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A Patriotic Fresh Start

If you’re financially hurting during this 4th of July, you may not exactly be feeling like this is a great country. But it is.


Here’s why:

  • We are the fresh-start nation of the world. We’ve all heard the famous words from the poem at the base of the Statute of Liberty:

Give me your tired, your poor,
Your huddled masses yearning to breathe free,
The wretched refuse of your teeming shore.
Send these, the homeless, tempest-tost to me,
I lift my lamp beside the golden door!

Emma Lazarus, 1883

  • Much of our history is one of migration within or beyond the edges of the country in hopes of finding a better life:
    • in the late 1700s, following Daniel Boone’s route through the Cumberland Gap of the Appalachian Mountains from Virginia to Kentucky
    • during the first half of the 1800’s, pouring into and throughout the Ohio Valley and the Great Lakes region, and across the southeast into Texas
    • from the 1840s through the 1860s, trekking 2,000 mile along the dangerous Oregon, California , and Mormon Pioneer Trails
    • populating the Great Plains as encouraged by the Homestead Act of 1862 which distributed free land  to those who “have resided upon or cultivated the same for the term of five years,” and the Oklahoma Land Run of 1889
    • in the first half of the 20th century, 6 million African Americans participating in the “Great Migration” from the rural South to the urban North and West
    • since the end of World War II, the consistent shift in population from the northeast and Midwest Rust Belt to the southern and western Sun Belt.
  • The spirit of a fresh start is woven into our history and culture, as expressed in our laws, starting with our foundational law, the Constitution: “The Congress shall have Power… To establish… uniform Laws on the subject of Bankruptcies throughout the United States” According to a famous commentary on the Constitution, this clause was not in the original draft, but was added after a vote of 9 states in favor and 1 against.
  • In spite of this clear Constitutional mandate, it took Congress more than 100 years– until 1898—to pass a bankruptcy law that wasn’t repealed within a few years!  We’ve managed to have a comprehensive bankruptcy law in effect ever since then.
  • Property exemptions—your right to keep a certain amount of your property when filing bankruptcy–is the result of a 200-year-old Constitutional battle of states’ right versus federal power.  Throughout the 1800s, the country waged a political and economic war between Northeastern bankers and Western and Southern farmers and small merchants. Because of reoccurring devastating financial “panics” during that century, the farmers and merchants had good reason to worry about losing their homes and farms to out-of-state creditors. As a result, the first law exempting property from the collection of debt was adopted in 1839 in the Republic of Texas, and spread quickly through the South and the Midwest during the 1840s and 1850s. Exemption laws continue to protect our property from creditors today.
  • In spite of huge efforts over the years by creditors to make bankruptcy less accessible to consumers, the Chapter 7 and Chapter 13 options do continue to provide tremendous relief for most people who need them. Although not perfect, they give you a relatively flexible, balanced, and effective way to personally take part in the centuries-old and sometimes necessary American tradition of a financial fresh start.
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What Can I Do If I’m Behind on My Vehicle Loan?

Bankruptcy saves your vehicle from immediate repossession. Whether you choose to file under Chapter 7 or 13 depends in part on how strong of a medicine you need for dealing with the back payments.

My last blog focused on ways in which Chapter 7 and Chapter 13 bankruptcy each make it possible for you to keep your vehicle by keeping your vehicle lender satisfied.  But to be very practical, today let’s hone in on one very common scenario: you’ve fallen behind on your vehicle loan, but need to keep that vehicle. What are your options?

Saved by the Automatic Stay

As you probably already feel in your gut, you’ve got to accept right away that you are in a very precarious situation. Vehicle loans are very dangerous because of how quickly the collateral—your car or truck—can be repossessed. With a mortgage foreclosure you usually have a number of major warnings, stretching over months, sometimes over a year or more. Instead, with just about all vehicle loans, you get no warning. Once you’re in default—missed a monthly payment or let your insurance lapse—your vehicle could get repossessed at any time. Realistically, most repossessions do not happen until you’re about 2 months late. But that depends on your payment history, the overall aggressiveness of the creditor, and, frankly, how the repo manager happens to be feeling that day. If you’re not current, you’re in danger.  

Once a repossession happens, that does not always mean that your vehicle is gone for good. But in many situations that IS the practical result. To get a vehicle back after a repo usually takes serious money. Money you don’t likely have hanging around if you’re behind on your car payments.

