in the formation of the business. In the general definitions of Pennsylvania’s law, a “member” is defined; however, this definition is rather vague. Among the other definitions, one can gain a better understanding of what a member is. A person must provide a contribution that can consist of “property transferred to, services performed for or another benefit provided to the limited liability company;” an agreement to transfer property, perform services, or provide another benefit to the company; or a combination of these (Section 8842). In return, the individual gains a transferable interest to receive distributions from the Limited Liability Company (Section 8812).

The Importance of a “Transferable Interest”

The member is most easily viewed as an owner, but what does the member own? Section 8851 specifies that a transferable interest, which is what a member of an LLC actually owns, is personal property. This could be viewed as analogous to shares of stock in a corporation and, as will be seen, can play a large part when a member is forced to consider personal bankruptcy.

Personal Debt and Charging Orders

A brief review of the Pennsylvania Uniform Limited Liability Company Act of 2016, particularly the parts that are relevant to members with personal debt, is the necessary starting point. As already noted, Pennsylvania defines a member’s transferable interest as personal property. This is linked in the statute to potential consequences of a member’s personal debt. In Section 8853, the risk of a “charging order” and its negative implications for an LLC member is set forth. Basically, judgment creditors with unsatisfied judgments against a member can apply to the court for a charging order, which amounts to a lien on the member’s transferable interest.

Furthermore, the court has the authority to make all necessary orders regarding the charging order so that the creditor will be paid in full. If the judgment creditor can make a showing to the court that the charging order will not result in the debt being satisfied within a “reasonable time,” Subsection (c) of Section 8853 allows the court to foreclose on the lien and to order that the transferable interest be sold.

MMLLC’s Advantage If a Member Has Financial Problems

This produces a different outcome for a MMLLC and a SMLLC. As long as the Limited Liability Company has more than one member, the purchaser does not become a member. The former member would be forced to dissociate from the LLC, however; Section 8863 explains the implications. When an SMLLC is involved, the same judgment debt can be fatal to the member’s business because, if the sole member of the LLC is dissociated, ownership will change if the Limited Liability Company is to continue. A member of an SMLLC cannot afford to be in a situation that could result in foreclosure if the individual wants to continue in business.

“Dissociation” as Dictated by Pennsylvania Law

In Section 8861 (“Events causing dissociation”), Pennsylvania lists various situations in which a member of a member-managed LLC will be required to withdraw from the company. Subsection (8)(i) states that a debtor in bankruptcy must dissociate from the Limited Liability Company. How this would work with a MMLLC is fairly straightforward. However, this is a provision in which there is a need to interpret how it would be implemented when there is a single member. If applied as written, whenever the sole member of an SMLLC would seek protection under the bankruptcy laws, this person automatically must dissociate from the LLC. This leads to a scenario in which no one would be in position to manage business as soon as a bankruptcy is filed.

A more reasoned approach is necessary because the SMLLC can be a significant asset in the bankruptcy estate so leaving it rudderless is of no benefit to anyone involved in the bankruptcy. As previously noted, a member of an LLC owns a transferable interest, which is not the business itself; instead, this is considered personal property that could be viewed as similar to corporate stock. The transferable interest becomes part of the bankruptcy estate, to the extent that it cannot be exempted. If a Chapter 7 trustee holds the entire transferable interest of the Limited Liability Company, then the trustee could step into the shoes of the debtor, with the same management rights in addition to the ability to sell the LLC’s property to acquire funds to pay the debtor’s personal debts.

Should the SMLLC Consider Adding Another Member?

To protect the SMLLC from this fate, the member can look at potential actions that could be effective. However, none of them come with any guarantees of success, and they certainly have potential downsides. For example, when the individual has a significant personal debt load and realizes that action must be taken on the personal and business fronts, the person may think about bringing in a second member, who would have to have sufficient funds to pay fair market value for interest being transferred – it cannot be a sham transaction. Of course, this is not without risk. After all, a person establishes an SMLLC with a vision in mind that could be undermined when an additional member is recruited to participate in the Limited Liability Company.

Bankruptcy Could Equal Liquidation for SMLLCs

Bankruptcy itself is an option with obvious risks as well as possible opportunities for an attempt to save the business. When the member files for bankruptcy, the individual’s interest in the LLC will be part of the bankruptcy estate. Liquidation of its assets is a distinct possibility. On the other hand, this is not a foregone conclusion. Since the Limited Liability Company actually has not filed for bankruptcy, its equity position is a major factor in the trustee’s decision regarding what should happen to the business.

An Option to Consider when Liabilities Exceed Assets

The debtor could decide to explore ways to achieve a result that salvages the business entity. The first step is preparing balance sheet with a good methodology underlying its numbers. If the document reveals that liabilities exceed assets, then the trustee would not be fulfilling a trustee’s duty of paying the creditors as much as is feasible to limit what they would lose based on the impact of the bankruptcy. There is no positive value in liquidating the LLC so the bankruptcy trustee lacks an incentive to take pursue this approach. This leaves open the possibility that the debtor may be able to arrange to continue running the business depending on the circumstances that exist with the company and the ability to make a good-faith argument in its favor.

