The settlement agreement, fully executed, provided explicitly that the obligation was not dischargeable in bankruptcy. So why did plaintiff’s counsel have to  prosecute the claim again when the defendant filed bankruptcy? Because the terms of the  settlement agreement didn’t track the elements of  the bankruptcy code’s elements for non dischargeable debts. Done properly, the agreement would have been entitled to collateral estoppel.  Little more than the filing of the nondischargeability complaint would have been required to preserve the claim from discharge. But just reciting the result you want doesn’t get the job done in bankruptcy court. Three exceptions to discharge The bankruptcy code lists a long string of debts that simply can’t be wiped out in bankruptcy. But in that list of debts that are not dischargeable in bankruptcy, three categories are called out for special treatment. Debts incurred by fraud or other forms of rank dishonesty Debts for breach of fiduciary duty, larceny or embezzlement Debts for willful and malicious injury To be excepted from discharge, the creditor asserting a claim based in one of these theories must file a timely adversary complaint, challenging the discharge of the debt.  11 USC 523(c).  Then the creditor has to prove that the debt is really what he claims. Labels don’t carry the day Plaintiff bears the burden to show that the facts surrounding the debt fit the bankruptcy definition of the exception.  The fact that state law denominated it as fraud, breach of fiduciary duty, or a willful tort isn’t sufficient. The first judge before whom I appeared as a newly fledged bankruptcy lawyer used to complain that, under our state law, everyone was a fiduciary to those around him.  However, the bankruptcy exception to discharge covered only express trusts and defalcation.  So a state law judgment for breach of fiduciary duty may not spare the claimant from proving up his case in bankruptcy court. We saw that play out when the Supreme Court recently held that “defalcation” required an intentional wrong.  The creditor held a state court judgment for breach of fiduciary duty grounded, not in any financial loss to the trust, but for self dealing. So, you are not home free as plaintiff’s counsel by getting a judgment that calls the challenged behavior fraud, etc. Make it truly non dischargeable Nor, as I said at the top, is it sufficient to get an agreement in writing that the debt will not be dischargeable in bankruptcy.  That doesn’t prove that the conduct in question squares with the bankruptcy definition of a non dischargeable debt. You need to establish the operative facts, by agreement or in judicial findings of fact, to be spared a trial in bankruptcy court. If you are alleging non dischargeable fraud,  you’ll need facts adding up to the following: the debtor made a representation; the debtor knew at the time the representation was false; the debtor made the representation with the intention and purpose of deceiving the creditor; the creditor relied on the representation; and the creditor sustained damage as the proximate result of the representation. In re Apte, 96 F.3d 1319, 1322 (9th Cir. 1996);  In re Kirsh, 973 F.2d 1454, 1457 (9th Cir. 1992). Your settlement agreement must then have the defendant admit that he made a representation to induce the behavior; that he knew at the time it was false, etc. Then you have undisputed facts entitling you to summary judgment in your non dischargeability action. Image courtesy of Flickr and HeyThereSpaceman.  

  The Bankruptcy Court for the Western District of Arkansas, Judge Taylor, had suspended a debtor's attorney from practicing for six months, and entered a $1,000 sanction against the attorney, for conduct relating to a debtor's post-petition arrearage on a domestic support obligation.   In re Young, 497 B.R. 922 (W.D. Ark., 2013).  When the bankruptcy was filed, the divorce order awarding alimony was on appeal.  The appeal was resolved in favor of the spouse, and the bankruptcy case remained pending without confirmation for two years following that, with numerous amended plans and with a budget showing $1,100/month in alimony payments that were not being paid.  The trustee had filed objections that he had not received proof that the alimony payments were current post-petition.  The final amended plan stated that the Debtor believed he was current on post-petition alimony payments, which appeared to resolve the trustee's objection and resulted in confirmation of the plan.  Prior to confirmation the debtor's attorney filed a Complaint and and Amended Complaint for sanctions alleging a stay violation for attempts to collect prepetition alimony.    The Bankruptcy Court cited Rule 9011(b).  Once an attorney files a pleading or paper with the court, he or she certifies:to the best of the person's knowledge, information, and belief, formed after an inquiry reasonable under the circumstances,—(1) it is not being presented for any improper purpose, such as to harass or to cause unnecessary delay or needless increase in the cost of litigation;(2) the claims, defenses, and other legal contentions therein are warranted by existing law or by a nonfrivolous argument for extension, modification, or reversal of existing law or the establishment of new law;(3) the allegations and other factual contentions have evidentiary support or, if specifically so identified, are likely to have evidentiary support after a reasonable opportunity for further investigation or discovery.      The Bankruptcy Court found that the modified plans providing for payment of the post-petition alimony as a prepetition priority debt violated Rule 9011 as being filed for an improper purpose, and the term that the Debtor would 'continue' post-petition alimony payments inferred that the debtor had been making post-petition payments, which counsel knew he had not.  