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Notable parallels between the 2008-2009 financial crisis and today's high-risk alternative lending sector

This week, the American Bankruptcy Institute posted an article (which is reprinted below) identifying a growing trend that may impact a large sector of the economy: alternative lenders making risky loans. As many know, the 2008-2009 meltdown ensnared a lot of big and established financial institutions and if not for substantial government intervention the fallout would have been worse and perhaps longer-lasting. For purposes of context, a Wikipedia report states that the “financial crisis of 2007–2008, also known as the global financial crisis and the 2008 financial crisis, is considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930. It began in 2007 with a crisis in the subprime mortgage market in the United States, and developed into a full-blown international banking crisis with the collapse of the investment bank Lehman Brothers on September 15, 2008. Excessive risk-taking by banks such as Lehman Brothers helped to magnify the financial impact globally. Massive bail-outs of financial institutions and other palliative monetary and fiscal policies were employed to prevent a possible collapse of the world financial system. The crisis was nonetheless followed by a global economic downturn, the Great Recession. The European debt crisis, a crisis in the banking system of the European countries using the euro, followed later. In 2010, the Dodd–Frank Wall Street Reform and Consumer Protection Act was enacted in the US following the crisis to “promote the financial stability of the United States”. The Basel III capital and liquidity standards were adopted by countries around the world.” If one juxtaposes the above summary of the 2008-2009 crisis with the ABI’s summary of the current high-risk lending environment (see below), there are notable parallels that should make insolvency professionals take note. Of particular relevance is the current tendency of less regulated institutions to engage in risky transactions (some of which are not unlike the subprime mortgages (see above) that helped precipitate the 2008-2009 meltdown). According to the ABI: “A decade after reckless home lending nearly destroyed the financial system, the business of making risky loans is back, the New York Times reported on Tuesday. This time, the money is bypassing the traditional, and heavily regulated, banking system and flowing through a growing network of businesses that have stepped in to provide loans to parts of the economy that banks abandoned after 2008. With almost $15 trillion in assets, the shadow-banking sector in the U.S. is roughly the same size as the entire banking system of Britain, the world’s fifth-largest economy. In certain areas — including mortgages, auto lending and some business loans — shadow banks have eclipsed traditional banks, which have spent much of the last decade pulling back on lending in the face of stricter regulatory standards aimed at keeping them out of trouble. But new problems arise when the industry depends on lenders that compete aggressively, operate with less of a cushion against losses and have fewer regulations to keep them from taking on too much risk. Recently, a chorus of industry officials and policymakers — including Federal Reserve Chair Jerome H. Powell — have started to signal that they’re watching the growth of riskier lending by these nonbanks. “We decided to regulate the banks, hoping for a more stable financial system, which doesn’t take as many risks,” said Amit Seru, a professor of finance at the Stanford Graduate School of Business. “Where the banks retreated, shadow banks stepped in.” Lately, that lending is coming from companies like Quicken Loans, loanDepot and Caliber Home Loans. Between 2009 and 2018, the share of mortgage loans made by these businesses and others like them soared from 9 percent to more than 52 percent, according to Inside Mortgage Finance. While they don’t have a nationwide regulator that ensures safety and soundness like banks do, non-banks say that they are monitored by a range of government entities, from the Consumer Financial Protection Bureau to state regulators.” Read More
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FactorLaw featured in Leading Lawyers Magazine, May 2019

An excerpt: “We are very much a family business, like many of the clients we are representing,” Factor says. “Providing top-notch service to our clients is the glue that holds us together. They’re getting the same service they would get at a major firm, but at a more affordable price, including flexible fee structures and more personalized attention.” To access the complete article, click the link below. Download Read More
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Money inherited more than 180 days after petition date belongs to Chapter 13 bankruptcy estate

In Moore, the bankruptcy court for the Eastern District of Tennessee joined a majority of courts and held that money inherited outside of the 180 day window set forth in § 541 was still property of the chapter 13 estate.  In the Moore case, the debtors filed for chapter 13 relief on November 15, 2016.  The Debtor’s father passed away almost 18 months later and Mr. Moore received an inheritance of $14,76483 from his father’s estate.  The Debtors then filed a motion to retain the inheritance so they could purchase a vehicle.  The Chapter 13 Trustee objected, arguing the Debtors were seeking to retain non-exempt funds.  The legal issue for the court was whether the inheritance was property of the bankruptcy estate in light of §541, which provides that an inheritance received up to 6 months after the petition date is property of the bankruptcy estate  “The Debtors contended the inheritance I excluded from the estate because it would be excluded by § 541()(5)(A). “  Conversely, the trustee argued that in chapter 13 cases, property of the estate includes that which is brought in pursuant to §541, and also includes “all property of the kind specified in [§541] that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first[.] “ Noting that “There is a split in the authorities interpreting whether property inherited outside the 180-day period should be included in a chapter 13 estate,” the Moore court noted that “[t]he overwhelming majority of courts to have addressed this issue ‘agree that § 1306 modifies the § 541 time period in Chapter 13 cases” and concluded that post-petition inheritances received beyond 6 months after the petition date are also included in the bankruptcy estate. If you would like more information regarding bankruptcy filings and would like to speak to one of our experienced attorneys, please call (312) 878-6976 or fill out a contact form here. Read More
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Beware of Bankruptcy Petition Preparers

