Lien Stripping Case At Supreme Court

The United States Supreme Court may give us an answer to the following question:  If you have a home with a first mortgage that exceeds the value of the home, can you use a Chapter 7 bankruptcy to "strip off" a second mortgage?

Most of the judicial circuits around the country do not permit this in a Chapter 7, although most cases DO permit a person to do this in a Chapter 13 payment plan bankruptcy.

The case pending at the US Supreme Court is entitled "Bank of America, N.A., v. Caulkett" and comes out of the 11th Circuit.

The Caulkett case is linked with another case, Bank of America N.A., v. Toledo-Cardona. 



The Caulkett case is 13-1421.  The Toledo- Cardona case is No. 14-163.

This link should lead you to the 11th Circuit decision in the Caulkett case:

 https://cases.justia.com/federal/appellate-courts/ca11/14-10803/14-10803-2014-05-21.pdf 

The decisions are very brief, and basically hold that the 11th Circuit cases of McNeal and Folendore hold that this can be done in a Chapter 7.  Those case are: Folendore v. U.S.Small Bus. Admin., 862 F.2d 1537, 1538-39 (11th Cir. 1989) and McNeal v. GMAC Mortg., LLC, 735 F.3d 1263, 1265–66 (11th Cir. 2012) (percuriam).

This does not sound all that exciting, until you realize that being able to strip an underwater second mortgage in a Chapter 7 would tremendously help homeowners in that situation.  Many people could handle their first mortgage payments, but cannot pay both their first mortgage and their second mortgage.

The decision will be big news in the bankruptcy world when it is announced.  I will certainly post when the decision comes out.

Subprime loans were cash out, not purchase

Although not directly related to current bankruptcy practice, I thought this was interesting.

I came across an article in the New York Times, published on November 14, 2014, with the following interesting paragraph:

One of the most abjectly false narratives about the financial crisis is that risky mortgages proliferated so that people who couldn’t afford homes could nonetheless buy them. Modern subprime lending was not about homeownership. Instead, the 1990s crop of subprime mortgage makers allowed people with bad credit to borrow against the equity in their existing homes. According to a joint HUD-Treasury report published in 2000, by 1999, a staggering 82 percent of subprime mortgages were refinancings, and in nearly 60 percent of those cases, the borrower pulled out cash, adding to his debt burden. The report noted that “relatively few subprime mortgages are used to purchase a house.”

The full article can be accessed at:

http://www.nytimes.com/2014/11/14/opinion/a-house-is-not-a-credit-card.html?_r=0

Inherited IRA not automatically exempt

We commonly say that an IRA is exempt in a bankruptcy, up to $1,000,000.00 of value.  However the US Supreme Court has ruled that this general statement is not correct in the case of an inherited IRA. The citation is:  Clark v. Rameker, 134 S. Ct. 2242, 189 L. Ed. 2d 157 (2014).  In that case the Court said:  “[t]he text and purpose of the Bankruptcy Code make clear that funds held in inherited IRAs are not ‘retirement funds’ within the meaning of §522(b)(3)(C)’s bankruptcy exemption."

The facts of the case are that Mrs. Clark's mother set up an IRA in 2000 and named her daughter as the beneficiary of the IRA.  The mother died shortly thereafter, and the account passed to her daughter.  About nine years after that the daughter filed chapter 7 bankruptcy.  The account was worth about $300,000.00 at that time.

Mrs. Heffron-Clark claimed the IRA as exempt under 11 U.S.C. Sec. 522(b)(3). The trustee objected to the claimed exemption, arguing that the money in an inherited IRA is not "retirement funds" and therefore not exempt.

The Supreme Court opinion first noted that "Inherited IRAs do not operate like ordinary IRAs. Unlike with a traditional or Roth IRA, an individual may withdraw funds from an inherited IRA at any time, without paying a tax penalty."

The Court then said:  "Three legal characteristics of inherited IRAs lead us to conclude that funds held in such accounts are not objectively set aside for the purpose of retirement. First, the holder of an inherited IRA may never invest additional money in the account.... Second, holders of inherited IRAs are required to withdraw money from such accounts, no matter how many years they may be from retirement....Finally, the holder of an inherited IRA may withdraw the entire balance of the account at any time — and for any purpose — without penalty."

