THE first client is 48 and has just been sued for $10,000 by American Express. He recently received the summons and complaint.
He is single with one teenager dependent. He used to have a business but that has failed. He now works as a manager and earns $4,000 a month. He doesn’t own a house now, but did own a house as a joint tenant, which was sold about three years ago. The net proceeds from the sale of the house were $100,000. Being a joint tenant, half or $50,000 of the net proceeds went to him.
At first glance, this should be a Chapter 7 where he gets a fresh start and the court wipes out the $10,000 lawsuit and the rest of the $40,000 credit cards. There is really no problem qualifying for the means test for Chapter 7 because his income for a family of two is below the median for California. This looks like a slam-dunk case for Chapter 7.
However, there was a circumstance during the sale of the house that put a crinkle in this otherwise clear cut Chapter 7 case. For some reason that I don’t really understand, the client transferred his 50% share of the net proceeds from the sale of the house to the other joint tenant. Upon the close of escrow, the entire 100% of net proceeds went to the other joint tenant.
At this point in the analysis, this circumstance becomes a “transfer of asset” that occurred in the last four years. However, as the client explains it, he did make the transfer to the joint tenant, but the joint tenant gave him back the $50,000, which he has since used up completely for living expenses.
There could be some issue that a Chapter 7 trustee may raise because of the $50,000 transfer that occurred three years ago. The trustee might say that the $50,000 was a preferential transfer, which is within his powers to avoid or cancel. In other words, the trustee may try to get back the $50,000 from the transferee joint tenant even if the $50,000 was actually returned to the client who then used it all up for living expenses in the last three years.
Well, let’s just put it this way. There is a 10% chance that a Chapter 7 trustee may raise this issue but there is a 90% chance that no such issue will be raised in Chapter 7. The defense of the transferee would be that the transfer was nominal and the transferee merely held the $50K in trust for the client, the true owner of the $50K, and the transferee actually returned the $50K to the client immediately. This is a pretty good defense since it’s the truth that the actual owner of the $50,000 was still the client. It was property held in trust by the transferee for the client and under bankruptcy law, property held in trust by third parties for the debtor is still considered the property of the debtor.
The problem is that it’s an issue that can be litigated by the Chapter 7 trustee. Once the adversary proceeding is filed, the transferee needs to defend himself. In this situation, the legal expenses go up because it costs money to defend against an adversary complaint.
To avoid this problem completely, a low plan payment Chapter 13 is more suitable for the client. Since the client’s income is below the median, he will qualify for a low plan payment under Chapter 13. In Chapter 13, the $50,000 transfer is not a big issue because typically Chapter 13 trustees do not litigate this kind of issue. They may try to increase the plan payment to compensate for the transfer, but in this case, the fact is the $50,000 actually belonged to the client and the money has been used up. That’s the truth. The transfer was nominal only. The transferee held the $50K in trust for the client and immediately gave it back to him and he has used it all up for living expenses for the last three years.
How low can the plan payment be? I estimate that the client may pay $200 a month for 36 months. After paying $7,000, the balance of $43,000 will be discharged.
Without the Chapter 13 protection, the $10,000 lawsuit from American Express will eventually become a wage garnishment. In this instance, American Express will garnish 25% of the client’s gross income every month. That’s $1,000 a month. The amount is too big. The client will not be able to pay his rent. Of course, the client can apply for exemption from garnishment based on the grounds that he has no disposable income every month but the exemption is only good for 90 days. He has to show up in court every 90 days to show the judge that he has no money to pay. So this is very inconvenient.
For peace of mind, the best alternative for the client is Chapter 13 with a low plan payment. I had one client who pays only $150 a month for $60,000 of credit cards in the same situation. She sold her house to her brother-in-law for below market and in exchange, he allowed her to stay in the house rent-free until she dies. In Chapter 7, the trustee would try to get the property back because it was sold below market price by $100,000 within the last four years.
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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 1000 S. Fremont Ave, Mailstop 58, Building A-1 Suite 1125, Alhambra, CA 91803.