Southern California Law Advocates | Bankruptcy Firm
SCLA was founded to promote and emphasize an attorney-client relationship that is built on trust and communication. The founding attorney, Norma Duenas, previously worked for one of the largest consumer bankruptcy law firms in the country.
Preventing or Defending a Preference Challenge by the Bankruptcy Trustee
Dealing with a trustee's preference challenge can be one of the more frustrating aspects of your bankruptcy case. Most cases don'tinvolve preferences, partly because they can be easy to avoid, defend, or negotiate around. But you need to understand preferences so you and your lawyer
can avoid or otherwise deal with them.
Preference law is complicated. The section of the U.S. Bankruptcy Code titled "Preferences" (Section 547) has about 1,300 words within about 55 subsections. The
history of preference law goes back nearly 450 years in English law, adopted in the U.S. more than 175 years ago and revised many times since then. There's a lot to this area of bankruptcy law.
WHAT'S A PREFERENCE?
A preference, or preferential payment, is money you pay or property you give to one creditor within a certain amount of time before filing bankruptcy that you pay or give in preference to your other creditors. Under certain conditions that one creditor could be forced to repay that money or return that property to your bankruptcy trustee. The preference payment is essentially undone, or "avoided." If that one creditor you paid was a relative or friend, or someone else you really wanted paid, you'd likely want to avoid that result.
More specifically, preference law only kicks in if a creditor takes or receives money from you within the 90 days before you file your bankruptcy case. However, this lookback period is a full year before filing if the creditor is an "insider." That includes most relatives, friends, and pretty anybody else you'd have a reason to favor.
("Insider" is partially defined in the Bankruptcy Code at
Section 101(31). But this definition is only partial because it's "inclusive"—it lists types of creditors who are included as insiders but that list doesn't include some other possible ones. For example this definition says what
relatives are insiders but doesn't talk about
other personal relationships such as close friends. So the courts have had to flesh out this question of "non-statutory insiders." Within a few weeks I'll have a separate blog post here on what the local courts have said about this.)
SO ANY MONEY YOU PAY A CREDITOR WITHIN 90 DAYS/ONE YEAR IS A PREFERENCE?
No, it's a lot more involved than that. There are 5 elements that have to be met, and there are a number of significant exceptions. Here today I'll just list the 5 elements as they are stated in the statute, and then get into some of the main exceptions or defenses that apply to consumer bankruptcy cases.
The five elements are laid out at Section 547(b) of the Bankruptcy Code:
the trustee may avoid any transfer of an interest of the debtor in property—
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(A) on or within 90 days before the date of the filing of the petition; or
(B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and
(5) that enables such creditor to receive more than such creditor would receive if—
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the extent provided by the provisions of this title.
IS THERE A WAY TO AVOID A PREFERENCE ALTOGETHER?
First, as you can surmise from this list of statutory elements, your pre-petition payment may not be preferential even though at first you may think it is. You may not meet all five elements. Talk with an experienced bankruptcy lawyer to find out if you really have reason to be concerned.
Second, the 90-day/1-year element is a strict one, so it gives you a relatively easy out in many situations. If you've made a preferential payment or transfer that you care about within the pertinent time period, you could simply wait to file until enough time has passed since the payment or transfer. That would avoid the problem altogether.
Of course there are situations when the threat of creditor actions against you or your property you can't or shouldn't hold off filing.
SO HOW DO I DEFEND A PREFERENCE IF NECESSARY?
First, there are situations you may not need to defend a trustee's assertion of a preference.
The preference challenge by the trustee is not actually against you but rather against the person you paid. Sometimes you would do nothing and just let your payee deal with it. (More about this towards the end of this blog post.)
There's a statutory exception for payments/transfers of less than $600 in consumer bankruptcy cases (and less than $6,425 in business cases). See Subsections 547(c)(8) and (9).
For practical reasons bankruptcy trustees often don't pursue preference payments/transfers in consumer cases that are somewhat larger than $600 if there are no other assets at issue. This depends on the case and the tendencies of your local trustees so talk with your lawyer about this.
Some payees are uncollectible or not worth the cost and effort to try to collect against them. The person you paid may have no income or assets that the trustee can legally reach. Or finding or pursuing the person may be too risky. The trustee won't want to pay his or her lawyer to pursue a preferential payment if doing so would be fruitless.
BUT WHAT CAN I DO IF THE TRUSTEE IS REALLY GOING TO PURSUE A PREFERENCE?
There's a defense to a preference in the bankruptcy statute that states that the "trustee may not avoid . . . a transfer" "to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor." Subsection 547(c)(4). What this means is if you paid a friend or relative or other creditor back within the 90-day/1-year period before filing, but that creditor subsequently paid you
back that same amount, that new payment would be "new value" that would prevent the trustee from pursuing the amount you had paid. In effect this payment to you of this "new value" would undo your preferential payment.
This assumes that you have a friendly friend/relative/creditor who is willing and able to pay you back that payment to avoid having it go to the trustee. Plus the timing of this "new value" payment to you can be very important, along with what you do with the money so received. So this is definitely something you want to plan carefully with your bankruptcy lawyer.
CAN I PAY OFF THE TRUSTEE MYSELF TO SETTLE A PREFERENCE?
What if you clearly have a preferential payment that your Chapter 7 trustee is trying to "avoid"—make your creditor repay? What if you just can't let that happen, and your friendly creditor did not have the means to pay you the money back to create a "new value" defense as just outlined? If YOU have the means yourself to pay that same amount to the trustee, doing so may be a practical solution.
The trustee will usually not care where that money comes from—from the creditor you paid or from you. So you could offer to pay that that sum of money yourself. The trustee may even accept that in monthly payments from you. You may be able to pay less than the full preference payment amount, subtracting what it would have cost in attorney fees and other costs for him or her to get it from your relative. For example, if the preference amount is $3,000, you could offer to pay $2,500, maybe being allowed to pay 10 payments of $250.
HOW CAN CHAPTER 13 HELP RESOLVE A PREFERENCE?
What if you filed a Chapter 13 "adjustment of debts" case instead of a Chapter 7 one?
You may well do so for reasons nothing to do with the preference situation. Or if you're on the edge in deciding between one or the other, having a preference problem could push you in favor of Chapter 13 if there isn't any other good solution.
That's because Chapter 13 could be a good tool for paying the trustee the preference amount (or a reduced amount as described above) through your Chapter 13 payment plan. The advantages include:
avoiding the whims of a Chapter 7 trustee, such as whether he or she would accept payments from you and how quickly you'd have to pay the preference amount
more time to pay the preference amount through a Chapter 13 plan
much more flexibility in paying the preference amount while paying other important continuing debts like recent income taxes or home mortgage arrearage
WHEN SHOULD I JUST LET THE TRUSTEE CHASE THE PERSON I PAID?
All of this assumes that the person you paid before filing bankruptcy is one you want to protect. There certainly are situations you wouldn't try to protect him or her.
Your relationship with the person may not be that good. You may not care if the trustee would force that person to give back what you paid. Your relationship with the person may have deteriorated so much in the meantime that you now don't mind if your trustee now pursues repayment from that person.
Or your relationship with the person you paid pre-bankruptcy may be very good. If so, he or she may not mind so much paying back the payment to the trustee. (This assumes you did not already receive the same amount as "new value" before you file bankruptcy, as described above.) This especially makes sense if he or she can easily afford it. IF you want, you might even informally volunteer to later pay to him or her back the preference amount (a second time). Note that this would be completely voluntary on your part because very likely any debt you'd owe to the person would be legally discharged in your bankruptcy case.
BE HONEST AND THOROUGH WITH YOUR LAWYER
Maybe the most important thing to remember about this complicated area is that it's a great example why you need to be completely honest and thorough with your lawyer. He or she will ask you questions about recent payments you've made to anybody. You need to respond candidly and in detail.
Bankruptcy is stressful, so if you're not careful you might not be thinking clearly when you talk with your lawyer. You might consider a friend or relative not to be a "creditor" and so figure that payments to them don't count. You may genuinely forget about dealings with special people like that when you're asked about prior payments to creditors. Or you may try to sweep stuff like that under the rug. You might figure that if you don't tell your lawyer then nobody will find out.
All this can backfire. As you've seen here there are ways to prevent and defend a preference challenge. There may be other tactics that apply to you not covered here. Your lawyer is your advocate. It's his or her job to protect you and your interests, to find the very best path for you. Almost certainly a worse result would come from having you and your lawyer blindsided in the middle of your case by something you didn't tell him or her. Avoid that by just telling the truth and the whole truth.
A couple months ago we dug into this question, and why it matters. See "Avoiding the Means Test If Your Student Loans are Non-Consumer Debts." It matters because skipping the means test may allow you to file a Chapter 7 "straight bankruptcy" case instead of a 3-to-5-year Chapter 13 "adjustment of debts" one. A Chapter 7 case is not only much shorter; you usually pay much less to your creditors.
You skip the means test—an income and expenses test—and are more easily able to file a Chapter 7 case, if you have more non-consumer debts than consumer debts. Then you do not have "primarily consumer debt." So if all or most of your student loans can be considered non-consumer debts, and those are larger than your consumer debts, you can likely file a Chapter 7 case when otherwise you could not have.
The above earlier blog post focused on the law locally on this question, which is inconclusive. There are very few directly binding court opinions, and I discussed the noteworthy ones there. Today I look at pertinent court opinions outside California to see what further guidance they provide. I end up focusing on a couple important opinions in the federal circuit right next door, in the 10th Circuit, specifically from the District of Colorado.
WHAT'S THE BASIC RULE ABOUT WHAT MAKE A NON-CONSUMER DEBT?
The Bankruptcy Code defines "consumer debt" as "debt incurred by an individual primarily for a personal, family, or household purpose." Section 101(8). A non-consumer debt is simply one that was not incurred for any of those purposes.
