Ch. 7 Case Dismissed Under Sect. 727(a(3) Because Debtor Failed to Keep or Preserve Adequate Business & Financial Records on $800,000 in Bank Deposits

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

U.S. Trustee v. Caron (In re Caron)
Bankruptcy Court, District of Oregon
Adversary Proceeding 08-0365-rld; Case No. 07-33796-rld7

December 2, 2008 ((NOTE: this opinion was just uploaded to the Court's website although it is dated a month earlier.)
Unpublished opinion by Judge Randall Dunn


This opinion, although unpublished, presents good guidance on the standards for dismissal under § 727(a)(3).

Recent Ninth Circuit Opinion: Caneva
In his opinion Judge Dunn cites and relies on a very recent Ninth Circuit opinion, Caneva v. Sun Communities Operating Limited Partnership (In re Caneva), __ F.3d __, 2008 WL 4791680 (9th Cir. Nov. 5, 2008), which was the subject of this website's Bankruptcy Bulletin published on the day following its filing, titled Ninth Circuit Affirms Denial of Discharge under Section 727(a)(3) for Chapter 7 Debtor's Failure to Keep Financial Records.

The holding in Caneva was that under § 727(a)(3) the party moving for dismissal has the burden of:

establishing a prima facie case (1) that [debtor] had failed to keep or preserve records and (2) that such failure made it impossible to ascertain his financial condition and material business transactions. The prima facie case shifted to [debtor] the burden to avoid summary judgment by showing that a genuine issue of material fact existed with respect to whether his failure was justified under the circumstances of his case.
. . . .
[T]he statute imposes an affirmative duty on the debtor to keep and preserve recorded information that will allow his creditors to ascertain his financial condition and business transactions. A debtor who has admitted to owning businesses for which he kept no recorded information and to transferring a substantial sum of money without retaining any documentation has not kept or preserved information within the meaning of the statute, and must provide a justification for this failure that goes beyond a conclusory statement in an affidavit that he is entitled to discharge.

Summary of the Opinion
This Oregon Caron opinion largely mirrors Caneva but adds some additional important nuances. In this Chapter 7 case the United States Trustee (“UST”) filed an adversary proceeding to deny debtor’s discharge on various § 727 grounds in addition to subsection (a)(3), including §§ 727(a)(2)(B), (a)(4)(A), and (a)(5), but Judge Dunn did not have to address those because he found the (a)(3) grounds to be sufficient for dismissal. The judge entered a judgment denying "discharge for failing to keep and preserve adequate business and financial records to allow creditors and the chapter 7 trustee to ascertain and evaluate [the debtor] Mr. Caron’s financial condition and material business transactions." Specifically, during the two years before filing the case, debtor deposited a total of more than $800,000 in a number of different bank accounts without any accounting, "commingled indiscriminately," leaving the UST and the court unable to "determine what Mr. Caron’s income and expenses were for 2006 and 2007. The UST having met its burden of proof under section 727(a)(3), Judge Dunn further concluded "that Mr. Caron has not met his burden of proof to justify the lack of adequate business and financial records."

Standard of Proof
This opinion makes clear that while the "party seeking to deny a discharge to the debtor generally bears the burden of proof, "[s]ince the Supreme Court’s decision in Grogan v. Garner, 498 U.S. 279 (1991), the burden of proof standard for denial of discharge actions under § 727 is preponderance of the evidence." So:

ultimately, in spite of whatever weight on the scale favors the debtor’s discharge, a party seeking to deny the debtor a discharge under § 727 likely will prevail if the evidence establishes that it is more likely than not that the objecting party’s case is justified.

Section 727(a)(3)
Section 727(a)(3) denies a discharge to a debtor who “has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor’s financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case.”

Very importantly:

Unlike many of the other discharge denial provisions of § 727, § 727(a)(3) does NOT require that the party seeking to deny the debtor a discharge establish that the failure to keep or maintain adequate financial records was “knowing” or “fraudulent.” “What constitutes adequate books, documents, and records must be decided on a case-by-case basis, depending on the Debtors’ business operations and sophistication."

Finally,

§ 727(a)(3) is not appropriately used as a trap to deny a discharge to consumer debtors or business operators who through inadvertence, lack of competence, or both, maintain less than pristine business records. However, the Bankruptcy Code does not condone a complete default in maintaining and preserving records from which basic information regarding a debtor’s business and financial affairs can be obtained.

Burden of Proof, Initially with Proponent, then Shifts to Debtor

The plaintiff in a § 727(a)(3) action bears the initial burden of proof to establish “(1) that the debtor failed to maintain and preserve adequate records, and (2) that such failure makes it impossible to ascertain the debtor’s financial condition and material business transactions.” [Citation excluded.] Once plaintiff makes such a prima facie case, the burden shifts to the debtor defendant to justify the
inadequacy or nonexistence of the records.

