When a living expense is a business expenses

Once again, as with all my posts, this is not legal advice, and applies only to California, and sometimes only to the Northern District of California.

The Ninth Circuit Bankruptcy Appellate Panel (which is persuasive but non binding, but oftentimes is) issued a difficult to apply decision which characterized living expenses as business expenses when there is an underlying profit motive.  A similar opinion was issued regarding mortgages in Aspen Skiing Co. v. Cherrett (In re Cherrett)  (2014) and which the current case is based.

In the present case, the debtor borrowed money to write a book, and had an agreement that the money made from the book would be split with the lender if the book made money.  If it did not do well, then the loan would be repaid in full to the tune of $150,000.  11 USC 523(d), which concerns nondischargeable debt, addresses “consumer debt” which is defined as a debt incurred “for a personal, family, or household purpose.  The lender objected to the discharge of the debt and lost because he did not file the complaint on time- however, attorneys fee’s could not be recovered because it was consumer debt.

The case however may be less about the classification of debts and business or consumer, and more regarding the antagonism of courts to award attorneys fees and the shifting of fees from Debtor to Lender.

 

The Bankruptcy Estate in Chapter 7

I use the term “bankruptcy estate” repeatedly  – but what is a bankruptcy estate?

A legal fiction takes place when you file a bankruptcy.  This fiction is that an estate is created at the time of filing, and this estate is distinct from the individual who is filing.  This estate is administered by a Trustee, who is given the responsibility of maximizing profits for the creditors, while maintaining the fresh start of the Debtor, who gets to keep a certain amount of property.  A trust is a separate legal entity.  A Corporation is a good analogy – similarly, a corporation is a legal entity that exists separately from you.

Another way to think about it is that you lose control over your property for a limited period of time.  (Less so in Chapter 11 and 13, but very much so in a Chapter 7)  This is the price that Debtors pay for filing a bankruptcy.

Trustee’s make sure that the rules of bankruptcy procedure and the petitions are being prepared in a professional way but they are also incentivized by profit.  This happens because they get to keep some of what they recover from a Debtor, in the event there is something to recover.   Standing Chapter 7 Trustees are independent contractors, not employees of the government.  They get paid a nominal sum (less than a hundred dollars) to speak with you at a hearing called a Meeting of Creditors.  In a  no asset case this is all they would receive.   (By the way, this doesn’t mean there are no assets – it just means your assets are below a threshold amount that varies from state to state.)

In an asset case (meaning there are assets above the threshold amount) they are able to distribute the property to the creditors.  If it is not a liquid asset, an auction is held where they solicit bids for a certain length of time.  When it is sold, the trustee gets a percentage of the sale, and the rest is distributed to the creditors pro rata.

Chapter 7 is still the most preferred form of bankruptcy because most people don’t own that much, and don’t earn that much to be at risk.  Because it only take a few weeks, and all your debts are discharged, it oftentimes seems like a straightforward and easy process.  However, unlike Chapter 11 and Chapter 13, there is no turning back with a Chapter 7; once you have filed, you have put your assets in the hands of the bankruptcy estate.  The risk may be low, but if you miscalculate, the consequences can be devastating.

 

Square, Bankruptcy, and Escorts

Apparently I can’t use Square to process payments for my firm.  Below is the agreement – we are right below escort services.  I have highlighted in red for easier viewing.

Square Seller Agreement:   Section 6. Your Content

The Services may include functionality for uploading or providing photos, logos, products, loyalty programs, promotions, advertisements and other materials or information (“Content”).

 You grant us and our subsidiaries, affiliates, and successors a worldwide, non-exclusive, royalty-free, fully-paid, transferable, and sub-licensable right to use, reproduce, modify, adapt, publish, prepare derivative works of, distribute, publicly perform, and publicly display your Content throughout the world in any media in order to provide and promote the Services. You retain all rights in your Content, subject to the rights you granted to us in these General Terms. You may modify or remove your Content via your Square Account or by terminating your Square Account, but your Content may persist in historical, archived or cached copies and versions thereof available on or through the Services.

