Wealthy individuals' Chapter 11 bankruptcy filings jumped 73 percent in the second quarter from a year earlier, according to the National Bankruptcy Research Center, a research firm in Burlingame, Calif.
More individuals or families with at least $1,010,650 in secured debt and $336,900 unsecured are using Chapter 11 of the bankruptcy code typically associated with business reorganizations. Falling home prices leave them unable to refinance or sell properties when they drop below the value of the mortgage, said Joseph Baldi, a Chicago bankruptcy attorney.
Chapter 11 is more expensive and time-consuming for debtors and creditors than a Chapter 7 liquidation of assets. Wealthier people filing for bankruptcy typically have large homes, two car payments and children in private schools, said Leslie Linfield, executive director of the Institute for Financial Literacy in Portland, Maine, a credit-counseling and research group.
“You're living on the edge, you’re juggling those financial balls,” Linfield said. “When one ball goes, they all fall down.”
Listings of homes for sale worth $1 million or more increased 27.3 percent in July from October, according to Zillow.com, a Web site that tracks real estate transactions. The number of homes sold with a value between $1 million to $2 million fell 23 percent in July from a year earlier, according to the Chicago-based National Association of Realtors. There was a 21-month supply, up from 16 months last year.
Expensive real estate
Actor Stephen Baldwin sought voluntary Chapter 11 bankruptcy protection in July after lenders began foreclosure proceedings. Baldwin, 43, listed $1.1 million in assets and $2.3 million in debt in documents filed in U.S. Bankruptcy Court in White Plains, N.Y. His home is valued at $1.1 million and the banks sought to recover about $1.2 million in mortgage loans, according to court papers.
“There are a lot of people with real estate, and they can't afford it,” said Baldi, the Chicago attorney, who is scheduled to speak to the American Bankruptcy Institute on Chapter 11 next month. “They can’t make the payments, and they can’t sell the house.”
About 4.3 percent of homes, or one in 25 properties, were in foreclosure in the second quarter, according to an Aug. 20 report from the Mortgage Bankers Association in Washington. Thatís the most in three decades of data.
Go to zero
“Real estate is an incredible thing on the downside,” said Jason Green, a bankruptcy attorney based in Washington. “Equities can only go to zero. Property can go well below zero,” because of expenses such as property taxes, insurance and maintenance on primary residences, vacation homes and investment properties.
Congress amended the bankruptcy law in 2005, making it harder to file for Chapter 7, which allows debts to be completely discharged. Chapter 11 gives individuals time to make a plan to reorganize their finances.
Approval for National Football League quarterback Michael Vick's Chapter 11 plan took almost 14 months of legal wrangling with creditors who submitted more than $19 million in claims. His bankruptcy docket, beginning in July 2008, includes 795 entries for motions, requests for hearings and transcripts. The plan includes a promise to pay approximately $2 million to his legal team and to devote a portion of Vick’s future NFL earnings to pay creditors.
The debt levels in the 2005 law prevent many higher-income people from filing Chapter 7, Green said.
“They're locked out of Chapter 7, because they make a lot of money, and it’s a disaster,” Green said. “They’re in a netherworld, just hanging out there.”
Unlike Chapter 7, which may be resolved in a single hearing, Chapter 11 takes multiple steps, all of which can be contested, said Stephen Kass, a New York tax and bankruptcy attorney.
The process begins with the debtor's request for court protection preventing lenders from seizing assets, Kass said. The plan to repay a portion of the debt during bankruptcy is also usually contested, he said.
There are meetings with the U.S. Trustee, which oversees the case, the judge and creditors. When a debtor moves to sell an asset, a motion must be filed and is likely to be contested, Kass said. An operating report is prepared each month, including the debtorís activities, remaining debts, income, projections for the future and negotiations with other creditors, Kass said.
Chapter 7 cases may cost between $1,300 to $6,000 in legal fees, Kass said. Chapter 11 cases generally start at $15,000 and can easily grow to twice that amount.
“It's a lot of hearings, a lot of paperwork,” Kass said. “Chapter 11 is really geared for the big boys.”
Before filing for bankruptcy, all consumers must see an approved credit-counseling agency. An individual applying for Chapter 11 protection has 120 days to file a plan to repay a portion of debt, according to the Web site of the U.S. federal courts.
Rebuilding credit after a bankruptcy may take as much as five years of good payment history, said Ken Lin, chief executive officer of CreditKarma.com, a San Francisco-based Web site that allows consumers to monitor their credit scores. A secured credit card, which requires an upfront deposit, is a good way to start, he said.
Scores may actually improve because of the discharged debts, Lin said, but credit will still be difficult to get and will be more expensive, because most companies do a separate search for bankruptcies as part of their underwriting.
“There will be a penalty period where you'll be under extra scrutiny,” Lin said. “A consumer should be prepared to be declined a lot.”
Bankruptcy may be used by some employers in hiring decisions. In the brokerage industry, the filing becomes part of the Financial Industry Regulatory Authority's “BrokerCheck” report, which may affect an investor’s decision on working with that broker, said Finra spokesman Herb Perone.
If consumers are using credit cards to pay utilities or groceries, it may be time to speak to a counselor, said Dianne Reichl, group manager at Greenpath Debt Solutions in Detroit. Other signs of trouble: taking numerous cash advances; paying one bill one month, another the next month; and falling behind on basic needs, such as housing and utilities.
“We're seeing people who historically never would consider they were having a problem seeking help,” said Mike Croxson, president of Care One Services, a credit-counseling company in Columbia, Md.