Every now and then, a debtor will appear in bankruptcy court on a case that is set to be dismissed. The nervous debtor will stand at the podium, and the judge will ask the debtor why he or she has not filed certain required papers within the time prescribed by the Bankruptcy Code. The debtor will likely appear flustered, “I don’t know, Judge.” The judge will ask some more questions, and the debtor will often reveal that he or she does not have an attorney, but rather has paid a non-attorney bankruptcy petition preparer (BPP) a non-trivial sum of money to help them file for bankruptcy. Unfortunately, in many of these cases, the judge will have no choice but to dismiss the debtor’s case because various statutory requirements have not been satisfied. The debtor will inevitably be very disappointed, as he or she will not receive a discharge of their debts or a refund of their filing fee. Needing to file for bankruptcy can be an overwhelming experience. Hiring a BPP instead of a bankruptcy lawyer in order to save money may seem like a good idea. While it is not illegal to hire a BPP, it is not always wise. Section 110 of the Bankruptcy Code explicitly allows for debtors to hire non-attorney BPPs to type their petition and schedules. 11 U.S.C. § 110. There are some very specific limitations and disclosure requirements for BPPs. 11 U.S.C. § 110(b)-(h). For example, BPPs “may not offer a potential debtor legal advice” 11 U.S.C. § 110(e)(2), they may not use the word “legal” or similar terms in their advertisements, 11 U.S.C. §  110(f), and they are required to fill out Official Form 119 every time they help prepare documents that are filed in a case. 11 U.S.C. § 110(b)(2). Some bankruptcy courts have imposed even stricter regulations for BPPs. For example, in the Eastern District of Michigan, a BPP may charge no more than $100 for their services. Bankr. E.D. Mich. Admin. Order 10-21. If a BPP does not comply with all the requirements of Section 110 of the Bankruptcy Code, he or she may face some very steep penalties. A debtor, trustee, or U.S. Trustee may file a motion against the BPP pursuant to Sections 110(i) or 110(l) of the Bankruptcy Code. The penalties awarded under this statute may include a refund of the fee the debtor paid to the BPP and the greater of $2,000 or twice the amount of the BPP’s fee. 11 U.S.C. § 110(i). Additionally, a BPP may be required to pay up to $1500 in fines to the U.S. Trustee for each violation of Section 110 of the Bankruptcy Code if certain conditions are met. 11 U.S.C. § 110(l). The court may also enjoin (or forbid) the offending BPP from providing their services to other debtors. 11 U.S.C. § 110(j). Some BPPs have even ended up in jail for providing “services” in violation of Section 110 (see links here, here and here). While it is good that debtors who have been ripped off by unscrupulous or incompetent BPPs have some recourse, the relief offered by Section 110 of the Bankruptcy Code does nothing to help these debtors get any closer to receiving a discharge of their debts. Overall, if you are considering filing for bankruptcy, please consider hiring an experienced bankruptcy attorney who be able to competently represent you. If you cannot afford an attorney, contact the clerk’s office at your local court to see if they can refer you to a legal aid clinic. In the Chicago area, the Bankruptcy Assistance Desk or a legal aid organization such as Chicago Volunteer Legal Services may be able to help you.   If you have been a victim of a BPP, reach out to your local U.S. Trustee’s office for assistance. By cooperating with the U.S. Trustee, you may be able to recover your losses and you might be able to help prevent that BPP from harming another person like you. Read More
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According to a Recent Businessweek Article - Merchant Cash Advances are Wreaking Havoc on Small Businesses