Debtor's Justifications
After the UST met its burden of proof, debtor, through his counsel Michael Day, made the following arguments to justify the insufficient records:

1) Lack of access to one set of financial records: The opinion appears to be sympathetic to the realities that. as to one set of the debtor's businesses, the business records were maintained by a partner's wife on her computer, and that when the partner and his wife and the computer disappeared a number of months before the bankruptcy was filed, he had no access to those records. So although Judge Dunn was troubled by the lack of records maintained by debtor after the partner's disappearance, he said he "might be inclined to find that adequate justification for Mr. Caron’s lack of records for the Royal Air Cargo business was provided from the uncontradicted evidence of the absconding of his business partner . . . and his record-keeping wife," but the debtor's other other major business and financial activities "cry out for further justification."

2) Debtor is "not an accountant": While acknowledging that a § 727(a)(3) analysis "is fact dependent in each case and focuses in large part on the relative business sophistication of the debtor whose discharge is challenged," Judge Dunn was adamant about the limits of this excuse:

One does not have to be an accountant to be able to prepare and maintain a ledger, showing 1) when and how much money was received from a particular customer, 2) how the funds were handled or invested, 3) when and how much money was repaid to each customer, and 4) how much compensation Mr. Caron received for his services.

He found "the virtually complete lack of such records to be astonishing and ultimately not credible."

3) In his closing argument Mr. Day raised the argument that the debtor's lack of record-keeping could be "cultural." Although noting that no evidence was presented at trial on this argument, Judge Dunn could not resist addressing it, with a flash of his wry humor, by saying:

I am unaware generally of any culture that conducts commerce without some means of recording business transactions. The practice of keeping records of business transactions goes back at least to pre-cuneiform script on clay tablets in ancient Sumer. See the entry on “Sumer” in Wikipedia.

He found "that Mr. Caron’s cultural background as a Kazakh emigrant to the United States does not justify his failure to keep and preserve adequate financial and business records in this case."

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys

Mortgage Modification Programs Have Been Ineffective. Why?

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Influential financial leaders, including Federal Reserve Chairman Ben Bernanke and FDIC Chair Sheila Bair, have recently made strong statements about the ineffectiveness of the mortgage modification programs. For months Bair has been particularly relentless in her efforts to focus the attention of the Treasury Department and other agencies besides her own on dealing more aggressively with "the root cause of the financial crisis -- too many unaffordable mortgages creating too many delinquencies and foreclosures." (From her Statement on 11/18/08 before the U.S. House of Representatives Committee on Financial Services.)

Bernanke joined in with his usual measured but, considering the source, emphatic comments:

Despite good-faith efforts by both the private and public sectors, the foreclosure rate remains too high, with adverse consequences for both those directly involved and for the broader economy. More needs to be done. . . . . To be effective, loan modifications should aim to put borrowers into mortgages that they can afford over the longer term. . . . . [P]rincipal write-downs may need to be part of the toolkit that servicers use to achieve sustainable mortgage modifications.

(From his speech on December 4, 2008 at the Federal Reserve System Conference on Housing and Mortgage Markets.)

Initial Results of Mortgage Modification Programs

Hope for Homeowners

This major federal program was a component of the very high-profile Housing and Economic Recovery Act signed into law on July 30, 2008 and implemented on October 1, 2008. Please see my earlier Bulletin about it. The Act created a new voluntary program within the Federal Housing Administration (FHA) to back up to $300 billion in FHA-insured mortgages to distressed homeowners.

But according to a December 19, 2008 press release by the National Association of Consumer Bankruptcy Attorneys (NACBA), in spite of projections that about 400,000 homeowners would be helped, "there have been only 312 applications to date -- and no mortgage modifications whatsoever have taken place."

And if NACBA seems a one-sided source--it is unabashedly promoting amending the Bankruptcy Code to permit mortgage modifications in Chapter 13 plans--here is Ben Bernanke's assessment from the same speech quoted above, again in his understated language:

Another, more recent program, dubbed Hope for Homeowners (H4H), allows lenders to refinance a delinquent borrower into a new, FHA-insured fixed-rate mortgage if the lender writes down the mortgage balance to create some home equity for the borrower and pays an up-front insurance premium. In exchange for being put "above water" on the mortgage, the borrower is required to share any subsequent appreciation of the home with the government. Although the basic structure of the H4H program is appealing, some lenders have expressed concerns about its complexity and cost, including the requirement in many cases to undertake substantial principal write-downs. As a result, participation has thus far been low.

