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If You File a Chapter 7 Bankruptcy with an Attorney You are Nearly Ten Times More Likely to Reach Your Goal of Writing Off Your Debts

Here’s some hard evidence on why it’s dangerous to file bankruptcy without an attorney.

 

As a bankruptcy attorney, I get many phone calls from people who have tried to file a bankruptcy by themselves and have gotten into trouble, sometimes serious trouble. I also run into similar horror stories about what happens when people file without an attorney when I attend “meetings of creditors”—the usually straightforward, usually short meeting with the bankruptcy trustee that everyone filing bankruptcy must attend. I’ve run into countless example of how dangerous it is to file bankruptcy without an attorney.

But I HAVE wondered whether anybody has actually investigated this question. Now somebody has, and we have some pretty solid evidence to back up what I have been witnessing anecdotally.

“The Do-It-Yourself Mirage: Complexity in the Bankruptcy System”

That is the title to a chapter in a book about bankruptcy called Broke: How Debt Bankrupts the Middle Class. This book is a series of articles about many important current issues in the field, with this one chapter focusing on cases filed by debtors not represented by attorneys (“pro se” filers).

The author of this chapter, Asst. Professor Angela K. Littwin of the University of Texas School of Law, analyzed data from the Consumer Bankruptcy Project, “the leading [ongoing] national study of consumer bankruptcy for nearly 30 years.” Her finding: “pro se filers were significantly more likely to have their cases dismissed than their represented counterparts.”

Very interestingly, she also learned from the data that

consumers with more education were significantly more likely than others to try filing for bankruptcy on their own, but that their education didn’t appear to help them navigate the process. Pro se debtors with college degrees fared no better than those who had never set foot inside a college classroom.

She concluded that after bankruptcy law was significantly amended back in 2005 in an effort to discourage as many people from filing, “bankruptcy has become so complex that even the most potentially sophisticated consumers are unable to file correctly.”

Ten Times More Likely to Get a Discharge of Your Debts

In a closely related study, Prof. Littwin stated that “17.6 percent of unrepresented [Chapter 7 “straight bankruptcy”] debtors had their cases dismissed or converted” into 3-to-5-year Chapter 13 “adjustment of debts” cases.  “In contrast, only 1.9 percent of debtors with lawyers met this fate.”  Even after controlling for other factors such as “education, race and ethnicity, income, age, homeownership, prior bankruptcy, whether the debtor had any nonminimal unencumbered assets at the time of the filing,” “represented debtors were almost ten times more likely to receive a discharge than their pro se counterparts.”

Prof. Littwin concluded that “filing pro se dramatically escalates the chance that a Chapter 7 bankruptcy will not provide a person with debt relief.”

 

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Taking Advantage of the Rigidity of the Chapter 7 “Means Test”

Because of how precisely the amount of your “income” is calculated, filing bankruptcy just a day or two later can make all the difference.

 

Passing the “Means Test”

Our last blog post was about most people passing the “means test” by making no more than the median income for their state and family size. We also made clear that “income” for this purpose has a very broad meaning, by including non-taxable received from irregular sources such as child and spousal support payments, insurance settlements, cash gifts from relatives, and unemployment benefits. Also, we showed how time-sensitive the “means test” definition of “income” is in that it is based on the amount of money received during precisely the 6 FULL CALENDAR months before the date of filing. This means that your “income” can shift by waiting just a month or two, or even by waiting just a few days until the turn of the month (since that changes which 6 months of income is at issue).

Why is the Definition of “Income” for the “Means Test” So Rigid?

One of the much-touted goals of the last major amendments to the bankruptcy law in 2005 was to prevent people from filing Chapter 7 who were considered not deserving. The most direct means to that end was to try to force more people to pay a portion of their debts through Chapter 13 “adjustment of debts” instead of writing them off Chapter 7 “straight bankruptcy.”

The primary tool intended to accomplish this is the “means test,” Its rationale was that instead of allowing judges to decide who was abusing the bankruptcy system, a rigid financial test would determine who had the “means” to pay a meaningful amount to their creditors in a Chapter 13 case, and therefore could not file a Chapter 7 case.

