How The 2005 Bankruptcy Abuse Prevention And Consumer Protection Act Affects Planning For Physicians And Physician Practices
by Alan S. Gassman JD, LL.M, Gassman, Bates & Associates, P.A., Clearwater, FL and Justin Taylor Pikramenos, Stetson University College of Law in Gulfport, FL
The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) significantly affects planning for physicians who have to consider filing bankruptcy because of malpractice judgment or other financial issues.
The specter of malpractice claims resulting in judgments exceeding policy limits has increased as physicians will now find the process of discharging their debt through bankruptcy more difficult while maintaining ownership of significant assets.
Although the five-year payment plan requirements that apply to debtors having mostly “consumer debt” will not apply to physicians whose primary indebtedness stems from commercial and/or malpractice liability, other provisions of the BAPCPA may significantly and detrimentally effect physicians and their medical practices.
A summary of these provisions is as follows :
1. FRAUDULENT TRANSFER LOOK-BACK RULE INCREASED TO TWO YEARS
A bankruptcy discharge may be denied if the debtor has made a fraudulent transfer or a preferred insider transfer within two years of filing bankruptcy. The old rule denied fraudulent transfers made within one year of filing bankruptcy, and did not prohibit insider transfers. Most states have significantly longer fraudulent transfer periods that can cause assets transferred before a bankruptcy to be set aside, but this will generally not result in loss of the bankruptcy discharge.
A fraudulent transfer is defined under the Bankruptcy Code as a debtor’s transfer to a creditor of the debtor with the actual intent to hinder, delay, or defraud any creditor of the debtor. A fraudulent transfer also encompasses a debtor’s assumption of a creditor’s obligation instead of making a transfer. If a debtor makes a transfer to a creditor and does not receive equivalent value , a fraudulent transfer exists if (1) the debtor’s business (or impending business) held assets unreasonably low in value; (2) the debtor incurred or believed it would incur debts beyond what the debtor could repay; or (3) at the time of the transfer, the debtor was either already insolvent or became insolvent as a result of the transfer.
Although the new two-year rule applies with respect to fraudulent transfers to bankruptcies filed on or after April 20, 2006, the new prohibition of insider transfers became effective immediately upon President Bush signing BAPCPA into legislation on April 19, 2005. The new prohibition of insider transfersis defined under the Bankruptcy Code as: a transfer made by (or obligation incurred by) the debtor to (or for the benefit of) an insider under an employment contract and which was not in the ordinary course of business and for which the debtor did not receive reasonably equivalent value in exchange.
2. FORUM SHOPPING TIME LIMITS
Under the BAPCPA, a debtor must have maintained a domicile within a certain state for the two years (730 days) prior to filing a petition in order to have that state’s exemption laws apply in the bankruptcy. If the debtor’s domicile was not located in a single state for such 730-day period, then it is necessary to determine where the debtor resided for the 180 days before those 730 days (days 731 through 910). The exemption law of the state where the debtor was domiciled the greatest number of days between day 910 before filing and day 730 before filing will be the state law to apply in the bankruptcy. Further, as discussed below, a 1,215 day rule applies to qualify a “fraudulent transfer into a homestead” for full protection in bankruptcy where the state fraudulent transfer rules would not cause a set aside to occur (such as in Florida).
3. HOMESTEAD PROTECTION
The “mansion loophole closing” provisions of BAPCPA will reduce the protected homestead equity value to as low as $125,000 if one of the three exception provisions (summarized below) applies:
1. The entire value of homestead property will not be protected where its value has been increased by a disposition of non-exempt property made by the debtor during the 10 years prior to filing bankruptcy with the intent of hindering, delaying, or defrauding creditors.
The reduction is based upon the value of the homestead resulting from such “fraudulent transfers.” The courts must determine how to apportion appreciation in the value of a homestead that occurs after the “fraudulent conversion” has occurred.
2. A debtor cannot exempt any amount of homestead property worth in excess of $125,000 that is acquired during the 1,215 days (three years and four months) before the bankruptcy filing.
This is not an intent-based provision, but applies automatically when a person does not have the requisite time period to qualify for protection.
As an exception to this $125,000 cap, money derived from the sale of a prior residence is applied to facilitate the purchase of a replacement property. Where the new homestead costs significantly more than the prior homestead, the amount of homestead protection is limited to $125,000 plus the proceeds from the sale of the prior residence used to purchase the new residence.
Several issues will arise with respect to how to handle appreciation, depreciation, and amortization of mortgage indebtedness in the context of successor homes.
In a post-BAPCPA case decided in October of 2005, In re Charles H Wayrynen , a debtor who had not lived in Florida 1,215 days filed bankruptcy with a homestead and was found not to be subject to the $125,000 cap. The court found that the statute would only apply where the debtor elects to use state exemptions, and Floridians are required to use the state exemptions, and have no elective choice between the federal and state exemptions.