 You will not upload or provide Content or otherwise post, transmit, distribute, or disseminate through the Services any material that: (a) is false, misleading, unlawful, obscene, indecent, lewd, pornographic, defamatory, libelous, threatening, harassing, hateful, abusive, or inflammatory; (b) encourages conduct that would be considered a criminal offense or gives rise to civil liability; (c) breaches any duty toward or rights of any person or entity, including rights of publicity, privacy or trademark; (d) contains corrupted data or any other harmful, disruptive, or destructive files; (e) advertises products or services competitive with Square’s or its partners’ products and services, as determined by us in our sole discretion; or (f) in our sole judgment, is objectionable, restricts or inhibits any person or entity from using or enjoying any portion of the Services, or which may expose Square, its affiliates or its customers to harm or liability of any nature.

 Although we have no obligation to monitor any Content, we have absolute discretion to remove Content at any time and for any reason without notice. You understand that by using the Services, you may be exposed to Content that is offensive, indecent, or objectionable. We take no responsibility and assume no liability for any Content, including any loss or damage to any of your Content.

Prohibited Goods and Services with Square Register

 Information outlining what you may not sell when you use Square.

 Square strives to provide a safe environment for both buyers and sellers. As such, we do not permit the sale of certain goods and services that are listed in Square’s Terms. In this agreement, you confirmed that you will not accept payments in connection with the following businesses or business activities:

 Any illegal activity or goods
 Buyer or membership clubs, including dues associated with such clubs
 Credit counseling or credit repair agencies
 Credit protection or identity theft protection services
 Direct marketing or subscription offers or services
 Infomercial sales
 Internet/mail order/telephone order pharmacies or pharmacy referral services (where fulfillment of medication is performed with an Internet or telephone consultation, absent a physical visit with a physician including re-importation of pharmaceuticals from foreign countries)
> Unauthorized multi-level marketing businesses
> Inbound or outbound telemarketers
> Prepaid phone cards or phone services
> Rebate based businesses
> Up-sell merchants
> Bill payment services
> Betting, including lottery tickets, casino gaming chips, Fantasy Football, off-track betting, and wagers at races
> Financial institutions offering manual or automated cash disbursements
> Prepaid cards, checks or other financial merchandise or services
> Sales of money-orders or foreign currency by non-financial institutions
> Wire transfer money orders
> High-risk products and services, including telemarketing sales
> Service station merchants
> Automated fuel dispensers
> Adult entertainment oriented products or services (in any medium, including Internet, telephone or printed material)
> Sales of (i) firearms, firearm parts or hardware, and ammunition; or (ii) weapons and other devices designed to cause physical injury
> Internet/mail order/telephone order cigarette or tobacco sales
> Drug paraphernalia
> Occult materials
> Hate or harmful products
> Escort services
> Bankruptcy attorneys or collection agencies engaged in the collection of debt

Discharging Victim Restitution Claims

Under 11 USC 523(a)(3)(7), debts are nondischargeable

“to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty”

However, in the case “In Re Scheer” handed down on April 14th, 2016, the 9th Circuit appears to be challenging the logic of the Supreme Court case Kelly v. Robinson (479 US 36) (1986) for failing to follow the plain meaning of the statute – not only are debts owed to the government nondischargeable, but Kelly ruled that debts owed to the victims of crimes are also nondischargeable in bankruptcy.

The Scheer decision relied heavily on the 2010 Finley decision which held that costs associated with prosecuting a state disciplinary proceeding against a lawyer were dischargeable since they were for actual loss, and wouldn’t be considered as having the character of a fine.

All said and good – the 9th Circuit has a tendency to have a very unique opinions, and probably makes decisions with the hope the rest of the country follows its course.  How much effect this has on the Supreme Court remains to be seen, although it is promising with a vacancy on the bench – one that may be filled by a liberal judge.

 

 

Property Settlement Agreements

Under 11 USC 523, past due Domestic Support Obligations (DSO’s) are not dischargeable in bankruptcy, along with a whole laundry list including taxes less than three years old(sort of), criminal restitution, and debt owed by a spouse for his other spouse’s divorce attorney fees.

