Dewsnup case keeps rearing its ugly head

By doug | Published: April 29, 2020

The Freddy Krueger of consumer bankruptcy law is coming around to scare us again. That would be the Supreme Court case of Dewsnup v. Timm, which was decided way back in 1992. But because the Supreme’s interpretation of how to handle liens in bankruptcy court is so wishy-washy and apparently wrong, the controversy surrounding the subject never really gets solved, and continually pops up again. This time it happened in North Carolina.

Dewsnup attempted to address the question of how a court should view under secured liens when a borrower files for Chapter 7 bankruptcy.

The Supreme Court held that even if the collateral securing a loan isn’t worth enough to pay off the whole loan, the lender still holds its entire lien during and after the bankruptcy case.

As an example, take a $100,000 mortgage on a debtor’s house. A recession has plunged the value to $60,000. The debtor’s argument will be that after a bankruptcy case is filed, the lender should get a $60,000 secured claim with a lien on the property to that amount, and a $40,000 unsecured claim that gets wiped out during the case.

The Supreme Court says no, the lender gets to keep its full lien anyway, potentially worth up to $100,000, if the price of the property recovers after the bankruptcy filing. As a result, courts across the country following a strict view of Dewsnup don’t allow lien stripping motions in Chapter 7 cases.

This majority view was held by six justices in 1992. The late Justice Antonin Scalia and New Hampshire’s David Souter filed a blistering dissent, emphasizing the plain language of bankruptcy code section 506, which appears to allow claims to be split into secured and unsecured portions. At the time, Justice Clarence Thomas had not yet joined the court.

The confusing wording of the majority opinion in Dewsnup has spawned no fewer than 1,313 lower court interpretations through April of 2020. Many of these have been critical, although only the Supremes themselves can wipe the opinion from their books.

There have been some attempts over the years. In 2015, the Supreme Court heard another lien stripping case, and seemed poised to overturn Dewsnup in the Caulkett case, but they stopped short, saying that they might well have, but weren’t asked properly.

Tidbits like the Caulkett decision have tantalized conservative court watchers, who note that in addition to Thomas, Justice Neil Gorsuch appears to hold a jaundiced view of Dewsnup, based on his writing as an appellate judge for the Tenth Circuit in Denver.

But in 2019, the Court explicitly declined to hear the Dewsnup challenge of Ritter v. Brady.

So the battle goes on. In March, 2020 a North Carolina bankruptcy judge in Vasquez v. JP Morgan Chase wrote a decision that refused to allow the debtor a lien strip, but he picked apart the Dewsnup reasoning nevertheless.

The Vasquez case is being appealed. Perhaps it will go all the way to Washington. And maybe then Freddy Krueger’s head will finally be placed on a platter.

by Doug Beaton

Attorney Douglas J. Beaton has practiced bankruptcy law in the Northeast for twenty-six years, and is an active commentator on developments in bankruptcy practice and procedure. He can be reached through this form:

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Interim bankruptcy rules on the books in Massachusetts

By doug | Published: April 28, 2020

The bankruptcy judges in Massachusetts adopted the second set of changes to bankruptcy procedure rules this year, effective April 27, 2020. The compete set of rule changes can be read here.

A bit of background: The creation of a new Small Business Reorganization Act in August, 2019 spurred a need for many small changes to the Federal Rules of Bankruptcy Procedure, before the SBRA took effect in February of 2020.

Because formal changes to the bankruptcy rules on a national level take a long time, the committee of lawyers writing the changes came up with a proposed list of temporary changes, and offered that to bankruptcy courts around the country to use as a stopgap measure.

Then along came the corona virus. The federal stimulus bill known as the CARES ACT was enacted in March, 2020. Among the stimulus measures were more tweaks to the bankruptcy code, and thus the need for changes to the new rule changes.

The most significant upshot to these changes upon changes is that for businesses looking to re-organize under Chapter 11 (i.e. looking to keep operations going while shedding some debt), there are now three separate paths to that goal:

* Traditional Chapter 11 taken straight. This is large business re-organization, or “big boy” Chapter 11. Think: expensive, formal, traditional, but possibly a powerful way to deal with creditors.

* Small business Chapter 11 under the old rules. The middle ground for small business. Still expensive, but a little more streamlined.

