The great recession landed the second of a one-two punch as San Bernardino this week followed closely on the heels of Stockton, California in voting to file for Chapter 9 bankruptcy. San Bernardino is reporting a $45,000,000.00 budget deficit and is “so broke it can’t cover its payroll.” San Bernardino will follow Mammoth Lakes, a California mountain resort of 8,200, who filed for Chapter 9 protection on July 3 saying it can’t pay $43,000,000.00 owed on a legal judgment.
Like any struggling business or family, municipalities need to tighten their belts when faced with sharp declines of income. As the baby boomers continue to age, pension contribution obligations and retiree healthcare costs are beginning to spiral out of control. We may well be heading into an age where the security of a lifetime pension following a career in municipal service no longer exists. If cities, counties and states can no longer entice workers with this kind of financial security and the private sector becomes saturated with job applicants who have nowhere else to turn, we may all start to think of pensions, subsidized public transportation, and even reliable emergency services like police and firefighting as fond memories. The 20th Century may begin to take on the hazy glow of a golden age of innocence, as all of us begin to adjust to a very different role that government will play in our lives.
The classic silent film Metropolis by director Fritz Lang thrilled audiences in the 1920s by depicting a fantastic Art Deco image of a future civilization. Only four posters from that landmark film survive and one of them found its way into the hands of collector Kenneth Schacter, according to this article from Blastr.com. Schacter apparently bought the poster in 2005 for $690,000 but in December of 2011 needed to file Chapter 11 to get protection from his creditors after finding himself unable to make a $500,000 payment to an investor.
Chapter 11 is an extremely powerful and flexible procedure that allows a debtor to remain in control of his assets while he attempts to reorganize. One of the critical philosophies behind Chapter 11 is the idea that assets retain their highest value in the hands of the person or company who bought or developed them. Maintaining this “going concern” value is thought to be in the best interest of the debtor and its creditors.
Like most of the other powerful tools available under the bankruptcy laws, Chapter 11 is a privilege and not a right. Debtors operating under Chapter 11 have a fiduciary duty to protect their creditors. While debtors are permitted to operate normally with minimal court supervision, transactions outside of the ordinary course of business must be approved by the bankruptcy judge.
Schacter then must’ve known then that he was going to self-destruct when, according to Blastr.com, he tried to sell the Metropolis poster on an auction site without permission from the bankruptcy court. His asking price? $850,000 (he had apparently listed the value of the poster at $250,000 on his bankruptcy schedules). We can only guess what would have happened to this money had Schacter succeeded in this scheme.
As Blastr.com reports, the consequences for Schacter’s veiled subterfuge were predictable: he was swiftly removed from his Chapter 11 power and the case was converted to a liquidation under Chapter 7 of the bankruptcy code. Now, a trustee will attempt to sell the Metropolis poster which is expected to fetch over $1 million. The creditors will win, but Schacter may find himself scrambling to hang onto his discharge after his Chapter 11 meltdown.
It’s that second mortgage that’s causing all the problems. Values have taken a nosedive in the last 5 years and many of those junior liens are now completely underwater. Say the home is worth $250,000, the first mortgage is $300,000 and the second mortgage, maybe a home equity line of credit (HELOC) is $75,000. The first mortgage is undersecured in the amount of $50,000; the HELOC is totally unsecured.
In Chapter 13 the debtor could strip off that HELOC as described in this video. But in Chapter 7 most courts say no. Why? Because the US Supreme Court says so. For more details, see this article. The Supreme Court case that has caused this hardship (Dewsnup v. Timm for the legally minded) stems from 1992, more than 15 years before the current real estate and foreclosure crisis that has caused the loss of trillions of dollars of value in the residential home market.
This result makes no sense. Why should other unsecured creditors get a windfall by receiving coerced payments in Chapter 13 just because the debtors have a junior mortgage that is completely unsecured? The bankruptcy code is clear: “to the extent that a lien secures a claim against the debtor that is not an allowed secured claim (i.e., completely underwater) such lien is void.”
This result is especially wrong in light of the recent Atty. Gen. nationwide mortgage settlement which followed years of abusive foreclosure practices by the major mortgage servicers. Part of the settlement, which will be implemented in the months and years to come, is that mortgage companies need to adjust to the collapsed real estate market by writing down the principal on their loans when the property value does not support the mortgage.
The bankruptcy world should adapt to these realities and recognize that completely unsecured junior mortgages need to be stripped off in chapter 7 so that homeowners will be able to realize the appreciation in their properties and not simply pay rent or its equivalent to mortgage holders until the time comes that they are ready to abandon the home. Congress needs to amend the bankruptcy code to make clear that “void” means “void” and give homeowners real relief in chapter 7.
An 89 year old WWII vet hid $66,000 in gold and silver in his backyard, didn’t tell his lawyer about that and then filed for bankruptcy. His home, owned free of all secured claims other than a few minor judgment liens, is to be sold and he is forced from it. This story is creating a national outcry, as described in this article. The debtor’s wife died recently from cancer and the debtor too has cancer. Due to his dishonesty the debtor is losing his home and his bankruptcy discharge. It’s an awful story about a tragedy that didn’t need to happen.
