Alternatives to Consumer Bankruptcy * Advice to Lawyers is Good Advice to You
Below is an Article from the Institute of Continuing Legal Education that has tips for attorneys. This Article was written by Ken Gross for ICLE.
Alternatives to Consumer Bankruptcy
By Kenneth L. Gross, Thav Gross PC, Bingham Farms
#1
Preserve future income
Your goal is to preserve the client’s future income for his or her family and retirement rather than to satisfy debts of the past. Always refer back to the goal as you are faced with decisions or recommendations as you go forward. The goal will help dictate the proper action to take.
#2
Manage the financial crisis
Outside of bankruptcy, there are several tools available to eliminate or reduce debt. The primary ones are loan modification, foreclosure, and short sale in the housing arena; debt resolution (frequently called debt settlement by many companies) in the credit card and general creditor arena; and tax relief. You and your clients will hear many professed experts saying that they have the solution to resolving debts. You must examine the various alternatives that are available to relieve debt and then pick the best one (or ones) to fit each client’s circumstances. Debt settlement of credit card debt, when appropriate and properly executed, can be a great strategy. When not appropriate, adverse income tax consequences can arise—this can have the effect of converting dischargeable debt into nondischargeable income taxes.
#3
Select components of the plan
You should examine all available options and select the components of a financial management plan. Sometimes the strategies are complex. Some plans even combine with bankruptcy. For example, sometimes it is beneficial to first obtain a loan modification on the first mortgage and, after that is in place, use the benefits of a Chapter 13 or Chapter 7 bankruptcy to either eliminate a second mortgage or to discharge the debt postmodification. Critical to planning is an understanding of which tools of financial crisis management fit together and which work independently. If you act as a single source provider of only one tool (such as a loan modifier), you will not gain the necessary insight to formulate the plan.
#4
Determine the tax consequences
Cancellation of indebtedness gives rise to ordinary income and is taxable unless you meet one of the exceptions. Outside of bankruptcy (which is one of the exceptions), there are two. The first is that cancellation of indebtedness on a mortgage from now until December 31, 2013, is excludable as income if it is for your personal residence, up to $2 million, but only to the extent the debt was needed for the purchase or improvement of the residence. The second is the IRS’s insolvency test. Under this test, in general terms, the cancelled debt is excludable from income to the extent your client is insolvent before the cancellation of indebtedness.
#5
Estimate realistic costs and how your client will cover them
Before you select your plan and begin the process, you must have a solid idea of how much your client must pay to settle the debts and whether he or she has the income or other resources to cover the cost. Simply stated, if there is $100,000 of credit card debt, debt resolution is only a valid strategy if you can project that your client will have close to $2,000 per month of available income over the next 24 months to resolve the debts. If your client does not have the necessary resources, the plan will not work and you must find an alternate course.
#6
Be patient—haste is sure to make waste (i.e., greater cost)
Take your time and investigate all of the options before you embark on the plan. Too often, as a result of a client’s desire to gain relief from stress (which is very understandable), a plan begins before it is properly evaluated. Adverse tax consequences can occur or the plan can fall apart because the client lacks the needed resources to settle the debts.
#7
Don’t stop negotiating (even when the creditor refuses)
Virtually every time I speak with a lender’s representative (a mortgage or credit card company) and inquire about the available programs and options, I’m told that they have outlined every available option and that there are no other alternatives. They are wrong! Sometimes representatives will tell you this because they believe it to be so, and other times they are not being truthful. There are almost always more options. The best strategy is to hang up and try somebody else the next day.
#8
Push the envelope a bit too far
Negotiating is similar to playing cards. Bluffing is always in play. One of the great advantages of negotiation compared to playing cards is that you are never placed in the position where you have to call the other player. In cards, when you call the hand, there is no going back and starting over. Negotiation is different. You can push the other side as far as they will go, and then you can push them farther. Once they say no, you can step back and take the last deal. To me, unless you’ve pushed this far, you haven’t pushed far enough.
#9
Don’t believe everything that others tell you
In the credit card arena, it amazes me to hear the things that the collecting representatives will say. Most of them pretend to be pleasant and act as though they are trying to help your clients find a solution to their unfortunate situation. The key word here is act—some of them deserve Academy Awards for pretending to try to help. When they suggest things like borrowing from a client’s 401(k) account or skipping a mortgage payment to pay the credit card up to date so the client’s credit score will not be damaged, they are not trying to help. They are simply doing their job as dictated by an unscrupulous credit card company.
#10
Don’t walk away without a plan
In Michigan and other states that are recourse states, if the client walks away from the home and allows it to go through the foreclosure process, the lender can bid the market value of the home at the time of the foreclosure sale and then sue for the deficiency, which is the difference between the bid price and the outstanding mortgage balance on the date of sale. The lender has six years from the date of the client’s last payment to sue. There is a dangerous misconception that these lawsuits are not being filed. Deficiency claims are being pursued, and the numbers are increasing. If the mortgage balance your client owes is close to market value, the risk is far less. You should never counsel your client to just walk away, with eyes closed and hoping for the best. The goal is to know where you are taking the client, so the walk-away strategy must be part of the planning process.
#11
Have contingency plans in place
In more complex personal situations (or in business settings), the plan as developed often includes the best available options but does not necessarily have a guaranteed successful outcome. In that situation, you should have contingent options in place, including making sure there are additional emergency cash reserves in case the only realistic choice is to seek bankruptcy relief. The bottom line is that you have to make sure the plan includes a means to ensure your client’s continued financial viability in some form.
#12
Tell clients not to dwell on what might have been
When facing financial hardship, it is easy for the frustration, anxiety, and embarrassment, as well as an unfounded hope that the world will return to what it used to be, to cloud a client’s judgment and interfere with charting a positive course. The bottom line is that you must emphasize to your clients that they need to move forward and not get bogged down thinking about the past.