The new SBRA Chapter 11 for small businesses. Small means less than $7.5 million in total debt, for the time being. The SBRA borrows some of the concepts from the Chapter 13 and Chapter 12 cases that workers and family farmers have been using for years, and adapts them to the business re-organization system in a streamlined fashion.

by Doug Beaton

Attorney Douglas J. Beaton has practiced bankruptcy law in the Northeast for twenty-six years, and is an active commentator on developments in bankruptcy practice and procedure. He can be reached through this form:

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It’s time to get rid of creditor meetings in consumer bankruptcy cases

By doug | Published: April 27, 2020

Every debtor in bankruptcy travels somewhere, at least once. While most consumer bankruptcies are simple affairs, completed without a lot of trudging back and forth to court, each debtor must make at least one appearance, at a hearing with the somewhat misleading name “meeting of creditors.”

This is a good time to put an end to that.

The meting of creditors is not really “going to court” in the strict sense. It may or may not take place in a courthouse. No judge or magistrate is present. Instead, a trustee — a lawyer who signs up to review bankruptcy cases for the feds — presides. Creditors rarely show up. Most such meetings consist primarily of debtors answering a series of perfunctory questions under oath. A typical meeting lasts about five minutes when an individual, as opposed to a business, is the debtor.

These meetings are mentioned in section 341 of the bankruptcy code, hence the name “341 meeting” that is sometimes applied. For individuals filing Chapter 7 cases, this section instructs trustees to give the debtors a brief spiel on the consequences of filing bankruptcy, the effect of discharging debts, the ability to use other chapters of the code, and the meaning of a re-affirmation of debt.

Related bankruptcy code section 343 states that debtors “shall appear and submit to examination under oath at the meeting of creditors under section 341(a) of this title. Creditors, any indenture trustee, any trustee or examiner in the case, or the United States trustee may examine the debtor.”

In Chapter 11 cases involving major companies, creditors actually do get together and form committees, as they will soon be required to cast votes on the debtor’s plan of re-organization. The meetings make a certain amount of sense in this situation.

In consumer cases, the 341 meeting is mostly used instead to ferret out if the debtor has any hidden assets that have not yet been disclosed. Lawsuits from accidents and slip-and-fall cases, windfall inheritances, intangible assets like copywrighted songs, are often left off bankruptcy petitions, as debtors do not always equate them as assets, although they are.

But with the corona virus pandemic overtaking the court system and American life in general, 341 meetings are being cancelled left and right, and are piling up like cord wood. With a flood of new cases expected soon, it no longer makes sense to require all debtors to converge on a central location to mumble out some answers to a pre-fab list of questions.

If the creditor meetings were scrapped, some might complain that debtors wouldn’t have to “do anything’ to go bankrupt. Under this view the meetings serve as a form of penance for debtors trying to shed their burdens. But this view ignores the real costs of bankruptcy that debtors actually care about — fees and credit rating hits. Traveling to a room somewhere to answer questions is just an annoyance, doesn’t really even register on the scale.

And as far as debtors having carte blance in a system without regular creditor meetings, it probably ain’t so. The United States Trustee office is well adapted to auditing debtors, and for the most part does so without heavy reliance on face-to-face contact. E-mail, mail, and phone calls to the debtor’s attorney are the preferred methods, in what usually amounts to a large exchange of paperwork.

So if there is another stimulus package coming down the pike from Congress, lets put in a small line item saying good bye to section 341 for individuals declaring Chapter 7.

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Can a state file for bankruptcy?

By doug | Published: April 24, 2020

With tensions over corona virus and the financial meltdown left in its wake approaching the boiling point, on April 22, 2020 Senate majority leader Mitch McConnell (R-Ky.) appeared ready to ditch the idea of bailing out strapped state governments, suggesting that the states might be better off filing bankruptcy cases instead. This in turn brought a firestorm of Democratic retorts, led especially by New York Governor Andrew Cuomo. Be that as it may, Sen. McConnell’s brainstorm raises the question of whether bankruptcy by one or more of the fifty states is even possible. The answer turns out to be “no.”

Title 11 of the United States Code, section 109, right at the beginning of the Bankruptcy Code, controls who may be a debtor in a bankruptcy case. “Only a person that resides or has a domicile, a place of business, or property in the United States, or a municipality, may be a debtor under this title.” 11 USC s. 109 (a). No room for states there.