Whoever drafted the statute must have assumed that all debtors have the opportunity to elect to use the federal exemptions or the state exemptions, not realizing that in Florida the debtors are required to use the state exemptions. Congress’ obvious intent was to limit the Homestead Exemption to $125,000 for debtors who choose to flee to debtor-friendly Homestead Exemption states, the most notable being Florida and Texas, unless the debtor resides in the Homestead protection state for at least 1,215 days before filing.
At least three courts have found that the clear intent of the statue overrides the literal reading, and have enforced the 1,215-day rule in states, such as Florida and Nevada, that allow debtor’s to “opt out” of the federal exemptions in favor of using the state exemptions.
3. The homestead exemption can be limited to an absolute cap of $125,000 where the debtor is convicted of a felony, which evidences that the filing of the bankruptcy was abusive (perhaps the rationale here is that the debtor won’t need a house if he is going to jail).
The homestead protection is limited to $125,000 where the debt involved arises from the violation of federal or state securities laws, fiduciary fraud violations of RICO, intentional torts or willful or reckless conduct resulting in serious physical injury or death in the preceding five years. Doubtlessly, there will be more suits filed against doctors alleging willful and reckless conduct in malpractice actions.
The Section 522(q)(1) reduction to $125,000 will not apply to the extent that the homestead property is reasonably necessary for the support of the debtor and any dependant of the debtor. How much of a home will debtors be found to need?
4. OTHER HOMESTEAD ISSUES
a. May two spouses enjoy the benefit of two caps? It may well be that a joint husband/wife bankruptcy will entitle the parties to a $250,000 cap under Bankruptcy Code Section 522.
b. The homestead of a married debtor residing in a tenants by the entireties state may be protected if the homestead is owned as tenants by the entireties, thus, circumventing the exceptions to homestead protection described above.
c. The home to be protected does not appear to be required to be actually occupied as a principal residence for the 1,215 days. Many individuals will therefore be advised to acquire a second home in a homestead protective state such as Florida or Texas to start the 1,215-day period, and then to move to such state 730 days before filing a bankruptcy.
d. A DEBTOR CAN LOSE HIS OR HER HOUSE IF HE OR SHE LOSES THE DISCHARGE. Paying one’s mortgage down with non-exempt monies can be detrimental where the payment causes the debtor to lose his bankruptcy discharge. In the case of In re Chauncey , a pre-BAPCPA case, the United States District Court affirmed the Bankruptcy Court opinion where the debtor went bankrupt within one year from having a personal injury settlement applied to pay down her mortgage.
Because the personal injury settlement was non-exempt money, the Bankruptcy Court denied the discharge. Moreover, the Bankruptcy Court imposed an equitable lien upon Mrs. Chauncey’s home in order to allow the creditor to recover the monies that were secreted into the home from the personal injury settlement.
e. FEAR AND LOATHING IN FLORIDA - A MARRIED PHYSICIAN OWNING A JOINT MORTGAGED HOUSE AND INDIVIDUAL EXPOSED ASSETS MEETS A POTENTIAL JUDGMENT CREDITOR (THE FOLLOWING IS A HYPOTHETICAL SITUATION AND SHOULD NOT BE RELIED UPON):
Assume that a married physician has cash or similar liquid assets exposed to creditor claims and a serious malpractice action against her.
The Florida Supreme Court has held that a fraudulent transfer into a homestead owned by her would not be susceptible to the Florida Fraudulent Transfer Statute. This means that a creditor would not be able to force her to sell the home if it is her legitimate homestead when the creditor attempts to collect upon a judgment.
A “transfer into a homestead” can include buying a new home, paying to improve a home, or paying down a mortgage on a home.
The creditor might attempt to force the doctor into bankruptcy. If the doctor has 12 legitimate creditors, which could include “material” credit card debts and/or other individual (including joint) indebtedness, then it would take three creditors to force her into bankruptcy, and at least one well respected bankruptcy judge has indicated that he does not believe the law has been written to allow creditors to force someone into a bankruptcy.
If the doctor is forced into bankruptcy with her “fraudulently acquired” home, then under the Bankruptcy Code she loses the homestead protection (exemption) to the extent of the value of the homestead attributable to such fraudulent transfers (but there will be at least $125,000 of protection notwithstanding).
The transfer into the homestead may not actually be a fraudulent transfer under the Bankruptcy Code. For example, if the doctor buys the home because she wants to have a larger home for her family, and at the time she buys the house it is the opinion of reputable legal counsel that the lawsuit is nothing to worry about because she has enough malpractice insurance or other assets set aside to cover any likely potential verdict, then the creditor may not be able to satisfy its burden of showing that the homestead transfer was subject to the fraudulent transfer rules.
