Facebook Account Property of the Estate?

dislikeShould debtors be required to turn over control their social media accounts at the request of a trustee? Section 521 of the Bankruptcy Code states, “(a) [t]he debtor shall…(4) surrender to the trustee all property of the estate and any recorded information, including books, documents, records and papers, relating to property of the bankruptcy estate….” What if a trustee finds evidence of concealed property on a debtor’s public Facebook posts, or sees photos of a recent extravagant vacation? I have heard anecdotal stories of trustees requesting Facebook passwords at §341 meetings. Are social media accounts “property”, or “recorded information relating to property of the estate?” New technology raises new legal issues. Some of these issues are making their way into bankruptcy court and the trend will likely escalate.

In a case of first impression, a bankruptcy court in Texas addressed the issue of whether Facebook and Twitter accounts were property of a Chapter 11 debtor’s bankruptcy estate. See, In re CTLI, LLC, Case No. 14-33564, United States Bankruptcy Court for the Southern District of Texas, Houston Division, Dkt#334, April 3, 2015. The debtor, CTLI, LLC, operated a gun store and shooting range. A dispute arose between the majority and minority owners of the business and a bankruptcy was filed by the majority equity owner to thwart a state court receivership proceeding. A plan of reorganization was confirmed which resulted in the minority owner becoming the 100% owner of the reorganized debtor. The former majority owner refused to turn over the company’s Facebook and Twitter accounts. He asserted that the accounts were personal and were not property of the bankruptcy estate.

The bankruptcy court ruled that social media accounts for a business fall within the Bankruptcy Code’s broad definition of “property of the bankruptcy estate.” The court made a factual determination that the Facebook and Twitter accounts were “business accounts” and ordered administrative control be turned over to the new equity owner. The court found that the nature of the property right was similar to a business customer list which is generally recognized to be property under Texas law. The opinion distinguished between personal social media accounts and business accounts. Without ruling on the issue, the court suggested that personal social media accounts may involve personal liberty rights rather than property rights, but also acknowledged that in cases involving celebrities, or public figures, distinguishing between personal and business accounts may be difficult.

Whether a social media account is considered personal or business related, a trustee may be entitled to administrative access to social medial sites under Section 521. I am not aware of any reported opinions that address the issue. I have found Facebook to have limited value as an investigative tool. On a couple of instances I thought I had “busted” debtors with public posts about boats and vacations homes, only to find out later that they did not actually own the property they bragged about. Imagine that.

Attorneys Forging Debtors’ Signatures?

shamefulSometimes debtors seem puzzled when I ask them at the §341 meeting if they signed their bankruptcy petition and schedules.   They may look at their attorney for guidance in answering.   It could be poor memory or just nerves, but I have often wondered if some attorneys file petitions or schedules without first obtaining the debtors’ original signatures. Electronic filing has made this practice much harder to detect than the old fashion kind of forgery in which a signature had to be mimicked. But, forgery it is nonetheless.

Rule 1008 of the Federal Rules of Bankruptcy Procedure (“FRBP”) requires that all petitions, lists, schedules, statements and amendments be “verified” or contain an “unsworn declaration” as provided in 28 U.S.C. §1746. The official bankruptcy petition contains a declaration that meets the statutory requirement:

I declare under penalty of perjury that the information provided in this petition is true and correct.

I request relief in accordance with the chapter of title 11, United States Code, specified in this petition.

X Signature of Debtor        

The Declaration Concerning Debtor’s Schedules and the Statement of Financial Affairs contain similar language. The verification requirement of FRBP 1008 prohibits the attorney from signing the debtor’s name to the petition, schedules and SOFA. The adoption of Electronic Case Filing did not change the verification requirement. ECF merely shifted the responsibility to maintain the debtor’s original paperwork from the court to the debtor’s attorney. Pursuant to FRBP 5005, Local Rule 5005-1(a) and the Administrative Procedures for Electronic Case Filing, registered ECF users must maintain originally executed copies of signed documents for one year after the case is closed in the bankruptcy court. Placing a verified electronic signature on documents filed with the court without obtaining an original verified signature is forgery.

