R.C. Lim, Attorney and Counselor at Law

Difficult Times

Today’s report that second quarter GDP growth was revised down from 2.4% to 1.6% should not be a surprise to most working families actually struggling through these difficult times. Over the past several years, many consumers have grown to understand too well that the early figures that are announced do not reflect reality. As increased amounts of data arrive, downward revisions to the economic figures have become the norm.  This particular figure, 2010 second quarter GDP, will continue to be revised for the next three years to come.  Downward I expect. I personally will not be the slightest bit surprised to learn that growth was not only anemic but in fact stagnant or even falling during this period of time. If one backs out the one-time and temporary gains in employment through the addition of census workers, the jobs picture was then and still continues to be simply awful. It cuts across the economy among different economic segments, geographic regions, and types of employment. Unemployment figures that would include discourage workers and other categories commonly excluded from the headline figure is commonly believed to be as high as 20%.

On perhaps a somewhat different plane, it strikes me as quite significant that George Soros, the noted investor who rarely ever gets macroeconomic trends wrong, revealed in his most recent filings with the SEC a loss of faith of the US economic recovery and the fear of inflation. Another investing guru, Warren Buffett, has predicted the same. Again this simply recounts what struggling families already know: these are difficult times.

One issue that repeatedly recurs when families are having a difficult time meeting their monthly bills is that they must sometimes choose which bills to pay. One mistake families often make is trying to stay current on their credit card payments while giving up on their mortgage. While I do not want to suggest that there is a hard and fast rule here. That is, it may sometimes be the best decision to pay credit cards ahead of your mortgage. In most cases, it is not the right decision at all. One reason here is that if a family is struggling under a debt burden and is headed for a consumer bankruptcy filing, that bankruptcy would likely redress the unsecured credit card debt, but not other forms of secured debt, such as a mortgage. Another reason is that if there is equity in the home that equity may be exempt from your creditors from the state homestead exemption. The logic that many use of attempting to avoid stepped up interest payments is certainly sound. However, it is simply not necessarily a goal to be had at the expense of missing mortgage payments.

What is most important here is to be realistic. If you are in a home that you cannot afford, you are better off coming to the realization earlier rather than later. If you are grappling with credit card payments that you cannot afford, you are better off seeking to discharge them before you have run through all of your assets.

Student Loans Are A YOKE On the Backs Of Young Americans

At this point in my admittedly short career as a bankruptcy attorney, I have spoken to too many alums — many from very good schools — that have borrowed more than they can afford to pay off.

Unfortunately, there has been much too little about this story. Much like the case of mortgage lending that occurred before people actually began defaulting on their notes, there is hardly any coverage of the problem in the media. Today’s NY Times article is a wonderful exception. Unfortunately, it’s not news until people actually default. And with student loans, the loans can be deferred for a number of years before a default actually occurs.

The central problem is the same as that which happened with the mortgage crisis: deregulation! The reason that it is much much worse for consumers is that unlike other forms of debt, borrowers cannot discharge student loans except in exceptional circumstances. The Brunner test is so exacting that most bankruptcy attorneys don’t even bother.

Make yourself aware of this problem. And don’t let any college students you know take on too much debt. Even to go to Harvard, it’s simply not worth it.

Increased Rates of Filing

Well, it looks like the vast majority of the increased rates in the Central District are occuring not in Riverside or Orange Counties as I would have guessed. Rather the big bump — 75% — happened right here in Los Angeles County!

Supreme Court Gossip: Elizabeth Warren To Replace Justice Stevens?

The latest gossip among the chattering lawyers is that Elizabeth Warren may be in line for the Supreme Court nomination to replace Justice Stevens. Professor Warren would likely be a more popular choice and face less Republic resistance than many potential nominees. Her nomination would also provide a strong example against the rule that law professors make lousy nominees because they have said and written too much.

In fact, Professor Warren’s populist message is exactly the sort that would give the Republican leadership pause because it’s so likely to be popular with their own constituents.  Given Professor Warren’s personal background as a consumer debtor attorney, it’s extremely likely also that during her term she would forever change the operation of finance in the United States.

Derrick Coleman, NBA Star, Files Chapter 7

Derrick Coleman, the former number one pick in the NBA draft, recently filed for Chapter 7 protection under the bankruptcy code. His case will be one of the few Chapter 7 asset cases, and among his assets he lists many fancy cars and other tchotchkes one would expect an NBA great to have collected over a career as an NBA great.

