Tuesday, June 15, 2010

Attorneys finding vexing issues in bankruptcy cases

by Russ Wiles The Arizona Republic Jun. 13, 2010 12:00 AM

Bankruptcy doesn't always work as advertised. For starters, not all debts - including student loans, some tax liabilities and child-support obligations - can easily be shed, if at all. Also, not all applicants can qualify for the type of filing they want, such as debtor-friendly Chapter 7 plans that are restricted to people with relatively modest incomes. Besides, there are many nuances in the law that can thwart debtors and creditors - intricacies of which even some attorneys might not be aware.

"There are some things a bankruptcy attorney needs to be thinking about to try to minimize the impact, or at least notify and disclose to clients," said attorney Daniel J. Rylander of Robinson & Rylander PC in Tucson.

Some attorneys have gravitated only recently to bankruptcy work from personal injury, criminal or other areas that just aren't showing the same rapid growth. Yet bankruptcies can be a tricky field where experience and expertise count.

As consumers and small businesses continue to struggle amid a sluggish economy, a high unemployment rate, depressed real-estate values and more, filings for Chapter 7, Chapter 13 and other categories continue to surge.

The U.S. Bankruptcy Court in Phoenix counted 25,104 Valley filings in 2009, up from 13,817 the prior year. So far, the Phoenix metro area is on pace for roughly 30,000 filings this year.

While many of these cases are fairly routine, attorneys are coming across some vexing issues. Here are three examples:

• Debts and divorces.

Sometimes, as part of a divorce settlement, people will pledge to shield their former spouses from certain debts. Yet these promises might not hold up if one of the spouses later files for bankruptcy protection, since creditors aren't bound by them.

"These are promises made to protect an ex-spouse from unpaid debts," Rylander said, adding that they often involve debts incurred jointly during marriage.

For example, a husband might agree to pay the couple's joint credit-card debts. But if he later files for bankruptcy protection, creditors could go after the wife for payment.

Divorce attorneys often encourage the parties in a divorce settlement to indemnify or pledge to protect each other from debts each is assuming under the agreement.

"(But) this practice can be very problematic if one or both of the spouses know they will be filing for bankruptcy after divorcing," said Randy Nussbaum, a bankruptcy attorney at Nussbaum & Gillis PC in Scottsdale.

"By indemnifying the other spouse, that spouse will be creating a debt that is not dischargeable in a bankruptcy case," he said, with the exception of Chapter 13 filings.

A better strategy, Nussbaum said, would be for both spouses to be open and honest about their intentions and incorporate into the divorce settlement an understanding that recognizes a potential filing by either.

In short, a bankruptcy filing following a divorce is a potential can of worms.

"It's a gray area, but it can be very difficult to shield the ex-spouse," said Rylander, who co-chaired a State Bar seminar on bankruptcy issues last week. "So what sometimes happens is everyone goes bankrupt."

• Ongoing HOA fees.

Some people are learning that their former homeowners association can still go after them for unpaid dues, even after they surrender a home.

Rylander provides this example: A homeowner buys a home using a first originating mortgage, then tacks on additional debt with a home-equity loan. Unable to handle the debt, the owner leaves the property, and the lender starts foreclosure proceedings.

"A year and a half later, the homeowner gets sued by the HOA because he quit paying association dues," Rylander said. "Then he finds out the home never foreclosed," perhaps due to lender delays in working through a backlog or even a deliberate decision by the lender to avoid those HOA fees for as long as possible.

This creates a situation where unpaid dues could build into a sizable debt for which the homeowner would still be liable.

According to Rylander, unpaid association dues owed prior to a bankruptcy filing would be discharged, but dues accruing later would continue to mount until a person no longer holds legal title.

And because HOAs are facing severe financial pressures of their own, many are aggressively pursuing these debts.

"The monthly obligation will continue until the lender forecloses on the property," Nussbaum said.

One possible solution suggested by Nussbaum is for the departing homeowner to quitclaim the property to another party such as the HOA or lender. "Those parties don't have to accept, but you'd have a strong argument that you don't own the property," he said.

• Faulty deeds that open doors to trustees.

As some debtors and creditors are learning, court-appointed trustees, especially in Chapter 7 cases, can be quite aggressive in trying to collect money. Some even look for defects in mortgage paperwork that could allow them to push their claim ahead of a lender's.

Suppose a person buys a home, stays current on the payments but files for bankruptcy protection.

"The trustee can look at all the purchase documentation for problems," Rylander said, citing issues like an insufficient number of witnesses or errors in notarized signatures.

"Keep in mind the mortgage industry had been insanely busy (during the boom)," he said, so plenty of title companies probably made paperwork errors.

In fact, the lender, who would seek permission from a judge to complete a trustee sale, might not even be able to find the original paperwork, perhaps because the note has been sold several times, Nussbaum said.

"If the lender can't prove its claim, the trustee has an interest in a home that might not have a lien against it," he said.

Homeowners usually aren't aware of this and might wind up living free in the property for a while. But they also could see the dwelling sold out from under them if they file for bankruptcy protection.

"If there's no valid loan, the trustee could just sell the home," Nussbaum said.

Needless to say, all this can cause quite a surprise.

"This is a very scary topic," Rylander said, adding that it also could apply to car loans with faulty paperwork.

Attorneys finding vexing issues in bankruptcy cases

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