In an earlier post FactorLaw discussed Merchant Cash Advances, which is a form of financing that appears to be marketed to certain types of small businesses, according to an article dated November 20, 2018 published in Businessweek (the “BW Article”).  The BW Article offers what we believe is an in depth treatment of how Merchant Cash Advances work and how they can be abused to the detriment of small businesses.  The major premise of the BW Article is best summarized by the following lead-in: “How an obscure legal document turned New York’s court system into a debt-collection machine that’s chewing up small businesses across America?”  That “obscure legal document” is, of course, the confession of judgment that often accompanies the documentation for a Merchant Cash Advance.  According to the BW Article, “some lenders have abused this power.” The BW Article also indicates the authors conducted “dozens of interviews” and reviewed “court pleadings” and based upon those sources the BW Article reports that “borrowers describe lenders who’ve forged documents, lied about how much they were owed, or fabricated defaults out of thin air.”  The BW Article further reports that: “Cash-advance companies have secured more than 25,000 judgments in New York since 2012, mostly in the past two years, according to data on more than 350 lenders compiled by Bloomberg Businessweek.”  The authors of the BW Article opine that “New York’s courts are especially friendly to confessions and will accept them from anywhere, so lenders require customers to sign documents allowing them to file there. That’s turned the state into the industry’s collections department.” FactorLaw continues to handle cases for companies or individuals that are dealing with Merchant Cash Advances and continues to  believe that a bankruptcy filing sometimes is a viable option for dealing with a Merchant Cash Advance. The automatic stay generally stops all collection actions, and in a chapter 11 case individuals and businesses sometimes are able to restructure debt obligations, including secured debt or debt arising from a confession of judgment. Chapter 13 also is available to individuals and, like chapter 11, generally allows individuals to retain property while they are working to repay debt over time. If you would like more information regarding bankruptcy filings and would like to speak to one of our experienced attorneys, please call (312) 878-6976 or fill out a contact form here. Read More
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The Absolute Priority rule is alive and well for Chapter 11 cases

I. Explanation of absolute priority rule Consumer debtors that do not qualify for protection under Chapter 7 or Chapter 13 of the Bankruptcy Code, are left with filing under Chapter 11, where they will come face-to-face with the absolute priority rule (the “APR”).  The APR is a cornerstone of bankruptcy law.  It was first developed by the Supreme Court in the late nineteenth-century to deal with widespread collusion in railroad reorganizations. To prevent unfair deals between senior creditors and equity holders, the Court held that “stockholders are not entitled to any share of the capital stock nor to any dividend of the profits until all the debts of the corporation are paid.”[1] Simply stated, the APR establishes a hierarchy of rights in bankruptcy proceedings, commencing with secured creditors at the top of the heap and ending with equity holders (or the debtor when the case involves an individual) at the bottom.  This rule recognizes that equity holders, or debtors, have less rights and entitlement to recovery of a bankrupt enterprise’s assets because they stood to reap the most if the entity succeeded.  It also recognizes that equity-holders generally control the allocation of value and absent limitations, they would unfairly allocate a disproportionate share to themselves.  “This rule assured those who did business with the corporation that if the business were dissolved the creditors would be paid before the insiders would recover their investments. In case of collapse, the creditors could count on payment in full before equity collected anything from the business assets.”[2] Individuals debtors may find problematic their efforts to satisfy the APR because a Chapter 11 plan cannot be confirmed over the objection of a dissenting class of creditors if value is being allocated to the debtor, unless secured creditors and unsecured creditors are paid in full (see below discussion on the requirements for full payment), or the Plan meets the stringent “new value” test.[3]  On a practical level, an individual debtor cannot retain any property in a  Chapter 11,[4] unless all senior creditors are paid in full, including over an extended time period; all impaired classes accept the plan; or the debtor contributes what is known as “new value” in exchange for retaining its equity interests. [5] II. How the rule applies in chapter 11 The APR evolved beyond a judicially created doctrine when Congress codified it as part of the Bankruptcy Code in 1978.[6] To confirm a Chapter 11 plan, all impaired classes must accept the plan.[7]  However, a court may still confirm the plan (i.e., through a “cramdown”) if an impaired class rejects it, but only if the plan is otherwise “fair and equitable” within the meaning of the Bankruptcy Code, or, in some cases, the debtor contributes “new value” in accordance with that exception to the APR, and satisfies certain other criteria enumerated in §§1129(a)(1) through (a)(14).[8]  To be fair and equitable, a plan must provide property of a value, as of the effective date of the plan, equal to the allowed amount of a creditor’s claim or it must satisfy the APR.  A plan can satisfy the APR if value is allocated in accordance with the APR – e.g., if unsecured creditors are not paid in full, the debtor receives no property.  Full payment to senior classes does not necessarily require a single payment of the full amount owed and does not have to be immediate or in accordance with existing debt instruments (except for loans on an individual’s principal residence, which cannot be modified), so long as the payment stream is accompanied with an appropriate interest rate and is otherwise “fair and equitable.” Thus, the deferred cash payments can be structured in many ways, so long as the restructured terms are “fair and equitable” in the view of the Court.      This makes the cramdown of a Chapter 11 plan difficult for individual debtors that have a lot of debt and limited means to repay that debt.[9]    III. After BAPCPA a minority of lower courts have held that the APR no longer applies in individual chapter 11 cases. In 1988, the Supreme Court unanimously held the APR applied in individual Chapter 11 cases.[10] However, the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) that was enacted in 2005, led some courts to question whether the APR was still applicable in individual Chapter 11 cases.[11]  BAPCPA modified §1129(b)(2)(B)(ii) and added §1115.  The interaction between these two provisions has generated some decisions holding that the APR no longer applies when the debtor is an individual, although the majority view, which is followed by five Circuit Courts, holds otherwise – i.e., the APR still applies and was not abrogated by BAPCPA.  Section 1129(b)(2)(B)(ii) provides that, “in a case in which the debtor is an individual, the debtor may retain property inclu… Read More
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Bankruptcy Filings among Elderly Increased Exponentially over Last 25 Years

