Co-makers/Guarantors Must Show Undue Hardship To Discharge Student Loan Obligation In Bankruptcy

I work in North San Diego County with offices in Carlsbad and San Marcos. I serve clients in the areas of Bankruptcy, Elder Abuse and Probate, and I litigate those areas of law; always figured if your license allowed you to carry a big stick, you have to be willing use it when needed.

Ever since creation of the Student Loan, Congress and the Bankruptcy courts have made it more and more difficult for someone who is a co-maker or a guarantor of the loan to discharge it in bankruptcy. Initially bankruptcy courts were not as strict with co-makers or guarantors as they were with the students who actually received the benefit of an education paid for by the loan. As case-law evolved in the bankruptcy courts the rulings began to reflect the thought that Congress intended the loan to be non-dischargeable, not the debtor. Bankruptcy courts, in reviewing and interpreting the law’s legislative history concluded that congress was more concerned about the loan being repaid, not who repaid it. In today’s bankruptcy environment guarantors and co-makers are held to the same repayment standard as the students who received the loan and education.

For a guarantor or co-maker of a student loan to discharge a student loan now they must show that the loan came due seven years or more before they filed for bankruptcy and that paying back the loan will cause an undue hardship upon the guarantor, co-maker and his or her dependents. The seven-year requirement is pretty easy to calculate, but what is undue hardship? There are a couple of standards floating around out in the court system, one being the “Totality Of The Circumstances” test, and the second “The Bruner” test. In the totality of the circumstances the court does just that, it looks at everything in the guarantor’s or co-makers life and determines whether repaying the loan causes an undue hardship. What is undue hardship is left up to the bankruptcy judge’s discretion. Under the “Bruner Test” the guarantor/ co-maker of the student loan has to prove to the bankruptcy court by a preponderance of the evidence all the following three things: (1) the debtor cannot maintain, based on current income and expenses, a minimal standard of living for himself of his dependents if forced to repay the loan; (2) The state of affairs is likely to persist for a significant portion of the repayment period of the student loan; and (3) the debtor made a good faith effort to repay the student loan. There are a few courts that have found Bruner is too strict and have modified it by using an analysis of the debtor’s income and expense schedules and the allowances for living expenses used by the Internal Revenue Service (IRS) to guide them as to what constitutes a minimal standard of living. In those jurisdictions, if after taking into account the expenses normally recognized by the bankruptcy court in Schedule J (expenses) and the means test, a guarantor’s or co-maker’s income is insufficient to make full payment due under a student loan over a reasonable time, the obligation to repay the student loan is discharged.

Normally speaking, Student loans, even for guarantors or co-makers are non-dischargeable. If the co-maker or guarantor can prove undue hardship, discharge of the student loan is still not automatic. The debtor must bring a lawsuit inside the bankruptcy case to have the court grant a discharge of the student loan. This entails filing a complaint in an adversary proceeding under 11 U.S.C. 523(a)(8)and serving the student loan lender as a defendant in the action. But under the proper circumstances it is worth the trouble. Successful discharge becomes a giant step to giving someone a new lease on their financial life and helping them to become productive members of our society again.

STEPHEN C. HINZE, COUNSELOR AT LAW works and plays in North San Diego County serving the communities of San Marcos, Vista, Oceanside, Escondido, Carlsbad, Encinitas, Rancho Sante Fe, Rancho Bernardo, Fallbrook and Temecula in the legal practice areas of Bankruptcy, Elder Abuse, and Probate. © Steve Hinze October 12, 2013

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More on Co-maker/guarantor Liability Relief from Student Loans in Bankruptcy

I work in North San Diego County with offices in Carlsbad and San Marcos. I serve clients in the areas of Bankruptcy, Elder Abuse and Probate, and I litigate those areas of law; always figured if your license allowed to carry a big stick it was not much good if you were unable or unwilling to use it when needed.

