Why not bankruptcy?

Why not bankruptcy?

 

Consumer bankruptcy filings have steadily declined over the last 52 months.  There has not been an increase in filings in that time and most year-over –year drops have been at least 10% over the past 4 years or so.  In Vermont, total case filings, which are primarily consumer cases, have gone from 1,626 in 2010 to only approximately 600 cases so far this year.  Why such a significant drop?

 

The precipitous drop in filings has puzzled practitioners and economists alike.  Sure, the economy has been steadily improving, but the filing numbers are not tracking as consistently with the economic factors such as unemployment as they had in the past.  Unemployment can actually temporarily reduce filing numbers because the unemployed often cannot afford to file for relief and have more pressing needs to attend to.  Despite some uptick, a predominant theory remains that filings are down because people simply cannot afford to file for relief, especially those in the income segments that have historically been more likely to file. The improving economy is not necessarily reaching those folks, not quite yet.

 

Another theory relates to one of the primary reasons that consumers seek bankruptcy relief: credit card debt.  When the bankruptcy laws changed significantly in 2005, a pervasive myth began taking hold--that credit card debt is no longer dischargeable.  No one quite knows the origin of this myth, although it could be closely related to the near $100 million that the credit card industry spent over the years to lobby for the bankruptcy reform.  The rumor is simply unfounded and despite all of the significant changes to the bankruptcy laws in 2005, there is no filing restriction specifically with respect to credit card debt.  One thing is certain, however, credit card debt among consumers is down.  Statistics show that both lenders and borrowers alike have caused significant credit card debt decline since the 2008 recession.  Lenders have tightened their requirements and borrowers have curbed their usage since 2008, reducing, for now, one major reason to file.

 

Consumer bankruptcy filings also have some direct relation to foreclosure filing cycles.  The peak year of bankruptcy filings post-recession nationally was around 2009-2010, reported to be directly in relation to a wave of foreclosure filings.  With the potential for HAMP and other modifications and stricter foreclosure standards state-by-state, the foreclosure filings had either decreased since 2010 or had been delayed to the extent that bankruptcy filings became less urgent.  While foreclosure filings are decreasing some, it is troubling that mortgage default rates, while declining very slowly, are nowhere near the pre-2008 mortgage default rates.   Another troubling statistic indicates that consumers are struggling for nearly 2 years prior to filing compared to much shorter periods prior to the bankruptcy reform.  The mortgage default rates and increased period of struggle clearly show that the decline in consumer filings is neither permanent nor an indication that the economy has completely turned around.

 

While credit card debt has declined, student loan debt has not.  In fact, student loan debt among consumers has grown over 50% in the last ten years or so.  Unfortunately, student loan debt is essentially non-dischargeable in bankruptcy.  Despite that the debt cannot be eliminated, student loan debt also cannot be treated favorably over other unsecured debt in a Chapter 13 bankruptcy plan.  The inability to discharge or restructure the most significantly increased sector of unsecured debt must be another reason that consumer filings are down.  While bankruptcy is intended to provide relief from crippling debt, student loan debt is immune from the magic wand relief we’ve described previously.  As the debt only increases, it may spark the next big area of bankruptcy reform.  Stay tuned for a Bankrupt-C Y-blawg devoted exclusively to student loan issues.

 

Bankruptcy filings have become a bit more complicated since the 2005 bankruptcy reform, which is touted for the increased delay for consumers to seek relief. Just as ever, a filing can still provide a significant amount of relief for a person who is struggling financially.  Timing can be crucial, and we certainly find that the cost and effort required to complete a successful bankruptcy case may not be attainable or ideal for someone who is unemployed or in the midst of other crises.

 

A consultation, however, is beneficial to nearly everyone who is struggling financially.  The most important thing is to become informed and know your options.  We understand the effects of crippling debt and find that most people do wait far too long before they seek help.  The most rewarding part of my practice is to see the physical change in clients as options are presented to them that show some light at the end of the tunnel.  Over the course of a consultation, I watch the perceptible weight begin to lift and see the clients breathe more deeply. They may even smile. 

Why Collateral?

Why collateral?

As described in previous Y-blawgs, Vermont’s foreclosure laws were designed to protect the homeowner from losing their home too quickly by giving the homeowner a chance to halt the process, if possible, in order to modify, reinstate or perhaps even file for Chapter 13 relief.  To understand the process more fully, we have to start with the originating documents: the Note and Mortgage.  Most people are unaware of the subtle differences between all of the documentation they sign at a mortgage closing.  That event itself is overwhelming.  The two main documents being signed are the Note and Mortgage.  The Note is a promissory note saying that the homeowner is borrowing money and owes the lender x dollars.  The Mortgage secures that obligation by basically pledging the home as collateral for the money borrowed.  Both components are necessary to complete the transaction and to give the lender the later right to foreclose if payments are missed.

