Arizona Non-Compete Law

Here is the current status of the law of restrictive covenants (non-compete, non-solicit, anti-piracy, non-disclosure) in Arizona

 

“Arizona law does not look kindly upon restrictive covenants.  While the common-law principles invalidating all restrictive covenants no longer control, the law continues to disfavor such impositions on employees. See Amex Distrib. Co., Inc. v. Mascari, 150 Ariz. 510, 514, 724 P.2d 596, 600 (Ct. App. 1986). Of the various forms of restrictive covenants, those that "tend to prevent an employee from pursuing a similar vocation after termination of employment" are particularly disfavored. Id. In part because an employee is in a position of unequal bargaining power vis-a-vis his employer, such restrictive covenants are strictly construed against the employer. Id.

A restrictive covenant cannot simply squash fair competition by the former employee. Farber, 194 Ariz. at 367, 982 P.2d at 1281 (citing Bryceland v. Northey, 160 Ariz. 213, 216, 772 P.2d 36, 39 (Ct. App. 1989)). Stated differently, a covenant not to compete "is invalid unless it protects some legitimate interest beyond the employer's desire to protect itself from competition." Id. (citing Amex Distrib., 150 Ariz. at 518, 724 P.2d at 604). Legitimate interests may include protecting for some time certain types of information acquired by the employee during the course of employment and retaining the customer base. Id. at 367, 370, 982 P.2d at 1281, 1284. Conversely, a covenant cannot be used to preclude a former employee from using at a new job the skills he developed while working for the employer. Bryceland, 160 Ariz. at 217, 772 P.2d at 40.

A restraint that goes too far is unenforceable, and the validity of a restrictive covenant hinges on its reasonableness. Oliver/Pilcher Ins., Inc. v. Daniels, 148 Ariz. 530, 532, 715 P.2d 1218, 1220 (1986). A covenant is reasonable and will be enforceable only if: (1) the restraint is no greater than is necessary to protect the employer's legitimate interest; and (2) that interest is not in contravention of public policy or outweighed by the burden on the employee. Lessner Dental Labs., Inc. v. Kidney, 16 Ariz. App. 159, 161, 492 P.2d 39, 41 (1971)). To that end, to be enforceable, the covenant must be reasonable with respect to its duration, its geographic scope, and the range of employee's activities affected. See Farber, 194 Ariz. at 370-71, 982 P.2d at 1284-85. Further, any restraint on an employee's activities "must be limited to the particular specialty of the present employment." Id. at 371, 982 P.2d at 1285. The burden is on the employer to prove the extent of its protectable interests. See Compass Bank v. Hartley, 430 F. Supp. 2d 973, 979 (D. Ariz. 2006); Bryceland, 160 Ariz. at 216, 772 P.2d at 39.

Reasonableness, ultimately, is an issue of law. Farber, 194 Ariz. at 366-67, 982 P.2d at 1280-81. Generally, underpinning that issue of law is "a fact-intensive inquiry that depends on weighing the totality of the circumstances." Id. That the inquiry is usually fact-based does not, however, automatically preclude the possibility of a covenant being unreasonable on its face. See generally Heartland Sec. Corp v. Gerstenblatt, No. 99 CIV 3694 WHP, 99 CIV 3858 WHP, 2000 WL 303274, at *5-9 (S.D.N.Y. Mar. 22, 2000) (holding restrictive covenants unreasonable and thus unenforceable on a motion to dismiss).

Finally, when a covenant is deemed unreasonable, a court may "blue pencil" the covenant—strike out grammatically severable, unreasonable provisions—in order to save the covenant, if the contract so directs. Farber, 194 Ariz. at 372, 982 P.2d at 1286. However, the court need not and cannot rewrite the covenant or its provisions in order to render it enforceable. Id    

 

What are Arizona's "Anti-Deficiency" Statutes for Residential Mortgages and Why Should You Care?

If you are an Arizona homeowner, or know someone who is, you should be familiar with Arizona's "anti-deficiency" statutes.  

The anti-deficiency statutes answer this question: Can a lender who forecloses on a residential mortgage sue the former homeowner for the difference (the "deficiency") between what is owed on the home and what the home was sold for at auction?  Let's look at an example:

$250,000 owed by the homeowner at time of foreclosure LESS $150,000 received by the lender at auction EQUALS a $100,000 deficiency. Can the lender sue the homeowner for the $100,000 that remains due?

First, the most common answer: the  majority of residential foreclosures in Arizona concern Trustee’s Sales related to purchase money loans secured by deeds of trust upon single- family residences located on 2.5 acres or less. In such cases, the lender may not obtain a deficiency judgment against the borrower.

It is not always easy to determine if you qualify for protection under the statutes.   Here are Steps and Rules to help:

Do You Qualify?

