When filing for bankruptcy, most people are aware that they may have less control over their assets, and may even have to surrender some assets.  However, many people are unaware of the fact that a bankruptcy filing technically changes the nature of your assets in the eyes of the court, and that timing makes [...]

In two bankruptcy appeals decided this summer, the Supreme Court faithfully followed congressional intent in one case, while finding that the language used by Congress did not quite do the job in the other.    In RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S.Ct. 2065, 182 L.Ed.2d 967 (2012), the Court put In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3rd Cir. 2010) to rest, holding that a chapter 11 plan which provided for sale of the debtors assets while denying lenders the right to credit bid could not be approved as providing the lender the “indubitable equivalent” of its collateral.     However, in Hall v. United States, 132 S.Ct. 1882, 182 L.Ed.2d 840 (2012), the Court held that a tax provision intended to benefit family farmers who sell their farm during a chapter 12 proceeding was ineffective in the particular case because chapter 12 cases do not create a separate taxable estate.    The two decisions point out the imprecision present in the English language.Not So Rad for DebtorsIn the RadLAX case, the Supreme Court had to consider whether one of three confirmation cram-down options could contradict another.   The debtor proposed to sell its property pursuant to a plan of reorganization, but did not want to allow the secured creditor to credit bid.    The bankruptcy court and the Seventh Circuit said no.   However, the Third Circuit had previously said yes.  The debtor and the Third Circuit said that it was possible to use the phrase “indubitable equivalent” to get in through the back door what would otherwise not be possible under the provision dealing with sales free and clear of liens.  Justice Scalia and seven of his brethren were not impressed.   (Justice Kennedy did not participate so the decision was a unanimous 8-0).Under 11 U.S.C. Sec. 1129 (b)(1), a debtor seeking to overcome the dissenting class of claims must propose a plan that is “fair and equitable” and which does not discriminate “unfairly.”   The statute goes on to state that the requirement that a plan be “fair and equitable” “includes” certain requirements.   There may be more requirements to “fair and equitable” but Congress did not tell us what they are.    However, at a minimum, they include a checklist of items applicable to classes of secured claims, unsecured claims and interests.   For secured claims, the checklist says that treatment must include one of the following options:(       a. The creditor must retain its lien and receive payment of the present value of its secured claim;(      b. The debtor may sell the property free and clear of liens subject to the creditor’s right to credit bid; or(    c. The debtor must provide the creditor with the realization of the “indubitable equivalent” of its secured claim.While the first two options are fairly specific, “indubitable equivalent” is neither a defined term nor one whose meaning is readily apparent with the use of a dictionary.   The term does have a very learned history, since it originated from Learned Hand’s opinion in In re Murel Holding Corp, 75 F.2d 941 (2nd Cir. 1935).  However, Justice Scalia did not find it necessary to wade into the thicket of what constituted the “indubitable equivalent” of a secured claim.    Instead, he invoked a canon of statutory interpretation.    We find the debtor’s of §1129(b)(2)(A)—under which clause (iii) permits precisely what clause (ii) proscribes—to be hyperliteral and contrary to common sense.  A well established canon of statutory interpretation succinctly captures the problem:  “[I]t is a common place of statutory construction that the specific governs the general.”  (citation omitted).132 S.Ct. at 2070-71.Eric Brunstad, who successfully argued the case before the Supreme Court, described the case as “unsatisfying” in a keynote address to the National Conference of Bankruptcy Judges.  He compared canons of statutory interpretation to aphorisms, such as look before you leap and strike while the iron is hot—whoever chooses the canon to apply determines the outcome.While the opinion goes on for some nineteen pages, these two sentences capture its essence.   