The Journal of The DuPage County Bar Association

Back Issues > Vol. 26 (2013-14)

Bankruptcy Initial Interview: Tips and Traps
By Kent A. Gaertner

It would be beneficial to consumer bankruptcy attorneys (especially the younger ones) to have a nuts and bolts discussion on the initial interview with the client and getting the information you need to prepare a good solid bankruptcy petition. This article was written from a Chapter 7 perspective but ninety percent of the material also applies in the Chapter 13 scenario.

Initially, when prospective clients make their initial appointment, the author requests that they send an e-mail giving a short, couple paragraph, overview of their assets, liabilities and income. This would include values of real estate and vehicles, as well as liens secured on those assets. The author also asks for any specific questions or concerns clients have about filing. It is surprising how many times prospective clients disclose that they have a large amount of equity in their house or other real estate and do not realize that a Trustee could sell that property. Also, an attorney may learn that the clients have high income which would disqualify them for Chapter 7. In many of these cases, the author calls the prospective clients and let them know that either a Chapter 13 is in their future or a bankruptcy will not work for them. This brief introduction to their situation makes the initial interview more efficient and can reveal potential problems in their case even before they come in.

At the initial interview, the author works off a questionnaire that lists most common asset and debt types. It also has questions on the client’s financial background based loosely on the Statement of Financial Affairs, especially with regard to transfers and recent payments to creditors. Monthly gross income and where it comes from are also discussed. Also at the initial meeting, the prospective client is making an evaluation of his prospective attorney. At the same time, the attorney is evaluating the client as to apparent honesty and willingness to be forthcoming with answers to questions. Over the years of practice, one begins to develop a sixth sense of when a prospective client is not being forthcoming or fully honest. When the attorney asks a client how much something is worth and the reply is “what do you want it to be worth?” the lawyer should not be favorably impressed. When clients are unable to remember critical information on their finances, transfers of assets and what the asset was worth, the author gets suspicious. If the author suspects that there is a potential problem with the client, the author emphasizes the necessity of full disclosure of all assets and financial information and advises them that if they are caught committing perjury and/or bankruptcy fraud they will lose any discharge and could go to jail. The author also tells them clearly that he will not tolerate anything other than full and complete disclosure and cooperation.

All assets, creditors, transfers and preferential payments will be listed. Many times, after giving these warnings, the author never sees the prospective client again. That result is not bad as these types of clients will only get a lawyer in trouble.

An initial conference lasts about an hour and at the end of that time, the author gives the client a detailed questionnaire to fill out listing assets, debts, income, expenses and financial history. There are also instructions on other documents needed such as pay stubs, tax returns and how to fulfill the counseling requirement. Also given is an overview of the bankruptcy process, required notices and the legal services agreement. Upon return of the questionnaire and other required documents (and, most importantly, a retainer), we are ready to open a file and prepare the initial draft of the petition. By the way, make sure to review the tax returns the client provides. They can uncover to assets that the client may have not listed or that have been transferred. Reference to mortgage interest payments, depreciation, dividend income or references to other businesses, should prompt further inquiry. The Trustees review the returns for the same thing. The balance of this article will walk the reader through the various schedules and sections of a bankruptcy petition and discuss areas that are potential minefields for the unwary practitioner.

Means Test. Upon receipt of the client’s pay advices, make sure they match up with what the client said at the initial conference about income. If the author thinks there may be an issue with too much income to file a Chapter 7, he will start with the Means Test, going through all pay advices on a monthly basis for the last six months and listing out gross income and taxes withheld. Putting that information into the designated spots in the Means Test will, in most cases, result in a little green smiley face appearing at the bottom of the Means Test screens in our bankruptcy program.1 That means the client does not have a Means Test issue based upon income and withholding. If the program generates a scowling yellow face, there may be an issue with presumptive abuse and the author will then move to inputting Schedule D secured debt and expenses from Schedule J that can be deducted from income in the Means Test. With a presumptive abuse case, it is better to find out right at the start than to do the whole petition and then have to call the client and tell him he has to file a Chapter 13 lasting for five years, or not file at all.