But what is a domestic support obligation?  The most common examples are child support and spousal support.  It’s money used to provide for the day to day living expenses of ones children and former spouse.

Marital settlement agreements (MSA’s) are also usually nondischargeable in bankruptcy.   These are the orders that determine who gets what after a divorce.  However, if a Chapter 13 payment plan is completed, then an MSA can be discharged along with your other debts.

The lines get blurred of course when dealing with property settlement agreements that are meant as a form of support.  A common example is when a spouse is not working, so the Judge awards the house to the other party in order to substitute for the missing income.  This will be the case in long term marriages, i.e. old school, (since spousal support is increasingly looked down upon as sexist) and in the case where one spouse has acted in bad faith, e.g. quit his job on purpose and moved to another country in order to avoid paying.  There are no fast or easy rules, and it’s best to consult a lawyer to analyze the facts in detail to determine the character of the asset.

Preferential Transfers

A preferential transfer, codified under 11 U.S.C. 547(b), is a payment made to a creditor before a bankruptcy is filed.  There are two types that are relevant for bankruptcy in general: general transfers and insider transfers.

General transfers are payments made within the 90 days prior to filing.  There is a presumption that a Debtor (the term given to the person filing bankruptcy) is insolvent (meaning he is unable to meet his obligations as they become due) in the 90 days prior to bankruptcy.  As a result, any payment made during this time is “preferring” one creditor over the other.  A trustee in a bankruptcy is able to unwind these transfers, usually by suing the paid creditor, or more likely, politely asking for the money back.

Insider transfers refer to people who are friends and family of the Debtor.  This is where it gets sticky, because insiders have a special relationship with the Debtor, and can even be working with the Debtor to hide assets from the Trustee.  The lookback period therefore is one year from the date of the filing, which a good bankruptcy lawyer will be careful to avoid as no one wants their Nana to get sued, or to get a nasty letter requesting money that was received 12 months ago.

One further wrinkle concerns California Civil Code section 3439, which doesn’t concerns bankruptcy or preferential transfers, but is closely related to what I discussed above.  The term of art here is Fraudulent Transfer, and despite the word “fraud,” it doesn’t mean that you have to be lying or deceitful in concealing assets.  There are two types of fraud under CCC section 3439 : actual and constructive fraud.

Actual fraud, as noted above, doesn’t actually require the intent to commit fraud.  The intent element is satisfied just by the person intending to transfer the property. Economy Refining & Service Co. v. Royal Nat’l Bank (1971) 20 Cal. App. 3d 434, 441.  An eleven factor test is used to determine actual fraud, and I will be reviewing this in a future post.

Secondly, there is constructive fraud, and there are three different variations of this.  Each concerns the person giving the asset or money without receiving some of “reasonably equivalent value” back.  The other factors will also be discussed in the future post that I mentioned above.

Bottom line: State law matters in bankruptcy.  In California, CCC section 3439 is a potential landmine that can be a problem for a potential debtor and should be discussed with his attorney before filing.

 

 

The Automatic Stay

The most powerful feature of a bankruptcy is the automatic stay.  It functions as a restraining order against almost everyone and all legal proceedings.  There are a few exceptions (certain divorce and criminal matters) and allows you breathing space to sort out your finances.

Many people file in order to stop foreclosures and to keep their homes, or to stop garnishments on their wages, and even to get property (like cars) that were repossessed.

The last year has seen some changes to the automatic stay however – the changes to the Petition Form on December 1, 2015 now reduces the cost of a landlord trying to evict a client.  A tenant filing a bankruptcy who is late on his rent now has thirty (30) days to deposit the rent arrearage with the court.  In the past, the landlord would have had to file a motion for relief from the automatic stay, which would have required some legal knowledge and possibly a lawyer.  The burden essentially has been shifted to the tenant to show that he is capable of affording the unit.