The electronic signature of an attorney on the bankruptcy petition is a representation by the attorney that the debtor signed the petition. FRBP 9011(b) and Miss Bankr. L. R. Rule 9011-1(a). Bankruptcy courts across the country have begun to recognize the problem of forged petitions and schedules and are imposing sanctions on attorneys who engage in the practice. See, e.g., In re: Whitehill, 514 B.R. 687 (M.D. Fla. 2014)(The debtor’s attorney filed schedules when the debtor had not reviewed or signed the documents. The court imposed sanctions, including monetary sanctions of $15,000.00.); In re: Bradley, 495 B.R. 747 (S.D. Tex. 2013) (The attorney’s actions which included forging by electronic signature defiled the “temple of justice” and were in bad faith.); In re: Stomberg, 487 B.R. 775 (S.D. Tex 2013)(The Court held that there are no circumstances that would ever justify an attorney filing the debtor’s petition or schedules without first obtaining his signature. Sanctions were imposed.); In re: Wenk, 296 B.R. 719 (E.D. Va. 2002)(A debtor’s attorney filed a “Skeletal petition” without any signature in order to get the benefit of the automatic stay. The Court found that the practice was no less egregious than filing an electronic petition without an original signature. The court imposed sanctions under a separate order.).

An attorney who files a bankruptcy petition, schedules and statements on behalf of a debtor is representing to the court that the debtor’s original signature appears on conforming copies maintained in the office. Including an electronic signature when an original was not obtained is no less forgery than attempting to mimic the debtor’s own signature. Such conduct is properly sanctionable under FRBP 9011.

Single Member LLCs: Confusing and Messy in Bankruptcy

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Single member limited liability companies cause a lot of confusion in bankruptcy cases.   A small business owner operating through an LLC often considers the assets and liabilities of the company to be his, personally.  He acquired the company’s assets through his own toil and he likely guaranteed the company’s debt. He may know that “technically” the LLC is a separate entity, but he probably feels that he and his company are one and the same.  He is not alone.  The IRS ignores single member LLCs for most purposes. Many lawyers would also ignore the distinction and include the individual owner as a defendant in a lawsuit involving the business of the LLC.   Loosely speaking, rightly or wrongly, single member LLCs are widely ignored – except in bankruptcy court.

Consider the following: if the individual owner of a single member LLC files bankruptcy (any chapter) –

  • Are the assets of the LLC property of the debtor’s bankruptcy estate?
  • Can the individual debtor claim the assets of the LLC as exempt?  What if the assets are necessary for the debtor’s trade?
  • Does the bankruptcy filing of the individual debtor stay the collection efforts of the LLC’s creditors seeking to recover from the LLC’s assets?

The answer to these questions is, NO.  The individual and the LLC are separate legal entities, and the assets and liabilities of the individual are separate from the assets and liabilities of the LLC.   See Miss. Code Ann. §79-29-311; In re Chang, Bankr. S.D. Miss., Case No. 10-51012 NPO (Dk#123); In re Modanlo, 412 B.R. 715 (Bankr. D. Md. 2006), aff’d, 266 F. App’x 272 (4th Cir. 2008); In re Desmond, 316 B.R. 593 (Bankr. D.N.H. 2004).

If the primary cause of the debtor’s financial difficulty is business related, a Chapter 11 reorganization of the LLC may be the only option if saving the business is paramount.  In such a case, filing a bankruptcy for the debtor, individually, is likely the wrong course of action.   Filing a Chapter 13 case for the individual will not help because the LLC’s debts cannot be modified or adjusted.  In an individual Chapter 7 case, the debtor risks losing his business altogether.  Although the assets of the LLC are not property of the bankruptcy estate, the LLC membership interest is subject to the control of the trustee. LLC membership interests are intangible personal property under Mississippi law.  Miss. Code Ann. §79-29-701. Even if the LLC interest has no obvious value, the trustee may have an opportunity to sell the LLC interest. I know of one case in which a competitor of a debtor’s business offered the trustee $10,000.00 for the LLC interest just to close the debtor’s business and shut out the competition.  You should carefully consider the potential consequences before filing a bankruptcy case for an individual who operates his business through a single member LLC.