cases, it simply was not necessary here.   Whatever else “indubitable equivalent” means, it does not mean that courts can make an end run around the more specific provisions of section 1129(b)(2)(A)(i) and (ii).By the way, my preferred definition of “indubitable equivalent” is a treatment which causes the judge to don a monocle and remark “indubitably” in an upper-class British accent.A Taxing ResultIn Hall v. United States, the chapter 12 debtors were not able to save the farm or escape paying capital gains tax on its sale—despite Congressional efforts to the contrary.  The debtors filed chapter 12 and sold the family farm.   They sought to classify $29,000 in post-petition capital gains liability as a dischargeable pre-petition debt.   While this might seem audacious, the debtors were simply trying to take advantage of 2005 legislation meant to protect family farmers from crushing tax bills.   Under 11 U.S.C. Sec. 1222(a)(2)(A), a chapter 12 plan must pay priority claims under section 507 in full unless the claim:arises as a result of a sale, transfer, exchange, or other disposition of any farm asset used in the debtor’s farming operation in which case the claim shall be treated as an unsecured claim that is not entitled to priority under section 507 . . . .If Congress had simply stated that tax claims arising from sale of a farming asset shall be treated as unsecured claims, the Halls would have been protected.   However, because the exemption was included within a general section on priority claims, the provision interacted with other provisions to deny the debtors relief.          The provision classifying taxes from sale of farm assets as unsecured claims is included in an exception to the rule that a chapter 12 plan must pay priority claims under section 507 in full..     Section 507 has two tax provisions within it. Section 507(a)(8) grants priority status to prepetition tax claims.   Section 507(a)(2) incorporates section 503(b) which refers to “any tax . . . incurred by the estate.”  a. Under 26 U.S.C. Sec. 1398 and 1399, filing chapter 12 does not create a separate taxable estate.  b. As a result, post-petition taxes in a chapter 12 case are incurred by the debtor, not the bankruptcy estate.  c. Because post-petition taxes in a chapter 12 case are incurred by the debtor and not the estate, they do not qualify as priority claims under section 507.  d. Because they do not qualify as priority claims under section 507, they do not get the benefit of the exception to treatment of priority claims in chapter 12. This is undoubtedly a result contrary to Congressional intent.   Sen. Charles Grassley, who authored the legislation, is known to be an ardent advocate for family farmers.   However, under the Supreme Court’s decision, capital gains arising from sale of a family farm prior to bankruptcy would be dischargeable as general, unsecured claims, while claims arising from a sale during the bankruptcy would be a non-dischargeable post-petition debt.    Furthermore, the proceeds from sale of the farm would be property of the estate which would be required to be used to pay creditors, even though the debtor could not use that same estate property to pay the taxes.   Even if the IRS wanted to allow the taxes to be paid through the plan, there is not a statutory mechanism for doing so.   While section 1305(a), allows a post-petition creditor in a chapter 13 proceeding to file a claim, there is no similar provision in chapter 12.This is unfortunately a case where the statutory language used was not robust enough to do the job.   If Congress wants to fix the problem, they could do so by replacing section 1222(a)(2)(A) with the following language:A claim owing to a governmental unit arising from a sale, transfer, exchange, or other disposition of any farm asset used in the debtor’s farming operation, regardless of whether such sale, transfer, exchange or other disposition occurs prior to the petition date or during the pendency of the bankruptcy case, shall be includable in the plan and shall be treated as an unsecured claim that is not entitled to priority under section 507, but the debt shall be treated in such manner only if the debtor receives a discharge.

