The Supreme Court’s recent decision in Lanning and the application of the infamous “means test” to a client’s changing income picture has changed my advice about when to file bankruptcy.

My standard advice to clients newly unemployed who see clearly they won’t be able to pay their existing bills has been to wait.  Wait until you can see things improving.  Wait til you have acquired something that a creditor with a judgment could take from you.  Wait til you have an income such that my fee doesn’t take food off the table.

The Kagenveama decision holding  that the means test was mechanical and meant what it said about how we measured ability to pay creditors.  The means test, after all, was the statute to end judicial discretion on this subject.  I knew that as long as we were measuring ability to pay by looking backward into a period of unemployment, my client would pass the means test.

Now, Lanning says the court can take into account, on ability-to- pay issues, changes that are virtually certain to occur in the future.  Bingo, the future income of my previously unemployed client now must be factored into the mix.

In the usual fashion of Supreme Court decisions, the justices don’t tell us how to do that.  Lanning dealt with a significant, one time payment in the look back period which distorted the current monthly income average.  In that case,  being decoupled from the mechanical means test meant the bonus could be excluded from the  calculation.  We aren’t told how to deal with a future of steady, level income replacing months of no income.  Does the means test become irrelevant on those facts?

Since I’m not anxious to have my clients be the next test case if I can help it, I’m changing my advice:  let’s consider filing sooner rather than later, so we are confident that finally getting reemployed isn’t going to doom the client to failure on the means test.

On doing the means test yourself.

My friend David Leibowitz explores the fears his clients have of bankruptcy on Bankruptcy Law Network.  I encounter clients with the same emotions, fear that life as they know it will end if they file bankruptcy.  Well, at some level, the miserable life of living in debt; sleepless nights;  having no financial  reserves will end.  But their fears are of something more horrible yet, bankruptcy.

Why aren’t they afraid of being penniless in their old age? This seems to me to be a real fear.  Almost every client who’s struggling to repay credit cards, now at 29% interest, is skimping on saving for retirement.  Courtesy of the Great Recession, they have no equity in their homes.  If they have a job, there’s no pension attached.  They have little or nothing set aside to augment Social Security.  Yet fear of bankruptcy keeps them paying on debt they can never repay.

My last post talked about the institutional purveyors of this fear.  I’m on this soapbox and don’t want to step down til I make some headway on this issue.

As one of the Peanuts characters said, “Arghhhhhhh!”

The clients in financial trouble couldn’t get the attention of their mortgage lender about the coming train wreck.  But you’re current, said the telephone representative for the lender.  So, the clients deliberately missed a payment to make their point that they needed help.

Care to guess what happened next?  Determined to remain only one payment down, they sent the next payment, and IT WAS RETURNED.  It was followed by a notice of default.

So now the clients are talking to bankruptcy counsel and are looking for ways to get the constructive attention of PNC Bank.

The would be client had millions of dollars of equity in the house at stake, yet waited til the week of the foreclosure to look for a bankruptcy lawyer.  The required case would be a Chapter 11, which is heavy on procedure.  I didn’t have the capacity to take on such a case on an emergency basis.  Neither could one of my most esteemed colleagues.

How did the homeowner get into this bind?  He’d been trying to negotiate a resolution and a modification right up to the last minute, and at the last minute, the lender said “no”.

I’d like to report that this scenario is aberrational, but it isn’t.  I am not seeing many accepted modifications or even workouts, much less ones that actually improve the homeowner’s situation.  If you are facing foreclosure, don’t bank on positive response from the bank if you envision bankruptcy as the last ditch choice.  There may no capable bankruptcy attorneys available who can turn a case around in less than a week.

I’ve continued to think about my response to David Leibowitz’s discussion of getting out of debt without bankruptcy.  My first response focused on the choices inherent in paying off creditors outside of bankruptcy.

I forgot to point out the efficacy issue:  if you try to pay off your debts via settlement, it takes only one or two big creditors who won’t settle on tolerable terms to undermine the entire effort to repay creditors.  If you can’t get a big creditor to join the rest in compromise, you may have wasted everything you’ve paid out to compliant creditors in an effort to avoid filing bankruptcy.

My favorite story explaining why I don’t attempt debt settlements for clients involves a client who had only two creditors.  Her parents were willing to fund a 50 cents on the dollar settlement if I could get both creditors to agree.  It was obvious that the client could count on filing bankruptcy and discharging the debt.

Over a period of months, I was unable to get just two creditors to buy into a solution that got them half of their debt on the spot.  The client ended up filing Chapter 7; the creditors got nothing.

If you want to pay creditors and be assured of a resolution, file a Chapter 13.  Compel the creditor to accept partial payment.

In short, the weakness of an out of court settlement with creditors is that a real, non bankruptcy solution requires 100% participation of creditors and an absolutely assured stream of cash to pay creditors.

