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The Benefits of Both “Asset” and “No Asset” Chapter 7 After Closing Down a Business

A Chapter 7 case will wipe out all or most of your personal liability from a closed sole proprietorship, corporation, LLC, or partnership.

 

If you have closed down a business, or are about to do so, filing a Chapter 7 “straight bankruptcy” case can be the best way of putting the debts of that business permanently behind you.

That Chapter 7 case will likely be a simpler one if you have a “no asset” case instead of an “asset” one. But an “asset case” may be worth the extra time it would likely take.

“Asset” and “No Asset” Chapter 7

Chapter 7 is sometimes called the liquidation form of bankruptcy. That usually does NOT mean that if you file a Chapter 7 case something you own will be liquidated, or sold. Most of the time you can keep everything you own. That’s if everything you own is “exempt”—included within a set of property “exemptions,” those types and amounts of property that are protected from your creditors. If everything is exempt, you would have a “no asset” case, so-called because the Chapter 7 trustee has no assets to collect.

In contrast, if you own something that is not exempt, and the trustee decides that it is worth liquidating and using the proceeds to pay a portion of your debts, then your case is an “asset case.”

The Quick “No Asset” and the Drawn Out “Asset” Case

Generally, a “no asset case” is simpler and quicker than an “asset case” because it avoids the asset liquidation and distribution-to-creditors process.

A simple “no asset” case can be completed in about three to four months after it is filed (assuming no other complications arise).  That’s in contrast to an “asset” case which always takes at least a few months more, easily a year or so, sometimes even multiple years.

Why does an “asset” case take so long? Because it can take time for a trustee to locate and take possession of an asset, sell it in a fair and open manner with notice to all interested parties, give creditors the opportunity to file claims to get paid out of the sale proceeds, for the trustee to object to any inappropriate claims, and then to distribute the funds as the law provides.  Each of these steps can take extra time. Especially if you have unusual or intangible asset, such as a disputed claim against a third party—a claim arising from an auto accident, for example—it can take a few years for the trustee to resolve and convert such a claim into cash, keeping the bankruptcy case open throughout this time.

The Potential Benefits of an “Asset” Case

If the trustee does have some asset(s) to collect from you, that can be turned to your advantages.  Two situations come to mind.

First, you may decide to close down your business and file a bankruptcy quite quickly after that in order to hand over to the trustee the headaches of collecting and liquidating the assets and paying the creditors in a fair and legally appropriate way. If you’ve been fighting for a long time to try to save your business, you may well find it not worth your effort to negotiate work-out terms with all the creditors. And you likely have no available money to pay an attorney to do this for you.

Second, you may particularly want your assets to go through the Chapter 7 liquidation process if the debts that the trustee will likely pay first out of your assets are ones that you especially want to be paid. The trustee pays creditors according to a legal list of priorities. For example, at the top of that list are child and spousal support arrearages, with certain tax claims not far behind. You may well want to take care of claims by your ex-spouse and/or children and the tax authorities. That’s especially true if you would continue to be personally liable on these obligations after the bankruptcy is over. 

 

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Choosing the Right Solution in a Closed-Business Bankruptcy Case

Whether to file under Chapter 7 or Chapter 13 depends largely on your business assets, taxes, and other nondischargeable debts.

 

Hoping to File a Chapter 7 “Straight Bankruptcy”

Once you’ve closed down your business and are considering bankruptcy, it would be understandable if you preferred to file under Chapter 7 instead of under a Chapter 13 “adjustment of debts.”

After all you’ve been through the last few years trying to keep your business afloat, you just want a fresh, clean start, as quickly as possible. You likely feel like just putting the debts behind you. The last thing you likely want is to do is stretch things out for the next three to five years that a Chapter 13 case would usually take.

Likely Can File Under Chapter 7 Under the “Means Test”

The “means test” determines whether, with your income and expenses, you can file a Chapter 7 case. In my last blog I described how you can avoid the “means test” altogether if more than half of your debts are business debts instead of consumer debts.

But even if that does not apply to you, the “means test” will still not likely be a problem if you closed down your business recently. That’s because the period of income that counts for the “means test” is the six full calendar months before your bankruptcy case is filed. An about-to-fail business usually isn’t generating much income. So, there is a very good chance that your income for “means test” purposes is less than the published median income amount for your family size, in your state. If your prior 6-month income is less than the median amount, by that fact alone you’ve passed the means test and qualified for Chapter 7.