   The 10th Circuit has ruled that it was error for a bankruptcy court to deny confirmation based on the debtor's refusal to commit social security benefits to a chapter 13 plan.  In re Cranmer, 2012 WL 5235365 (10th Cir., Oct 24, 2012).  The Debtor who was above median income, received $1940 in social security (SSI) benefits but excluded that amount from the disposable income computations on the means test, and while including the income on I, included a deduction on J for a portion of the funds as exempt social security funds.  The bankruptcy court denied confirmation finding that good faith required that SSI income had to be included in the disposable income computation in determining the plan payments.  The Chapter 13 Trustee acknowledged that the funds were excluded from the means test, but had to be included in the disposable income test based on schedules I and J.  Upon the sustaining of the trustee's objection by the bankruptcy court, the debtor filed an amended plan under protest, including the social security income in the plan; which was confirmed.  The Debtor subsequently defaulted in plan payments, resulting in dismissal of the case for failure to comply with the confirmation order, which dismissal order was then appealed.  This procedural status avoided the issue of appealing an interlocutory order.  §1325 defines disposable income as the current monthly income received by the debtor, less certain amounts including that necessary to support the debtor or dependents.  §101(10A)(A) defines current monthly income as the average monthly income the debtor and any spouse receive without regard to whether such income is taxable.  However, §101(10A)(B) specifically excludes benefits received under the social security act from the computation of current monthly income.  The trustee argued that the exclusion of social security benefits from disposable income does not extend to projected disposable income.  The 10th Circuit ruled that generally projected disposable income is the average disposable income received during the six months prior to filing multiplied by the months of the chapter 13 plan.   The Supreme Court's Hamilton v. Lanning ___ U.S. ___, 130 S.Ct. 2464, 2469, 177 L.Ed.2d 23 (2010) ruled that this figure must be adjusted when the six month figure is substantially higher or lower than the debtor's disposable income during the plan period.  The Trustee argued that this debtor would receive $87,000 SSI benefits during the life of the plan which an above-median-income debtor should not be allowed to shield from distribution to creditors.  The 10th Circuit rejected this argument finding the SSI benefits do not constitute a change in the debtor's income, and more importantly is income the Code expressly allows him to exclude from disposable income. The mere inclusion of 'projected' to the term 'disposable income' does not imbue the term with different substantive components.   Lanning made clear that not only is disposable income the starting point in determining projected disposable income, but in most cases it is determinative.  The Social Security Act itself supports this conclusion by shielding such payments from execution, levy, attachment, garnishment, or other legal process, or 'from the operation of bankruptcy or insolvency law.'  42 U.S.C.  §407(a).  The trustee argued that good faith requires a separate inquiry from the disposable income computation. When a Chapter 13 debtor calculates his repayment plan payments exactly as the Bankruptcy Code and the Social Security Act allow him to, and thereby excludes SSI, that exclusion cannot constitute a lack of good faith.  Drummond v. Welsh (In re Welsh), 465 B.R. 843, 856 (B.A.P. 9th Cir.2012); Fink v. Thompson (In re Thompson), 439 B.R. 140, 144 (B.A.P. 8th Cir.2010). To rule to the contrary would render the Codes express exclusion of SSI benefits from disposable income meaningless.      

Most contests have rules.  Charny wrote on medieval jousting; Hoyle on cards;  Queensberry on boxing. Rule 9014 provides the rules of bankruptcy disputes. 9014 recognizes contested matters:  disputes in bankruptcy cases that  don’t require an adversary proceeding but do require the court to decide a disputed issue. You can hardly be an effective player if you don’t know the rules. What’s a contested matter? Any time there are at least two sides to an issue  that needs to be made by a judge, you have a contested matter. Think:  objection to confirmation; objection to proof of claim; objection to claim of exemption; opposition to motion to avoid lien impairing an exemption. Each arises in the administration of a case or in motion practice.  Absent a negotiated settlement, each will require the court to enter an order resolving the matter. That’s a contested matter. Rule book With a few exceptions, Rule 9014 gives the parties to a contested matter the rights and tools that parties to an adversary have: Notice as provided in Rule 7004. Note that provides for  service on banks by certified mail addressed to an officer Discovery, including production of documents, depositions and interrogatories Live testimony at an evidentiary hearing Costs to a prevailing party The Part VII rules applicable to contested matters allow you to flush out information in the possession of your opponent. Get a nonsensical objection to plan confirmation?  propound some discovery.   Ask  for admissions;  demand production of documents. Make the opposition flesh out their position or admit it is knee jerk nonsense.  Each of those Part Vll tools is available in a contested matter. That’s real power.  Let the games begin. Image courtesy of getasword.com    Like This Article? You'll Love These! Produce Real Evidence In Bankruptcy Disputes Evidence Rules In Mortgage Litigation How To Enforce The Discharge Injunction

