Just this morning, I e-mailed back and forth with a client who wants and needs to wait until this fall to file his bankruptcy case.  He said that he’s getting constant calls from bill collectors at work, which is obviously never good.  We discussed his right to mail a letter to his creditors, instructing them not to contact him by telephone.  The Federal Trade Commission has an excellent page advising of this right, and how to exercise it, step-by-step; it also answers many other frequently asked questions about the federal Fair Debt Collection Practices Act.

Yes, you can find templates for cease and desist letters online.  Use such templates at your discretion–this is not legal advice. 

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Perhaps because of the stigma of bankruptcy, or desperation to hold on to something they can no longer afford, we see clients who act against their own financial interests. They do things that can’t be undone or mitigated when they finally do file for bankruptcy protection.  We see this acutely in the construction sector, which has been decimated in this recession.

Don’t liquidate your retirement funds to settle your debts

I was recently asked what’s the most frequent financial error we  see contractors and developers make time and again, and my answer was  liquidating exempt property, especially personal retirement accounts to pay debts.

I began working in construction litigation approximately ten years ago, but since starting Mitchell & Culp, PLLC in 2006 with my partner Rick, I have spent less time on construction defect litigation, focusing more on advising and representing developers, contractors, subcontractors, and vendors who have legal problems because of the 2008 downturn in the construction industry.

Since then we’ve seen, all too often,  new clients who have liquidated their personal retirement accounts and other exempt assets to pay their business creditors. They often did this with the very best of intentions, wanting to pay people that they’ve worked with and been friends with for years.

Their creditors never could have reached these assets, though, if they had not been voluntarily liquidated. So now the clients are still in financial distress with no means to support themselves and their families in their retirement because work has dried up and they’ve spent their retirement paying creditors.  Worse still, many of them are in their 60′s and 70′s, at the end of their earning ability, with little or no time to rebuild – and many others owe taxes and penalties on their retirement distributions, which they cannot pay and which are not immediately dischargeable in a bankruptcy case.

Case study: consequences of liquidating retirement accounts

Recently I met with a new potential client who owes perhaps $50K in taxes and penalties for approximately $250,000 in early distributions from his retirement accounts over the past few years. There is nothing left in the retirement accounts, he cannot pay the taxes, and he still cannot pay his debts.

He will eventually need to file for bankruptcy protection to discharge his unpaid debts, and he could have kept the $250K in the retirement accounts in that bankruptcy case.

My law partner, Rick Mitchell, has a way with words, so I’ll quote him here. “We have freedom of contract. That means that we have freedom to make a great deal for ourselves, and we have freedom to make damn fools of ourselves.”

Before you make any decision about winding down a troubled business or making good on business debts, consult an experienced bankruptcy attorney — yes, even if you do not want to file for bankruptcy protection.

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Here’s the kind of question that occasionally comes up when we counsel a married couple about bankruptcy.

Q: The exempt property statute, it is not clear as to how North Carolina’s statutory exemptions apply to a married couple contemplating filing a joint Chapter 7 petition, or facing execution on a judgment against both of them.  Do you, in effect, double these?

A: Ownership, not marital status, is key.

Example One: Wife drives a Mazda worth $3500, paid off/no liens, and the title lists Husband only as owner. Husband drives a Ford worth $5000, paid off with no liens,and the title lists Husband only as owner. Wife cannot use any of her $3500 vehicle exemption because she doesn’t have any ownership interest in either vehicle. Husband can use his vehicle exemption to protect the first $3500.00 in equity in one vehicle or the other, and can use his wildcard exemption to protect the remaining vehicle equity, assuming he doesn’t want to use it on other property, and has not used his full $35,000 homestead exemption.

Example Two: Husband works as a contractor, and in his work, uses a pickup truck that he owns, worth $2500 (paid off, no liens), and tools that he owns, worth $2000. Husband can claim a $2000 tools of the trade exemption to protect the tools, the first $2000 in value in the pickup, or some portion of both, limited to a total of $2000 (say, $1500 in the tools and $500 in the truck). Wife cannot use any tools of the trade exemption to protect these items because she does not own them and use them in her work.

These are the kinds of questions addressed in a bankruptcy counseling session. 

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• even where that spouse did not sign a credit application and
• even where that spouse did not sign or any agreement to be responsible for the bills

Introducing the doctrine of necessaries

Thanks to the “doctrine of necessaries,” North Carolina law* provides that in order to state a case against a spouse for the recovery of medical expenses for the other spouse, the claimant must show that:

1. medical services were provided to the spouse;
2. the medical services were reasonably necessary for the health and well-being of the receiving spouse;
3. the person against whom the action is brought was married to the person to whom the medical services were provided at the time the services were provided; and
4. the payment for the medical expenses has not been made.

The need for an asset planning and protection session

This can be a real problem for married couples with assets because a judgment could force them to liquidate assets to satisfy the debt.  If you or your spouse have medical bills that you cannot pay, it’s a good idea to consult a bankruptcy professional for an asset protection counseling session to determine the best course of action to protect your finances.