How about if the doctor transfers her cash into a jointly owned homestead, either by simply purchasing a joint homestead, or improving or paying down the mortgage on a jointly owned homestead?
Using this approach, the doctor could later file bankruptcy and would not have to “take the homestead exemption” in bankruptcy because her Florida jointly owned property can qualify under the “tenancy by the entireties” exception. Therefore, the bankruptcy code 10-year look back for fraudulent transfers into a homestead would not apply, because the exemption in bankruptcy would be based upon tenancy by the entireties, and not homestead.
A possible problem here is that the transfer of monies by the debtor into a joint homestead could be considered a fraudulent transfer of one half of those monies to the husband under the BAPCPA. While the Florida Fraudulent Transfer Rules are trumped by the state law homestead exclusion, if the doctor is forced into bankruptcy it is possible that the Bankruptcy Court’s ability to pursue the “transferee of a fraudulent transfer” could result in the husband being pursued for one-half (2) of the amounts transferred.
If the husband has no other significant assets, then this may not be a problem. Even if there is a judgment against the husband for having received a fraudulent transfer, the creditor will not be able to attach the husband’s homestead under Florida law, unless the husband could then be forced into bankruptcy and then be subject to the 10-year look back rule. If the husband has other assets that would be subject to creditor claims in bankruptcy, then this alternative of transferring assets into a joint homestead, as opposed to moving such assets into a solely held homestead, may not be advantageous.
What about if the doctor uses her money to buy out her husband’s half of the homestead?
If the wife has $500,000 in cash and the jointly owned home has $1,000,000 in equity, she can transfer the $500,000 in cash to her husband in exchange for 100% ownership of the home. In effect she has purchased the husband’s ownership in the home.
The question becomes whether the husband has then received $500,000 as a fraudulent transfer that could be set aside under the fraudulent transfer rules.
When the debtor (doctor) has transferred assets as “good and valuable consideration” in exchange for 100% ownership in a homestead, then the creditor is going to have a more difficult burden to satisfy, because under the fraudulent transfer rules a “fraudulent transfer” made for “adequate consideration” can only be set aside if it can be proven that the transfer was made with “actual intent to hinder, delay, or defraud” a creditor.
If a transfer is not made for valuable consideration, then the creditors have a lower burden in establishing that the “fraudulent transfer statute” applies. Under such circumstances (where there is not adequate consideration for the transfer) the fraudulent transfer statutes allow for the transfer to be set aside under circumstances defined in the Statute.
Thus, if a physician senses impending insolvency she may be wise to buy her spouse’s half of the homestead property and have him hold the cash in a separate account, portfolio, or other liquid form. If the transfer is deemed “fraudulent” the spouse can return the money to the doctor’s creditor without penalty, none-the-worse for having tried. If the transfer is not deemed “fraudulent” the physician has in effect saved a substantial asset by keeping it in the family.
5. ASSET PROTECTION TRUSTS
Asset Protection Trusts are arrangements whereby creditors of a beneficiary may not have access to trust assets where prevented by the law of the jurisdiction where the trust is formed and operated. Asset protection trust jurisdictions in the United States and abroad have therefore proliferated an industry that Congress would like to put to a halt.
BAPCPA makes transfers to self-settled trusts or similar devices subject to being set aside in bankruptcy when made within 10 years of filing. This applies if the transfer was made with “actual intent” to hinder, delay, or defraud present or future creditors. For this rule to apply, the debtor must be a beneficiary of the trust.
The 10-year rule should not apply; however, if the debtor forms the offshore trust for the benefit of the debtor’s family, but not for the debtor himself or herself. However, “substantial de facto control” has been found to be sufficient for a court to find a fraudulent transfer. This new Bankruptcy Code Section 548(e)(1) applies to both domestic and offshore asset protection trusts and time will tell whether asset protection trusts that have been funded for more than 10 years before the filing of bankruptcy will be better respected than they have been in the past by bankruptcy courts.
6. LIFE INSURANCE AND ANNUITIES
Some states offer unlimited protection of life insurance and the cash values of annuity contracts. The life insurance and annuity industries have come to market with mutual fund wrapped products that provide income tax deferral and creditor protection for policyholders and their families.
Is an annuity a “similar device” that would not be protected in bankruptcy, under the provision applying to ASSET PROTECTION TRUSTS described above, where within 10 years of filing, a transfer is made into an annuity or life insurance product with the actual intent to hinder, delay or defraud present or future creditors? At one point, the proposed legislation with respect to this asset protection trust provision was to apply to “a self-settled trust or similar device”, but specifically excluded qualified retirement plans. Is the language “self-settled trust or similar device” broad enough to include annuity and life insurance arrangements where money is given to a life insurance company that invests it and makes cash available at a later time, subject to state or foreign jurisdiction creditor protection laws and arrangements?