Three Factors about Filing Chapter 7 vs. 13—Business Assets, Taxes, and Other Non-Discharged Debt

The following three factors seem to come up all the time when deciding between filing Chapter 7 or 13:

1. Business assets: A Chapter 7 case is either “asset” or “no asset.” In a “no asset” case, the Chapter 7 trustee decides—usually quite quickly—that all of your assets are exempt (protected by exemptions) and so cannot be taken from you to pay creditors.

If you had a recently closed business, there more likely are assets that are not exempt and are worth the trustee’s effort to collect and liquidate. If you have such collectable business assets, discuss with your attorney where the money from the proceeds of the Chapter 7 trustee’s sale of those assets would likely go, and whether that result is in your best interest compared to what would happen to those assets in a Chapter 13 case.

2. Taxes: It seems like every person who has recently closed a business and is considering bankruptcy has tax debts. Although some taxes can be discharged in a Chapter 7 case, many cannot. Especially in situations in which a lot of taxes would not be discharged, Chapter 13 is often a better way to deal with them. Which option is better depends on the precise kind of tax—personal income tax, employee withholding tax, sales tax—and on a series of other factors such as when the tax became due, whether a tax return was filed, if so when, and whether a tax lien was recorded.

3. Other nondischargeable debts: Bankruptcies involving former businesses get more than the usual amount of challenges by creditors. These challenges are usually by creditors trying to avoid the discharge (legal write-off) of its debts based on allegations of fraud or misrepresentation. The business owner may be accused of acting in some fraudulent fashion against a former business partner, his or her business landlord, or some other major creditor.  These kinds of disputes can greatly complicate a bankruptcy case, regardless whether occurring under Chapter 7 or 13. But in some situations Chapter 13 could give you certain legal and tactical advantages over Chapter 7.

These three factors will be the topics of my next three blogs. After reviewing them you will have a much better idea whether your business bankruptcy case should be in a Chapter 7 or Chapter 13.

 

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When Chapter 7 “Straight Bankruptcy” is Not So Straightforward

How can you tell if your Chapter 7 case will be straightforward? Avoid 4 problems.

 

Most Chapter 7 cases ARE straightforward. Your bankruptcy documents are prepared by your attorney and filed at court, about a month later you go to a simple 10-minute hearing with your attorney, and then two more months later your debts are discharged—written off. There’s a lot going on behind the scenes but that’s usually the gist of it.

But some cases ARE more complicated. How can you tell if your case will likely be straightforward or instead will be one of the relatively few more complicated ones?

The four main problem areas are: 1) income, 2) assets, 3) creditor challenges, and 4) trustee challenges.

1) Income

Most people filing under Chapter 7 have less income than the median income amounts for their state and family size. That enables them to easily pass the “means test.” But if instead you made or received too much money during the precise period of 6 full calendar months before your case is filed, you can be disqualified from Chapter 7. Or you may have to jump through some more complicated steps to establish that you are not “abusing” Chapter 7. Otherwise you could be forced into a 3-to-5 year Chapter 13 case or your case could be dismissed—thrown out of court. These results can sometimes be avoided with careful timing of your case, or even by making change to your income before filing.

2) Assets

Under Chapter 7 if you have an asset which is not protected (“exempt”), the Chapter 7 trustee can take and sell that asset, and pay the proceeds to the creditors. You may be willing to surrender a particular asset you don’t need in return for the discharge of your debts. That could especially be true if the trustee would use those proceeds in part to pay a debt that you want and need to be paid anyway, such as back payments of child support or income taxes. Or you may want to pay off the trustee through monthly payments in return for the privilege of keeping that asset. In these “asset” scenarios, there are complications not present in the more common “no asset” cases.

3) Creditor Challenges to the Dischargeability of a Debt

Creditors have a limited right to raise objections to the discharge of their individual debts. This is limited to grounds such as fraud, misrepresentation, theft, intentional injury to person or property, and similar bad acts. With most of these, the creditor must raise such objections to dischargeability within about three months of the filing of your Chapter 7 case—precisely 60 days after your “Meeting of Creditors.” Once that deadline passes your creditors can no longer complain, assuming that they received notice of your bankruptcy case.