The court also examined an amended Schedule E showing $9,300 as an unsecured priority claim when she knew it was post-petition alimony.  However, the Court found that schedules were not subject to Rule 9011.  The Court found that the Complaint and Amended Complaint violated Rule 9011 that the conduct related to collection of prepetition alimony, and that the reason the wife had not been paid was that no claim had been filed, were both incorrect and the result of studied calculation.  The Court found the most egregious violation to be in the final amended plan when the statement was made that the debtor believed he was current on all post-petition domestic support obligations that were due after the filing of his chapter 13 plan.   The Court found this to be an attempt to manipulate the language of the plan to defeat the express purpose of §1325(a)(8) for the improper purpose of obtaining confirmation of the chapter 13 plan.    The 8th Circuit BAP affirmed these findings and sanctions in In re Young, 2014 WL 944846 (8th Cir. BAP, March 12, 2014).  The appellate court noted that an attorney must make a reasonable inquiry into whether there is a factual and legal basis for a claim before the filing of such.  The established standard for imposing sanctions is an objective determination of whether a party's conduct was reasonable under the circumstances.    The court determined that Cruz had to have known that the Debtor failed to make his required postpetition alimony payments, so Cruz amended the Debtor's schedules and his plan to treat the alimony debt as prepetition priority debt and to state that the Debtor would “continue” to pay his postpetition alimony outside of his plan. In addition, the plan involved the filing of a false certification regarding payment of postpetition domestic support obligations to obtain confirmation. Meanwhile, Cruz allowed the Debtor to maintain an expense on the Debtor's Schedule J for postpetition alimony payments, thus excluding that amount from the calculation of the Debtor's payments to creditors under his plan. Therefore, the bankruptcy court found that Cruz promoted confirmation of a plan that excluded the alimony amount from the funds available to creditors, while affording priority payment to the same alimony debt, at the expense of other creditors. Sanctions shall be “limited to what is sufficient to deter repetition of such conduct or comparable conduct by others similarly situated.” FED. R. BANKR.P. 9011(c)(2). In addition, sanctions entered on a court's initiative may be in a nonmonetary form or in the form of an order to pay a penalty into the court. FED. R. BANKR.P. 9011(c)(2).    The appellate court only reversed and remanded for a separate hearing on sanctions awarded for testimony made by the counsel at the hearing on the order show cause as to the prior conduct, indicating that a separate hearing and notice was required to award sanctions for that conduct.  

   In In re Ruitenberg, 2014 WL  959485 (3rd Cir., March 13, 2014) the Court found that the wife's right to a partnership interest titled just in the husband's name at the time a chapter 7 case was filed, constituted an allowed claim in the husband's chapter 7 case.  A divorce was pending at the time the husband filed the chapter 7 petition.  Apparently the wife also filed chapter 7, and her trustee pursued the claim in the husband's case.  In the bankruptcy court, the husband's trustee sought to expunge the claim asserting that the right to a division of marital property was not a claim under 11 U.S.C. §101(5) because no divorce order had been entered.  The wife's trustee asserted the claim was a contingent claim for equitable distribution.  The Bankruptcy Court for the District of New Jersey, Judge Lyons agreed that the claim should be allowed, and the district court certified the matter for a direct appeal to the 3rd Circuit.  The appellate court initially noted that under BAPCPA equitable distribution claims are not discharged in chapter 7.  11 U.S.C. 523(a)(15).  However, despite the nondischargeability issue, if the claim were determined to be post-petition, rather than sharing in the husband's chapter 7 estate, the wife would be left to collect her interest from a smaller corpus after the bankruptcy were complete.  Even if no final judgment of divorce existed for Candace and Paul when he entered bankruptcy, her interest was, at the least, unliquidated and contingent on a final decree apportioning marital property, perhaps unmatured, and likely disputed. But, no matter, it literally is a “claim” under § 101(5).  The Court disagreed with the accrual test, where a claim did not exist until the right to payment arose under state law. Specifically, the accrual test “failed to give sufficient weight to the words modifying the ‘right to payment’: ‘contingent,’ ‘unmatured,’ and ‘unliquidated.  This also comported with the 3rd Circuit's earlier ruling that a debtor seeking a marital property distribution in a divorce must disclose that as an asset in her filing.  In re Kane, 628 F.3d 631, 641 (3d Cir.2010) 