Legislatures encourage entrepreneurial risk taking by allowing individuals to form artificial entities to limit their personal exposure for corporate debts.    Plaintiffs’ lawyers attempt to tear down those walls by piercing the corporate veil.   In recent years, the Texas legislature has moved away from a formulaic approach to veil piercing (i.e., did the entity keep regular minutes) toward one focusing on whether the corporate vehicle had been used by the owner to perpetuate a fraud.   A Texas court of appeals has now confirmed that this principle applies to limited liability companies even prior to the enactment of corrective legislation.    Shook v. Walden, 368 S.W.3d 604 (Tex. App.—Austin, 2012, pet. filed).    The case involved a father who wanted to set up his new son-in-law in business.   Shook, the father, and Jahne, the son-in-law, formed S & J Endeavors, LLC.   S & J was supposed to build a home for the Waldens.    Problems ensued and the Waldens sued.   After a fourteen day trial, the jury rendered a verdict against S & J and Jahne for fraud but did not award damages.   The jury also found that S & J had breached its contract with the Waldens and awarded $80,000 in actual damages and $315,000 in attorney’s fees.   The jury imposed personal liability on both Shook and Jahne by finding that S & J was the alter ego of the individuals, that they constituted a “single-business entity” and that the LLC was a “sham.”    On appeal, the Waldens conceded that “single-business entity” was no longer a viable theory for piercing the corporate veil under Texas law.  See SSP Partners v. Gladstrong Invs. (USA) Corp., 275 S.W.3d 444 (Tex. 2008).    This left the alter ego and sham findings.The Court noted that the Texas legislature had restricted the alter ego doctrine in cases involving business corporations to cases where the defendant used the corporation to commit an “actual fraud” for his “direct personal benefit.”   This eliminated veil piercing based on failure to keep minutes and other technical violations.   While this legislation was evolving over the period from 1989 to 1997, the legislature created the limited liability company as a new form of entity in 1991.   While the legislation contained general provisions that the members of an LLC were not liable for the entity’s debts, it did not address veil piercing principles until 2011.  See Business Organizations Code Sec. 21.223 and 21.224.    Unfortunately, this legislative change did not apply to Shook's case.Nevertheless, after an extensive discussion, the Austin Court of Appeals concluded that the “actual fraud” for “direct personal benefit” standard should apply to a limited liability company even prior to the recent legislative amendments.    While this seems like a sensible conclusion, one Justice dissented and a petition for review is now pending before the Texas Supreme Court.   For cases arising after September 1, 2011, the new legislation dictates the higher standard for veil piercing.   I would suggest that the facts of the Shook case illustrate why the legislature was right to make this change.    Mr. Shook invested approximately $200,000 in the home-building business.    He was one of two members and managers.    The company used the Shook residence as its mailing address and he signed a few checks.    Shook contributed some nominal services to the company such as helping to install door hinges, door knobs and towel bars.   Mr. Shook would have been quite justified in asking, "Does this make me a bad guy?"The issue submitted to the jury allowed them to find that “a corporation is the alter ego of a shareholder when there is such a unity between the corporation and the shareholder that the separateness of the corporation has ceased, or when a corporation operates as a mere tool or business conduit of its shareholder” as “shown from the total dealings” of the shareholder and the corporation.    The jury was also instructed to consider eight other factors including “the amount of financial interest, ownership and control the shareholder maintains over the corporation.”  Unfortunately, the instructions submitted to the jury gave them virtual carte blanche to impose liability based upon their subjective whims.  In my personal view, if the legislature is going to allow persons to use artificial entities to do business, the Courts should respect that judgment by setting a high bar to impose personal liability.    While it is reassuring that the much-maligned Texas legislature has set standards to rein in the courts, it is also comforting that in this particular case, the appellate court (or at least 2/3 of its members) did the sensible thing.   Note:  While the reader may discern that I have some personal opinions about the issue in this case, I did not have any involvement.