4) Trustee Challenges to the Discharge of All Debts

In rare circumstances, such as if you do not disclose all your assets or fail to answer other questions accurately, either in writing or orally at the trustee’s Meeting of Creditors, or if you don’t cooperate with the trustee’s review of your financial circumstances, you could possibly lose the right to discharge any of your debts. The bankruptcy system largely relies on the honesty and accuracy of debtors. So it is quite harsh towards those who abuse the system through deceit.

No Surprises

Most of the time, Chapter 7s are straightforward. The most important thing you can do towards that end is to be completely honest and thorough with your attorney during your meetings and through the information and documents you provide. That way you will find out if there are likely to be any complications, and if so whether they can be avoided, or, if not, how they can be addressed in the best way possible. 

 

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Keeping All that You Own by Filing a Chapter 13 Case

How does a Chapter 13 “adjustment of debts” protect what you may otherwise lose in a Chapter 7 “straight bankruptcy”?

 

Chapter 13 is often an excellent way to keep possessions that are not “exempt”—which are worth too much or have too much equity so that their value exceeds the allowed exemption, or that simply don’t fit within any available exemption.

Options Other Than Chapter 13

If you want to protect possessions which are not exempt, you may have some choices besides Chapter 13.

You could just go ahead and file a Chapter 7 case and surrender the non-exempt asset to the trustee. This may be a sensible choice if that asset is something you don’t really need, such as equipment or inventory from a business that you’ve closed.  Surrendering an asset under Chapter 7 may also make sense if you have “priority” debts that you want and need to be paid—such as recent income taxes or back child support—which the Chapter 7 trustee would pay with the proceeds of sale of your surrendered asset(s), ahead of the other debts.

There are also asset protection techniques—such as selling or encumbering those assets before filing the bankruptcy, or negotiating payment terms with the Chapter 7 trustee —which are delicate procedures beyond the scope of this blog post.

Chapter 13 Non-Exempt Asset Protection

If you have an asset that is not protected by an exemption which you really need or simply want to keep, by filing under Chapter 13 you can keep that asset by paying over time for the privilege of keeping it.  Your attorney simply calculates your Chapter 13 plan so that your creditors receive as much as they would have received if you would have surrendered that asset to a Chapter 7 trustee.

For example, if you own a free and clear vehicle worth $3,000 more than the applicable exemption, you would pay that amount into your plan (in addition to amounts being paid to secured creditors such as back payments on your mortgage). You would have 3 to 5 years—the usual span of a Chapter 13 case—throughout which time you’d be protected from your creditors. Your asset-protection payments are spread out over this length of time, making it relatively easy and predictable to pay.

This is in contrast to negotiating with a Chapter 7 trustee to pay to keep an asset, in which you would usually have less time to pay it and less predictability as to how much you’d have to pay.

Chapter 7 vs. Chapter 13 Asset Protection

Whether the asset(s) that you are protecting is worth the additional time and expense of a Chapter 13 case depends on the importance of that asset, and other factors.

First note that people with assets to protect have other reasons to be in a Chapter 13 case, and the asset protection feature is just one more benefit.

Furthermore, in some Chapter 13s you can retain your non-exempt assets without paying anything more to your creditors than if you did not have any assets to protect. If you owe recent income taxes and/or back support payments (or any other special “priority” debts which must be paid in full in a Chapter 13 case), you can use these debts to your advantage. Since in a Chapter 7 case such “priority” debts would be paid in full before other creditors would receive any proceeds of the sale of any surrendered assets, if the amount of such “priority” debts are more than the asset value you are seeking to protect, you may well only need to pay enough into your Chapter 13 case to pay off these “priority” debts.

This way you would get an immediate solution—your assets protected right away and the IRS or other “priority” debt creditor off your back. And you’d have a long-term solution, too—your assets would be protected throughout the Chapter 13 case, and the IRS and/or other “priority” creditor would get paid off. Once your case is completed, you would be debt-free. 

 

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Keeping All that You Own in Bankruptcy

Can you really keep everything you own if you file bankruptcy?

 

The Answer: Usually Yes.

1) Yes, usually you can keep those possessions that you own free and clear—meaning you don’t owe any money to a creditor which has a lien on those possessions. 

2) Yes, usually you can keep those possessions which you don’t own free and clear—meaning you owe money to a creditor which has a lien on them—IF you want to keep them, AND are willing and able to meet certain conditions.