Schedule A- Real Estate. It is a simple matter to check if a person owns real estate in the collar counties. The various Recorder of Deeds offices access to those records that on line. The Bankruptcy Trustees take advantage of this. Lawyers should too. Also, as stated above, review the tax returns for the last four years. Indications of mortgage interest deduction or rental income should trigger an inquiry about what happened to that real estate. Upon double checking to make sure the client listed all his real estate the next question is the value of the real estate. The lawyer should the client for a value of the property. Many times clients have had a market evaluation or a recent appraisal. They also frequently know what other homes in their neighborhood, comparable to theirs, have sold for recently. Some clients have no idea what their home is worth or they cannot provide any kind of a reason for the value they give. In that case, it is wise to take a moment to look up the real estate value on line. Although there is wide variation on value using the various websites, it can provide a feel for the property value.

Once a lawyer has an idea of value, existing liens and other encumbrances against the property should be ascertained. It is always a good idea to have the client provide a copy of the monthly statement for each mortgage. These documents usually have the current principal balance listed. It is not unheard of for the client to indicate a mortgage payoff which is substantially over stated. If there is money due the IRS or Illinois Department of Revenue, ask about any tax liens filed. If the client has had a judgment rendered against him, there may be a judgment lien. Sometimes it is necessary to order a tract search before filing a case to determine the liens and the amount of equity in the property. Deducting known liens from calculated value will reveal whether there is any equity to interest a Trustee. The value of the property (at quick sale) less mortgages, other liens, outstanding real estate taxes (if any), closing costs and the debtors’ homestead exemption equal the value of equity available to a Trustee. If it looks as if there may be equity in the property after that calculus the client should be advised to get a market evaluation (or two) from real estate professionals who are not family members. If there is a chance the Trustee may want to sell the property, the client needs to know that up front and by able to make plans on how to deal with the situation, perhaps by filing a Chapter 13. If the property has a second mortgage that is totally unsecured (meaning the value of the property is less than the amount of the first mortgage), then a Chapter 13 would allow that second mortgage lien to be avoided upon the completion of a plan. That may be a reason for a client to choose a chapter 13 filing over a chapter 7.

If only one spouse will be filing and the marital home has substantial equity, the client will want to avail himself of the tenants by the entirety exemption which states that a homestead cannot be sold to satisfy the debt of only one of the tenants.2 The author encounters this situation where the debtor owned a business and has guaranteed business debt which his spouse has not guaranteed. The client should be requested provide a copy of the deed to verify that the property is actually in tenants by the entirety and when it was put into that form of ownership. A recent transfer (four years or less) by the debtor and spouse into a tenancy by the entirety ownership could be considered a fraudulent transfer if the sole intent was to avoid payment of debts, existing at the time of the transfer, that were beyond the transferee’s ability to pay. It should be noted, however, that this exemption does not protect the non-filing spouse to the extent that the non-filing spouse has joint debt with the debtor. A Trustee could sell the house to provide funds to pay the joint debts of the debtor and his spouse. In this situation, it may make sense to advise the debtor to have the non-filing spouse pay any joint debt out of funds owned by the non-filing spouse prior to the bankruptcy filing. Additionally, the tenancy by the entirety exemption is trumped by a federal tax lien allowing a Trustee to sell the real estate to satisfy that lien.3

For most debtors, saving their residence is the highest priority they have in bankruptcy. However, these days, many of the author’s prospective clients have homes that are underwater by $50,000 or more. Many times it is simply a bad idea to continue to throw good money after bad into a property that will likely not break even for a decade or more. The author will talk to these clients about the option of filing the bankruptcy and then just letting the lender foreclose the mortgage. In DuPage and Kane counties a normal foreclosure takes 12 to 18 months. The clients can live in the residence (post-bankruptcy filing) for the cost of utilities (and homeowner association dues if applicable). That can save the clients a couple of thousand dollars per month which they get to keep because they are post-petition dollars. That is a very good way to get that fresh start. Eventually the foreclosure will complete and the clients will have to move. At least they will have cash in the bank to assist that process. This does not preclude trying to do a mortgage modification post-filing if the lender is willing to wait on completing the foreclosure.