In a display of pre-election bipartisanship, the Fifth Circuit affirmed a fraudulent transfer judgment in favor of Stanford International Bank Receiver Ralph Janvey against five Democratic and Republican campaign committees totaling approximately $1.6 million.    Janvey v. Democratic Senatorial Campaign Committee, Inc., No. 11-10704 (5th Cir. 10/23/12), which can be found here. While the opinion involved a receivership rather than a bankruptcy proceeding, the issues under the Texas Uniform Fraudulent Transfer Act have bankruptcy implications as well.The District Court granted summary judgment to the Receiver on claims that the contributions were made with actual intent to hinder, delay or defraud creditors.    The Receiver alleged, and the District Court agreed, that payments made as part of a Ponzi scheme are presumptively made with intent to hinder, delay or defraud.   According to the Receiver, this shifted the burden to the committees to show a defense such as good faith or reasonably equivalent value.   The Committees did not argue on appeal that the Stanford entities received reasonably equivalent value for their political contributions.   Unfortunately this meant that the opinion did not contain what would have been an interesting discussion of what contributors receive for their donations.   The Committees no doubt concluded that the political risks of arguing that fraudsters receive a reasonably equivalent benefit for their contributions was too dangerous to advance (even if it could have been factually supported).Instead, the Fifth Circuit addressed three issues.   First, the Court ruled that a Receiver, like a bankruptcy trustee, may pursue claims under the Texas Uniform Fraudulent Transfer Act on behalf of creditors.   The Committee had argued that the Receiver was not himself a creditor and therefore lacked standing to pursue the claims.Next, the Court concluded that the transfers were made within the applicable limitations period.    Under Tex. Bus. & Com. Code Section 24.010(a)(1), a plaintiff must institute an action to recover transfers under the intent to defraud provision within one year after the later of when the transfers were made or when they "reasonably could have been discovered by the claimant."    In this case, the Receiver was appointed on February 16, 2009 and filed suit on February 20, 2010.    The Committees argued that because records of  the contributions were available online and had been discussed in the media, that the Receiver should have known about them not later than February 18, 2009, which would have made the suit untimely.   Because February 16 was President's Day, the Receiver was not able to gain access to the Stanford offices until February 17.    While this would have given the Receiver two days to discover the fraud, the Fifth Circuit applied a more sympathetic standard.   It stated: Given the extent of the Stanford enterprises, the Receiver’s duties with regard to them, and the extent of the fraudulent transfers, it would not have been reasonable to expect him to immediately discover the fraud. Opinion, p. 7.   Furthermore, the Court noted that it was the Defendants' burden to prove the limitations defense which meant that they were required to prove when the Receiver should have discovered the fraud.   Apparently, three days to discover a fraud, even one based on publicly available records, was reasonable.   Because 11 U.S.C. Sec. 546 gives a bankruptcy trustee two years to commence an avoidance action, the benefit of the one year discovery rule is not readily apparent.    However, if a transfer took place more than one year prior to bankruptcy but was not readily discoverable during that time, a trustee could still file suit within two years after the order for relief.   Assume that a transfer was made on January 1, 2010 and the Debtor filed bankruptcy on January 1, 2012.    If creditors of the Debtor could not have discovered the transfer during the one year period prior to bankruptcy, then the trustee would have until January 1, 2014 to file suit.   While the discovery rule does not extend the trustee's period of time to file suit after bankruptcy is filed, it would extend the reach-back period for avoiding a transfer made prior to bankruptcy.    Finally, the Fifth Circuit held that federal election law did not preempt TUFTA.    The Federal Campaign Act of 1971 preempts "any provision of State law with respect to election to federal office."    Unfortunately for the Committees, the Court held that generally applicable fraudulent transfer laws are not state laws "with respect to election to federal office."   The Court also held that the federal election laws do not occupy the field of election law so thoroughly as to preempt the suit.   The Court wrote that the federal election law did not apply to a contributor using an impermissible source of funds as opposed to the committee making an improper use of those funds.   Further, the Court noted that the committees' argument would lead to the absurd result that funds "stolen by force or fraud" would be protected so long as the committees otherwise complied with election law.Because firms likely to fail have been known to curry favor by making political contributions, this opinion may help trustees avoid preemption arguments in the future.  

Upper Crust Pizza files for Chapter 11 bankruptcy protection. Upper Crust is a Boston based chain of pizza parlors. Prior to the filing, they operated 17 locations. As part of the restructuring of those locations has been closed. This company plans to keep operating the other 16 locations. The filing of a bankruptcy petition under [...]

