THE first client is in his 40s, married with two children, ages 8 and 9. He doesn’t own a house. The absence of a house makes eligibility analysis easier. If he did own a house, the current equity in the house would come into play and dominate the entire analysis for eligibility. If the equity in the house is more than $100,000, then it’s better all-around to file a Chapter 13, not Chapter 7.
For the client in his 40s with a wife and two children, he would be able to exempt $100,000 of equity in the house in Chapter 7. For example, if the current fair market value of the residence were $700,000 and the balance of the mortgage $600,000, then the equity is $100,000 and fully within the homestead exemption 704.730 of the California Code of Civil Procedure. It does not matter if a homestead claim was ever filed, it’s automatic by operation of law that $100,000 is exempt if there is at least one family member who lives with the debtor in the residence. If the debtor lives by himself in the residence, then he can only claim $75,000 as a homestead exemption for the very same house.
Analysis of owning a residence
The client doesn’t own a house so the house exemption issue does not even come into the equation. Now the next question is did debtor sell or transfer ownership in a house within the last year, two years or four years. If affirmative, the issue that must be resolved first is whether or not that transfer was a bona fide sale to a third person for value, or was it done under suspicious circumstances. What’s a bona fide sale to a third person for value? In this example, let’s say the client sold his house last year for $750,000 to a buyer who is not related to him in any way. So, the client had a net of $150,000 after deducting selling commissions and other escrow expenses. Since the sale, the debtor has left the house and the buyer has moved into the house. That appears to be a bona fide (for real) sale to a third party at the current fair market value at the time of sale.
In that event, the Chapter 7 trustee would not be able to question the legality of the sale. All he can ask the debtor is “what happened to the $150,000 that you received from the sale of the house?”
The client would have to explain how the $150,000 was used up. An acceptable explanation would be: well, I had no income so my monthly expense was $5,000 a month, so that used up $60,000. Then I put $50,000 into my business to keep it afloat because business started to slow down a lot starting November of 2019. And I sent $20,000 to my father for his kidney transplant abroad. I still have $20,000 left. The most that the trustee would ask for is documentary proof to corroborate the explanation. What happens to the $20,000 of cash left with the debtor? He can keep the entire amount using the wild card exemption 703.140(b)(5) of the California Code of Civil Procedure.
Sale under suspicious circumstances
What is a sale under suspicious circumstances? Let’s say the client sold his house to his brother-in-law in exchange for nothing, just a straight out quitclaim. The brother-in-law now holds title to the house in his own name. The client is no longer on the title but who lives in the house? The client and his family continue to live in the house. Obviously, this is a spurious sale that can easily be invalidated by the Chapter 7 trustee. When the sale is invalidated, the entire equity of $150,000 would become part of the bankruptcy estate subject to the jurisdiction of the trustee, and the client would not be able to save the $100,000 by claiming it as his homestead of exemption.
House not part of bankruptcy estate
Certainly, there are many other possible circumstances that may apply. For example, the client can say that even if his name is on the title, the house doesn’t belong to him, that the house belongs to his parents who provided the $100,000 down payment on the house, and all of the monthly mortgage payments were all paid by his parents. If there are documents to prove this explanation, then it should be smooth sailing for the client.
There could be a possibility that the trustee may attempt to challenge this explanation through an adversarial proceeding consisting of a complaint and a trial, but if client documents are adequate, the trial judge would likely rule in favor of the client that the house belongs to his parents, not to him.
Therefore, the house is not the property of the bankruptcy estate. This is more easily said than done, and the litigation may take at least a year or two to reach trial but with good documents, the preponderance of the evidence is in favor of the debtor.
Why the client owes $100K credit cards
But in our discussion, the client has no house and has not been involved in any transfer of any house in the last couple of years. So this is excellent for his qualification for Chapter 7. How did the client get to owe $100,000 of credit cards?
It appears that most of the $100,000 went into the financing of his business in the last five years. When the business was good, gross sales were about $15,000 a month with net profit about $3,000 a month. Well, with $100,000 of credit cards, the client needs $3,000 a month for minimum credit card payments to keep the $100,000 current, which wipes out the entire profit. So what’s the point of doing this kind of business when all along, the client is doing is slaving away for Mastercard and Visa every month? There’s no point, right. But if he wiped out the $100,000 of cards with Chapter 7, then his net profit would be $3,000 a month, and he’s still his own boss. All around, that’s a lot better situation to be in. No debt and with $3,000 net profit a month.
Then the pandemic showed its ugly face. So from $12,000 a month of gross sales, sales for the last three months have been zero. No sales. Believe it or not, that’s the truth, there’s just no sale at all. He still wants to continue the business even if he files for Chapter 7. Can he do this? Sure he can file for Chapter 7 and still keep the business assuming certain conditions are met. One condition is he must be able to exempt the fair market value of the business. Another condition is that he must have liability insurance to cover any accidents on the business premises.
Pandemic’s throttling effect on business
This pandemic has put a throttle on all of us, to say the least. For business people, there’s the added burden of what to do with the business: To close or not to close permanently and start again fresh later with no debt.
It is estimated that at least a third of small businesses will opt for filing bankruptcy to deal with this situation. It’s the right thing to do. As I said so many times before, even Walt Disney filed for Chapter 7 twice before Disney became wildly successful. Every businessman knows that a fresh start without accumulated debt is the right way to go.
Even Milton Hershey of Hershey Chocolates, the biggest chocolate business in the world today also filed for Chapter 7 once before his chocolate business became successful. What other well-known businesses are under bankruptcy right now? Sears, Toys R Us, Hertz Rent A Car and Forever 21, to name a few. You’ve all done business with these companies at one time or another, haven’t you? They are all going through bankruptcy reorganization right now. So don’t feel bad if you have a small business that’s getting killed right now.
Another client just obtained $120,000 to cover his payroll from government loans that could become grants. But the entire $120,000 has been spent, and there still no business! Well, that’s another story for another day.
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Disclaimer: None of the foregoing is considered legal advice. Each case is different.
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Lawrence Bautista Yang specializes in Bankruptcy, Business, Real Estate and Civil Litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 20274 Carrey Road, Walnut, CA 91789 or 1000 S. Fremont Ave., Mailstop 58, Building A-10 South, Suite 10042, Alhambra, CA 91803.