WHAT DETERMINES WHETHER A STUDENT LOAN WAS INCURRED FOR THESE CONSUMER PURPOSES?
This is the heart of the question.
One phrase that courts have focused on is "profit motive." If the debt was incurred with a profit motive then that would not be a consumer debt but rather a non-consumer one.
The main example of this by a relatively high court is the 10th Circuit Court of Appeals in a 1999 opinion called In re Stewart. (175 F. 3d 796) After citing the above statutory definition of consumer debt, this appeals court said: " 'Consumer debt' is further distinguished from 'non-consumer' debt as a debt incurred with a 'profit motive.' " (175 F. 3d 796, 806.)
WHAT DOES INCURRING A STUDENT LOAN WITH A "PROFIT MOTIVE" MEAN?
Although this 10th Circuit opinion did involve student loans, it did not explain what it meant by "profit motive" for student loans. The court first asserted that at that time no "persuasive authority exists to help us determine the characterization of educational expenses such as books, tuition, and room and board as either consumer or business debt." (175 F. 3d 796, 807.) Then the court did not say anything further about whether or not these "educational expenses" were incurred with a profit motive. That's because under the facts of that case there were so much consumer debts that the court did not need to look any more closely at the student loans.
But a much more recent case from within that same 10th Circuit dug deeply into what the profit motive means with student loans. About a year and a half ago in Palmer v. Laying (559 BR 746, November 2016), the federal district court in Colorado overturned a bankruptcy court by characterizing $91,000 in student loans as non-consumer debts, enabling the debtor to avoid the means test.
The district court said that "the primary purpose for which the debt was incurred must be determinative. . . . [A]t least under the circumstances of this case, . . . non-consumer debts include those [student loans] incurred primarily as a business investment in oneself." (559 BR 746, 750.)
So what were the circumstances of this Colorado case?
First, "all of [the debtor's] student loans were used to pay for tuition and books." (559 BR 746, 749.)
Second, the debtor's "personal goal in taking the doctorate program was to advance his business knowledge and, ultimately, own and run a business." (559 BR 746, 755.) "If wanting to own a business is not profit related, the Court does not know what is, at least where, as here, [the debtor] had an actual business and opportunity in mind . . . ." (559 BR 746, 756.)
Third, "the courses [debtor] took helped him understand how to attract customers to a business, build relationships with them, and, importantly, run a profitable business. . . . . No more was required for [debtor] to show that the student loan debt was incurred with a profit motive." (559 BR 746, 756.)
DOES THE PROFIT MOTIVE NEED TO BE THIS CLOSELY RELATED TO RUNNING A BUSINESS?
Not necessarily. The primary principle laid down in this Colorado case is that "non-consumer debts include those [student loans] incurred primarily as a business investment in oneself." (559 BR 746, 750, emphasis added.) This court makes clear that the facts there made for an easy decision. But the court also stated some principles that signal that the profit motive could well be much, much broader.
In rejecting the bankruptcy court's rationales for considering the student loans to be consumer debt, the district court determined the following:
1. The debtor does not need to "demonstrate a tangible benefit to an existing business." That would "[flip] the inquiry and places the focus upon the benefit to (or investment in) the employer [instead of the debtor]. This is not the focus of the profit motive test." (559 BR 746, 751.)
2. The debtor does not need to "show some requirement for advancement or greater compensation in a
current job or organization. . . . [T]here is . . . no suggestion in [the 10th Circuit
Stewart case cited above] that a debtor must have incurred student debt or pursued education while being
currently employed." (559 BR 746, 751.)
3. The education received by the debtor does not need to be required by an employer. This would "[remove] any semblance of employee initiative from the decision to seek further education." (559 BR 746, 751.)
4. The profit motive should not "be interpreted narrowly because it is 'in keeping with the intent of the changes made to the [Bankruptcy] Code in 2005,' specifically the 'means test' . . . . [T]he weeding out of undeserving debtors is done by the "means test," not in deciding whether a debtor has "primarily consumer debts." (559 BR 746, 752.)
5. The profit motive should also not be narrowly construed because there is
no presumption that student loans are consumer loans. The profit motive is not an exception to that presumption. Instead "it is a way of differentiating between consumer and non-consumer debt." (559 BR 746, 753.)
6. The profit motive should also not be narrowly construed because it would "be 'problematic' to determine which facts equated to a business investment rather than a personal investment. . . . . [T]his Court does not see why such inquiries would be any more problematic than in any other context where a court must inquire into the purpose of incurring a debt." (559 BR 746, 753.)
7. "[P]rofit motive does not mean profit realized. Motive necessarily looks to the reasons behind a course of action, it does not suggest that the course of action need come to fruition. Thus, provided that a debtor can show that he or she took steps to realize the potential of his or her education, there is no reason why such evidence would not show that the debtor had a profit motive in incurring his or her student debt." (559 BR 746, 754.)
IS THIS COLORADO FEDERAL DISTRICT COURT OPINION RELEVANT TO US IN CALIFORNIA?
Yes, although this Palmer v. Laying court opinion is not directly binding on the local bankruptcy courts, it could have a positive effect in at least two ways.
First, in questions of law without direct local precedent, well-reasoned court opinions on that question in other jurisdictions have persuasive value. This is especially true if the opinion is an appellate one, as is Palmer v. Laying, not just a trial-level bankruptcy court opinion. It may also be helpful that this case arose in the federal circuit geographically adjoining our 9th Circuit, and is quite recent. More importantly, the analysis in
Palmer v. Laying is extensive and compelling.
Second, this federal district court in Colorado overturned the bankruptcy court opinion which had provided essentially the entire legal foundation for a California bankruptcy court's very unfavorable opinion for debtors with student loans. In my last blog post I referred to a published opinion from February 2016 by a bankruptcy judge in Sacramento,
In re Ferreira, 549 B.R. 232 (E.D. Calif.). That Sacramento judge's opinion relied very heavily on the Colorado bankruptcy court's opinion,
In re Palmer, 542 B.R. 289 (Bankr.D.Colo. 2015), that was so emphatically rejected and overturned on appeal to the federal district court in
Palmer v. Laying a few months later. Although
In re Ferreira was never binding on bankruptcy courts in Southern California, it was quite unhelpful to have another 9th Circuit bankruptcy court, much less one in California, adopting such an extremely narrow interpretation of the profit motive for student loans. Having the foundation of
In re Ferreira torn out from under it and supplanted by the infinitely friendlier, though also unbinding,
Palmer v. Laying opinion can only help.
This is an evolving area of bankruptcy law, one that may make a tremendous difference for you if you have substantial student loan debts. So it is worth looking closely at what courts are saying outside our 9th Circuit. This is particularly true when, as here, what they are saying supports our pro-debtor arguments and undercuts an adverse opinion within our Circuit.
WHY DOES IT MATTER WHETHER OR NOT STUDENT LOANS ARE CONSIDERED CONSUMER DEBTS?
Whether your student loans are considered consumer debts may determine whether you can file a Chapter 7 "straight bankruptcy" case. If you have a lot of student loans, and if they can be classified as non-consumer debts, then you may qualify for Chapter 7 when otherwise you could not have.
Why would that matter? If you wouldn't qualify for Chapter 7 your other alternative would be filing a Chapter 13 "adjustment of debts" case, which requires you to pay all you can afford to your creditors during a 3 to 5 year period. Instead, under Chapter 7 you could discharge—legally, permanently write off—your other debts within about 4 months and then be able to focus on paying your student loans. Or you could then deal with your student loans in other ways (such as through an income-driven repayment plan).
WHY MAY I NOT BE ABLE TO FILE A CHAPTER 7 CASE?
You have to financially qualify to go through a Chapter 7 case. You have to pass the "means test." If you don't pass you would likely instead have to go through a lengthy Chapter 13 case.
The "means test" involves as many as three steps. The first step compares your current income (focusing on your last 6 months of income) with the median income of people of your family size in your state. If your income is too high, the second step involves subtracting a set of allowed expenses from your income to see whether that leaves you with too much disposable income. If so, there's a final rare possibility that you qualify by showing "special circumstances." See Section 707(b) of the U.S. Bankruptcy Code.
If you don't qualify under the "means test" your Chapter 7 case would be "dismissed"—thrown out—or changed into a Chapter 13 case.
WHAT'S WRONG WITH FILING A CHAPTER 13 CASE INSTEAD OF A CHAPTER 7 ONE?
Chapter 13 does have significant advantages in the right circumstances. But it usually takes 3 to 5 years, instead of the 3 to 4
months that a consumer Chapter 7 case takes. So if you don't have special debts or other circumstances requiring a Chapter 13 case, Chapter 7 can be much, much better.
This can be particularly true if you have student loans that you want to deal with after discharging your other debts. Under Chapter 13 you have to pay your "general unsecured" debts as much as you can afford to during the 3-to-5-year "applicable commitment period." (The length of the "applicable commitment period" depends on your current monthly income.) So instead of being able to just quickly discharge non-student loan debts in a Chapter 7 case, under Chapter 13 you have to pay these as much as you can for years.
Also, under Chapter 13 your student loans are paid a pro rata share along with the other unsecured creditors. You do have the advantage that throughout the 3-to-5-year period the student loan creditors can't take collection action against you. But you also can't favor them. As a result, by the time you get out of the Chapter 13 case all your student loans are in deep default. By then you likely have lost opportunities to deal with your loan through income-driven payment plans and other relatively favorable ways.
HOW CAN CLASSIFYING STUDENT LOANS AS NON-CONSUMER DEBTS ALLOW ME TO GO THROUGH A CHAPTER 7 CASE?
You may avoid the "means test" and otherwise qualify for Chapter 7. You don't have to pass the "means test" if your debts are not "primarily consumer debts." The relevant statute says that
the [bankruptcy] court . . . may dismiss a case filed by an individual debtor under [Chapter 7] whose debts are primarily consumer debts, or, with the debtor's consent, convert such a case to a case under chapter 11 or 13 of this title, if it finds that the granting of relief would be an abuse of the provisions of this chapter.