And once the repo happens, thing’s often just get worse—your vehicle is sold at an auction, and you often end up owing thousands of dollars for the “deficiency balance,” the difference between what the vehicle was auctioned off for and the amount you owed on the loan (plus repo and sale costs). Next thing you know, you’re being sued for those thousands of dollars.

All that is preventable, IF you file either a Chapter 7 or Chapter 13 bankruptcy BEFORE the repossession. The “automatic stay”— a legal injunction against repossession—goes into effect instantaneously upon the filing of bankruptcy. Even if the repo man is already looking for your vehicle to repo, once you file that gets you off his list. At least for the moment.

Dealing with Missed Payments under Chapter 7

As stated in the last blog, most vehicle lenders play a “take it or leave it” game if you file a Chapter 7 case. If you want to keep the vehicle, you must bring the loan current quickly—usually within about two months after filing.  Unless your lender is one of the relatively few  that are more flexible, you need to figure out if not paying your other creditors is going to free up enough cash to catch up on your missed payments within that short time. If not, the lender will have the right to repossess your vehicle if you are not current the minute the Chapter 7 case is completed, usually about 3 months after it is filed. In fact, you may have even less time if the lender asks the bankruptcy court for permission to repossess earlier.  

Dealing with Missed Payments under Chapter 13

You have much more flexibility about missed payments under Chapter 13. In fact, you do not need to catch up on them at all.

There are two scenarios, alluded to in the last blog.

If your vehicle is worth at least as much as your loan balance OR if you entered into your vehicle loan two and a half years or less before filing the case, than you will have to pay the entire loan off within the 3-to-5-year Chapter 13 plan period. Depending on the amount of the loan balance, that may or may not mean a reduction in monthly payments. Sometimes it could even mean an increase in payments.

If your vehicle is worth less than your loan balance AND you entered into your vehicle loan more than two and a half years before filing the case, then you can reduce the total amount to be paid down to the value of the vehicle. With this so-called “cramdown,” you still must pay that reduced amount within the life of the Chapter 13 plan. And you may need to pay a portion of the remaining balance, primarily based on whether you have extra money in your budget to do so. But the savings in terms of both the monthly payments and the total amount to be paid are often huge.

Conclusion

Bankruptcy stops your vehicle from being repossessed, and gives you options for dealing with previously missed payments. Chapter 7 may work if you can pay off the entire arrearage fast enough. Otherwise you may need the extra help Chapter 13 provides. Or you might want to file Chapter 13 to take advantage of the “cramdown” option if that applies to you, after also weighing all the other considerations between Chapter 7 and 13.  

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Keeping Your Wheels in Bankruptcy

Under Chapter 7, you can pay your vehicle loan mostly by getting rid of all or most of your other debts. Under Chapter 13, you can pay your vehicle loan ahead of most of your other creditors.


Bankruptcy law is all about balancing the rights of debtors and creditors. When you file bankruptcy you gain a lot of leverage against your creditors. But exactly how much leverage depends on the kind of debt and certain crucial details about it. With a vehicle loan, you get much less leverage than with some other types of debts because the lender has a right to its collateral–your car or truck. But if you want to keep your vehicle, you can often use the lender’s rights over your collateral to your advantage.

That’s because bankruptcy is also about sorting out the rights of the creditors among themselves. So if you WANT to keep your vehicle, you are able to favor that vehicle lender over most of your other creditors.

Let’s see how this works under Chapter 7 and then under Chapter 13.

Favoring your vehicle loan in a Chapter 7 “straight bankruptcy”

Between you and the vehicle lender, your leverage is that you have the right to simply surrender your vehicle to the creditor and pay nothing. The bankruptcy discharges (writes off) any remaining debt. Usually the lender does not get paid enough from selling the vehicle to cover the full balance on the debt—especially after accounting for the costs of repossession and resale.  Rarely the vehicle is worth more than the loan balance, such as towards the very end of a loan term, when the balance is low and the vehicle has retained some value. But, most of the time a vehicle depreciates faster than the balance goes down. So the lender usually loses money on a surrender.

This means that sometimes we can use the threat of surrender to improve the vehicle loan’s terms, maybe even reduce the balance to an amount closer to the current fair market value of the vehicle.

