Money Law Blog

Practicing bankruptcy law in the greater Washington, DC area, we often get this question from nervous government employees and defense contractors: "If I file bankruptcy, will I lose my security clearance?"

The answer is: It's not the bankruptcy itself that is the problem. It's the underlying circumstances leading to the bankruptcy that is the determining factor.

Think about it. If you got a very serious illness and racked up a million dollars in medical bills you could not pay, and needed bankruptcy relief to stop the collection calls, lawsuits and garnishments, does the bankruptcy -- in any way -- reflect upon you personally as a security risk? Was the illness your fault? Is it evidence of a personality defect that would make it more likely you would breach security? I think you know the answer.

Where the circumstances leading to the bankruptcy were financial irresponsibility, then that's another matter. But then, the late charges, delinquencies, high credit balances, judgments, tax liens, etc. would already exist on your credit report. If anything, the bankruptcy would actually show you acting responsibility by exercising your legal right to "wipe the slate clean" and get the "fresh start" the law allows.

The US Air Force Academy's website discusses this issue and provides some interesting guidance: (The highlighted text is mine.)

The status of your security clearance can be affected, but it is not automatic. The outcome depends on the circumstances that led up to the bankruptcy and a number of other factors, such as your job performance and relationship with your chain of command. The security section will weigh whether the bankruptcy was caused primarily by an unexpected event, such as medical bills following a serious accident, or by financial irresponsibility. The security section may also consider the recommendations and comments of your chain of command and co-workers. This is an issue that can be argued both ways, so as a practical matter your security clearance probably should not be a significant factor in making your decision about whether to file bankruptcy. The amount of your unpaid debts, by itself, may jeopardize your clearance, even if you don't file bankruptcy. In that sense, not filing for bankruptcy may make you more of a security risk due to the size of your outstanding debts. By the same token, using a government-approved means of dealing with your debts may actually be viewed as an indication of financial responsibility. Eliminating your debts through bankruptcy may make you less of a security risk. There is no hard and fast answer here, with one exception: it never hurts to have a good reputation with your co-workers and your chain of command.

Call us and make an appointment. We'll analyze your situation, and discuss all options to address your problem in person.

Tis the time for resolutions. As an attorney specializing in the financial woes of small businesses and the self-employed in DC, VA and MD and drawing from my 22 years of experience, here are three tips to consider as you draw up your list for 2012:

1) Keep books. It's that simple. So many of the financial problems of small business could be solved simply by keeping regular books, including:

• Cash flow problems. This is almost certainly the leading factor causing a bankruptcy filing. Often, the business will actually be profitable or have positive net value, but because the managers have not managed the finances to maintain liquidity, they cannot pay bills on a current basis. This, in turn, leads to the debt enforcement actions that force the business to seek bankruptcy court protection so that it can reorganize its finances. It might have been avoided if the managers kept regular books and knew where they stood in terms of cash, account receivables and payables.


• Tax problems. Without keeping books, business may rely solely on what is in the bank account as a gauge of how they're doing. Unfortunately, the balance in the account does not take into account non-cash accruals that have built up during the year, the most critical being taxes. At year end, they don't have cash enough to pay the tax bill.


• Getting loans or selling your business. Persons evaluating the business as purchasers or lenders will not give you financing or top dollar unless there are regular books showing the business' performance over time or its ability to service the debt. (By the way, as a business owner you need to look at your business as a asset for eventually sale and not merely as a job provide you solely with income.)

Also, keep separate bank accounts for your business and personal life. This is a corollary to the first rule. If you're keeping books for your business to track your business' performance, you will have to create a separate business bank account.

2) Watch how you pay the people who work for you. Again, this is near the top of the list of small business problems seen by our DC-based tax and bankruptcy law firm. Know how the tax law distinguishes "independent contractors" from "employees," and how that law requires the business owner to withhold taxes and contribute to Social Security and Medicate for the latter, or face personal fines -- basically equal to that amount -- for NOT doing so. It's not fun.

3) Get help from professional accountants and business lawyers. No one wants to pay for advice at the front end, but when the problems hit, the cost can be much, much more. It's a cliche, but true: An ounce of prevention is worth a pound of cure.

The evidence is coming in, and it makes absolutely perfect sense: The federal and state governments are ramping up tax examinations and collections to bring in more money.

Just this morning in our tax and bankruptcy law firm: Five new cases, not including the other tax cases on my desk. I sensed this was coming. It's a no-brainer for a policy-maker: Why raise taxes and antagonize the citizenry, when you can just enforce more aggressively what's already on the books?