STEP 1: DETERMINE WHETHER YOUR MORTGAGE LOAN IS “PURCHASE MONEY” OR “NON-PURCHASE MONEY”

• A loan is purchase money if it secures a mortgage given to secure the payment of all or part of the purchase price of the subject real property.
• A mortgage loan secured by a borrower’s residence is not purchase money if the proceeds of the loan are used to purchase a different residence such as a vacation home.
• Home equity loans that are not 80/20 loans typically are not purchase money.
• A construction loan is purchase money if the proceeds of the loan are used to build a residence and: (i) the deed of trust securing the loan covers the land and the dwelling; and (ii) the loan proceeds were in fact used to construct the residence.

STEP 2:  DETERMINE WHETHER YOUR PROPERTY IS A “QUALIFIED PROPERTY “ PROTECTED BY THE ARIZONA “ANTI-DEFICIENCY” STATUTES

•  A “Qualified Property” protected by Arizona’s “anti-deficiency” statutes means real property of 2.5 acres or less and that is limited to and utilized as a single one-family or single two- family dwelling. Real Property, regardless of its use, located on more than 2.5 acres of land is not a Qualified Property.
•  Is the property  being “utilized” as a single family dwelling?

STEP 3: DETERMINE WHICH OF THE FOUR GENERAL RULES LISTED BELOW APPLY TO YOUR LOAN

RULE #1: PURCHASE MONEY LOAN + SECURED BY A QUALIFIED PROPERTY

• Trustee’s Sale: NO DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER.
• Judicial Foreclosure: NO DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER.
• Short Sale: NO DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER—the mortgage lender cannot elect the remedy to voluntarily release/waive the mortgage lien on the real property collateral and sue the borrower directly on the unsecured note.

RULE #2: PURCHASE MONEY LOAN + SECURED BY A NON-QUALIFIED PROPERTY

• Trustee’s Sale: DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER.
• Judicial Foreclosure: DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER.
• Short Sale: DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER.

RULE #3: NON-PURCHASE MONEY LOAN + SECURED BY A QUALIFIED PROPERTY

• Trustee’s Sale: NO DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER.
• Judicial Foreclosure: DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER.
• Short Sale: DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER.

RULE #4: NON-PURCHASE MONEY LOAN + SECURED BY A NON-QUALIFIED PROPERTY

• Trustee’s Sale: DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER.
• Judicial Foreclosure: DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER.
• Short Sale: DEFICIENCY JUDGMENT IS ALLOWED AGAINST THE BORROWER.

STEP 4: CONSIDER THE “FAIR MARKET VALUE” LIMITATION OF ANY DEFICIENCY JUDGMENT OBTAINED BY THE MORTGAGE LENDER

• Any deficiency following a Trustee’s Sale or a Judicial Foreclosure permitted against either a borrower, or a guarantor, is subject to a “fair market value” limitation. In other words, the deficiency amount is calculated as the difference between the loan balance due on the date of the foreclosure sale less the greater of the foreclosure sale price or the “fair market value” of the property on the date of the sale.

Finally, a word of caution.  There are numerous exceptions to the Rules listed above, and not every example under each Step has been provided because of the complexity of circumstances that may exist in unique situations.  As with any information posted on this blog, you should consult with a competent attorney if you have questions.

Can You Discharge Student Loan Debt in Bankruptcy?

It is possible, but under very limited circumstances.  Take a look at the following case to find out if you might qualify:

446 F.3d 938

In re Lorna Kaye NYS, Debtor,
Educational Credit Management Corporation, Appellant,
v.
Lorna Kaye Nys, Appellee.

No. 04-16007.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted February 15, 2006.

Filed April 26, 2006.

1

Debtor-Appellee Lorna Kaye Nys ("Nys") filed an adversary complaint in bankruptcy court to have her student loans discharged under 11 U.S.C. § 523(a)(8). The trial court found from the evidence that Nys's current income is "not nearly enough to pay off her student loans," and that it "is the most she can reasonably be expected to earn in the foreseeable future." The bankruptcy court nonetheless ruled against Nys, concluding that "undue hardship" requires the showing of an "exceptional circumstance" beyond the mere inability to pay.

2

Nys appealed to the Bankruptcy Appellate Panel ("BAP"). In a published decision, Nys v. Educ. Credit Mgmt. Corp. (In re Nys), 308 B.R. 436 (9th Cir. BAP 2004), the BAP reversed and remanded, directing the bankruptcy court to reevaluate Nys's claim using the correct legal standard. The BAP reasoned that the three-prong test we adopted in United Student Aid Funds, Inc. v. Pena (In re Pena), 155 F.3d 1108 (9th Cir.1998),1 for determining whether the repayment of student loans would impose an "undue hardship" on the debtor or her dependents requires the debtor to show "additional circumstances" that prove that her inability to pay in the present will likely persist for a significant portion of the loan's repayment period. Nys, 308 B.R. at 444. We affirm the BAP. "Undue hardship" does not require an exceptional circumstance beyond the inability to pay now and for a substantial portion of the loan's repayment period.

