Spend the rents generated by a property in foreclosure and you may have invited big trouble even if bankruptcy is in your future.

The borrower in the typical real estate transaction pledged the rental income and other proceeds of the encumbered property to the lender along with the real estate, as security for the obligation to repay the loan. Those rents are “cash collateral” in which the lender has a legal interest.

The borrower may have a fiduciary relationship to the lender with respect to those rents. Failure to pay them over to the lender may be a species of fraud, potentially non dischargeable in bankruptcy.

I’ve seen a rash of clients in the past couple of weeks who have rental houses that are now, or soon will be, in foreclosure. Once a notice of default is recorded, starting the foreclosure process, the lender won’t accept payments unless the borrower can tender the entire amount necessary to cure the default.

So, the borrower is collecting rent from the tenants but the lender isn’t accepting payment of those rents if not sufficient to cure. The borrower is in possession of a hot potato.

My advice to such clients is to set up a bank account and deposit any rent net of the costs of preserving the property to this separate account which contains only the cash collateral that belongs to the lender in question.

I haven’t yet had to figure out if/when the lender will accept payment of those funds, but that’s a far better problem to have than a nondischargeability action against the borrower for fraudulent misuse of the lender’s security.

If this fact pattern mirrors your situation, get an attorney involved in making sure that you don’t lose more than the property to foreclosure.

My colleague at the Bankruptcy Law Network Karen Oakes talks about some reasons a debtor in bankruptcy may want to object to a claim filed in the case. There is another, a real bombshell, arising out of a 9th Circuit Court of Appeals case Siegel 143 F.3d 525.

Siegel addressed a post bankruptcy dispute between the discharged debtor and his mortgage lender. Even though Siegel’s bankruptcy case had been a no asset case, in which there was no practical need to examine the bona fides of the claims filed, the 9th Cir. held that the Bankruptcy Code presumption that a filed claim was allowed, bound the debtor after bankruptcy.

This holding, which seems to me to be a case of bad facts make bad law, is scary in at least two very common fact patterns in bankruptcy. One is the pattern in Siegel, involving the debtor and the mortgage lender. A second could be the Chapter 13 case that is dismissed, either voluntarily or involuntarily. Will an unchallenged claim in a dismissed case be deemed accurate and enforceable against the debtor?

I don’t know, but I’d rather not find out on my watch.

Bankruptcy works on disclosure: in exchange for full disclosure of assets, debts, and financial history, creditors with notice of the case are bound by the outcome, hopefully the discharge. Disclosure costs the debtor nothing and it insulates the debtor from charges that he has concealed property of value or otherwise been less than candid with the court.

My colleague Jay Fleischman wrote about the consequences of failing to disclose even the right to sue for a violation of consumer law. My questionnaire for clients says repeatedly that you must disclose all of your assets, yet I get back questionnaires showing no clothing (did they come to my office in a barrel?), no bank accounts, no furniture, no car, etc.

Sometimes, they don’t have the kind of property in question, but more often, they made assumptions. They assumed that 1) if the account was overdrawn, they didn’t have to list it; 2) if the clothing was worth little, they didn’t have to list it; 3) if the bank had a lien on it, they didn’t have to list it. The erroneous assumptions go on.

I declined representation in a case this week that promised a five figure retainer in large part because I believed that I could not get the prospective client to take seriously the need to be open and candid with the court.

If you want to keep any asset, tangible or intangible, after the bankruptcy, list it in your schedules. That way, you also get to keep the discharge, the real prize in this exercise.

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.

A small business owner finds it hard to separate themselves from the business, even when that business is incorporated. After all, the owner’s financial livelihood rises and falls with the success of the corporation’s business.

Twice in the past two days, I had occasion to point out to clients who own small corporations that when the bankruptcy trustee says “you”, the trustee is talking about you, the individual, not the business that you have been immersed in.

But the important legal distinction is that the corporation that owns the business is a separate legal “person” from the flesh and blood human being who owns the stock in the corporation and serves as its officer and director. The debts of the corporation are not necessarily the debts of the shareholder. The corporation can file bankruptcy without the shareholder, and conversely, the shareholder can file bankruptcy without impacting the day to day operations of the corporation.

In analyzing a bankruptcy filing or answering questions from a bankruptcy lawyer or bankruptcy trustee, make sure you know who you are.

More on business bankruptcy.

My colleague at the Bankruptcy Law Network Pam Stewart addressed the question “should I pay off my Chapter 13 plan early?”.

Her conclusion addressed the policy in some jurisdictions that a payoff earlier than the plan proposed may trigger a requirement to pay 100% of the debt. That isn’t the rule where I practice, at least under pre “reform” law, thanks in part to an appellate decision I won allowing early payoff without an increase in the pay in.

I think there remains a reason not to pay off a plan early: the plan payments, at least to the extent they are going to general unsecured creditors, represent an interest free loan. Why rush to pay off a debt where there is no cost to paying later?

One danger in proposing to pay off a plan early is the possibility that the trustee might seek an increase in the monthly payment if the debtor now has more available money each month.

I see the continuance of the Chapter 13 plan in circumstances where the debtor’s situation has improved as a chance to build up cash reserves. None of my clients have sufficient money set aside for the unexpected. It’s a chance to put some extra money into delayed maintenance, whether it’s on your possessions or your own health. Practice saving money while the Chapter 13 still exercises some control over your spending.