The difference between what is collected on time and what is legally owed to the government is known as the "tax gap." IRS has examined the problem and published its a study.

IRS estimates that, for the 2001 year studied, the federal government was losing about 15 to 16.6 percent of the dollars owed to it. (Since most states mimic the federal tax scheme, the state loss in Maryland, Virginia and the District of Columbia would be comparable.)

As a dollar figure, it amounts to between $312 billion and $352 billion. Collecting that is not chump change and would have a significant impact on public financing. Hence the collection initiative.

According to the study, there are three components making up the "tax gap":
1) Failure to file tax returns.
2) Underreporting of actual income on tax returns.
3) Underpayment of the tax stated on the tax return.

Underreporting occurs when the taxpayer files a return but omits reporting some income and/or overstates or takes deductions or credits to which they are not entitled, whether purposely or out of ignorance.

Underpayment occurs when the tax return is filed reporting the correct tax amount, but the taxpayer does not, or cannot, make full payment when due.

Many of the tax problems we see in this office can be traced to incompetent or downright criminal tax preparers. However, when the taxpayer is caught by the IRS or state tax agents the tax preparer will be of interest to them, but the tax preparer's conduct generally is not a defense for the taxpayer to the tax liability.

My advice: Avoid a tax preparer without demonstrated licensing, education, and experience. Some questions to ask:

• What are your credentials? Generally, you can trust tax preparation by a CPA, tax attorney, or a preparer with a large, national company that has been in business for a long time.


• Of what tax organizations are you a member? Membership in an organization indicates they are serious about what they do, want to keep up with developments in the field, and are not afraid to be in the company of peers.


• What education do you have? Look for a bachelors degree in accounting, finance, or business administration.


• Do you have a license? Attorneys need to be licensed in the state in which they practice or offer services, and CPAs have to pass a rigorous exam. Unfortunately, generally you do not have to be licensed to offer tax preparation services. (Although the IRS is considering licensing.) At a minimum, ask to see a business license, which is required in most jurisdictions. This will indicate the preparer is not afraid to make himself or herself known to the local government and meet some basic qualifications.

What the most current tax scams we are seeing perpetrated by fly-by-night tax preparers:

• Taking TWO head of household deductions by having the couple do two tax returns claiming they live in separate residences. Often they use a relative's address.


• Qualifying for the earned income credit or taking more exemptions by claiming children who do NOT reside with the taxpayer.

It's up to you to be informed. Be careful and seek out competent counsel.

Sometimes it is worthwhile to put up a fight when you're being sued on a credit card or mortgage loan deficiency. The truth is, many times, the lender does not have the evidence available to prove the case, or does not have the means to get the proof admitted into evidence -- a crucial step to win a judgment for the debt against the borrower.

J.P. Morgan Chase & Co. tacitly admitted this recently when it voluntarily dismissed more than a thousand of its credit card lawsuits across the country. The company won't admit WHY it took this step which was reported in last week's Wall Street Journal.

It has been coming to light in the courts, however, that, just like the "robo-signers" that surfaced with the foreclosure mess, credit card lawsuit affidavits of the debt allegedly owed have been signed by employees who are not personally-familiar with the company records and have not verified the debt.

Rather than risk public disclosure and embarrassment, speculation is that the company decided to withdraw the cases until the documentation could be fixed.

For the poor soul facing a lawsuit, it is important to know that the collection "model" used by the credit card companies is based largely on the fact that very few debtors respond to the suit. In fact, about 94% of suits end up in "default judgments" because there is no response by the defendant.

To defend, you may have to have some knowledge of the law. This attorney frequently sees unrepresented debtors showing up in court and responding in this typical fashion to the judge's query as to whether they owe the debt: "I cannot afford to pay." By responding this way, the debtor has implicitly admitted the debt is owed, hence, the judge will issue judgment, and not being able to pay is not a valid legal defense to establishing the liability.

The debtor will have to, in good faith, contest the liability and ask for trial. Some understanding of the rules of evidence and "discovery" are helpful to know what proof the lender will have bring forward, how the debtor can ask for it, and what the lender's attorney will need to establish to get it admitted into the record.

It's not foolproof, but sometimes worthwhile, particularly when the debtor cannot simply declare bankruptcy, maybe because he has property which cannot be protected and which he would lose, or other personal reasons.