3

* Nys filed a Chapter 7 bankruptcy petition in the Northern District of California on June 12, 2002.2 Shortly thereafter, she filed an adversary complaint against Educational Credit Management Corporation ("ECMC"), the holder of her federally guaranteed student loans, to have those loans fully discharged under 11 U.S.C. § 523(a)(8).3

4

Between 1988 and 1992, Nys took out thirteen separate student loans to finance an Associate of Arts Degree in Science and Drafting Technology from the College of the Redwoods and a Bachelor of Arts Degree from Humboldt State University. In 1996, Nys began working at Humboldt State University as a drafting technician. She is employed as a Drafter II, the highest drafter position available at Humboldt State. In 2002, Nys's net gross income was $40,244. Because she pays $140 per month to her retirement plan, her 2002 W-2 shows an adjusted gross income of $36,981.74. The bankruptcy judge found that this income was about as high as one could reasonably expect in Humboldt County given her profession and educational background. The evidence also showed that Nys lived in a modest home in Fortuna, California, which was in need of extensive repairs. At the time of trial, Nys was 51 years old. She plans to retire at age 65, and at that time her income will drop considerably.

5

Nys borrowed approximately $30,000 through student loans. At the time of trial, she owed approximately $85,000 in accumulated principal and interest. Nys's net monthly income was $2,299.33. She claimed $2,295.05 in monthly expenses.

6

Because she was granted deferments, Nys made no payments on her student loans until August 2001, when she received a wage garnishment notice from ECMC's predecessor-in-interest. To avoid garnishment, Nys paid $130 per month on her student loans. She made those payments until May 2002, when ECMC notified her that her monthly payments would increase to $917.56.

7

At that time, Nys contacted the William D. Ford Loan Program ("Ford"), see 34 C.F.R. § 685.100, in an attempt to establish an affordable payment plan. The parties dispute what type of payment plan Ford offered Nys. Nys claims that Ford informed her that her monthly payments would still be between $800 and $900, and that she would need to pay an initial assessment fee of almost $14,000. ECMC argues that Nys is eligible for an Income Contingency Repayment Plan4 and that under this program her monthly payment would be between $389 and $453.5

8

During the trial, Nys argued that she is still unable to make payments on her student loans, and that because of additional circumstances, her inability to pay will continue into the foreseeable future. Her "additional circumstances" were that (1) she is 51 years old (14 years from legal retirement age), (2) she has "maxed out" in her career and her income is as high as it is ever going to be, (3) her house is in need of substantial repairs, and (4) she commutes daily at some distance in an old automobile with high mileage that will soon need to be replaced.

9

The bankruptcy court ruled for ECMC, finding that Nys had not proved "undue hardship." Although it concluded that "Nys is clearly incapable of repaying more than a portion of her student loans and this situation will almost certainly persist for the foreseeable future," it found no undue hardship because "[Nys] ha[d] demonstrated no additional circumstances beyond the mere inability to pay." The bankruptcy court rejected Nys's argument that "undue hardship exists any time the debtor cannot afford to pay the loans now or in the foreseeable future." It found that "[e]xceptional circumstances must be shown to meet the second prong of the Brunner test."

10

The BAP reversed the bankruptcy court because it concluded that the bankruptcy court had applied the wrong legal standard when addressing the second prong of the Brunner test. As the BAP characterized the test, "[a]dditional circumstances are any circumstances, beyond the mere current inability to pay, that show that the inability to pay is likely to persist for a significant portion of the repayment period." Nys, 308 B.R. at 444. Because the bankruptcy court required the additional circumstances to be exceptional, the BAP reversed and remanded for an application of the correct "additional circumstances" test.

II

11

The bankruptcy court had jurisdiction under 28 U.S.C. § 157(b), the BAP had jurisdiction under 28 U.S.C. § 158(b), and we have jurisdiction under 28 U.S.C. § 158(d). We independently review the bankruptcy court's decision. Rifino v. United States (In re Rifino), 245 F.3d 1083, 1086 (9th Cir.2001). The bankruptcy court's findings of fact are reviewed for clear error and its application of the legal standard is reviewed de novo. Id. at 1086-87.

III

12

The issue we must decide is whether "undue hardship" requires an additional or exceptional circumstance beyond an impervious financial situation that will continue to impede the debtor's ability to make payments on her student loans and maintain a minimal standard of living. Section 523(a)(8) provides that a student loan is not dischargeable "unless excepting such debt from discharge ... would impose an undue hardship on the debtor and the debtor's dependents." 11 U.S.C. § 523(a)(8). "Undue hardship" is not defined in the Bankruptcy Code; however, we and a majority of the other circuits have expressly adopted the Brunner test. See supra note 1.

13

When it adopted the Brunner test, the Second Circuit explicitly incorporated the reasoning of the district court in toto. Brunner, 831 F.2d at 396. The district court had thoroughly analyzed the limited legislative history pertaining to the "undue hardship" requirement, Brunner v. N.Y. State Higher Educ. Servs. Corp. (In re Brunner), 46 B.R. 752, 753-55 (1985), and therefore, because the legislative history was influential in the development of the Brunner test, we will discuss it again here.

