Bankruptcy Bits

The Berman Hook Theory – planning the timing of filing bankruptcy

 There are statistics that evidence that a substantial number of Chapter 11 plans fail, and that even in cases in which a plan is confirmed, the reorganized debtor fails shortly after confirmation.

An explanation for the phenomenon is contained in a theory that has become known as "The Berman Hook." Envision a hook: a line straight down, a perpendicular line at the bottom with another line headed up. Think of a fishhook.

The Berman Hook Theory incorporates the previously expressed viewpoint that timing can be everything. Like "location, location, location," the manta is, "timing, timing, timing" for debtors.

The theory is simple: during the period of declining business, the entity survives by using its capital (cash, inventory, accounts receivable) and available credit to survive. Debt is incurred and continues to be incurred during the downturn and at the leveling off phase. The cash flow and capital crisis really occurs when the business turns around and new capital and credit are required for new inventory, (or to finance the production of new product,) and to finance the accounts receivable created by new sales. The real crisis occurs when capital is depleted, debt is the highest and demands for capital, cash and credit are newly needed. A classic scenario.

The theory suggests that the filing of a petition in bankruptcy provides little long term relief when filed in the downward spiral but is best exercised when there is a realty of a fresh start, i.e. when relief from existing debts can be most beneficial. A successfully reorganized debtor is relieved of the burden of incurring additional debt and has the opportunity to engage in business when there is an opportunity to succeed. A simple, pragmatic theory.

And the concept is equally applicable to individuals. Timing is everything. You should not seek recourse in Bankruptcy Court until you have bottomed out. By means of example, you’re best advised not to file before you have the operation and will be out of work for a prolonged time or are unemployed with no early prospect of employment. Timing can be everything.

While the theory is valid, there are, of course, unusual circumstances under which you don’t have the luxury of choosing the time.

by: Eugene B. Berman, Esq.

Timing is everything when filing bankruptcy.

We are all aware that the timing of the filing of a petition - voluntary or involuntary - determines the time frame within which preference, fraudulent conveyance, and other claims can be asserted. A debtor may well delay a filing to protect a purported preference to a "friend" or to avoid claims ascertain insider preferences. Or visa versa: a petition may be filed to preserve the 90-day preference period so that an action can be undertaken. The consequences of when to file is one of the major considerations to be addressed by any entity contemplating the filing of bankruptcy.

One of the considerations frequently overlooked by debtors and their counsel is consideration of the most auspicious time to file for them. It is suggested that all too often a debtor files prematurely...at a time that things are bad but will probably get worse. An individual should not file when he loses his job...he should wait until he gets a new job. A business should not file at the first signs of trouble, it should wait until there is the beginning of a turn around.

The lesson is to bottom out before seeking relief in bankruptcy.

By: Eugene B. Berman, Esq.

Condo association’s filing of lien can violate automatic stay

In a recent ruling, it was found that a condo association’s filing of a lien seeking to recover common charges against a person who had filed Chapter 13 bankruptcy was an intentional violation of the automatic stay provisions of the US Bankruptcy Code (11 USC 362.)

The board of managers of a townhouse complex knew of the bankruptcy filing, and did file a motion for Relief From Stay with the bankruptcy court, seeking permission to name the debtor as a defendant, along with the debtor’s mortgage company, in order for the association to foreclose on its lien. The U.S. District Court for Eastern N.Y. overturned the bankruptcy court’s prior decision supporting the condo association and ruled that the debtor’s possession of the property gave her an interest sufficient to invoke the 362 stay, and therefore the underlying lien that the association was seeking to foreclose on was void, since it was placed on the debtor’s property after she had filed her Chapter 13 petition.

The lesson learned is that a Motion for Relief from Stay should have been filed by the condo association before they sought to file the lien, regardless of their actions in later seeking relief from stay to enforce the lien. (Ford v. Board of Managers of Cameo Townhouses, 2009 US Dist., Lexus 13124, E.D.N.Y., 2-18-09.)


by: Michael B. Katz, Esq.

 

Chapter 11 filings up 49%

Under the amended bankruptcy laws (BAPCPA), Chapter 11 is far more restrictive, costly and burdensome, but those factors have not prevented growing numbers of business bankruptcy filings over the past year.

According to statistics recently released by the Administrative Office of the U.S. Court, in fiscal year 2008, (which is the 12 month period ending 9-30-08,) Chapter 11 filings rose 49% from the prior 2007 fiscal year. The actual numbers were an increase to 8,799 from 5,888 cases.