Several months back I wrote an entry about co-maker/guarantor liability in Bankruptcy. It turned out to be pretty popular and I received some requests for more information, especially concerning co-making or guarantying student loans. What I can say is the law is a living thing and changes over time. In the early days student loans could be discharged in bankruptcy. Unfortunately, too many students decided it was easier to take the loan, get the education, then discharge the debt in bankruptcy. In the 1970s congress responded with 11 USC 523(c)(8) which excepted student loans from discharge. Back then the court’s, relying on legislative history, started to rule that the exception to discharge did not apply to debtors who were co-makers or guarantors of the loan. The thinking was that the guarantors or Co-makers did not really receive any benefit from the loan and it was not fair to deny them a discharge. Congress changed the law to make it more restrictive and the courts began to rule that Congress intended to exclude the loan from discharge, not the person getting the loan. This meant that the loan could not be discharged in bankruptcy, and since the guarantor or co-maker was obligated to pay the loan, their secondary obligation to pay the loan would not be relieved or discharged either. Again, some of the legal reasoning changed in that the courts found that parents who guaranteed or co-made student loans actually did benefit from the loan and should not escape duty to repay. This does not address the situation where the guarantor was not a parent or even a family member. The cases kept getting more restrictive in granting discharge to co-makers and guarantors to the point that today, the majority rule is that co-makers or guarantors of student loans will not have their obligation to pay unless the loan came due 7 years before filing the bankruptcy petition and the debtor can prove by a preponderance of the evidence that repayment of the loan will cause an undue financial hardship upon the debtor and dependents. And the debtor has to prove it; that means bringing a separate lawsuit inside the bankruptcy case and introducing evidence that shows paying the loan for another person is both a current and future undue hardship. More on what constitutes an undue hardship later. I am still trying to find the rational for denying discharge to a guarantor or co-maker on their secondary duty to pay if the student who received the loan cannot receive a discharge. There is always more to learn in this business.

STEPHEN C. HINZE, COUNSELOR AT LAW works and plays in North San Diego County serving the communities of San Marcos, Vista, Oceanside, Escondido, Carlsbad, Encinitas, Rancho Sante Fe, Rancho Bernardo, Fallbrook and Temecula in the legal practice areas of Bankruptcy, Elder Abuse, and Probate.

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I cannot take credit for any of the information in this blog. This article was taken directly from the web site of the National Association Of Consumer Bankruptcy Attorneys. It is important and should be considered by everyone who is considering debt settlement. Read and learn from the experts and those with experience, this is one area of your life where is better to learn from mistakes of others than to make your own. I hope you get something valuable from the following.

Already struggling with home foreclosures, harsh bank and credit card fees, and other major financial challenges, America’s most deeply indebted consumers are now falling victim to a major new threat: so-called “debt settlement” schemes that promise to make clients “debt free” in a relatively short period of time. Unfortunately, most consumers who pursue debt settlement services find themselves facing not relief but even steeper financial losses.

Even the industry acknowledges – though not in its ever-present radio and online advertising–that debt settlement schemes fail to work for about two thirds of clients. Federal and state officials put the debt-settlement success rate even lower – at about one in 10 cases – meaning that the vast majority of unwary and uninformed consumers end up with more red ink, not the promised debt-free outcome.

There is now widespread documentation of the danger that debt settlement schemes pose to consumers. The Better Business Bureau has designated debt settlement as an “inherently problematic business.”1 Similarly, the New York City Department of Consumer Affairs called debt settlement “the single greatest consumer fraud of the year.” Across the country, the U.S. Government Accountability Office (GAO),2 the Federal Trade Commission (FTC), 41 state attorneys general,3 consumer and legal services entities,4 and consumer bankruptcy attorneys have all uncovered substantial evidence of abuses by a wide range of debt settlement companies.

The debt settlement industry is regulated by state attorneys general and the FTC. Though state laws vary widely in terms of overseeing the industry and its practices, experts agree it is very risky and that consumers should proceed with extreme caution before entering into a contact with a debt settlement company.