This law office specializing in financial matters in DC, VA and MD has successfully defended creditor lawsuits and settled others. One current case involves a suit for $185,000 for a second mortgage that was left over from a foreclosure on the client's home. Today, we got a letter from the lender who has brought his settlement offer down to $30,000 -- not a bad discount.

It doesn't hurt to investigate all the options. Don't be in the 94% who just let the lender get a judgment against them without a fight.

It's a little known, but extremely valuable, technique employed by experienced bankruptcy lawyers: Using the "automatic stay" feature of bankruptcy to get a repossessed car back into the hands of its owner.

Our DC-based bankruptcy law firm used it the other day to get a car back for a young man in Northern Virginia who needed his car to get around and commute to his job.

When a car is repossessed, physically it comes under the control of the lender. However, legal title does not pass, and remains with the owner, until a legally-valid auction has been conducted and title then conveyed to the winning bidder, which oftentimes is the lender.

Until that auction takes place, which also must be conducted according to procedures stated in the contract and/or state law (and which usually includes notice of the auction date, time, and location to the owner), legally the car still belongs to the individual.

If a bankruptcy is filed by the owner, the "automatic stay" (a court order requiring debtors to stop enforcement action) comes into existence halting the auction. Our firm's practice is to immediately fax confirmation of the bankruptcy filing to the lender, and then make arrangements for the owner to pick up the car.

To keep the car, the owner must become current on the loan by paying all arrears, late fees and costs of repossession, and also make the regular payment going forward. The owner has to bring the loan current and re-start payments shortly after filing in Chapter 7, or the lender will ask the court for permission to "lift the stay" and proceed once again with the repo. Otherwise, if the owner has the money, or can raise it quickly, he can exercise redemption rights in Chapter 7 and fully pay off the car at its current value in a lump sum payment.

Chapter 13 bankruptcy offers additional options, such as paying the arrears and costs, through a plan of 36 to 60 months. And an even more powerful right exists in Chapter 13 to re-set high interest rates to a little more than prime, and/or pay only what the car is worth through the plan (if the owner has owned the car for more than two and half years, or the vehicle is used in his business) in what's known as a "cram down."

Automobile lenders are getting more aggressive and creative. Recently one of our clients had her car repossessed on a Sunday from a supermarket parking lot when she went out briefly for groceries. Obviously the lender staked out her home waiting for an opportunity.

It can happen, but remember that it's not the end of the story. There are still ways to fix it.

Undoubtedly, as tax day approaches, there are people right now who are struggling with the question: "I haven't filed in [fill in the blank]____ years. Should I file this year?" As a tax and bankruptcy lawyer serving individuals and businesses in Maryland, Virginia and DC, this law firm is very familiar with this taxpayer's quandary.

On the whole, it's better to file -- even if you can't pay -- for a number of reasons:

• IRS, and the state tax authority, make a distinction when it comes to charging you with civil tax infractions. There are a separate set of penalties added to your tax bill for "failure to file" and "failure to pay." Go ahead and file, at least. You'll save yourself some money in penalties.
• If you can't pay the tax bill all at once, you can always ask for an installment agreement to pay over time. For tax debts of $25,000 or less in combined tax, penalties, and interest, you are virtually guaranteed an installment plan and at a monthly payment you propose and can afford. Note that you will still be accruing interest and penalties so that the tax debt grows at about a 25% rate. You will need to make a large payment to actually pay down the tax bill. Don't end up like a lot of the taxpayers who come into our office and lament: "We've been paying IRS for several years now, and it's not going down!" Otherwise, at most, you are buying time.
• If you can't pay at all, you can always ask to be placed in "uncollectible status." However, if successful, that only forestalls the day of reckoning. Eventually, it's hoped, you will be earning more, and when that happens the taxman will see it from W-2s sent to the agency, and he will come a-knocking for what's owed.
• Three years from now, if you're still in a financial fix, you can completely discharge the tax debt in a bankruptcy. One of the key requirements to discharge a tax debt is that you must have filed a tax return for that tax year more than TWO years before the bankruptcy filing. The two-year rule for tax returns causes a serious problem for serial non-filers. We often see taxpayers who have not filed for many years who now want to resolve the back tax problem. We can help them to freeze the last three years of taxes from growing and pay them off in a Chapter 13 bankruptcy, but there is no discharge, unfortunately, for the other years. There are solutions, but it's much more complicated, expensive and uncertain.