An Option to Consider when Assets Exceed Liabilities

Even if the balance sheet that the debtor presents to the trustee reveals that equity exceeds liabilities, the debtor still has nothing to lose by approaching the trustee before the trustee starts to liquidate the Limited Liability Company. Again, the member must have well-prepared balance sheet that the bankruptcy trustee will believe is sufficiently accurate when making the decision about the business’s fate. The debtor, if possible, could offer to pay the LLC’s liquidation value to the trustee – this is roughly is the dollar amount by which the assets exceed the liabilities.

Of course, the trustee does not have to accept, but, again, the trustee has a duty the debtor’s creditors to attempt to recoup as much money as possible to pay them for the debts that they are owed. The debtor would take the position that this duty is best met by agreeing to the amount proffered by the debtor. If the trustee agrees, then the debtor can be well positioned to salvage the Limited Liability Company and also be in a good position for a “fresh start” after a discharge is granted in a personal bankruptcy filed under Chapter 7.

LLCs Can Survive Personal Debt, But There’s No Guarantee

In the end, there are no guarantees regarding what will become of a Single Member Limited Liability Company in Pennsylvania when its sole member faces dire financial straits on a personal level. The future is easier to predict if the LLC has multiple members. However, in either situation, there are times when a person has run out of options other than bankruptcy, and this will affect the Limited Liability Company to some extent. Especially with an SMLLC, one must look at what potentially viable strategies exist and – if feasible – pursue an option that can allow both the debtor and the business opportunities to survive a bankruptcy positioned to make fresh starts and avoid facing a similar situation in the future.

Surrender of Property in Consumer Bankruptcy

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When individuals with sizable debts decide to file for bankruptcy, they face other decisions that include whether or not to surrender property in their possession. The property to be surrendered secures debt that no longer can be paid. The implications of this decision are defined by definition of “surrender.” This is the necessary starting point.

What Does Surrender Really Mean?

The Bankruptcy Code does not provide a definition of the word. Instead, one is left to reviewing cases to determine what actually happens when property is surrendered. Also, property surrender can occur in Chapter 13 as well as Chapter 7. The main focus is on Chapter 7 bankruptcies since it is more often seen in this context. Following this post is a look at instances in which Chapter 13 surrenders can differ from those under Chapter 7 as well as what the differences can mean to debtors.

One Analysis of Surrender

In re Kasper is a 2004 case involving a Chapter 7 bankruptcy decided by the U.S. District Court in Washington, D.C. It provides an extensive analysis of relevant parts of the Bankruptcy Code to interpret “surrender.” The debtor had filed for bankruptcy under Chapter 7. As a result, he had to file a Statement of Intention regarding what he planned to do with property that acted as collateral for secured loans according to Section 521 of the Bankruptcy Code.

The debtor filed this form but did not select any of the choices that were listed. Instead, since he was current with the loan payments owed to Ford Motor Credit Company, the debtor’s stated intent was to “retain possession” of the car (which had a loan balance greater than the car’s current value).

Before the estate closed, Ford filed a motion to compel the debtor to file a statement in which he had to make one of three choices: surrender the property; redeem the property; or reaffirm the debt. Redemption would involve the payment of the amount of the allowed secured claim on the property. Reaffirmation restores personal liability that would cease with the closing of the case, although the car itself still would be collateral for the debt.

Defining “surrender” was the key to the court’s decision regarding the motion. The court focused on the 3 options listed with the retention of property in the Statement of Intention. These are exempting property, redeeming property, and reaffirming debt. A person who decides to retain property can choose among these options “if applicable.”

This interpretation led the court to see “surrender” as meaning turning over property to the trustee (and not directly to the lienholder) for administration under the debtor’s surrender obligation in  Section 521(a)(4) of the Code. Essentially, this would result in the car being subject to any lien enforcement rights under nonbankruptcy law that the creditor could exercise after the Chapter 7 automatic stay ended. The court denied Ford’s motion, believing that the debtor actually stated the intention to surrender the collateral to the trustee’s administration. This would result in Ford eventually having the option to enforce its rights under nonbankruptcy laws to get the car returned to it.

Courts Have Differed In Interpreting Surrender

Other courts, including the Bankruptcy Court for the Western District of Pennsylvania, have not made as an extensive of an analysis of “surrender” and have found a simpler meaning that seems to leave out a step (although the Bankruptcy Code’s lack of a clear definition for “surrender” makes this debatable). For example, in In re Losak (2007), the Western District of Pennsylvania decided that surrender means that collateral is given to the lienholder, which then can decide to pursue its rights under nonbankruptcy law. In re Failla, from Florida’s Southern District in 2014, focused on surrender meaning that a debtor agrees to not fight the lienholder’s exercise of rights under nonbankruptcy law. Of course, the endpoint is the same, and, ultimately, this is what matters.

When property that secures a debt is surrendered, a lienholder can pursue enforcement rights via nonbankruptcy law while the debtor indicates no intent to fight these actions, as long as those laws are not violated (see In re Ryan, 560 B.R. 339 (2016), from Hawaii that makes this point). However, until the creditor acts, the debtor retains title or ownership in the property. This last point is the main concern: surrender, by itself, does not change the owner of property.