The Unintended Consequences of the “Means Test”

The last blog post explained the first part of the means test: comparing the income and money you received from virtually all sources during the six full calendar months before filing bankruptcy to a standard median income amount for your state and your family size. If your income is at or under the applicable median income, then you generally get to file a Chapter 7 case. If your income is higher than the median amount, you may still be able to file a Chapter 7 case but you have to jump through a whole bunch of extra hoops to do so. Having income below the median income amount makes qualifying for Chapter 7 much simpler and less risky.

Filing your case a day earlier or later can matter so much because of the means test’s fixation on the six prior full calendar months, AND because you include ALL income during that precise period (other than social security). 

So if you receive some irregular chunk of money, that can push you over your applicable median income amount, and jeopardize your ability to qualify for Chapter 7.  

An Example

It does not necessarily take a large irregular chunk of money to make this difference, especially if your income without that is already close to the median income amount. An income tax refund, some catch-up child support payments, or an insurance settlement or reimbursement could be enough. 

Imagine having received $3,000 from one of these sources on October 15 of last year. Your only other income is from your job, where make a $42,000 salary, or $3,500 gross per month. Let’s assume the median annual income for your state and family size is $45,000.

So imagine that now in the early part of April 2014, your Chapter 7 bankruptcy paperwork is ready to file, and you would like to get it filed to get protection from your aggressive creditors. If your case is filed on or before April 30, then the last six full calendar month period would be from October 1, 2013 through March 31, 2014. That period includes that $3,000 extra money you received in mid-October. Your work income of 6 times $3,500 equals $21,000, plus the extra $3,000 received, totals $24,000 received during that 6-month period. Multiply that by 2 for the annual amount—$48,000. Since that’s larger than the applicable $45,000 median income, you would have failed the income portion of the “means test.”

But if you just wait to file until May 1, then the applicable 6-month period jumps forward by one full month to the period from November 1 of last year through April 30 of this year. Now that new period no longer includes the $3,000 you received in mid-October. So now your income during the 6-month period is $21,000, multiplied by 2 is $42,000. This results in your income being less than the $45,000 median income amount. You’ve now passed the “means test,” and qualified for Chapter 7. 

 

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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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You Can Write Off Some Income Taxes with a “Straight Bankruptcy”

Chapter 13 can be a great way to deal with tax debts. But you don’t always need it, or its 3-to-5-year payment plan.

 

Chapter 7 vs. 13 for Income Taxes

Thinking that the only way to handle your income tax debts in bankruptcy is through Chapter 13 is a misunderstanding of the law. It’s an angle on the broader error thinking that you can’t write off taxes in a bankruptcy.

Both are understandable mistakes.

It is true that some taxes cannot be discharged (legally written off) in bankruptcy. But some can be.

And it is true that Chapter 13 can be the best way to solve many income tax problems. But that does not necessarily mean it is the best for you. Chapter 7 might be instead.

When Chapter 13 Is Better

Chapter 13 tends to be the better option if you owe a string of income tax debts, and especially if some are relatively recent ones. That’s because in these situations Chapter 13 solves two huge problems in one package.

First, if you owe recent income taxes which cannot be discharged, you get lots of advantages under Chapter 13, including paying less by avoiding most penalties and interest. That can be a huge savings, especially if you can afford only relatively small payments. Indeed the amount you pay each month is based on what you can afford to pay. You can often even hold off on paying anything towards the back taxes while you first pay even more important debts—such as back child support, or home mortgage arrearage.

Second, if you have older back taxes, under Chapter 13 you pay these only to the extent that you can afford to do so after first paying your more recent taxes. Then whatever of these older taxes are not paid during your case are discharged at the end of it.

When Chapter 7 is Better

But you don’t need the Chapter 13 package if all or most of your income tax debts are dischargeable. In that situation, the generally much simpler Chapter 7 could be enough.

So, what makes an income tax debt dischargeable under Chapter 7?

The Conditions for Discharging Income Taxes

Some of the conditions for determining which taxes can be discharged are quite straightforward, but some are more complicated. It’s not as simple as applying a simple formula to any particular tax debt to see if it is dischargeable. Figuring out whether a particular tax debt will be discharged requires the careful judgment of an experienced attorney.

The conditions for discharging income taxes are listed here, and then will be explained in the next blog. As listed, they may well not make perfect sense, so make sure you see the next blog post.