There's a saying you've surely heard before, but it is very, very true: Nothing's as certain as death and taxes. If you have a social security number, IRS knows where you work, have bank accounts or maintain investments. Eventually, IRS will prepare a taxreturn for you, but with minimal, if any, deductions such that your tax bill will be much larger than if you prepared it yourself. Also, before IRS or the bankruptcy court considers tax relief in your case, you will have to get all the missing tax returns prepared and filed. So, why wait? Just get it done.

Homeowners in DC, VA and MD seeking loan modifications to save the family home may see improvements in the currently messy process if a group of state attorney generals and federal officials are successful in on-going settlement talks with major US banks.

"What we're really trying to do is change a dysfunctional system," Iowa Attorney General Tom Miller, the point man for a 50-state effort, told the Washington Post in a March news article. "We really want to try and change all that."

Homeowners who have asked mortgage lenders (or more specifically, the mortgage servicing department of banks who administer the loans on behalf of bond investors) know very well the many and outrageous modification abuses including:

• Losing homeowner's modification applications and causing them to have to submit the documents numerous times, or giving up altogether.
• Leaving homeowners in the dark for months or years as to the status of the applications.
• "Dual tracking" homeowners so that while the modification is pending the loan is also put on track for a foreclosure catching the homeowner unaware as he or she is awaiting a decision.
• Rejections of the modification application without a statement of the reason(s).
• Fraudulent statements from mortgage servicers misstating the amount owed by employees who swear to, but have not actually checked, the lender's records.
• Employees at the mortgage servicing departments telling homeowners to make a reduced payment pending the modification, then holding the homeowner in default for thousands of dollars later when the modification is denied. It's either pay up all at once or go to foreclosure.

Many of the mortgage modification abuses have been written about in this blog based on the experiences of the clients of our bankruptcy law firm.

The government's initial 27-page proposal provides for some important reforms:

• A time-line for decisions.
• Guidelines for determinations, and possibly mortgage principal reductions.
• A web-based portal for homeowners to track the application in real time.
• A ban on "dual tracking."

Most importantly, the proposal provides for penalties for the mortgage servicers. For this writer, that would be the single most important reform. At present, lenders operate with impunity. There is no law that clearly holds mortgage servicers accountable. Penalties would put teeth into the reforms and, it's hoped, put an end to the abuses.

It feels like another kick in the teeth: You lose a home or rental property in a foreclosure or short sale, get a Form 1099-C from the mortgage company, and now you have to pay income taxes on it, too? Like a lot of things in the law, it depends.

It's a curious, but absolutely-settled principle of tax law, that a debt that is forgiven by a lender becomes taxable income to the borrower. Basically the accounting works like this: When you took out the loan it's not considered income because you have an obligation to pay it back. When, however, that obligation is removed, you become richer by the amount of debt that you will not have to pay, and the tax law says that must be recognized and you must pay income taxes on it.

Unfair, you may say, but it's the law. In late 2007, federal lawmakers decided to give SOME relief to taxpayers losing personal residences and changed the law so that the resulting income could be excluded from income tax, if the forgiveness (also known as "cancellation in indebtedness" and
"cancellation of debt" ("COD") income) meets key requirements:

1. The mortgage debt was for a principal residence (that is, the property was the taxpayer's "home" under the law) and,
2. The mortgage debt was the original loan used to purchase the home, or, if the loan was a refinance of the original loan, the proceeds from the refinance were used to make improvements to that property.

Note that the author of this blog emphasizes the term "some" because there is a lot of misinformation out there, probably propagated by commission-hungry, short-sale realtors, that there is a blanket exclusion from COD income for all primary residence mortgage debt forgiven in short sales (or foreclosures, which, for the tax law, are functionally the same).

Nope, doesn't work that way. If the loan was a refinance or second mortgage where part of the proceeds was used to pay off car loans, credit cards, take vacations, etc., those proceeds will NOT qualify for income tax exclusion under the tax law.

Your tax preparer will need to fill out Form 982 and see if the COD income reported to IRS on the Form 1099-C can be excluded under the exceptions available. Our DC-based tax and bankruptcy law firm has prepared an guide to the tax effects of foreclosures and short sales explaining the issue.

One of the most important exceptions is the "insolvency" exclusion. You can exclude the COD income from taxable income to the extent your net worth calculation shows you are insolvent.

If you use that exclusion, it's a good idea to keep the documents you use to calculate your net worth. Generally, the government has three years to audit your tax return. Values of assets and debt balances can change significantly in the interim and determining them years later will be impossible.