Honesty is the lynchpin of the bankruptcy system. Discharge and protection from creditors are powerful privileges, made possible by a debtor’s complete and accurate disclosure of his assets and debts, income and expenses. When a debtor refuses to disclose assets there is a subversion of the process. When this vet lied on his schedules, he gave up any right he had to receive the benefits from the bankruptcy system.
In truth, this debtor should never have filed his case. In the first instance, he has a $250,000 homestead exemption under Montana law. Had he not committed perjury on his bankruptcy schedules he never would have had to lose his home. He could have lived out the rest of his life peacefully.
As far as the creditors who were hounding him for the $109,000 in credit card and medical bills? He could have settled with the loudest of them by liquidating small amounts of the $66,000 and paying them accordingly. I believe he could have transferred the money to a trusted relative and then in three years filed a bankruptcy case. This is the kind of careful planning that is essential any time a person is considering a bankruptcy case.
I have long admired, and will probably always admire, Elizabeth Warren. Since before my career began in 1985 as an aspiring bankruptcy lawyer (I was in law school then, to graduate in 1986) Elizabeth Warren has been a strong supporter of consumers’ rights. Hers has always been one of the most prominent voices in support of families in our country. Ms. Warren is a professor of bankruptcy law at Harvard, certainly a deep well of legal pedigree in our country (don’t believe me? Watch the Pilot for the USA original series “Suits“: Top NY law firm Pearson Harden only hires out of Harvard Law School). Beginning in the late 1990’s Ms. Warren leapt to national prominence with her strong opposition to the changes the credit card cartel sought to impose on the U.S. bankruptcy laws through BAPCPA (Bankruptcy Abuse Prevention and Consumer Protection Act). She and the rest of the commission appointed by Congress to review the proposed changes all agreed that BAPCPA is an abomination, but never mind: in 2005 at the beginning of GW Bush’s second term in office, BAPCPA became the law of the land.
Not long after BAPCPA became law our national economy began to suffer the meltdown we all know too well: crashing stock market prices, bottomless real estate values, rampant corporate layoffs. Elizabeth Warren stepped up and is running for office to become the US Senator for Massachusetts. She is involved in a hotly contested fight for the seat against Republican incumbent Scott Brown. She ran unopposed in the Democratic primary, receiving a record 95.77% of the delegates. Everything is set for Elizabeth Warren to speak truth to power on Capitol Hill, but now she has hit a roadblock.
Apparently Warren identified herself as a minority in a directory of law professors from 1986 to 1995, specifically a native american. She claims that “she had heard family stories about her Cherokee ancestors her entire life.” Indeed, according to Michael Dean of the Oklahoma Historical Society, as intermarriage had been common in the 1890s in Oklahoma (Warren’s home), many individuals refer to having some Native American ancestry. Unfortunately, the Boston Globe reported on May 25 of this year that “both Harvard’s guidelines and federal regulations for the statistics lay out a specific definition of Native American that Warren does not meet.” Even a Cherokee group has protested.
This controversy is a shame, as it drowns out the really important national discussion on how to help families and our economy. However, if the charges are true, Professor Warren should know better. Honesty is the lynchpin of our consumer bankruptcy system. Schedules of assets, debts, income and expenses are largely presented on the honor system: the bankruptcy process would become hopelessly clogged if each debtor’s sworn financial statements had to be independently verified. The penalty for lying on your schedules is denial of discharge, as explained in this video. This is true whether or not the omission is material. In every court in the country, bankruptcy judges will rule without fail that a discharge in bankruptcy is reserved for only honest debtors.
So it is with our political representatives. As a bankruptcy professor, Elizabeth Warren knows better than most the premium of honesty required to obtain the enormous privilege of a political office or a discharge of debts in bankruptcy.
Sometimes, there’s a reason to hurry up the bankruptcy filing. This usually happens when the client really needs protection from creditors. Trying to stop an impending foreclosure sale, Sheriff Levy, wage garnishment, or seizure of a bank account are all very good reasons to get that bankruptcy case filed. When the creditors are moving to seize your assets bankruptcy protection may be your only choice.
Frequently, however, the creditors are not circling overhead, just making you uncomfortable. Or else you may have decided to let go of a certain financial lifestyle and you want to finally move on with your life. It takes a lot of soul-searching and sleepless nights to get to that point so the desire to put the painful past behind is understandable. However, if one of these situations apply to you you may do much better to plan carefully, wait out the storm and file on your own terms:
You owe significant taxes. Income taxes are generally nondischargeable in bankruptcy but there are critical exceptions as you can see in this video. You may have to wait a year or 2 or 3 so that taxes may become dischargeable. If you can hang on during the wait the ability to get rid of the IRS once and for all may completely change your life.
You have too many assets. In Maryland bankruptcies individual debtors may claim exemptions and keep approximately $21,000 in the equity in their home, $1,000 in household goods, $5,000 in tools of the trade and approximately $11,000 in everything else. (IRAs, 401(k)s, life insurance policies, cash recovery on account of personal injuries are not subject to any limitations).If your assets are worth substantially more than this you may have to take the time to spend down excess cash or transfer property outright. If that happens you may have to wait up to 3 years to file that bankruptcy case. If you plan properly it will be worth it.
There are ways to hang on while you wait for the time to pass and be ready to file. If there’s a reason to rush into bankruptcy, you should get it done without procrastinating. But just as frequently, the better course is to calmly survey the landscape and file the case when you and your lawyer have considered all the possibilities.
