Part of New Bankrtupcy Law Ruled Unconstitutional

One of the provisions of the new bankruptcy law (the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA")) places limits and requirements on what an attorney may and may not say to clients considering bankruptcy. Some of these requirements are quite onerous. For example, 11 U.S.C. Sec. 526(a)(4) states as follows:

A debt relief agency shall not . . . advise an assisted person or prospective assisted person to incur more debt in contemplation of such person filing a case under this title or to pay an attorney or bankruptcy petition preparer fee or charge for services performed as part of preparing for or representing a debtor in a case under this title.

There are many legitimate instances where an attorney might advise a client to incur additional debt before filing bankruptcy. For example, courts have held that it is okay for a debtor to take steps to maximize his exemptions before filing bankruptcy. That might involve borrowing against a car to maximize the available homestead exemption. It does not hurt the lender on the car, because the borrower will have to reaffirm the debt and it allows the debtor to maximize the value of the exemption.

In Zelotes v. Martini, Case No. 3:05cv1591 in the United States District Court for the District of Connecticut, the Court recently ruled that these limitations on attorney speech are facially unconstitutional. The Court stated as follows:

Rather than changing the bankruptcy system by closing the loopholes, eliminating the incentives for opportunistic action or enacting penalties for those who take on such debt prior to filing for bankruptcy, Congress enacted § 526(a)(4), a prophylactic rule which prohibits attorneys from advising their clients to take on any additional debt in contemplation of bankruptcy, even when doing so would be lawful. As Plaintiff argues, and as both the Hersh and Olsen courts found, there are instances whereby taking on more debt in contemplation of bankruptcy would not constitute abuse of the bankruptcy system. Without delving too deep into the complexities of bankruptcy law, it is clear that the prohibition in § 526(a)(4), while addressing opportunistic abuses, could also ensnare lawful, financially prudent actions. The Hersh and Olsen courts noted examples where the prohibition could reach lawful and beneficial actions, including (1) “refinancing at a lower rate to reduce payments and forestall or even prevent entering bankruptcy,” (2) “taking on secured debt such as [a] loan on an automobile that would survive bankruptcy and also enable the debtor to continue to get to work and make payments,” (3) “taking out a loan to obtain the services of bankruptcy attorney, to pay the filing fee in a bankruptcy case or the conversion of a non-exempt asset to an exempt asset which is still allowed under the Bankruptcy code,” and (4) “refinanc[ing] a mortgage that allows a debtor to pay off the mortgage and other debts, such as credit card debt, in a chapter 13 where failure to refinance may only allow the debtor sufficient funds to pay off one or the other but not both.” Hersh, 347 B.R. at 24; Olsen, 2006 U.S. Dist. LEXIS 56197, at *20. Plaintiff cited these and other examples of lawful, financially prudent actions, including: (1) borrowing money from friends and family or taking out a secured loan to obtain the services of a bankruptcy attorney or to pay a filing fee, in order to (a) prevent a wage garnishment or attachment, (b) prevent a home foreclosure, repossession or associated costs or (c) avoid a preferential payment or fraudulent transfer to insiders; and (2) borrowing from friends and family or taking out a secured loan to finance the purchase of a new vehicle in order to (a) purchase a less expensive vehicle with lower monthly payments in order to maintain transportation, (b) obtain transportation and secure employment, (c) avoid the higher rate of interest—and therefore, potentially higher likelihood of default—which the debtor would face after filing for bankruptcy, (d) obtain a more economical and/or reliable vehicle in order to reduce average monthly expenses.

By prohibiting lawyers from advising clients to take a course of action that is lawful and in the client’s best financial interest, albeit a counterintuitive one, § 526(a)(4) prevents lawyers from giving clients the best and most complete advice. As Plaintiff argues, “[s]ection 526 chills the attorney’s very exercise of the advice and counsel function that is the defining feature of our profession.” (Pl.’s Opp. 11.) By prohibiting lawyers from advising clients to take lawful, prudent actions as well as abusive ones, § 526(a)(4) is overbroad and restricts attorney speech beyond what is “narrow and necessary” to further the governmental interest. Gentile, 501 U.S. at 1075; Hersh, 347 B.R. at 25 (citing In re R. M. J., 455 U.S. 191, 203, 102 S. Ct. 929, 71 L. Ed. 2d 64 (1982) (Even under intermediate scrutiny, “[s]tates may not place an absolute prohibition on certain types of potentially misleading information . . . if the information also may be presented in a way that is not deceptive.”); Conant v. Walters, 309 F.3d 629, 638-39 (9th Cir. 2002) (finding that government could not justify policy that threatened to punish a physician for recommending to a patient the medical use of marijuana on ground that such a recommendation might encourage illegal conduct by the patient)); Olsen, 2006 U.S. Dist. LEXIS 56197, at *21. Accordingly, the Court finds 11 U.S.C. § 526(a)(4) facially unconstitutional.