In today’s blog post we’ll address the first part of the above answer. We’ll get to the second part in the near future.

Keep What You Own Because of Property Exemptions, and Possibly Because of Chapter 13

Most people who file bankruptcy can keep what they own for two reasons: 1) property exemptions and 2) Chapter 13 protections. In a nutshell, property exemptions designate what types and amounts of assets you can keep; if you have any type or amount of property that isn’t covered, Chapter 13 adds an additional layer of protection.

The Core Principle of Chapter 7 Bankruptcy

In a Chapter 7 “straight bankruptcy,” your debts are discharged—legally written off forever—in return for you giving your unprotected assets to your creditors (as represented by the bankruptcy trustee). BUT, for most people, all or most of their assets ARE protected, or “exempt.”

As a result, debtors in Chapter 7 generally get a discharge of their debts without having to give any of their assets, or only a select set of assets, to the trustee.

Property Exemptions Aren’t As Simple As May Seem

  • The Bankruptcy Code has a set of federal exemptions, and each state also has its own exemptions. In some states you have a choice between using the federal exemptions or the state ones, while in other states you are only permitted to use the state exemptions. When you have a choice, choosing which of the two exemption schemes is better for you is often not clear and you need an experienced attorney to help with this.
  • If you have moved relatively recently from another state, you may have to use the exemption rules of your prior state. Because different state’s exemption types and amounts can differ widely, thousands of dollars can be at stake depending on when your bankruptcy case is filed.
  • Even once you know which set of exemptions apply to you, whether all of your assets are covered by an exemption and protected is often not clear. The exemption statues in many instances were written long ago using outdated language, often interpreted by the courts as to their current meaning. Plus the local trustees often have unwritten rules about how they interpret the exemption categories in practice. As a result, determining whether an asset is exempt or not involves much more than merely comparing a list of your assets against a list of the applicable exemptions.

So navigating through exemptions can be much more complicated than it looks, and is one of the most important services provided by your bankruptcy attorney.

If You Do Own Non-Exempt Assets

Most people who file a Chapter 7 bankruptcy case lose nothing to the trustee because everything they own is exempt.  But what if you DO own one or more assets which do not fit any of the available exemptions? If you want to keep those assets, they can often be protected through a Chapter 13 case.  We’ll cover that in our next blog post.

 

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Filing a Chapter 7 Case to Save Your Business

A Chapter 13 case is often the preferred way to keep a sole proprietorship business alive. But can a regular Chapter 7 one ever do the same?

 

In my last blog I said that “if you own an ongoing business… which you intend to keep operating, Chapter 7 may be a risky option.” Why? Because Chapter 7 is a “liquidating bankruptcy,” so the bankruptcy trustee could make you surrender any valuable components of your business, thereby jeopardizing the viability of the business. But this deserves further exploration.

Your Assets in a Chapter 7 Bankruptcy

When a Chapter 7 bankruptcy is filed, everything the debtor owns is considered to be part of the bankruptcy “estate.” A bankruptcy trustee oversees this estate. One of his or her primary tasks is to determine whether this estate has any assets worth collecting and distributing to creditors. Often there are no estate assets to collect and distribute because the debtor can protect, or “exempt,” certain categories and amounts of assets. The exempt assets continue to belong to the debtor and can’t be taken by the trustee for distribution to the creditors. The purpose of these “exemptions” is to let people filing bankruptcy keep a minimum amount of assets with which to begin their fresh financial start afterwards. In the vast majority of consumer Chapter 7 cases, the debtor can exempt everything in the estate, leaving nothing for the trustee to collect.  This is called a “no-asset” estate.

Business Assets in a Chapter 7 Case

If you own a sole proprietorship, are all the assets of that business exempt and protected? In other words, is the entire value of the business covered by exemptions, whether approaching the business as a “going concern” or broken up into its distinct assets.

Many very small businesses cannot be sold as an ongoing business because they are operated by and completely reliant for their survival on the services of its one or two owners.  In most such situations the business only has value when broken into its distinct assets.  So the Chapter 7 trustee must consider whether the debtor has exempted all of these business assets to put them out of the trustee’s reach.

The assets of a very small business may include tools and equipment, receivables (money owed by customers for goods or services previously provided), supplies, inventory, and cash on hand or in an account. Sometimes the business may also have some value in a brand name or trademark, a below-market lease, or perhaps in some other unusual asset.  

