Wednesday, September 28, 2005
BANKRUPTCY BILL MERITS ATTENTION FROM PHYSICIANS AND OTHER HIGH NET INCOME PROFESSIONALS By Craig R. Hersch @ 5:54 PM
Do Not Wait to Plan – Enactment Likely by April 2005.
The new bankruptcy bill passed by the Senate would annihilate the ability of "high income" individuals to file a Chapter 7 bankruptcy and extinguish debt without sacrificing significant income. The bill also limits the homestead exemption to $125,000 for many debtors, and contains a 10-year look-back provision in fraudulent transfers and asset protection trust situations.
The House of Representatives expects to pass its version of the bill that should be fairly similar to the Senate version recently passed. President Bush is then expected to sign the bill into law sometime in April. The effective date of the law is anticipated to be 180 days after enactment.
The new bankruptcy laws contain provisions that should be of paramount concern to potential debtors, including physicians who may incur a malpractice claim in excess of insurance limits, corporate executives who are prone to shareholder lawsuits and other high net worth individuals.
No More Chapter 7 Protection for High Income Debtors
Chapter 7 bankruptcy filings generally allow individuals to extinguish many debts and start afresh. The new bankruptcy laws disallow Chapter 7 filings for individuals who have income above the state median.
In order to extinguish all debt, a debtor who falls into this category must enter into a 5 year payment plan whereby most, if not all, of the income above a fairly low level would have to be paid to the creditors.
Most affluent debtors would have to spend down exempt assets (such as life insurance and annuities) to make ends meet during this five year period, especially if they have other significant obligations such as children in private school or alimony and child support payments.
The Debtor Fugitive
The new law may very well create a new class of individuals deemed "debtor fugitives" by my colleagues Alan Gassman and Jonathan Alper, both of whom are asset protection attorneys and serve as directors with me in the Academy of Florida Wealth Protection Lawyers.
These debtor fugitives would be debtors with judgments against them but who never attempt to discharge the debt in bankruptcy because of the new restrictive laws. It would be very important for these individuals to have structured their assets to remain "judgment proof". Such a person would want to take advantage of Florida’s wage exemption laws, but would have to be careful about the erosion of those very laws by the bankruptcy courts. For more information on those laws, please see my article published in the Florida Bar Journal (I can provide you a copy on request).
Where the debtor has structured his assets to be judgment proof, a plaintiff should be expected to settle his claim for less than the judgment in order to get paid something, as opposed to waiting for years for the opportunity to garnish exposed assets.
Homestead Protection Eroded
A noteworthy feature of the Senate Bankruptcy Bill diminishes the homestead protection available in several states, including Florida. Florida law protects an unlimited amount of equity in homestead value. Under the new bill, homestead would still be protected, but only 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 homestead law protection still applies so long as the debtor does not declare bankruptcy. The bill has no negative impact on a situation where the debtor has resided in their home for the 3 year and 4 month period, even if the debtor recently paid down significant portions of the mortgage.
A carryforward provision applies to homes that have been purchased within the 3 year 4 month period before the debtor declares bankruptcy, but it was purchased from the proceeds from another home occupied by the debtor exceeding the 3 year 4 month period. In that scenario, the newer home is protected to the extent of the sales proceeds derived from the protected home’s sale.
An exception to the 3 year 4 month rule could be problematic for practicing physicians. Even if the home was owned for that period of time, an "intentional tort" or "misconduct causing serious physical injury or death to another individual in the preceding 5 years" places the home at risk in a bankruptcy setting.
Tenants by the Entireties
Many states exempt real property owned by a husband and wife as tenants by the entireties from creditor claims where only one spouse is the debtor. Arkansas, Delaware, Michigan, Pennsylvania, Rhode Island, the District of Columbia, Missouri, Tennessee, Hawaii, Florida and Vermont recognize tenants by the entireties property. Where one spouse lives in Florida and the other spouse lives in a state that does not recognize this form of ownership, it is likely that only the Florida spouse will enjoy creditor protected status.
A homestead may be protected using tenants by the entireties, and there may not be any limitation on the protection of the home under this exemption even under the new law.
Involuntary Bankruptcy
The Bankruptcy Reform Act as passed by the Senate does not significantly change the rules applicable to whether a malpractice creditor can force a physician or other professional out of state law protections and into involuntary bankruptcy.
Under the rules, a single creditor may file a petition for involuntary bankruptcy if the debtor has fewer than 12 unsecured creditors. Considering credit cards, utilities, cable bills and other household debts, most high income professionals will have more than 12 unsecured creditors. If not, proper advice would be to quickly create more unsecured obligations if a lawsuit is on the horizon.
If a debtor has more than 12 unsecured creditors, then an involuntary petition for bankruptcy requires joinder of at least three creditors. This would make it difficult for most malpractice creditors to succeed in a petition for involuntary bankruptcy. This result is enhanced as a creditor could be held liable for compensatory and punitive damages if he or she is unsuccessful in his or her petition, and could also be liable for the debtor’s attorneys fees and costs.
In any event it will be important for physicians and other professionals to understand their exposure and plan around it to the extent possible as creditors will most likely have enhanced leverage under the new laws.
Transfers to Asset Protected Trusts
A third important provision may void and reverse transfers made by a debtor to a trust where the debtor is a beneficiary 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 "self-settled trust or similar devise". Time will tell whether most asset protection techniques, including offshore trusts, annuities and life insurance contracts to name a few are "similar devises" if the legislation is passed as enacted.
Doctors Need to Review Planning Now
The Senate Bill is definitely bad news for practicing physicians and others who may be victims of our out-of-control court system. Most malpractice claims settle within policy limits. It will be that much more important to have your own counsel review settlement offers, as the carrier may still be liable for excess verdict amounts if there was opportunity for them to settle by paying no more than policy limits, but they chose not to.
Before this law comes into effect, doctors need to carefully review their asset protection planning. Further, doctors need to protect themselves from the situation where they have to go bankrupt as a result of their malpractice carriers "going under" while in the process of defending a claim. A careful review of malpractice coverage and the strength of the carrier is that much more important.
Advance Planning Important
Now is the time to act. The House of Representatives may not pass the full Senate version, and it might not be a bad idea to contact House members and express your displeasure with various aspects of this legislation.
In the meantime, use the period of time before the enactment, as a time to review and implement any additional planning that might now be available.
Special thanks and acknowledgments to Alan Gassman, Esq. and Jonathan Alper, Esq. who published their findings of the new bankruptcy laws which assisted me in developing this memo.