Section 707(b)(1) of the Bankruptcy Code, with bold added. In other words, if your debts are "primarily consumer debts" then you have to pass the "means test" or else you are in "abuse" of the law and your case will be dismissed or converted to Chapter 13.
But if your debts are NOT "primarily consumer debts" then you don't have to take and pass the "means test."
WHAT DOES IT TAKE TO NOT HAVE "PRIMARILY CONSUMER DEBTS" AND AVOID THE "MEANS TEST?
First, "consumer debt" is defined in the Bankruptcy Code as "debt incurred by an individual primarily for a personal, family, or household purpose." The big issue is whether or not student loans fit this definition. More on that in a minute.
Second, "primarily" means "more than half." According to the decision that decided this for California (and the rest of the federal Ninth Circuit):
"Primarily" means "for the most part." Webster's Ninth New Collegiate Dictionary 934 (1984). Thus, when "the most part" — i.e., more than half — of the dollar amount owed is consumer debt, the statutory threshold is passed.
So, if all the non-consumer debts are equal to or more than the consumer debts, than the "primarily consumer debts" statutory threshold requiring the "means test" is NOT met. Therefore, if your student loans are not consumer debts, and their balances total more than your consumer debts, you don't have "primarily consumer debts." You don't need to take and pass the "means test" and can still file a Chapter 7 case, quickly discharging all or most of your non-student loan debts so you can then focus on your student loans.
SO IS A STUDENT LOAN A CONSUMER DEBT OR NOT?
Plugging this question into the legal definition, is a student loan a debt incurred "primarily for a personal, family, or household purpose"? Section 101(8) of the Bankruptcy Code.
A good starting point is that student loans aren't necessarily consumer debts. For example a bankruptcy court in Sacramento ruled in 2016 that it "declines to adopt a per se rule that holds all student loans are always consumer debt." The judge rejected the contrary argument that
student loans are or should be per se consumer debt because education is a benefit inherently personal, that is, it is instilled in a person's mind and can never be separated from the person.
In re Ferreira, 549 B.R. 232, 237 (Bankr. Court, E.D. California, 2016). So far so good—student loans aren't necessarily consumer debts; they could be non-consumer ones.
SO WHAT FACTORS DO BANKRUPTCY JUDGES LOOK AT IN DECIDING WHETHER A STUDENT LOAN IS A NON-CONSUMER DEBT?
Let's focus first on court rulings that govern what factors bankruptcy judges in Southern California are required to consider. We are in the 9th Circuit (which covers California and 8 other Western States). Our local bankruptcy judges are bound by what the 9th Circuit Court of Appeals and the 9th Circuit Bankruptcy Appellate Panel decides. The local judges also tend to seriously consider what other bankruptcy judges in the 9th Circuit have said, without being bound by them.
The 9th Circuit Court of Appeals has said that "[w]e must look to the purpose of the debt in determining whether it falls within the statutory definition" of a consumer debt quoted above.
Kelly, 841 F.2d at 913.
What purpose would a debt need to have for it to be considered a non-consumer debt? This same 9th Circuit Court of Appeals opinion held that "[d]ebt incurred for business ventures or other profit-seeking activities is plainly not consumer debt."
Kelly, 841 F.2d at 913.
MUSTA DEBT'S PURPOSE BE PROFIT-SEEKING OR A BUSINESS VENTURE FOR IT TO BE A NON-CONSUMER DEBT?
No, this language does NOT mean that these are the only purposes that would make for a non-consumer debt. Yes, incurring a debt "for business ventures or other profit-seeking activities" would clearly work. But other non-consumer purposes might also. Indeed, a very recent (October 2017) opinion by the 9th Circuit Court of Appeals emphasized that "it is appropriate to consider all the circumstances indicative of the debtor's primary purpose." In particular, while "the profit motive analysis may assist in the determination of which debts are not consumer debt, it does not prohibit other debts from falling outside of the category of consumer debt."
In re Cherrett, (9th Cir., October 16, 2017) (quoting from other court opinions). In other words, a non-consumer debt can have a purpose other than "profit-seeking" or the operation of a business.
As a good example, individual income tax debts are not incurred for business or profit-seeking purposes, yet have been overwhelmingly classified as non-consumer debt. Instead of being "incurred for personal or household purposes, as stated in the statute, . . . taxes are incurred for a public purpose." In re Westberry, 215 F. 3d 589, 591 (6th Cir., 2000)(re the same statutory definition of "consumer debts," although in a different context).
SO WHAT ARE OTHER PERTINENT PURPOSES HAVE COURTS USED THAT MAY APPLY TO STUDENT LOANS?
I don't know of a recent published opinion that the local bankruptcy courts must follow that answers this question. But we do have some guidance.
The 9th Circuit
Cherrett decision of this last October cited above was not specifically about student loans. The court determined that a home loan provided by an employer as part of a new management employee's compensation package was a not a consumer debt. As a result, the debts of the debtor and his wife were not "primarily consumer debts" and they could proceed with their Chapter 7 case without being dismissed or forced into a Chapter 13 case.
The language that the 9th Circuit Court of Appeals used in
Cherrett could be applied to student loans. The "court found that Cherrett primarily had a business purpose—not a personal, family, or household purpose—for incurring the Housing Loan." He accepted the new employer's "offer and the Housing Loan so that he could 'grow in salary and responsibility' and have the opportunity to oversee expansion of the . . . brand."
Accordingly, if a student loan is incurred in order to increase income and work opportunities, Cherrett arguably provides some helpful authority.
IS ALL OF THIS CHERRETT 9TH CIRCUIT OPINION ENTIRELY SUPPORTIVE?
No, because there is also language in this opinion that could cut in the opposite direction with student loans:
This is not the ordinary situation where a person takes out a loan to move closer to a job for convenience or better schools, for example. This is the unusual situation where a person accepts a loan from his employer as part of a larger transaction to further his career. . . . [T]he the Housing Loan and the annual bonus were part of Cherrett's negotiated compensation package, undertaken for a business purpose connected to furthering his career, rather than a personal, family, or household expense.
Yes, student loans are often taken out to "further [one's] career. But it's a stretch to say that just about any conventional student loan would have a purpose anywhere as closely tied to a direct business or profit-seeking motive as in the facts of the Cherrett case.
IS THERE OTHER POTENTIALLY BINDING JUDICIAL AUTHORITY ON THIS?
It's worth noting that the Cherrett Chapter 7 case was filed here in the federal Central District of Calfiornia (the greater Los Angeles area). After the local bankruptcy judge ruled in favor of the Cherretts against the creditor/former employer, it filed an appeal at the Bankruptcy Appellate Panel. The creditor/former employer lost again, and so appealed once more to the 9th Circuit Court of Appeals, resulting in the opinion favoring the Cherretts you've been hearing about.
The Bankruptcy Appellate Panel's published opinion (In re Cherrett, 523 B.R. 660 (9th BAP, 2014)), affirmed by the 9th Circuit, is still good law to the extent it wasn't contradicted by that higher court's opinion. The Bankruptcy Appellate Panel's opinion goes through the evidence presented at the bankruptcy court trial in detail before concluding that the debtor
provided ample evidence that he obtained the Housing Loan for a business purpose with respect to his employment with Aspen. Given his testimony at the Hearing, his deposition and his declaration, as well as the written offer of employment from [the prospective employer] Aspen, the bankruptcy court had sufficient evidence to find that Paul's purpose in obtaining the Housing Loan was primarily related to his employment. We discern no clear error by the bankruptcy court in making that determination.
This language could cut either way regarding student loans. If you take out a student loan for the purpose of qualifying for anticipated employment, this language is arguably helpful. On the other hand, that employment would be a number of further steps removed from the specific "offer of employment" in this situation.
ISNT' THERE ANY BINDING CASE LAW INVOLVING STUDENT LOANS BEING NON-CONSUMER DEBTS?
Neither the 9th Circuit Court of Appeals nor its Bankruptcy Appellate Panel has a published opinion on this. There
is an opinion from 2016 by a bankruptcy judge in Sacramento,
In re Ferreira, 549 B.R. 232 (E.D. Calif. 2016). Since that is in a different federal district it's not binding locally, although our local judges would likely look at it with at least some deference.
This Ferreira opinion is not favorable to debtors. Ferreira owed $53,123 in student loans to attend nursing school, resulting in employment as a nurse at a gross annual income of $148,000. The court held that the debtor has failed to satisfy her burden of demonstrating that she incurred any of the student loan debt with the necessary profit motive.
. . .
The profit motive element in the consumer debt analysis is interpreted narrowly.
In support of this assertion the judge briefly and questionably cited the Bankruptcy Appellate Panel's Cherrett opinion (the Court of Appeals one had at that point not yet been decided), and then based most of his rationale on a Colorado bankruptcy judge's opinion,
In re Palmer, 542 BR 289 (D. Colorado 2015). The gist of the Palmer opinion was a "narrow interpretation of the profit motive":
[I]n order to show a student loan was incurred with a profit motive, the debtor must demonstrate a tangible benefit to an existing business, or show some requirement for advancement or greater compensation in a
current job or organization. The goal must be more than a hope or an aspiration that the education funded, in whole or in part, by student loans will necessarily lead to a better life through more income or profit. More than hindsight representations are needed to meet this burden.
Most student loans are not incurred to benefit an existing business or are not required to advance in a current job or with a current employer. So the standard laid out in Ferreira would not be helpful for most people.
SO WHERE DOES THIS LEAVE US?
First, Ferreira is not binding on bankruptcy judges in the Los Angeles area.
Second, both appellate Cherrett opinions have some potentially helpful language.