Debt settlement companies are for-profit entities that offer to negotiate with creditors to reduce the amounts owed by a debt-strapped consumer. They typically charge steep fees for every settlement they achieve. In some cases, they charge very high fees even without obtaining any settlements.

Here are the “red flags” that consumers need to know about when dealing with debt-settlement firms:

Debt-settlement schemes encourage consumers to default on their debts. Because creditors frequently will not negotiate reduced balances with consumers who are still current on their bills, debt settlement companies often instruct their clients to stop making monthly payments, explaining that they will negotiate a settlement with funds the client has paid in lieu of their monthly debt repayments. Once the client defaults, he or she faces fines, penalties, higher interest rates, and are subjected to increasingly aggressive debt-collection efforts including litigation and wage garnishment. Consequently, consumers often find themselves worse off than when the process of debt settlement began: They are deeper in debt, with their credit scores severely harmed.

Debt settlement often makes a bad problem even worse. When a consumer defaults on his or her debt, the overall debt burden can rise quickly. As accumulating penalties and interest charges inflate the consumer’s debt-load, creditors begin collection efforts and many eventually sue. This is why debt settlement is always a gamble: If any of the creditors refuse to settle, the consumer is left worse off than when they started.

The painful bottom line is that most consumers lose the debt settlement gamble. In most cases, the consumer loses the gamble: The debt settlement company is unable to settle with all the consumer’s creditors, so the consumer’s unsettled debts rapidly grow out of control. Even debt settlement companies acknowledge that only about a third (34.4 percent) of debt settlement clients have at least 70 percent of their debts settled after three years in the program.5 The industry acknowledges that debt settlement is unsuccessful for two-thirds of their clients. According to a Government Accountability Office investigation of debt settlement, even the industry’s extremely low success rate is overly optimistic.6 The FTC and state attorneys general found that less than 10 percent of consumers successfully complete these programs.7

Even “successful” debt settlements can come with a high price. The few consumers who are successful in debt settlement may find themselves with another unexpected bill: tax liability. Depending on the consumer’s financial condition, the amount of savings realized from debt settlement can be considered taxable income. Credit card companies and other creditors may report a debt reduction to the IRS. Unless the consumer is considered insolvent, the IRS considers it income and the consumer will be on the hook to pay taxes on it.

The problem is not limited to “bad actors” since the debt-settlement approach itself is flawed. Debt settlement schemes are a trap for most consumers because inherent in the industry’s standard business model is the requirement that clients breach their contractual obligations with creditors.


 When Cipriano and Shelia, of Vallejo, CA, approached a Florida-based debt settlement company, the couple had approximately $60,000 in credit card debt. While grossly miscalculating the couple’s monthly expenses and income, the firm advised them that they need only pay a total of $31,200.00, including the firm’s fees, and that they’d save approximately $28,800 as a result. The firm took an initial service fee of $6,900 and continued collecting monthly “set-aside” funds in payments of $460 and later $230. The firm’s method of evaluating the couple’s ability to participate in a debt repayment plan not only was flawed, but the firm never provided any information to prove that they could secure more favorable terms from the settlement than the couple might obtain on their own or through bankruptcy. Ultimately they could not afford to save enough money to settle their debts and received none of the benefits from the debt settlement program that they expected.

 Sewnarine, of Newark, NJ, is a hardworking immigrant limo driver who owns his house and rents out rooms to make ends meet. When he lost his job for a short period, Sewnarine saw an ad by a debt settlement company and called. Sewnarine had limited literacy skills and could not read and understand the agreements he signed. Even though he was unemployed and had no income other than his rental income, the debt settlement company took $1,200 from his account and eventually lowered his payments to $567 per month. Sewnarine paid a total of $5,152 to the debt settlement company. He quit the debt settlement when he was sued by his creditors for debts of $13,000 and $5,000. Despite having paid over $5,000 to the debt settlement company, Sewnarine was told he didn’t have enough funds to settle either debt. The debt settlement company kept over $5,800 in fees when Sewnarine quit the program, despite having settled none of his accounts. Shortly after, the debt settlement company filed for bankruptcy, leaving Sewnarine with no recovery whatsoever.