Click here for a PDF version of the decision.

Sue up or Shut up!

Have you ever received a letter threatening to sue to collect $388? Those fortunate souls who are unfamiliar with the court system might believe someone would actually sue to collect $388. But it is just not worth it and debt collectors know it. Here's an interesting article from Time regarding debt collectors who threatened to sue even when they knew suit was unlikely.

A class action was brought against the debt collectors alleging violation of the Fair Debt Collection Practices Act ("FDCPA"). The FDCPA prohibits debt collectors from making false or misleading statements in attempting to collect a debt. The debt collectors' letter stated that failure to pay the debt "could" result in a lawsuit. Thus, they claimed, the letters did not speak of an imminent lawsuit and did not violate the FDCPA. The District Court agreed with this reasoning and dismissed the claims. The Third Circuit Court of Appeals, however, did not agree and reversed the District Court, holding that the District Court must use a "least sophisticated debtor" standard of review in determining whether the statements were misleading.

Wall Street Journal on New Bankruptcy Law

The Wall Street Journal posted an article claiming (or at least inferring) the new bankruptcy law is a success and denigrating those who opposed the law.

Henry Sommer, president of the National Association of Bankruptcy Attorneys (and co-editor of Collier on Bankruptcy) posted the following response:

"I was not surprised to see the Journal's editorial page echo the financial services industry's talking points on the recent bankruptcy legislation. Unfortunately, you have your facts wrong. You don't state the source of your figures supposedly showing a decline in debtors' incomes, but the numbers most frequently being reported for debtors who have
filed in the last year reflect those debtors' "current monthly income," a new statutory term that excludes various types of income and therefore cannot meaningfully be compared to the income reported in cases filed before the legislation was enacted.

"In fact, our members report that the vaunted new means test is having negligible effects in terms of pushing higher income debtors into chapter 13 for the simple reason that there were never many debtors who could afford to pay their debts. The same types of debtors are filing chapter 7 cases as before the legislation. Consumer credit counselors, to whom every individual debtor must go before filing a bankruptcy case, also report that virtually
no debtors they see are able to pay their debts.

"The truth is that the biggest effect of the new law is the substantially increased cost of filing bankruptcy cases, borne by all debtors and acknowledged by everyone. These costs have limited access of lower income families to much-needed relief from financial problems caused by medical expenses, unemployment, and divorce. They are the result of unnecessarily
increased government bureaucracy and onerous new paperwork requirements, and would have been condemned by the Journal had they been imposed on businesses instead of struggling families."

My own view is that those who prophesied the end of bankruptcy before the bill took effect were engaging in a bit of hyperbole. The law has some serious problems and doesn't really fix a whole lot. It does make it harder and more expensive for people to file bankruptcy, simply because it creates more hoops to jump through. But (speaking from my own experience) the means test that the WSJ is boasting about in this article results in wildly inconsistent results. For example, let's say a salesman is paid on commission only. He usually makes about $12,000 a month. However, his commissions go down to about $6,000/month for five straight months before going back up to $12,000. The means test says he has to use $7,000 as his monthly income, even though he might make $12,000/month for the next year. Most likely, he will have expenses over $7,000/month and would satisfy the means test for Chapter 7 or have a low payment for Chapter 13. The WSJ's claim that the new law is successful is premature.

But, as anyone knows who has read something in the papers about their profession, newspaper reporters usually don't get deep enough into a topic to really understand it and consequently, they usually have at least some level of inaccuracy in their reporting.