7. PENSIONS AND IRAS
Debtors whose state laws do not protect IRAs will be delighted to find that their individual retirement accounts will be protected in bankruptcy under the BAPCPA. While many debtors may avoid bankruptcy to protect their homestead, offshore trusts, and “similar devices,” many debtors will dive into bankruptcy in order to protect their IRA and pension accounts if they reside in states that otherwise do not provide IRA protection.
The IRA protection is limited to $1,000,000 of IRA assets, plus the value of IRA assets attributable to pension plan and SEP IRA (Simplified Employee Pension IRA) rollovers. However, this article’s authors never expect to meet anyone whose non-pension, non-SEP IRA contributions have caused an IRA to exceed $1,000,000, so most should be safe.
BAPCPA enhances the protection of pension plans by expanding the types of plans that will qualify for creditor protection. While the smoke has not cleared on exactly what the provisions of BAPCPA mean in the context of ERISA law and spendthrift trust arrangements, it is widely believed that single employer pension plans and other arrangements that have not qualified for creditor protection in the past will qualify under the BAPCPA.
8. WHAT ABOUT WAGES AND DEFERRED COMPENSATION AS PROTECTED ASSETS?
Some states allow for protection of wages and even deferred compensation from creditor claims. BAPCPA provides that a Trustee may avoid a transfer of property or an obligation (including any “transfer to or for the benefit of an insider under an Employment Agreement”) if made within two years before filing, as a fraudulent conveyance, if the transfer was made with the actual intent to hinder, delay or defraud creditors to which the practice was or became liable after the transfer, or was received for less than adequate consideration.
10. INVOLUNTARY BANKRUPTCY RULES STILL APPLY
Because of the stricter bankruptcy rules now applicable, more clients with large judgments against them will become insolvent, yet will attempt to avoid or delay bankruptcy while maintaining their creditor-exempt assets. A single creditor may force a debtor with fewer than 12 creditors into bankruptcy. As noted above, a debtor with 12 or more creditors may be forced into bankruptcy by a joint action filed by three or more creditors. While Denham v. Shellman Grain Elevator, Inc. was a major case in which the court refused small and recurring claims, other courts abandon Denham and allow small and recurring claims based on the argument that Congress has not specifically excluded small and /or recurring debts. However, one Florida bankruptcy case, In re Smith , cited Denham and excluded creditors holding de minimis claims for $20-$275. It could be argued by a debtor anticipating a similar decision as Denham and In re Smith that a creditor should be counted towards the 12 where the debtor owes a small claim and is on a payment plan but the amount is final and has been reduced to judgment.
The same courts that abandon Denham have dismissed the de minimis exception as an argument to disqualify one or more creditors, based on the argument that Congress has not explicitly ruled out small and/or recurring debts and the statute , therefore, should be applied literally. Some courts, however, such as the court in Matter of Runyan that indicated that a $25 debt would not be sufficient, will evaluate the claims on a case-by-case basis.
A creditor who files for an involuntarily bankruptcy “in bad faith” can be forced to pay costs, fees, and actual and punitive damages. This area of law will obviously develop significantly in the next few months and years.
JOINT DEBT AND BANKRUPTCY. Where a married couple has joint debt in existence at the time of filing bankruptcy, an issue exists as to whether such joint debt will trigger loss of equity in joint assets. Such joint debt will not be problematic where it is a mortgage on creditor-protected homestead only, except as to the mortgage on the homestead property itself (if adequately secured). Clients should, therefore, be advised to have adequate means to satisfy any joint debts before ever having to file a bankruptcy, and clients who might individually declare bankruptcy or who may be forced into bankruptcy may be well advised to have at least 12 substantial individual creditors not also owed money by the debtor’s spouse. Clients who invest in real estate or other leveraged assets may wish to do so under a business entity which becomes the obligor, so that the clients themselves do not have personal joint debt.
The new bankruptcy act requires that a debtor in bankruptcy take credit counseling to be in a Chapter 7 bankruptcy, but provides no mechanism for the court to order the taking of the course where an involuntary bankruptcy is filed. Time will tell whether the law now actually allows for involuntary bankruptcies to be an effective tool for judgment creditors.
11. CONSUMER DEBT PAYMENT PLANS REPAYMENT REQUIRED
In a consumer debt bankruptcy, the debtor may have to enter into a five-year payment plan and lose significant earnings during the five years. This will not apply where the debt being discharged is for a malpractice judgment or other tort liability.
12. CREDIT COUNSELING
Doctors who have the misfortune of having to file bankruptcy under Chapter 7 must also attend credit-counseling classes to qualify. As mentioned above, these classes are not required of the physician forced into involuntary bankruptcy. These courses are sure to have all of the excitement and self-fulfillment as driver education courses and taking notary courses and exams.