Personal Property- Schedule B. Schedule B of the bankruptcy petition lists 35 categories of personal property. Keep in mind the following tips and potential problems in the following categories:

a. Bank Accounts: The author advises his clients to pay normal household bills that are due at the time the bankruptcy is ready to be filed. These include utility bills, insurance, and mortgage/rent payments. This frees up more exemption dollars to use on other assets. Of course, they should not be paying any debt that will be discharged in the bankruptcy.

b. Household Goods: Get a list of the larger household goods by room so they can be reported accurately. Also get the age of the items from the client. Ten-year old furniture is worth very little. Pay special attention to electronics and newly acquired furniture.

c. Books, Pictures, Collections, Photography Equipment and Sporting Goods: If the client is not sure of value, E-Bay is a valuable tool for finding comparable items for sale on the internet. Most artwork purchased at art fairs, antique shows, flea markets., etc., has very little value.

d. Furs and Jewelry: If the client has significant jewelry, have them take it to a jeweler and see what the jeweler would offer them for the pieces. Clients are usually astounded at how little resale value jewelry has. That is because most jewelry is personal in nature and does not have wide appeal.

e. Cash Surrender Value of Life Insurance: This is exempt if the beneficiary is the spouse, or a dependant child or other dependant of the debtor. Adult children are not generally dependants.4

f. IRAs, 401Ks: These are generally exempt in full. However the Seventh Circuit recently ruled in In re Clark, 714 F.3d 559 (7th Cir. 2013), cert. granted, ___ U.S. ___, 134 S.Ct. 678 (2013), that inherited IRAs are not exempt because the funds were not the debtor’s retirement funds. They came from someone else. This is directly opposite from the ruling by the Fifth Circuit in Chilton v. Moser 5 where that court stated the plain reading of the statute shows it does not require that the funds be initially earned by the debtor. This issue is headed to the U. S. Supreme Court. Until that Court issues its decision, if practitioners in the Seventh Circuit will find these funds are not exempt. Trustees are on the lookout for relatively young debtors who have large IRAs, a tell tale sign of a possible inherited IRA.5

g. Tax Refunds: In December, the Trustees starts asking debtors at the 341 meeting if they are expecting a tax refund. That issue needs to be explored with client before filing. Tax refunds are not exempt except to the extent they can be covered by the general wild card exemption of $4,000/debtor. If their income level is similar to the last year, the refund should be about the same. If they can get the current year’s return done before filing, the refund can be handled with exemption dollars otherwise the client should be advised that the refund may go to the Trustee.

h. Stock and Interests in Business: If the debtor owns the majority of stock in a small business, that stock belongs to the Trustee unless its value can be exempted with the general personal property exemption. If assets of the company exceed its liabilities, a Trustee could liquidate the company, pay the company liabilities and retain the balance of the liquidated funds to pay personal creditors of the debtor. The, a lawyer should make sure to discuss with the debtors the assets and liabilities of any corporations they own. If there are significant assets that greatly exceed liabilities, it may make sense to hold off a bankruptcy filing or the debtor could find himself without a company or a job. The value of debtor’s interest is significantly less when they are a minority shareholder and cannot force a liquidation of the company. Also, if there is a shareholder agreement, the Trustee is bound by that agreement to the same extent the debtor would be. Therefore restrictions on transfer of shares may drastically affect the value of the shares. Make sure you get a current P & L statement and balance sheet on the business and a copy of the shareholder agreement.

i. Causes of Action: A cause of action the debtor may have, even if no lawsuit has been filed, is an asset of the bankruptcy estate. Failure to list a cause of action on Schedule B can result in the debtor being judicially estopped from bringing that action at a later date.6

j. Autos/Motorcycles/Boats: As far as valuation, there are numerous sites on the web to get the current value on any of these types of assets. Many of the web sites seem to give inflated values. The client may wish to get an appraisal from a used car dealer such as CarMax or others. They tend to be lower because the appraiser actually has the vehicle in front of him. For Schedule B purposes, the less value the better.

k. Tools of the Debtor’s Trade: For a mechanic, carpenter, plumber, etc., the tools they use in the course of their employment can be exempted up to the $1,500 limit. However, not just tools qualify for this exemption. If a debtor works from home or is self-employed may also have office equipment and computers that qualify. For someone who is in a band and makes extra income doing that, musical equipment would qualify. This leaves more of the general wild card exemption dollars available for other uses.