 Perry of Highland Lakes, NJ, is a union glazier who started out with $60,000 in unsecured debt. Although he was current on all of his debts, Perry saw an advertisement for a debt-settlement company in November 2009, and jumped at their offer that for $500 per month he could be debt free in three to four years. He started paying into their “savings account” and was immediately sued by two large credit card companies. Although Perry paid $9,510 to the debt settlement company, they told him he didn’t have enough money in his “account” to settle so he’d have to have a default entered or file an answer. Perry is now filing a Chapter 13 bankruptcy. His credit has been ruined as a result of his dealing with the debt-settlement company.


Steer clear of any companies that:

Make promises that unsecured debts can be paid off for pennies on the dollar. There is no guarantee that any creditor will accept partial payment of a legitimate debt. Your best bet is to contact the creditor directly as soon as you have problems making payments.

Require substantial monthly service fees and demand payment of a percentage of what they’ve supposedly saved you. Most debt settlement companies charge hefty fees for their services, including a fee to establish the account with the debt negotiator, a monthly service fee, and a final fee– a percentage of the money you’ve allegedly saved.

Tell you to stop making payments or to stop communicating with your creditors. If you stop making payments on a credit card or other debts, expect late fees and interest to be added to the amount you owe each month. If you exceed your credit limit, expect additional fees and charges to be added. Your credit score will also suffer as a result of not making payments.

Suggest that there is only a small likelihood that you will be sued by creditors. In fact, this is a likely outcome. Signing up with a debt settlement company makes it more likely that creditors will accelerate collection efforts against you. Creditors have the right to sue you to recover the money you owe. And sometimes when creditors win a lawsuit, they have the right to garnish your wages or put a lien on your home.

State that they can remove accurate negative information from your credit report. No company or person can remove negative information from your credit report that is accurate and timely.


Many different kinds of services claim to help people with debt problems. The truth is that no single solution will work for everyone. Bankruptcy is an option that makes sense for some consumers, but it’s not for everyone. For example, the National Association of Consumer Bankruptcy Attorneys and its individual consumer bankruptcy attorney members do not encourage every person who looks at bankruptcy to enter into it. What makes sense for each consumer will depend on their individual circumstances:

 If you have just a single debt that you are having trouble paying (a single credit card debt for example) and you have cash on hand that can be used to settle the debt, you may be able to negotiate favorable settlement terms with the creditor yourself. Creditors typically require anywhere from 25 to 70 percent on the dollar to settle a debt so you will need that much cash for a successful offer. Be sure to get an explicit written document from the creditor spelling out the terms of the debt settlement and relieving you of any future liability. Also be prepared to pay income taxes on any of the forgiven debt.

 If, like most people, you owe multiple creditors and do not have the cash on hand to settle those debts, you may want to consult a non-profit credit counseling agency to see if there is a way for you to get out of debt. But make sure to check it out first: Just because an organization says it’s a “nonprofit” there is no guarantee that its services are free, affordable or even legitimate. Some credit counseling organizations charge high fees (which may not be obvious initially) or urge consumers to make “voluntary” contributions that may lead to more debt. The federal government maintains a list of government-approved credit counseling organizations, by state, at If a credit counseling organization says it is government-approved, check them out first.