When a lender forecloses, the lengthy procedure gives the lender the ultimate right to do two things if certain steps are followed:  One, take ownership of the property in order to sell; Two, collect any deficiency IF the property doesn’t sell for enough to pay what’s owed.  These are two separate remedies; the first being a right under the Mortgage and the second being a right under the Note.  In the vast majority of cases, particularly with large out-of-state lenders, the bank only seeks ownership of the property, and will not sue the borrower to collect on any deficiency.  Recently, however, some lenders have sought deficiencies against borrowers in Vermont, so it is important to review the paperwork thoroughly.  To collect on a deficiency, a lender must ask for it initially and also seek to recover the specific amount at confirmation of any foreclosure sale that didn’t make them whole.

It is important to recognize the difference between the Note and Mortgage and their separate remedies, particularly when a bankruptcy is involved.   All transactions involving the pledging of collateral have these components—one showing the amount borrowed, and one pledging the collateral.  When a person files for bankruptcy relief, that person is seeking to discharge debt.  If a Chapter 7 discharge is received, for example, all dischargeable debts such as an amount owing under the Note will be eliminated.  The borrower no longer owes the lender any money.

A bankruptcy, however, does not affect a properly recorded Mortgage.  This is why so many people are able to file for Chapter 7 bankruptcy relief and keep their homes.  The Mortgage stays put, and so long as the debtor continues to pay their mortgage payments, they keep the home.  If they are later unable to afford the home, a lender can commence a foreclosure action.  Post-discharge, however, a lender can never collect on the Note (unless the debtor “reaffirmed” in their bankruptcy case, which warrants its own blawg entry), it can only recover from the property itself.  Absent a new contract within the bankruptcy case, called “reaffirmation” the mortgage lenders would never be able to collect from the borrowers after a discharge.  This benefit of bankruptcy can be huge, especially when dealing with property that may be upside-down in terms of loan to value.

It is important to know, when borrowing money, what, if anything, is being pledged as collateral and what rights you have under the agreements.  Collateral gives lenders greater rights both inside and outside the bankruptcy world and significantly impacts a borrower’s options.  Lenders have to follow certain procedures to validate the Mortgage.  Understanding how a bankruptcy discharge affects a Note but not a Mortgage is extremely important when considering bankruptcy or even when considering whether to enter into a deed in lieu of foreclosure with a lender.  Giving property back to the lender does not necessarily eliminate the Note obligation, so it is important to read any agreement carefully. 

Merely having some understanding of the two essential components of a mortgage lending transaction gives a borrower the ability to retain some control in an otherwise overwhelming process.  If you are unsure of your rights and obligations with respect to your home, a consultation with an attorney concentrating in debtor-creditor relations may be beneficial, especially if you are having financial difficulties.  We at OEBlaw will take the time to review your situation and any loan documents carefully to best advise you as to your options.

Why the Vermont Bar Association?

      Taking a short break from our substantive law blawgs on foreclosure, bankruptcy, mediation and collection, today is all about praise for the Vermont Bar Association.  As many of our readers may know, I have been serving first as the Chair of the Bankruptcy Law Section of the VBA and now on the VBA Board of Managers since 2006.  Since bankruptcy lawyers spend most of their time mired in the federal system, one might ask why would a Vermont bankruptcy lawyer either belong to, or donate time to, the Vermont Bar Association? 

        The easiest and most simplistic answer could be gleaned from why I served to begin with.  Serving on the board does fulfill a lawyer’s duty to promote the profession and donate time to benefit its members and, in turn, their clients.  For me, belonging to a small group of no more than 40 or so federal bankruptcy practitioners, it gave me a chance to learn more about what the rest of the State Court practitioners were doing.  I assumed it would be a great way to make connections with other lawyers in the state.  This, of course, is all true, however, I have found over the years that it is so much more than that.  

        With the transformation of the practice of law in recent decades to more impersonal communication methods, competition from online service providers, such as Legal Zoom, increased specialization, social media concerns and complex technological confidentiality issues, to name a few, the Board of Managers allows a group of concerned legal minds to gather monthly as a think-tank to address these broader issues.  Every effort is made to engage in meaningful discussions about the future of the practice of law and how the VBA can assist Vermont lawyers.  Being Vermont practitioners, we also grapple with Vermont’s aging demographics, the cost of law school in relation to the limited financial benefit of practice in Vermont and the needs of small and solo practitioners, many of whom are in rural areas, for support on a larger scale for education, technology and networking.  While of course continuing legal education is an essential service that the VBA provides, the Board of Bar Managers constantly strives to find ways to be of greater service to its members.

        What many Vermont lawyers may be less aware of is the VBA’s consistent presence in the Vermont legislature.  Recently, I took a day to shadow VBA’s executive director, Bob Paolini, at the statehouse.  As president-elect of the VBA, I thought it important to see Bob in action before the summer adjournment. 