Chapter 9 of the bankruptcy code deals with cases brought by governmental units. “An entity may be a debtor under chapter 9 of this title if and only if such entity is a municipality …” and meets four other qualification, one of which involves being permitted by state law to file for relief. 11 USC 109 (c).

The answer to the question therefore obviously depends of the definition of municipality, which is found in bankruptcy code section 101 (40): “Municipality” means political subdivision or public agency or instrumentality of a State.”

So only a subpart of a state may file a bankruptcy case according to both code sections 109 (a) or (c). If Congress is serious about seeing whole states lining up in bankruptcy court, it is going to have to tweak the code in at least a couple of places.

by Doug Beaton

Attorney Douglas J. Beaton has practiced bankruptcy law in the Northeast for twenty-six years, and is an active commentator on developments in bankruptcy practice and procedure. He can be reached through this form:

Posted in Bankruptcy News, The Bankruptcy Code | Comments closed

Massachusetts adds local rules to implement new small business bankruptcy cases

By doug | Published: April 23, 2020

The Small Business Reorganization Act took effect in February of 2020, adding a streamlined Chapter 11 bankruptcy process for businesses with less than $7M in debt, and in April the bankruptcy court in Massachusetts issued some new local rules for handling these cases.

Local rule 1002 -1 implements the requirement that the judge assigned to a SBRA case must hold a status conference on the case no later than sixty days after it is filed. Although the local rule doesn’t mention it, debtor’s counsel should be aware that a statement summarizing the status of negotiations with creditors must be filed 14 days prior to the conference, or in other words, no later than 46 days in to the case.

Rule 2014-1 has been amended to reflect that professionals with claims of less than $10,000.00 against the debtor can now be employed to do post-petition work in the case without triggering a conflict of interest.

Rule 3014-1 forces creditors to make their section 1111(b) election no later than 14 days in to the case. Under secured creditors can elect to protect themselves against a debtor undervaluing collateral supporting a loan, but have to give a vote on treatment of unsecured claims.

Rule 3017.1-1 allows some small business debtors to move for a combined hearing on disclosures and plan confirmation, and provides a suggested motion and forms to use. The wording of this rule is interesting, because it confirms that there are now not two, but three paths for a Chapter 11 case: small business treatment under the SBRA, small business treatment under the pre-existing Chapter 11 code sections, and what might be called “large business” bankruptcy.

Rule 3022-1 has been clarified to specify that an SBRA case is fully administered when the case trustee has finished his work — which may be 3-5 years after filing, considering the length of SBRA Chapter 11 plans.

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Yes, you can discharge utility bills in bankruptcy — and still keep the lights on

By doug | Published: April 22, 2020

In my experience, one of the most underused provisions of the bankruptcy code involve the ability to discharge utility bills with very little consequence to the debtor.

In a Chapter 7 case, utility bills are nearly always classified as unsecured debts, and are discharged 100% simply by listing them on Schedule F accompanying a voluntary petition. In Chapter 13 bankruptcy, it is typical to propose a plan that pays utilities only pennies on the dollar, sometimes as little as 1%.

Yet debtors contemplating bankruptcy are quite hesitant to “include” utility bills with their filing. This is true though even small debtors often owe hundreds of dollars in back payments, and if they are discharged in bankruptcy, which they will be, often pay for the legal fees to file the bankruptcy all by themselves.

Debtors often have three inter-related worries concerning how utility bills are handled in bankruptcy court. First is will service be shut off? Second is will future service be denied? Also worrying to debtors is future service being contingent on payment of large deposits.

Bankruptcy doesn’t cause utility shut-offs, it prevents them. Filing a case sets an “automatic stay” into action, which makes it an offense to shut off service as of the date the case was filed. The debtor doesn’t have to do anything special to get this protection — that’s why it’s automatic. If the utility “misses” the notice of the case (accidentally or on purpose) and shuts off service a few days into the case, it has to come back out and turn it on again — with no charge to the debtor. If the violation appears to be deliberate, the utility can be fined by the bankruptcy judge.