Hope Now

Here's NACBA's assessment:

This voluntary effort by the industry, promoted by the Administration, has produced more public relations than real results. Homeowners have great difficulties getting answers because the services do not have adequate staff to deal with requests. When some accommodation is reached, servicers virtually never reduce loan principal and often enter into repayment agreements that do not even reduce loan payments. Studies have shown that most of the workouts negotiated through Hope Now provide at best temporary short-term relief from foreclosure, and in a large percentage of cases, the homeowner cannot keep up with payments because the agreement does not adequately modify the loan. As of September 2008, Hope Now worked out loan modifications resulting in lower monthly payments for 266,087 homeowners; loan modifications with the same or HIGHER monthly payments for 226,667 families; and 780,000 short term repayment plans.

FDIC/IndyMac Federal Bank

After the Federal Deposit Insurance Corporation took over this huge mortgage company in July of last year, it implemented a modification program that has been emulated in other private and public efforts. Its goal is "to systematically modify troubled mortgages," "to achieve affordable and sustainable mortgage payments for borrowers and increase the value of distressed mortgages by rehabilitating them into performing loans."

According to the independent mortgage website HousingWire.com:

It’s not clear, however, if that implied modification rate — 12.5 percent of eligible severe delinquencies, and 8.7 percent of total delinquencies — is significantly better or worse than what the former Alt-A lender was seeing before its servicing platform was assumed by the FDIC.
. . . .
Some policy experts that have spoken with HousingWire privately have suggested that if the FDIC’s modification approach at IndyMac is truly and honestly successful, and widely implemented, it will clearly incent performing borrowers to default in an effort to secure below-market interest rates on their own mortgage debt. “Bair and the FDIC are walking a fine line here,” said one economist, who asked not to be named because his view were his own and not those of his employer. “Her program needs to succeed, but not so much so that everyone decides they too ought to get a 3 percent mortgage.”

And again the critical word from NACBA:

This effort covers 65,000 borrowers who are more than two months delinquent on their mortgage, but doesn't reduce the outstanding debt in any meaningful way and therefore has not attracted much interest. So far, 7,200 homeowners have modified their loans under this program. And, after a two-month moratorium on foreclosures pending the modification program, IndyMac foreclosures in November skyrocketed 242 percent from October, according to Mark Hanson of the Field Check Group.

Why Mortgage Modification Programs Are Ineffective

1) Many commentators have focused on the now-familiar complaint that with securitized mortgages, which include a disproportionate amount of the troubled loans, the multiplicity of owners make negotiating modifications virtually impossible. The owners often cannot agree or cannot even be found, and simply do not respond to modification pleas.

In Ben Bernanke's cautious words:

[D]espite the substantial costs imposed by foreclosure [on mortgage holders], anecdotal evidence suggests that some foreclosures are continuing to occur even in cases in which the narrow economic interests of the lender would appear to be better served through modification of the mortgage. This apparent market failure owes in part to the widespread practice of securitizing mortgages, which typically results in their being put into the hands of third-party servicers rather than those of a single owner or lender.

In more direct terms, by New York Times' business columnist Joe Nocera:

You see, all of these programs deal only with “whole loans” — that is loans on the books of the institutions, unencumbered by securitizations. So far, the attitude of all involved when it comes to securitized mortgages is to throw up their hands and say — “it’s too hard to deal with!” And it may well be: mortgages that were sold to Wall Street and wound up in mortgage-backed securities have been sliced and diced and sold and resold to investors with varying risk tolerances. They are serviced by people who owe a fiduciary duty to all these investors, no matter what their place on the risk continuum.
. . . .
The situations borders on the absurd. Investors will not allow mortgage modifications that would hurt them more than some other investors — thereby insuring that everyone gets hurt even more as foreclosures continue.

2) Modifications are stymied because the key players, mortgage servicers, risk investor lawsuits if they modify mortgages.

In NACBA's words:

The servicer has obligations to the investors who have purchased the mortgage-backed securities through pooling and servicing contracts, and the interests of these investors conflict. Servicers are hesitant to modify the loans because they are concerned that it will impact different tranches of the security differently, and thereby raise the risk of investor lawsuits when one or more tranche loses potential income. At least one servicer has already been sued. Under the current system, the legally safest course for the servicer clearly is foreclosure.

Bernanke echos this same concern: "The problem is exacerbated because some modifications may benefit some tranches of the securities more than others, raising the risk of investor lawsuits."

3) Simultaneously acquired second mortgages stymie voluntary modifications.