Remember, finally, that a discharge in bankruptcy avoids the tax issue entirely. So, if you're not sure the lender will forgive the debt after the foreclosure, or if you know the debt will be forgiven but are unsure or worry about the tax consequences, you may want to consider that option.

Last Friday, the attorney generals of Arizona and Nevada filed suit against Bank of America alleging state consumer fraud violations for a practice that's come to be known as "dual tracking" -- bank employees are telling homeowners seeking modifications to make a reduced payment while the "modification is pending."

All the while, the lender is still holding the homeowner in breach of the contract and taking payments until such time as it decides to go ahead and foreclosure. It's a slimy tactic. If the homeowner knew they were getting nothing for the deal it would have been better to save the money and short sell or surrender the property in bankruptcy.

This bankruptcy law firm has seen a number of similar cases during the past year with homeowners in Maryland, Virginia and DC. We have written about this abuse against homeowners in another posting on this blog.

Most states, including Maryland, Virginia and DC, have similar consumers laws addressing "unfair and deceptive acts and practices."

Good for you Arizona and Nevada. May this suit go places.

The Internal Revenue Service reported this week that IRS audits are up 11% for this year. Frankly, it's not real surprising.

It's during hard times that taxpayers feel the pinch and are more likely to cut corners and try to pay a little less into the public fisc. Likewise, as tax revenue goes down, the government will look for more income by increasing audits, publicizing that fact, and thereby scare more taxpayers into compliance.

This tax law firm expects to have more than the usual number of cases in the near future as more unlucky taxpayers get caught in the taxman's web.

Here are tips to avoid an audit, especially for the self-employed and business owners, who tend to be favorite enforcement targets for IRS:

1. Be scrupulously honest. Report all income, even when you don't get a 1099 or W-2. Deposit all cash, religiously, into the business account. Don't take cash, bypass depositing it into an account, and use it to pay expenses. If the agent sees a lot of this, it'll make the case easier for unreported income. Remember: The burden of proof is on the taxpayer. Ignorance and sloppiness are not an adequate defense. Regarding deductions, don't try to reach. Always ask yourself: Is this a defensible position? Am I clearly entitled to the deduction? Here's an expression one hears often: "Pigs get fat, hogs get slaughtered." I'm told it was first uttered by a judge -- in a tax case.
2. Speaking of deductions, beware of "constructive dividends." This is a favorite of the IRS. Small business owners often use the corporate account to pay for personal goods or services, such a car used for the personal errands of the owner, non-business meals, vacations, home improvements, and so on. IRS and the state tax agents know it, and look for it. If it's personal, report it in your personal income tax return or reimburse the company and make sure to give it only the correct tax treatment as compensation, or dividend, in consultation with your accountant. This is often one of the charges in a tax criminal case.
3. Use a reputable tax preparer. Tax is very complicated. Furthermore, the law changes every year. The person preparing your return should have credentials (education and experience). Mistakes, including math errors, in one part of the tax return increase the odds that the whole return will be audited. Don't pick someone because they promise to get you the biggest refund or the lowest tax bill. That's a red flag signaling a fraudster. You don't want to be questioned by the IRS when they investigate this scammer's entire client list.
4. Keep good records. Of course this is something you should have done throughout the year, but you can still heed this advice for the coming year. Keep your receipts, especially for expenses you deduct. You will be asked for them on audit. Remember: To deduct actual mileage you must keep a "contemporaneous" log, i.e. at the time of the trip, not a reconstruction weeks afterward. Likewise, you want to have invoices for an payments you make. (Otherwise, on audit, how do you prove the deduction you took for office supplies wasn't just money you pocketed? Bring the paid bills from Staples.) Meticulously deposit all your income into an account and pay your bills out of that account or designated credit cards. If you're self-employed, or have a side-line business in addition to your employment, DO NOT commingle income and expenses of your business with your personal. Keep and use separate accounts, ATM cards, and credit cards for your personal transactions and your business transactions. One of the biggest problems we face as tax practitioners working with small businesses is the lack of good record-keeping. Just keeping "books" makes such a difference for business planning and profits, as well as defending an IRS audit
5. Keep regular books if you have a business. It's good business practice, too, to keep books during the year. Many of our clients get into tax trouble because they didn't pay estimated taxes during the year and so don't have the cash (or available credit) to pay when they file the tax return for the year. Had they paid estimated taxes during the year, this would have been avoided. From a business point of view, they would also had a better idea of profitability had they taken into account tax "accrual" expenses building up during the year. So many contractors under-bid because they don't take taxes into account, and end up subsidizing the buyer with the tax liability they will later face!