Denial of future service can also be considered a violation of the automatic stay. In the real world, it just doesn’t happen. If the debtor lists a utility bill on a bankruptcy petition, the standard response is to zero out the balance and issue a new account number. Debtors should be aware that they will have to pay for services received after the date of the case filing, however.

The bankruptcy code does allow utility companies to demand a deposit for future service, however. But for debtors in Massachusetts, there is no worry here either, as state regulations prohibit the use of deposit in most instances. One exception is city-owned utility companies, like the Wakefield Municipal Light Department, who can charge deposits. Even then, they are not required to.

New Hampshire debtors face a murkier situation, as there is no specific state regulation of deposits, but in practice they enjoy something of a spillover effect from the Massachusetts rule, as some companies in southern NH are doing business in both states and are just not set up to collect deposits.

Debtors contemplating bankruptcy can and should list as many utility bills as they have on their filing petitions. Doing so will often pay for the case all by itself.

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Analysis of the key differences between small business and traditional Chapter 11 bankruptcy cases

By doug | Published: April 21, 2020

Bankruptcy courts nationwide began implementing a new law, the Small Business Reorganization Act, in February, 2020, just in advance of one of the sharpest, swiftest economic swoons in memory.

The new law, sometimes tagged with the initials SBRA, creates a streamlined version of Chapter 11 bankruptcy reorganization for small companies and entrepreneurs who want to continue operations, but are facing the shock of a swift reversal of fortune.

Through the new laws, qualified individuals and firms have the opportunity for meaningful reorganization and a second chance at survival without the fearsome burdens and expenses of “traditional” or “standard” Chapter 11 cases.

Here is a breakdown of the main ways the two paths differ:

1. The new law, found in “subchapter V” of Chapter 11 applies to both individuals and entities: LLCs and corporations can file, and so can self-employed individuals. Commentary: this is identical to standard cases, although the SBRA provisions may be more attractive to individual filers. To use the SBRA, debtors must be under the “debt ceiling” of $7.5 million in total debts. The ceiling is set to go back to $2.3 million when the CARES Act corona virus stimulus law expires in March, 2021.

2. Now there are two (or three) paths for Chapter 11: SBRA or traditional. Note that the traditional path also has small business provisions, which remain in force.

3. To play by the SBRA rules, debtors must opt-in at the time of filing the case. Check boxes on the petition used to start the case have been changed to allow opt-in. Constant switching back-and-forth between options does not seem possible.

4. A SBRA debtor is a “debtor in possession.” SBRA debtors retain physical control over business assets and decisions. This is identical to standard Chapter 11 practice.

5. A debtor in possession can be removed — or re-instated — by a bankruptcy judge for good cause under the SBRA. Fraud or incompetence would be the typical reasons. The procedure is streamlined compared to standard cases.

6. A status conference will be held by the bankruptcy judge within sixty days of filing a case. This will normally be held in the city where the courthouse is located, with attendant expenses. The conference comes up sooner under the SBRA. Fourteen days prior to the conference, the debtor’s attorney must file a report detailing negotiations with creditors. Attorneys should note that civil negotiation with creditors is therefore implicitly encouraged.

7. The SBRA debtor has ninety days to file a plan. A traditional debtor has 300 days to file a plan. Attorneys should note that plans (or at least rough drafts of plans) should be worked on before actually filing the case. Under the SBRA, only a debtor can file a plan. Under traditional Chapter 11 practice, creditors or trustees can file plans too, and then vote on which one they like best.

8. Most SBRA cases will not involve creditor committees. A judge can allow committees “for cause.”

9. Disclosure statements are not used in SBRA cases. Debtors save money because they don’t have to pay their attorney to draft them. Some of the disclosure requirements are handled through the plan, instead.

10. The absolute priority rule does not apply in SBRA cases. The prohibition on equity owners retaining their interests in the debtor without paying holders of non-consenting impaired classes (see sec. 1129(b)), does not apply in cases under Subchapter V.  See § 1181(a). For debtors, this is a major advantage to the SBRA, and may alone dictate using the new sections.

11. Plans can be confirmed over the objection of any or all creditors. To accomplish this, the judge must find that the plan is “fair and equitable” to impaired creditors.

12. In turn, the definition of what “fair and equitable” means has been spelled out in the bankruptcy code. A fair and equitable plan is one that distributes all of the debtor’s projected disposable income to the plan for the 3-5 year duration of the plan, in either cash payments or property distribution. The judge must also find that the debtor is likely to have enough income to make the plan payments.