But unfortunately, most major vehicle lenders don’t see it that way. They made a decision at some point that they make more money by requiring all their Chapter 7 customers to pay the full balance on the vehicle loans, and then take losses on those who aren’t willing to do that and instead surrender their vehicles. Talk with your attorney about whether your creditor is one which will require you to stick to the contract terms, or instead one who might be more flexible.

As between your vehicle lender and your other creditors, in a Chapter 7 case you will likely be able to discharge the debts of most or even all those other creditors. The vehicle lender has leverage—its lienholder rights against the vehicle that you want to keep—greater than most of your other creditors. With the exception of other creditors which have other collateral you want to keep, and those relatively few creditors whose debts aren’t discharged in bankruptcy, during and after filing the Chapter 7 case you will be able to focus all of your financial energy on paying the vehicle loan.

Favoring your vehicle loan in a Chapter 13 “payment plan”

Between you and the vehicle lender, your leverage is both lesser and greater under Chapter 13 than under Chapter 7.

You have less leverage in threatening surrender if your Chapter 13 plan is paying anything to your unsecured creditors. That’s because the vehicle lender would recoup from you at least some of its losses upon surrender, instead of none.

And if your vehicle loan is two and a half years old or less, if you want to keep the vehicle you must pay the full balance of the loan, regardless of the value of the vehicle compared to the loan balance.  

But you have more leverage in two ways. With any vehicle loan, including those two and a half years old or less, you do not have to cure any arrearage, and can change the monthly payment, as long as the balance is paid in full by the end of the case.

And if the loan is more than two and a half years old, you can do a “cramdown”—reduce the amount you pay to the fair market value of the vehicle, plus whatever percentage you’re paying to the pool of unsecured debt, if any.

As between your vehicle lender and your other creditors, in a Chapter 13 case if you want to keep the vehicle and you follow the above rules, most of your other creditors generally can’t object to how much you’re paying for the vehicle instead of to them. Other creditors secured by other collateral have their own rights to their collateral, and whatever payments arise from that. And “priority” creditors are generally entitled to be paid in full. And there are other rules you must follow in Chapter 13. But unless the vehicle you want to keep is unreasonably expensive, or is an unnecessary extra vehicle, you will be allowed to make the required payments so that you can keep it.

 

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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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Debts for Recent “Luxury Goods or Services” and Cash Advances

What is the “presumption” that certain recent credit card purchases and cash advances will not be discharged in bankruptcy?

 

In the last couple of blogs I have written about the types of debts that get written-off (“discharged”) and those that don’t. Included on my earlier list of those that might NOT be discharged are those “incurred through fraud or misrepresentation, including recent cash advances and ‘luxury’ purchases.” Today’s blog focuses on this one type of debts.

In fact, this blog just looks at one particular subcategory of these debts—those that the Bankruptcy Code says “are presumed to be nondischargeable.” What is this “presumption,” how does it work, and what should you do about it?

The Fraud/Misrepresentation Exception to Discharge

First of all, the idea behind this exception to discharge is that debtor who cheats the creditor to borrow the money or get the credit should not be able to discharge that debt in bankruptcy. That follows one of the most basic principles of bankruptcy, that you have to be honest to get the benefits of bankruptcy. As the U.S. Supreme Court said 78 years ago, the purpose of bankruptcy is “that it gives to the honest but unfortunate debtor… a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.” Local Loan Co. v. Hunt, 292 US 234, 244 (1934).

So this exception to discharge says that a creditor can challenge your ability to write off a particular debt “to the extent obtained by… “false pretenses, false representation, or actual fraud… .” Section 523(a)(2) of the Bankruptcy Code. In other words, if you got the loan or credit through fraud or misrepresentation, the creditor could make that argument in order to exclude that debt from the discharge of your debts.

The Point of a “Presumption”

Debts which potentially belong to this fraud/misrepresentation category of debts ARE discharged UNLESS the creditor formally objects to the discharge of the debt within a rather quick deadline, usually 60 days after your meeting with the bankruptcy trustee. That objection would be in the form of a lawsuit the creditor files at the bankruptcy court. In that lawsuit the creditor lays out the facts of fraud or misrepresentation that would justify the debt not being discharged.  The creditor would then need to prove those facts with evidence. The debt is still discharged unless the creditor present evidence that leads the bankruptcy judge to decide that the debt was in fact obtained by the debtor’s fraud or misrepresentation.