Implications of Surrender for the Debtor Remain the Same

Since the owner has not changed, who is responsible for the property has not changed unless there is further action. Many debtors who have decided to surrender property seem to be caught unaware of the implications of this.

The Statement of Intention in Chapter 7 provides a blueprint for the future because the debtor does not transfer ownership or title immediately to the creditor. The implications are easiest to see if real property is involved. When a house secured by a mortgage note is surrendered, the debtor’s obligation regarding the mortgage payments and any deficiency balance that may exist will cease after the bankruptcy. While personal liability ends, there remains a property lien on which the creditor can foreclose. Obligations that arise after the date that the bankruptcy was filed belong to whoever is the named owner on the deed.

Problems When the Creditor Is In No Hurry to Foreclose On a House

The debtor’s problem is that the creditor may decide not to foreclose, and, until a foreclosure sale occurs, the debtor remains the person whose name is on the deed. This leads to consequences that a debtor often did not anticipate when the surrender option was chosen.

As long as the debtor in bankruptcy remains the owner on the deed, this individual remains responsible for property taxes that will be assessed. In addition, if a third party gets injured while on the property, the record owner of the property could face liability. This means that insurance should be maintained, despite the surrender of the property. Maintenance and upkeep also must be considered – for example, some utilities may need to remain turned on, and the debtor will get the bills.

The individual could look at options to get rid of the property when the creditor is in no hurry to foreclose. The property potentially could be sold, but anyone who has a lien in place must agree to the sale. Offering a deed in lieu of foreclose is a possibility, but acceptance by the creditor is not likely. Then again, the debtor could wait for the foreclosure process to occur, although a Chapter 7 bankruptcy as well as nonbankruptcy laws do not provide ways to force the issue. However, even after a surrender of this property, the debtor could decide to remain there as long as possible because ownership has not changed. Depending on the condition of the real estate, this could be the best choice.

Consider Possible Problems When Surrendering Property

Other types of property securing debts that were surrendered during the course of the bankruptcy can present similar problems, although on a somewhat smaller scale. A car must be maintained and insured, for example. If the debtor’s name remains on the title, then the debtor will be responsible for the collateral. Therefore, whenever property surrender is the chosen method of dealing with secured debt, the debtor filing the Statement of Intention under Chapter 7 first must consider the consequences since surrender does not mean an instantaneous change in ownership.

A Few Words about Surrender in Chapter 13

A Chapter 13 bankruptcy can involve surrender of property, too. This can occur when the Chapter 13 plan does not provide for payments regarding property that secures a debt. The creditor in this situation may pursue a deficiency claim and follows this by participating in the distributions to unsecured creditors. This debt must be handled in this way because, after the collateral has been surrendered under this chapter, the debt that had secured specific property becomes unsecured debt.

However, the surrender of property in Chapter 13 does not automatically change ownership of that property so debtors are in the same position here as with a Chapter 7. There is a potential mechanism for a surrender to result in the creditor being forced to take ownership in a Chapter 13 bankruptcy. When a debtor’s Chapter 13 plan is confirmed, the case does not end because the plan may take 3 to 5 years to be completed. During this time, the Bankruptcy Court continues to have jurisdiction over issues involving the plan. If a confirmed plan’s success is jeopardized when a creditor leaves property to be returned in limbo, the Court could issue an order that forces the completion of the transfer.

Debt Forgiveness and Income Tax

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Debt forgiveness, which is the cancellation of a debt that you owe to someone, often can lead the IRS to see an increase in your income tax bill. However, there is no simple rule to be applied to every situation. For example, if you are in bankruptcy, the IRS is unlikely to see income that can be taxed after debt forgiveness. On the other hand, when a commercial lender cancels your obligation to repay a debt, you may find yourself with income equal to the amount of debt forgiven. In this situation, you do not have any money in hand, but you can expect a tax bill on the amount of money that the lender decided could not be collected from you. Your former lender usually should send you an IRS Form 1099-C (“Cancellation of Debt”) to let you know that the debt that you no longer owe triggered an increase in income taxes at the time of debt forgiveness. Remember that the IRS also gets a copy of the 1099-C and is unlikely to forget the incomes taxes that you now owe.

You may wonder why you receive debt forgiveness income when you cannot repay a loan. One point that will be discussed later is that the IRS does not see income when a debt is cancelled so the explanation here is general. The idea behind debt forgiveness resulting in income begins with the fact that the funds you originally borrowed were not income since those funds represented money loaned to you that had to repay to the lender. When a debt is forgiven, you no longer have to have any obligation to pay back whatever amount of the loan remains unpaid – essentially, your wealth has increased now that you have money that you can keep.

As long as none of the exclusions or exceptions (which will be mentioned below) regarding debt forgiveness income applies, the formula for calculating income simply involves subtracting the fair market value of the property from the debt owed at the time that the lender took a specific action, such as foreclosure or repossession. Also, you may receive a capital gain due to foreclosure, for example; this is not debt forgiveness income but usually occurs when the property’s fair market value is greater than its adjusted basis (approximately your original purchase price plus the costs from major improvements). An amount could be excluded due to the length of time that this was your personal residence during the last five years – I won’t go into the details here because the focus is on debt forgiveness for the moment.