   In a somewhat controversial decision, the 11th Circuit sustained the Bankruptcy Judge's denial of confirmation of a chapter 13 plan filed primarily to pay attorneys fees for a debtor that could not afford a $1,000 retainer in In re Brown, 2014 WL 563601 (11th Cir., Feb 14, 2014).  The bankruptcy was filed in the northern district of Alabama, proposing $150/month for 36 months, paying $2,000 in attorneys fees through the plan, the $281 filing fee through the plan, $50 to reimburse counsel for the credit counselling course, and $20 to reimburse counsel for the credit report.  While $16,203 in unsecured claims were scheduled (which would have resulted in a 17% dividend) as of confirmation after the bar date only $1,355.08 claims were actually filed, which would result in a 100% dividend to unsecured creditors.  The chapter 13 trustee objected to confirmation on the ground that the plan was filed in bad faith as the Debtor should be in chapter 7, and that it appeared the debtor would be unable to comply with the plan.  The Debtor's sole source of income was social security in the amount of $1,134/month and $230/month rental income (no real estate assets or vehicles were scheduled, and minimal personal property was shown).   Debtor's counsel indicated that the only reason the case was filed under chapter 13 rather than chapter 7 was to pay the attorneys fees.     11 U.S.C. §1325(a)(3) requires that the chapter 13 plan be filed in good faith.   §1325(a)(7) requires that the filing of the petition be in good faith.  The bankruptcy court noted that Mr. Brown would likely have qualified to waive the court's $306 filing fee if he had filed chapter 7.  He had no non-exempt assets, so should have qualified for a discharge in chapter 7 with no payments to the trustee, and hence no trustee fee.  Thus, other than the attorney's fee issue, a chapter 7 would have been more beneficial for the Debtor.  The bankruptcy court noted that the Debtor would have had to pay an attorney fee of $750-$1000 to file chapter 7.    While Mr. Brown appeared at the confirmation hearing, it does not appear he testified at the hearing.  The bankruptcy court determined that the only reason the Debtor filed chapter 13 was to finance the attorneys fees, and suggested that he could have saved the $150/month payments for a few months and he would have had funds to pay the attorney for a chapter 7.  The bankruptcy court also expressed concern that if a Debtor could not afford to pay attorney's fees, it was unlikely a chapter 13 plan for a three to five year repayment schedule would be successful.   The bankruptcy court examined the factor designated in In re Kitchens for determination of good faith, especially factor (5) the motivations of the debtor and his sincerity in seeking relief under the provisions of Chapter 13.  In re Kitchens, 702 F.2d 885, 889 (11th Cir. 1983).  The bankruptcy court found that Brown's motivations and sincerity were tainted because [he] sought relief under chapter 13, not to adjust debts and preserve assets, but to accommodate payment of attorney fees. The bankruptcy court noted that if the plan were confirmed, everything that could be accomplished in the chapter 13 could be accomplished with more certainty and cheaper in a chapter 7 case.  The District Court for the Northern District of Alabama affirmed the bankruptcy court's decision.  The Eleventh Circuit also examined the Kitchens factors in determining that the plan was not filed in good faith.  It found that the same factors go to determining whether the petition was filed in good faith.   The facts of each bankruptcy case must be individually examined in light of these various criteria to determine whether the chapter 13 plan at issue was proposed in good faith.  Based on the factors, the 11th Circuit could not find that the bankruptcy court's ruling was clearly erroneous, as required for reversal.  It found that the record supported the bankruptcy court's findings that Brown sought Chapter 13 relief not to adjust debts and preserve assets but to pay his attorney's fees, and that Brown was far better off in a Chapter 7, over a Chapter 13, bankruptcy.  It also found support for the finding that the only reason Brown filed a Chapter 13 petition and plan was so that Brown's attorney's fees could be paid in installments through a Chapter 13 plan. Brown's Chapter 13 plan was all about attorney's fees, and not Brown's best interest or the creditors.  The record had no evidence of the Debtor's unique circumstance that filing a chapter 13 would have been in his best interest.  The Court discounted the fact that the plan would have provided a 100% dividend to unsecured creditors in that it determined that there was a reasonable likelihood that the Debtor would not complete the plan, noting minimal cushion in the budget for unexpected expenses, and a 'failure' rate of 65% of chapter 13 cases in the district.  It also was concerned of the possibility that the Debtor would convert to chapter 7 once the attorney had been paid.    The appellate court also commended the bankruptcy court for not having a categorical rule prohibiting attorney-fee-centric or attorney-fee-only chapter 13 plans.   Rather, the record supported that the only one benefiting from the chapter 13 was the debtor's attorney.  The Eleventh Circuit specifically held that it was issuing no opinion as to the propriety of attorney-fee-centric chapter 13 plans in other cases, but rather simply that there must be a case-by-case examination of the factual circumstances in each instance.  It appears that the Brown case boils down to a failure of evidence by the Debtor at the confirmation hearing.  The 11th Circuit is clear that a rule prohibiting attorney-fee-centric plans is improper, but counsel for debtor must be prepared to show specific facts in each case why this debtor is better off in chapter 13 as opposed to chapter 7.  A simple claim that the debtor could not afford the fees up front in chapter 7 is unlikely to prevail.  On the other hand, the Court's cannot expect debtor's counsel to take every such case pro-bono, where debtor's are at imminent risk of creditor collection activity; and there has to be a mechanism allowing a debtor with minimal or no available funds to get relief from the bankruptcy court when exigent circumstances require immediate action.   The alternative is simply to encourage even more pro-se debtors, creating an even greater burden on the courts and clerk's offices.       