Foreclosure Consultants Are Bad News

I have people come in my office frequently who have had this happen. They defaulted on their home loan and the house is going into foreclosure. They were contacted by someone who offered to help them get out of the default. They offer to help in different ways: (1) buying the house, (2) assuming the loan, (3) making payments until the borrower can refinance, and (4) getting a new loan for the borrower. Most of the time, however, they charge high (and hidden) fees and/or they buy the property for a fraction of what it is worth.

This is a group that was caught by the California Attorney General, but there are many more out there. Consumers need to know that there are laws protecting them against these predators. California Civil Code Sec. 2945, et seq. severely restricts what a foreclosure consultant can do and provides extensive remedies when a foreclosure consultant does not comply with the law. The Better Business Bureau provides an explanation of this law here.

If a foreclosure consultant has taken advantage of you, please call our office to arrange a free consultation (559.436.6575) or visit my website to schedule an appointment online.

QWR's and RESPA

One thing I have been seeing a lot of recently is mortgage companies hiding the ball on consumer loans in bankruptcy. For example, a mortgage company might allocate certain payments from a Chapter 13 Trustee to a "suspense account" and not to principal and interest as they should. Or maybe there is a substantial "escrow shortage" when there was no escrow account to begin with. If you try to get information from the companies just by calling them, it is often like a shell game and sometimes, you just need documentation of what happened. And mortgage companies are required to provide such information under the Real Estate Settlement Procedures Act ("RESPA"). The procedure to request such information is by means of a "qualified written request." You can see a sample request here.

Fool me once, fool me twice . . . but not three times

Bankruptcy Judge Whitney Rimel (of Fresno) issue an interesting opinion (In re Gay, No. 06-10472) recently on the issue of the circumstances under which the automatic stay can be reinstated. By way of background, the automatic stay goes into effect immediately upon the filing of a bankruptcy case. It prevents creditors from taking any action to collect a debt.

The new bankruptcy law (BAPCPA) made some changes to the automatic stay, including a provision that if you filed one bankruptcy within the year preceding the current filing and that filing was dismissed for any one of several reasons, the automatic stay expires after 30 days and another provision that if you filed had two bankruptcy cases dismissed within the last year, there is no automatic stay upon the filing. It can be reinstated upon a showing by clear and convincing evidence that the case was filed in good faith.

In In re Gay, there had been two previous dismissals. In considering whether the new case was filed in good faith, Judge Rimel looked primarily to the issue of whether there had been a change in circumstances. The debtors presented evidence that their income had stabilized since the previous filings. However, the court found this unpersuasive and determined that the debtors did not rebut by clear and convincing evidence the presumption that the third filing was not in good faith. Consequently, the stay was not reinstated and the debtors probably lost their home.

This should give anyone pause who is considering filing a bankruptcy case. If the case is dismissed, you may lose the automatic stay if you have to file again. This is especially a problem for debtors who represent themselves in bankruptcy. I had that issue with a client recently. He filed in pro per (without an attorney), did not comply with all of the requirements, and his case was dismissed. He immediately refiled and then hired me to get the automatic stay reinstated (which we did). He could have avoided a lot of problems by hiring an attorney to help him with the first case.

12 myths about bankruptcy

This article entitled 12 myths about bankruptcy has some good information. For additional myths, go to
http://www.fresnobklaw.com/myths.php.

New Bankruptcy Law: Credit Cards Before God?

Here is an article about a bankruptcy ruling out of New York that said a religious debtor was not allowed to use chartiable contributions as an expense; ergo, the debtor had to pay credit card debt for 5 years before he could again donate to the church. Click here for the full text of the decision. Most of the news articles on this don't do a very good job of explaining what actually happened.

Many people have heard of the "means test" that is part of the new bankruptcy law (BAPCPA). Essentially what happens is that a debtor's income is examined and if the debtor is above the median income for his state, the debtor has to use a set of IRS guidelines to determine whether the debtor has any disposable income that could be used to pay creditors. Debtors who are under the median income do not have to use the IRS standards. They use their actual expenses. The importance of what set of expenses you use is that if your expenses are more than your income, you qualify to file Chapter 7, and even if your expenses are less than your income, your expenses determine how much you have to pay per month in a Chapter 13. (This is a great oversimplification, but it states it in concise terms.)