        During the legislative session, Bob is certainly active at the state house, either testifying, putting people in touch with each other to find common ground, finding lawyers to testify or merely being the proverbial fly on the wall.  If there is proposed legislation that has even a whiff of a potential effect on the practice of law, Bob is quick to alert concerned members, whichever ‘side’ they may be on.  Some issues are major, like the recent proposal to tax legal services or proposed cuts to the funding of the judiciary.  Some may seem minor, like choosing individuals to serve on study or rules committees, assessing incremental fee hikes or reviewing form changes.  No matter the issue, if it affects a member’s practice of law, Bob is there to make sure the VBA member’s voice is heard.  Having a seat at the table is a crucial and often silent benefit that the VBA provides to its members.  And as everyone knows, if you aren’t given a seat at the table, you just might be on the menu.

Why Chapter 13 for Homeowners in Foreclosure?

       

      Last substantive blawg, we scratched the surface of the long and involved Vermont foreclosure process and hinted that a Chapter 13 bankruptcy sometimes may be an option for borrowers facing foreclosure.  As described previously, with the available modification programs such as HAMP, it is usually recommended to seek modification through the lender or through mediation before resorting to bankruptcy.  This is because the bankruptcy code specifically limits a debtor’s ability to modify their home mortgage through a Chapter 13 plan without consent. 

        Outside of home mortgage debts, a Chapter 13 debtor has a number of tools available to restructure their financial situation.  One very powerful tool is called “cram down,” which, put simply, allows a borrower to pay only the value of the collateral rather than the whole balance due under a note.  For example, if a borrower had some investment property or equipment worth $50,000, but owed $150,000 to the lender, that borrower could restructure the debt to pay only $50,000 and treat the remaining $100,000 as unsecured, paying a small percentage along with credit cards and other non-collateralized debt.  Another tool would allow that borrower to utilize what may be a lower interest rate in bankruptcy.  Finally, if that loan were already called or due in full, a debtor can instead pay that lower debt over 5 years, instead of immediately.  When dealing with loans that aren’t the debtor’s primary mortgage loan, these powerful tools allow debtors to cram-down the value, interest rate and modify the terms of certain loans.  These tools are an essential part of the bankruptcy process, utilized in all Chapters in slightly different ways, but useful modification methods nonetheless.

        When a loan is specifically collateralized by a debtor’s primary residence, however, the modification tools have been limited.  While this may seem counterintuitive, since it would seem a borrower’s home is always more important to save than investment property or equipment, the bankruptcy code specifically prohibits a Chapter 13 debtor from restructuring or modifying their home loan.  This ‘anti-modification’ provision has been in existence since the original bankruptcy code and was affirmed by the US Supreme Court in 1993.  As became all too clear in 2008, the mortgage industry, while more volatile than we may have thought, is the backbone of our economy.  The lobbying efforts for that industry are so strong, that any attempt to allow bankruptcy judges to modify home mortgages was met with strong and forceful resistance, citing the collapse of our entire economy as a result.  While most bankruptcy judges, scholars and consumer advocates would agree that allowing Chapter 13 debtors to modify or cram-down home mortgages would have gone and would go a long way toward repairing the economy, the lobby could not be overcome. 

        If no modification, what are a Chapter 13 debtor’s options with respect to his or her home?  While the modification programs are extremely helpful to those who have a chronic or ongoing hardship, they do not offer much assistance to people who are recovering fairly well from a past, temporary hardship.  Most modification programs are focused on trying to get the borrower to an affordable mortgage payment, which under HAMP is 31% of their gross income, including taxes and insurance.  This really is the upper end of “affordable” for most people.  Where prospective debtors have a household monthly income of $5,000 and a mortgage payment of less than $1,550, they will find that there are likely no modification options available, since the mortgage is already “deemed affordable.”  This is notwithstanding that they may now have an arrearage of $25,000 which has been accruing during the foreclosure case, during which the lender has refused to accept payments.  Most lenders will require the $25,000 up front or over no more than 12 months, and offer no modification for this scenario.

        Enter Chapter 13.  While the loan in this scenario can’t be modified in Chapter 13, a Chapter 13 would allow the debtors to force a reinstatement over time, up to a period of 60 months.  For debtors who have recovered from a hardship and can now pay their regular mortgage payment, plus 1/60^th of the arrearage every month (plus Chapter 13 administration costs), a Chapter 13 will allow them to save their home.  The mortgage lender can be forced to reinstate, accept regular payments and accept the arrearage over a 60 month period.  This is undoubtedly expensive, but may be the only option available for those who have recovered from a prior hardship and don’t otherwise qualify for a modification. 

        I would encourage anyone who has been through mediation or has been denied a modification for reasons such as “unable to lower PITI payment,” loan “deemed affordable” or “housing ratio too low” to consult with bankruptcy counsel and see if a Chapter 13 would assist them in saving their home.   We take the counseling aspect of our job very seriously, so that if the Chapter 13 option seems too expensive or the loan-to-value ratio on the home does not seem to make economic sense, we will take the time to discuss all available options and alternatives so that our clients can make the best informed decision as to how to proceed.  If this all seems overwhelming and technical, don’t worry!  You won’t leave OEBlaw without a greater understanding and skilled counsel to help you navigate this process.