A presumption in the bankruptcy law that a debt is not dischargeable simply makes it much easier for the creditor to prove that point, in those specific circumstances where the presumption applies. The creditor simply needs to establish that those circumstances apply to the challenged debt. Then that debt is “presumed” not to be discharged. And it will not be discharged unless the debtor can bring contrary evidence showing the lack of fraud or misrepresentation by him or her. In terms that may be familiar, a presumption “shifts the burden of proof” from the creditor to the debtor.

Why is this important? Litigation is expensive. Most cases are settled before going to trial because the amounts at issue are not worth the costs of battling it out in court. Congress has decided in two sets of  circumstances to tip the advantage in favor of the creditors, by giving them the presumption of no discharge.

The “Luxury Goods or Services” Presumption

The first of these circumstances arises if a consumer incurs a debt of more than $500 in “luxury goods or services” in the 90 days before filing the bankruptcy. That debt is presumed not to be dischargeable, meaning that the creditor doesn’t need to bring evidence establishing that the debtor intended to cheat the creditor by not paying the debt. The thought behind this is that either the person making the purchase knew he or she was going to file bankruptcy and was not going to pay the debt, or else at least was quite reckless to be using creditor that close to filing bankruptcy.

So what are “luxury goods or services”? Broader than it sounds. They include anything except those “reasonably necessary for the support or maintenance of the debtor or a dependent of the debtor.” The court decides what fits that definition. It’s up to the debtor to persuade the court that the goods and/or services totaling more than $500 were “reasonably necessary,” or that the debt was incurred with the honest intention, at that time, of paying it.

The Cash Advances Presumption

The second of these circumstances arises if a consumer incurs a debt of more than $750 through a cash advance or advances made in the 70 days before filing the bankruptcy. In the same way as with the “luxury goods” presumption, the creditor does not need to bring evidence establishing that the debtor did not intend to pay the debt. And in the same way, the debtor can try to persuade the court that the cash advance was incurred with the intention of paying it.

A Creditor Does Not Need a Presumption

Just because a “luxury good” was purchased more than 90 days before your bankruptcy case is filed or a cash advance was made more than 70 days before then, these do not necessarily mean that the creditor will not challenge your ability to discharge that debt. In these situations the presumption would not apply. So the creditor would have to show the court convincing evidence that you did not intend to pay the debt. Since that is often not easy to show, creditors are not as likely to challenge purchases and cash advances that were made before the presumption period.

Avoiding These Presumptions

Avoid these presumptions by not using any credit and making cash advances in the few months before filing bankruptcy. But if you did avoid these, can you just wait to file until enough time has passed to get beyond these 70 and 90-day periods? Yes, that is a way to get past the presumption periods, as long as you do not have an urgent need to file your case. But although that may make it less likely that a creditor will raise a challenge, this does not necessarily mean it won’t happen.  If a creditor thinks it has evidence that you incurred a debt that you did not intend to pay, or that you incurred in other circumstances involving fraud or misrepresentation, the creditor may still decide to raise the issue without the benefit of a presumption.

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What’s Different about the Discharge of Your Debts under Chapter 13?

Here’s the good news/bad news about the discharge of debts in a Chapter 13 payment plan compared to the discharge you get in a straight Chapter 7 case.


Sometimes choosing between Chapter 7 and 13 is easy, but other times it means carefully weighing lots of considerations. Whether the choice is easy or hard, one of those considerations is how these two options compare in their discharge (legal write-off) of your debts.

The good news in favor of Chapter 13 is that it discharges a couple more types of debts than Chapter 7 does. So in the right case this “super discharge” could be reason enough to choose Chapter 13.

The bad news is about timing—the discharge is not effective until the very end of a Chapter 13 case—usually 3 to 5 years after it is filed. That means you have to successfully complete the case to get a discharge of your debts. The fact is that a significant percentage of Chapter 13 cases are not successfully completed, leaving the debts still owed. That’s a risk that needs to be seriously considered before filing a Chapter 13 case.

The Mini “Super Discharge”

In the past, one way that Congress encouraged debtors to file Chapter 13s is by allowing various kinds of debts to be discharged under Chapter 13 that could not be discharged under Chapter 7. Chapter 13 was said to provide a “super discharge.” But over the last quarter-century or so, Congress has whittled away at the list of debts treated more favorably under Chapter 13 until now only two noteworthy ones remain:

1. You can discharge non-support obligations owed to an ex-spouse in a Chapter 13 case (and not in a Chapter 7 one). These obligations usually include those in a divorce decree requiring you to pay off a joint marital debt or to pay the ex-spouse to compensate for you receiving more than your share of the marital property. They are often called the “property settlement” part of your divorce.