NACBA put it well:

Perhaps the most intractable problem is the fact that a third to a half of all 2006 subprime borrowers took out piggyback second mortgages on their homes at the same time they took out their first mortgages. In these cases, the holders of the first mortgages have no incentive to provide modifications that would free up borrower resources to make payments on the second mortgages. At the same time, the holders of the second mortgages have no incentive to support effective modifications by waiving their rights, which would likely cause them to face a 100 percent loss. The holders of the second mortgages are better off waiting to see if a borrower can make a few payments before foreclosure.

4) Mortgage holders and servicers have not been structurally designed or trained to modify, but rather to collect and foreclose, and these structures can only be re-engineered to a limited degree in an extremely short period. As a result, even when the intentions are good, these organizations have been overwhelmed by the volume of modifications needed.

Again, from Ben Bernanke: "the sheer volume of delinquent loans has overwhelmed the capacity of many servicers, including portfolio lenders, to undertake effective modifications."

5) Finally, the incentive structure for mortgage servicers in most cases greatly favors foreclosures over modifications. This is perhaps one of the most important and least recognized reasons for so few modifications. (See my upcoming Bulletin of January 26, 2008 on this crucial problem.)

An insightful article bylined "Servicers Profit While Investors Face Losses" states:

An environment of increasing delinquencies provides servicers with incentives to pursue their own self interests at the expense of investors and borrowers. Existing compensation structures, lack of oversight, informational asymmetry and consolidation of the mortgage servicing industry ensure servicers can act in their own interests with limited impunity.

(from RGE Monitor, named one of the world's best economics websites by BusinessWeek, The Economist, Forbes and the Wall Street Journal.)

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys

Is a Self-Settled Trust with a Spendthrift Clause Property of the Chapter 7 Estate? The Ninth Circuit BAP Balances the Countervailing Principles

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Cutter v. Seror (In re Cutter)

Ninth Circuit BAP Nos. CC-07-1436-MoDK, CC-08-1024-MoDK, CC-08-1025-MoDK
Filed September 4, 2008
Amended December 3, 2008

This opinion involves "a failed asset protection scheme" which the BAP published "to call attention to a fundamental fallacy inherent in that scheme," "a self-settled trust that identifies only unnamed “surviving” descendants of the trustor as beneficiaries (whose interests vest only after the trustor’s death), but leaves in the trustor/trustee the power to deplete the trust of all of its assets for his own benefit." As is no doubt clear from this statement of the case by the Court, it ruled in favor of the trustee and against the debtor that certain trust assets could be reached by debtor's creditors and thus were property of his bankruptcy estate. The details of this opinion are valuable guidance for any attorney who creates or tries to preserve asset protection mechanisms, or works to defeat them.

(This opinion, although originally "filed" by the Bankruptcy Appellate Panel in September and amended in early December, only became available on the BAP website for the first time, in its amended form a week or so ago, after a timely petition for rehearing resulted in an amended opinion "correct a factual error and to adjust the legal analysis accordingly." Judge Randall Dunn participated in this Panel but did not author the opinion.)

Critical Facts about the Trust
Although the Court took many pages to lay out the detailed facts regarding the various parcel of real estate at issue and the transactions involving them, and the terms of the trust established by the debtor, the critical facts are as follows: Debtor Cutter created an irrevocable trust in 1989 with himself as trustee and the "primary beneficiaries" his "surviving issue . . . and the lineal descendants of non-surviving issue." Debtor was not named a beneficiary but as trustee the Trust Agreement provided him "sole discretion" to make distributions from the trust "to provide for the health, the education, or the support or maintenance in the customary manner of living of the trustor" while he was alive. The Trust Agreement contained a standard spendthrift clause.

The Property at Issue
The Debtor contributed four items of real property to the trust (the "Trust Properties") between 1992 and 2002 through various means including by quitclaim deed directly by him and by grant deed to the trust by a brother but paid for by debtor. In addition a fifth parcel, the "Thurston Circle Property," was transferred in 2003 by grant deed by debtor's son's godfather to "Edward W. Cutter, a Single Man" and a dispute existed as to whether this referred to debtor, Edward William Cutter II, or to his son, Edward William Cutter III.

The Bankruptcy Court's Rulings
Debtor filed a Chapter 7 case in July 2005. The trustee filed an adversary proceeding with many claims but the only one at issue in this appeal is for quiet title. On a motion for summary judgment by the trustee to quiet title in the trustee for both the Trust Properties and the Thurston Circle Property, the bankruptcy court granted the trustee partial summary judgment in holding that the Trust Properties belonged to the Chapter 7 estate, and denied summary judgment as to the Thurston Circle Property because of genuine issues of material fact about the intended grantee of that property.