Good luck, but if you end up getting snagged, for individuals or businesses with tax problems in Maryland, Virginia and DC, we're happy to talk to you about ways you can minimize or eliminate tax problems and get back on track.

Fannie Mae and Freddie Mac have complete power to address a large part of the national foreclosure problem by demanding that the mortgage servicers and law firms they hire to execute foreclosures do so correctly and fairly.

At this foreclosure defense law firm, we see a large number of the same abuses discussed at the December 1, 2010, Senate Banking Committee hearing in our Maryland, Virginia and DC cases.

Among the worst abuses, the practice of putting homeowners in a dual-track:

Mortgage servicers (the bank departments administering loans from whom homeowners get all correspondence and bills on behalf of the mortgage holders) maintain discussions with homeowners about a modification while at the same they have directed attorneys to take steps toward a foreclosure. This is not disclosed to the loan modification applicant.

It's quite a surprise to homeowners who think they are negotiating a resolution when they get notice that the house has been sold and they need to move out! Had the homeowner known he could have taken steps such as initiating formal legal process to protect himself. This deceit happens all the time. I have written about how lenders abuse homeowner seeking modification in this blog and I warn everyone with whom I meet. This is how the Freddie Mac official responds, according to a Washington Post article on the hearing:

Meanwhile, Bisenius defended the dual-track approach to mortgage modification and foreclosure embraced by many of its servicers: Attempt to modify a loan to make it more affordable, but also prepare to foreclose if that is not possible.

"While we believe that borrowers who already are under significant stress arising from their financial situations should not be subjected to needless confusion, we also believe that unnecessary delays in an already lengthy foreclosure process would be counterproductive," Bisenius said.

He noted that foreclosures usually last well over a year, and sometimes close to two. "The dual-track process allows for a delicate balance between the need to minimize losses and protect communities while protecting borrower interests. Lengthy foreclosure delays impose substantial losses on Freddie Mac and taxpayers - by some estimates, $30 to 40 per day and $10,000 to $15,000 per year for every defaulted loan," Bisenius said. "These costs do not include additional losses resulting from depreciation in the value of the property."

That's hardly the case in the Washington, DC area. All foreclosures in Maryland, Virginia and DC are non-judicial -- that is, nothing is presented by the lender to a judge before the foreclosure is initiated to prove the lender's right to foreclose such as a valid note, deed of trust, or the existence of an arrearage. (In Maryland, foreclosures are "docketed" with the court, but nothing is presented to the court except an accounting afterwards for "ratification" of the foreclosure.)

Under Virginia law, a foreclosure can proceed in as little as three weeks. Maryland foreclosures can proceed quickly, but average about six months. DC foreclosures average a couple of months from start to finish.

Other servicer abuses complained about at the hearing, and which we see in this law office:

• Employees of mortgage servicers telling homeowners to stop paying or make a reduced payment to get a modification, without disclosing to them that there is NO legally enforceable agreement to forbear, and that the lender will still hold them default and eventually move the case to foreclosure. I have written about the dangers of lenders telling homeowners NOT to pay before in this blog.


• While the servicer continues to accept reduced payments, they pile on late fees and default charges which the servicer, at foreclosure, collects at 100%, generally right off the top of the foreclosure proceeds.

Most galling is the fact that Fannie Mae and Freddie Mac were also bailed out by the taxpayers, and salaries for employees at both firms are generally above the norm even for the Washington, DC area.

Homeowners and advocates can only hope lawmakers will force Fannie and Freddie to treat the public fairly.

Fannie Mae and Freddie Mac, government-backed businesses who together own or guarantee about half of the outstanding mortgages in the country, were in Washington, DC last week defending themselves before a Senate committee looking into abusive - and in some cases illegal - foreclosure practices that have come to light in recent months.

The excuses voiced by the company's top officials would be out-and-out laughable, if the consequences of the attitudes they demonstrate weren't so tragic. The arguments Fannie and Freddie made indicate just how clueless they are to what is actually going on but is well-known by homeowners with mortgage problems and the advocates who defend them. Here's an excerpt from a Washington Post article which drew from testimony prepared for the Wednesday, December 1, 2010, hearing :

Speaking to the Senate Banking Committee at a hearing on the national foreclosure debacle, Fannie and Freddie executives emphasized that they are not responsible for managing payments by borrowers on home loans or foreclosing on homeowners when they default.