 Consult with a bankruptcy attorney about your options. Bankruptcy is a legal proceeding that offers a fresh start for people who face financial difficulty and can’t repay their debts. If you are facing foreclosure, repossession of your car, wage garnishment, utility shut-off or other debt collection activity, bankruptcy may be the only option available for stopping those actions. There are two primary types of personal bankruptcy: Chapter 7 and Chapter 13. Chapter 13 allows people with a stable income to keep property, such as a house or car, which they may otherwise lose through foreclosure or repossession. In a Chapter 13 proceeding, the bankruptcy court approves a repayment plan that allows you to pay your debts during a three-to-five year period. After you have made all the payments under the plan, you receive a discharge of all or most remaining debts. For tax purposes, a person filing for bankruptcy is considered insolvent and the forgiven debt is not considered income. Chapter 7 also eliminates most debts without tax consequences, and without any loss of property in over 90 percent of cases. To learn more about bankruptcy and whether it makes sense for you, go to


 Center for Responsible Lending: Debt Settlement (

 Federal Trade Commission: Debt Relief Services (

 National Association of Consumer Bankruptcy Attorneys (

Stephen C. Hinze is a bankruptcy attorney and federally designated debt relief agent under federal law. He helps consumers navigate through financial hardship, including filing for bankruptcy if necessary. He serves North San Diego County and Southern Riverside and Orange Counties, including, but not limited to the communities of Carlsbad, Encinitas, Lucadia, Oceanside, Vista, San Marcos, Escondido, Rancho Bernardo, Fallbrook, Rainbow, Temecula, Murrieta, San Clemente, Mission Viejo, and San Juan Capistrano. He may be contacted by telephone at (760) 330-9472, e-mail at or visit him on the web at

1 The Better Business Bureau provided data to State attorneys general showing that since 2007, debt settlement and debt negotiation companies have annually generated the most complaints received by the Bureau. See Comments of the National Association of Attorneys General to Federal Trade Commission re Telemarketing Sales Rule – Debt Relief Amendments, Matter No. R411001 at n.5 and text (Oct. 23, 2009, available at

2 Debt Settlement: Fraudulent, Abusive, and Deceptive Practices Pose Risk to Consumers (U.S. Gov’t. Accountability Office Rep. No. GAO-10-593T Apr. 22, 2010) [hereinafter U.S. GAO Report], available at

3 Comments of National Association of Attorneys General to Federal Trade Commission re Telemarketing Sales Rule – Debt Relief Amendments, Matter No. R4110011 (Oct. 23, 2009), available at

4 Comments of South Brooklyn Legal Services to Federal Trade Commission re Telemarketing Sales Rule Debt Relief Amendments, Matter No. R411001 (Oct. 26, 2009), available at; Comments of Consumer Federation of

America to Federal Trade Commission re Telemarketing Sales Rule – Debt Relief Amendments, Matter No.R411001 (Oct. 16, 2009), available at; Comments of Consumers Union to Federal Trade Commission re Telemarketing Sales Rule – Debt Relief Amendments, Matter No. R411001 (Oct. 9, 2009), available at; Comments of Queens Legal Services to Federal Trade Commission re Telemarketing Sales Rule – Debt Relief Amendments, Matter No. R411001

(Oct. 22, 2009), available at; Comments of Southeastern Ohio Legal Services to Federal Trade Commission re Telemarketing Sales Rule – Debt Relief Amendments, Matter No. R411001 (Sept. 25, 2009), available at

5 Letter of Andrew Houser of The Association of Settlement Companies (American Fair Credit Council) to the Federal Trade Commission (Mar. 8, 2010), available at at 10 (describing the result of TASC’s survey of its members, including the 14 of its 20 largest members).

6 GAO Report at 10-11 (“[F]ederal and state agencies have raised concerns with the methodology behind TASC’s data.” “When these agencies have obtained documentation on debt settlement success rates, the figures have often been in the single digits.”)