The Fifth Circuit has added a new decision to its judicial estoppel jurisprudence, holding that a creditor that submitted claims in different amounts in successive cases was not estopped.   While it may seem that the court is applying the estoppel doctrine in an uneven manner, penalizing debtors but not creditors, the decision faithfully follows the elements laid out by the court.    Wells Fargo Bank, N.A. v. Oparaji (Matter of Oparaji), No. 11-20871 (5th Cir. 10/5/12), which can be found here.   What HappenedThe Debtor Titus Chinedu Oparaji filed a chapter 13 proceeding on September 2, 2004 (“First Case”).   During the First Case, he fell behind on his mortgage payments to Wells Fargo.   Over time, Wells Fargo filed several amended claims and the Debtor filed several modified plans.   The amended claims filed by Wells Fargo understated the amount of the post-petition arrearages.  When the Debtor failed to complete his plan payments within five years, the First Case was dismissed.After the First Case was dismissed, the Debtor continued to miss payments to Wells Fargo.  On February 1, 2010, the Debtor filed his second chapter 13 case (“Second Case”).   By this time, the arrearage owed to Wells Fargo had grown to $86,003.25.   The Debtor argued that based on the claims filed in the First Case that the arrearage could not possibly be that high.   The Bankruptcy Court found that Wells Fargo was bound by the claims filed in the First Case under the doctrine of judicial estoppel and the District Court affirmed.The RulingThe Fifth Circuit reversed, finding that Wells Fargo had not “asserted a legally inconsistent position that was accepted by the Bankruptcy Court.”   Opinion, p. 6.   The elements of judicial estoppel are: (1)  a party asserts a legal position that is “plainly inconsistent” with the position taken in another case; (2) the court in the other case accepted the party’s original position; and (3) the inconsistent positions were not taken inadvertently.The Court found that a creditor who files a post-petition claim in one case is not estopped from asserting a higher claim in a subsequent case.   Under section 1305(a), a creditor may file a post-petition claim but is not required to.   This contrasts with the common scenario where a debtor omits an asset.   While a debtor must list all assets in its schedules, the creditor is not under a duty to amend its proof of claim to include post-petition arrearages.   The Debtor argued that while Wells Fargo was not required to file a post-petition claim, that once it did so, it was required to include all post-petition amounts.   The Fifth Circuit distinguished the Oparaji case from In re Burford, 231 B.R. 913 (N.D. Tex. 1999).  In Burford, the confirmation order required the creditor to create a payment schedule that would “fully retire the debt.”   However, in this case, the creditor submitted a claim without expressly representing that there were no additional amounts owing.Because Wells Fargo never asserted that the amount contained in its post-petition claim constituted all the amounts owed, the Fifth Circuit found that it had not asserted inconsistent positions.   As a result, judicial estoppel did not apply.    The Court went further and found that even if Wells Fargo had asserted inconsistent positions, the dismissal of the First Case meant that the parties were returned to their position status quo ante.  What It MeansJudicial estoppel is meant to prevent parties from gaming the system. While, on the surface, it might appear that Wells Fargo took inconsistent positions, its inconsistency was not legally significant.  Wells Fargo’s only fault was that they did not assert their rights in the First Case as aggressively as they could have.   Had the Debtor completed its plan in the First Case, the parties and the Court would have had a difficult time sorting out which post-petition defaults were included in the plan and which ones were not.   Had the Debtor filed an “all current” motion at the conclusion of its plan and obtained an order, it could have bound Wells Fargo.  However, neither one of these occurred.   The Debtor did not complete its plan and it did not obtain a determination that it was current on its mortgage.   As a general rule, a dismissed case should rarely, if ever, give rise to judicial estoppel.   By definition, a dismissed case is one in which no party obtains relief (although the debtor enjoyed the benefits of the automatic stay for a period of time).    If a party does not obtain relief, then it is hard to say that the court accepted the party’s position in any meaningful respect.   The real benefit of this case may be for debtors who omit a creditor or an asset in an initial case and then accurately disclose it in a subsequent case.   In that instance, Oparaji should be good precedent that judicial estoppel will not apply.