14

Congress provided little in the way of express legislative intent specifically addressing the "undue hardship" requirement when it passed the statute. Id. at 753. Nonetheless, the phrase "undue hardship" was lifted verbatim from a bill proposed by the Commission on the Bankruptcy Laws of the United States ("Commission"), and with no clear indication to the contrary, we may impute the Commission's intent to Congress. Id. at 754; see also McClendon v. Cal-Wood Door (In re Wadsworth Bldg. Components, Inc.), 711 F.2d 122, 124 (9th Cir.1983) (looking to the Commission's report to interpret congressional intent). The Commission recognized that there was a high incidence of students filing for bankruptcy after finishing their education. Brunner, 46 B.R. at 754.

15

This "rising incidence" contravened the general policy that "a loan ... that enables a person to earn substantially greater income over his working life should not as a matter of policy be dischargeable before he has demonstrated that for any reason he is unable to earn sufficient income to maintain himself and his dependents and to repay the educational debt."

16

Id. (quoting Report of the Comm'n on the Bankr.Laws of the United States, H.R. Doc. No. 93-137, at 140 n. 15 (1973) [hereinafter Report of the Comm'n] (alteration in original)). By requiring a showing of undue hardship,

17

the Commission envisioned a determination of whether the amount and reliability of income and other wealth which the debtor could reasonably be expected to receive in the future could maintain the debtor and his or her dependents at a minimal standard of living as well as pay off the student loans.

18

Id. (citing Report of the Comm'n, H.R. Doc. No. 93-137, at 140-41 n. 17).

19

Therefore, Congress sought to prohibit a "garden-variety debtor" from discharging student loans, especially when that "garden-variety debtor" will presumably use her loan-funded education to substantially increase her income in the near future. See Rifino, 245 F.3d at 1087 ("`Congress viewed garden-variety hardship as [an] insufficient excuse for a discharge of student loans ....'" (quoting Pena, 155 F.3d at 1111) (second alteration in original)). What separates a "garden-variety debtor" from a debtor who can show "undue hardship" is the realistic possibility that a "garden-variety debtor" could improve her financial situation in the future. With increased financial stability, a debtor can make payments on her student loans and maintain a minimal standard of living. In comparison, forcing debtors who cannot reasonably be expected to increase their future income to make payments on their student loans when it causes them to fall below a minimal standard of living constitutes an "undue hardship."

20

Consequently, in an effort to comply with congressional intent and to provide some guidance for the lower courts that are primarily responsible for administering the "undue hardship" standard, the Second Circuit adopted the three-prong test formulated by the district court. See Brunner, 831 F.2d at 396. The dispositive issue in this appeal is what is meant by the phrase "additional circumstances" as it is used in the second prong. ECMC argues that the "[m]ere inability to repay one's student loans in the future has never been the test for determining undue hardship." ECMC contends that "Pena and Brunner require a debtor to show not just future inability to repay, but that `additional circumstances' preclude future repayment." In other words, ECMC contends that "undue hardship" requires the debtor to show (1) the inability to pay now and in the foreseeable future and (2) some additional or exceptional circumstance beyond the mere inability to repay. ECMC misinterprets our case law and the purpose of the "additional circumstances" language in the Brunner test.6

21

To be eligible for a discharge of student loans, the debtor must prove that her present inability to pay will likely persist throughout a substantial portion of the loan's repayment period. See Pena, 155 F.3d at 1114 (finding that the debtors satisfied the Brunner test in part because "their unfortunate financial situation was likely to continue for a substantial portion of the repayment period"). The focus of this inquiry is the debtor's financial situation.

22

We recognize that courts have found it difficult to predict future income. Consequently, courts have required debtors to present "additional circumstances" to prove that their present financial situation will persist well into the future, preventing them from making payments throughout a substantial portion of the loans' repayment period. See, e.g., Brunner, 831 F.2d at 396 ("Predicting future income is ... problematic. Requiring evidence not only of current inability to pay but also of additional, exceptional circumstances, strongly suggestive of continuing inability to repay over an extended period of time, more reliably guarantees that the hardship presented is `undue.'"). These "additional circumstances" are meant to be objective factors that courts can consider when trying to predict the debtor's future income; the debtor does not have a separate burden to prove "additional circumstances," beyond the inability to pay presently or in the future, which would justify the complete or partial discharge of her student loans.

23

In support of its contrary position, ECMC cites the Sixth Circuit's decision in Cheesman v. Tennessee Student Assistance Corp. (In re Cheesman), 25 F.3d 356 (6th Cir.1994). In Cheesman, although the Sixth Circuit discussed Brunner, it did not expressly adopt Brunner's three-prong test. Id. at 359. Rather, it found that the debtor's "loans were dischargeable under any undue hardship test the [trial] court may have used." Id. In reaching that conclusion, the Sixth Circuit stated that "there is no indication that the Cheesmans' financial situation will improve in the foreseeable future." Id. at 360.