7 Ibid.

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Banks Legally Manipulate Your Debit Card Purchases To Increase Overdraft Fees

As some may know, in 2005 the bankruptcy code was rewritten by banking industry lobbyists without the advice of any bankruptcy lawyers from either the creditor or debtor side of the aisle. Consequently, some of the results of the new law that congress adopted are irrational and not conducive to the underlying policy of bankruptcy, which is to allow a debtor to pay back what he or she can afford and get a fresh start in life free of the debt he or she cannot afford to pay. One of the aberrant result is that as the national average wage decreases, it becomes harder for a debtor to qualify for Chapter 7 bankruptcy.

We often find that bank charges and fees are contributing factors to some debtors’ inability to get control of their debt. It always seems a bit unfair that the same institutions that complain about the effect of the bankruptcy law and that orchestrate efforts to put bankruptcy beyond the reach of people are the organizations whose conduct and business practices make it necessary for people to seek bankruptcy protection. My dad told me often I could not have my cake and eat it too. Apparently the banking industry and their friends in congress don’t abide by such common wisdom. I imagine it has something to do with the recent bank bailouts, the banks’ immediate return to stellar profitability and the crazy unbalanced national budget; but hey, I am just a small time bankruptcy lawyer trying to help normal hard-working people get back on their feet.

The major banks, especially those federally chartered, have long been known for their ability to find new and innovative ways to charge fees to their customers. No longer do banks make their money by lending to credit worthy borrowers and charging a reasonable rate of interest, or by charging a reasonable fee for maintaining a savings or checking account. That way of doing business just does not make enough money for the big institutions; they could not justify the multimillion dollar salaries they pay their management if all they did was provide reliable, reasonably priced service to their customers. A very interesting aspect of these innovative fee enhancing practices, was recently considered by the Ninth Circuit Court of Appeal arising out of a case filed in California against Wells Fargo Bank. The case was Veronica Gutierrez v. Wells Fargo Bank and the court handed down its ruling just recently on December 26, 2012. It seems in this case Ms. Gutierrez believed that Wells Fargo’s practice of posting debit card purchases to an account in the order of the highest charge or largest purchase first to the lowest last rather than in reverse or even in the order in which the charges were actually incurred was an unfair business practice designed for the sole purpose of increasing overdraft charges on her account. It seemed to be a reasonable argument; posting the debit card charges using the highest first clearly results in diminishing the balance of the account faster so that multiple small charges that may have been made earlier, result in multiple overdraft fees where posting the large charge last or when it was actually incurred might result in the imposition of fewer overdrafts. From the bank’s perspective, what better way to boost overdraft fees? From the customer’s perspective, what better reason to leave the bank and find a place that treats customers fairly?

The federal district Court agreed with Ms. Gutierrez and found that Wells Fargo’s practice was unfair and unreasonable under California law regulating business practices, particularly unfair business practices. It issued an injunction directing the bank to stop doing that to its customers and ordered Wells Fargo to pay $203,000 million in restitution. It seems that between 2005 and 2007 Wells Fargo collected some 1.4 billion in overdraft fees from customers. The District Court found that ““the bank’s dominant, indeed sole, motive” for choosing high-to-low posting “was to maximize the number of overdrafts and squeeze as much as possible out of what it called its ‘ODRI customers’(overdraft/returned item).”” The district court also found that Wells Fargo had “affirmatively reinforced the expectation that transactions were covered in the sequence [the purchases were] made while obfuscating its contrary practice of posting transactions in high-to-low order to maximize the number of overdrafts assessed on customers.”(This background is drawn from the district court’s Findings of Fact and Conclusions of Law After Bench Trial).

The Ninth Circuit Court of Appeal, one level below the U. S. Supreme Court, while not condoning the practice, found that Wells Fargo’s activity was legal under federal law and not subject to the California Law that the District Court applied. Then Ninth Circuit said that although the District Court found that Wells Fargo broke California law, it did not matter! Wells Fargo could not be held accountable to California residents under California law because it was a Federally Chartered Bank and thus only Federal law applies! Federal law allows Wells Fargo to do pretty much whatever it wants as far as how it posts its accounts. That’s how it goes when you have a good lobby and a lot of money to influence votes. If I recall correctly, Wells Fargo got its start in California and a large portion of its customers are Californians, which means that a large slice of its $1.4 billion in overdraft fees probably came from the state.