Third, the door remains open for finding non-consumer purposes of student loans beyond the profit-seeking/business purposes that both Cherrett and
Ferreira seemed to rely on.
There are other interesting cases along these lines outside the 9th Circuit, although those were beyond the scope of this blog post. If you have substantial student loans, the strategy laid out earlier—discharging other debts in a Chapter 7 case so you can focus on your student loans—may still be viable. This is clearly a complex and emerging area of law, so it's crucial to discuss it with an experienced bankruptcy lawyer. The result will likely depend on the specific details about the purposes for which you incurred your student loan(s).
IS THERE A STATUTE OF LIMITATIONS ON THE COLLECTION OF SBA LOANS?
Yes, there is. The U.S. Government has 6 years to sue you under a contract, such as an SBA loan contract.
Under a federal statute more than 50 years old the Government can "recover upon a contract for money damages" only if its lawsuit against you is "filed within 6 years from the date the cause of action accrued." See
28 U.S.C. Section 2415(a). The date that a cause of action accrues is when you defaulted on the debt, or the last time you made a payment or otherwise acknowledged the debt in writing.
For example, if you defaulted on an SBA loan on January 1, 2011, then generally the Government would only have up until about January 1, 2017 to sue to collect from you. Otherwise any lawsuit filed after this date would be barred by the above 6-year federal statute of limitations defense.
SO DOES THAT MEAN YOU DON'T OWE AN SBA DEBT AFTER WAITING OUT THE 6 YEARS?
Unfortunately, just because the Government can no longer sue does not mean it can no longer collect.
The very last subsection of the Section 2415 cited above gives the Government the ability to pursue a debt, or "claim," through "administrative offset," regardless of the 6-year statute of limitations:
this section shall not prevent the United States or an officer or agency thereof from collecting any claim of the United States by means of administrative offset
An administrative offset is defined in federal law as "withholding funds payable by the United States . . . to, or held by the United States for, a person to satisfy a claim." See 31 U.S.C. Section 3701(a)(1). In other words, it's a way for the federal government to pay itself on a debt you owe—such as an unpaid SBA loan—by taking it out of funds the government would otherwise pay to you—such as tax refunds or any kind of governmental benefit. It's "offsetting" (or seizing!) money it owes you to pay on your SBA loan.
The seizures are done through the Treasury Offset Program (TOP) administered by the Bureau of Financial Management Services, a branch of the U.S. Department of Treasury.
TOP can authorize seizure of your wages including military pay (without a lawsuit and judgment), and offsets of Social Security benefits (but not Supplemental Security Income), Retirement benefits (again, including military retirement pay), contractor/vendor payments, travel advances and reimbursements, and your federal income tax refund. TOP also has a general provision allowing collection from federal payments that are otherwise not exempt by law.
WHAT IS THE PROCEDURE AFTER DEFAULTING ON AN SBA LOAN, INCLUDING REFERRAL TO THE TREASURY OFFSET PROGRAM?
The SBA Collection process is laid out in the SBA Standard Operating Procedures (SOPs). These SOPs are incredibly detailed, actually consisting of a series of procedure manuals totaling thousands of pages. The procedures pertinent here are in
SOP 50 57 2 about the servicing and liquidation of
SBA's 7(a) Loans, its "flagship loan guaranty program." At 162 pages it's detailed enough!
WHAT ARE MY RIGHTS WHEN MY SBA LOAN IS IN THE TREASURY OFFSET PROGRAM (TOP)?
For example, before any collection by administrative offset SBA must give you—
(1) written notice of the type and amount of the claim, the intention of the head of the agency to collect the claim by administrative offset, and an explanation of the rights of the debtor under this section;
(2) an opportunity to inspect and copy the records of the agency related to the claim;
(3) an opportunity for a review within the agency of the decision of the agency related to the claim; and
(4) an opportunity to make a written agreement with the head of the agency to repay the amount of the claim.
The SBA can send the information about your debt to TOP as soon as the debt is more than 90 days delinquent, although things usually don't move that fast.
Among all the different types of benefits and payments owed to you that TOP can offset to pay an SBA debt, depending on your circumstances there might be limits on how much can be seized at any given time. All or part of your payments could be seized.
Again, you're supposed to receive notice that this is happening. But that doesn't always happen. Or the notice may have been years or even decades ago!
Treasury says that taxpayers who have concerns about the status of a debt or an offset can call the TOP Call Center at 800-304-3107 to ask questions. It doesn't do much good to call the paying governmental entity (for example, the Social Security Administration) because these entities can't reverse an offset or give you meaningful information about the SBA debt being paid.
On the other hand, although TOP can answer some questions it can't make arrangements for you to pay off your debt, tell you when the debt was alleged to have been incurred, or even tell you how much you owe! TOP can only give you the contact information for the SBA office attempting to collect the debt.
Beyond the debt, plus any penalties and interest, by law you may be charged an administrative offset fee. "The Secretary of the Treasury may charge a fee sufficient to cover the full cost of implementing this subsection." See 31 U.S.C. Section 3716(c)(4). Yes, you may have to pay the government a fee to help it make you repay your debt!
So, yes, you have some rights under TOPS. But once you get to this stage they are limited. If you have a steam of benefits you're relying on, bankruptcy may be your only practical refuge.
HOW LONG CAN THE GOVERNMENT COLLECT AN SBA LOAN THROUGH ADMINISTRATIVE OFFSET?
This is where it gets truly nasty.
Up until 2008 the above Section on administrative offset contained the following language:
This section does not apply—. . . to a claim under this subchapter that has been outstanding for more than 10 years
no limitation on the period within which an offset may be initiated or taken pursuant to this section shall be effective
(This sentence—unrelated to anything else in this massive bill of more than a quarter million words —is really buried: it's in a section of the bill labeled "Miscellaneous," and then within "Other Miscellaneous Provisions"!)
This sentence replaced the 10-year limitation on administrative offsets with no deadline whatsoever. In other words, the government gave itself the right to chase SBA debtors forever through offsets. So at any point in your life, even decades after defaulting on an SBA loan, even without being sued and a judgment entered against you, you can be tracked down and be made to pay your SBA debt.
AREN'T STUDENT LOANS NOT ABLE TO BE DISCHARGED IN BANKRUPTCY?
Student loans are generally difficult to discharge—legally write off—in bankruptcy. Most of the time you have to prove "undue hardship," a tough standard to meet. Broadly speaking this requires a lot more hardship than experienced by the average person filing bankruptcy. More specifically, the courts have created a set of challenging requirements in proving "undue hardship." (See my earlier blog post "Student Loans and Bankruptcy" for a short discussion about what it takes to discharge a student loan through a showing of "undue hardship.")
But even if you have a student loan that requires "undue hardship" to discharge, it may be worth trying to qualify.
DO ALL STUDENT LOANS HAVE TO MEET THE "UNDUE HARDSHIP" STANDARD TO BE DISCHARGED?
Let's start by broadening this question to include all educational debts. So, no, some educational debts can be discharged like most other debts, without having to show "undue hardship." The rest of this blog post focuses on these.
WHAT DETERMINES WHETHER MY EDUCATIONAL DEBT AVOIDS THE "UNDUE HARDSHIP" STANDARD?
The federal Bankruptcy Code establishes this distinction in a section appropriately titled "Exceptions to discharge." Its subsection describing the educational debts (at Section 523(a)(8)) requiring "undue hardship" for discharge has two main parts.
The first is for loans and overpayments "made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution." This covers virtually all federal or state guaranteed or insured student loans, which includes a large portion of them. This language also covers loans funded through non-profit educational institutions. To discharge these you have to show "undue hardship."
The second part refers to "qualified educational loan[s] as defined in section 221(d)(1) of the Internal Revenue Code . . . ." This is where there are opportunities for discharging educational debts without "undue hardship."
That's because a broad bankruptcy principal is that a debt can be discharged unless the law specifically says it can't be. This means that if you have an educational debt that doesn't fit within the first part of the statute cited above (government-guaranteed/non-profit funded), and is not a "qualified educational loan," it can be discharged without jumping over the "undue hardship" hurdle.
WHAT'S A "QUALIFIED EDUCATIONAL LOAN"?
That's the most important question when looking at the dischargeability of private educational debts.
The three main kinds of debts that may NOT qualify as a "qualified educational loan" focus on:
the type of expenses for which the debt was incurred
the timing of the loan
the type of educational institution attended
WHAT KIND OF EXPENSES DISQUALIFIES A DEBT AND MAKES IT EASILY DISCHARGEABLE?
This means that a mixed-use debt—one that is used partly to fund education expenses and partly for an unrelated purpose—can be discharged without "undue hardship." The definition of qualified higher education expenses is quite broad. Plus, student loan contracts usually make you assert that all of the loan proceeds are being used for educational purposes. But private loans that fund expenses beyond what the educational institution determines to be the reasonable costs of attendance should be considered "mixed use" and be completely dischargeable.
WHAT ABOUT THE TIMING FACTOR?
If the debt is incurred to pay educational expenses during a period of time in which you were not an eligible student, that debt is dischargeable without "undue hardship." For example, you may have been encouraged to apply to a proprietary school before you were eligible for that education. If so, that debt should be eligible for easy discharge.
Also, to be an eligible student you must be enrolled at least half-time and be in a degree- or certificate-seeking program. Educational debts from a time when you were ineligible are dischargeable.
WHY MIGHT THE TYPE OF EDUCATIONAL INSTITUTION MATTER?
The educational debt is not a qualified one if you're not at an "eligible educational institution." Most, but not all, are "eligible." Many ineligible educational institutions have come into and gone out of business in the last several years, including some relatively large ones. Debts from any of them would be dischargeable without "undue hardship." It's worth asking your bankruptcy lawyer whether the school you attended was eligible or not.