Bankruptcy sometimes provides a window into unfamiliar worlds.   The recent chapter 15 filing by MtGox Co., Ltd. contains an interesting explanation of the bitcoin phenomenon as well as Japanese involvency proceedures.   In re MtGox Co., Ltd., No. 14-31229 (Bankr. N.D. Tx.).   Here are a few nuggets that I picked up from the initial filings.   By way of introduction, MtGox Co., Ltd. is a Japanese company that operated a bitcoin exchange in Tokyo.  According to Wikipedia, MtGox is an acronym for “Magic:  The Gathering Online Exchange.”  Unforutnately for MtGox, the magic turned sour.   On February 28, 2014, it filed for reorganization in Japan after it found that it was missing bitcoins valued at $473 million which constituted about 7% of all of the bitcoins in circulation.   This raises the question of just what is a bitcoin and how does someone steal half a billion dollars’ worth of them.   All About BitcoinAccording to the Declaration of Robert Marie Mark Karpeles (Dkt. #3), “Bitcoin is a form of digital currency that was first conceived of in 2008 by a person or group going by the name of Satoshi Nakamoto.”     Attributing the conception of bitcoin to a pseudonymous person or group suggests that this digital medium of exchange is to currency what Anonymous is to the internet, that is, a shadowy, disruptive force.    According to Wikipedia, Satoshi Nakamoto is probably not Japanese and is probably not an individual.   Whether he is an individual or a group, he launched the first Bitcoin software in 2009 and then handed it over to Gavin Andresen (an engineer with a degree from Princeton) in mid-2010.   For his or its troubles, “Nakamoto” ended up with a million bitcoins.    Continuing on with the Declaration: The first actual bitcoin was created, or "mined" in 2009. There are several ways in which a person can obtain bitcoin, including the following:o Bitcoins are "created" through a computer software algorithm which, at any point in time, resides on thousands of computers on the Internet. Persons who accept to certify bitcoin transactions over the bitcoin peer-to-peer network are remunerated by the issuance of a fixed number of bitcoins which evolves over time. The certification is done by the solving of an "algorithm" with the use of ever-more powerful computers. These persons are called "miners" and the process of obtaining bitcoin in this fashion is called "mining."o A person can also obtain bitcoins that have already been mined by buying them from another. These transactions can consist of "one-to-one" transactions between a buyer and seller. In addition, a person can buy or sell bitcoin through an online exchange, such as the exchange operated by MtGox on the mtgox.com website. In these exchange transactions, the buyer and seller create accounts at the exchange and then fund the account with currency funds, bitcoin or both. The user can then enter a buy or sell order online and the website will match the buy or sell order with one or more sell or buy orders. The buyer receives an increase in bitcoin in his/her account and the seller receives an increase in currency in his/her account. The bitcoin exchange receives a fee or commission for the transaction.o A person can also obtain and use bitcoin through commercial or merchant transactions; that is, a person can use bitcoin in certain circumstances to pay for goods and services.Users store bitcoins in a digital "wallet" using either the software provided as part of the bitcoin software or a wallet provided by various providers. MtGox provides a wallet feature. A wallet can be materialized on a piece of paper and bitcoins need not be stored on a computer.The MtGox exchange allowed persons with MtGox accounts to buy and sell bitcoin among themselves. In this regard, a person was to first open an account at MtGox and was assigned an account number. Once a user wanted to start buying or selling bitcoin on the mtgox website, he or she would need to "fund" the account with currency, bitcoin, or both. In addition, the account holder would be subject to "anti-money laundering" ("AML") procedures.Once the account was "funded," the account holder would have a "currency balance" in the account, corresponding to the amount of currency he or she had a right to withdraw; and, a "bitcoin balance" in the account, corresponding to the amount of bitcoin he or she had a right to withdraw.  Declaration, pp. 2-4. While the part about mining bitcoins by solving an algorithm using ever more powerful computers sounds really technical, I think it can be boiled down to this.  