YBK, Part Two: Part of my concern about “YBK” stems from my experience when I first started practicing bankruptcy law in Southern California. In the mid-90’s, grifters and con-artists, with more than a few attorneys at their side, would mark people on the verge of losing their homes. They would utilize several different legal maneuvers to separate the victim from his dwindling assets, many of which included the filing of a bankruptcy petition.

In bankruptcy, the filer immediately receives an “automatic stay”, a court order which immediately halts all collection activity, including the prosecution and enforcement of civil suits, foreclosures, and other efforts by the secured lender to obtain the right of possession to the home or automobile. In the typical Chapter 13 case, a debtor who has defaulted on his mortgage will use the automatic stay to prevent a foreclosure sale, and submit for court approval a plan to repay the amount in default, usually over three years, while keeping current on future monthly payments as they come due.

Before the housing boom of the late-90’s, we witnessed in Southern California an explosion in bankruptcy filings, including a disproportionately high number of Chapter 13’s. These occurred in spite of an otherwise strong economy, then at the height of the dotcom boom and amidst national prosperity. Those who hadn’t made it, burdened with heavy debt, and unable to utilize the equity in their homes to refinance, chose to do whatever was necessary to hang on until things got better.

From 1996 to 1999, California averaged over 196,000 bankruptcies a year, with a high of 213,213 in 1998 (in comparison, there were only 122,696 filings last year). During that same four-year period, there was an average of over 37,000 Chapter 13 petitions filed, including 40,286 in 1997. Last year, only 17,117 Chapter 13’s were filed in California, a downward trend that, as I noted last week, has continued even during the recent explosion in filings following passage of the new law. The difference between 1998, the height of the dot com boom, when the national budget ran a surplus, and now, is that while the rest of the economy went to hell in a handbasket, the housing market exploded.

But before we had an “exploding” housing market, bankruptcy was the popular option for people desperate to save their homes, led, in no small part, by some of the worst bottomfeeders in our society. These articles (here and here) show the lengths to which some scam artists will prey on those who’ve fallen behind on their mortgage. Using public records, they find out who has a Notice of Default recorded on their property, or even a Notice of Trustee’s Sale, which sets the date for foreclosure, and will send out mailings offering a solution.

From there, two scams were popular. One was to file a bankruptcy, and use the automatic stay to postpone the foreclosure sale. Since the fees for filing a Chapter 13 are lower, and the burden it imposes on the mortgagor to prove bad faith is much higher, it usually could be sold to a prospective debtor pretty easily. Hopefully, the debtor would remain current under the plan, buy some valuable time, and keep his home.

All too frequently, however, the party filing the Chapter 13 simply didn’t have the wherewithal to pay off his debts, and the whole exercise was pointless. The debtor would not be given adequate legal advice as to what his obligations were under a 13, and he’d show up at the initial creditors meeting without payments, which would lead to the immediate dismissal of his case. He could immediately refile, and if he played his cards right, he could file several cases consecutively, but ultimately, he would still lose his home.

Frequently, the debtor would never even be told that he had to attend this meeting in the first place, and see his case dismissed with an additional bar on refilling for six months. And, of course, he would still lose his home, plus have a bankruptcy filing on his credit.

Those were the lucky ones.

Some of the more sophisticated scams involved a debtor “signing” over title to his property to a third party. He would be told to begin making mortgage payments to a different entity, which would in turn pay off his arrearage. What the debtor didn’t know was that the third party had no plans to make any payments. Instead, the entity would accept the mortgage payments from the homeowner, file a Chapter 13 bankruptcy, either under the debtor’s name or under the name of a fictitious party, and use the automatic stay to buy time, fooling the debtor into believing that the foreclosure had been permanently postponed.

But of course, it had only been temporarily delayed. One particular con man set up a whole series of “trusts” that did little more than transfer fractional interests in real property between each other. The “trust” would then file bankruptcy. In order to get assigned to a particular judge who was known for his “do nothing” stand on bankruptcy fraud, information would be included on the bankruptcy petition linking the new case with a previous case before the same judge. If the debtor ceased making payments to the con man, the bankruptcies would cease, and the home would be foreclosed; at that point, the debtor would lose both the home and his credit rating, plus be the subject of a criminal investigation by the FBI for activities of which he had been completely unaware.

Some of the more brazen scams involved outright forgery. Someone who filed bankruptcy previously would later discover that his petition had been “refiled”, using a different address, with the intention of using the automatic stay to protect someone else’s property. On several occasions, the “debtor” didn’t even bother to file a new case; he simply whited-out the case number on a copy of someone else’s petition, added a new name and case number, and voila, instant bankruptcy.

Back then, I was principally a counsel for institutional lenders, so I would get cases like the ones described above on a daily basis. Then, in 1999, a combination of factors, led principally by an improvement in the housing market which alleviated the root cause, but also due to the efforts of the local U.S. Trustee, Maureen Tighe (now a Bankruptcy Judge in the SFV), and the attorneys on her staff, to more vigorously pursue fraud, the Central District began to see a decrease in foreclosure scams. Chapter 13 filings declined, much of my workload disappeared, and I was forced to pursue the joys of sole practitioning.

So it is with a great deal of trepidation that I see this same thing happening again: homeowners unable to refinance because their equity has been exhausted, unable to keep current on their mortgages, but still hoping against hope that their homes might be saved. Bankruptcy, like any other area of law, can be gamed by the unscrupulous, who will look at the new law as a challenge, not a barrier.