If you fall behind on child or spousal support in California, you can be hit by some super aggressive collection actions by your ex-spouse or support enforcement agency. Those actions can't be prevented or stopped by filing a Chapter 7 "straight bankruptcy" case. It takes a Chapter 13 "adjustment of debts" filing.
Today's blog post gets into
what actions California law allows your ex-spouse or support enforcement agency to take against you if you fall behind on support payments
why filing a Chapter 7 bankruptcy may help but doesn't usually help you enough
how filing a Chapter 13 case can give you the help you need
the importance of seeing a bankruptcy lawyer before the support collection actions are taken against you
WHAT DOES CALIFORNIA LAW ALLOW BESIDES GARNISHING MY PAYCHECKS?
Garnishing your wages is just the start.
You can lose the right to renew your driver's license if you fall only 30 days behind on child support payments. (Calif. Family Code Section 17520). Your license can be suspended if you fall four months behind. (Calif. Family Code Section 17520(e)(3)). You're given 150 days to catch up on the support. Then within that time your local support enforcement agency must inform the DMV that that you are current in order for your license not to be suspended. If your license gets suspended, it's suspended indefinitely, until you're in compliance with the support order and the DMV receives a release from the support enforcement agency.
It gets much worse. These license non-renewal and suspension laws also apply to occupational and professional licenses issued by the State of California. In fact, they apply to virtually any business, occupational, professional, and recreational "license, certificate, credential, permit, registration, or any other authorization" issued by California "boards, commissions, departments, committees, examiners, entities, and agencies." (Calif. Family Code Section 17520(a)(2)). Losing such a license or other authorization often means the loss of your ability to earn a living in your occupation or profession.
CAN BANKRUPTCY FIX THIS BY WIPING OUT MY UNPAID CHILD OR SPOUSAL SUPPORT DEBT?
No. No form of bankruptcy can "discharge"—legally right off—child or spousal support. This includes both your ongoing monthly support obligation and any unpaid support you're behind on. Bankruptcy can discharge most debts, but not child and spousal support. See Sections 523(a)(5) on exceptions to discharge, and
101(14A), of the United States Bankruptcy Code.
The federal bankruptcy system respects the state divorce systems. State divorce laws and divorce courts decide on the appropriate amount of child and/or spousal support. Bankruptcy law does not get in the way of those legislative and judicial decisions.
SO WHAT DO I DO IF MY SUPPORT PAYMENTS ARE TOO HIGH?
As quickly as possible you need to ask for a reduction in the support amount, or its elimination altogether, in the same divorce court that determined the support amount. You need to show a change in circumstances since the support order was made. The change can be in the income of one or both parents, loss of employment, change in parenting time, change in needs or expenses, or in any of the other factors used to calculate support. See this information from the State of California Courts website on changing child support or
The new support amount can either be agreed upon between you and your ex-spouse (or local support enforcement agency), or it can be determined by the divorce court judge. Either way the previously ordered support continues until a new support order is entered. That's why it's important to act quickly to officially lower it instead of just letting it continue at an inappropriately high amount.
CAN'T BANKRUPTCY AT LEAST STOP ACTIONS TO COLLECT SUPPORT?
Mostly not. As I said at the beginning, regular Chapter 7 bankruptcy does not stop the collection of any support obligation. This applies to the collection both of
ongoing monthly support and any accrued
unpaid support. So, any garnishment or other collection of monthly support payments would continue after you would file a Chapter 7 case. Same thing with the collection of any accrued unpaid support.
BUT DOESN'T FILING BANKRUPTCY GIVE YOU A TEMPORARY BREAK FROM COLLECTIONS?
It's true that filing bankruptcy usually stops the collection even of debts that can't be discharged, such as recent income taxes or student loans. That happens through the power of the "automatic stay." See more about this in my earlier blog post, "The Automatic Stay in a Chapter 7 and Chapter 13 Bankruptcy."
But child and spousal support debts are an exception to the automatic stay". The U.S. Bankruptcy Code explicitly excludes "the collection of a domestic support obligation" from the stopping power of the automatic stay. Section 362(b)(2)(B) of the Bankruptcy Code. A "domestic support obligation" includes both child and spousal support, including any that accrue "before, on, or after the date" of filing the bankruptcy case.
COULDN'T FILING A CHAPTER 7 "STRAIGHT BANKRUPTCY" CASE STILL HELP ME?
Sure, if immediately stopping the collection of all or most other debts, and then discharging all or most of those debts helps you enough, then Chapter 7 may solve your child/spousal support problem. This is more likely if you are not too far behind in your support payments, and if the collection actions have not gotten unbearably aggressive.
If you are current on your support payments but struggling to pay them along with your other debts, Chapter 7 may be the right solution. Or if you are behind but are confident that you'd be able to catch up quite quickly after discharging your other debts, again Chapter 7 may be what you need. Discuss this thoroughly with your bankruptcy lawyer so that you are being accurate about what other debts you'll be able to discharge.
CAUTION: After discharging your other debts through Chapter 7 your ex-spouse may be tempted to ask for an increase in your ongoing support because of this change in your circumstances. This does not apply if there is no longer any ongoing support.
IS THERE ANYTHING ELSE I CAN DO IF CHAPTER 7 ISN'T HELPFUL ENOUGH?
As mentioned in my first paragraph, unlike Chapter 7, Chapter 13 CAN prevent and stop the collection of unpaid accrued support.
That's huge. If you are behind on child or spousal support payments Chapter 13 gives you up to 5 years to catch up. And, crucially, it protects you throughout that time. Your Chapter 13 case protects you from your ex-spouse or your local support enforcement agency. And it also protects you from all of your other creditors as you deal with all your debts at once through a court-approved payment plan.
That payment plan is put together based on what you can afford to pay. It also takes care of everybody you owe so that you don't worry about not being able to catch up on support because of the aggressiveness of another creditor.
SO HOW DOES THIS WORK IN PRACTICE UNDER CHAPTER 13?
Assume you're 5 months behind on your $800 per month child or spousal support, so $4,000 behind. If your ex-spouse or your local support enforcements agency hasn't already done so, it can garnish you wages and take the actions outlined earlier to collect that $4,000, as well as the monthly $800. You could lose the income you need to pay your mortgage and vehicle loan, your other creditors, and put food on the table. You could lose your right to drive your car or to work in your chosen occupation.
Filing a Chapter 7 case would not stop you from any of this. That is, it wouldn't unless you had some way to catch up on the $4,000 back support very fast.
If you didn't have a way to catch up fast, Chapter 13 "adjustment of debts" could well be your best option. Here's what filing a Chapter 13 case could do:
immediately stop any present collection action on the $4,000 unpaid support
prevent any new collection action on that $4,000
budget enough money to pay the $800 monthly support going forward so you'd not fall any further behind
create a payment plan with a single monthly payment to all your creditors, based on what you could afford to pay
this payment plan would include enough in the payments to catch up on the $4,000 in unpaid support—as little as about $67 per month stretched out over 5 years
prevent your other creditors from getting in the way of doing all this
DOES CHAPTER 13 ALWAYS WORK?
You have to follow the Chapter 13 requirements to make it work. Your income has to be steady enough to be able to propose and execute a payment plan of consistent payments.(There can be room for some inconsistency.) Your income has to be large enough so you can keep current on ongoing support plus pay enough into your Chapter 13 plan.
If you don't make an ongoing support payment on time, your ex-spouse/support enforcement agency can ask the bankruptcy court for your protection to be taken away. And if you do not make your plan payment on time, same result. If the court agrees, you would again be subjected to aggressive collection actions.
So, Chapter 13 powerfully gives you a break. But if you don't follow the rules, you could lose that advantage easily.
SINCE FILING CHAPTER 13 STOPS SUPPORT COLLECTION ACTIONS WHY SEE A LAWYER BEFOREHAND?
First, it's better to prevent bad things from happening to you in the first place. Sure it's nice to be able to stop a garnishment of your paycheck or bank account after it has started. But why wait until after they've already begun hurting you?
Imagine the hassles and real hardship that would come if you lost your driver's license? Or maybe even more so, what if you lost your license allowing you to work in your occupation was suspended? Sure, it's great to be able to un-suspend such licenses or stop garnishments by filing under Chapter 13. But why go through the unnecessary misery if it can be prevented by finding out your options and preventing those bad things from happening?
Second, in the last section I stressed that Chapter 13's protection is conditional. You can lose it if you don't follow the rules. Those rules tend to be enforced more flexibly if you don't wait until the collection procedures have really ratcheted up against you. The ex-spouse/support enforcement agency will tend to be less aggressive if you've dealt with the problem earlier. The bankruptcy judge will likely be more flexible.
Third, being proactive would likely save you money, be better on your credit record, and preserve options. For example, you would more likely be able to solve your problems with a Chapter 7 case instead of a Chapter 13 one. The former takes usually less than 4 months; the latter 3 to 5 years. Also, past-due child support accrues interest in California at 10% annually (California Code of Civil Procedure Section 685.010(a)) , and penalties can accrue at the rate of "6 percent of the delinquent payment for each month that it remains unpaid, up to a maximum of 72 percent of the unpaid balance due". (California Family Code Section 4722). There are
fees for reinstating a driver's license You can save a lot of money and anxiety by getting advice about how to avoid all this as soon as possible.
And finally, if you'd ever get in the crosshairs of an aggressive support collection campaign against you, it would likely make you very cash poor and desperate for an immediate solution. That's not the best time to be calmly considering your options. That's not the best time to be coming up with money for bankruptcy court filing fees and lawyer fees. In fact, you may even be unable to use your legal options if you are pinned so tightly to the wall financially.
Don't let that happen to you. Find out how Chapter 7 or Chapter 13 can help you get a handle on your support debts, sooner rather than later.
Your home is likely your biggest asset, and your mortgage your biggest debt. Whatever you do with that asset and that debt has a big effect on your present and future financial life. If you are having financial trouble paying the mortgage it only makes sense to fully understand your options about your home and its mortgage. You likely have options and advantages you don't know about.