According to an article posted today in the New York Times by Tara Segal Bernard, “[f]or a rapidly growing share of older Americans, traditional ideas about life in retirement are being upended by a dismal reality: bankruptcy.” According to Ms. Bernard, “[t]he signs of potential trouble — vanishing pensions, soaring medical expenses, inadequate savings — have been building for years.”  A large part of her conclusions are drawn from a recently published study by the Consumer Bankruptcy Project, which found that the “rate of people 65 and older filing for bankruptcy is three times what it was in 1991, the study found, and the same group accounts for a far greater share of all filers.”    Ms. Bernard further reports that: Driving the surge, the study suggests, is a three-decade shift of financial risk from government and employers to individuals, who are bearing an ever-greater responsibility for their own financial well-being as the social safety net shrinks.  The transfer has come in the form of, among other things, longer waits for full Social Security benefits, the replacement of employer-provided pensions with 401(k) savings plans and more out-of-pocket spending on health care. Declining incomes, whether in retirement or leading up to it, compound the challenge.  As the study, from the Consumer Bankruptcy Project, explains, older people whose finances are precarious have few places to turn. “When the costs of aging are off-loaded onto a population that simply does not have access to adequate resources, something has to give,” the study says, “and older Americans turn to what little is left of the social safety net — bankruptcy court.” “The forces at work affect many Americans, but older people are often less able to weather them, according to Professor Thorne and her colleagues in the study. Finding, and keeping, one job is hard enough for an older person. Taking on another to pay unexpected bills is almost unfathomable.  Bankruptcy can offer a fresh start for people who need one, but for older Americans it ‘is too little too late,’ the study says. ‘By the time they file, their wealth has vanished and they simply do not have enough years to get back on their feet.’” Ms. Barnard also cites statistics from the Federal Reserve’s survey of consumer finances, via the Consumer Bankruptcy Project, showing that filings by people in the 55 to 64 age group increased by 66% from 1991 to 2016 and filings by people in the 65 to 74 age grou increased by 204% over the same period.  According to Ms. Bernard: The data gathered by the researchers is stark. From February 2013 to November 2016, there were 3.6 bankruptcy filers per 1,000 people 65 to 74; in 1991, there were 1.2.  Not only are more older people seeking relief through bankruptcy, but they also represent a widening slice of all filers: 12.2 percent of filers are now 65 or older, up from 2.1 percent in 1991.  The jump is so pronounced, the study says, that the aging of the baby boom generation cannot explain it. If you would like more information regarding bankruptcy filings and would like to speak to one of our experienced attorneys, please call (312) 878-6976 or fill out a contact form here. Read More
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Experts predicting increased ilIiquidity and link it to the climate that led to the 2008 crisis