I think that what happened was that someone came up with the idea of bitcoin and persuaded other people to exchange currency or products in return for it.   This is basically the story of currency everywhere.   While we may have once relied upon coins made of precious metals, it still required an agreement that these shiny objects had value.  All money is based on the shared idea that it has value.    Once enough people agree that a thing has value, then it does—at least until people stop thinking it does.Meanwhile, MtGox was founded in 2007 by Jed McCaleb as a site for trading cards like stocks.   In July 2010, McCaleb read about Bitcoin on Slashdot and decided to create an exchange for trading Bitcoin and regular currencies.   In March 2011, McCaleb sold MtGox to Mark Karpeles while retaining a 12% interest.   Karpeles is a software developer who was born in France in 1985 and moved to Japan in 2009.    The problem with having something of value is that people who are not nice may try to take it from you.   This happened with MtGox.   Going back to the Declaration: The mtgox.com website has been subject to numerous attempts by persons to breach its security, create denial of service ("DOS") situations, or to otherwise "hack" the system, and this has been the case since MtGox started operating the website in July 2011. In certain circumstances such attempts have led to the company shutting down the site for periods at a time.On February 7, 2014, all bitcoin withdrawals were halted by MtGox due to the theft or disappearance of hundreds of thousands of bitcoins owned by MtGox customers as well as MtGox itself. The cause of the theft or disappearance is the subject of intensive investigation by me and others -- as of the present time I believe it was caused or related to a defect or "bug" in the bitcoin software algorithm, which was exploited by one or more persons who had "hacked" the bitcoin network. On February 24, 2014, MtGox suspended all trading after internal investigations discovered a loss of 744,408 bitcoins presumably from this method of theft. Declaration, p. 4.    This illustrates another peril of the digital world.   When your asset consists of computer code, there are going to be hackers who will want to breach your network and mess with your stuff, which is apparently what happened to MtGox.    While losing half a billion dollars of your customers’ non-corporeal assets to theft is embarrassing, it is not as bad as JP Morgan losing $5.8 billion from trading credit default swaps or MF Global losing $1.6 billion of customer funds from bad trades.The Japanese Main Proceeding and the Dallas Chapter 15While the internet does not exist within fixed borders, companies do.   MtGox was physically located in Tokyo, Japan.   While it is curious that the creator of bitcoin used a Japanese pseudonym, Mark Karpeles was already living in Tokyo when he acquired MtGox in 2011.   So what you have is a Frenchman living in Tokyo who acquires an exchange from an American for trading a digital currency developed by an anonymous person or collective using a Japanese name.    Returning to the Declaration: In order to protect the MtGox business as a going concern and retain its value while MtGox investigates the theft of the bitcoins under its control and addresses security defects in the bitcoin exchange, MtGox filed a petition (the "Japan Petition") for the commencement of the Japan Proceeding in the Tokyo Court pursuant to Article 21(1) of the JCRA on February 28, 20 I4, reporting that the company had lost almost 750,000 of its customers' bitcoins, and around 100,000 of its own bitcoins, totaling around 7% of all bitcoins in the world, and worth around $473 million near the time of the filing. The Japan Proceeding is a civil rehabilitation. The purpose of a civil rehabilitation proceeding is to formulate a rehabilitation plan as consented to by a requisite number of creditors and confirmed by the court, to appropriately coordinate the relationships of rights between creditors and the debtor, with the aim of ensuring rehabilitation of the debtor's business or economic life. In addition to the petition for commencement, MtGox also filed applications for a temporary restraining order and for a comprehensive prohibition order which were issued by the Tokyo Court on February 28, 2014. At the same time, the Tokyo Court issued orders for the appointment of a supervisor and examiner (collectively, the 'Tokyo Court Orders").The Tokyo Court appointed Mr. Nobuaki Kobayashi, a Japanese attorney, as MtGox's supervisor and examiner. Under the Tokyo Court Orders, the Debtor cannot execute any agreement with any third party without the