  Life has a way of moving on, even when the client is in a Chapter 13. Assets come and go, life gets better or sometimes worse. The direction of travel changes. When a Chapter 13 case converts to Chapter 7, bankruptcy lawyers struggle with what assets the Chapter 7 trustee can liquidate. The facts in Warfield v. Salazar illustrate the problem: the debtors filed Chapter 13 when they were entitled to a pre petition tax refund. They did not succeed in confirming a plan and the case converted.  Only between filing and conversion, they had received and spent the tax refund. The Chapter 7 trustee made demand on the debtors for the amount of the refund. There was no contention that the right to the refund wasn’t property of the estate as of the commencement of the case.  But at conversion, it no longer existed. Both the bankruptcy court and the Bankruptcy Appellate Panel held that the plain language of 348(f) controlled:  Except as provided in paragraph (2), when a case under chapter 13 of this title is converted to a case under another chapter under this title— (A) property of the estate in the converted case shall consist of property of the estate, as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion; The refund didn’t exist as of the conversion date and therefore the debtor has no obligation to turn over its value to the Chapter 7 trustee. In the absence of bad behavior that lend to the loss of the asset, the plain language of the statute prevails. Note too how 348 deals with one of the other condundrums of Chapter 13:  the provisions of §1306  that property of the estate includes all property acquired during the Chapter 13 and all earnings after the commencement of the case. Suppose the debtor has prospered during the 13 and has twice the cash on hand at conversion that he had at filing.  Or he inherited property more than 6 months after filing, or he received a gift or other windfall. Section 348 provides that the Chapter 7 estate upon conversion is limited to the assets the debtor had at filing and still has at conversion. Not only does 348 simplify our analysis, but it assures the debtor, worried about the reach of 13 into their post filing life, that the good that comes after filing but before conversion is not lost to creditors. Image courtesy of InAweOfGod’sCreation. Like This Article? You'll Love These! What You Need To Know About Converted Cases Exemptions & Property of the Estate Convert, Don’t Dismiss, That Bankruptcy Case

Letters in the client’s mailbox superficially offer great news:  the junior mortgage will be forgiven! That good news just adds on a new facet to our job description:  spotting possible  tax consequences and alternatives for our clients by reason of  tax on cancellation of debt. As  the National Mortgage Settlement  gains momentum, we can expect to encounter this more often. The topic is huge and the taxes nominally involved may swamp all the other unsecured debt that a prospective client has. All I can do here is outline the issues and the resources for further study.  Master this area and your clients will think you walk on water. In the beginning We start with the principle that when debt is forgiven, the amount forgiven is treated for tax purposes as if it was received in cash by the debtor.  It is included in income and subject to tax  IRC 108 lists the statutory exceptions to that rule, including our stock in trade: bankruptcy.  Debts forgiven in bankruptcy do not cause the inclusion of  the forgiven debt in income. Foreclosure Your clients may be surprised or dismayed to learn that a foreclosure may result  not only in the loss of the property but in a tax bill to boot. Where the value of real estate has fallen dramatically, a foreclosure not involving bankruptcy may generate a 1099-C  (the statement of the amount of cancelled debt) for the difference between the loan balance and the deemed fair market value of the property.  Six digit numbers are easily possible. Therein is one of the stellar qualities of a bankruptcy solution to debt.  If the individual’s personal liability for a junior mortgage loan is discharged in bankruptcy, should the debt be subject to a foreclosure in the future, no tax consequences ensue.  It is also one of the reasons that I have taken clients with no significant, existing debt, into bankruptcy before the inevitable foreclosure.  The bankruptcy discharge will insulate them from tax on the difference between the mortgage balance and the fair market value of the property. Qualified principal residence safe harbor When the foreclosure crisis started, perhaps  the  only useful Congressional response was creating an exclusion from inclusion in taxable income for qualified debt on a taxpayer’s principal residence. The exclusion only applies to debt used to buy, build or substantially improve the home.    So, if the debt is a refinance, your client may not qualify. Further, the provision is set to expire at the end of 2012. Insolvency Another exception to the rule that cancelled debt is included in gross income for tax purposes is insolvency.  If the debtor is insolvent, the cancelled debt is not included.  The non obvious trap here is that retirement assets are included in the balance sheet test.  So, your client may think he has nothing, but if there is a fat 401(k), they may not be as broke as they think they are.  The worksheet for calculating insolvency for these purposes is found in IRS publication 4681. So, if you have the opportunity to counsel a homeowner who has received an announcement that their line of credit loan is being cancelled, point out the issues to them.  Look at the alternatives and be prepared to send them to sophisticated tax advisors who can assess the tax consequences of the disappearing debt. Image courtesy of Pixabay.  Like This Article? You'll Love These! Beware The Taxes That Follow Foreclosure Lien on Phantom Property Upsets Debt Totals How Long Can Underwater Lien Hold Its Breath?