Sunday, October 3rd, 2010
Most of the clients who I represent in Chapter 7 or Chapter 13 cases view bankruptcy as their absolute last resort. Usually, by the time they get to me, these clients have exhausted every other alternative – they have borrowed money from relatives and friends, sold possessions on eBay and cashed out or borrowed against retirement plans.
All of these choices, by the way, create unintended consequences – if you are reaching that point of desperation where you are thinking about selling things, cashing out retirement plans, etc., I would rather that you call me before taking any action because of the risk that you might unknowingly lose some of the benefit from your bankruptcy filing, or possibly disqualify yourself altogether.
Retirement plan loans such as 401(k) loans create a variety of issues and are almost always a bad idea in a bankruptcy context. Presumably you borrow against your 401(k) because you need cash now, you expect to repay that loan in the near term, you want to preserve your 401(k) account for the future, and because you do not want the tax consequences associated with cashing out your 401(k).
Bankruptcy trustees, however, look at 401(k) loans in a different light. They see any allocation to repay a 401(k) loan (and sometimes any ongoing contribution to a 401(k) plan) as an unnecessary reduction of disposable income that would otherwise be available to pay creditors. 401(k) loan payments cannot be counted as allowable deductions in your means test calculations. And both Chapter 7 and Chapter 13 trustees and/or creditors will often object if you include a 401(k) loan repayment allocation in your Schedule I and J budget in either a Chapter 7 or Chapter 13.
Since 401(k) plan funds are generally considered "exempt" or sheltered property in a Georgia Chapter 7 or Chapter 13, your best choice often means not using your 401(k) as a last gasp source of cash.
401(k) loans and on-going 401(k) contributions do not make bankruptcy impossible, but they do complicate matters. If you are in financial trouble and are thinking about raiding your 401(k) or retirement plan but have not done so, you should not take any action until you have spoken to a bankruptcy lawyer. If you have already cashed out or borrowed against your 401(k), make sure that your attorney is aware of this fact.
Posted in 401 k, 401(k) loans in bankruptcy, Bankruptcy budgets, Consequences, General consumer bankruptcy info, Georgia Bankruptcy, Loans, Retirement, Trustee objections in Chapter 13, allocation, allowable, altogether retirement, borrowed, cashed, cashing, counted, create, deductions, loan, plan, plans, plans all, repayment, trustee objections, unintended | Comments Off
Sunday, July 4th, 2010
On June 7, 2010, the United States Supreme Court released its decision in the case of Hamilton, Chapter 13 Trustee v. Lanning. The Supreme Court rarely hears argument in consumer bankruptcy cases so the Lanning decision is big news to consumer bankruptcy lawyers.
The issue in Lanning is one that has troubled bankruptcy lawyers since 2005, when the "means test" was added to the Bankruptcy Code. The means test functions as a test – do you have the "means" or disposable income to fund a Chapter 13 repayment plan? If the means test shows that you do not have sufficient disposable income to make a Chapter 13 work, then you qualify for Chapter 7.
As one of the assistant United States trustees once told me – the purpose of the means test is to disqualify as many people as possible from Chapter 7, and to force them into Chapter 13.
In practice, the means test does not work very well in predicting who can make a Chapter 13 work. One of the biggest complaints has to do with the mechanical nature of means testing. To run a means test, I have to gather pay stubs from the past 6 months. I then create a monthly average, which represents available income. Next I prepare a means test budget, but I do not use actual expense amounts. Instead, the means test tells me how much my clients are allowed to spend for food, medicine, utilities, etc. And where do these budget numbers come from? Means test numbers are based on IRS budgets used in delinquent tax repayment plans. In other words, the means test budget allocations are not especially generous.
This explanation of the means test is somewhat oversimplified, but you get the main idea – every bankruptcy debtor's income and expense numbers have to be run through the means test, and not surprisingly this somewhat mechanical test produces some absurd results.
The classic example of absurd results occurs when a debtor has received a Christmas bonus or a one time payment. That bonus/one time payment has to be included in the monthly income numbers even if it is not guaranteed or likely to happen again. In other situations a debtor may have earned a comfortable income but has now lost his job – under a strict reading of the means test, he earns too much money to file Chapter 7. And he can't afford to file a Chapter 13 because he now has no income.
The Supreme Court has injected some common sense into this situation. In the Lemming case, which was filed in Topeka, Kansas, the debtor's 6 month average was skewed by a one time payment arising from a buyout from her former employer. The debtor filed a Chapter 13 plan that called for a payment that the debtor could afford based on her actual, current income. The trustee objected on the grounds that the means test dictated a higher number (that the debtor clearly could not afford based on his actual income).
The Topeka bankruptcy judge agreed with the debtor and approved a plan that Ms. Lemming could afford. The trustee appealed and lost in the 10th Circuit Court of Appeals. The trustee appealed again and the Supreme Court granted certiorari.
The Supreme Court affirmed the decision of the 10th Circuit Court of Appeals and held that bankruptcy judges need not apply a "mechanical approach" to means testing in Chapter 13 cases. Instead, judges should "take into account other known or virtually known certain information about the debtor's future income or expenses." Rather than looking backwards, judges can take a forward looking approach and consider the realities of a debtor's income. This forward looking approach should be considered in cases with unusual facts and the Lemming decision should not be construed as an invalidation of the means testing formula.
Despite the Supreme Court's warning that a "forward looking" approach should only be used in limited situations, I suspect that bankruptcy judges will use "Lemming arguments" mitigate some of the harsh results of Chapter 13 in general. Bankruptcy judges recognize that Chapter 13 cases often do not work because means testing and aggressive trustee arguments force debtors to agree to plans that commit debtors to pay every last dime to the trustee. Unfortunately, family emergencies and unexpected things happen over the course of a five year bankruptcy plan and many plans will fail – not because the debtor did anything wrong, but because there is no "give" in the plan.
I predict that judges will use the rationale of Lemming to reduce some of the harsh results of the means test and help debtors improve their chances at success in Chapter 13.
If you want to read the Lemming decision, click on the link. I also found a nice summary of Lemming in attorney Jordan Bublick's fine South Florida bankruptcy blog.
Posted in 13, 2010, Chapter 13 issues, Debtors, Hamilton Chapter 13 trustee v. Lemming, Means Test issues, Trustee, Trustee objections in Chapter 13, affirmed, aggressive, and, argument, arguments, cases, certiorari the, chapter, chapter 13 plans, court, decision, facts, force, formula despite, granted, hamilton, hears, lanning , lemming, means, means testing, rarely, read, released, states, supreme, testing, the, trustee objections to chapter 13, united, unusual, v, work | Comments Off
