A new bankruptcy attorney called with a question about Ohio exemptions in a multi-thousand dollar life insurance payout. He researched the issue and concluded that it was exempt. After a back and forth regarding the facts I suggested maybe he was not so correct, and it will be better if the client spends the funds before filing bankruptcy.
An Exemption Is:
In a debtor-creditor-bankruptcy context it is a federal or state law, which defines the portion of equity in an asset protected from creditors. By extension it applies to the bankruptcy trustee since he acts on behalf of creditors.
The problem is, the attorney already filed the case for the client and reported the funds in Schedule A/B and might have tried to exempt them in Schedule C. The attorney is upset because the client needs the money to start a new life after the death of a spouse.
What Will The Bankruptcy Trustee Do With My Money?
The chapter 7 trustee will identify this asset, will object to the exemption, and will make a play for the funds. What happens next? The trustee will:
- File a motion to turn over of the funds,
- Collect the non-exempt funds,
- Request the United State Trustee send out claim forms to creditors, and
- Disburse nonexempt funds to creditors less his fees and expenses.
A Cheap Bankruptcy Lawyer With Thousands on the Line, Really?
This is all very normal in an asset bankruptcy. The problem for this debtor is, should this be an asset case at all? The problem lies with the initial selection of a bankruptcy attorney. Remember Indiana Jones and the Last Crusade? The Nazi drinks from the cup, turns to dust, and blows away. The old knight glibly says, “he chose poorly.”
Many prospective bankruptcy clients consider only, “how much will it cost?” When you have thousands of dollars at stake is this really the time to pinch pennies on a cheap bankruptcy attorney?
Is Money in The Bank Account Exempt?
The attorney correctly concluded that Ohio law exempts life insurance where the beneficiary of the policy is either an immediate family member or a dependent. This analysis breaks down once the policy is paid. Now a whole new set of exemptions can kick in. The money is now nothing more than cash or bank deposits. The unlimited life insurance exemption might apply, but the issue has not been decided by an Ohio court. There is no case law saying the exemption carries forward to funds in the bank after payment of the death benefit. There is case law that carries forward the exemption in wages, and tax refunds derived from the Earned Income credit (EIC) and Additional Child Tax Credit (CTC). Maybe that reasoning can prevail here as well. It can turn into a long, expensive fight the client cannot afford, and the attorney lacks the skills to handle.
Often bankruptcy clients hope to keep a nest egg to help them get started after bankruptcy. Ohio law strictly defines the size of that egg. It’s what you get to keep after you file bankruptcy. These numbers are controlled by the Ohio legislature (and the bank and credit card lobbyists). Ohio says that number is $1725 plus social security, 75% of any funds derived from wages, a prorated share of your tax refund, Earned Income Credit, and Additional Child Tax Credit. In this case there was no wage income, EIC, CTC, refund or social security.
Exemption Planning 101
When I have a client who has anything which may not be exempt, I first tell them that if they do nothing the trustee will attempt to take the money for creditors. I suggest they put the asset into a form that will protect it. This can be as easy spending the money before filing bankruptcy on things needed that will be exempt. All I ask is they keep receipts for the purchases. Don’t assume a bank statement listing debit transactions is enough. Your bankruptcy trustee will want to know what you bought, not where you bought it.
The attorney who called and his client each have a problem. The bankruptcy may not go the way either intended. It will certainly involve an exemption battle. An experienced bankruptcy attorney sees the danger and acts beforehand. Sometimes a client intends the Chapter 7 Trustee recover and disburse assets. That is part of a plan. Not an unintended consequence.