on the Bankruptcy Soapbox

My colleague Rachel Foley explains the limited circumstances when debt is enforceable after a bankruptcy discharge.

Despite the fact that credit card debt has been discharged in bankruptcy, odds are that some discharged debt will surface years after a bankruptcy discharge with a demand for payment.  Debtors tend to come back to their lawyers and claim the lawyer screwed up, if this debt survived.  The truth is that the debt didn’t survive:  it is unenforceable and the original creditor never bothered to tell the debt buyer who purchased the worthless debt. It’s the debtor who is subjected to the distress of worrying that the discharge didn’t kill off all of his debt.

Bottom line, attempts to collect discharged debt violate the discharge injunction  Debtors should be prepared to copy debt buyers with copies of the discharge and list of creditors showing the original creditors.  A second contact after such notice may entitle the debtor to damages for violation of the discharge.

An article on the  Network Bankruptcy Law on exemptions touched obliquely on a point not widely discussed:  debtors get to keep assets where the sale value of the asset equals the exempt amount PLUS the costs of administering the asset.  A basic principle guiding what a Chapter 7 trustee does is that he only administer assets of the debtor where his sale of the assets results in a meaningful dividend to creditors.   Where I practice, trustees are not interested in opening a case where the gross funds in the estate is several hundred, or even several thousand dollars.  By the time the trustee pays his commission, an accountant to prepare a tax return and examine claims, that sum of money won’t pay a meaningful dividend to creditors.  In those situations, most trustees will abandon the non exempt value in assets.

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A basic principle of law is that each person is only personally liable for debts they create:  marriage does not automatically make the spouses liable for each others debts.  An exception is debts for necessities of life.

In California, a marriage can be seen as comprising three entities (wouldn’t you know it in California):  husband, wife, and the community property.  California law assumes that assets acquired during marriage are community property.  The entirity of the community property is liable for the debts of  either spouse.

Under this system, then, if husband contracts a debt, husband’s creditor can reach both halves of the community property to satisfy that debt.  If the parties don’t have community property, as by reason of a pre nuptial agreement, then the creditor can reach only the husband’s earnings and assets.  If the spouses divorce, the community is terminated.  Once the community property is divided in the divorce, that former community property becomes the separate property of the recipient spouse.

More about community property in bankruptcy. 

I wrote earlier about the erroneous assumptions that clients make when they are served with a suit for money owed.  The first is that there is an immediate, life changing emergency.  The second, which I want to explore today, is that they have a court date some months in the future. Wrong.

California law provides that a defendant, the person sued, has 30 days from the service of the summons in which to answer the complaint.  The answer tells the other side and the court what are the disputed issues in the suit.  Does the defendant claim he’s not the person who owes the money?  that the amount of money is incorrectly stated?  that he’s paid it in full?  Unless the parties settle, the court will decide those disputed issues at trial.

However, if the defendant does not answer the complaint, the court assumes that the defendant does not dispute the contentions of the complaint.  If there is not dispute, and the plaintiff has followed the procedural rules, the court will enter a judgment for the plaintiff just as soon as the plaintiff submitts the correct papers.  There is no need for that hearing date in the papers if there is no properly teed up dispute for the court to resolve.

So, the moral of this story is that the defendant must file a timely answer to the complaint in order to prevent entry of a default judgment for the relief sought in the prayer of the complaint.

If the defendant agrees that they owe the money, which is most often the case among my clients, then the real issue is what to do about debts you can’t pay.  We discuss their bankruptcy options.

Cathy Moran

Bankruptcy in Brief 

What often brings a prospective bankruptcy client to my office is the filing of a collection suit by a creditor. Almost invariably, the client has leapt to two incorrect assumptions: one is that the world as they know it is coming to an end; and two, they don’t have to do anything until the date set for the case management conference, months down the road.

On the issue of the implications of a lawsuit, it is a step toward a judgment in favor of the creditor. A judgment is a determination that the debtor owes the amount of the debt and usually the creditor’s expenses to get the judgment. A judgment entitles the judgment creditor to enlist the coercive power of the state to collect that judgment by levy, lien or garnishment.

A judgment in California does not automatically constitute a lien on the debtor’s assets, as it does in Georgia where my colleague Jonathan Ginsberg practices. Jonathan writes that a judgment creditor is automatically a secured creditor.

In California a creditor with a judgment must take an additional step to create a judgment lien. A judgment lien on real estate is created when an abstract of judgment, issued by the court after entry of judgment, is recorded in the records of the county recorder. A judgment lien on personal property is created by filing a notice of judgment with the Secretary of State.

A judgment lien allows a creditor to execute on that lien through the courts. In that process, even outside of bankruptcy, the judgment debtor may claim an exemption in certain kinds of property. The California state exemptions are set out in Bankruptcy in Brief.