The BAP's Holding and Rationale re the "Trust Properties"

Section 541 of the Code and Trusts
Since Debtor held title to the Trust Properties as trustee of the Trust, "under section 541(d), the corpus of the Trust would not be property of Debtor’s estate, unless he held an equitable interest in the Trust and its assets, or unless he could exercise powers over the corpus of the Trust for his own benefit." The BAP held that debtor did hold an equitable interest in the Trust as a beneficiary because he "possessed the right, at his sole discretion, to make distributions in order to provide for his health, education, or 'support and maintenance in [his] customary standard of living.' ”

Appropriate to Apply California Law on Self-Settled Spendthrift Trusts
The BAP observed that

California law invalidating efforts of a settlor from using a trust to shield property from his or her creditors applies “even where the settlor is not a nominal beneficiary, as where a settlor attempts to create a spendthrift trust for the benefit of his or her minor children, to be managed by the settlor and revocable at his or her pleasure.” (Citation excluded.)

And citing a Ninth Circuit opinion, the

critical inquiry in determining whether a spendthrift trust is valid under California law is whether the trust’s beneficiaries exercise excessive control over the trust.
. . . .
[Thus] under California law, a settlor of a spendthrift trust cannot also act as beneficiary of that trust (i.e., California law prohibits ‘self-settled’ trusts).

Since under the Trust Agreement the Debtor in his role as Trustee of his self-settled trust "could potentially use all of the Trust’s principal and income to maintain his standard of living," thus he exercised "excessive control" making the spendthrift trust invalid, and making the trust assets a part of his bankruptcy estate.

Section 541 Sufficient in Itself to Make Trust Assets Property of Chapter 7 Estate
Although generally "if only a portion of a spendthrift trust’s corpus is contributed by a beneficiary-debtor, only that portion becomes property of the beneficiary-debtor’s estate," "[i]f, . . . the trust agreement allows the debtor-beneficiary to exercise control over and reach trust property contributed by others, the estate is entitled to the maximum amount that the trust could pay or distribute to the debtor-beneficiary." Thus, since debtor had complete discretion regarding all of the trust assets, his "beneficial interest in all of the Trust corpus became property of the estate and Debtor’s power to use Trust assets for his benefit became property of the estate."

The BAP's Decision about the "Thurston Circle Property"

The trustee appealed the bankruptcy court's denial of summary judgment on this one parcel of property, but the BAP declined to hear the matter, based on Rule 54, Federal Rules of Civil Procedure.

Rule 54(a) and (b) are as follows:

Rule 54. Judgments; Costs
(a) Definition; Form.
“Judgment” as used in these rules includes a decree and any order from which an appeal lies. A judgment should not include recitals of pleadings, a master's report, or a record of prior proceedings.(b) Judgment on Multiple Claims or Involving Multiple Parties.
(b) Judgment on Multiple Claims or Involving Multiple Parties.
When an action presents more than one claim for relief — whether as a claim, counterclaim, crossclaim, or third-party claim — or when multiple parties are involved, the court may direct entry of a final judgment as to one or more, but fewer than all, claims or parties only if the court expressly determines that there is no just reason for delay. Otherwise, any order or other decision, however designated, that adjudicates fewer than all the claims or the rights and liabilities of fewer than all the parties does not end the action as to any of the claims or parties and may be revised at any time before the entry of a judgment adjudicating all the claims and all the parties' rights and liabilities.

The bankruptcy court had entered a partial summary judgment on the "Trust Properties" citing Rule 54, but that judgment specifically stated: "Other issues in this adversary proceeding remain pending and will be separately adjudicated.” Thus the bankruptcy court's Rule 54(b) determination did not reach the issues reached in trustee's appeal on the "Thurston Circle Property." The BAP stated that although it had discretion "to entertain interlocutory appeals from judgments that are not final," it chose not to because of the disputed factual issues about ownership of that property. Instead the BAP declined to accept jurisdiction and dismissed that portion of the appeal.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys

Projected Foreclosure Rates Are Increasing: the Insights in the Credit Suisse Report Beyond the Headlines

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Last month a much-cited Credit Suisse report greatly increased its forecast of the number of U.S. residential mortgages anticipated to go into foreclosure, from its prior report last April. The report's headline was that 8.1 million mortgages are now anticipated to be in foreclosure within the next four years. But none of the stories about this report seemed to go beyond the first few sentences of the report's summary. (See this CNN-Money story, one in the Washington Post, and even one from a NACBA--National Association of Consumer Bankruptcy Attorneys--press release) Here are some valuable insights from inside this report.