Whether a business’ assets are exempt depends on the nature and value of those assets, and on the particular exemptions that the law provides for them. For example, a very small business may truly own nothing more than a modest amount of office equipment and supplies, and/or receivables. In these situations the applicable state or federal “tool of trade” or “wildcard” exemptions may protect all the business assets. You need to work conscientiously with your attorney to make certain that all the assets are covered.

So it is possible for a business-owning debtor to have a no-asset Chapter 7 case, potentially allowing the business to pass through the case unscathed.

The Potential Liability Risks of the Business

However, there is an additional issue: will the trustee allow the business to continue to operate during the (usually) three-four months that a no-asset case is open or instead try to force the business to be shut down because of its potential liability risks for the trustee?

How could the Chapter 7 trustee be able to shut down the business? Recall that everything that a debtor owns, including his or her business, becomes part of the bankruptcy estate.  As the technical owner—even if only temporarily—of the business, the trustee becomes potentially liable for damages caused by the business while the Chapter 7 case is open. For example, if a debtor who is a roofing subcontractor drops a load of shingles on someone during the Chapter 7 case, the estate, and thus the trustee, may be liable for the injuries.

The main factors that come into play are whether the business has sufficient liability insurance, and the extent to which the business is of the type prone to generating liabilities. There’s a lot of room for the trustees’ discretion in such matters, so knowing the particular trustee’s inclinations can be very important. That’s one of many reasons why a debtor needs to be represented by an experienced and conscientious attorney who knows all of the trustees on the local Chapter 7 trustee panel and how they deal with this issue.

Conclusion

In many situations it IS risky to file a Chapter 7 case when you want to continue operating a business. You need to be confident that the business assets are exempt from the bankruptcy estate, and that in your situation the trustee will not require the closing of the business to avoid any potential business liability. 

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Choose between Your Prior and Present State’s Property Exemptions When You Have Timing Flexibility

If you moved to your present state less than two years ago, when you file bankruptcy can affect how much of your property is protected.

 

Even though bankruptcy is a federal procedure, the state where you are “domiciled” can greatly affect how much of your property you can protect in bankruptcy. In a Chapter 7 “straight bankruptcy” case, this can determine whether you have to surrender any of your property to the bankruptcy trustee. In a Chapter 13 “adjustment of debts” case, this can determine how much you need to pay to your creditors during your payment plan.

Property Exemptions Can Be Very Different State to State

The property exemption laws of one state can be radically different from those of another state, even if that state is right next door.

Take the example of the exemptions available to a person who lives in Mobile, on the southern tip of Alabama, and those available to someone who lives an hour drive to the east in Pensacola, on the Florida Panhandle.

First one similarity: both Alabama and Florida, like a majority of the states, require their residents to use their state property exemptions instead of a federal set of exemptions in the Bankruptcy Code. So a long-time resident of Mobile must use the Alabama exemptions in her bankruptcy filing, while a long-time resident of Pensacola must use the Florida exemptions.

These two states’ homestead exemptions—the amount of value in your home that you can protect from creditors—are a stark example how exemptions can be radically different. Alabama has one of the least generous homestead exemption amounts—$5,000 in value or equity, or $10,000 for a couple—while Florida has one of the most generous—unlimited value or equity. Simply put, if a person owned a $150,000 free and clear home in Mobile (or one with that much equity) and filed a Chapter 7 case, the Chapter 7 trustee would take that home, sell it to pay creditors, and give the person the $5,000 exemption amount (and possibly any left over after paying the creditors in full). That same valued house in Pensacola (or one with that much equity) would be completely protected, the trustee could not touch it, and the creditors would get nothing from it.

(Note that if you “acquired” your present homestead within 1,215 days (about 40 months) before filing bankruptcy—and the equity for it did not come from a prior principal residence in that same state—then your homestead exemption is limited to a maximum of $155,675, even if your present state’s exemption is more generous. (See Section 522(p) of the Bankruptcy Code.) The point of this law is to discourage people from moving to and buying a house in a state with a high or unlimited homestead exemption in order to shield their assets from bankruptcy.)

Choosing between Your Prior and Present States’ Exemptions

You may have an opportunity to take advantage of the difference in exemptions between your prior and present state because of the bankruptcy law that determines which state’s laws you must use. If you have lived in your present state for the last 730 days (2 times 365 days), then the property exemptions which will apply to your bankruptcy case are the ones allowed in your state. However, if you moved during these last 730 days from another state, then the exemptions of your prior state will apply.