There are several exceptions when debt forgiveness does not lead to taxable income. The examples provide general rules about various exceptions, which could be subject to exceptions themselves – consulting with someone who handles these matters about your specific situation always is advisable.

In general, a debt that is cancelled through a gift, a bequest or devise, or an inheritance is not considered income. Certain student loans also provide that all or part of the debt incurred to attend a qualified educational institution will be canceled if the person who received the loan works for a certain period of time in certain professions for any of a broad class of employers. If your student loan is canceled as the result of this type of provision, the cancellation of this debt isn’t included in your gross income. To qualify for this treatment, the loan must have been made by entities in one of three categories: 1) the federal government, a state or local government, or an instrumentality, agency, or subdivision of one of those governments; 2) a tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital, having employees defined as public employees under state law; or 3) an educational institution (an organization that has a regular faculty and curriculum as well as regularly enrolled students who attended educational activities at that place). Other criteria have to be met for these loans not to be income if they are cancelled. One major reason for debt forgiveness here is to encourage students to serve in occupations or areas with unmet needs in which the services provided are for, or under the direction of, a governmental unit or a tax-exempt Section 501(c)(3) organization.

There also is an exception for deductible debts. Most individuals use the cash method of accounting so income is seen when the money is received while expenses are counted when money is paid for goods or services. Therefore, when a debt was supposed to be paid but the obligation to do so was forgiven, you would not realize income at that time if payment of the debt would have been a deductible expense for you.

The Home Affordable Modification Program (HAMP) also has some exceptions to debt forgiveness income. Reduction of your principal mortgage balance generally is not income when Pay-for-Performance Success Payments and PRA investor incentive payments are involved. Meanwhile, when the principal balance is reduced due to Principal Reduction Alternative under the same program, you should expect that you have taxable debt forgiveness income. Any exception to possible debt forgiveness income can become complicated; again, seeking a professional’s assistance is the best way to protect yourself from making costly mistakes in this area.

After any possible exceptions are reviewed, you then look at the exclusions. For individuals, some of the most common situations that are excluded from consideration as income from the cancellation of a debt would be the following. The most common one probably involves bankruptcy – if a debt is discharged in a bankruptcy case, then it cannot be counted as income from debt forgiveness. Insolvency, which involves a situation when your assets have a fair market value that is less than the amount of all of your debts, also would exclude you from having debt forgiveness income. However, this is not easily determined so you would be wise to have a tax professional examine your financial position to determine if you are insolvent.

Another category of exclusion that is complicated and would require the help of a tax professional usually deals with certain farm debts. The IRS also has noted that non-recourse loans are not subject to debt forgiveness. These loans permit a lender to repossess the property that you financed with the unpaid debt or, if this does not apply, the property that you used as collateral in the event that you defaulted on the loan. There is no personal liability for the default on a non-recourse loan, which is why you do not gain taxable income from the debt’s cancellation. On the other hand, this type of loan still could result in a capital gain when the property is sold.

Exceptions should be applied before you apply the exclusions because their effects on “tax attributes” of yours are different. Unlike exceptions to tax forgiveness income, exclusions require you to reduce tax attributes, which include certain credits and losses as well as the basis of assets. Remember that, while income due to debt forgiveness can seem to be a relatively simple concept, there are many twists to this concept of which you must be aware, and the only way to approach this is to consult with a tax professional about all of the implications that ultimately will impact your tax bill.

There is one final word of caution when the possibility of income from debt forgiveness exists. Whether or not a Form 1099-C was received does not determine income tax implications. The IRS requires these forms only under certain circumstances. When a creditor cancels a debt of less than $600, you may not get a Form 1099-C. However, you must look at the possibility that you received income that is taxable due to debt forgiveness despite the absence of the 1099-C because the IRS would look for income in this situation and will not be do forgiving if you neglected to pay tax that you owed.

Business and Chapter 11 Bankruptcy

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Business – particularly small business – forms the backbone of the U.S. economy. According to the Small Business Association website, there are 28 million small businesses in this country, and they account for 54 percent of all sales and 55 percent of all jobs. There is no good definition for “small business” because this classification differs from industry to industry. However, all businesses face an unfortunate fact of life: most that start up must wind down sooner than later. Depending on the industry, at least one half of new businesses are unlikely to survive for five years. When a business begins to fail, it may look to protections that the Bankruptcy Code can provide. This often means looking at a Chapter 11 filing in an attempt to save the business, but this is a possibility exists mainly for one established as a separate legal entity, such as a corporation (including a Limited Liability Company) or legally formed partnership (including Limited Liability Partnerships).

A sole proprietor is in a different position. If the business or the individual files for bankruptcy, the individual or the business, respectively, also files. Chapter 11 generally is not available here. However, if the debtor wants the business to survive the bankruptcy, then a filing under Chapter 7 would not be helpful since a trustee will be appointed and will control the bankruptcy estate. The trustee is likely to shut down operations and liquidate assets in order to make payments to creditors.