24

ECMC argues that Cheesman presents an easier test because the debtor is only required to show a future inability to pay, and that we explicitly rejected such a standard when we adopted the Brunner test in Pena. Therefore, ECMC contends that future inability to pay has never been the standard for proving "undue hardship" in the Ninth Circuit. We disagree.

25

In Pena, although we recognized the semantical difference in language employed between Cheesman and Brunner, we concluded that "[i]t does not appear that the Sixth Circuit in Cheesman was proclaiming a test distinct from Brunner." 155 F.3d at 1112. Accordingly, we reject ECMC's argument, but will set forth here the manner in which Pena and Brunner apply to a court's effort to predict a debtor's future income. We do not presume that an individual's present inability to make loan payments will continue indefinitely. Rather, we hold that the burden is on the debtor to provide the court with additional circumstances, i.e., "circumstances, beyond the mere current inability to pay, that show that the inability to pay is likely to persist for a significant portion of the repayment period. The circumstances need be `exceptional' only in the sense that they demonstrate insurmountable barriers to the debtors' financial recovery and ability to pay." Nys, 308 B.R. at 444.7 However, although the trial court should look to "additional circumstances" to make this finding, the determinative question is whether the debtor's inability to pay will, given all we know about the salient features of her existence, persist throughout a substantial portion of the loan's repayment period.

26

Under this standard, the debtor cannot purposely choose to live a lifestyle that prevents her from repaying her student loans. Thus, the debtor cannot have a reasonable opportunity to improve her financial situation, yet choose not to do so. See Rifino, 245 F.3d at 1089 (stating the bankruptcy court's factual finding that the debtor's financial situation was not likely to improve was clearly erroneous because, after she gained experience, the debtor would have opportunities to advance to higher paying positions within her profession). At the same time, we cannot fault the debtor for having made reasonable choices that now inhibit her ability to substantially increase her income in the future. See Brunner, 46 B.R. at 754 (relying on the Commission's report and its belief that the "undue hardship" test looks at what the "debtor could reasonably be expected to receive in the future").

27

We agree with the BAP that neither Brunner nor Pena imposes a requirement that additional circumstances be "exceptional" in the sense that the debtor must prove a "serious illness, psychiatric problems, disability of a depend[e]nt, or something which makes the debtor's circumstances more compelling than that of an ordinary person in debt." Nys, 308 B.R. at 444 (internal quotation marks omitted). Undue hardship requires only a showing that the debtor will not be able to maintain a minimal standard of living now and in the future if forced to repay her student loans. We will presume that the debtor's income will increase to a point where she can make payments and maintain a minimal standard of living; however, the debtor may rebut that presumption with "additional circumstances" indicating that her income cannot reasonably be expected to increase and that her inability to make payments will likely persist throughout a substantial portion of the loan's repayment period.

28

Bankruptcy courts may look to the unexhaustive list of "additional circumstances" provided by the BAP in its published decision. See Nys, 308 B.R. at 446-47. The factors a court may consider include, but are not limited to:

29

[(1)] Serious mental or physical disability of the debtor or the debtor's dependents which prevents employment or advancement; [(2)] The debtor's obligations to care for dependents; [(3)] Lack of, or severely limited education; [(4)] Poor quality of education; [(5)] Lack of usable or marketable job skills; [(6)] Underemployment; [(7)] Maximized income potential in the chosen educational field, and no other more lucrative job skills; [(8)] Limited number of years remaining in [the debtor's] work life to allow payment of the loan; [(9)] Age or other factors that prevent retraining or relocation as a means for payment of the loan; [(10)] Lack of assets, whether or not exempt, which could be used to pay the loan; [(11)] Potentially increasing expenses that outweigh any potential appreciation in the value of the debtor's assets and/or likely increases in the debtor's income; [(12)] Lack of better financial options elsewhere.

30

Id. (citations and footnotes omitted).

IV

31

The bankruptcy court erred in requiring Nys to show exceptional circumstances beyond the inability to pay in the present and a likely inability to pay in the future. We affirm the BAP's decision to reverse and remand the case back to the bankruptcy court to allow it to apply the correct legal standard. The bankruptcy court should consider whether Nys has shown that her inability to pay will likely persist throughout a substantial portion of her loans' repayment period. We express no opinion as to whether Nys has established entitlement to a partial or complete discharge. The bankruptcy court must determine the merits of her claim by applying the correct legal standard and all three Brunner prongs to the factual record.8

32

On remand, the bankruptcy court must also determine whether Nys has made a good faith effort to repay her student loans, since all three prongs of the Brunner test must be met before a court can make a finding of undue hardship. See Rifino, 245 F.3d at 1087-88. This determination will require the bankruptcy court to consider the evidence regarding the Ford program, and whether Nys, in good faith, considered consolidation options. See Alderete v. Educ. Credit Mgmt. Corp. (In re Alderete), 412 F.3d 1200, 1206 (10th Cir.2005) (agreeing that "[although] participation in a repayment program is not required to satisfy the good-faith prong" it is considered "an important indicator of good faith" (internal quotation marks omitted)).