One last word of caution – don’t get too creative in attempting a “work around.”  An individual bankruptcy case filed as “John Q. Debtor” d/b/a “John Q. Debtor, LLC” will face tough scrutiny and may be dismissed as filed in bad faith.   Also, efforts to “dissolve” the LLC with the Secretary of State to transfer ownership of assets prior to filing an individual bankruptcy will not work.  Mississippi law prohibits most distributions from an LLC if the LLC is insolvent.  Proper procedures for winding-up the business must be followed before in-kind distributions can be made to the member(s) of an LLC.  See generally, the Revised Mississippi Limited Liability Company Act,  Miss. Code Ann §79-29-101, et. seq., and, specifically, Miss. Code Ann. §79-29-609 which limits distributions by insolvent LLCs.  The Bankruptcy Judges in the Southern District have made it clear that they follow the mandates of the Mississippi Code regarding dissolution and that they treat LLCs and their owners as separate legal entities.

If you ultimately determine that it is in the best interest of an individual debtor with an LLC to file bankruptcy (because of problems with personal indebtedness such as medical bills or credit card debt, e.g.), it is important that the schedules and statements properly reflect the membership interest in the LLC.

  • The debtor should not include the assets of the LLC in the schedules.
  • The debtor should include the membership interest in the LLC on Schedule B, Line 13 – “Stock and interests in incorporated and unincorporated businesses.”
  • The debtor should place a value on the membership interest in the LLC.
  • The debtor should not include debt secured by assets of the LLC on Schedule D – “Creditors Holding Secured Claims.”  If the debtor personally guaranteed the secured debts of the LLC, then the debtor should include the LLC’s creditors on Schedule F – “Creditors Holding Unsecured Nonpriority Claims.”
  • The debtor should not include the LLC’s secured debt on the Statement of Intent, and the debtor will not have the option to reaffirm the debt or surrender the property.

Personal Note: The debtor should be prepared to provide the trustee with the LLC’s tax returns, bank statements, a detailed list of assets and liabilities.  The easier you can make it for the trustee to assess the case, the faster the debtor will receive a discharge and get on with his fresh start.

DISCLAIMER

7th Circuit-Inherited IRA Not Exempt-Circuit Split

The Seventh Circuit Court of Appeals in In re Clark (12-1241) (April 23, 2013) disagreed with the Fifth Circuit case In re Chilton that held Inherited Individual Retirement Accounts are exempt.  I wrote about Chilton in an earlier post.   The Chilton case was fairly long and relied on highly technical language and definitions from the Internal Revenue Code. The Fifth Circuit held that an inherited IRA contains “retirement funds” within the meaning of §522(d)(12) and can include funds that others had set aside for retirement and are not limited to funds set aside by the debtors.   The Seventh Circuit disagreed and made itself clear in an 8 page opinion.

In Clark, the debtor claimed funds held in an inherited IRA as exempt.  The Bankruptcy Court (W.D. Wisc.) disallowed the exemption claim on the basis that the inherited IRA did not represent “retirement funds” in the hands of the debtor.  The District Court reversed on the basis that the question was “close” and should therefore be decided in favor of the debtor. The Seventh Circuit stated that the case was not close at all and found that the bankruptcy judge got it right.  The Court of Appeals stressed the differences between a regular IRA and in inherited IRA.  No new contributions can be made to an inherited IRA and it cannot be rolled over or merged with another account.  The inherited IRA cannot be used for the beneficiary’s retirement-the funds must be withdrawn in five years in most instances.  In short, the Court found that, “an inherited IRA does not represent ‘retirement funds’ in the hands of the current owner…” and that “money constitutes ‘retirement funds’ (a term that the Bankruptcy Code does not define) only when held for the owner’s retirement. “(Page 3).  Inherited IRAs are not “savings reserved for use after their owners stop working.” (Page 8).

The issue of inherited IRAs as exempt arises periodically in Mississippi.  Although Chilton and Clark construe the federal exemption statute, the same rationales would likely apply under the Mississippi exemption scheme.