Potential for Even More Foreclosures
Beyond the 8.1 million foreclosure headline, the report made clear that a more severe recession would push the number of foreclosures higher to a projected 10.2 million. Just factoring the "consensus increase in the unemployment rate to 8%" alone pushes the projection to 9.0 million. But on the other hand even a moderately successful loan modification program could bring the
foreclosures down to as "low" as 6.3 million.

However this last number assumes a modification rate of 50% of mortgages facing foreclosure along with a re-default rate of 40% of those modified mortgages. Given the tremendous ineffectiveness of mortgage modification programs so far (see my future Bulletin of 1/07/09 on this), these may be a very optimistic assumptions.

Rationale for Increase in Anticipated Foreclosures
The last Credit Suisse report on anticipated foreclosures in April 2008 forecast 6.5 million foreclosures in the next four years, so the increase to 8.1 million is substantial. The update is based on changes in mortgage delinquency rates, with home values continuing to decline putting more homeowners into negative equity positions.

The home price decline up to September 2008 has resulted in about 48% of subprime borrowers "underwater”, i.e., those with outstanding mortgage balances (including both first and second liens) that were higher than current property values. Among all non-agency loans, 41% were under water by September, with the highest percentage seen in option ARM loans (66%) and the lowest in prime jumbo loans (25%). Further, . . . we expect that 72% of subprime loans and 62% of all non-agency loans will have negative equity within two years. This is important because the propensity to default is highly correlated with the degree of negative equity. . . . . On average, the likelihood of rolling into default for borrowers deeply underwater, as measured by current loan-to-value (LTV) ratio higher than 110%, is two (for subprime loans) to four times (for other non-agency loans) that for borrowers whose current LTV is still less than 80%.

In summary, "despite some initial signs that subprime foreclosures were near a plateau, the combination of severe weakening in the economy, continued decline in home prices, steady increase in delinquencies, particularly in the prime mortgage space, ensure that foreclosure numbers, absent more dramatic intervention, will march steadily higher."

Effect of Changes in the Labor Market
In this study, the increases in foreclosures were correlated to increases in the unemployment rate based on the assumptions that the home ownership rate is about 67%, so for every 100 newly unemployed, 67 will be homeowners, and a very high percentage of those have mortgages on their homes (those who own free and clear are largely either retired or self-employed, not in the conventional labor force). With some having cushions in the form of savings and/or a second income earner, the study assumed 60% of those who become unemployed will lose their homes. This yields a "40% response ratio of foreclosure to new unemployment."

Using this 40% ratio, and assuming "a steady rise in the unemployment rate, peaking at 8% at the end of 2009, then falling to 7% by the end of 2010 as the economy starts recovering" brings the total foreclosures to 9.0 million; while a "deep recession scenario follows the base case through 2009 but keeps increasing after that, peaking at 10% by the end of 2010" brings the total foreclosures to 10.0 million foreclosures during the four-year period.

The report also noted that not only do foreclosures go up directly with increases in the unemployment rate, foreclosures also increase among the formerly unemployed who find employment but with lower income, and among the underemployed, those going from full-time to part-time employment. Given the large number of homeowners who are overleveraged, even modest reductions in income among the employed will lead to foreclosures for many beyond those resulting from outright unemployment.

Effect of Loan Modification Programs
This study acknowledged the "aggressive effort, from both the government and the private sector, to expand loan modification efforts significantly," but stated that "there are many flaws with these programs and they won’t be sufficient to stem the rising tide of foreclosures." The study cited the limitations in eligibility to owner-occupied homes and for owner-occupiers who do not have second homes or any investment property. And "since most . . . programs only allow principal forbearance, borrowers deeply underwater may choose not to accept mod[ification]s if they will be obligated to pay the forbearance amount upon sale of the home."

Nevertheless the study presented two loan modification scenarios, a "best scenario, in which 70% of expected foreclosures are assumed to be modified with a re-default rate of 20%, total future foreclosure would decline [from 9.0] to 4.0 million, a 56% deduction. In comparison, the most conservative scenario, in which only 30% of foreclosures are modified and re-default at 60%, the total foreclosures would decline to 8.0 million."

Again, please return to this website to see my future Bulletin of 1/07/09 on the performance thus far of the current loan modification programs to see whether these are realistic assumptions.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys

Ninth Circuit Panel Affirms Dismissal of Chapter 11 Case Instead of Conversion to Chapter 7

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Shulkin Hutton v. Treiger (In re Owens)
Ninth Circuit Case No. 07-35634
December 31, 2008

In this case from the bankruptcy court of the Western District of Washington, in its last bankruptcy case of 2008 the Ninth Circuit upheld that court's decision to dismiss a personal Chapter 11 case instead of convert it to Chapter 7.