If there are assets that cannot be covered by the client’s exemptions, be up front with the client about it. Clients may not like losing an asset but they get the big picture. They are discharging a large amount of debt and getting a fresh start in exchange for the loss of that asset. The client can make an offer to the Trustee to buy out their interest in any given asset that is not exempt. These funds could come from exempt retirement accounts or perhaps from a friend or family member.

Credit or Schedules/ Statement of Financial Affairs. It is the client’s responsibility to provide a list of creditors, including accurate addresses and account numbers. This should be done in writing. The author does not accept credit reports as a substitute for this, nor does he accept grocery bags full of monthly invoices from the debtors’ creditors. It is not the attorney’s job to develop a creditor list for the client. If a creditor does not get on the creditor list and problems ensue, it should not be the lawyer’s fault. If client provides a written list and the lawyer ensures that all those creditors are on the petition, the lawyer is protected. For credit cards, have the client provide the customer service address and not the payment lockbox.

Many clients think they can list some creditors but not others. They should know they cannot “cherry pick” their creditors. All must be listed, even family members. They can voluntarily repay anyone they like after the bankruptcy is filed. That usually resolves the situation. The lawyer should talk to your clients about any lawsuits they are involved in, any lawsuits that are threatened, or any lawsuits they have been a party to in the last three years. Any large payments to creditors in the last 90 days, or to family members in the last year should be discussed. Anything a client has sold, transferred or given away in the last four years should be investigated. Likewise any large purchases on credit in the last year should be discussed so as to determine if some kind objection to discharge or dischargeability is possible. If so, it is imperative to make sure the client understands the risk and the process. Also, most flat fees for the bankruptcy do not include representation in the event of an adversary complaint. That should also be discussed.

Final Thoughts. In real estate sales the most important factor is location, location, location. The most important goal in preparing a bankruptcy petition is full disclosure, full disclosure, full disclosure. Clients may innocently leave out important assets, liabilities or transfers. It is the lawyer’s job to try to ask the right questions and check client documentation for indications of missing information. The client must understand that all assets get listed even if they think the asset has no value. The Trustee is the one with the authority to say what is valuable or not when dealing with estate property.

If a lawyer has a bad feeling about the client’s veracity either she should not take the case or at least have the client initial every page of the final document. The author has gone so far as to prepare an affidavit for the clients to sign stating that they have fully reviewed every page of the petition, discussed any questions they may have had with counsel to their satisfaction and that the petition is true and accurate in all respects. Sometimes not taking a bad client is more profitable for your practice than taking a good one. 

1 The author uses the Bestcase Bankruptcy filing program. When the Means Test is satisfied and a client is not a presumptive abuse case, a small green smiley face appears at the bottom corner of the screen. On the other hand, if the client is considered an abuse case, a small but nasty yellow scowling faces appears at the bottom of the screen.

2 765 ILCS 1005/1c and 735 ILCS 5/12-112

3 United States v. Craft, 535 U.S. 274, 122 S.Ct. 1414 (2002)

4 215 ILCS 5/238

5 Chilton v. Moser, 674 F3d 486 (5th Cir. 2012)

6 Cannon–Stokes v. Potter, 453 F.3d 446 (7th Cir. 2006)

Kent Gaertner has practiced bankruptcy law for over 30 years. He represents clients in Chapters 7, 11, and 13 of the Code and in litigation, non-bankruptcy workouts and reorganizations. His clients include consumers and businesses, debtors and well as creditors. Mr. Gaertner is a past President of the DCBA and is now serving yet another term as vice chair of the DCBA Bankruptcy Committee. He is a member of the ISBA section council on Commercial Banking, Collections and Bankruptcy. He recently completed two terms as the chair of the Bankruptcy sub committee of the section council.

Mr. Gaertner is Of Counsel to Springer Brown, LLC. in Wheaton, Il. which concentrates its entire practice to bankruptcy law. He invites his fellow DCBA members to feel free to contact him if they have questions about bankruptcy law or procedure.

 
 
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