Because of a furor over decisions like the Diagostino decision before BAPCPA, Congress enacted a law that allowed religious contributions to be counted as an expense. The Diagostino decision essentially says that by enacting BAPCPA, Congress undid that allowance for any debtor who is over median. So, now over-median debtors are not allowed to make charitable contributions while in a Chapter 13 case. Just for example, a single debtor in California is over median if he makes about $50,000 a year.

UPDATE: Orrin Hatch, a proponent of BAPCPA and senator from Utah, issued a press release stating his disagreement with the opinion. Then, he got a bill (Senate Bill 4044) passed by the Senate changing the law so that the Court's ruling would be overturned. The bill has been sent to the house, but probably will not be considered soon do to the impending election. But to hear Senator Hatch talk about it, he's saved the (tithing) world.

Payday Loan Companies Prey on Military Personnel

Here is an interesting article on a new report issued by the Department of Defense finding that payday loan companies are taking advantage of military personnel.

These companies generally prey on more than just military personnel. I often have people come into my office and tell me they took out a $300 loan that will result in $350 being taken out of a paycheck in 2 weeks. That's over 400% interest. One other thing that bothers me is that the payday loan people often tell my clients "you can't file bankruptcy on a payday loan." This is completely false. First, payday loans are not exempt from the bankrputcy process. Second, the whole idea of filing bankruptcy "on" a debt is one of the bankruptcy myths. You have to list ALL of your debts in a bankruptcy.

Personal Bankruptcy Filings Plunge in Quarter - Los Angeles Times

Click here to read about the tremendous drop in bankruptcy filings over a year ago. Bankruptcy filings in Fresno are also down significantly. There were 732 Chapter 7 filings for the first six months of 2006, compared with 4704 for the same period in 2005, a drop of 84.4%. Chapter 13 filings were also down, although not as much. There were 222 filings in the first six months of 2006, compared with 539 a year ago, a drop of "only" 58.8%. Click here for the detailed statistics.

Of course, the main reason for the precipitous drop in filings is that most people who were thinking about bankruptcy filed before the new law went into effect on October 17, 2005. The other reasons for lower filing numbers are: (1) misinformation regarding the availability of bankruptcy after the new law went into effect, (2) higher attorney fees necessitated by the increased work for attorneys under the new law means that people have a harder time affording a bankruptcy filing, and (3) the new law has made it harder for some people to file.

It appears that the new law may have succeeded in accomplishing exactly what the credit card industry hoped for. If they can get debtors to pay for even a few more months than they would have under the old law, the credit card industry could reap billions in additional profits. And it looks like that is coming to pass.

It is important to remember that bankruptcy is still an option and most people will still be able to file under the new law, although everyone has to jump through a few more hoops to do so now. Click here to see other common bankruptcy myths debunked.

Credit card minimum payments doubling

Toward the end of 2005, many of the credit card companies began increasing minimum required monthly payments. In many instances, the payments doubled. See here and here for more information. I noticed that quite a few clients during the first six months of this year were forced to consider bankruptcy because of the minimum payment increase. I'm curious how much the payment amounts have actually gone up for others in the Fresno area. If your monthly minimum payments have gone up, please post a comment stating the percent your minimum payments increased.

Thanks,
www.fresnobklaw.com

Report finds credit-card firms push users deeper into debt

This news article discusses a new report that accuses credit card issuers of pushing consumers to borrow beyond their means. The new bankruptcy law was enacted to keep more people from filing bankruptcy, but as long as credit card companies push people to spend beyond their limits, there will be a need for the fresh start that bankruptcy provides. Click here for more bankruptcy information.

Foreclosures jump 90% in San Joaquin County

Three factors are coalescing to form the perfect storm for foreclosures in the residential real estate market: (1) increasing interest rates, (2) decreasing real estate values and (3) an abundance of variable rate mortgages. For example, the number of foreclosures in San Joaquin County, California increased by 90% for the second quarter of 2006. Chapter 13 bankruptcy can be used to catch up mortgage arrears. For more information, go to www.fresnobklaw.com.

Fresno Bankruptcy Law Website

For more information about bankruptcy or to schedule a free half-hour consultation with a Fresno bankruptcy lawyer, visit www.fresnobklaw.com.