Too often, there are too many things that can go awry in such a scheme, and money is spent on some creditors before the approach craters.

My clients often ask if there is an alternative to bankruptcy.  David Leibowitz, my colleague at Bankruptcy Law Network, outlined what it takes to get out of debt without bankruptcy.  The simple answer is make more money;  spend less on today’s expenses; use all your savings to pay off debt.

I want to pose the question:  even if that’s possible,  is it smart?  What do you forgo in that scenario?  If it’s travel; lattes; and premium cable, I’m OK with that.  But, if what you do without is emergency reserves; health insurance; and retirement savings, I think that a poor choice.

Whether financial difficulty was caused by bad luck or bad choices,  don’t make a bad decision, driven by pride, to compound the trouble by living without a safety net.  Too many of my clients arrive in my office with the conviction that they incurred this debt and, by damn, they want to repay it.  At some level, I applaud that desire.  But what are the likely consequences of repaying that debt if it means making no provision for financial stability now and in the future?

Part of reforming your financial situation involves looking beyond this month’s bills to the needs of the next decade and beyond. Lots of folks got into credit card debt focusing on their ability to make the monthly minimums, rather than on their ultimate ability to pay the debt off.

Particularly in times of profound economic uncertainty, consider the merits of a  fresh start and a plan for financial self sufficiency.

A bankruptcy court in Oakland recently rebuffed a mortgage lender who claimed it had been defrauded by borrowers who lied on the loan application. The judge agreed the debtors falsely inflated their income, but found that the lender had not reasonably relied on the false representations. The lies were not enough to make the debt non dischargeable when the lender was asleep at the switch.

The broader question in the mortgage meltdown is whether the Wall Street firms that bought these liar loans from the sleeping lenders have any recourse against the lender. Can the seller of the loan escape responsibility for selling a financial instrument of questionable value? Did the Wall Street buyer have to investigate the actual bona fides of the loans or is it entitled to rely on the lender’s representation that the loan was sound?

Street smarts suggest that Wall Street was content not to look too closely at these loans so it could pretend that all of this profitable paper was what it was puffed up to be. Under the theory of the Hill case, they, too, may be found not to have been reasonable in their reliance.

Susanne Robicsek and I must be lawyer twins, separated at birth. She suggests that those with financial troubles consult a bankruptcy lawyer sooner rather than later. Amen.

Countless times a caller has asked me, should I wait until all of my savings are gone to file bankruptcy? And these folks didn’t mean, until my net worth is greatly reduced; they meant, until my bank balance is zero.

One has to admire the resolve of those who propose to pay on debts that they can never repay up to the point when they literally have nothing left. My advice of course is “no”.

Bankruptcy allows you to keep a collection of assets necessary for a fresh start. There is no bankruptcy entrance requirement that you be destitute or even insolvent to file bankruptcy.

So often I wish clients had come to me earlier: before they borrowed against their retirement to pay credit cards; before they took bad home loans that imperil their home; before they borrowed from one credit card to pay on another.

Susanne is right: it can never hurt, and often help, to get sound advice as soon as you realize you have a problem.

At least three homeowners called my office this week with a foreclosure sale set in less than 5 days and wanted to file bankruptcy to stop the sale. What is with people who wait until the last minute to look for a solution to losing their home? When I’m tired and cynical, I think they must believe in the genie in a bottle, willing to give them three wishes.

But the stories got stranger still, as we talked to these callers: two of the three wanted to stall the foreclosure so that they could complete a short sale. The sale was going to result in no money to the homeowner and they would lose the home, yet they thought they were ready to spend money to file bankruptcy for the privilege of selling rather than being foreclosed.

Historically, we have found that people who wait til the last minute make difficult clients. They put off unpleasant tasks and fail to appreciate deadlines, or even that their lawyer is bugging them in order to make things better.

I decided that I am not willing to take on emergency bankruptcy filings for procrastinators unless there is something to save by the exercise. Enabling a short sale doesn’t measure up.

My colleague Susanne Robicsek wrote about the implications of a state to state move on filing bankruptcy. Where you live and how long you have lived there drive where you file and what exemptions are available.

A different issue arises when you contemplate moving from a house that’s been foreclosed to rental housing in the same area. The impact of a bankruptcy filing on potential landlords is one of the things I have found hardest to predict for clients. Some landlords want an elaborate application, references, and a credit check; others want far less.

It is my sense that if you must secure rental housing around the time you expect to file bankruptcy, you are better off shopping for and leasing before you file bankruptcy. While your credit score may be poor, being a debtor in a pending bankruptcy is usually scarier for a landlord.

Like any credit transaction you complete before filing bankruptcy, make sure to be completely honest in answering any questions put by the landlord. Lying on your application may invalidate the agreement. You don’t have to volunteer bad news, but don’t willfully misstate the facts.