2. An obligation arising from a “willful and malicious” injury that you are accused of causing to a person or to property can be discharged in Chapter 13. This refers to allegations that you hurt somebody or their property not merely through your negligence—which would be discharged in Chapter 7—but instead either intentionally or recklessly—the discharge of which could be challenged in a Chapter 7 case.

These are both very delicate areas. What’s a “property settlement” type of divorce obligation instead of a support obligation, and what’s a “willful and malicious” injury instead just of a negligent one—these are often not straightforward distinctions. The decision to use Chapter 13 to undo part of a divorce decree or to escape accusations of “willful and malicious” injury can have a variety of legal, human, and tactical considerations. Weigh these carefully with an experienced bankruptcy attorney before relying on the Chapter 13 super discharge.

No Discharge until the End of the Case

Not getting a discharge until the end of a Chapter 13 case is theoretically no different than under Chapter 7. In Chapter 7 as well you must satisfy a number of conditions before you can successfully complete the case and receive a discharge. But, if you are being guided through the process by an experienced bankruptcy attorney, the Chapter 7 conditions are usually met relatively easily. As a result most of the time within about three months you receive the court order discharging your debts.

In contrast, completing a Chapter 13 case requires you to meet many more conditions, and to do so consistently over the course of years. This includes making monthly “plan payments” to your Chapter 13 trustee for distribution to your creditors, and sometimes also sending payments directly to some creditors (usually vehicle and mortgage lenders). But you also must stay current on spousal and child support obligations, file income tax returns on time, and often meet other special requirements laid out in your plan. Your Chapter 13 case will be designed so that you should be able to meet all the conditions, but sometime circumstances change so that you can’t.

If your circumstances do change, you may well still be able to get a discharge of your debts. Your attorney may be able to adjust your budget and amend your plan to deal with the changes, allowing you to complete the Chapter 13 case and discharge the debts. You may qualify for a “hardship discharge.” Or it may be best to “convert” your Chapter 13 case into a Chapter 7 one, and receive a Chapter 7 discharge.

At the beginning of your Chapter 13 case discuss with your attorney possible future changes in your circumstances, and what options you would have if these happened. And then if any significant changes do happen, inform your attorney right away so that you can get advice about your options. In most cases you can get a discharge of your debts even when your circumstances change if you deal with the situation proactively.

 

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The Power of Chapter 13 to Save Your Home, Brought to Life

A mere list of the many ways that Chapter 13 can help save a home can start sounding dry. So here’s a powerful example that shows off some of its extraordinary advantages.

 

Let’s start by setting the scene. Say you lost your job in early 2010 and, except for temporary, part-time work, you did not find new full-time employment until 3 months ago. It pays less than your old job.

  • While you weren’t working full-time, you used up your savings and then borrowed on your credit cards to try to pay the house payments. That seemed to make sense at the time because you kept getting promising job leads, none of which panned out until you finally got hired for your present job. So you owe $18,000 on the credit cards, with minimum payments totaling $550 per month.
  • After your savings and available credit ran out, you still fell $5,000 behind on your first mortgage and $3,000 behind on your second. They are both starting to send papers sounding like they are going to start foreclosing.
  • Because there wasn’t enough money in your property tax escrow account with your first mortgage lender to pay the recently due annual $2,000 property tax bill, the lender is demanding that you pay that right away. It is threatening to foreclose for this separate reason if you don’t.
  • You had some medical problems soon after losing your earlier job, while you had no medical insurance, resulting in a $7,500 medical bill. That went to a collection agency, turned into a lawsuit, and then recently into an $8,000 judgment lien against your home.
  • Money had been tight even back before you’d lost your job because of cutbacks in hours, so you cut your tax withholding way back, so that you owed $2,000 to the IRS for 2009 income taxes. You couldn’t make the agreed monthly installment payments, and have just found out that that a tax lien has been recorded against your home in the amount of $3,000, after adding in all the accrued penalties and interest.
  • While you were working temporary jobs during 2010 and 2011, you were desperate for every dollar you could bring home, and so didn’t have any taxes withheld. As a result you owe the IRS another $2,500 for each year, or a total of another $5,000 that you have not even filed tax returns for yet.  You’re afraid to because you have no money to pay it and are afraid of more tax liens against your home.
  • Your home was worth $300,000 in 2008, but has lost about 25% of its value by now, so is worth $225,000. You owe $230,000 on the first mortgage, with monthly payments of $1,000, and owe $50,000 on the second mortgage, with monthly payments of $300.
  • With your current reliable income, after paying modest but reasonable living expenses, you have $1,500 available monthly for all creditors, including the two mortgages. That’s only $200 per month beyond the two mortgage payments, a drop in the bucket considering this mountain of debt:
    • credit cards: $18,000
    • first mortgage arrears: $5,000
    • second mortgage arrears: $3,000
    • property tax arrears: $2,000
    • judgment lien: $8,000
    • 2009 income tax with tax lien: $3,000
    • 2010 and 2011 income tax: $5,000

