We see situations where people whose incomes have been cut will forego paying the second mortgage while staying current with the first. When they are able to resume payments on the second mortgage balance but the mortgage company is unwilling to modify their mortgage so that they can catch up on the missed payments, Chapter 13 is a court-supervised way to accomplish the goal.

(Mortgages are actually called “deeds of trust” in North Carolina, but we’ll use the term mortgages here.)

We have dealt using Chapter 13 to help homeowners catch up on missed mortgage payments (first and second mortgage payments) in other posts.

Three options in Chapter 13 for a second mortgage

There are three options for a second mortgage in a Chapter 13, where the debtor is current on the first mortgage:

1. Get caught up on the second mortgage through bankruptcy plan payments. The second mortgage arrearage, as of the date of the filing of the bankruptcy petition, is paid back in full through the plan payments, over time.

Chapter 13 cases typically involve proposing a plan to pay back creditors over sixty monthly payments (five years); a debtor can propose a plan to pay what’s owed as of the date of the bankruptcy filing back, in sixty monthly installments. At the same time, the debtor must make each current mortgage payment.

For example, if a Chapter 13 case is filed on October 1, 2011, and as of that date, the borrower is past due on a total of $12,000.00 in second mortgage payments, then the debtor can, through a Chapter 13 bankruptcy case, pay the $12,000.00 back over sixty months, but must at the same time pay each and every month all mortgage payments (first and second). Thus, in October, the debtor must pay his or her October 2011 first and second mortgage payment PLUS the Chapter 13 payment, a portion of which goes to paying the pre-petition second mortgage arrearage. This goes on for sixty months (the life of the Chapter 13 case).

2. Surrender the property and discharge the debt that is secured by it.  Sometimes, borrowers either simply cannot afford to pay second mortgage arrearages in a Chapter 13 case (see above) while at the same time remaining current on their mortgages, or decide not to make those payments because the debt exceeds the value of the property (it is “underwater”). These situations often cause a borrower to decide to give up (surrender) the property in a bankruptcy case and discharge the mortgage debts.

Depending on the borrower’s overall financial situation, the borrower may qualify for Chapter 7, discharging the debt and making no payments to the mortgage lender – or, be limited to a Chapter 13, discharging the debt and paying a fraction of what’s owed to the mortgage lender (the payment depends on the debtor’s individual financial circumstances).

The mortgage lenders will eventually foreclose on the surrendered property, and their recovery is limited to (a) the proceeds realized from the foreclosure sale and (b) any payment through the Chapter 13 plan. Because the property is being surrendered as part of the bankruptcy case, the mortgage debts are treated as unsecured (because the house goes through foreclosure) and are paid the same amount as credit cards, medical bills, and other unsecured debt, according to what the plan proposes that unsecured creditors be paid (generally less than 10 cents on the dollar, but the plan payment depends entirely on each borrower’s financial situation).

3. Strip the second mortgage through an adversary proceeding in the Chapter 13 case.   This is a complex subject that my law partner, Rick Mitchell, covered thoroughly in another post.

Evaluating the various ways of dealing with mortgaged real property is too complex for a blog post. This one is designed to give you hope for a solution that is monitored by the federal bankruptcy courts and that your mortgage lenders will probably not tell you about. Call a qualified bankruptcy attorney.

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Generally, these are parents who plan to seek PLUS loans for their kids’ college educations, but sometimes it is the client who plans to go back to school and needs financial assistance in order to do so.

The bankruptcy code is specific

The Bankruptcy Code contains a specific provision forbidding those making student loans from discriminating against student loan borrowers because of their bankruptcy.  11 U.S.C. §525 is the anti-discrimination provision of the Code, and subsection (c) provides as follows:

 (1) A governmental unit that operates a student grant or loan program and a person engaged in a business that includes the making of loans guaranteed or insured under a student loan program may not deny a grant, loan, loan guarantee, or loan insurance to a person that is or has been a debtor under this title or a bankrupt or debtor under the Bankruptcy Act, or another person with whom the debtor or bankrupt has been associated, because the debtor or bankrupt is or has been a debtor under this title or a bankrupt or debtor under the Bankruptcy Act, has been insolvent before the commencement of a case under this title or during the pendency of the case but before the debtor is granted or denied a discharge, or has not paid a debt that is dischargeable in the case under this title or that was discharged under the Bankruptcy Act.