3. For individuals who file as small businesses, the definition of “projected disposable income” has been adjusted. Projected disposable income is net income — after reasonable living expenses and child support payments have been subtracted — which is what is due to creditors.

14. In SBRA cases, income earned after the filing date is part of the bankruptcy estate. Property bought after filing is, too. This is a potential disadvantage for debtors.

15. Mortgages on a debtor’s principle residence can be modified under the SBRA, so long as the loan was obtained for business purposes (i.e. not to buy the house). The type of modification that could benefit the debtor is a split of the mortgage claim into a secured portion (paid in full with interest) and an unsecured portion (paid pennies on the dollar like other unsecured bills). For a debtor with this type of loan, this could be a major advantage of the SBRA, as altering home mortgages is generally forbidden under the other bankruptcy provisions.

16. Discharge: Under the SBRA, discharge occurs when all the plan payments are made (i.e. in 3-5 years). This is later than standard Chapter 11. Excepted from discharge is any debt on which the last payment is due after the end of the plan. This could be a deal-breaker for some debtors. The exclusion is not found in standard Chapter 13 cases.

17. Trustees. A specific trustee is appointed in every SBRA case. Most districts will handle this by appointing a standing trustee to handle all SBRA matters in a given area, similar to Chapter 12 and Chapter 13 practice. Case specific trustees are rare in standard Chapter 11 cases, assigned only where fraud or incompetence has caused a problem. Trustees earn a 5% fee, paid by the debtor through the plan.

18. In SBRA cases, debtors may pay “administrative” expenses through the plan. These typically include the debtor’s attorney’s fees for post-petition work, which may be substantial. In standard cases these must be paid in cash before confirmation of a plan.

Which way to go? If you can get a debtor in under the cap, probably with the SBRA version, unless the prohibition of discharging long-term debts is a deal breaker.

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Americans are asking for mortgage forbearances, but should be wary of the consequences

By doug | Published: April 20, 2020

Three weeks after the passage of the CARES Act, so far the main response of the federal government to the corona virus quarantines, almost three million Americans had signed up to skip their mortgage payments under the act’s forbearance program.

That amounts to about 5.5% of American homeowners and $651 billion in missed payments according to financial consultants Black Knight, Inc.

In terms of underwriting, 4.9% of Fannie Mae or Freddie Mac borrowers are asking for forbearance. At the Veteran’s Administration and FHA, the rate has hit 7.6%.

The CARES Act stimulus package allows borrowers with federally backed mortgages to delay mortgage payments for as much as six months if they have lost income due to the corona virus.

But the concession comes with a major catch — when a forbearance is granted, the payments become due immediately after the grace period ends. As an example, a homeowner with a $2,000 monthly mortgage payment who skipped six consecutive payments legally under the Act, would still face making a $14,000 payment when the six months were up — i.e. all of the missed payments, plus the current one.

That’s why the forebearance program ultimately will be of limited help to homeowners, and is just a form of kinging the can down the road a bit. What would actually help them is a deferral of payments instead. Deferrals work more like loan modifications — the deferred payments become due some time in the far away future, such as when the promissory note connected to the mortgage expires.

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Will the First Circuit screw up the Small Business Reorganization Act?

By doug | Published: April 17, 2020

The newly enacted Small Business Reorganization Act, creating a new subchapter V in Chapter 11 of the bankruptcy code geared toward smaller enterprises, gives bankruptcy lawyers a whole new toolbox when it comes to helping entrepreneurs with less than $7.5 million in debts. One of the new sections, 11 USC s. 1190, appears to specifically allow for the first time the ability of a debtor to modify or “cram down” a home mortgage, provided that the borrowed funds were used for business purposes and not to acquire the residence.

Now let’s hope the First Circuit lets debtors in New England actually use this provision.

Why should that be a concern? Well, when debtor attorneys tried to fashion similar relief packages in Chapter 13 a few years ago, their plans were ultimately shot down by a First Circuit bankruptcy appellate panel ruling that was criticized by the National Consumer Bankruptcy Rights Center for its flawed reasoning.