What should be interesting to us as consumers and normal working people is that large banks and credit card lenders were pretty much given free rein when it came to rewriting the bankruptcy laws, especially those laws related to Chapter 7 and Chapter 13, the law that consumers rely on the most. These same big lending institutions are the ones that came up with the insane lending policies, both in the issuance of credit cards and mortgages, which have thrown many of those same consumers into unmanageable debt. Add to it the ability to manipulate how overdraft fees are charged and It seems to me, that the way things work in the banking industry just are not right, at least not for the little guy paying the bills. To me it seems similar giving the tobacco companies the freedom to sell whatever they want, and then allowing them to write laws to make it more and more difficult to get treatment for the cancer their products cause.

The purpose of the bankruptcy law is to allow people to pay what they can, get relief from having to pay what they cannot afford, get a fresh start and become productive contributing citizens again. It seems that the people who should be making the decisions about what is reasonable and appropriate in connection with Chapter 7 bankruptcy and Chapter 13 bankruptcy should be our elected representatives, not the people who have created the problem and have a vested interest in not having it solved. The way things stand today, it is much too much like having the fox guard the hen-house.

Stephen C. Hinze is a bankruptcy attorney and federally designated debt relief agent under federal law. He helps consumers navigate through financial hardship, including filing for bankruptcy if necessary. He serves North San Diego County and Southern Riverside and Orange Counties, including, but not limited to the communities of Carlsbad, Encinitas, Lucadia, Oceanside, Vista, San Marcos, Escondido, Rancho Bernardo, Fallbrook, Rainbow, Temecula, Murrieta, San Clemente, Mission Viejo, and San Juan Capistrano. He may be contacted by telephone at (760) 330-9472, e-mail at or visit him on the web at

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Inherited IRA’s: Exempt From Use To Pay Creditors

In San Marcos California we tend to run into bankruptcy cases, especially Chapter 7 and Chapter 13 cases, involving issues of inheritance on the part of debtors. Our community and the communities surrounding us such as Vista, Escondido, Oceanside, Rancho Bernardo, Carlsbad and others have large populations of seniors who often leave legacies to children or other heirs who have seen hard times as a result of the economy over the last several years. One of the interesting issues that sometimes comes up has been whether IRA proceeds, inherited from someone else, if placed in a new IRA account rather than taken in cash, are exempt from use by the bankruptcy trustee to pay creditors. Many trustees across the country have taken the position that IRA proceeds received from a parent’s account are not exempt and have to be turned over to the trustee to be used to pay off creditors. However, a recent case out of the 5th circuit holds that IRA proceeds received from a parent or other person and deposited into another IRA account in the name of the debtor are exempt. The case in question is In Re Chilton and was decided in March 2012. It focused its analysis on the language of section 522 of the bankruptcy code to conclude that money set aside by the debtor for retirement are exempt and those funds do not have to have been the debtors money before they were set aside. This gives debtors a powerful tool to use in bankruptcy planning and a way to help insure they receive a fresh start and maintain a healthy financial status in the future, hopefully avoiding the need for a second bankruptcy if another spate of bad luck is suffered.

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Practicing as a probate lawyer in San Marcos, Vista, Escondido and Oceanside I find that many people do not understand the very basics of the probate process and it sometimes leads to trouble. When someone dies, if they do not have a trust, and often, even when they do, probate is needed. Probate is simply the process used by the legal system to make sure a dead person’s bills are paid and their remaining assets get legally transferred to either their beneficiaries or their heirs. Since the person who owned the house and the bank accounts and automobiles and furniture etc. has died, there is no one to make the transfer. Probate is the legal process where the court gives a person called an administrator or personal representative the legal authority to pay the deceased person’s bills and transfer title in their property to their beneficiaries or heirs. The process gets started when someone files a petition with the court, and publishes a notice that the decedent has died and telling everyone in the county where the decedent lived, that a petition for probate has been filed. This gives creditors and other interested parties the chance to let the court know they might have a right or claim to some of the decedent’s property or the right to be paid from the decedent’s estate. Depending on the complexity of the estate, it can take years to put one through probate. The goal is to get it done in less than a year, but in many instances, especially if there is a lot of real property or a business involved, it can take much longer than a year. It can be a complicated process and really needs a probate attorney to make the program work well.