These tasks, executives say, are the responsibility of mortgage servicers and law firms with which the companies contract.

"I want to underscore that Fannie Mae does not service loans. We rely on the loan servicing divisions of major banks and other financial institutions as the primary front-line operators and points of contact with the borrowers," said Terence Edwards, executive vice president for credit portfolio management at Fannie Mae. "We pay servicers significant fees during the life of a loan to work with borrowers. Servicers are required under our servicing contracts to help borrowers in trouble, not just collect payments."

Donald Bisenius, executive vice president of the single family credit guarantee business at Freddie Mac, made the same point. "Freddie Mac provides guidelines for the origination and servicing of our loans, and contracts with sellers and servicers to carry out these operations."

Reading this, I almost fell out of my chair. I was dumbstruck. As an attorney at a law firm devoted to helping Maryland, Virginia, and DC homeowners with mortgage troubles, I could not believe they would proffer this defense, and certainly not with a straight face.

In my own law practice, if I make an error of law, I cannot blame my paralegals - the employees and contractors I hired personally, whom I control, and for whom I am absolutely responsible. (A friend of mine at the Office of US Trustee and I joke about this as the "respondeat inferior" defense - a play upon the legal doctrine of "respondeat superior" where an employer is liable for the actions of his employees.)

If I tried this argument in court, I would not be surprised to see a judge to roll his eyes.

Here are the facts:

1. All bankruptcy attorneys filing in a specific court charge within a few hundred dollars of each other. This goes for the bankruptcy courts in DC, Maryland and Virginia. The reason: Bankruptcy fees are disclosed in all cases and they are easily available for viewing on-line by attorneys e-filing in that court. Any attorney wanting to see what the other guy or gal is charging? Go to the court's website, a few clicks and voila, you know! Everybody charges within that range.
2. Lawyers are not stupid. (OK, no jokes!) They have to run a business and earn a profit to make a living. The guys or gals who charge low-ball prices and tout inexpensive bankruptcy make up for the lower margins by running more cases through the office in less time. It's what's known as a "mill." Expect less attention and time answering your questions and concerns. You get what you pay for.
3. You cannot be overcharged. The US Trustee's Office (UST), which is the US Justice Department's watch-dog guarding the bankruptcy system from abuse, closely monitors attorney fees. (This is especially true for the US Bankruptcy Court, District of Maryland, Greenbelt Division, the court serving residents of suburban Maryland, outside Washington, DC.) The UST attorneys, and the judges, know the "going rates" for a bankruptcy. Too high, and the UST will file a motion asking the judge to order the attorney to "disgorge" -- return excess attorney fees back to the client.
4. For Chapter 13 bankruptcy cases in Northern Virginia and suburban Maryland, the court has a set preferred fee schedule. In bankruptcy, attorney's fees must be approved by the court. To save time and reduce effort by everyone, the local bankruptcy courts (except DC) have set pre-approved fees for cases, based on the range of services to be delivered. As of this writing (November, 2010), for a routine Chapter 13 case (with no special issues) an attorney will be allowed $3,000 (not including costs) in the US Bankruptcy Court, Eastern District of Virginia, Alexandria Division. In the US Bankruptcy Court, District of Maryland, Greenbelt Division, the court allows $2,000 for services that are limited to plan confirmation only (with additional services at an hourly rate), $3,500 for services including all matters in the case (with unexpected, extraordinary services, and services occurring 90 days after confirmation, at an hourly rate) and $4,500 for services including all matters (with no additional fees ever, except for unexpected, extraordinary services). Since most cases will involve additional work beyond plan confirmation, the $3,500 flat fee is the most cost-effective for clients and the one usually charged by attorneys.
5. The cost of a bankruptcy is tiny compared to the benefits. Run the numbers. If it costs $1,500 (the average for a typical Chapter 7) to get rid of $30,000 in credit cards, what is the net benefit? Answer: $28,500! Know any investments where you can invest $1,500 and get back a return of $28,500 in only four months? If you do, then you shouldn't be here reading this. You should be out running a hedge fund. A few dollars more or less is insignificant compared to a benefit ten times your cost -- assuming you have chosen an attorney for the experience and qualifications to get you results.
6. "I can't afford it." When the garnishments begin and a creditor seizes your bank account or a significant part of your paycheck, you cannot NOT afford the protection and relief from debt that bankruptcy affords. So how do you finance the fees and cost? A few options:
   • Save it up. Stop paying on debts you will discharge anyway, such as unsecured debt or loans on property you are planning on giving back to the lender. Continuing to pay is a waste of money and also a possible "preference" in bankruptcy in which the creditor can be forced to pay the money back to the case administrator to be divved up among all creditors fairly. Also, don't be accused of "bad faith" if you pay one creditor and don't pay another before the filing. If you don't have the means, just stop paying them all.
   • The "friends and family" financing plan. Bankruptcy removes the legal obligation, but it's not against the law to voluntarily pay if you want. Many clients get loans or gifts from persons they know to pay for the service. Post-discharge they have more excess income to make voluntary re-pay.
   • Borrow from, or partially liquidate, an "exempt" asset to generate funds. In bankruptcy, some assets are protected and remain property of the debtor. Retirement plans, for example, are generally exempt. If necessary, you may be able to borrow from it or take a hardship withdrawal, depending on the plan's rules. Plan with your attorney.