consent of the supervisor and examiner. The Debtor however remains free to initiate or pursue any legal proceeding provided that the costs of these proceedings be approved by the supervisor and examiner. On March 10, 2014, Mr. Kobayashi, pursuant to the powers conferred upon him by the Tokyo Court Orders, issued a consent allowing the Debtor to hire Baker & McKenzie to file this Chapter 15 case as counsel of Debtor, allowing the payment of Baker & McKenzie's fees and further acknowledging that this consent was granted at the condition that MtGox's sole Director and Chief Executive Officer, Mr. Karpeles, file this Chapter 15 case as the foreign representative of MtGox.Under the current status of the Japan Proceeding, the supervisor/examiner does not have the powers to manage the assets of the Debtor. As a consequence, the current management of MtGox remains in place and is allowed to continue to operate its businesses as a debtor-in-possession. I understand that this is permitted under the JCRA and that MtGox has submitted the evidence legally required for the relief to be granted upon formal commencement.Declaration, pp. 5-6.   In case you were wondering what a Japanese Insolvency order looks like, here is an image of one page: From what I can discern, the JCRA allows something like our debtor-in-possession procedure with an independent supervisor and examiner who must approve certain actions but does not run the business.  According to a Brief filed by MtGox's American lawyers, Baker & McKenzie, the JCRA was modeled on Chapter X of the U.S. Bankruptcy Act of 1898.  The Chapter 15 proceeding was filed in response to legal proceedings in the United States.    After Jed McCaleb sold his majority interest in MtGox to Mr. Karpeles, he founded a company named CoinLab, Inc. in the United States.    CoinLab filed suit against MtGox in the Western District of Washington in 2013.   Immediately after MtGox ceased operating, a class action was filed against it in the Northern District of Illinois.    When the Chapter 15 proceeding was filed, MtGox filed a Verified Petition for Recognition and Chapter 15 Relief in which it sought to have Mark Karpeles recognized as the “foreign representative” of MtGox.  It also requested that it be granted provisional relief pending recognition to have the automatic stay apply to MtGox in the United States.    On March 10, 2014, Judge Harlin Hale entered an order providing that the automatic stay apply “to the Debtor and its assets until further order of this Court or as so ordered at the Recognition Hearing.    The Court scheduled a hearing on recognition of the foreign proceeding before Judge Stacey Jernigan to be commenced on April 1, 2014.    Somehow it seems fitting that the hearing for recognition of the bankruptcy for the exchange that had its digital crypto-currency pilfered will begin on April Fools’ Day.       

The automatic stay in bankruptcy is the notice that puts creditors on notice that they cannot take certain actions against you in terms of collecting the debt.  The automatic stay is created immediately upon filing of the bankruptcy case whether or not official notice has been received by that creditor or not.  The automatic stay+ Read MoreThe post What Is The Automatic Stay In Bankruptcy? appeared first on David M. Siegel.

The overhaul of the U.S. Bankruptcy laws in 2005 significantly impacted the way secured debt is handled in a bankruptcy proceeding. Those changes were to the great benefit of debtors, our clients. Secured debt is a loan where you have pledged an asset (most commonly a car or a house) as collateral. In the event you do not repay the loan, the creditor has the right to take possession of the property, sell it, and recover what money it can from the sale. The post Secured Debt in Arizona Bankruptcy appeared first on Tucson Bankruptcy Attorney.

Madison did research on the bankruptcy means test.  Then she emails me for help. Hello. I have been doing some research and I believe my husband and I should file for Chapter 7 Bankruptcy but I’ve taken the means test and our income is well over what I’ve seen the limit for a three household […]The post Madison emails about the Bankruptcy Means Test appeared first on Robert Weed.

A Mortgage Company Rep Buys Me Lunch Every week I assure five or six nervous couples that, yes, it is possible to buy a house and get a mortgage after filing bankruptcy. Current government regs say you can qualify for a mortgage and buy a house two years after a chapter 7 discharge.  (It’s three […]The post Can I get a mortgage after filing bankruptcy? appeared first on Robert Weed.