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Bankruptcy Means Test

In 2005 when the bankruptcy code was rewritten the legislature imposed many new requirements on debtors to making them prove entitlement to bankruptcy relief. One new requirement was a means test arguably designed to help show whether a person was abusing the right to file chapter 7. Bankruptcy is one of the few areas of law where you have to prove you are entitled to protection under the law before you get the protection. The rest of the citizens of the USA get to rely on protection of our laws, especially the ones guaranteed to us in the constitution, and it is up to the person who wants to deny us of those protections to prove that we are not entitled to them. But bankruptcy now works backwards, did not used to, but is does now.
Under the means test, if a person makes more than the average income of people living in the same region, then that person is presumed to be abusing the bankruptcy code by filing a chapter 7. That person gets a chance to rebut the presumption but it is still there.

A person’s average monthly income is calculated in the means test by taking gross income for the prior six months, doubling it and dividing by 12. If that figure is above the average for the reason, taking into account family size, then the debtor has to rebut the presumption of bankruptcy abuse. This test results in some really interesting results. For example, a person who had a good job then lost it might not qualify for chapter 7 bankruptcy because his or her income for the six months prior would cause the presumption to arise. The opposite might happen if a person who had been unemployed for 5 months found a very good job with a great income going into the future but because of being previously unemployed he or she would qualify for a chapter 7 bankruptcy as long as they moved fast enough.

Current Monthly Income is defined in the bankruptcy code as:
(10A) The term “current monthly income”—
(A) means the average monthly income from all sources that the debtor receives (or in a joint case the debtor and the debtor’s spouse receive) without regard to whether such income is taxable income, derived during the 6-month period ending on—
(i) the last day of the calendar month immediately preceding the date of the commencement of the case if the debtor files the schedule of current income required by section 521 (a)(1)(B)(ii); or
(ii) the date on which current income is determined by the court for purposes of this title if the debtor does not file the schedule of current income required by section 521 (a)(1)(B)(ii); and
(B) includes any amount paid by any entity other than the debtor (or in a joint case the debtor and the debtor’s spouse), on a regular basis for the household expenses of the debtor or the debtor’s dependents (and in a joint case the debtor’s spouse if not otherwise a dependent), but excludes benefits received under the Social Security Act, payments to victims of war crimes or crimes against humanity on account of their status as victims of such crimes, and payments to victims of international terrorism (as defined in section 2331 of title 18) or domestic terrorism (as defined in section 2331 of title 18) on account of their status as victims of such terrorism.

One quandary with this definition is what “average monthly income from all sources” applies to. Suppose for example a debtor received a onetime settlement equal to a few months income shortly before needing to file. Including this settlement in the means test exponentially skews the income because of the way the means test calculates income. A $20,000 settlement would make the average monthly income seem to be $40,000 a year higher. It would require a debtor to file chapter 13 and make it look like the disposable income was based on an income $40,000 more that it really is, in a circumstance when the true income justifies filing for chapter 7 bankruptcy. So how is such a settlement handled? Perhaps because the statute talks in terms of monthly income, section B even mentions payment on a regular basis, neither of which apply to the one time settlement, then the settlement is not income, but merely an asset and should not be used as part of the means test. It surely could not be relied upon as a regular payment in the future to contribute to any chapter 13 bankruptcy plan payments. It is something to think about.

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