(2) In this section, “student loan program” means any program operated under title IV of the Higher Education Act of 1965 or a similar program operated under State or local law.

11 U.S.C. §525(c) was added to the Bankruptcy Code in 1994.  Importantly, it applies to both governmental and private lenders (banks) and prevents both from student loan discrimination on the basis of bankruptcy.

From our extensive bankruptcy experience, here’s what we know

There is not much case law explaining or shedding light on how this provision applies to real people and real facts.  However, based on our experience, we can tell our bankruptcy clients that:

• if no one is willing to make student loans to those with a bankruptcy on their credit report, then the pool of potential borrowers would be greatly reduced, and this hasn’t happened yet, to our knowledge.
• the financial problems that necessitate a bankruptcy filing may very well hinder your ability to obtain student loans, so you may be damned either way.
• bankruptcy provides the honest debtor with a fresh start, discharging debts and freeing up income that can now be demonstrated as available to repay student loans; anecdotally, one of our clients this past year called because the local school to which she’d been admitted told her she had a better chance of qualifying for student loans after she obtained a Chapter 7 discharge.
• a parent’s bankruptcy does not affect a dependent’s creditworthiness, or the dependent’s eligibility for student loans.
• while in a Chapter 13 bankruptcy case, a debtor may not incur additional debt without court approval.

Bottom line, if you’re considering bankruptcy and have any concerns or questions the treatment of your student loans, consult a qualified bankruptcy attorney.

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Does this mean that there is nothing that homeowners can do to try to save their homes?  Unfortunately, in most instances the answer is yes.

However, there is a way that some homeowners can protect their homes by the use of something called lien stripping.

Lien stripping: great option for the few who can qualify

Unfortunately, lien stripping works only in a narrow set of circumstances.  There are three elements that must be present.

• First, there must be a first and second mortgage on the home.  A home equity line of credit (“HELOC”) is one form of second mortgage.
• Second, the value of the home must be such that there is no equity to secure the second mortgage.
• Third, if the homeowner did not have to pay the second mortgage payment, he or she would be able to afford the home.

If these three elements are present the homeowner may file a Chapter 13 bankruptcy reorganization and propose a plan that strips the second mortgage.  Stripping means that the second mortgage is removed as a mortgage lien on the home, and the second mortgage lien debt becomes a general unsecured debt that can be paid pennies on the dollar.

John and Jane Doe strip their lien

An example of lien stripping involves John and Jane Doe.  The Does have a home with a value of $175,000.  They have a first mortgage lien to Number One Lender Bank of $180,000 with a payment of $1,500 per month.  They have a second mortgage lien of $50,000 to HELOC Bank with a payment of $350 per month that is an interest only payment.  The Does can afford the first mortgage payment, but they cannot afford both the first mortgage and second mortgage payments.  In addition, they realize that the property is worth far less than what is owed on it, and since the loan with HELOC Bank is interest only, they are making little if any progress toward creating any equity in the home.

In this situation, the Does can file a Chapter 13 reorganization case and propose to strip HELOC Bank’s second mortgage lien.  The debt owed to HELOC Bank is treated in the plan as a general unsecured creditor along with other general unsecured creditors such as credit cards, medical bills and the like.

The general unsecured creditors are paid based on the financial ability of the Does to make payments and in many instances these payments can be five percent or less of the debt, with no interest, over a period of up to five years.  At the end of the plan, the bankruptcy court will enter an order stating that the HELOC Bank’s second mortgage lien no longer encumbers the Does’ home.

Who cannot use lien stripping

Simply having a second mortgage will not help a number of homeowners.  In order to have the ability to strip a second or third mortgage lien, there must be not one penny of equity securing the second mortgage lien.

In the example above, if we assume that the value of the property is $185,000 with all the other factors remaining the constant, there will be $5,000 in equity securing HELOC Bank, thus the Does cannot strip the lien.

Do not hesitate to attempt lien stripping

Consultation with a qualified bankruptcy attorney is essential for those thinking about lien stripping. If the attorney believes that the property is low enough to allow for lien stripping, it makes sense to proceed since creditors do not have incentive to fight the proceeding. After all, if the creditor prevails, and the debtor afford the payments to keep the home, the creditor can’t get paid anyway. In a closed case the call will go to the debtor.