*North Carolina Baptist Hospitals, Inc. v. Harris, 319 N.C. 347; 354 S.E.2d 471; 1987 N.C. LEXIS 2012 (N.C. 1987).

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How does this apply in bankruptcy?

But what about money on deposit in a bank account at the time a bankruptcy case is filed?  A recent decision, “In re Phillips – re Wells Fargo administrative freeze of funds“ from the U.S. Bankruptcy Court for the Middle District of North Carolina instructs that it is permissible for a bank to place an administrative freeze on a Chapter 7 debtor’s deposits where some portion of the funds belong to the bankruptcy estate.

In the Phillips decision, Wells Fargo was not sanctioned for its freeze of the debtors’ entire bank accounts, even where no money was owed to Wells Fargo on the date of the bankruptcy filing, and some of the money belonged to the debtors.

This is a case where having legal counsel saves heartburn and money. As bankruptcy lawyers, we stay abreast of these developments and advise our clients accordingly.

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True story of a Charlotte mortgage modification in process

There’s nothing like a local story to tell the cautionary tale. Meet Barry Lancett, who bravely told his story to The Charlotte Observer.

The 55-year-old father of two physically shakes when he discusses his case and says the effort has distracted him when he should be focused on his job. In his crusade, he has accumulated mounds of paperwork and saved numerous recordings of his conversations with bank representatives…

The family’s finances began a downward spiral in late 2007, when, he says, he was fired by Wachovia for not selling the required amount of Pick-A-Payment mortgages. These were the adjustable-rate loans that later hemorrhaged losses for the Charlotte bank. He says he was soon burning through his 401(k) to keep up with mortgage payments and other debts…

In fall 2008, before he had missed any payments, Lancett says he wrote Wachovia asking for a restructuring of his mortgage and that the bank turned him down…He received a modification offer dated Dec. 21, 2009…But Wells soon sent him a second modification offer…When he called to ask about the second offer, Lancett said a representative told him the first one was a mistake, and he had to sign the new agreement or start the process again. He signed that one on March 17 but made monthly payments under the initial offer for March, April and May…

Lancett said he noticed that his payments weren’t being applied to his balance, and in June he received a letter saying he was in default. He owed Wells $8,724.97. “That’s when I started to lose it,” he said…

In August, he got a foreclosure notice, which set a hearing for Nov. 3. Lancett told the Observer about his situation, and the paper contacted Wells…”It’s moving in the right direction, but it’s still not over,” Lancett said. He said it’s impossible to understand the stress he’s been through over the past two years. If the Observer hadn’t contacted Wells, he said he believes the bank would have foreclosed on him.

Lessons to learn

If you are in a similar position as Mr. Lancett, be grateful that he went public. There is a great deal that his case can teach you.

(1) 401(k)s, IRAs, and other ERISA-qualified retirement plans are exempt (protected from creditors). If Mr. Lancett had defaulted on his mortgage, the mortgage company could not touch his 401(k).

(2) “Burning through his 401(k)” to pay mortgage payments or other debts creates problems.

• First, early retirement distributions are subject to both ordinary income tax and a 10% penalty, meaning it’s an expensive way to get money.
• Second, income taxes incurred through early retirement distributions are not immediately dischargeable in a bankruptcy, and the IRS can be a very pushy creditor – much harder to deal with than a mortgage company.
• Third, there may not be any money to live on come retirement time. And fourth, in the event that a bankruptcy becomes the best way to deal with debt problems, the early retirement distributions are income that may mess up eligibility for a Chapter 7 bankruptcy.
• And fourth, in the event that a bankruptcy becomes the best way to deal with debt problems, the early retirement distributions are income that may mess up eligibility for a Chapter 7 bankruptcy.

(3) Mr. Lancett’s efforts at modification, and the run-around by the mortgage company, are typical.

(4) Out of hundreds of clients, we can think of only a handful who’ve obtained permanent mortgage modifications in an amount that they can pay. The process and the typical outcome are deeply flawed and immensely frustrating for borrowers.

(5) A modification may, in fact, trap the borrower in his or her home, creating a completely new problem. Proposed mortgage modifications we’ve seen offered to clients create a dramatically higher promissory note reflecting old principal plus arrearages; meanwhile, the home continues to decrease in value with no recovery in sight. Five years from now, will the homeowner be able to sell without bringing money to the table to pay off the lender?

(6) Our clients often report that while they were in a trial modification period (making the trial payments), or in modification discussions with their lender, they received a notice of foreclosure hearing. It’s a mistake to assume that the modification process puts the foreclosure process on hold.

(7) The additional of foreclosure and other fees Mr Lancett described is typical.

(8) The reality is that this home (even modified) appears to be unaffordable for Mr. Lancett. A realistic look at affordability is always something to consider.