In reviewing all types of business cases that were filed, the numbers show a jump from 25,925 cases to 38,651, which is a 49% jump.

The same increased filings are found in almost every type of bankruptcy filing, except for the rarely used Chapter 12 farm filings. Nationally, Chapter 7 liquidation cases were up 40%, while consumer wage plans under Chapter 13 were up 14%, but likely to continue rising with the continued foreclosure problems facing many people trying to save their homes.

In Massachusetts, there were a total of 15,636 filings, of which 11,525 were Chapter 7, 3957 were Chapter 13, 149 were Chapter 11 and 4 were for Chapter 12 cases.

It appears that bankruptcy filings are on pace to increase over the 2008 filings, so more record filings can be expected.

By: Michael B. Katz, Esq.

Bankruptcy filing statistics for the 12 months ending 6-30-08

In the District of Massachusetts, a total of 15,047 bankruptcy cases were filed in the 1-year period commencing on 6-30-07 and ending on 6-30-08.  In breaking down those numbers, a total of 10,643 cases were filed under Chapter 7; 154 cases were under Chapter 11;  3 cases were filed under Chapter 12;  and 4246 were Chapter 13 cases. 

In examining the breakdown of those cases between consumer and business cases, only 334 cases of the total were for businesses, and of those cases, they were distinguished into 184 Chapter 7, 134 Chapter 11,  3 Chapter 12 and  12 Chapter 13 cases.

Filings in every category but Chapter 12 and Chapter 11 remain strong, and it is expected that this quarter, ending 12-31-08, will show a growing number of cases being filed. The increase in filings is expected to continue to increase through 2009.


by: Michael B. Katz, Esq

Mortgage Cram Down

In most cases, a homeowner filing bankruptcy has the option of either (i) keeping their house as long as they continue to make their mortgage payments; or (ii) surrendering their house and discharging the mortgage obligations allowing for a fresh start.

Recently, as housing prices have spiraled downward, many homeowners, who at one point had equity in their homes (even with two mortgages,) began considering surrendering their homes, as they were unable to keep up with their mortgage payments (many of which are adjustable.) Although Congress has been discussing future legislation that would allow bankruptcy judges to reduce and/or modify mortgages terms, (known as a "cram down,") in order to make the payments more affordable, today there already exists a way to cram down a second mortgage in some cases. Specifically, 11 USC 1322 states that someone filing a Chapter 13 bankruptcy plan may:

(b)(2) modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims. (Emphasis added.)

Although not expressly stated, this section has been interpreted by many judges to mean that a mortgage cannot be modified if it is secured by the debtor's principal residence. As such, if you have a first mortgage in which you owe $200,000, and a second mortgage in which you owe $50,000, however due to the adverse real estate market, your $300,000 house has fallen in value to $200,000, you may be able to cram down or strip the second mortgage off your house, as the second mortgage is not secured by any equity in the real estate.

As such, an approved Chapter 13 plan that purports to turn the second mortgage into an unsecured debt may be approved, thus saving the homeowner significant money and possibly allowing that homeowner to keep his house and afford the remaining mortgage payment.


By: Justin H. Dion, Esq.

Debtors must turn over necessary documents to the audit firm upon request

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) added two additional duties for debtors specifically related to debtor audits, which include the duty to cooperate with the audit process and the duty to turn over necessary documents to the audit firm. Debtors must also explain and/or produce additional documentation relative to the source of any deposit over $500. In their discretion, audit firms may request an explanation or additional documentation to support any other transaction contained in an account statement, such as large cash withdrawals or transfers to accounts not identified on the debtor's bankruptcy schedules.

Debtors have 21 days to provide the audit firm with the requested documents. They must cooperate with the audit firm and provide records to the auditor in a timely fashion. The debtor's discharge may be revoked and/or case dismissed if the debtor does not satisfactorily explain the failure to make available all documents or property requested by the audit firm. If the Debtor fails to comply with the audit process, the audit firm will issue a Report of No Audit.

Once the audit is complete, the audit firm will issue a report that must specify any “material misstatements” of income, expenses, or assets identified by the audit firm. Before including a material misstatement in an audit report, the audit firm will contact the debtor's counsel or the debtor in writing about the concern and offering the debtor an opportunity to provide an immediate written explanation for the item(s) in question.