The problem we usually see is when there is sufficient equity in the home to prevent lien stripping while at the same time, the homeowner cannot pay the first mortgage. This is truly cause for a bankruptcy consultation.

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• Chapter 7–$306
• Chapter 11–$1,046
• Chapter 12–$246
• Chapter 13–$281
• Chapter 15–$1,046

There are other miscellaneous fee increases for certification, exemplification, audio recording, records searches, record retrieval, and returned checks.

Source:  http://www.wieb.uscourts.gov/

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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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Five options for taxpayers who are unable to pay their taxes in full and on time

There are only five options for taxpayers who are unable to pay their taxes, in full, when owed:

1. Get current.  Some choose to get current through whatever means necessary, including a bank loan or gift from family. The IRS accepts payment by credit card. So does the North Carolina Department of Revenue (NCDOR). Be aware, though, that credit card debt used to pay taxes may not be dischargeable in a bankruptcy case.
2. Installment agreement and payment plan.  The IRS and the NCDOR both offer installment agreements in many circumstances.
3. Bankruptcy.  We rely on a 600+ page book that analyzes the dischargeability of taxes in consumer bankruptcy cases, so please understand that this is a highly complex area of the law that cannot be adequately summarized for this website.  That being said:

• Many people (and lawyers, for that matter) are not aware that income tax debt can, under certain circumstances, be discharged in full (no payments) in a Chapter 7 bankruptcy case.
• In other circumstances, income taxes can be discharged in a Chapter 13 bankruptcy case, with the taxes paid in full over five years, but with interest and penalties paid over five years at a discount.
• On the other hand, trust fund taxes are generally not dischargeable in a bankruptcy case. Trust fund taxes are taxes that are required to be collected or withheld from a third party, such as sales taxes and payroll taxes.

4. Offer in compromise (OIC). This is an option for both federal and North Carolina tax liability.

• A federal OIC is an agreement between a taxpayer and the Internal Revenue Service that settles the taxpayers tax liabilities for less than the full amount owed.  If the liabilities can be fully paid through an installment agreement or other means, the taxpayer will in most cases not be eligible for an OIC.
• The North Carolina Secretary of Revenue has statutory authority to accept full settlement of a liability for a lesser amount that is due when, in his or her opinion, it is in the best interest of the state.
• WARNING: Offers in compromise are a waste of time and money for most taxpayers, and this area is fraught with traps for the unwary. The IRS has specifically warned of advertisements and solicitations offering to settle tax debt for  pennies on the dollar.  Taxpayers should consult with a qualified and experienced advisor (such as a CPA, enrolled agent, tax attorney, or bankruptcy attorney) before going down this path.

5. Collection, through tax liens, levies, sales, and garnishments.  Above all, remember that the IRS and the NCDOR are super-creditors. Unlike most creditors trying to collect from North Carolina debtors (see N.C.G.S. 1-362), the IRS and NCDOR can and do garnish wages and levy on taxpayer bank accounts. Many exemptions do not apply to tax collections; in other words, property that might be beyond the reach of North Carolina residents’ other creditors can be taken to pay IRS and NCDOR tax debt.

If you are an attorney, you may be interested in the continuing legal education seminar about taxpayer rights and responsibilities that I am planning for the Mecklenburg County Bar.

If you are behind in your tax obligations, do not rely on this post or any information found on the Internet as qualified legal advice for your particular circumstances; get legal advice from a good attorney who goes over your entire financial situation with you.  With the heavy hands granted tax authorities you should seek qualified legal counsel so that your rights and options are thoroughly explained for your circumstances.

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I spent some of my day assisting yet another elderly client with financial problems.  Surprised?  Don’t be.  Rick and I and our paralegals discussed at lunch today the fact that we seem to be seeing more and more elderly people with debts that they cannot pay.

The causes vary from client to client, but usually include either medical problems (both the cost of health care, and the inability to focus on finances while ill), or a limited, fixed income, or both.  After all, as we age, our health inevitable declines, and it is tough to rebuild when you will never work again and are limited to a modest Social Security or other retirement income, and these two problems are more common among the elderly.  Of course, the elderly also may experience the same problems as the rest of us:  failed businesses, decline in value of real estate, inability to modify mortgages, etc.