(To be picky, you follow the law of the state where you had your domicile—generally, where you were living—“during the 180 days immediately preceding the 730-day period.” See Section 522(b)(3)(A) of the Bankruptcy Code for all the gory details.)

So if you moved from another state to your present state in less than two years, and you file a bankruptcy before the 730-day period expires, than you must use the exemptions of your prior state. But if you wait until immediately after that 730-day period expires, you must use the exemptions of your present state.

Find Out If the Different States’ Exemptions Matter to You

It is definitely possible that all of your property is protected by the exemptions available in EITHER state. The contrast in homestead exemptions above between Alabama and Florida is an extreme one. Most people who file bankruptcy do NOT lose any of their property. So the first thing you need to do if you have moved in the last two years from another state and are in financial trouble is talk to a local bankruptcy attorney. Find out if you have any assets which would be protected better by either of your two states. And if so, see if it is worthwhile in your particular situation to pick when you file your bankruptcy case based on which state’s exemptions are better for you. You certainly don’t want to be in the situation when you find out too late that you could have protected your property better by filing a few months or even a few days earlier. 

 

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Creditors to Whom You Feel a Special Loyalty

In bankruptcy it’s okay to FEEL differently towards some creditors than others. You can also sometimes ACT differently, but only if you very carefully follow the rules.


The last blog was about making a good decision about filing bankruptcy, one that sits well with you morally and serves your best interests legally. If you do decide to file bankruptcy, you usually also have the chance to decide how to deal with some of your creditors. Today’s blog is about creditors you would like to favor for some personal reason, usually because of a special relationship. Specifically, how you favor such creditors BEFORE your bankruptcy is filed is the subject of today’s blog.

The special creditors we’re talking about here are people you feel you must pay, whether out of family connection, loyalty to a friend, or any other personal reason. Your desire to pay this person can be an honorable moral obligation that just about trumps everything. For example, someone may have made a personal loan to you who now desperately needs you to pay it back.

The problem with favoring certain creditors is that doing so flies in the face of one of the basic principles of bankruptcy law—that creditors which are legally the same should be treated the same. Mostly that applies to how creditors are treated DURING the bankruptcy case itself. But in certain limited but crucial ways this principle spills over into the time BEFORE your case is filed. Payments you made to a creditor can be undone—the creditor can be forced to pay to the bankruptcy trustee whatever you paid to the creditor within a certain period of time before your bankruptcy filing.

The practical consequences of this can be devastating. You make a special effort to pay someone that you care about, likely when you don’t have much money, only to later risk having your bankruptcy trustee make that person pay that money “back,” not to you but rather to the trustee. Since this can happen long after you paid that creditor, the money you paid probably has long ago been spent, often leaving that creditor scrambling. Instead of you helping that person as you intended, he or she can get significantly inconvenienced and frustrated, or worse.  And after all that, you may feel obligated to pay that same amount of money a second time to that creditor if you still want to make him or her whole.

What’s the point of this seeming craziness? It goes back to that principle of treating creditors the same. For example, in the relatively rare Chapter 7 case in which you have assets at the time of filing that are not “exempt”—not protected—the trustee takes them, sells them, and distributes the proceeds to your creditors. If you pay a creditor not long before filing the bankruptcy case, the theory is that you “preferred” that creditor over others. The inappropriate payments are called “preference payments,” or simply “preferences.” The idea is that had you not made those payments, there would have been money to distribute to the creditors overall.

So what are the rules about this so that one can avoid them? If you’d like very effective sleep-inducing bedtime reading, here is Section 547 of the Bankruptcy Code explaining preferences. Nearly 1,400 words, in 57 subsections and sub-subsections!

But the good news is that the basic rule is both reasonably straightforward and often easy to work around if you understand it. So here it is.  A preference is a payment (usually money, but it can be any asset) made (voluntarily or involuntarily such as a garnishment) on a prior debt to a creditor (anybody to whom you legally owe money) during the period of 90 days before the filing of a bankruptcy.  That period of time stretches out to a full year before filing for payments made to “insiders”—basically relatives, friends, and business associates.

So how do you work around this? Well, if you know about the rule in advance, you avoid paying creditors you care about during those 90-day and 1-year periods before filing, whichever is applicable. And if you’ve already made those payments, you avoid the problem by waiting to file long enough to get past those time periods.