The Facts and the Case Below
Owens and Treiger divorced in 2002, but before the divorce decree was entered Treiger filed a Chapter 13 which was converted to Chapter 7. The trustee in that case filed an adversary proceeding against Owens for the estate's interest in a residence purchased by Owens and Treiger during their marriage, which was settled with Owens paying $215,000 in full satisfaction of the estate's claim against her and the trustee quit claiming the estate's interest to her. After Treiger's Chapter 7 case was closed, the divorce case proceeded and concluded with the state court ordering that same residence to be sold and the proceeds divided equally between Owens and Treiger. Shortly before its sale, Owens filed a Chapter 11 case with her interest in the residence as the case's primary asset. Treiger filed a motion under § 1112(b) to dismiss that case as being filed in bad faith, which the bankruptcy court granted, "ruling that the bankruptcy was filed in bad faith as a litigation tactic intended to delay [the residence's] sale." An unsecured creditor, a law firm to whom Owens owed attorney fees, appealed the dismissal to the BAP, which upheld the bankruptcy court's dismissal.

Dismissal or Conversion?
§ 1112(b) states in part that "the court shall convert a case under this chapter to a case under Chapter 7 or dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, if the movant establishes cause."

The creditor's argument was that the bankruptcy court should have converted the case to Chapter 7 instead of dismissing it, because conversion would be "in the best interests of creditors and the estate." But the Ninth Circuit panel looked to a Fourth Circuit opinion holding that the statute requires the court to "consider the interests of all of the creditors," and held that the creditor had "not shown that conversion would be in the best interests of Owens’ other creditors." (Emphasis in original.)

Interestingly, the Ninth Circuit panel focused on a finding of fact NOT by the bankruptcy court but rather by the BAP, that "Owens has substantial future earning capacity," specifically "an annual earning capacity between $150,000 and $800,000." "Consequently, Owens’ other creditors would fare worse under Chapter 7 because the accompanying discharge would deny them access to Owens’ future income." Since the standard of appellate review for findings of fact by the BAP is "clear error" and "the record contained sufficient evidence for the court to decide that the best interests of creditors and the estate would favor dismissal over conversion," the Ninth Circuit found no clear error and affirmed the bankruptcy court's decision to dismiss the Chapter 11 case.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys

Oregon's Bankruptcy Filing Rates Rising Even Faster Than the Rapidly Accelerating National Rate: Oregon vs. U.S. vs. Northern District of Texas

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Even though the national bankruptcy filing rates are climbing very steeply, Oregon's are climbing even more so. Thus, while the number of total bankruptcy filings in the 4th quarter of federal fiscal year 2008 (which ended Sept. 30, 2008) increased nationally by 19.0% from the prior quarter--a huge increase on a quarter-to-quarter basis--in Oregon the increase in total bankruptcy fillings was 37.8%, virtually twice the national increase. Similarly, comparing that same 4th quarter of this year to the 4th quarter of fiscal year 2007, the national increase between those two quarters was 33.5% whereas Oregon's was a 46.7% increase.

The increase in the filing numbers in Oregon is noteworthy enough when compared to the national rates, but are even more so when compared to rates in one particular other federal district. The national rate in effect averages the filing rate changes all over the country, with the areas of the country with the greatest bankruptcy filing increases diluted by those areas with lesser increases. So comparing Oregon with another federal district presents some even more striking differences. The Northern District of Texas, based in Dallas, is an area that has a diverse economy which has not been struck nearly as hard as many other parts of the country by the housing boom and bust. I chose this federal district somewhat arbitrarily for this comparison, in large part because this federal district is the source of this website's most recent Bulletin on a Circuit Court case outside the Ninth Circuit, and through that I have been in touch with some attorneys there. Also, this district has a similar amount of total bankruptcy filings as Oregon, and tends to have the most filings of the twelve federal districts of the Fifth Circuit, which includes Mississippi, Louisiana and Texas. (See "Last Week's New Circuit Court Opinions on BAPCPA: Fifth Circuit Says 'Gag Rule' Against Advising Debtors to 'Incur More Debt' IS Constitutional").

Comparing 3rd & 4th Quarter Fiscal 2008
During the 4th quarter of the 2008 fiscal year, Oregon had a total of 3,532 bankruptcy filings: 2,634 Chapter 7's, 888 Chapter 13's, and 10 Chapter 11's (no Chapter 12's). Along with the 37.8% increase in total cases filed from the prior quarter, this represents a 40.9% quarterly increase in Chapter 7's, a 28.9% increase in Chapter 13's, and a 66.7% increase in Chapter 11's. Chapter 7's are increasing more than Chapter 13's, mirroring the national trend during this same period: while total filings nationally went up 19.0%, Chapter 7's went up 23.1% and 13's went up 10.8%. Nationally, Chapter 11's were up 34.7%. Note that the Oregon quarter-to-quarter increases are about twice or even more then these national increases.