Ruling against Mrs. Clark, Justice Sotomayor said:  "For if an individual is allowed to exempt an inherited IRA from her bankruptcy estate, nothing about the inherited IRA's legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete. Allowing that kind of exemption would convert the Bankruptcy Code's purposes of preserving debtors' ability to meet their basic needs and ensuring that they have a "fresh start,"Rousey, 544 U. S., at 325, into a "free pass," Schwab, 560 U. S., at 791"

Fortunately, this is a pretty limited decision, for most people will set up their own IRA, not inherit one.  However, I mention it as it is yet another example in which there is an important exception to the general rule.

Judgments, again

As I said in a prior post, the Minnesota state court central administration has come out with an interpretation that requires a person with a judgment to pay a full filing fee in order to discharge a judgment entered against them, rather than the $5 that the statute (Minn. Stat. 548.181) calls for.  The full filing fee is $322 or $324, and it is very unusual for a defendant to have paid a filing fee.

I had hoped the Legislature would "overrule" this interpretation.  I thought it would have been reasonable to change the law and have the court system charge $25 or $40 or something like that, but $324 per judgment seems pretty outrageous.  After all, the defendant did not invoke the legal machinery of the court system, the plaintiff did.  (I will have a letter in to Jeff Shorba, the state court administrator, asking him how much money the state court system really collects out of defendant filing fees;   if I get a response I will post it here.)

Well, the Legislature has gone home for the rest of the year, so apparently we are not going to get any change in the law for the rest of 2014.

My thought, therefore, is to for the most part delay using the state court application to discharge judgments until 2015, in the hopes that the Legislature will take this up next year.

If you are going to any candidate forums this election year, maybe you could ask your candidate for State Representative or State Senator about this issue.

Discharging judgments in Minnesota

Very often a client who needs to file bankruptcy will have one or more judgments already entered against them in state court.

Bankruptcy is done in the federal court system;  judgments (for the most part) are entered in the state court system.  The two court systems do not "talk to each other".

So, what happens to a judgment in bankruptcy?

Briefly, a money judgment is a court order that determines that you owe a certain amount of money to a particular person or company, and authorizes that person or creditor to take your non-exempt property.  Bankruptcy wipes out the personal obligation for a judgment*, and means that a creditor cannot take active steps to collect the judgment.  However, a bankruptcy discharge does not remove the judgment from the records of the state court..  

We have a very simple procedure here in Minnesota to get the judgments off the state court record.  The law which authorizes this is Minn. Stat. 548.181.  What we have to do is to get a copy of your bankruptcy discharge, fill out a particular form, and mail both items to the last known address of the judgment creditor, and pay the court $5 per judgment.  If the judgment creditor does not file an objection within 20 days, the Court Administrator discharges the judgment upon the court records.

A caveat:  The state court administrator has recently come up with a theory that this application is a "paper filed with the court", and is apparently demanding that applicants pay a full court filing fee ($324.00 in most counties) instead of $5.00.  Ouch!  I understand that the state court system would like to have more funding, but I hope this new interpretation is rolled back, either by specific legislation or by one or more lawsuits.

*  Of course, some judgments are for non-dischargeable debt.

Reaffirming Home Mortgages

Recently I have gotten several calls from clients who have been told by some anonymous person at their mortgage company: "You should have reaffirmed your mortgage".

First off, what is reaffirmation?   It is a procedure under the Bankruptcy Code in which you sign a formal agreement stating that, even though you filed bankruptcy, you are still personally obligated to pay the debt.

How does this apply to mortgages?  Some background:  A mortgage is actually two things.  One is the promissory note, in which you promise to pay Wells Fargo Bank N.A. $100,000 at 4% interest over thirty years.  The second thing is the mortgage itself, which says that you put up a particular piece of real estate as collateral to secure the payment you promised to make in the promissory note.

A chapter 7 bankruptcy discharges the personal obligation to pay, but does not remove the lien from the real estate.  (Some mortgages can be removed through a chapter 13, but that is a different issue).

So, if you own a house and file bankruptcy and get a discharge, the end result is that you still must pay the mortgage to keep the home -- if you do not, the mortgage holder will foreclose its lien and take the home. However, if you have not reaffirmed, the mortgage holder cannot pursue you for any deficiency if the house does not bring enough to cover the amount owed on the mortgage.

If you have reaffirmed the debt, however, the mortgage holder could pursue you for any deficiency.  (This is not terribly likely, since most conventional mortgages in Minnesota are foreclosed by advertisement, with a six month redemption period -- but again, this is a subject to a different post.)