DOESN'T IT MAKE SENSE TO SELL YOUR HOME IF YOU CAN'T AFFORD IT AND TO PREVENT ITS FORECLOSURE?
Maybe. But this question leads to two important other questions:
Could you actually afford your home with the help of either a Chapter 7 "straight bankruptcy" or a Chapter 13 "adjustment of debts"?
Are there ways to sell your home and avoid its foreclosure but to sell on a timetable that would maximize its value and better fit into your life?
HOW COULD BANKRUPTCY HELP ME KEEP MY HOME?
If you are current or not too far behind on the mortgage or property taxes, Chapter 7 could help as follows:
As soon as your bankruptcy case is filed you can stop paying all or most of your other debts, and the creditors can't try to collect on them. Then about 3 months later all or most of those other debts are discharged—permanently written off. This often frees up enough cash flow so that you can more easily afford to make your mortgage payments. Chapter 7 allows you to focus your financial resources on your home.
If you are somewhat behind on your mortgage or property taxes, your mortgage lender will usually be willing to enter into a "forbearance agreement." That's an arrangement in which you agree to catch up on the mortgage and/or taxes on a schedule of payments. In return the mortgage lender agrees not to foreclose—to forbear asserting its rights—as long as you pay as agreed. Different lenders have different policies on this, but in general lenders tend to give you about a year to catch up on your back payments.
WHAT IF I'M SO FAR BEHIND ON MY MORTGAGE OR PROPERTY TAXES THAT I COULDN'T POSSIBLY CATCH UP WITHIN A YEAR OR SO?
Then Chapter 13 would likely be a better solution. It would give you much more time to catch up, as long as 5 years.
Also, Chapter 13 gives to power over your mortgage lender that Chapter 7 cannot give. In a Chapter 7 case you are at the mercy of the mortgage lender as to how much time you'll have to catch up. But in Chapter 13 you are the one who proposes the length of time and terms of payment, based on your budget and on your other creditor responsibilities. Your lender may object but usually it doesn't have grounds for objection as long as your Chapter 13 plan shows that you will be current by the end of the case. Then of course you have to comply with the plan in order catch up on time and save your home.
BUT IF MY HOUSE IS "UNDER WATER"—I OWE MORE THAN IT'S WORTH? IS IT WORTH WORKING SO HARD TO CATCH UP INSTEAD OF JUST SELLING THROUGH A SHORT SALE NOW?
Excellent question. Yes, sometimes paying thousands or even tens of thousands of dollars over the course of years to catch up on a mortgage is not worthwhile. Selling instead on a short sale may get you out of a bad situation quicker and easier. A short sale is one in which your lender accepts less than its full balance to settle the debt and allow a sale to go through.
But short sales have their risks:
You have to make sure that your lender does not have the right to pursue you afterwards for the portion of the debt left unpaid.
If you have a second mortgage or any other lien on the real estate, those obligations have to be taken care of somehow.
A short sale would hurt your credit, likely worse than if you succeeded in hanging onto your home or selling it for a higher price a few years later and paying off your mortgage in full.
You may have to pay income taxes on the amount of debt forgiven.
A short sale can be very challenging to pull off. So don't count on it as a solution until it is finalized.
Rushing into a short sale before your home has gotten enough market exposure to get the highest price likely leaves money on the table that you can sorely afford to waste.
Short sales have advantages and disadvantages that turn on your unique circumstances. You truly need the advice of a debtor/creditor lawyer to sort through them as they apply to you. A short sale may well NOT be the best solution for your home compared to your other options.
WHAT HELP CAN BANKRUPTCY GIVE ME TO DEAL WITH MY SECOND MORTGAGE, WHICH I'M ALSO BEHIND ON?
Chapter 7 doesn't provide any direct help with a second mortgage, other than get rid of other debts so that hopefully you could better afford the second mortgage payments.
But Chapter 13 may be able to help very significantly with a second mortgage. If your FIRST mortgage has a higher balance than the value of your home, then the second mortgage is effective not secured at all by the home. All of the home's value, and then some, is taken up by the first mortgage debt, leaving none for the second.
In this situation, under Chapter 13 the bankruptcy court can declare the second mortgage to be unsecured. Then it can be treated accordingly. You can stop making the second mortgage payments. The second mortgage debt is lumped in with all of the "general unsecured" debts, which you only pay to the extent you can afford to do so. Then at the end of your Chapter 13 case whatever portion hasn't been paid is forever discharged.
This "second mortgage stripping" can make keeping your home much less expensive to pay for each month. It can save you many thousands or even tens of thousands of dollars over time. And it bring you much closer to building equity in your home.
This is a prime example why it makes sense to find out about your bankruptcy options instead just blindly selling your home.
WHAT ABOUT IF I'M BEHIND ON PROPERTY TAXES?
You may be at risk of property tax foreclosure, but you have to be very far behind for that to happen.
What's more immediately a problem is almost certainly being behind on property taxes is grounds for foreclosure of the mortgage itself.
Just like with the mortgage debt, Chapter 7 buys you some time, while Chapter 13 buys
much more time. With Chapter 7 you'd likely be given a few months to catch up on the unpaid property taxes (as well as any unpaid mortgage payments). With Chapter 13 you'd be given as long as 5 years to catch up.
BUT WE HAVE DECIDED THAT WE HAVE TOO MUCH HOUSE AND NEED TO DOWNSIZE, SO HOW COULD CHAPTER 13 HELP US?
It buys you time so that you are not rushed to sell the home immediately, before the market's right, before you've prepared it for sale, and/or before your life circumstances make it the right time to sell.
If you are behind in payments, and even on the brink of foreclosure, Chapter 13 would stop the pending foreclosure, or stop one from being started. Then you would usually be able to market the home on your own schedule, months later.
HOW ABOUT SEVERAL YEARS LATER? BECAUSE OF LIFE CIRCUMSTANCES (SUCH AS KIDS IN LOCAL SCHOOLS) WE'D LIKE TO STAY IN OUR HOME FOR THE NEXT COUPLE OF YEARS, AND THEN DOWNSIZE AT THAT POINT. DOES CHAPTER 13 ALLOW FOR THAT?
It likely would. It depends on your ability to make the regular monthly payments (just about always required), and to pay catch-up payments in the meantime.
HOW DOES ALL THIS HELP ME SHORT-TERM?
It's probably unwise to sell your biggest asset for whatever you could get for it in a distress sale. We all make financial mistakes in life and have some bad luck. But you don't want to compound the mistakes and bad luck with a bad decision now. You owe it to yourself to get good advice about your options, so that you can choose smartly among them.
If you do this you'll have the peace of mind that comes from knowing that you are dealing with your situation responsibly. You get a game plan and a timetable for dealing with your home in the way that is the best for you and your family.
If you do decide to file a Chapter 7 or Chapter 13 case, you'd get the relief of knowing that any pending foreclosure is being stopped. Your creditors can no longer harass you. You are putting into action an option with certain benefits that you need. You are taking charge of your own destiny.
AND HOW DOES THIS HELP ME LONG-TERM?
If you do choose to save your home with either type of bankruptcy, and you succeed, you will have prevented the stain of a home foreclosure on your overall credit record and on your special mortgage-related record. You would have saved what perhaps is your best opportunity for building future equity, future wealth.
WILL FILING BANKRUPTCY CAUSE PROBLEMS WITH MY SECURITY CLEARANCE?
The short answer is that the filing of a bankruptcy caseitself will not affect your security clearance. However,
the reasons that a person might file a bankruptcy case could cause a security clearance problem.
This is a very important question with a nuanced answer, so we will go through our explanation carefully.
WHY WOULDN'T FILING BANKRUPTCY NOT CAUSE PROBLEMS?
Let's start simple: bankruptcy itself is not a problem because it makes you LESS of a security risk than if you didn't file.
When you complete the security clearance application form, you are required to disclose your financial life in great detail. See, for example, the 7-page Financial Record portion of the Standard Form 86 Questionnaire (for National Security Positions). So to the extent you are in financial trouble, your application form will show it.
The question is how you address your financial difficulties. Generally, filing bankruptcy shows that you are dealing with your debts. Bankruptcy can eliminate debts, restructure them, and even enable you to pay important debts. A security clearance is about your reliability and trustworthiness. Bankruptcy INCREASES your reliability and trustworthiness. It lowers the risk that you'd be tempted to take care of financial problems through wrongdoing.
purpose of a security clearance is to determine whether a person is able and willing to safeguard classified national security information, based on his or her loyalty, character, trustworthiness, and reliability.
How is this determined? According to the Defense Security Service's answer:
All available, reliable information about the person, past and present, favorable and unfavorable, is considered in reaching a clearance determination. When an individual's life history shows evidence of unreliability or untrustworthiness, questions arise whether the individual can be relied on and trusted to exercise the responsibility necessary for working in a secure environment where protection of classified information is paramount.
Under these guidelines, again it's not bankruptcy itself that's a potential problem. Rather the reasons for the bankruptcy may be. If the reasons for filing bankruptcy relate to fraud, criminal behavior, gross irresponsibility, or a consistent lifelong history of financial problems, then these reasons indicate the lack of trustworthiness and reliability, a deficiency of character, and a likely inability to act with loyalty.
HOW ARE FINANCIAL PROBLEMS TREATED FOR SECURITY CLEARANCES?
The Department of Defense's Directive 5220.6 contains the general rules about the security clearance process. Its Guideline F (at pages 29-30) addresses the potential concern of "Financial considerations." The concern is that an " individual who is financially overextended is at risk of having to engage in illegal acts to generate funds."
The Guideline gives a list of 5 "[c]onditions that could raise a security concern and may be disqualifying." It's very noteworthy that these conditions do NOT include filing bankruptcy.