In significant contrast, in this same 3rd to 4th quarter period, in the Northern District of Texas total bankruptcy filings were actually slightly DOWN, from 3,789 to 3,781. Chapter 13's were down from 2,099 to 1,980, Chapter 11's were down from 57 to 47, even Chapter 12's went from 2 to 0. Only Chapter 7's went up, but only by 7.5% from 1,631 to 1,754. This mirrors the trend noted above both in Oregon and nationally towards a higher ratio of Chapter 7's to 13's.

Comparing 4th Quarter Fiscal 2007 with 4th Quarter Fiscal 2008
In Oregon, compared to the same quarter a year earlier--4th quarter of 2008 to the 4th quarter of 2007, along with the 46.7% increase in total bankruptcy filings noted earlier, this represents a huge 51.4% increase in Chapter 7's, a 33.9% increase in Chapter 13's, and a 100% increase in Chapter 11's.

Comparing these increases with the national ones shows Oregon increased at a faster rate year-to-year in each Chapter, but not nearly as much more as in the above quarter-to-quarter increases: nationally in this one-year period Chapter 7 filings were up a very significant 47.8%, Chapter 13 were up 10.7%, and Chapter 11 up a huge 71.3%. Even more than nationally, the year-to-year increase in filings occurred primarily in the last two quarters, again indicating a greatly accelerating trend.

And again in stark contrast, in this same period from the 4th quarter of fiscal 2007 to the 4th quarter of fiscal 2008, in the Northern District of Texas total bankruptcy filings were slightly DOWN, from 3,877 to 3,781. Chapter 13's were down from 2,269 to 1,980, Chapter 11's were virtually the same going slightly up from 46 to 47, and even Chapter 12's went from 1 to 0. Only Chapter 7's went up, but only by 12.4% over the course of the year, from 1,561 to 1,754. Contrast that with Chapter 7 increases in the same period nationally of 47.8% and in Oregon of 51.4%

Ratio of Chapter 7's to 13's
Although in all three jurisdictions there is a clear trend towards a larger proportion of Chapter 7's, both from the 4th quarter of fiscal 2007 to the 4th quarter 2008, and also from the 3rd quarter to the 4th quarter 2008, there are wide differences in the proportions between these two Chapters. In the most recent quarter, the District of Oregon had a nearly three-to-one ratio of Chapter 7's to 13's (2.96 ratio), while the Northern District of Texas had MORE CHAPTER 13's than 7's (0.89 ratio). The national ratio was in between, close to a two-to-one ratio of 7's to 13's (2.07 ratio).

Per Capita Bankruptcy Filings
One of the most revelatory ways of comparing bankruptcy filings over time and over different regions is to count the number of bankruptcies per capita, the number of flings per 1,000 residents. For the 12-month period ending on September 30, 2008, the nation had 3.38 bankruptcy filings per 1,000, compared to 3.15 per 1,000 in the prior quarter. That is a 7.3 percent increase in the number of bankruptcy filings, a significant increase in the number of bankruptcies.

Oregon had a little lower than that national average, 3.06 filings per 1,000 residents, compared to 2.78 filings per 1,000 in the prior year, but that brought it a little closer to the national average. It ranks 25th of the 50 states in filings per capita.

Texas (separate information on the Northern District is not readily available) in great contrast had almost half the per capita filing rate: 1.80 filings per 1,000 residents, ranking 46th of all the states.

Reflecting the information in the above section on the ratio of Chapter 7's to 13's, the national per capita filings of Chapter 7's has gone up from the one-year period ending the 3rd quarter of fiscal 2008 to the one-year period ending on the 4th quarter of this same year, from 2.00 filings per 1,000 to 2.21, and in that same period the per capita filings of Chapter 13's has barely budged from 1.12 filings per 1,000 to 1.15. In the latest quarter, the per capita Chapter 7 rate in Oregon is 2.26, in contrast to only .84 in Texas, and the per capita Chapter 13 rates are .80 and .93, respectively, putting Oregon a little about the national average and Texas way below in per capita Chapter 7 filings, and both states somewhat below the per capita Chapter 13 filings.

The data providing the basis for the calculations in this Bulletin are from the
Administrative Office of the U.S. Courts.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT written or intended for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as legal advice to anyone.

© 2008 Bankruptcy Litigation Support for Attorneys