33

The decision of the Bankruptcy Appellate Panel is AFFIRMED.

Notes:

1 InPena, we adopted the three-prong test set forth by the Second Circuit in Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2d Cir. 1987) (per curiam). Under this test, the debtor must show: "(1) that the debtor cannot maintain, based on current income and expenses, a `minimal' standard of living for herself and her dependents if forced to repay the loans; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and (3) that the debtor has made good faith efforts to repay the loans." Id. at 396. Hereinafter, we will refer to this test as the Brunner test.

2 We extract most of the facts from the BAP's published opinion, confirmed by our own independent review of the record

3 In relevant part, § 523(a)(8) provides that a Chapter 7 discharge does not discharge an individual debtor from any debt "unless excepting such debt from discharge ... would impose anundue hardship on the debtor and the debtor's dependents, for ... an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution." 11 U.S.C. § 523(a)(8) (emphasis added).

4 Nys claimed that she was never offered an Income Contingency Repayment Plan. The trial court did not resolve this discrepancy given its disposition of the case

5 At the time of the trial, Nys was still able to claim one of her children as a dependent. As a result, ECMC argued that her payments under the Ford Program would have been $389 per month. Now, if she can no longer claim any dependents, ECMC acknowledges that her monthly payment would be approximately $453

6 Under the test as proposed by ECMC, any decision within the debtor's control could not qualify as an "additional circumstance." Therefore, a person who has chosen to go into a certain field and who, despite her best efforts, has topped out in her career with no possibility of future advancement cannot obtain a discharge of her student loans. ECMC argues that the debtor must either uproot her family and move, or switch careers to try to obtain a higher paying job. Because a college education is expensive no matter what field a student chooses, we cannot say that a debtor who, in good faith, chooses a certain field but ultimately cannot increase her income to a point that allows her to repay her student loans, is foreclosed from seeking a discharge. Furthermore, courts have recognized that a lack of useable job skills may constitute "additional circumstances."Pa. Higher Educ. Assistance Agency v. Birrane (In re Birrane), 287 B.R. 490, 497 (9th Cir. BAP 2002). Clearly, a student makes a choice as to which skills she will pursue during her education. We cannot fault a debtor for making such a choice when, later on, it turns out that despite her best efforts her skills are simply not sufficient to allow her to earn adequate sums to repay accumulated principal and interest.

7 By "additional circumstances" or "exceptional circumstances" we mean only that the debtor must present something more than her current financial situation. In other words, she cannot rely on the fact that if she made payments now on her student loans, she would not be able to maintain a minimal standard of living. Rather, she must present the court with circumstances that she cannot reasonably change. To prove "undue hardship," the circumstances must indicate that the debtor cannot reasonably be expected to increase her income and make payments for a substantial portion of the loan's repayment period

8 It may be that Nys is entitled to only a partial discharge due to the amount of the debt and the unlikelihood that her income will increase substantially between now and her retirement. Nys conceded that she has the ability to pay a portion of the debt. Therefore, on remand, the bankruptcy court should consider whether Nys is entitled to only a partial dischargeSee Saxman v. Educ. Credit Mgmt. Corp. (In re Saxman), 325 F.3d 1168, 1175 (9th Cir.2003) (holding that before a bankruptcy court can use its equitable powers under 11 U.S.C. § 105(a) to partially discharge a student loan, it must find undue hardship).

What You Should Know About Lifetime Asset Protection Trusts

Anderson Banta Clarkson, PLLC

What You Should Know About Lifetime Asset Protection Trusts
by Tom Bouman

1.         What is an IRA Protection Trust?

The IRA Protection Trust is a sophisticated estate planning technique intended to coordinate the administration and distribution of IRA assets after death.  While generally reserved for persons with more than $100,000 in tax-advantaged retirement accounts, the IRA Protection Trust is fast becoming an integral component of comprehensive estate plans.  The IRA Protection Trust is a legal document that formalizes the availability of the income tax-saving “stretch IRA” rules and permits extensive post-death contingency planning and asset protection planning.

2.         What are the benefits of an IRA Protection Trust?  

Typically, an individual beneficiary of an IRA has the option to take a lump sum payment or take required minimum distributions (“RMDs”) each year, which are calculated using the beneficiary’s life expectancy.  The latter is referred to as a “stretch IRA.” The stretch IRA is generally a better choice because it allows for continued income tax deferral inside the account.

An IRA Protection Trust mandates the use of stretch IRA treatment by the beneficiaries.  In other words, the strategy compels long term income tax deferral, rather than assuming the beneficiary will elect it.