When a debtor who is a sole proprietor wants business to continue in business after a bankruptcy filing, the individual should consider incorporation prior to filing or, possibly, a Chapter 13 case since the debtor generally would remain in possession of the business in a filing under Chapter 13. If there was an incorporation, then Chapter 11 again can be viewed as a possibility. This article will look at separate legal entities seeking to continue operating into the future. As with General Motors during the last decade, bankruptcy under Chapter 11 can succeed, but a small business that looks to protection under this chapter must understand what it is getting into and the likelihood of getting out of it successfully.

The general purpose for filing for bankruptcy under Chapter 11 is “reorganization.” This actually amounts to a plan for the repayment of debts while the entity continues in business. As an aside, Chapter 11 can be used by certain individuals when their amount of debt prevents them from filing under Chapter 13; however, this is the exception to the usual filing under Chapter 11. There also is Chapter 11 “liquidation” for a business, but this not the usual reason for a Chapter 11 filing so it will not be discussed here.

A business that continues to operate as it pursues bankruptcy under Chapter 11 is a “debtor-in-possession,” which essentially places it in the position that an appointed trustee usually occupies. The trustee is supposed to manage the bankruptcy estate and to sell off its assets in order to pay creditors when possible, but, with an ongoing business, its assets remain in the hands of the entity to provide an opportunity to continue operating. This also means that the business has fiduciary responsibilities and must act in the best interests of its creditors, which may be contrary to its own best interests.

While the business faces obstacles due to fiduciary responsibilities to creditors, Chapter 11 does give it various powers that can increase the chances of success. These include is ability to object to creditors’ claims, avoid liens, reject leases and contracts without penalty, extend the time to repay to current creditors and potentially reduce the amount owed to them.

Although having the potential to use these powers is beneficial, there also are realities that reduce the chance of emerging from Chapter 11 successfully. There tends to be more litigation involved in these bankruptcies – creditors suing the business, and vis-a-versa. Even if the litigation ends favorably, the cost to finance it can be considerable.

There are other practical problems when a business files under Chapter 11. It not only involves a time-consuming process (which could take years to resolve), but it also entails the likelihood of considerable costs beyond those already mentioned. As of February, 2016, the filing fee to begin the process is $1,717. However, there are additional costs that can be much higher. For example, attorney’s fees and related costs can begin in excess of $10,000 and may increase considerably depending on the case’s complexity and amount of work that is likely. Also, attorneys and any other professionals usually need to be paid prior to filing since any further payments require authorization by the Bankruptcy Court. There also are numerous administrative burdens along the way – there are reports that must be filed regularly with the Court as well as the Office of the United States Trustee, along with additional fees to be paid.

With so many difficulties facing a business that already is failing, one should not rush to file under Chapter 11. If there will be any chance of success, there must be significant planning in advance. Of course, this really applies to all bankruptcies – a successful outcome is unlikely when a debtor pushes to file right after meeting with the attorney. However, this is even more applicable to Chapter 11 filings, which have the additional financial burdens and administrative requirements that cannot be avoided. Therefore, anyone who would consider such a filing must plan well in advance of an attorney’s involvement in the case, producing as much relevant documentation as possible for the attorney to review before any decision is made.

With all of the requirements during the process itself, it must be remembered that the fundamental purpose here is to prepare a viable Plan of Reorganization that the Bankruptcy Court will confirm. This essentially becomes a contract with creditors, with details about how debts will be repaid as well as the source for payments. Before seeking court approval, creditors generally vote on the plan. They do so by particular creditor classes (secured, unsecured, etc.) that are established. If a creditor class does not approve the plan, the class members still may have to accept it, although this also may force the business to relinquish some assets as a result.

To improve the likelihood of a plan’s approval, a business should attempt to negotiate agreements with creditors for the payment of its debts. A skilled attorney who can craft a proposal that is acceptable to creditors and provides the business with an opportunity to attempt to move forward in a stronger, more stable position is essential.

In the end, all of these efforts may serve simply to forestall the inevitable – a business filing a Chapter 11 case may intend to continue operating after the bankruptcy, but most that file under Chapter 11 will not survive. This must be realized before filing, and other options must be reviewed, including filing a Chapter 7 case.

This is a quick primer on business reorganization under Chapter 11. Any entity that is considering this possibility needs to explore all of the details and implications involved before deciding to pursue this option.

The Value of Valuing Personal Property in Bankruptcy

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If you file for bankruptcy, you also must file a Schedule B, listing all personal property in which you have any legal or equitable interest. This is important because you cannot protect what is not listed in this schedule. The description must contain sufficient detail so that the trustee and creditors have a good idea regarding what the property is, what its condition is, and so forth – this will help to determine what could happen to it prior to the bankruptcy discharge. You also need to make clear about your interest in the property since this will impact the value included in Schedule B, which leads to the point of this schedule: it must provide the current value of your interest in the property, without adjustment for secured claims or exemptions.

You must include all property, even if it would not be in the bankruptcy estate (which places it under the trustee’s control). The list includes causes of action for which you can sue, government grants for which you are eligible, security deposits, earned income tax credits as well as tax refunds that you will receive, and support obligations payable to you.