   
   Shopping for a low-price bankruptcy is not a smart way to pick a bankruptcy law professional. Cost is only one factor, and a factor of very low relative importance, at that. Instead look for an attorney you trust, with whom you have a good working relationship, who answers your questions, and who has the legal experience and qualifications to get the results you need.
   

The take-away lesson from the recent disclosure of fraudulent lender documents and the subsequent suspension of foreclosures throughout the country is this: Yes, lender mortgage documents are defective and faulty, and it's been that way for some time.

The big news last month was the revelation that hundreds of thousands of phony affidavits had been signed by an employee of GMAC Mortgage (a unit of Ally Financial) and then submitted to courts throughout the country to support foreclosures. That admission in turn prompted the company to voluntarily suspend foreclosures in 23 states, as well as prompting demands by state attorneys general in Connecticut, Colorado and California to stop foreclosures in those states.

Recently joining the list of lenders suspending foreclosures are Bank of America, JP Morgan Chase and PNC.

In Maryland, Governor Martin O'Malley last week called on lenders to freeze foreclosures and evictions, re-examine procedures and then report back to the state what steps they are taking to address the problem. "In light of recent events, it seems reasonable to question whether the manner in which affidavits are prepared, reviewed and signed, and the sufficiency of the process employed to verify elements of default leading to foreclosure may be in violation of Maryland law," the governor wrote in a letter to lenders.

Foreclosure law in Maryland requires affidavits from mortgage lenders swearing to:

1. The default and, if applicable, that a notice of intent to foreclose was sent to the homeowner
2. Amount due and payable
3. Ownership of the debt
4. That the homeowner is not in the armed services, and
5. That the homeowner has been evaluated for "loss mitigation" alternatives (such as loan modification, deed in lieu of foreclosure, etc.) as required by Maryland's new foreclosure mediation law.

At our bankruptcy and foreclosure defense law firm, we have used documentation errors by lenders to the advantage of homeowners. More than a few times in Virginia we have been able to remove second mortgages from property because - in a hurry to get as many loans done as possible - lenders failed to get the signatures of both husband and wife, when both were on the title of the home, on the contract putting the house up as collateral for the loan. That meant the loan was not guaranteed by the house and it was an unsecured loan that could be discharged in bankruptcy, or that its unsecured status could be used as leverage to obtain a settlement with the lender.

In another case, the lender sought permission from the bankruptcy court to proceed on a foreclosure of our client's house alleging a failure to keep up with mortgage payments after the filing. The homeowner contested the amount and the lender backed off and dismissed its motion after itself coming up documentation for two different arrearage amounts.

Will you get a free house? No. And for many, eventually they may have to give up the home particularly if they cannot pay and have a substantial arrearage anyway. But in the meantime the sloppy documentation can present some opportunity to delay the foreclosure, or obtain leverage to extract economic benefits from the lender.

Bank of American Stops US Foreclosures for Review, Associated Press, October 8, 2010

Government Had Been Warned For Months About Trouble in Mortgage Servicer Industry, Washington Post, October 10, 2010

If the legal and financial technicalities of the foreclosure mess have you bewildered, you are not alone. (After all, even Wall Street got the documentation wrong, which is why we're seeing the recent suspension of foreclosures.) This is a short video by Rep. Alan Grayson of Florida who does a very good job of explaining it to a lay audience.