Audit firms file the audit report with the court and transmit it to the United States Trustee. The clerk of court must send a notice to creditors in cases in which one or more material misstatements have been identified in an audit report. If material misstatements are not adequately explained by the debtor, the United States Trustee (although not required) may take appropriate civil action, and where appropriate, make a criminal referral to the U.S. Attorney.

In a recent decision by the Eastern District of New York, In re Rafael Ventura (375 B.R. 103, 2007), the United States Trustee filed motion to dismiss debtor's Chapter 7 case with prejudice based on the debtor’s failure to cooperate after his case was randomly selected for audit. Unlike some other tools regularly used by the U.S. Trustee program in its “watchdog” role, such as targeted audits, the random audits mandated by Section 603 do not reflect a judgment that a debtor's case bears any taint of fraud or abuse.

In Ventura, the Court stated that “an individual debtor's case may be selected for a random audit without regard to whether the debtor is eligible to be a debtor under the Bankruptcy Code, whether the debtor satisfies the requirements of the Bankruptcy Code to complete his or her case, or whether the debtor receives a discharge. Indeed, even a bankruptcy case that is filed by a debtor based on incorrect information, or one that is filed in error, could be subject to an audit if it is among those randomly selected.” Although the Trustee’s Motion to dismiss was allowed, the debtor's non-cooperation did not warrant dismissal with prejudice and deny his ability to re-file.

In the first eight months of the audit program, 1631 audits were completed. Of those, 29% of the cases audited were found to have at least one material misstatement and 12% of the audits resulted in a Report of No Audit. There is no indication as to the seriousness of the cases in which a material misstatement was found nor is there any statistical information available about what actions were taken by the United States Trustee Program in cases where there were material misstatements.

By: Justin H. Dion, Esq.

§ 603(a) Audits – All Bark and No Bite?

Part of the overriding policy behind the Bankruptcy Abuse and Consumer Protection Act involved addressing Congress’s concern over consumers abusing the bankruptcy process to the determent of creditors. In addition to the adding the Means Test and reducing repeat filing eligibility, Section 603(a) of Public Law 109-8 required that random audits be conducted in at least one out of each 250 non business Chapter 7 and 13 cases. The United States Trustee contracted with outside third party audit firms and accountants to perform the audits.

The process begins with debtor’s counsel receiving a notification of audit and requirement of compliance directly from the United States Trustee. Shortly thereafter, the private auditor will send correspondence to counsel requesting:

1. Permission to communicate directly with the Debtor (which in general is not recommended); and
2. A detailed document production list intended to evidence complete accuracy of the bankruptcy schedules, which includes production of the following:

• Pay stubs for the six calendar months prior to filing;
• Two years of federal tax returns, including any schedules and forms;
• Account statements for all depository and investment accounts for the six calendar months preceding the date of the filing of the petition, plus the month in which the petition was filed, along with sufficient documentation to reasonably explain the source of deposits or credits, and the purpose of checks, wthdrawals or debits; and
• A copy of any divorce decree and/or property settlement entered within the last three years, and any current child support/alimony obligation involving the debtor.

By: Justin H. Dion, Esq.

Get your credit counseling done at least one full day before you file chapter 7 or 13 bankruptcy

Obtaining your mandatory credit counseling on the day of your filing does not satisfy Section 109 (h) (1) of the Code.

A recent decision from the District of New Mexico made this point clear, to the dismay of a Chapter 13 debtor, whose case was dismissed by Bankruptcy Judge Jim Starzynski, when he ruled that the debtor was required to take her credit counseling no later than the day prior to the insolvency filing. (In re Francisco, #13-07-12810 SF (Bankr. DNM, 1-25-08).

In this case, the debtor apparently knew the requirement that she needed to take the mandatory credit counseling course before she could file her Chapter 13 petition, but she took the course the same day that she filed her petition. Subsequently, the issue was raised before the Court as to whether she was eligible to be a Chapter 13 debtor, and if not, was she able to cure the problem, or did her case require that it be dismissed?

Finding that the credit counseling was not taken on a timely basis, and that Section 109 (h) (1) requires that a debtor take the course “during the 180 day period preceding the date of filing of the petition”, the Court opined that the term “date” means “day”, and not “time”, so that the debtor in the Francisco case was a day late, and therefore many dollars short. Consequently, the Court ruled that the case be dismissed.

The moral: Take the counseling as soon as possible, but not more than 180 days before you file, nor on the same day you file.

By: Michael B. Katz, Esq.