What are the benefits of reaffirming a mortgage debt?:

1)  If you do not reaffirm your mortgage in a chapter 7 bankruptcy, the lender may may not let you refinance with them in the future.  Wells Fargo Bank N.A., I am told informally, does this.  My response is:  Try a different bank.  There are dozens of them. 
2) The lender may (likely will) refuse to report your ongoing payments to the credit reporting agencies.  The work-around is to pull a payment history from the mortgage company and then pull a credit report (through (www.annualcreditreport.com) and  dispute the credit reporting agency report if your payments do not show up.

I hope the real estate market has stabilized, although I do not know for sure;  if so, it may be somewhat less scary to reaffirm a home mortgage.  However, you must realize that, if you reaffirm, you are putting yourself back on the line personally for a very large obligation, with no real benefit other than the two minor points noted above.  If the real estate market turns sour again, or the if the mortgage company chooses to foreclose by action, they can hold you liable for a very large deficiency, even though you filed bankruptcy.

1099C received from creditor?

Tax returns were just due, which means that I have gotten several calls from clients who have gotten a 1099C form from their creditor and want to know what to do.

A form 1099C is an IRS form (like a W-2) which a creditor uses to tell the IRS that a debt was forgiven, in whole or in part.

The IRS will get the form 1099C from the creditor and will think that you have taxable income.  This is because usually the cancellation of debt is a taxable event.  Say that you owe Discover Card $5,000, and you settle the debt by paying Discover Card $3,000.00.  On paper you are $2,000 better off ($5,000 owed minus $3,000 paid = $2,000 improvement), and that $2,000 looks like income.  As the basic rule is that income is taxable, it looks on paper as though you "made" $2,000.00.  

There are five exceptions to this however, of which two are most common.  You use IRS Form 982 to tell the IRS that one of the exceptions applies to you.

You can get Form 982 and the instructions at the IRS website, which is www.irs.gov  Also useful is Publication 4681, which goes into more detail and gives examples.   Both of these are free to download.

The first major exception to having to recognize cancelled debt as income is that the cancellation of the debt took place in a bankruptcy.  In my practice that is the most common.  Unfortunately, some creditors will send the 1099C even though the debt was discharged in a bankruptcy.   If your tax preparer does not ask you if you filed bankruptcy, you may wind up paying tax on cancellation of indebtedness income, even though the bankruptcy exception applies.  The moral of this part of the story:  Tell your preparer about your bankruptcy discharge and be sure a Form 982 is included in your filing, if applicable.

The second major exception, applicable outside of bankruptcy, is that after the cancellation of the debt you were still insolvent (meaning, you owed more than your assets were worth).  For example, let's say that you own nothing in the world except household goods and clothing worth $4,000 and a car worth $3,000 and $3,500 cash in the bank.  At the same time you owe Visa $4,000, MasterCard $3,000.00 and Discover Card $5,000.  So, your assets add up to $10,500;  your liabilities add up to $12,000.00.  You are insolvent by $1,500.  So, if you settle your Discover Card for $3,000.00, your situation now looks like this:

household goods and clothing $4,000
car $3,000
cash $500
total of assets: $7,500.00

Debts:

Visa $4,000
MasterCard $3,000
Discover Card $0
total of debts:  $7,000.00

So, before Discover Card cancelled $2,000 worth of debt,  you were insolvent by $1,500;  the cancellation of debt in the amount of $2,000 thus made your assets in surplus by $500.  Thus, in this example, you would have to claim $500 of income on your tax return from the $2,000 that Discover Card cancelled.

As you can see, the second major exception will involve some amount of math.

The point of this post, however, is to tell you  to not simply accept the 1099C as income;  get Form 982 and the instructions from the IRS website, fill it out, and file it with your taxes.  It may save you a lot of aggravation later on!

I  should add that there are three other exceptions, and that there is a very important one relating to "qualified principal residence indebtedness", meaning the mortgage against your home.  

For more details, get Publication 4681, which has a number of examples.

 CIRCULAR 230 NOTICE: In accordance with IRS Treasury Regulations, we are required to notify you that any tax advice given herein (including attachments) is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding any penalties that may be imposed by any governmental taxing authority or agency or (2) promoting, marketing or recommending to another person any tax related matter.