According to a recent report by Morgan Stanley “market liquidity across assets is in decline” and  “low liquidity were the fundamental triggers of the 2008 crisis.”  Those bankruptcy practitioners that had first hand experience of the 2008-2010 turmoil, will recall the frustration of not being able to help clients workout of a distressed situation because of the lack of liquidity (e.g., alternatives).  Often bankruptcy was the only alternative and even that option was less than optimal because the market for additional capital or options was broken.  Liquidation was often the only option.    One example cited by Morgan Stanley relates to corporate bonds.  According to their report: “Dealer holdings of corporate bonds have shrunk from 3% of the market to just 0.3% today. While this means that dealers themselves have less to liquidate, their capacity to move risk to a new buyer may be limited and require larger repricing of the asset class in times of stress.”  The repricing is likely to mean reduced value for corporate bonds and may result in other strategies for offloading such positions.  One such strategy might be vulture buying of this asset class and potentially an “own to loan” strategy or a liquidation strategy for certain asset classes.   Morgan Stanley cites another example related to public debt.  According to Morgan Stanley, in the recent past, central banks built large positions in bonds.  “As central banks built these positions, liquidity in the affected assets was excellent. It’s hard to imagine anything better for liquidity than the presence of a steady, deep, well-telegraphed bid. But these forces are now swinging in the other direction. The Fed’s purchases have already begun to reverse, the ECB’s are likely to over the next six months, and with close to half of its bond market already owned by the BoJ, it will eventually face a constraint.” Given that the U.S. economy is in the late stages of an extended recovery that is close to a record-setting duration, and given the near certainty that the economy operates like a pendulum, the open question is not “if” but “when” will the U.S. economy stumble, how bad will it get and what will it mean for bankruptcy and other workout professionals.     If you would like more information regarding bankruptcy filings and would like to speak to one of our experienced attorneys, please call (312) 878-6976 or fill out a contact form here. Read More
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Discharge injunction violation results in $90,000 award

A recent case in the District Court, Romanucci & Blandin, LLC et al. v. Lempesis, affirmed a judgment by the Bankruptcy Court awarding $90,000 for an especially egregious violation of the discharge injunction, including damages for emotional distress and punitive damages. Spiro Lempesis, a former baseball coach, was sued by Anthony Collaro, one of his former players, with the help of Roamanucci & Blandin, a law firm. Lempesis filed for bankruptcy. But because of how the law firm dealt with the bankruptcy filing and eventually with the discharge injunction, the law firm wound up owing the defendant money. The filing of a bankruptcy case creates an automatic stay, stopping all collections actions in favor of the debtor. Not only are actions taken in violation of the automatic stay void, there are consequences for violating the stay. Generally, a plaintiff in a lawsuit has to seek relief from the stay in the bankruptcy court before proceeding in any other court. In addition to providing the debtor with a breathing spell, the stay helps to channel lawsuits into the bankruptcy court so the bankruptcy court can provide air traffic control. The discharge injunction provides the debtor with permanent protection against lawsuits for pre-petition conduct. While there are exceptions to both the automatic stay and the discharge, an order from the bankruptcy court is often required. Here, after the bankruptcy was filed, notice was sent to the law firm, but the mail was returned because the law firm had moved. So Lempesis’s bankruptcy lawyer faxed it to the law firm, where an associate put it in the file, but apparently didn’t tell anyone else at the law firm about it. Lempesis received a discharge. The lawsuit was voluntarily nonsuited and later refiled (a common strategy in Illinois courts, used by plaintiffs to buy time when the statute of limitations is looming). Even after Lempesis moved to enforce the discharge and for sanctions, the law firm continued to pursue Lempesis in the state court lawsuit, and even went on TV to repeat the allegations. The bankruptcy court eventually awarded $90,000 in damages: $11,000 in attorneys’ fees and costs, $12,000 in emotional distress damages, $50,000 in punitive damages, and $17,000 of additional attorney’s fees based on a supplemental statement of fees, presumably required to bring the discharge injunction litigation to trial. This award was appealed to the district court, which affirmed the whole award against the firm, but vacated the award against the client. Things did not have to turn out this way. If the notice of bankruptcy had not been ignored, it would have been possible to ask the bankruptcy court’s permission to continue with the lawsuit, and to keep any claim against Lempesis alive despite the discharge. Based on the facts we know from the court opinions, it would have been worth a shot to seek denial of the dischargeability of Collaro’s claim. But by the time Lempesis sought relief of his own, that boat had sailed. The law firm also ran up damages by pursuing the lawsuit even after the motion for sanctions was filed. Discharge injunction litigation is for all intents and purposes a lawsuit in federal court, and lawsuits in federal court are expensive. One aspect of the punitive damages was judge’s conclusion that a lawyer should have known better. Of course, not all lawyers need to know the nuances of  how the discharge works, but  they should all know to proceed with caution. Even so, it is also necessary to proceed quickly. Damages for a violation of the stay can multiply as time goes on. The deadline for seeking a dischargeability determination comes and goes quickly, and can only be extended before the time expires. It is important for a lawyer to be educated about these potential consequences, or to have experienced bankruptcy counsel on the team so as to not run afoul of the automatic stay and the discharge injunction, and to preserve client rights considering fast and inexorable bankruptcy deadlines. Read More
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