Coleman owed more than $4 million than his assets were worth. As a high profile case, Coleman hopefully did a more thorough job filling out his schedules than the former auto dealer Danny Hecker I wrote about a few days ago did. Having made some $89 million over his career, Coleman’s monetary troubles seem to have come from investing money in his struggling hometown of Detroit.

I suspect that Coleman could have done a little better had he visited an asset protection planning attorney. One thing that such attorney can do is advise you on how to segregate your assets and risk so that when one business fails it does not spill over to the rest of your assets or businesses. This is what parent corporations do when they create subsidiaries. The subsidiary can then fail without harming the parent. In Coleman’s case, it might have allowed him to close a business without having his creditors reach his personal assets.  In the context of corporations owning corporations, this can be quite expensive — separate and then consolidated taxes and books for auditing. In the context of smaller businesses, the series LLC offered in several states makes this considerably easier and cheaper to accomplish.

Some Lessons from In Re Hecker

Danny Hecker filed for Chapter 7 protection last June. His case reported some $750 million plus in debts perhaps the biggest case ever in his Minnesota jurisdiction. As a former car dealer, Hecker’s house of cards had collapsed from a high perch. Hecker’s assets were also significant, and he listed them at $18.5 million. As it turns out, he left a few important things out. Then he compounded the error by lying to the court. As the scheme unraveled, his ex-father-in-law who was implicated in the scheme apparently shot himself before he could give testimony.

The trustee in the case accused Hecker of fraud which led to an ongoing 25-count criminal indictment against Hecker. Among the assets that he left out were sizeable quanitites of cash that he handed over for the benefit of a girlfriend, motorcycles, boats, trailers, expensive watches, club memberships, a handgun, boat docks, airplane tickets, a car, and several hundred dollars of $2 bills. The ugly result here is that the settlement of his Chapter 7 suit has been dismissal of his case without discharge.  In other words, Hecker will continue to face the 25-count criminal indictment AND all of his assets will be sold–including those he thought he was hiding–AND Hecker will still be personally liable for some $725 million dollars to his creditors. Hecker’s lack of money is now very much affecting his criminal case for the worse. Hecker has already had two sets of criminal attorneys withdraw from representing him for nonpayment of fees. The man is clearly broke. And unlike a bankruptcy attorney who can petition the court to be paid from the sale of assets–assuming certain other things–his criminal attorneys can do no such thing. This leaves him with the Federal Public Defender’s office.

Hecker has fired his bankruptcy attorney who Hecker claims did a terrible job. As it turns out, the attorney Bill Skolnick is a pretty big deal there in Minnesota. I think it’s still had to tell what this means. But the case stands as cautionary tale of why it’s important to be truthful in the petition, truthful in the 341 meeting, and truthful in a 2002 exam. While the actual rate of prosecution for bankruptcy fraud is low and getting lower, the magnitude of the harm on the other side could not be worse. Essentially, you have all of your stuff sold–you keep all of your debts–and you go to jail.

Given the list of assets that were excluded, I am led to believe here that part of the mistake may have been simply that Hecker did not pay enough attention to filling out the forms completely. As a debtor, it is good to remember that when in doubt - DISCLOSE! While the trustee may not like wading through your extra entries, you will have removed the risk that you forgot something.  This process is considerably harder for the person who has a lot of things. While a stack of a hundred $2 bills might be rather hard to forget for some. For others, it’s only one of thousand other things exactly like it. The next thing for debtors to remember is that they really need to rack their brains and not expect to get everything on the first pass or to be prompted by their attorney for everything they own or control.  It is up to the debtor and the debtor alone to provide a complete list to the attorney. And much more importantly, it is the debtor’s signature(s) that go on the petition! You want to get it right.

Inherited IRAs and Bankruptcy

IRAs benefit from a federal bankruptcy exemption on an amount something north of $1.1 million. (The previous amount should have had its 3-year inflation reset on April 1, 2010.) This is a touch more complicated, and “roll-over” IRAs, or IRAs that are funded from ERISA plans can potentially qualify for unlimited amounts although there is very little guidance right now on what happens once such plans become “mixed” when a roll-over plan is mixed with regular contributions. (See Natalie Choate at Morninstar.com).