To discharge an income tax debt in a Chapter 7 case, it must meet these conditions:

1) 3 years since tax return due: The tax return for the pertinent tax must have been due more than three years before you file your Chapter 7 case. Also, if you requested any extensions for filing the applicable tax returns, add that extra time to this three-year period.

2) 2 years since tax return actually filed: Regardless when the tax return was due, you must have filed at least two years before your bankruptcy is filed in court.

3) 240 days since “assessment”: The taxing authority must have assessed the tax more than 240 days before the bankruptcy filing.

4) Fraudulent tax returns and tax evasion: You cannot file a “fraudulent return” or “willfully attempt in any manner to evade or defeat such tax.”

These four conditions need clarification, which will be provided in the next blog post.

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What Are Priority Debts and Why Are They Important?

You may or may not know that all of your debts are not all treated equally in bankruptcy.

Most debts can be “discharged” (legally written-off), but some can’t be, or only in certain situations. Some debts have no collateral—they are unsecured—while other debts are secured by collateral.

A secured debt can be treated differently depending on how much the collateral is worth compared to the amount of the debt it secures, and depending on whether you intend to surrender or retain the collateral.

A handy starting point in understanding debts in bankruptcy is to divide all debts into three categories: secured debts, unsecured debts, and “priority” debts. Today’s blog is on this last category.

Priority debts are a list of special debts which Congress has decided deserve special treatment, and in certain circumstances should get paid through your bankruptcy case ahead of other debts.

For consumers this priority list only comes into play with “asset” Chapter 7 cases and with Chapter 13 cases. This blog will cover the “asset” Chapter 7 cases; the next one will cover Chapter 13.

10 Different Priority Debts

There are 10 different priority debts. They are listed in the Bankruptcy Code in order of priority. So not only do priority debts usually get paid in a bankruptcy case before debts that are not priority debts, the priority debts themselves get paid in the order that they show up on the list.

Most of the 10 different kinds of priority debts are not applicable to a conventional consumer bankruptcy. But two of them are quite common: 1) child and spousal support arrearage, and 2) tax debts of various kinds. The support debt is listed as a higher priority than taxes, and indeed is the highest one on the entire list.

Most Chapter 7 cases are “no asset” ones—all your assets are protected from creditors through “exemptions,” so you keep everything you own and nothing goes to the Chapter 7 trustee to distribute to your creditors.

But in an “asset” Chapter 7 case you own something that is not covered by any exemption, so the trustee can take, sell, and distribute its proceeds to your creditors.

If you have a particular “non-exempt” asset, perhaps something that you do not mind surrendering to the trustee, and if you owe a priority debt, a Chapter 7 case can be way to turn these to your benefit.

Most priority debts are not dischargeable in a Chapter 7 case—such as support arrearage and most debts—so it’s beneficial to have the trustee use your unprotected asset as the means to paying off or paying down a support arrearage or tax.

Here’s an illustration. Assume you own a boat free and clear with a marketable value of $4,000 that you admit that you can’t afford to keep any longer, it is not exempt, and so you would surrender it to your Chapter 7 trustee.

You owe $1,000 in last year’s income taxes, plus $2,000 in back child support. Theoretically you could have sold the boat before filing bankruptcy and paid the taxes and support, but you may not have time if you were trying to stop a garnishment or some other creditor action.

In this case, the Chapter 7 trustee would sell the boat, pay herself a trustee fee (25% of the first $5000 collected, so $1,000 here), pay first the support obligation and then the tax debt. If the boat indeed sold for $4,000, you would finish your Chapter 7 case owing neither of those priority debts, and hopefully with all your other debts discharged.

You can see by this illustration that a carefully planned Chapter 7 can be a good tool in these kinds of situations.

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Business Tax Debts-the Myths and the Truth

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Bankruptcy can often help you deal effectively with business taxes. Here are three myths, and the truth exploding them.



Myth #1: Bankruptcy can’t write off taxes.




Truth: Some taxes can’t be written off. But many others CAN be through either a Chapter 7 “straight bankruptcy” or a Chapter 13 “adjustment of debts.” This depends on a number of rather complicated factors, including the following:



  • whether you filed a tax return for the tax year at issue
  • if so, when that tax return was filed
  • how long it’s been since that tax was first due
  • whether and when you asked to get a compromise of that tax
  • whether you tried to evade that tax in any way



So any particular tax you may owe has to be analyzed carefully with your attorney. But don’t start with the assumption that your taxes can’t be written off, or dealt with in some other favorable way.