In short, getting a judgment is just a step toward actually taking something from the judgment debtor. All these steps take time and cost the creditor something. The filing of a suit may be a good indicator that the client needs to do something proactive about their financial situation but it is not an emergency.

More about the second erroneous assumption tomorrow.

Two tax issues popped up as I discussed impending foreclosures with a client with several investment properties.  Remember that a foreclosure sale is treated for tax purposes as though it was an actual sale, with the winning bid treated as though the property owner got the money.  The result is that a capital gain may result.  This is more likely if the property has been held for a substantial period and the tax basis reduced by depreciation or the property has been refinanced and the equity pulled out.

The second possible tax gotcha may arise in short sale situations where the amount of the shortage may result in cancellation of debt income.

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While most folks considering bankruptcy believe they can live without credit cards, they worry that they will need a loan to replace a car at some point in the near future. The debt management/debt settlement industry has conditioned them to believe that no credit is available for eons to those who have filed bankruptcy. Hogwash.

Steve Otto has some good advice about applying for a car loan after bankruptcy. He points out that under the credit scoring system used by Fair Isaacs, your credit score improves after bankruptcy.

The most compelling evidence that credit for a car is available after bankruptcy is the fact that many debtors currently in Chapter 13 (meaning they haven’t even gotten the discharge of their debts yet) get loans to replace old cars. The auto industry can be counted on to see that you can get a loan to buy their product!

Talking about our financial difficulties is taboo in this society. We lionize those who make a fortune; everyone expects to live the middle class life. Most of those meeting with a bankruptcy lawyer for the first time manifest some kind of shame, the sense that their financial hole is the sign of a moral as well as financial failure.

As long as no one will talk about it, each person imagines that they are the only one with this sort of problem. ( see a profile of the typical bankruptcy filer). They imagine that they will have to justify their situation to the bankruptcy system in order to get a discharge.

The cult of silence may be why the debt settlement/debt management businesses do so well. For a price, you can hire someone to get you out of the hole without declaring bankruptcy, and therefore failure. Only those models seldom work for one of two reasons: writing one check for the same amount as you wrote a bunch of smaller checks is still the same amount of money. It’s not the number of checks that is the problem, it’s the amount of money necessary to retire that debt, even over time.

The debt settlement model fails because creditors don’t stop trying to collect when contacted by one of these for profit outfits. The first money paid by the consumer goes to the company, not the creditors. So the consumer gets hassled by creditors or sued by one of more before the debt settlement folks have paid anyone but themselves.

Individually and societally we would be better off with more openness about personal finance. As I wrote earlier,we should practice candor about money with our kids. Collectively, have an honest dialogue about the role of credit in our economy and about the massive transfer of money from the middle class to the financial industry in the form of credit card interest, fees and penalties. Look at the extent to which borrowing on credit cards has replaced a societal safety net.

How will filing bankruptcy change your life?  Rachel Foley over at BankruptcyLawNetwork pondered about how bankruptcy might not change clients lives if they continue to confuse “wants” with “needs”.

My short, irreverent answer to that question from clients is that they will sleep better at night.  They will experience a drop off in telephone calls from collectors and their mail will shrink in volume.  The more serious answer has to reflect how they got to my office to file bankruptcy. 

When the  driving force was gambling or some other irresponsible behavior, I tell them that I can dig them out of this hole with bankruptcy relief, but I can’t save them from a recurrence of that kind of spending.  When the driving force is one of those things beyond their control, like job loss, divorce or illness, I can be far more certain that they will cherish a fresh start. pay for insurance or savings rather than minimum payments on credit cards, and savor relief from crippling debt.

JumpStart, a national coalition of financial education organizations, tested high school seniors on financial literacy:  the average score was an F-!  No wonder young adults get caught up in the credit trap right out of school.

I see financial illiteracy in their parents, as well.  So many of my clients seem to measure their financial management skills by their ability to make the minimum payments on overwhelming credit card debt on time.  Too few of them have considered that it may take 30-40 years to pay off credit card debt making minimum payments.  Meanwhile, they have no cash reserves and no retirement savings.

As a society, we have a real reluctance to speak openly even within our families about money matters.  Our kids grow up knowing only what we tell them about how they manage their money, not about the financial realities of our family money situation.  Educating kids about money is not just a task for the schools;  it needs to be discussed and modeled at home.

I don’t believe that a more money savy populace will necessarily significantly lower the rates of bankruptcy filings;  bankruptcy is driven in the most part by illness, job loss, and divorce.  I can hope that consumers with some financial skills may recognize earlier that they can’t escape their money woes by making minimum payments, and consider a fresh start sooner.

Technorati Tags: bankruptcy, financial literacy, kids & money