However they do include the "inability or unwillingness to satisfy debts," and a "history of not meeting financial obligations."
Guideline F also has a list of 6 "[c]onditions that could mitigate security concerns, including:
The conditions that resulted in the behavior were largely beyond the person's control (e.g., loss of employment, a business downturn, unexpected medical emergency, or a death, divorce or separation);
The individual initiated a good-faith effort to repay overdue creditors or otherwise resolve debts.
IS FILING BANKRUPTCY AN APPROPRIATE WAY TO "OTHERWISE RESOLVE DEBTS"?
Bankruptcy is authorized by the United States Constitution. (Article 1, Section 8, Clause 4.) It's near the top of a long list of legislative powers granted by the Constitution to Congress. Under the resulting
Bankruptcy Code you have legal ways to permanently "discharge" debts (write them off), restructure them by paying less or changing the payment terms, or to pay certain important debts and pay less or nothing on other debts. All of these are legal ways to "otherwise resolve debts."
AREN'T FINANCIAL CONSIDERATIONS A MAJOR REASON FOR DENYING SECURITY CLEARANCES?
There are 13 Guidelines covering reasons why security clearances are denied. These include:
Guideline A: Allegiance to the United States
Guideline B: Foreign Influence
Guideline C: Foreign Preference
Guideline D: Sexual Behavior
Guideline E: Personal Conduct
Guideline F: Financial Considerations
Guideline G: Alcohol Consumption
Guideline H: Drug Involvement
Guideline I: Psychological Conditions
Guideline J: Criminal Conduct
Guideline K: Handling Protected Information
Guideline L: Outside Activities
Guideline M: Use of Information Technology Systems
Based on the 273 decisions issued by the Department of Defense Office of Hearings and Appeals during the first 4 months of 2016, by far the most common reason why a security clearance was denied was based on Guideline F, Financial Considerations. This Guideline was involved in 205 of those 273 decisions. No bankruptcy was filed in most of those decisions.
SO WHAT HAPPENED IN SECURITY CLEARANCE CASES WITH A BANKRUPTCY FILING?
As I said earlier, whether a security clearance is granted turns on the conduct or circumstances that caused the bankruptcy, and also whether the debts were "resolved" through bankruptcy.
Here are three situations that show this quite clearly.
1. A security clearance was granted to a 40-year-old security guard who filed a Chapter 7 case after a home foreclosure and vehicle repossession, to discharge those and other debts. He'd had no financial difficulties until 2007 when his home went to foreclosure. That was the result of the unexpected loss of financial contributions towards the mortgages by his fiancée when she lost her job. According to the administrative judge he acted responsibly given the misleading representations made by his mortgage lender that he would be able to refinance within a year.
It seems clear that this person would not have been successful in getting a security clearance had he not filed the Chapter 7 case. The decision states as part of the justification for granting the security clearance:
On the advice of an attorney, he filed for bankruptcy, and his nonpriority debts were discharged in April 2013. He no longer has delinquent debt. . . . . He is saving money. He benefitted from the financial counseling component of the bankruptcy. . . . . His current financial status is stable. He has a savings account. He has not acquired any new delinquent debt.
2. Another case shows how bankruptcy does not necessarily lead to the granting of a security clearance when it does not solve the underlying problem. A woman filed a Chapter 7 case discharging a substantial amount of debts. A portion, about $2,200, was in the form of 5 bounced checks to a casino related to her gambling. She admitted to gambling regularly since about 2000, and had continued to do so up through the prior year, about 2012, unsuccessfully trying to win back her losses.
The administrative judge's conclusion was that:
Overall, Applicant's long history of gambling has contributed to her financial problems, and her attempts at chasing losses, plus her continued gambling is a significant concern that has not been mitigated. Therefore, I conclude that Applicant has not mitigated the financial concerns of the Government.
Important for our purposes,
Since most of Applicant's debts have been resolved in bankruptcy, and Applicant is current with her recent debts, this mitigating condition is a factor for consideration in this case.
This is an indication that but for the gambling issue this woman may well have won her security clearance, largely because of the resolution of most of her debts through bankruptcy.
3. The final case involved an equipment test technician who had filed a Chapter 7 bankruptcy case back in 1992 resulting from a year-long layoff, and then filed a Chapter 13 case in 2013. The Chapter 13 case was ongoing, with a court-approved payment plan. This case had mostly resulted from owning two rental properties which caused him great financially difficulties in light of the financial downturn in real estate values between 2007-2011. The administrative judge stated:
Applicant received some financial counseling, and he generated a budget as part of the Chapter 13 Bankruptcy process. Although there is limited evidence of record that he established and maintained contact with his creditors, his financial problem is being resolved or is under control. He has a bankruptcy court-approved payment plan to resolve his remaining debts.
In sum, Applicant fell behind on his debts primarily because of the decline in the real estate market, failure of his tenants to pay rent, increased credit card fees and interests, and insufficient income. The Bankruptcy Court has assessed his ability to pay his creditors and determined his monthly payment. . . . . He has established his financial responsibility. It is unlikely that financial problems will recur. His efforts are sufficient to fully mitigate financial considerations security concerns.
The security clearance in this case was granted.
These three cases, and everything we've said here, show that bankruptcy itself does not hurt your security clearance. Indeed filing bankruptcy can often be crucial in successfully getting or retaining your security clearance. But it's very much depends on the facts of each person's case, and on the nature of the debts and the person's conduct in acquiring and then dealing with them.
When getting or retaining a security clearance in the midst of financial hardship, it is important to get the advice of a knowledgeable lawyer as you consider filing bankruptcy.
As a bankruptcy lawyer I want to help my clients resolve their financial situation and eliminate their debts. One of the largest frustrations I encounter is when a client can't use the bankruptcy laws nearly as well because of actions he or she took instead of first getting legal advice. Or sometimes it's clients' lack of action which then limits their options.
So today we'll focus on the avoidable problems that happen in two sets of circumstances. When delay in getting advice from a bankruptcy lawyer limits your options because:
your situation has gotten worse
your situation has gotten better
DOESN'T IT MAKE SENSE TO CONSIDER FILING BANKRUPTCY BECAUSE YOUR SITUATION HAS GOTTEN WORSE?
The bankruptcy laws provide many, many ways of protection you, your assets, and your income. Overall, people wait longer than they should before seeing a bankruptcy lawyer, for a bunch of understandable reasons.
They think and hope their financial situation will improve. Sometimes it does improve but often it doesn't.
Clients think they can't be helped. They often simply have big misassumptions about how bankruptcy works, and would be surprised to learn about the kinds of help that are in fact available.
They are afraid of getting bad news. So they avoid getting advice, not realizing that they would likely actually feel much better than they thought possible.
They are embarrassed about their situation. They feel guilty for making actual and imagined mistakes, and are afraid of being judged and put down by the lawyer. They don't know that most consumer bankruptcy lawyers work in this area of law because they are compassionate and like to help people.
The problem with waiting until things have gotten worse is that you can seriously miss out on the benefits of bankruptcy.
HOW COULD DELAYING SEEING A BANKRUPTCY LAWYER UNTIL THINGS ARE WORSE HURT ME?
In cold practical terms, delay could cut you off from bankruptcy protection altogether, at least for a certain length of time.
If you wait until you've been sued and your wages and/or bank accounts are being garnished, you would likely be intensely cash-poor. And that's not good because it costs money to file bankruptcy. The filing fee alone for a Chapter 7 and 13 cases are $335 and $310, respectively. It's very unwise to file bankruptcy without a lawyer, and for sensible reasons competent lawyers will not file a case for you without a certain amount paid up front.
So waiting until you are desperate is—as in many things in life—not a good idea. You could get into a vicious cycle of being cut off from the protection that you need just when you most need it.
BEYOND NOT WAITING UNTIL I'M FINANCIALLY DESPERATE, WHAT OTHER DISADVANTAGES CAN COME FROM WAITING UNTIL THINGS GET WORSE?
The different bankruptcy options can protect your property and possessions in diverse ways. However, before getting advice you might:
sell or use up precious property to survive financially, instead of preserving that property
sell or give away things because you're afraid you'd otherwise lose them to creditors or the bankruptcy court
DOESN'T IT MAKE SENSE TO SELL THINGS TO RAISE CASH AND PAY DEBTS?
Sure, sometimes that's the responsible and sensible thing to do.
But often it's not. Here's a fact: my clients often deeply regret having sold something or used up a fund to pay debts when, if they still had that possession or fund it would be fully protected and the debt would simply be written off. For example, they wish they had not used up their 401(k) or IRA instead of paying it over time to creditors.
Sure, you can't predict the future, and it may be possible that you can end up not needing bankruptcy help. But in the meantime doesn't it make the most sense to get practical, legal advice about your options? Then you can have your eyes open about the potential advantages and disadvantages of using up what you own. Your choices will then be honest ones, not ones made in the dark, impulsively without knowing the potential consequences.
DOESN'T IT MAKE SENSE TO SELL OR OTHERWISE GET RID OF POSSESSIONS BEFORE CREDITORS OR THE BANKRUPTCY COURT WOULD TAKE THEM?
In many, and probably most, situations it's dangerous to sell or give away possessions to prevent your creditors or the bankruptcy system from taking them from you. It could really backfire.
First, there are often legally safe ways to protect what is important to you without trying to sell or hide them. Sometimes they can be protected from your creditors without you filing bankruptcy. California has two alternate sets of property exemptions that can protect much or maybe even everything you own. Then federal bankruptcy law incorporates those California exemptions, and strengthens them is many ways.
Second, you can jeopardize those protections by selling or giving away what you own before filing bankruptcy. A bankruptcy trustee may be able to undo such a sale or gift, and you can lose your property exemption protecting that item of property. (See Section 522(g) of the United States Bankruptcy Code.)