Expanding upon its decision in Matter of Zibman, 268 F.3d 298 (5th Cir. 2001), the Fifth Circuit has ruled that the proceeds from sale of a Texas homestead lose their exempt character if they are not reinvested within six months--even when the sale takes place post-petition.   Viegelahn v. Frost (In re Frost), No. 12-50811 (5th Cir. 3/5/14).    The opinion can be found here.   The opinion creates a malpractice trap and arguably conflicts with this week's Supreme Court decision in Law v. Siegel.   The ProblemThe Bankruptcy Code states that "property exempted under this section is not liable during or after the case for any debt of the debtor that arose . . . before the commencement of the case" except for debts for taxes and domestic support obligations, unavoided liens, debts owed by an institution-affiliated party and debts for fraud incurred in obtaining a student loan.   11 U.S.C. Sec. 523(c).   Further, exempt property is not liable for administrative expenses except for the cost of recovering that property.   11 U.S.C. Sec. 522(k).    These provisions should make it pretty clear that once property is allowed as exempt, it is not liable for pre-petition debts or administrative claims with very limited exemptions.   However, Texas has a vanishing exemption.    While Texas has one of the most generous homestead exemptions in the country, proceeds from sale of a homestead only remain exempt so long as they are reinvested within six months.   Texas Property Code Sec. 41.001(c). In Matter of Zibman, the Fifth Circuit held that the Texas Property Code grants only a provisional exemption to homestead proceeds.   Where the homestead was sold prior to bankruptcy and the debtor held proceeds on the petition date, the exemption would be allowed subject to the reinvestment provision.  Zibman can be reconciled with section 522(c) and (k) for the reason that the limitation on the exemption existed on the petition date.   In other words, the debtor had an exemption in a fund of money so long as he used that money to purchase a new homestead within six months.   This is contrasted with the exemption in the homestead itself which was not subject to defeasance.   The Frost FactsMark Frost filed a chapter 13 petition on November 30, 2009.   At that time, he owned a home in Cibolo, Texas.    On March 26, 2010, the Bankruptcy Court entered an order allowing him to sell his home.  The Trustee objected to the sale on the basis that the Debtor should be required to re-invest the proceeds within six months.    The Court allowed the sale but provided that any liens or interests not specifically provided for in the Order would attach to the proceeds and that the proceeds would be deposited with the Chapter 13 Trustee "pending further orders of this Court as to the validity, priority and extent of such liens and interests."    The sale closed on July 1, 2010 and resulted in net proceeds of $81,108.67.    The Debtor subsequently proposed a plan that would pay creditors 1% on their claims.   On December 5, 2010, which was about seven months after the sale, the Trustee objected to the plan. The Trustee argued that the proceeds from sale of the homestead should be paid to creditors because they had not been reinvested within six months.   Of course, the proceeds could NOT have been reinvested within six months because the Trustee had been holding them.    The Bankruptcy Court entered an interim order allowing the Trustee to retain sufficient funds to ensure a 100% distribution to creditors and returning $40,000 to the Debtor.     On January 27, 2011, the Court conducted a hearing on the Trustee's Objection to the Motion to Sell Property Free and Clear of Liens.    This was odd because the prior order entered on March 26, 2010 did not indicate that the Court was reserving a ruling upon the Trustee's objection.   At this hearing, the Court ruled that the Debtor would be given six months in which to reinvest the proceeds.   Because the Trustee had been in possession of the proceeds, the Court held that the six month period would be tolled until January 27, 2011.    However, the Court also ruled that because the Debtor had spent $23,000.00 of the funds previously distributed to him for purposes other than buying a new homestead, that these funds had lost their exempt character and would have to be paid to creditors under the plan.   Thus, the Court gave and the Court gave away.   While the Court authorized payment of $40,000.00 to the Debtor, it took back $23,000. The Debtor appealed to the District Court which affirmed.    The Court's ruling was limited to the $23,000 which was not reinvested.   While the record is not clear, apparently the other funds released to the Debtor were reinvested in a homestead since they were not mentioned again.Note:   According to the Fifth Circuit, $18,000 was held in trust for the Debtor to purchase a new homestead and the remaining funds were paid to creditors.   This does not appear to accurately describe what transpired below.   The facts listed above are taken from my review of the Bankruptcy Court docket and orders rather than the Fifth Circuit's opinion.     The Fifth Circuit's RulingThe Fifth Circuit affirmed.   It held that Zibman applied to the post-petition sale of the homestead.   The Court found that while the Debtor's exemption was fixed on the petition date under the "snapshot" rule that "it is the entire state law applicable on the filing date that is determinative."   The Fifth Circuit rejected the argument that section 522(c) rendered the homestead and its subsequent proceeds permanently exempt.    The Court stated:Frost’s homestead was exempted from the estate—when the rest of his assets were not—by virtue of its character as a homestead. As in Zibman, this “essential element of the exemption must continue in effect even during the pendency of the bankruptcy.” Id. Once Frost sold his homestead, the essential character of the homestead changed from “homestead” to “proceeds,” placing it under section 41.001(c)’s six month exemption. Because he did not reinvest those proceeds within that time period, they are removed from the protection of Texas bankruptcy law and no longer exempt from the estate.Opinion, pp. 5-6.The Fifth Circuit also ruled that the timing of the sale, whether pre or post-petition did not affect the analysis.  