Myth #2: Business taxes particularly can’t be written off.




Truth: Income that you pay yourself from your business is generally treated as your personal income. And particularly if your business is a sole proprietorship or a partnership, then your share of the business’ income (after expenses) flow through to you as personal income.




If your business is a corporation, then your salary or any other form of income you receive from the business is generally treated as personal income. The income tax on these various sources of “business” income can be written off just like any personal income tax from a conventional employer, depending on the same factors listed above.




If any of your taxes can’t be discharged in either a Chapter 7 or 13 case, Chapter 13 would nevertheless give you 3-to-5 years to pay those taxes, while under the protection of the IRS (and any applicable state tax authorities). Also, usually all interest and penalties which would otherwise have accumulated during this time would be waived, as long as you finished the case successfully.




Furthermore you can often pay less–and maybe even nothing—to your other creditors, allowing instead for your money to go to pay off the taxes. So at the completion of your case you would owe nothing in either taxes or any other debts.




Myth #3: Bankruptcy particularly does not help with unpaid employee withholding taxes that as an employer you were supposed to turn over to the IRS or state.




Truth: Although bankruptcy never discharges this category of taxes, in a Chapter 13 case these withholding taxes are basically treated just like other taxes that can’t be discharged, as discussed immediately above.




So you would have years to pay off those withholding taxes, all while being protected from the tax authorities, and usually with the interest and penalties not accruing.




Finally, usually you’d be allowed to pay these taxes while paying less or nothing to many of your other creditors. These are huge advantages.



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More Good Examples of How Bankruptcy Really Helps Even When You Can’t Write Off Every Debt

Three more very practical ways that bankruptcy works to let you take control of your debts, even those that can’t be written off.


Two blogs ago I gave six reasons why it’s worth looking into bankruptcy even when you can’t discharge (write off) one or more of your debts. Today here are the final three of those reasons, each one paired with a concrete example illustrating it.

Reason #4: Taking control over the amount of the monthly payments.

The taxing authorities, support enforcement agencies, and student loan creditors have extraordinary power to take your money and your assets if you fall behind in paying them. Because of that tremendous leverage, you normally have no choice but to play by their rules about how much to pay them each month. Chapter 13 largely throws their rules out the window.

Let’s say you owe $15,000 to the IRS—including interest and penalties—from the 2010 and 2011 tax years, resulting from a business that failed. You’ve now got a steady job but one that gives you very little to pay the IRS after taking care of your very basic living expenses. The IRS is requiring you to pay that debt, plus ongoing interest and penalties, within 3 years. And it calculates the amount you must pay it monthly without any regard for your other debts, or for your actual living expenses. Even if you did not have unexpected expenses during those 3 years, paying the required amount would be extremely difficult. But if your vehicle needed a major repair or you had a medical problem, keeping up those payments would become absolutely impossible.  But the IRS gives you no choice.

In a Chapter 13 case, on the other hand, the repayment period would stretch out to as long as five years, which lowers the monthly payment amount. And instead of a rigid mandatory monthly payment going to the IRS, how it is paid in Chapter 13 is much more flexible. For example, if in your situation money was very tight now but you could more each month later—for example, after paying off a vehicle loan—you would likely be allowed to make very low or even no payments to the IRS at the beginning, as long as its debt was paid in full by the end. Also, you would be allowed to budget for vehicle maintenance and repairs, and medical costs, and other reasonable expenses, usually much more than the IRS would allow. And if you had unexpected vehicle, medical, or other necessary expenses beyond their budgeted amounts, Chapter 13 has a mechanism for adjusting the original payment schedule. Throughout all this, you’d be protected from the IRS.

 Reason #5: Stopping the addition of interest, penalties, and other costs.

Under the above facts, if you were not in a Chapter 13 case, the IRS would be continuously adding interest and penalties. So that much less of your monthly payment goes to reduce the $15,000 owed, significantly increasing the amount you need to pay each month to take care of the whole debt in the required 3 years.

In Chapter 13, in contrast, unless the IRS has imposed a tax lien, no additional interest is added from the minute the case is filed. No additional penalties get added. So not only do you have more time to pay off the tax debt, and much more flexibility, you have also have significantly less to pay before you finish off that debt.