My advice might differ where the clients are younger or might have a real chance to rebuild to buy a house, etc. where getting the discharge behind them has a tangible, rather than a psychological, advantage. But absent that need, sit back, make the payments, and pocket any improvement in your situation for a rainy day.

One of the most frustrating things after the debtor gets a discharge is establishing just what debt was affected by the discharge. Creditors and some debtors expect to find a single document telling them what is no longer enforceable and what survives the bankruptcy. No such luck.

The official form used by most bankruptcy courts merely states that the debtor is granted a discharge. The general information on the second page of the form suggests that you might need an attorney to understand the application of the discharge in a particular case.

That’s why Gene Melchionne’s article on saving your bankruptcy papers is so on point. In this era of debt buyers and zombie debt, most debtors can expect to get a collection letter on a debt that was discharged in their bankruptcy.

In California, where 9th Circuit decisions are controlling, the Beezley opinion (994 F.2d 1433 1993) tells us that even a creditor who wasn’t listed or didn’t get notice is discharged in a no asset bankruptcy. The caveat is that if the creditor has a claim to non dischargeability because of the debtor’s bad acts, the claim survives until the creditor has a chance to challenge the discharge of his debt.

Usually what it takes to make a zombie debt collector go away is a copy of the discharge order and a copy of the schedules showing that the original creditor was listed in the bankruptcy.

So, save your bankruptcy documents, and if copies of the schedules don’t make the creditor go away, contact a bankruptcy lawyer to pursue an action under the bankruptcy code for sanctions against the creditor.

I’m always delighted when I uncover another aspect of the bankruptcy “reform” act of 2005 that operates in my client’s favor. We all know that the law was written to skewer the consumer debtor who was painted as irresponsible and profligate, a picture absolutely at odds with the world as I’ve seen it in 28 years of bankruptcy practice.

Yesterday’s discovery was how the law treats broken families better than intact families. My client is a single woman with a teenage child for whom she receives substantial and regular support. (Thank you, Dad). In preparing the Chapter 13 version of Form B22 to determine what Mom will have to pay to unsecured creditors, one includes the child support she receives in income; takes the deductions based on a household of two; then subtracts the support from the final number!

End result: Mom, my client, gets to figure her expenses including the cost of housing, feeding, and educating her daughter, but then gets to back out of the equation the support she gets for the child. In this case, it made a $1000/month difference, a $1000 less per month that she must pay to creditors.

I wonder if the cock sure Congressmen who wrote and passed this bill realized that the “new” law treats divided families better than the traditional, intact family. In the meantime, I will take every advantage I can find in this wretched law where it benefits my clients.

The newly enacted prohibition on stripping down car loans in Chapter 13 bankruptcy to the value of the car may not cover as many transactions as drafters thought. When the bankruptcy bill was working its way through Congress prior to 2005, the car lenders persuaded Congress to protect them from having their claim in a bankruptcy measured by the value of the car that is the collateral.

You see, new cars lose a lot of value when they are driven off the lot, and lose value more rapidly for the first several years of the loan than the payments on the loan reduce the loan balance. If bankruptcy is filed during those years, there may be several thousand dollars difference between what is owed on the car and what that car is worth.

So the amendment prohibited stripping down car loans on cars purchased within 910 days of the bankruptcy filing where the lien on the car is a “purchase money security interest.” That term has a meaning outside of bankruptcy, describing a lien that secured a loan to buy the collateral. But what if the loan bought a bunch of other stuff too?

Bankruptcy lawyers have started analyzing all the things that the “car loan” bought: there is GAP insurance (protecting only the lender from the gap between the car’s value and the debt); there’s the unpaid loan balance on a trade in; there are various kinds of warranties, etc. All of these other things muddy the waters as to whether the lien in question is a “purchase money security interest” under state law.

As cases work there way through the courts, we will see how bankruptcy judges and appellate court judges apply longstanding non bankruptcy legal terms to this provision of the gloriously ill-drafted Bankruptcy “Reform” Act.

Wish I had a buck for every time a client has told me, “Yes, I signed it, but I didn’t read it”. This is usually delivered as though the signature had no meaning if it wasn’t coupled with reading. Unfortunately, it isn’t so.

Why does the Bankruptcy Code require the debtor to sign the documents filed to initiate the case? First, the signature serves to identify the person who is taking this action. Signatures are unique, or nearly so. The signature then allows us to determine that the person who signed is the same person as the one whose name is on the schedules. [ Some areas of the country actually have a problem with cases filed in the name of a person, without the person's knowledge or involvement.]
More significantly, the signature of the debtor serves to authenticate the information in the bankruptcy schedules. It is the debtor’s shorthand way of saying “the contents of this document are true”.

This becomes important in bankruptcy cases if there is a claim that the debtor misstated or omitted something. The signature, right below the declaration that the document is signed under penalty of perjury, commits the debtor to that version of the facts.

This is not to say that innocent errors cannot be corrected once the schedules are filed; schedules are amended all the time, usually without challenge. The lack of challenge however, is generally related to the magnitude of the change presented in the amended schedule: try telling the court you “forgot” about the two carat diamond ring or the power boat, and you may have credibility problems.

My experience is that most omissions in the schedules come about because the debtor doesn’t take the time to both read, and think, about the question asked and the answer proposed by counsel. Carelessness about the completeness of the schedules at best increases the cost of a bankruptcy proceeding; at worst, puts the discharge at risk.
Bankruptcy is a serious step, which should return a significant benefit to the debtor. It is worth the time to read before you sign.