That’s a total debt of $44,000, besides the $230,000 first mortgage and $50,000 second mortgage.

  • Last fact: your two school-age kids live with you, they’ve lived in this home their whole lives, and have gone to the good local public schools for years, with their friends who live in the neighborhood. So more than anything you want to maintain this home and the stability it brings to their lives (and yours!). But it sure seems hopeless.

A Chapter 7 “straight bankruptcy” would help by discharging (writing off) tens of thousands of dollars, but NOT likely help nearly enough for you to be able to keep the home. A Chapter 7 case would likely discharge all or most of the credit card balances, as well as the medical bill that turned into the judgment, and likely even get rid of that judgment’s lien on your home title. That would save you about $26,000, and take away one threat to your home. But with only $200 to spare after paying the current first and second mortgage payments, that $200 is just way too small to even begin to satisfy the mortgage lenders or the IRS, much less both.

So after your Chapter 7 case would be completed, the IRS would attempt to collect the 2009 debt through garnishments of your bank account or wages, and sooner or later you’d have to deal with the 2010 and 2011 taxes, possibly resulting in them at some point turning into tax liens. And sooner or later your home would be foreclosed because you would have no way to catch up on the mortgage arrears.

However, if INSTEAD you filed a Chapter 13 case, under these circumstances you very likely you WOULD be able to keep your home, cure the mortgage arrears, and pay off all the taxes. And all this would happen while you and your home was protected from collection efforts by any of your creditors. How could that possibly be? I’ll show you in my very next blog. Sorry to keep you hanging, but today’s blog is way too long already.

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What Happens to Your “General Unsecured Debts” in Chapter 13?

In most Chapter 7 “straight bankruptcies,” most debts are legally written off, especially debts that are not secured by any collateral and don’t belong to any of the special “priority” categories of debt. But how about in a Chapter 13 payment plan? What determines whether these creditors get paid, and if so how much?

The beauty of Chapter 13 is that it is both flexible and structured. Flexibility allows Chapter 13 to help people with wildly different circumstances. Structure—the set of rules governing Chapter 13—is important because clear rules balancing the rights of debtors and creditors reduces disputes between them. There is only so much money to go around to the creditors, so less fighting means less precious money spent on attorneys and more available for satisfying the creditors. And then getting on with life.

How much the general unsecured debts get paid in any Chapter 13 case is a reflection of these two themes working together. These are illustrated through the following rules, and their impact on the payout to these creditors.

1. Creditors which are legally the same are treated the same. So, all general unsecured creditors get paid the same percent of their debt through a Chapter 13 plan.

2. For any creditor—including a general unsecured one—to share in the distribution of payments, it has to file a proof of claim on time with the bankruptcy court. A general unsecured creditor which fails to file this simple document stating the amount and nature of the debt will receive nothing through the plan, and the debt will be discharged at the end of the case if it completed successfully.

3. The failure of one or more creditors to file its proof of claim usually, but not always, means that there will be more money available for the other creditors. Two exceptions: a “0% plan,” in which the general unsecured creditors are receiving nothing; or a “100% plan,” in which these creditors are being paid the entire amount of their debts.

4. “0% plans” are those in which all of the money paid by the debtor through the Chapter 13 trustee is earmarked to pay secured creditors, “priority” creditors (such as taxes and child/spousal support), and/or trustee and attorney fees. Some bankruptcy courts frown on “0% plans,” especially in certain situations, such as when there does not seem to be good reason to be in a Chapter 13 case instead of a usually much less expensive Chapter 7.