We also regularly spend time advising clients who are high earners, but nonetheless have financial problems.  A good deal of our practice these days involves advising individuals whose household income exceeds $250,000.00 annually, but cannot pay their debts as they become due.  How does this happen, you ask?  Generally, it is the result of a failed or failing business, crushing student loan debt (whether their own or that of children, etc. for which they co-signed), investment in real estate prior to the real estate collapse, or some combination thereof.  Sometimes, illness, a layoff, or a divorce also plays a role.

Bottom line, in this economy, no one economic bracket or age group seems to be immune from financial disaster.

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Q: What questions does Mitchell & Culp, PLLC ask a prospective Chapter 11 client to determine whether they should “collapse the company” or restructure in Chapter 11?

A: We start by asking about the assets and liabilities of the company, whether the business is currently operating and if so to what extent, and what it would take for the company to (1) break even and (2) be profitable. Sometimes, it is immediately obvious that the business simply needs to close, and the owners need to focus instead on their finances and find a new line of work. For example, if the business sells widgets, and has not sold enough widgets for the past year or two to pay its overhead, then no reorganization is going to save the business.

“Collapsing the company” – a closely held corporate entity transfers its assets and liabilities to the owner(s), usually a husband and/or wife, and then the individual(s) file for Chapter 13 and do business as sole proprietor(s) – is appropriate only for small businesses, what we think of as mom and pop businesses. That will not work where there are multiple owners or shareholders, or where the owner(s) personally have significant assets that they would lose in a personal bankruptcy case.

Q: What other types of entities can consider Chapter 11 bankruptcy? Can non-profits file for Chapter 11 bankruptcy?

A: Corporations (including LLCs), partnerships, individuals, and individuals doing business can all be a debtor under Chapter 11. This all includes both for profits and non-profits. Restaurants, retail businesses, golf courses, real estate developers, consultants, churches, and manufacturers have been debtors in the Western District over the years, and none of them infrequently.

Q: What advice do you usually give to prospective clients when Chapter 11 isn’t viable for them?

A: It depends on whether the financial problems are limited to the business, or spread to the owners; also depends on whether the entity wants to try to continue in business or not.

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Chapter 11 is not as straightforward to explain as Chapter 7 or Chapter 13, so we designed this FAQ:

Q: How “big” does the owner’s business have to be to even consider Chapter 11?

A: We cannot quantify how big a debtor should be in a Chapter 11. We have filed Chapter 11 cases for at least four individuals in the last five years, so it’s more a question of assets (including revenue stream).

Liabilities can also come into play; there are unsecured and secured debt limits on eligibility to be a Chapter 13 debtor, so sometimes that must be factored in and may make a Chapter 11 case more appropriate.

Everything is a very fact-specific, case-by-case analysis.

Q: How much does it cost to file a Chapter 11 case?

A: Chapter 11 cases are costly. The filing fee alone (what’s paid to the court at the time of filing) is $1039.00, compared to $274.00 for a Chapter 13 and $299.00 for a Chapter 7.

In addition, we handle Chapter 11 cases on an hourly basis, as do most experienced Chapter 11 attorneys. It is impossible to predict at the time of filing how much time will be spent by the attorneys throughout the case, because there are so many variables. However, at a minimum, our firm’s attorneys’ fees and expenses for a Chapter 11 are rarely less than $20,000.00, and in some instances, are significantly higher.

Q: What usually disqualifies a business for consideration as a Chapter 11 case?

A: If the business has stopped operating, or has no assets, then there is no point in attempting reorganization. Also, we discourage single asset real estate debtors from Chapter 11 if they have been unable to secure (re)financing after giving it their all. Chapter 11 can do lots of things, but it can’t raise capital or force financing that doesn’t exist.

Q: Who shouldn’t even bother asking for representation for Chapter 11?

A:  People who aren’t comfortable with transparency, because bankruptcy requires full disclosure of financial affairs.

People who can’t trust their attorneys, because we need free and full communication with our clients in order to represent them.

People who can’t listen, aren’t open to new ideas and ways of doing business, and/or can’t take advice – entrepreneurs, especially, tend to be risk-taking cowboys. If it works, great, but if Chapter 11 is on the table, then some things need to change.

The only way to understand your bankruptcy options is through a bankruptcy counseling session with a qualified bankruptcy attorney. 

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