There are other aspects that make this easier than it might sound. Payments to most secured debts (on your home, vehicle) don’t count. The trustee can’t chase payments to a single creditor totaling less than $600 in the case of a consumer debtor or less than $5,000 for a business debtor.  And there are various other exceptions.

The bottom line is that overall it’s dangerous to pay creditors who you feel a special loyalty to before filing bankruptcy. The basic 90-day/1-year rule is rather simple, but it has lots of twists and turns so it’s safer to just avoid the issue whenever possible. Often it’s better to wait until after you file your bankruptcy case to pay these people. That’s the subject of the next blog.

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Can Child or Spousal Support Ever Be Written Off in Bankruptcy?

You’ve heard that no debt in bankruptcy is more untouchable than child support and spousal support. Is that true? Can Chapter 7 or 13 ever help?

 

Support is Not Dischargeable, IF It’s Really Support

If you owe a debt “in the nature of” child or spousal support, that debt cannot be discharged (legally written-off) in either a Chapter 7 or Chapter 13 case. See Bankruptcy Code Sections 101(14A), 523(a)(5), and 1328(a)(2).  

The point of the “in the nature of” language is that an obligation could be called support in a divorce decree or court order, and yet not actually be “in the nature of” support. The bankruptcy court looks beyond the label given to a debt in the separation or divorce documents to what kind of debt it actually is under the unique facts of the case. Practically speaking, if an obligation is labeled as support, most of the time it will indeed be “in the nature of” support. But not always, so it’s worth looking deeper.

So what’s an example of a debt which is called support but is not really “in the nature” of support? This is always in the discretion of the bankruptcy court, but here’s one example which would likely not be “in the nature of support. Imagine a personal loan provided to the two spouses during their marriage by one of the spouse’s parents. In the subsequent divorce, the divorce decree obligated the other spouse to repay that loan by paying making payments of “spousal support” until that loan was paid off. In that obligated spouse’s subsequent bankruptcy case, that obligation for so-called “spousal support” would likely be seen as one not “in the nature of” support. Instead the court could well see that obligation for what it really is: an obligation for one spouse to pay a marital debt, not one actually to pay spousal support.

But this cuts in the other direction, too. An obligation “in the nature of” child or spousal support can be called something else in the separation or divorce documents but would still be treated as a support obligation and not discharged in bankruptcy.

Any Possible Benefit from Chapter 7?

Usually the best thing that a “straight” Chapter 7 can do to help with your support obligations is to discharge your other debts so that you can better afford to pay your support.

Beyond that there is one other relatively rare situation that can help if you owe back support payments—an “asset” Chapter 7 case.

In most Chapter 7 cases, all of the assets that the debtors own are protected by exemptions, so the debtors keep all their assets. Nothing has to be given to the trustee. Since the “bankruptcy estate” contains nothing, it’s a “no asset” case.

But if you do surrender anything to the trustee—usually something you no longer need or that is worth giving up for the benefit of doing a Chapter 7 case—the trustee will pay your creditors out of the sale proceeds of whatever you surrendered. And guess what’s the first thing that gets paid by the trustee out of the “bankruptcy estate”? Support obligations owed at the time your Chapter 7 case is filed are paid ahead of any other creditor (after the trustee’s fees and costs). So if you owe back child or spousal support, some or all of it could be paid this way.

Any Possible Benefit from Chapter 13?

Although a Chapter 13 case does not discharge support obligations any better than a Chapter 7 one, it still gives you a potentially huge advantage: Chapter 13 stops collection activity for back support obligations. Chapter 7 does not. This is significant because support collection can be extremely aggressive, in many states including the potential loss of your driver’s license and even occupational licenses. Then after stopping these, Chapter 13 provides you a handy mechanism to pay off that back support, usually allowing you to pay that debt ahead of most or all other debts. Sometimes you can even reduce how much you must pay to your other creditors by the amount of back support, in effect allowing you to pay your back support “for free.”

Although Chapter 13 does not discharge any obligations “in the nature of” support, unlike Chapter 7 it does discharge other obligations arising from a separation or divorce decree or settlement. So as to those relatively rare obligations discussed above which are labeled as support obligations but in fact are not “in the nature of” support, they would be discharged  under Chapter 13.

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