5. “100% plans” are those in which all of the general unsecured creditors’ debts are paid in full through the trustee. These happen primarily for two reasons. The debtors:

a. are required to make payments based on their budget, which provides enough money over the course of the case to pay off their debts in full; or

b. own more non-exempt assets which they are protecting through their Chapter 13 case than they have debts, which requires them to pay off their debts in full.

6. A major consideration for how much the general unsecured creditors receive is how long the debtors are required to pay into their Chapter 13 case. Generally, if debtors’ pre-filing income is less than the published “median income” for their applicable state and family size, then they pay for 3 years into their plan. If their income is more than that amount, they must pay for 5 years instead. The length of the case obviously affects how much is paid in, and so usually affects how much the general unsecured creditors receive.

7. Payments to general unsecured creditors can be affected by changes which occur during the case—income increases or decreases adjusting the plan payment amount, unexpected tax refunds and employee bonuses paid over to the trustee, and even additional allowed debtors’ attorney fees reducing what is available to the creditors.

8. Once the general unsecured creditors receive whatever the Chapter 13 plan provides for them (and the rest of the plan requirements are met), the remaining balances are legally discharged. The result is that all general unsecured creditors receive the same pro rata share, and that’s the end of the story for them. The exception is the relatively rare creditor which succeeds during the case in convincing the court that its debt should not be discharged at all. This only applies to situations involving a debtor’s fraud or other similar significant wrongdoing, and only if the creditor raises the issue by a very strict deadline just a few months into the case. This creditor still shares in the distribution of payments to all the general unsecured creditors. But at the end of the case, there is no discharge of its remaining debt, which the creditor can then pursue against the debtor.

Clearly, a lot of considerations go into how much the general unsecured creditors will be paid in any Chapter 13 case. There are many interacting rules to be applied to the unique financial and human factors of each case.

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The Most Basic Concept in Bankruptcy: Debts

The most practical questions you likely have if you are considering bankruptcy is what it will do to each of your debts. Will you still owe anything to anybody? What about debts you want to keep like a vehicle loan or mortgage? How to handle special debts like income taxes and child support?

To understand bankruptcy you need to understand debts. One of the most basic principles of bankruptcy is that it treats all creditors in the same legal category the same as all the other creditors in that category. So the first step in understanding debts is to understand the three main categories of debts. Not everybody has debts in each of these categories, but lots of people do. At the end of this blog, you should be able to at least start dividing your debts among these three categories. From there, bankruptcy and how it deals with each of your creditors will start making more sense.

The three categories are “general unsecured debt,” “secured debt,” and “priority debt.”

Secured Debts

All debts are either secured by collateral or not. Whether or not a debt is secured is often very straightforward, such as with a vehicle loan in which the vehicle’s title specifies your lender as the lienholder. That lien on the title, together with the documents you signed with that lender, gives that lender certain rights as to that collateral, such as the right to repossess it if you fail to make payments.

In the case of every secured debt, there is a legally prescribed way to attach the debt’s collateral to the debt. In the case of the vehicle loan, the lender and you have to jump through certain hoops for the lender to become a lienholder on the title. If those aren’t done right, the vehicle might not attach as collateral to your loan.

Debts can be fully secured or only partially secured. If you owe $10,000 on a vehicle worth only $8,000, the debt is only partially secured—secured as to $8,000, and unsecured as to the remaining $2,000 of the debt.

Debts can be voluntarily or involuntarily secured. Examples of the latter are judgment liens on your home, IRS income tax liens on all your personal property, and a mechanic’s or repairman’s lien on a vehicle that’s been repaired and the repair bill not paid.

General Unsecured Debts

All debts that are not legally secured by collateral are simply unsecured debt. And “general” unsecured debts are simply those which do not belong to any of the categories of “priority” debts (discussed below). So general unsecured debts are the default category—if a debt is not secured and not a priority debt, it’s a general unsecured one. They include every imaginable type of debt or claim. Common ones include most credit cards, essentially all medical bills, personal loans without any collateral, bounced checks, most payday loans (although those sometimes have collateral), unpaid rent and utilities, balances left over after a vehicle is repossessed, many personal loans, and uninsured or underinsured motor accident claims against you.

Sometimes debts which were previously secured can become general unsecured ones, and vice versa. An example of the first: once you’ve surrendered all the collateral—such as a vehicle on a vehicle loan—any remaining debt is general unsecured. And an example of the second: a general unsecured medical bill can become secured after a lawsuit is filed against you and a judgment entered, resulting in a judgment lien attached to your real estate.