There are other benefits:

• Owner can establish a post-death contingency plan for the IRA funds in the event of a beneficiary’s death, divorce, or extended incapacity.
• Owner can direct balance of IRA at surviving spouse’s death to owner’s children from a prior marriage, rather than spouse’s children or new spouse.

• Beneficiary receives a much larger inheritance by leveraging the income tax deferral over a longer period.
• Beneficiary receives an inheritance fund that is protected from frivolous lawsuits and ex-spouses.
• Beneficiary with special needs will not lose eligibility for government benefits.

3.         Does the IRA owner lose control of the IRA?  

No.  The IRA Protection Trust will not change any aspects of the IRA owner’s retirement planning until after the owner’s death.  The IRA owner retains total control over the IRA investments, distributions, and choice of beneficiaries.  There are no restrictions.           

4.         What type of IRA Protection Trust provides the most asset protection?  

There are two types of IRA Protection Trusts:  conduit and accumulation.  While both include asset protection features, the accumulation trust is stronger.  Here’s why:

The conduit trust requires that the trustee forward the RMDs from the IRA to the beneficiary each year.  The trust actually serves as a flow-through – conduit – when RMDs are paid out.

The accumulation trust permits the trustee to retain – accumulate – the RMDs inside a separate account owned by the trust instead of giving them outright to the beneficiary.  The accumulated money is secure from creditors.

The trustee of a conduit trust does not have any discretion about whether a trust distribution is appropriate.  In fact, the trustee must distribute at least the amount of the RMD each year.  However, the trustee of an accumulation trust will use its discretion when choosing whether to distribute trust funds to the beneficiary.

5.         Why not incorporate these provisions into a Living Trust?  

Most living trusts fail to consider all of the complex rules regarding retirement accounts payable to trusts.  They are focused on dealing with assets otherwise eligible for probate, like your real estate and bank accounts.  For example, if the living trust directs IRA assets to an accumulation trust (meaning that the trustee has the power to accumulate distributions in the trust), then the RMDs must be calculated based on the life expectancy of the oldest beneficiary.  Unfortunately, even potential beneficiaries count, so for example, even naming your parent as contingent beneficiary of your assets is enough to trigger use of the parent’s life expectancy instead of a younger, primary beneficiary’s life expectancy.  Living trusts are rarely drafted with the necessary precision to avoid problems like this.

6.         Why not use a Trusteed IRA?  

A few select IRA custodians offer a technique called the Trusteed IRA (aka individual retirement trust).  This is similar to an IRA Protection Trust because it grants additional control over the choice each beneficiary makes regarding the distribution plan.  However, the Trusteed IRA does not permit the accumulation feature and limits trustee discretion.  Also, the minimum account size tends to be $500,000 or more.

About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection.  He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law.  Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.

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Thomas J. Bouman
Attorney - Author - Speaker

www.TomBoumanLaw.com
Book an Appointment online 24/7
or call during business hours

(520) 546-3558

2013 Estate Tax Law Update

Anderson Banta Clarkson, PLLC

2013 Estate Tax Law Update
by Tom Bouman

Effective January 1, 2013, the “American Taxpayer Relief Act of 2012” signed by President Obama, provides a welcome dose of certainty to the estate tax laws.  The new law maintains the current law for the most part, while indexing the estate, gift, and generation-skipping transfer (“GST”) tax exemptions for inflation.

For persons dying in 2013, the estate, gift, and generation-skipping transfer (“GST”) tax exemptions are $5.25 million, up from $5 million in 2012.  The maximum federal tax rate is 40% (up from 35% in 2012).  The new law continues to permit unlimited deductions for qualified transfers to a surviving spouse or charities.

A major feature introduced by the 2010 Tax Relief Act – “exemption portability” – was made permanent by the new law.  This feature allows married couples to share their estate tax exemptions, making it simpler to shelter up to $10.5 million from estate taxes.  For example, if Husband dies in 2013 with a $2 million estate, then Wife may have an $8.5 million exemption ($5.25M for Wife + $3.25M unused by Husband).

At first glance, the portability feature provides an attractive alternative to the traditional use of a Credit Shelter trust (aka Bypass trust) during the lifetime of the surviving spouse.  In fact, it may be the best choice in some situations.  However, a closer look reveals many reasons to continue with traditional planning rather than rely on portability of the unused exemption.
 

1. In order for Wife to claim the additional unused exemption upon Husband’s death, she will have to file a federal estate tax return (when it would otherwise be unnecessary).
2. A Credit Shelter trust provides asset protection for the surviving spouse (outright distribution does not).
3. A Credit Shelter trust protects the deceased spouse’s children in the event of remarriage by the surviving spouse.
4. Any appreciation of assets in a Credit Shelter trust is exempt from estate tax, but the “portable” exemption amount is not inflation-adjusted. 
5. Many states (not Arizona) have a separate estate tax, but do not provide the same portability offered by the federal tax system.
6. The portability feature is only applicable if both spouses die when the feature is in effect.  Of course, Congress could change the law at any time.

