Steve Leimberg’s Asset Protection Planning Email Newsletter – Archive Message #62
From: Steve Leimberg’s Asset Protection Planning Newsletter
Subject: New Bankruptcy Bill – Who Pays It?
The new bankruptcy bill is important. It is so important, LISI plans several commentaries on it. In our first, Alan S. Gassman and Jonathan Alper discuss their take on the new Bankruptcy law.
Alan S. Gassman of Alan S. Gassman, P.A., practices in Clearwater, Florida in the areas of estate tax and trust planning, taxation, physician representation, and corporate and business law. Jonathan Alper is an asset protection and bankruptcy attorney practicing in Orlando, Florida.
According to Alan and Jonathan, you might call this new bankruptcy law, THE CREDITORS STRIKE BACK! Or, you might call it, THE DRAMA OF ASSET AND INCOME CONFISCATION. Or, “I’M SORRY, THE DOCTOR TOOK A JOB IN A CLINIC FOR THE NEXT FIVE YEARS”
The new bankruptcy bill would destroy the ability of “high earner” individuals to file a Chapter 7 bankruptcy and extinguish debt without sacrificing significant income. The bill also limits the homestead exemption to $125,000 in bankruptcy for many debtors, and contains a 10-year look-back provision in “fraudulent transfer” asset protection trust situations.
MORE ON THE NEW BANKRUPTCY LAW TO FOLLOW. BUT FIRST, EDITOR ANDY DeMAIO ISSUES A LAWTHREADS ALERT!
1. DOES AN AGENT UNDER A POWER OF ATTORNEY HAVE A DUTY TO MAKE GIFTS?
Under the terms of applicable law and the power of attorney itself, an agent often has the power to make gifts from the principal. Does the power create a potential liability for the agent? If no gifts are made, can the agent be held liable for taxes that could have been saved? Practitioners mull the issue in a recent ABA-PTL discussion.
2. ESTATE DEFECTIVE TRUST ALLOWS INCOME TAX PLANNING
PLR 200502014 illustrates a technique for creating a trust that is included in the estate of the grantor for estate tax purposes, permitting a step-up in basis, but whose income is taxed to beneficiaries. Such a trust can also provide non tax related personal benefits, according to participants in a recent online thread. A January, 2005 article explaining the technique is also available online.
To read these and other recent LawThreads reports, log in at http://www.leimbergservices.com. Once logged in, click the blue LawThreads button under Recent Entries.
NOW BACK TO ALAN GASSMAN AND JONATHAN ALPER’S COMMENTARY:
The United States Senate has passed a new bankruptcy law. This law will come into effect if agreed upon by the House of Representatives and signed by the President. Most commentators expect the President will sign the Bill in April. The Bill states that the law will be effective 180 after passage. This Bill contains provisions that are of paramount concern to potential debtors and their advisors.
NO MORE CHAPTER 7 FOR HIGH INCOME DEBTORS!
Of primary concern is that the ability to extinguish all debt by filing a Chapter 7 bankruptcy will NOT apply where the debtor has income above the state median.
In order to extinguish all debt, a debtor with income exceeding the state median would have to enter into a 5-year payment plan whereby most, if not all, of the income above a fairly low level would have to paid to the creditor.
Most affluent debtors would have to spend down exempt assets to make ends meet during this 5-year period, especially if they have children in private schools.
Debtors with judgments against them may never have to seek a discharge of debt in bankruptcy, but would be gravely inconvenienced by having to structure their lives going forward to remain “judgment proof.”
A non-bankrupt debtor would not lose his or her exempt assets, but would have “debtor fugitive” status by having to work and live without having exposed assets. Such a debtor might have to take a job in a state where wages are protected from garnishment, and where these wages may be converted to other assets that could be used in a livable fashion. For example, a Florida debtor can convert wages to annuities, life insurance policies, and homestead, notwithstanding that there would be a judgment in place against him or her.
In such a situation it would be expected that a plaintiff would settle for an amount significantly less than the judgment in order to get paid something, as opposed to waiting for years to see whether the debtor would ever have exposed assets.
HOMESTEAD PROTECTION – NEW 3 YEAR FOUR MONTH RULE
Another notable feature of the Senate Bankruptcy Bill involves the homestead protection available in many states. Florida, Texas, and Iowa, for example, protect unlimited amounts of homestead value. Homestead would still be protected to the extent of existing state law if it has been owned and lived in for at least 3 years and 4 months.
It is important to note that state law homestead protection will still apply so long as the debtor does not declare bankruptcy. The Bill has no negative impact on a situation where a debtor has lived in their home for 3 years and 4 months, even if the debtor recently paid down significant portions of the mortgage.
Where the home was purchased within 3 years and 4 months of filing bankruptcy, and was purchased with the proceeds of the sale of another home that was owned at the 3 year-4 month point, then the new home is still protected to the extent of the value derived from the proceeds of the sale of the old home.