Priority Debts

Just like it sounds, priority debts are special ones that the law has selected to be treated better than general unsecured debts. In fact, there are very specific levels of priority among all the priority debts.

It’s all about who gets paid first (which often means who gets paid at all). This comes up in two main ways.

First, most Chapter 7 cases don’t involve the trustee receiving any of your assets for distribution to your creditors. But in those cases where there are non-exempt assets, the priority creditors are paid in full before the general unsecured ones receive anything. And the higher priority creditors are paid in full before the lower priority ones.

Second, in a Chapter 13 case, your formal plan has to show that you will pay all priority debts before the completion of your case, and then you must in fact do so before you are allowed to finish it.

The most common priority debts for consumers or small business owners are the following, in order starting from the highest priority:

• child and spousal support—amounts owed as of the time of the filing of the bankruptcy case

• the administrative costs of the bankruptcy case—trustee fees and costs, and in some cases attorney fees

• wages and other forms of compensation owed to employees—maximum of $10,000 per employee, for work done in the final 180 days before the bankruptcy filing or close of business, whichever was first

• certain income taxes, and some other kinds of taxes—some are priority but others are general unsecured if they are old enough and meet some other conditions

In the next blog I’ll get more into how debts in each category are treated in Chapter 7 and Chapter 13.

 

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Protecting Yourself When Your Business Has to Throw in the Towel

If you’re seriously considering closing down a struggling business, you are likely very concerned about personal damage control: how do you end the business without being pulled down with it?

My last blog was about saving your business through a Chapter 13 case. I can explore that option with you when you come in to see me, but let’s assume here today that either before or after talking with me you’ve made up your mind to close the business. And let’s keep it simpler by assuming that your business is or was a sole proprietorship, as I did in the last blog, and that you truly need bankruptcy relief because of the totally unmanageable size of the debts.

Lots of considerations come into play, but let’s focus on two main ones—assets and debts—in looking at three options: 1) a no-asset Chapter 7 case, 2) an asset Chapter 7 one, and 3) a Chapter 13 case.

No-Asset Chapter 7 for a Fast Fresh Start

After putting so much effort and hope into your business, once you accept the reality that you have to give up on it, you understandably may just want to clean up after it as fast as possible. And in fact a “straight bankruptcy” may be the most consistent with both your gut feelings and with your legal realities.

IF everything that you own—both from the business and personally—fits within the allowed asset exemptions, then your case will likely be relatively simple and quick. A no-asset Chapter 7 case is usually completed from start to finish in about three months. And if none of your assets are within the reach of the trustee, there is nothing to liquidate and distribute among your creditors. The liquidation and distribution process can take many additional months—or even years, so avoiding that streamlines a Chapter 7 case greatly.

But this assumes that all your debts can be handled appropriately in a Chapter 7 case—the debts that you want to discharge (write off) would be discharged and those that would not are ones that you either want to or are able and willing to pay. The debts you want to pay may include secured debts like vehicle loans and mortgages; debts you are able and willing to pay may include certain taxes, support payments, and perhaps student loans.

Asset Chapter 7 Case As a Convenient Liquidation Procedure

If you do have some assets that are not exempt, that alone may not be a reason to avoid Chapter 7. Assuming that those are assets that you can do without—and maybe even are happy to be rid of, such as if they came from your former business—letting the bankruptcy trustee mess with them instead of you doing so may be a sensible and fair way of putting the past behind you.

That may especially be true if you have some debts that you would not mind the trustee paying out of the proceeds of selling your non-exempt assets. You can’t predict with certainly how a trustee will act and how much if any would trickle down to which creditors, but this is something to keep in mind with this option.

Chapter 13 to Deal with the Leftover Consequences

Even if you’d prefer putting your closed business behind you quickly, there may be fallout from that business that a Chapter 7 would not deal with adequately. For example, if the business left you with substantial tax debts that cannot be discharged, non-exempt assets that you need to protect, or a significant mortgage arrearage, Chapter 13 could sometimes save you thousands of dollars and provide you protection from and a better way of dealing with these kinds of creditors. Deciding between Chapter 7 and 13 when different factors point in different directions is where you truly benefit from having an highly experienced bankruptcy attorney help you make that delicate judgment call.

 

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