Property has to be listed so you can protect it. You will exempt the property using available exemptions — not doing so allows the trustee to sell it to pay creditors whom you owe. Without a listing and a description that is detailed, an exemption could be denied because the trustee cannot get a good idea of the property’s value – again, the potential for a sale exists. If you forget to list something, you may be able to amend the schedule to include it, but you should take care to have a complete inventory as of the date of filing. Scheduled property that the trustee has not administered by the end of the bankruptcy is abandoned to the debtor so you will not lose it, but unlisted property can cause you many problems, including losing it.

After you have the list of personal property, you need to review it and place values on items in the list. This doesn’t mean that each item has to be valued. Some things that would have an individual value below $575 and would be considered household goods can be combined into one category – for example, you could value pots and pans or silverware or your clothing in groups (although you should give some idea of how much is in these groups since details matter here). With property such as furniture, appliances, and clothing, remember that they tend to lose value quickly, and the value to list is the current fair market value, not replacement values. Basically, you look at the price that they reasonably could bring at a garage sale. Since they wouldn’t raise much money, a trustee – who seeks to raise funds to distribute among creditors – is unlikely to go to the expense of, essentially, holding this garage sale.

Personal property of greater value (such as expensive jewelry or artwork) could be worth more than the value that you can exempt. Property in these categories might be sold during a bankruptcy, which is a consideration before filing but cannot be “forgotten” in Schedule B if you do file. Also, you might want to have these appraised before they’re listed since they are not common, ordinary items like the property mentioned in the preceding paragraph.

A few other categories of personal property merit some mention here. One consists of your financial account, including checking accounts. The value as of the date of filing is needed. If you have written checks that have not been cashed yet, this is not a problem. You simply would exempt the higher value. However, never add funds after the account is valued on the date of filing because you don’t want to list a value that is too low on Schedule B.

Additionally, intangible personal property must appear on the schedule. You need to pay attention to detail in your description of this type of property because valuation often is difficult. As an example, if you have a cause of action against someone and seek a monetary award, the value to include is not the amount that you are seeking because you may not receive this. You have to adjust the value based on the odds that you will win and be awarded that amount – in law, there is no such thing as a sure thing. Beyond this reality is the possibility that, while you may be awarded monetary damages, you could have trouble collecting the judgment. The value in Schedule B should be reduced to reflect such reasonable possibilities. If the value is too hard to estimate with any accuracy, you might list it as “unknown” while providing an accurate description so that you can attempt to exempt it while the trustee has an opportunity to try to place a value on it.

The last category, for now, consists of property that is not part of the bankruptcy estate, which only includes non-exempted items and is under the control of the trustee. Because Schedule B requires the inclusion of all your personal property, everything appears in it. A common example is an interest in an ERISA-qualified pension. Generally, this is not part of the bankruptcy estate, but, if you take this position, you should include a reference to a statute that protects it in the schedule. Meanwhile, just in case the trustee doesn’t agree with your interpretation, you could claim an exemption in Schedule C “in the alternative” for additional protection.

With all personal property in Schedule B, you want to be as thorough and accurate as possible with descriptions and valuations. You don’t want to face the possible loss of property because you neglected to list it, and you also want to exempt as much of the listed value from the bankruptcy estate so that the property can remain yours after the bankruptcy has ended.

Credit Card Debt & the Statute of Limitations

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When a person owes credit card debts, but the amount to be paid has grown to a level that the person realistically cannot repay, the individual may experience overwhelming anxiety about what a creditor or debt collector might do. If you are in this situation, you cannot let anxiety keep you from looking at possible options. For example, with debt collectors purchasing older debts for pennies on the dollar, you have to view the possibilities with the credit card debt’s age in mind because you might be inclined to file for bankruptcy when the defense provided by the statute of limitations could be a better solution under the circumstances.

A statute of limitations exists for most civil and criminal matters in order to provide finality and to ensure that this will occur when evidence remains reasonably fresh. In Pennsylvania, credit card debt generally stems from an open-end, or revolving, account based on a written contract. This places the statute of limitations for such debt at 4 years. This means that, if you have not used a credit card during the last 4 years, you could use the limitations period as a perfect defense against an attempt by a creditor or debt collector to obtain and enforce a judgment against you.

You have to be careful, however. If you discuss the debt with a debt collector, for example, you must avoid reaffirming that you owe the debt, entering into a new payment arrangement, or – especially – making a payment on the credit card debt because you do not want to act in a way that actually starts the statute of limitations over again. The defense cannot protect you for at least another 4 years.

For this reason, you want to avoid talking with anyone attempting to collect an old debt. You do not want to do anything that would be seen as an acknowledgment by you that you owe the debt. You always should bear in mind that you do not have to speak with a creditor or debt collector, which is the safest course of action to take.

You could have an attorney speak or write on your behalf not to make a deal but to deal with the issue of the statute of limitations. A letter also can be written which communicates that you are not to be contacted and that doing so could result in a penalty being paid by a debt collector to you under the Federal Fair Debt Collection Practices Act. Pennsylvania has a similar law – the Fair Credit Extension Uniformity Act – that applies to creditors as well. It describes unfair and deceptive debt collection practices and sets forth the penalties that can be enforced against those engaging in these practices.