Whether a person is married or single, if the person’s current net worth – plus the value of life insurance death benefits – is more than $1 million, an estate plan review is appropriate in light of the new tax law.  If married, it is important to review any formulas used in the will or living trust that would be used to allocate assets to a Credit Shelter trust upon the death of the first spouse.  The $5.25 million exemption amount and portability rules may provide an opportunity to simplify the tax planning components of the estate plan.

I also want to counsel against overemphasis of estate tax planning.  This is only one component of a comprehensive estate plan, which includes a wide array of non-tax objectives.  However, the changing tax landscape should serve as a reminder that we should all revisit our estate plan regularly.

About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection.  He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law.  Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.

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Thomas J. Bouman
Attorney - Author - Speaker

www.TomBoumanLaw.com
Book an Appointment online 24/7
or call during business hours

(520) 546-3558

Can a Trustee Keep Trust Matters Private from Beneficiaries?

Stephen F. Banta, P.L.L.C.

What You Should Know About Trust Beneficiary Notices and Trustee Reports
by Tom Bouman

1.         May a Trustee keep all trust matters private from the beneficiaries?


No.  Under Arizona law, the manager of a trust (“trustee”) has a duty to inform and report to the beneficiaries of the trust.  The duty to inform includes an initial requirement to notify the beneficiaries within 60 days after a formerly revocable trust becomes irrevocable (usually after the trust creator’s death) or within 60 days after the trustee accepts the duties of trusteeship.  The duty to report includes an annual requirement to deliver a trustee’s report to current beneficiaries.
The notice and reporting requirements do not apply to a revocable living trust provided the trust creator is alive and serving as trustee.
The trustee also has a general duty to keep the qualified beneficiaries reasonably informed about the administration of the trust and of the material facts necessary for the beneficiaries to protect their interests.  The definition of “qualified beneficiary” includes both current beneficiaries, and the contingent beneficiaries who would inherit if a current beneficiary died or the trust was dissolved.
There are two exceptions to this general duty.  First, the trust document might include a statement to the opposite effect, instructing the trustee, to the extent permitted by law, to refrain from distributing information about the trust to the beneficiaries.  Second, the trustee may decide that a beneficiary’s request for information is unreasonable under the circumstances.

However, not all information may be withheld.  Regardless of what the trust document says about the subject, the trustee must provide a copy of the portions of the trust document that are necessary to describe the beneficiary’s interest to any beneficiary who makes the request.  In addition, the trustee must provide a trustee’s report to current beneficiaries, and other beneficiaries who request it, at least annually.  This report serves to provide a minimum amount of essential information about the trust to the beneficiaries.  Arizona law does not permit the creation of a secret trust fund for a beneficiary.


2.         What are the requirements of a Trust Beneficiary Notice?


The trustee must deliver an initial trust beneficiary notification to all qualified beneficiaries of the trust.  The notice must (1) state the trustee’s name and contact information; (2) disclose the beneficiary’s right to request a copy of the portions of the trust document that are necessary to describe the beneficiary’s interest (generally, a copy of the entire document); and (3) disclose the beneficiary’s right to receive or request a trustee’s report at least annually.

3.         What are the requirements of a Trustee’s Report?


A trustee’s duty to report is met by delivering a trustee’s report to each current beneficiary of an ongoing trust, and other beneficiaries who request it, at least annually.  A current beneficiary is someone who is able to receive distributions from the trust at that time – whether mandatory or in the discretion of the trustee.  Other beneficiaries are entitled to a trustee’s report upon request.
The annual trustee’s report must include an up-to-date list of trust assets and liabilities accompanied by a ledger showing all receipts and disbursements during the prior reporting period, including the source and amount of the trustee’s compensation (if any).  There is no statutory form for this report, although it should be detailed enough to satisfy the curiosity of a reasonable beneficiary. 


4.         What is the format of a Trustee’s Report?


Unless the trustee’s report is intended for use in a court proceeding, the report need not use any prescribed format.  For the disclosure of trust assets, a simple Word document or Excel spreadsheet with a list of assets and their current values, if feasible, is adequate.  A similar list could be used for liabilities and trustee compensation, if needed.

For the disclosure of receipts and disbursements, an Excel spreadsheet is commonly used to supplement the regular statements from a financial institution, although a handwritten ledger also works fine.  The spreadsheet or ledger should track each transaction into and out of each account by (1) date, (2) payor/payee, (3) description, (4) check number, if appropriate, and (5) running balance.  A trustee may wish to include a copy of the most recent statement from each financial institution holding trust assets in order to back up the integrity of the report.

The report may be delivered by first class mail, personal delivery, delivery to last known place of residence, or by e-mail if the address is valid.  Notices are not required for a beneficiary who cannot be located by the trustee after reasonable effort.

About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection.  He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law.  Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.

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Thomas J. Bouman
Attorney - Author - Speaker

www.TomBoumanLaw.com
Book an Appointment online 24/7
or call during business hours

(520) 546-3558