Inherited IRAs have become a fairly common tax planning strategy for estate planners. If not planning is done, an IRA can trigger a whopping tax bill. Tax is immediately due on long-term and any short-term gains. The capital gains tax would be in addition to any estate taxes on the estate. However, the IRS permits a decedent to pass an IRA without triggering a distribution and a tax and most importantly to replace the new beneficiary’s age for the purpose of calculating the minimum withdrawal calculations. This permits a “stretch-out” of the IRA distributions over a potentially very long period, depending on the age of the beneficiary, thereby permitting the assets to continue to grow tax free for an even longer time.

However, a Texas case, In re Jarboe, 2007 WL 987314 (Bkrtcy. S.D. Tex. 2007),  suggests that these inherited IRAs are not entitled to the same $1.1 million plus protection that they would have had in the hands of their original holder. Although this case is merely persuasive in other jurisdictions, like our 9th Circuit, bankruptcy practitioners are probably simply steering clear of its seemingly solid reasoning by advising clients to pay the capital gains tax and then push the former IRA assets into other categories of clearly exempt assets, like a home. If the client is already using his or her full homestead exemption, the exemption planning might be a bit more challenging.

Another View on Sky High Rates of Bankruptcy Filings

One way to approach the 35% spike in last month’s personal bankruptcy filings is to notice the spike. A more complete view, however, might take that figure and attempt to contextualize it within the larger economic troubles. Using such an approach that considers the unemployment level and problems that many folks are having with their mortgages, it’s possible to reach a different conclusion.

Two articles I dug approach the problem from this larger perspective to arrive at the conclusion that despite the high reported rates of filing, in actuality, there are not enough people getting relief under the bankruptcy code since the 2005 BAPCPA bankruptcy reform law funnels most debtors who make over the median income into Chapter 13. David Weidner writing in MarketWatch describe how the law is contributing to banks “feasting” on consumers. His analysis suggest that fewer are filing for bankruptcy and instead defaulting on credit cards (without filing for bankruptcy) and then funneling that money toward their mortgages.

A story that ran in the Philadelphia Business Journal interviews speculates that BAPCPA has caused attorney’s fees to double which has kept many low income would-be filers away from the bankruptcy courts. And that many of the richer candidates no longer find themselves eligible because of the BAPCPA means test that requires consumers who make more than the state median income for the size of their household to file under Chapter 13 instead of Chapter 7.

Beyond the Consumer BK Surge Stories, There’s A Piece on Hope…

This week’s rundown on consumer bankruptcy has pretty much been consistent:

Personal Bankruptcies Hit a High and May Keep Rising (Time)

Sharp Increase in March in Personal Bankruptcies (New York Times)

Personal Bankruptcy Filings Increase (Marketplace)

March Bankruptcy Filings Up 35 Percent (CreditNet)

Most of these reports are digesting the 35% spike in consumer filings over the month of may from the prior month. That’s certainly a big number.

The shred of hope, however, lies in a New York Daily News Piece entitled: There is Life After Bankruptcy; Credit Could Thaw in 18-24 Months. Kevin Chern is quoted as saying that most start receiving credit card applications in 18-24 months after filing. It’s of course notoriously difficult to much know what to expect from the credit bureaus who are extremely secretive about how exactly your credit score is tabulated. Next it’s perhaps even harder to predict what banks–collectively–will do with that information. That said, history is certainly a pretty good guide.

By filing bankruptcy, one can improve one’s debt-to-income ratio by removing the unsecured debt. This not only improves one’s financial picture, it also helps one creditworthiness. It’s important to remember that banks are pragmatic and impersonal and do not treat your bankruptcy discharge as a personal affront.

Moreover, the ability to find credit is cyclical and particular. Today I spoke with a man who had difficulty several months ago getting approved on a tiny $25,000 loan from a bank that he had had a relationship with for years on a paid off house worth over $800,000.

New Federal Loan Mod Program Aimed at Principal Reductions

Now that the housing crisis is bad and getting worse, the Feds have announced a new $75 billion program that will aim at principal reduction for borrowers who are underwater on their first and second mortgages but current on payments. The program will provide incentives for lenders to work with borrowers to avoid strategic defaults by borrowers who are struggling.

Like many of the programs that have come before, like the Making Home Affordable program, this program will exclude most borrowers. The requirement that borrowers be current would exclude nearly all of my clients since even among the ones that could have been current have gotten behind in some (misguided) attempt to force a loan modification from their lender. In fact, I have heard several clients actually report that they have been indirectly given the advice to fall behind to improve their chances at working out a loan modification.