These and other laws provide some protection against harassment by creditors and debt collectors. However, even after the statute of limitations has run out your credit card debt, the debt still exists. You may find yourself receiving notice of a lawsuit to obtain a judgment for this debt. This is when you need to know what to do – after you have been served with the required notice, you probably should consult with an attorney to make sure that you are protected and, possibly, to pursue a claim for damages under the various laws that apply.

When this situation occurs, you no longer are safe if you do nothing. Because you owe the credit card debt, you will face a default judgment if you do not answer the other party’s complaint. You could lose things that you own when such a judgment is enforced. Also, judgments have a 5-year statute of limitations but can be revived before this period ends, potentially resulting in a long string of 5-year periods when you may face enforcement of the judgment.

However, instead of doing nothing, you need to have an answer to the complaint filed on your behalf in which the statute of limitations that applies to credit card debt is raised as a defense. As long as it applies and is raised in a timely manner after you receive the complaint, you have a perfect defense against the creditor or debt collector because, although the credit card debt exists, the other side waited too long to enforce the right to a judgment for that debt. This is the power of the statute of limitations.

I had mentioned bankruptcy earlier. Your factual circumstances will dictate whether or not it should be considered. When faced only with an unsecured debt, such as most credit card debts, that can be defended by the appropriate statute of limitations, you probably would want to delay taking the more drastic action of filing for bankruptcy. You do not want to file now because you have a perfect defense against the creditor or debt collector at this time. Also, you may need to pursue a bankruptcy in the future but could be prevented from doing so if you file when you would not gain more relief through bankruptcy.

In addition, you need to consider the statute of limitations regarding credit reports. The credit card debt can be reported for 7 years, even though it technically can be collected only for 4 years. Even so, a bankruptcy can remain on your credit reports for ten years after you file. This means that you should be able to clean up your credit reports sooner in this scenario by relying on the 4-year statute of limitations applicable to your credit card debt.

Of course, this is a brief look at some options that you have in handling your debts. Different situations will point to different courses of action. The defense provided by the statute of limitations may be the best solution when people attempt to collect credit card debt from you. To review and understand what you can do, you should contact an attorney when problems with debt need to be resolved.

Income Tax: Priority Debt in Bankruptcy?

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The general rule for income taxes owed to federal, state, and local governments is that they will not be discharged in a Chapter 7 bankruptcy – you will owe them after your bankruptcy ends because they often are classified as priority debts. However, as with all generalizations, there are exceptions. We will look at both the general rule regarding priority debts as well as some exceptions. Also, the way that these taxes are handled in Chapter 13 bankruptcies will be mentioned briefly.

The first point to remember is that we aren’t looking at taxes for which a lien exists. For example, if the IRS files a federal tax lien against you for income taxes that you did not pay, there are no exceptions because this makes the tax debt into a secured debt that must be paid.

When there is no lien, any income taxes that you owe are unsecured debts. While the general rule with unsecured debts is that they are dischargeable in Chapter 7 bankruptcies, general rules – while not made to be broken – do bend at times under our laws. There are a number of unsecured debts that have been classified as priority unsecured debts. These must be paid prior to other claims, which is why they are termed “priority debts.” Although the nondischargeability makes them look like secured debts, this category of debts has no collateral protecting the creditor. However, their payment is considered more important than most unsecured debts, which is why this category exists.

Income tax debts – when not secured by liens – belong to this select group of unsecured debts given priority in bankruptcy. I had mentioned that income taxes generally are not discharged but need to explain when they are given priority. First, taxes on income for a year that ends no later than the date that you file your bankruptcy petition “for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition” are given priority. When these words from the Bankruptcy Code read very carefully, they basically mean that, if you fail to file a tax return that was due within three years before you filed for bankruptcy, you face a priority debt for any taxes that you owe for that tax return.

A second factor also can create a priority debt. The tax liability must have been assessed by the government within 240 days of your bankruptcy filing. When an “assessment” is made is defined by federal and state laws, but this date is when the amount of taxes that you owe has been determined by the government. In addition, if an offer in compromise existed or was pending during the 240 days, then the length of time that the offer existed is added to this period, along with an additional 30 days. In addition, there also are times when a bankruptcy previously filed during this time frame can extend the period for filing a new bankruptcy beyond the 240 days.

A third way that income tax debts can become priority unsecured claims is when you don’t file a tax return when it was due, which usually is April 15th of the following year for individuals. If the tax return was not filed, you cannot get the tax debt discharged in a Chapter 7 bankruptcy. You also can’t get the debt discharged if you failed to file the return when it was due and only filed it fewer than two years before filing for bankruptcy. In addition, if you filed a false return or simply attempted to evade paying your taxes, then you have created a priority debt. Income taxes that are assessable after a bankruptcy is filed will remain after the bankruptcy ends, as well.

As for interest and penalties on any income tax debts, you should expect these to be nondischargeable, too. On occasion, a tax penalty might be discharged if it is found to be punitive, which basically means that the penalty is so excessive to be a punishment instead of reflecting the cost of investigating and the loss based on what you did (or didn’t do), for example.