The case of Bullard v. Hyde Park Savings Bank (494 B.R. 92 (2013)) involved the use a of Chapter 13 hybrid plan, a concept that at the time was approved by some of the Massachusetts bankruptcy court judges. In a hybrid plan, debtor’s attorneys piece together several sections of the code to fashion new mortgage terms that the debtor can live with.

For example, the debtor in Bullard had a two-family house that was worth less than the mortgage balance. he proposed in his Chapter 13 plan to divide, or bifurcate, the loan into secured and unsecured parts. The lender would retain its lien on the secured claim up to its value, but would be paid pennies on the dollar for the unsecured claim through the plan. The debtor would continue making regular payments to the lender outside the plan, and these would stretch on into the future, past the end of the plan.

But a First Circuit bankruptcy appellate panel (“the BAP”) comprised of three disinterested bankruptcy judges, balked at this, claiming the code itself was full of fatal contradictions. Specifically, the BAP said that code section 1322 (b) (2) — allowing the bifurcation — was incompatible with code section 1322 (b) (5) — which sets the rules for a “cure and maintain” plan with most payments going directly to the lender outside the plan, and continuing after the bankruptcy case is over.

Leaving aside the issue of whether BAP opinions have any precedential value to start with, the Bullard case essentially terminated the use of hybrid plans in Massachusetts, Maine, New Hampshire, and Rhode Island.

Fast forward to the spring of 2020: could the situation repeat with the SBRA?

Newly added section 11 USC s. 1190 explicitly states that a small business debtor “may modify the rights of the holder of a claim secured only by a security interest in real property that is the principal residence of the debtor if the new value received in connection with the granting of the security interest was—(A) not used primarily to acquire the real property; and (B)used primarily in connection with the small business of the debtor.”

However, the newly added section on discharge erases most small business debts, except any debt—(1) on which the last payment is due after the first 3 years of the plan, or such other time not to exceed 5 years fixed by the court. 11 USC 1392.

Isn’t this just asking the First Circuit to bring its flawed reasoning back again? Since most home mortgages are going to have more than 3 to 5 years of payments remaining, and most debtors aren’t going to be able to pay off the balance (even a crammed-down balance) in less than 3 years through a plan, its possible we could see the death of hybrid Chapter 11 plans in the First Circuit just like we did with Chapter 13.

Let’s hope better reasoning prevails, and debtors catch a break this time.

Posted in Chapter 11, Small business bankruptcy | Tagged | Comments closed

Controversy swirls over creditors ability to snatch stimulus checks

By doug | Published: April 16, 2020

The possibility of Covid-19 stimulus checks — $1,200 for most Americans — ending up in the pockets of banks and bill collectors instead keeps popping up in the headlines, with much of the reporting driven by David Dayen of the American Prospect e-zine.

Dayen has posted that Treasury Secretary Steven Mnuchin was aware a technical problem with the massive CARES stimulus bill that would potentially allow dunning companies to snatch debtor’s stimulus payments as soon as they hit banks, if they were to act fast enough when the payments start to go out in April 2020.

According to Dayen’s post in the Prospect’s blog, Democratic US Senator Sherrod Brown of Ohio clued Mnuchin in to the flaw on April 1st, just five days after the massive bailout package became law. Brown and other legislators worried that there was no protection form collection agencies seeking to time garnishment orders for past due debts for the weeks when the stimulus payments will start hitting debtor’s bank accounts.

Mr. Dayen, who appeared on Julie Mason’s SiriusXM Press Pool show on satellite radio as well, has also been exploring a sub-section of this story: namely the possibility that banks may get a windfall when the stimulus checks land in overdrawn accounts, and they are allowed to “set-off” the funds to recoup the deficit. On April 16th, American Prospect reports that USAA, a credit union serving military personnel and veterans, is in fact setting off the government payments against bounced checks.

How much of a problem this becomes nationwide remains to be seen, but it is not a danger for Massachusetts debtors, because the state has enacted temporary bans that should prevent stimulus snatching.

According to Mr. Dayen’s reports,Massachusetts senator Elizabeth Warren and Ohio Senator Sherrod Brown have both been writing letters to US Treasury officials, trying to get a national regulation prohibiting the seizures put in place.

However, until — and if– it does, debtor’s should try to be proactive in updating their banking information, so that stimulus payments don’t end up in old accounts with negative balances.

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