We’ve seen hundreds of people try to do “the right thing” and make the best decisions in cases like Mr. Lancett’s. If you can’t prevail upon your local paper to champion your cause (ha!) seek competent legal counsel through a bankruptcy counseling session.

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The WSJ reports that borrowers who receive a permanent mortgage modification still have lots of other debt. The median ratio of total debt payments to pretax income stands at 63.5%.  This means 20% of borrowers  (or more) with permanent modifications are likely to re-default, primarily because of those high debt levels.

If you have significant debt in addition to an un-affordable mortgage, you need a strategic plan; mortgage modification is tactical.

When bankruptcy counseling makes sense

Before going through an exhaustive application process for a mortgage modification, we’d like to recommend a bankruptcy counseling session with a qualified attorney. Yes, even if you want to avoid bankruptcy at all costs.

A bankruptcy counseling session with a straight-talking attorney can result in:

• Asset planning and protection strategies
• An analysis of whether you are at risk of re-defaulting after a mortgage modification
• A referral to agencies that may be able to help you with your financial difficulties

Many people we see in our offices want us to handle negotiations with credit card companies or provide them with credit card counseling.  Most often these individuals need bankruptcy protection, not creditor negotiation or credit card counseling.  You may be the exception, so contact our office for an initial consultation.

Bankruptcy checklist (not legal advice)

Here’s a checklist to consider before calling our office.  If several of these apply in your situation, bankruptcy is a viable consideration:

• Your wages have been garnished or your bank account has been attached
• Most of your debts are unsecured debts like credit card bills, hospital or doctor’s bills, etc.
• Your total debt, not including your car or house loan, is more than you could pay, even over five or more years
• Collection agencies are calling you at home and/or at work
• Your payments are more than 30 days behind on more than one bill
• There are lawsuits pending against you
• You have high medical bills not covered by insurance
• You owe income taxes that you are currently unable to pay
• You have few assets
• You have little or no savings
• You have had property repossessed (such as a vehicle)

Visit our Bankruptcy Resource Center before calling a qualified attorney (Mitchell & Culp or another firm) for a bankruptcy counseling session.

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Strategic default is the term used to describe a property owner’s decision to stop making mortgage payments and otherwise default on his or her obligations to the lender, despite having the ability to afford it.

In our law practice, it is rare to meet and work with clients who have strategically defaulted, or intend to strategically default.  Instead, the vast majority of people we see have no means to pay their mortgage.  They are in default, despite all of their best efforts to continue to meet their obligations; they simply cannot pay.

For the rare person who intends to strategically default, it must be clear that there are consequences to this decision.  Simply put, a borrower can choose to walk away from a mortgage obligation, but for most North Carolina residents, the mortgage company can and will follow the borrower to recoup any deficiency.  (North Carolina is a non-recourse state, but the exceptions swallow up the rule such that we rarely see a true non-recourse loan.)  Borrowers considering defaulting on a mortgage should understand that the mortgage company will almost always foreclose on a property, leaving a deficiency that they can legally ask the borrower to pay.

Contact a qualified, experienced bankruptcy attorney to discuss how these laws apply may to you, and then weigh your options carefully.

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Time will tell whether the Act becomes law; if it does, it is likely to undergo substantial revisions prior to passage.

Student loans are not dischargeable

Under the current law, student loans are not dischargeable in a bankruptcy. There are certain provisions allowing for dischargeability in the event that the bankrupt debtor can show “undue hardship,” but experience has taught us that if the debtor is blind, deaf, mute, and is missing all four limbs, there is a small chance that the debtor can show undue hardship and thus have his or her student loans discharged in a bankruptcy.

In other words, undue hardship just doesn’t happen.

Q: What about all the exemptions  that exist at the federal and state levels– can’t I use exemptions to keep the feds from liquidating my assets to try and collect on student loan debt?

A: GOOD QUESTION and the answer is NO! The feds don’t have to abide by the exemptions, as to student loan default and certain other debts. Check out this helpful set of FAQs from the Federal Student Aid Collections site, which includes these on financial hardship caused by:

• My federal and/or state tax refund has been offset
• My social security or other federal and/or state payment is being offset
• My wages are being garnished
• The agency that holds my loan is demanding unreasonably high payments

If you have student debt in addition to other debts you struggle to pay, a debt counseling session with a qualified bankruptcy practitioner will give you clarity for how to proceed with satisfying your obligations.

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Did you file for an extension on your income taxes? If you did so because you owe the government more than you can afford to pay, USAToday ran a good article on how to proceed.

The best advice may be in this paragraph about installment agreements:

You’ll have to pay interest on the unpaid amount at a rate that’s adjusted quarterly. The rate for the first quarter of 2010 is 4%, which is lower than you’d pay on most credit cards. The IRS charges a $105 processing fee but will reduce it to $52 if you agree to electronic withdrawal of your payments. Low-income taxpayers qualify for a $43 fee.

We find that people who can’t pay their taxes in a timely manner often have other financial concerns. A qualified advisor who works for YOU, not your creditor, may be in the best position to guide your next steps.

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