Even if the home qualifies for protection under the 3 year-4 month rule, debtors who are convicted of “any criminal act, intentional tort, or willful or reckless misconduct that caused serious physical injury or death to another individual in the preceding 5 years” as part of their judgment would not have the home protected if they file a bankruptcy.
TENANTS BY THE ENTIRETIES
Many states exempt real property owned by husband and wife as tenants by entireties from creditor claims where only one spouse is a debtor. In those states, a married couple’s house will still be absolutely protected from the creditors of one spouse if it is held as tenants by entireties between husband and wife. For example, if a multi-million dollar judgment is placed against a husband who owns a home as a tenant by the entirety with his wife, then upon filing bankruptcy, there will be no limitation on protection of the home because of the tenancy by the entireties rules.
Tenancy by entireties is a common law rule of property ownership, and bankruptcy law has traditionally deferred to state property law.
Many clients will continue to have their spouses own most or all of the family investment assets, particularly where tenancy by the entireties protection is not available.
Many debtors will ask whether a malpractice creditor could force them out of state law protections and into an involuntary bankruptcy under the new bankruptcy law.
The answer? The Bankruptcy Reform Act does not significantly change the rules applicable to involuntary bankruptcy.
A single creditor may file a petition for involuntary bankruptcy if the debtor has fewer than 12 unsecured creditors. Considering credit cards, utilities, and other normal household debts, most doctors will have more than 12 unsecured creditors. If not, they can quickly create more unsecured obligations if a lawsuit is on the horizon.
If a debtor has more than 12 creditors, then an involuntary petition requires joinder of three creditors. In most cases, a single malpractice creditor would find it difficult to solicit smaller unsecured creditors to join in an involuntary petition.
Creditors take a risk in filing an involuntary petition. If the petition is not successful (and bankruptcy courts often dismiss or abstain from hearing the petition) the creditors may be liable for compensatory and punitive damages, as well as the debtor’s attorneys fees and costs.
Nevertheless, because of creditors’ enhanced leverage under the new bankruptcy law the possibility of involuntary bankruptcy will be much more important for physicians concerned about malpractice exposure.
TRANSFERS TO CERTAIN TRUSTS
A third important provision provides that a transfer made by a debtor to a trust that the debtor is a beneficiary of may be voided if bankruptcy is filed within 10 years of the transfer and “the debtor made such transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made, indebted.” The statute applies to transfers made to “a self-settled trust or similar devise.” Time will tell whether the courts interpret this law to mean that private placement offshore life insurance and annuity contracts are “similar devises,” if this legislation is passed.
DOCTORS NEED SPECIAL CARE!
The Senate Bill is definitely bad news for doctors and others who are victims of an “out of control” court system. Fortunately, the vast majority of malpractice claims settle within policy limits, or if not, the carrier will still be responsible for an excess verdict if there was an opportunity for them to settle by paying no more than policy limits, and they failed to do so.
Before this new law comes into effect (180 days after enactment under the Senate bill), doctors need to carefully review their asset protection planning, and in many cases more closely monitor their litigation matters to help assure that the malpractice insurance carrier will be responsible for any excess verdict.
In many years of practice we have NEVER had a client sustain an excess malpractice verdict that they had to pay themselves. Clients who have their asset protection planning prudently arranged, and who properly monitor and have independent counsel involved in malpractice matters, will almost never have a significant probability of sustaining catastrophic results. Most excess verdicts are paid for by the malpractice insurance carriers that had the opportunity to settle within policy limits, which helps to explain high malpractice insurance rates.
We have, however, had a number of clients go bankrupt as a result of their malpractice carriers “going under” while in the process of defending a claim. This makes it all the more important to make sure that insurance carriers and coverage are appropriately in place.
HOPE IN THE HOUSE?
Hopefully the House of Representatives will see fit to limit these terrible proposed provisions to credit card and other “consumer debt” situations. We will know shortly whether the proponents of saving the victims of “the out-of-control jury system” have succumbed to the credit card industry in leaving professionals and unfortunate entrepreneurs and others “hanging in the wind.”
Planners are more challenged than ever as our clients are squeezed by an out-of-control jury trial system, rising malpractice insurance rates, and fewer and fewer places “to hide” when misfortune comes their way. Estate and asset protection planners are going to need to provide as much leverage as possible through proper advance planning for clients who may become debtors under catastrophic circumstances, especially in the face of this upcoming legislation.
HOPE THIS HELPS YOU HELP OTHERS!
Alan Gassman and Jonathan Alper
Edited by Steve Leimberg
Senate Bill 256, Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, to amend Title 11, United States Code, Involuntary Bankruptcy rules are found under Section 303(a)(b) of the Bankruptcy Code and the Chapter 13 rules are found at §§1326, 1327, 1328, and 1329.
Copyright © 2005 Leimberg Information Services Inc.