This temporal distinction is insufficient to escape the holding of Zibman. The court’s insistence that an “essential element of the exemption must continue in effect even during the pendency of the bankruptcy case” indicates that a change in the character of the property that eliminates an element required for the exemption voids the exemption, even if the bankruptcy proceedings have already begun. Under this court’s precedent, (i) the sale of the homestead voided the homestead exemption and (ii) the failure to reinvest the proceeds within six months voided the proceeds exemption, regardless of whether the sale occurred pre- or post-petition.Opinion, p. 6.    The Court also rejected the argument that Schwab v. Reilly, 560 U.S. 770 (2010) preempted the Texas law.  Schwab v. Reilly divided exemptions into those which consist of a dollar amount versus those which attach to the thing itself. The Debtor argued that because the thing was exempt that it remained exempt.   As stated by the Debtor, Schwab held that "exempt is exempt."   The Fifth Circuit stated that "The rationale of Schwab simply does not apply to this case."    However, its stated rationale suggests that the Court did not understand the Debtor's argument.   The Court said that Schwab did not apply because Schwab involved an exemption limited by dollar amount and the Texas exemption was unlimited.   However, that really misses the Debtor's point that under Schwab, the thing itself was exempt and therefore could not return to the estate.The Need for ReconsiderationThe Fifth Circuit might want to take another look at this one.   For one thing, the opinion completely fails to appreciate the case's unique procedural posture which could have provided a more coherent basis for the Court's ruling.  It also seems to fumble the intersection between the Bankruptcy Code and Texas exemption law.   This could result in major mayhem in future cases.  This was a chapter 13 case.   As a result, property acquired post-petition is included in the estate.   11 U.S.C. Sec. 1306.   The proceeds from sale of the homestead could have been analogized to property acquired post-petition which would only be exempt if re-invested in a new homestead within six months.    As a result, the timing that would matter is whether the homestead was sold during the case or subsequently.    However, under the Court's ruling, if a debtor files chapter 7 bankruptcy and sells his homestead many years later, the Trustee could reopen the case and seek to administer the proceeds if they were not reinvested.    Judge Tony Davis rejected the application of Zibman to a post-petition sale of a homestead in a chapter 7 case in a well-reasoned opinion in In re D'Avila, No. 13-11173 (Bankr. W. D. Tex. 8/21/13), which can be found here.    The Frost opinion suggests that it would be equally applicable in a chapter 7 or a chapter 13 case.   That would be bad.    I also think the Court was incorrect on the temporal issue.  When the Debtor filed bankruptcy on November 30, 2009, he owned a homestead.   By the time that he filed the Motion to Sell Property Free and Clear of Liens, the exemption on that property was final.   As a result, the property left the estate.   In the words of Neil Young, "once you're gone, you can't come back."   That applies to property of the estate as well.    Would the court hold that property sold free and clear of liens or abandoned could revert back to the estate after the debtor and third parties had acted in reliance?  I don't think so.  Additionally, the factual application of the case is contrary to Texas law.   Under Texas law, proceeds from a homestead remain exempt for six months.  The Debtor can do whatever he wants with the money during those six months.   If the Debtor spends the proceeds of the homestead on fine dining and poor investments, creditors can't get the money back.   However, the Bankruptcy Court held (and the reviewing courts agreed) that spending part of the homestead proceeds during the six month exemption period meant that a similar portion of the unexpended homestead proceeds lost their exempt character.   Huh?  That does not seem to make sense.   I think that the Debtor was on the right track.   Exempt is exempt with one caveat.   I would agree that if a debtor sells a homestead during a chapter 13 and has proceeds left over six months later, that the unexpended money would constitute property of the estate.   However, if the Debtor uses the money to buy a new home or spends it on wild living, it is simply not there to become property of the estate.  The Court might also want to think about how Law v. Siegel affects this case.    In Law, the Ninth Circuit held that a Bankruptcy Court could surcharge a debtor's exempt property based on bad behavior.    The Supreme Court reversed, holding that the clear language of section 522(k) prevented the Court from using exempt property to pay administrative expenses regardless of the reason.   Section 522(c) says the same thing with regard to pre-petition claims.    Granted, Law v. Siegel was about the abuse of section 105 to override a clear statutory provision while the Court did not rely on section 105 in this case.   However, the result of undermining the statutory protection is the same and should make a difference.   Proceed With Caution If This Opinion Remains the LawIf the Frost case remains good law, the only good advice to a debtor with a Texas homestead is plan to hold on to it indefinitely or be ready to buy a new homestead within six months.   Any other advice will place your client and your malpractice insurance at risk.   The other take away is never let the trustee hold the money from sale of your homestead.   Here, the trustee held on to the funds for six months and then tried to claim that the debtor had forfeited his exemption altogether.   Then when the Bankruptcy Court allowed some of the funds to be released to the Debtor without stating any conditions, the Court clawed that money back when it wasn't used for purchase of a homestead.   What the Debtor should have done in this case was to file his bankruptcy to get the benefit of the automatic stay and then dismissed or converted the case once the sale went through.   While this may seem like an abuse of chapter 13, it is a rational response to an irrational result.