Wednesday, January 22, 2014

Can a Mortgage Prevent you from Filing for Bankruptcy?

Individual bankruptcies, typically Chapter 7 or Chapter 13, are limited in certain ways.  For instance, Chapter 7 bankruptcy has income limitations, while Chapter 13 bankruptcy has debt limitations.   Below we will explain how your mortgage could disqualify you from filing Chapter 13 bankruptcy under the debt limitations.

A mortgage is a legal instrument typically securing a debt against real property, such as your residence. In our current real estate market, many homes are underwater. Not in the literal sense.  Figuratively, when a home is described as "underwater" it refers to the mortgages on said home having a value greater than the current fair market value of the home.

When filing a Chapter 13 bankruptcy, a wholly unsecured second mortgage or even the unsecured portion of an under-secured first mortgage should be listed as unsecured debt. Depending on other circumstances you may or not be able to discharge this "unsecured" debt, however that doesn't change the fact that the Court will consider it unsecured.

Why does this matter?

When filing a Chapter 13 bankruptcy, there are debt limits defined by 11 U.S.C. §§ 109(e). Said debt limits were recently raised, effective April 1, 2010. Under the current limits, a Chapter 13 bankruptcy will be dismissed if the debtor has unsecured debt greater than $336,900 and/or secured debt greater than $1,010,650. As of April 1, 2010, those figures rose to $360,475 and $1,081,400 respectively.

Consider the following scenario:
A debtor owns a $600,000 home but has $900,000 in mortgages. The debtor has a car with a lien of $20,000 (secured debt) and credit card (unsecured debt) of $100,000.

If the entire mortgage debt was considered secured then the debtor would be under the debt limits with a total secured debt of $920,000 and a total unsecured debt of $100,000. Unfortunately, because the Court considers the $300,000 of "underwater" mortgages unsecured, the debtor has a total unsecured debt of $400,000, which is above the debt limits. This debtor would, therefore, be ineligible to file for relief under Chapter 13 and be forced to seek other relief (possibly filing for bankruptcy under Chapter 7 or Chapter 11).

This is the exact scenario articulated by a California Court in an unpublished decision: In re Estrada.

Estrada refers to a Ninth Circuit decision: In re Scovis, 249 F.3d 975, 982 (9 th Cir. 2001). In Scovis, the Court stated that a "vast majority of courts, and all circuit courts that have considered the issue, have held that the unsecured portion of undersecured debt is counted as unsecured for 13 § 109(e) eligibility purposes."

It appears that this is also the law in Massachusetts. In re Marrama, 345 B.R. 458, 472 n.23 (Bkrtcy.D.Mass. 2006) In Marrama the court referenced Scovis and noted that the debtors failed to list the unseured portion of an undersecured mortgage as unsecured debt, which would have resulted in a greater unsecured debt.

Tuesday, January 14, 2014

Don't borrow from Peter to pay Paul, especially if you're planning to file for Bankruptcy!

Borrowing money leading up to a bankruptcy can cause multiple problems.

First, the debt for those funds could be non-dischargeable, meaning you will still owe it after the bankruptcy.  An example of how this could arise, was described in a previous post: Should I Pay My Student Loan with a Credit Card?  Debts such as student loans, certain judgments for personal injury resulting from gross negligence and or drunk driving and debts obtained by fraud cannot be discharged under the bankruptcy code.  If you borrow from another source, such as a credit card, to pay that loan then the new debt will be non-disagreeableness because the funds were obtained with the intention of filing bankruptcy and furthermore, the new loan can be treated the same as the original debt.

This means that even if the credit card company doesn't object to the discharge, they still might be able to pursue you after the discharge, just like a student loan company could (although best practice for the credit card company would be to object prior to the discharge).

Second, if you used these borrowed funds to pay another debt, those funds might be subject to taking by the bankruptcy court as a preference (a debt paid to the disadvantage of other creditors).  If that debt was a non-dischargeable debt, then you may still end up owing that debt after the bankruptcy, and the trustee could use those funds to pay other debts.

Third, and even worse, if the bankruptcy court found that you were attempting to commit a fraud upon the Court by moving this debt, the Court could deny your discharge altogether.

Finally, you could even be subject to criminal liability if the borrowing is determined to be a fraud, meaning you never intended to pay it back.  Fraud is a state crime and bankruptcy fraud is a federal crime.  

Thursday, January 2, 2014

What is the difference between Chapter 7 and Chapter 13 bankruptcy?

Generally speaking, a Chapter 7 Bankruptcy involves a total liquidation of the debtor’s assets (although the debtor may keep certain allowable exempt assets), and any non-exempt assets are used to satisfy the debtor’s unpaid debts.  Any remaining dischargeable debts are discharged, meaning they are no longer owed.  A Chapter 7 case places no limits on the amount of debt that may be discharged; however, there are income qualifications in order to be eligible for Chapter 7 as a result of the 2005 changes to the Bankruptcy law.

A Chapter 13 case places no income restrictions on the debtor, so if you cannot file Chapter 7 because you do not pass the means test, you can likely file Chapter 13.  Chapter 13 begins much like a Chapter 7 case, but after the liquidation of non-exempt assets, if any, the debtor will pay a certain amount based on his available income and after deduction of living expenses to the U.S. Trustee, who will distribute payment to creditors on a pro-rata basis.  The debtor will make monthly payments for 3-5 years, depending on certain factors, and then, as long as the debtor makes payments every month, the remaining unpaid portion of most debts will be discharged (though some debts, such as student loans may still be owed even after completion of the plan).

Chapter 13 has the benefit of permitting the debtor to spread out the repayment of certain debts over a 3-5 year period that would be otherwise non-dischargeable, such as tax debt, or student loans.  Additionally, the debtor could use Chapter 13 to avoid foreclosure and pay back mortgage arrearages over the term of the plan, which is helpful in cases where the lender is demanding a high “cure” amount to voluntarily get a house out of foreclosure.

Related Posts Plugin for WordPress, Blogger...