Although this is a somewhat simplified version regarding how income tax debt becomes a priority debt, some exceptions that will allow these debts to be discharged need to be noted. An income tax debt that is more than three years old with a return filed when it was due can be discharged. Another exception is when a return was filed late but was filed more than two years before the bankruptcy was filed – this debt may be dischargeable. In addition, any assessment of your tax liability by any of the taxing authorities (federal, state, or local) that occurred more than 240 days before you filed for bankruptcy can lead to a discharge of the tax debt. As mentioned earlier, older income tax debts are much less likely to be classified as priority debts.

Income tax debt also has implications in Chapter 13 bankruptcies. To summarize Chapter 13’s treatment of income tax debts, a lien again creates a secured debt, and this must be paid. Without the lien, an income tax debt can become a priority debt when it falls within the criteria outlined for a Chapter 7 filing. Although interest could be dischargeable, it is likely to remain when the tax debt has priority status. Likewise, penalties on these debts are nondischargeable to the same extent as they would be with Chapter 7. Therefore, your Chapter 13 plan would have to account for making payment of these debts.

Finally, it should be remembered that, when only one spouse owes the tax debt, a married couple’s property owned by the entireties is protected in a bankruptcy. In addition, this applies to the property of a spouse who does not owe taxes and is not part of the bankruptcy filing. And there is a last word of caution that anyone with income tax debts needs to remember: you can’t get around the priority nature of income tax debts by paying them with credit cards or other types of debt instruments – your new debt will be nondischargeable, even though your tax debt is gone.

As this brief look at priority debts that involve income taxes owed to federal, state, or municipal governments illustrates, this can be a difficult area of the law to navigate successfully. Of course, the same can be said of bankruptcy in general. This is why, if you are thinking of filing for bankruptcy, you also should think of discussing the possibility with someone who has experience helping individuals through this process. You do not want to get yourself into a situation that might do you more harm than good in the end.

Chapter 7 Bankruptcy and the Means Test

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When the Bankruptcy Code is changed in 2005, the idea that this would force people to file under Chapter 13, which requires a plan to repay as much of your debt as possible, instead of using Chapter 7 to get a “fresh start” by discharging most debts and allowing you to keep most (if not all) of your possessions was a commonly held belief. The new law did have a bias against Chapter 7 bankruptcies, but the reality is that most people still can file under the chapter that gives them their best options.

The means test, which can be used to force you pursue a Chapter 13 bankruptcy, has “safe harbors” that protects the average filer’s choice of which bankruptcy to pursue. For this reason, you need some understanding of this test and when the safe harbor based on income will allow you to consider a range of possibilities, including those under the Bankruptcy Code if necessary, to handle your financial struggles.

Due to the formula involved, we will take a greatly simplified journey through the means test. Its starting point is “current monthly income,” which actually looks at the average income from the previous six months to find a monthly average. Also, the focus is on income from all sources used to pay household expenses of the debtor and the debtor’s dependents on a regular basis during this period. The bankruptcy law provides for various deductions from the total and also excludes some sources of funds from being counted. The most prominent of these would be any benefit received under the Social Security Act. However, not everything paid under this Act is not counted necessarily – for example, the Advisory Committee on Bankruptcy Rules did not include Unemployment Compensation as being excluded. Also, we will see some other sources that are omitted due to the use of data regarding income from the Census Bureau.

“Current monthly income” must be calculated, after which it is multiplied by 12 to turn it into a yearly amount. The new total then can be compared to the median income in your state; the median income is the amount at which half of the households fall below it while the other half will be above it. As mentioned previously, the source of this data is the Census Bureau. For this reason, we have to be aware of various items that it leaves out of its income calculations, including Food Stamps, public-housing benefits, and lump-sum inheritances, so that the comparison is based on the same information. Meanwhile, in addition to income, your household size is important for establishing the median income level, as reported by the Census Bureau, that you would use for the means test. Unfortunately, this is another case in which the bankruptcy law does not provide clear guidance, which has made the definition of the size of any particular household an issue of contention at times.

However, despite the problems with ambiguity with the additions to the bankruptcy law in 2005, the means test eventually does produce an income figure to be compared to the median income borrowed from the Census Bureau. As of May 1, 2014, in Pennsylvania, the median income for a one-person household has been $47,809 while, for a household of two, this rises to $56,690. It continues to increase as the household size increases. The issue now becomes what all of this means to you.

Essentially, it means that the means test will be meaningless to you as long as your household income falls below the median level for a household of the same size in Pennsylvania (or the level for whatever state you live in). You would be in one of the safe harbors that Congress built into the means test. In turn, this means that the “presumption of abuse” (which focuses on a debtor’s ability to repay creditors) does not apply to you so that, if you decide to file for bankruptcy, you should be able to choose the chapter that would be most beneficial in meeting your goals for filing.

Most people who pursue a bankruptcy tend to be under the median income figure that applies to them, which means that the means test that can seem so intimidating due to its complexities actually has no effect on them. For those above the median income, the test will have implications, which can be explored at another time. What matters here is that you generally will not have to worry about the means test with its presumption of abuse preventing you from considering all of your options, including a possible Chapter 7 bankruptcy as a last resort, as you begin rebuilding your financial world.