There MAY be wise and legally safe ways of selling or otherwise disposing of possessions to raise money for creditors and/or living expenses. But given the potential dangers, it is only sensible to do so only after getting thorough legal advice about it.
HOW COULD FILING BANKRUPTCY AFTER MY SITUATION HAS IMPROVED HURT ME?
It could hurt you in many ways. It could disqualify you from filing a Chapter 7 "straight bankruptcy" altogether.
If you have "primarily consumer debts," to qualify for Chapter 7 you must pass the "means test." This is a multi-step test that focuses a lot on your income. If you hold off filing bankruptcy until after you get a better job or more working hours, or until after you get a particular chunk of money, that could disqualify you from the Chapter 7 option.
Then you may have to fall back on filing a Chapter 13 "adjustment of debts." If so, instead of writing off all or most of your debts within about 100 days under Chapter 7, you would have to pay all you could afford to pay to your creditors for a period of from 3 to 5 years! You'd likely pay thousands or even tens of thousands more dollars. On top of that you would not be free of your debts for years longer, and usually would not be able to clean up your credit record for that much longer.
There are circumstances appropriate for filing Chapter 13 (such as catching up on a home mortgage and dealing with serious income tax debts). But you don't want to be forced into one just because you didn't see a lawyer until your hands were tied income-wise.
BESIDES BEING CUT OFF FROM THE CHAPTER 7 OPTION, ARE THERE ANY OTHER ISSUES ABOUT WAITING UNTIL MY FINANCIAL SITUATION HAS SOMEWHAT IMPROVED?
Yes, if you want and need a Chapter 13 "adjustment of debts" case, your income determines whether you pay into a payment plan for 3 years instead of 5. So, delaying filing the case until your income improves could cost thousands more dollars and delay your fresh start for two years.
Let's illustrate this concretely with an example. Assume that your 3-year Chapter 13 payment plan requires you to pay $500 per month, with that $18,000 (36 months times $500) mostly earmarked to catching up on a mortgage arrearage and paying off some recent income taxes. As a result nothing is going to your other creditors. At the end of that 3-year plan you'd be current on your home mortgage and your income taxes, and all your other debts totaling $75,000 would simply be discharged (legally written off).
But here's what happens if you wait until your income increases, maybe even just modestly. If your income (as calculated for "means test" purposes) climbs above the "median income" for your family size, that triggers requiring you to pay 5 years instead of 3. And more likely you could afford to pay more per month to your creditors.
Applying the dollar amounts, assume you can now afford to pay $700 per month to all of your creditors instead of $500. That's about an extra $200 per month for the first 36 months ($7,200), and then 24 months of $700 payments ($16,800), or a total of $24,000. This is money that would all be going to debts that otherwise you would have simply discharged after 3 years (if you would have filed before your income increased).
Waiting to get legal advice is often detrimental, whether your circumstances end up improving or getting worse. And sometimes the downside for delaying is seriously detrimental.
Knowledge is power. Most consumer bankruptcy lawyers, including highly competent and experienced ones, do not charge for an initial consultation meeting. You will almost certainly learn a lot about your situation, and be much better armed with knowledge about your options and about how to avoid legal traps.
The "automatic stay" is one of the most valuable benefits of filing bankruptcy. This law makes just about every act of a creditor to collect a debt illegal once you file a bankruptcy case. See Section 362 of the U.S. Bankruptcy Code.
The automatic stay specifically stops:
the filing or continuation of a lawsuit or other legal proceeding against you to collect a debt
the enforcement of a prior judgment against your property
taking possession of or control over your property
the creation or enforcement of a lien against your property
IS A CREDITOR'S FILING OF A CREDIT REPORT A VIOLATION OF THE AUTOMATIC STAY?
If a creditor's filing of a credit report would be considered an "act to collect [or] recover" a debt, it would be a violation of the automatic stay. It would be illegal.
Courts have held that where a creditor's credit reporting was done for the purpose of making the debtor pay the debt, that's a violation of the automatic stay. (For example,
Weinhoeft v. Union Planters Bank, N.A. (In re Weinhoeft), 2000 WL 33963628, at *2 (Bankr. C.D. Ill. Aug. 1, 2000)).
IS A CREDITOR VIOLATING THE AUTOM ATIC STAY SIMPLY BY CREDIT REPORTING WITHOUT ANY EVIDENCE THIS WAS DONE TO COLLECT THE DEBT?
According to a recent opinion by the 9th Circuit Bankruptcy Appellate Panel, the answer is "no."
In re Keller (9th Cir. BAP May 26, 2017).
Specifically, a creditor's reporting of delinquent payments to a creditor reporting agency, in and of itself, is not a violation of the automatic stay.
WHAT ARE THE FACTS OF THIS RECENT CASE?
Robert and Finley Keller filed a Chapter 13 "adjustment of debts" case when they were $11,400 behind on their mortgage. Their court-approved Chapter 13 payment plan provided for catching up on that arrearage over time, and paying their ongoing monthly payments as well.
The Kellers made their required payments to the Chapter 13 trustee and caught up on their mortgage in less than three years. They continued in their case to finish dealing with other creditors. And they continued keeping current on their monthly mortgage payments.
Several months after catching up on their mortgage arrearage but while still in their Chapter 13 case, Mr. Keller applied for credit to buy a vehicle. He was denied. He was told he was an "Unacceptable Credit Risk" "based in whole or in part on information obtained on a report" from Experian.
The Kellers' 3-bureau credit reports at that time reported the account as $9,297 past due, even though at that point they were current. The "payment history" showed the account as "120 to 90 days late" during periods of time after the account had been brought current.
WHAT RECOURSE DID THE DEBTORS TAKE HERE?
The automatic stay has some teeth to it. The Bankruptcy Code states that
an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages.
So the Kellers' lawyer asked the bankruptcy court to find the mortgage holder in contempt and require it to pay sanctions for violating the automatic stay. The argument was that
by reporting misleading and inaccurate information on their credit reports — i.e., that the account was severely delinquent and with a past due balance — Defendants had willfully acted to collect on a debt that was subject to the automatic stay .
For reasons that aren't clear, the lawyer did not focus on the inaccuracy of the mortgage holder's credit reporting. Rather his argument was
that reporting of an account which has been included in a chapter 13 bankruptcy as "past due" or "late" is a per se violation of the automatic stay, because reporting late payments or past due balances is classic collection activity under § 362(a)(6) [cited above]. Debtors argued that such reporting did more than acknowledge that the debt still exists; it suggested that Debtors had failed to perform and served no other purpose than to coerce them into paying the debt directly to Shellpoint [their mortgage holder], despite the trustee's payments.
HOW DID THE BANKRUPTCY JUDGE RULE ON THIS?
The bankruptcy judge was Christopher Jaime, in the Eastern District of California based in Sacramento. He focused on the legal issue "whether past-due credit reporting is a per se violation of [the automatic stay]." Judge Jaime ruled by dening the Kellers' motion for contempt and sanctions for violation of the automatic stay.
So the Kellers appealed to the Bankruptcy Appellate Panel for the Ninth Circuit, an appeals court for bankruptcy cases. (The Ninth Circuit covers California and eight other western states.)
SO WHAT DID THE BANKRUPTCY APPELLATE PANEL DECIDE?
The 3-judge panel agreed with the Sacramento bankruptcy judge in deciding
that the act of postpetition [(after bankruptcy-filing)] credit reporting of overdue or delinquent payments while a bankruptcy case is pending is not a per se violation of § 362(a)(6),"
Section 362(a)(6) is the provision forbidding "any act to collect . . . or recover" a debt.
BUT DOESN'T CREDIT REPORTING FOR THE PURPOSE OF COLLECTION VIOLATE THE AUTOMATIC STAY? WHAT'S THE DIFFERENCE HERE?
The Bankruptcy Appellate Panel ("BAP") looked at the question narrowly, saying that the credit reporting, "without more, does not violate the automatic stay as a matter of law."
The BAP cited two Northern California cases in support. One said the automatic stay does not "bar reporting of late payments while a bankruptcy petition is pending." The other held that "negative postpetition credit reporting alone . . . is not a violation of the automatic stay."
The BAP then looked at two analogous areas of bankruptcy law, creditor violations of the discharge injunction and the codebtor stay.
First, creditors naturally are forbidden from attempting to collect a debt after it has been discharged (legally written off) in bankruptcy. The BAP looked at whether "negative credit reporting, without more," is a violation of the injunction against attempting to collect a discharged debt. The Panel cited nine different opinions from all over the country saying, no, the discharge injunction is violated only if "the credit reporting was done with the purpose of coercing the debtor to pay the reported debt."
Second, the codebtor stay forbids creditors of consumer debt from taking collection action against a debtor's co-debtor during a Chapter 13 case. The BAP cited three opinions concluding "that negative credit reporting, without more, does not violate the codebtor stay."
The BAP acknowledged that there was one opinion, In re Sommersdorf, that supported the Kellers' position. There an Ohio bankruptcy judge ruled that a credit reporting by a creditor
most certainly must be done in an effort to effect collection of the account. . . . . Such a notation on a credit report is, in fact, just the type of creditor shenanigans intended to be prohibited by the automatic stay.
But the BAP did "not find Sommersdorf persuasive" because the "court provided little analysis to support its holding, and what authority it did rely on does not support it." That's why, according to the BAP, this opinion's "per se analysis has been rejected or largely not followed."
Finally, the BAP rejected the Kellers' argument that reporting overdue payments during a Chapter 13 case "violates the automatic stay because its sole purpose is to coerce a debtor into paying the debt." Other purposes for credit reporting include "shar[ing] information relevant to credit granting decisions"—arguably the primary purpose of the credit reporting system.
SO WHAT HAPPENED IN THE END?
The BAP affirmed the decision of the bankruptcy judge in Sacramento. So the Kellers' efforts to make their mortgage holder pay damages for its credit reporting while they were in their Chapter 13 case were not successful.