Another important change is the overruling by the Ninth Circuit Sternberg v. Johnston, 595 F.3d 937 (9th Cir. 2010), which held that a Debtor could only recover fees associated with stopping stay violations, but not the costs associated with the lawsuit for damages.  In  America’s Servicing Co. v. Schwartz-Tallard, the Judge’s ruled that the plain language of 362(k) allowed Debtors to recover for both the costs of stay violation and the resulting damages.

The practical consequences are huge, as stay violations were not being litigated since client’s often couldn’t afford the litigation involved (they were filing bankruptcy after all) and the Creditor’s often prolonged litigation knowing full well that the Debtor’s attorney wouldn’t get paid for it at the end of the day.

Student Loan Discharge for Lawyer

Well, this gives some hope for us all.  A student loan was discharged for a 56 year old securities lawyer here in the good old Northern District of California. (In re Barrett, Case No 14-43516)

The Department of Education Lawyers argued that his failure to apply for Income Based Repayment precluded qualification from the Brunner test but the Honorable Judge Charles Novack in Oakland, California rejected that argument.

More than $250,000 was discharged so I have a feeling that this is still only the beginning.  The Department of Education’s next move will be to appeal the case to the District Court. Why? Because they appeal everything.

As I said in my previous post, the Brunner test is a pain in the butt. However, people do manage to get rid of their debts. However, it’s usually not on the first try, it’s not the full amount, and the attorneys for the creditors settle the cases outside of court because they don’t want to have a Judge make an unfavorable decision that sets a precedent, hence weakening the Brunner test.

(I also have a theory that it has something to do with China and the government being able to paint a better financial picture of itself via accounts receivable so it gets more favorable interest rates, but I have absolutely no data to back that up.)

Student Loans

In California, the Brunner Test is the standard for discharging student loans.  There are three prongs

1. You cannot maintain a minimal standard of living for yourself and your dependents if you repay your loan based on your present income.
2. Your current financial situation will most likely continue for the length of the payment of the student loan.
3. You did your best (good faith) to pay your student loans.

 

Doesn’t sound that difficult.  Unfortunately, the devil is in the details and the way it is applied makes it well nigh impossible for many students to qualify.  The Brunner standard is notoriously difficult to meet and most people fail.  I had a 65 year old cancer patient who lost her job, was undergoing chemotherapy, and still was unable to get a Brunner discharge.  (maybe the chemo will work, the cancer will go into remission, and she will be back to work in no time!) 

That being said, a new provision is being explored right now to give relief to students who were given student loans based on false employment numbers.  The litigation is currently going on, and may finally create a exception to the stringent requirements of Brunner.  The Defendant being targeted is Corinthian Colleges, (e.g. Everest, Heald and Bryman).  On a sidenote, Corinthian College declared Bankruptcy on May 4th, 2015.  Irony.

Trustee Abandonment

When a Chapter 7 BK is filed, an estate is created.  This estate is managed by a Trustee who is legally the owner of all your property.  This is a legal fiction in most no asset cases because you carry on with your life as before – however, if you are operating a business, the Trustee may be concerned about liability.

For you Uber driver’s out there, you may be ordered by the Trustee to stop operating your business (yes 1099 independent contractors are businesses according to the IRS) unless a motion for abandonment is filed by your attorney.  This is because even though the Trustee has the perks of standing in your shoes (allowing him or her to snoop through your bank statements, settle your lawsuits, sell your assets if there is non-exempt property) it also exposes the Trustee to liability if you are in an accident.  Accidents being more likely when you are a driver for hire, they tend to get a little worried when they see you putting heavy mileage on your car.  The abandonment motion essentially absolves the estate of all liability arising from your driving, or whatever risks your business entails.

That being said, in the Northern District of California, rarely is it a huge issue, unless you are operating heavy machinery or there is something terribly dangerous about your job.  That being said, you may want to bring up with your lawyer the possibility that you may have to stop running your business for a couple of months while the bankruptcy is pending.

 

Check out my website at http://www.clawgrp.com or email me at robert.chang.esq@gmail.com if you want to speak with me!