Reason #6: Focusing on paying off the debt that you can’t discharge by discharging those you can.

This may be obvious but can’t be overemphasized: often the most important and direct benefit of bankruptcy is its ability to clear away most of your debt burden so that you can put your financial energies into the one that remain.

Back to our example of the $15,000 IRS debt, let’s say the person also owes $20,000 in credit cards, $5,000 in medical bills, and a $6,000 deficiency balance on a repossessed vehicle. Discharging these other debts would both free up some of your money for the IRS and avoid the risk that those other creditors could jeopardize your payments to the IRS.   Entering into a mandatory monthly payment arrangement with the IRS when at any moment you could be hit with another creditor’s lawsuit and garnishment is a recipe for failure.

Instead, a Chapter 7 case would very likely discharge all of the credit card, medical and old vehicle loan debts. With then gone you would have a more sensible chance getting through an IRS payment arrangement.

In a Chapter 13 case, you may be required to pay a portion of the credit card, medical and vehicle debts, but in return you get the benefits of getting long-term protection from the IRS, a freeze on interest and penalties, and more flexible payments.

So whether Chapter 7 or Chapter 13 is better for you depends on the facts of your case. Either way, you would pay less or nothing to your other creditors so that you could take care of the IRS. Either way, you would much more likely succeed in becoming tax free and debt free, and would get there much quicker.

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Paying Your Special Creditor After Filing Bankruptcy

If you file bankruptcy, it’s okay to voluntarily repay any debt. But there can be unexpected consequences.


The Bankruptcy Code says “[n]othing…  prevents a debtor from voluntarily repaying any debt.” Section 524(f).

But that doesn’t mean that repaying a debt won’t have consequences, including sometimes some highly unexpected ones. So what are those consequences?

To start off let’s be clear that we’re NOT talking about a creditor which you want to pay because it has a right to repossess collateral that you want to keep. Nor is this about paying a debt because the law does not let you to discharge (write off) it. Those two categories of debts—secured debts and non-dischargeable ones—have their own sets of rules governing them. We’re talking here about voluntary repayment, paying a debt even though you’re not legally required to.

And let’s also make a big distinction about the timing of those voluntary payments. We’re NOT talking here about payments made to creditors BEFORE the filing of bankruptcy. That was covered in the last blog. Be sure to check that out because the consequences of paying certain creditors at certain times before bankruptcy can be very surprising and frustrating, seemly going against common sense.

Instead, today’s blog is about paying creditors AFTER filing your bankruptcy case. The straightforward rule here is that you can pay your special creditor after filing a “straight” Chapter 7 case, but can’t do so in a “payment plan’ Chapter 13 case. For that you must wait until the case is completed, which is usually three to five years after it starts. So, if you would absolutely want to start making payments to a special creditor—such as a relative who lent you money on a personal loan—right after filing your bankruptcy case, you would have to file a Chapter 7 case instead of a Chapter 13 one.

Why is there such a difference between Chapter 7 and 13 for this? Basically because Chapter 7 fixates for most purposes on your financial life as of the day your case is filed, while Chapter 13 cares about your financial life throughout the length of the payment plan. You can play favorites with one of your creditors right after your Chapter 7 is filed because doing so doesn’t affect your other creditors. In contrast, in a Chapter 13 case your payment plan is designed so that you are paying all you can afford in monthly payments to the trustee to distribute to the creditors in a legally appropriate fashion. Here the law does not allow you to favor one creditor over the other ones just because you have a special personal or moral reason to do so. You can only favor a creditor AFTER the case is completed, again usually three to five years after filing.

So what would the consequences be of paying your special creditor “on the side” during an ongoing Chapter 13 case? The simple answer is that it’s illegal so don’t do it. Beyond that it’s difficult to answer because it would depend on the circumstances of the case (such as how much you paid inappropriately) and would depend on the discretion of the Chapter 13 trustee and of the bankruptcy judge. You’d be risking having your entire Chapter 13 case be thrown out. You would be wasting a tremendous investment of time and money, risking years of your financial life. Clearly, things you want to avoid.

Instead, talk very candidly with your attorney about your special debt and why you are so committed to paying it. There are usually sensible ways for dealing with these kinds of situations once it’s all out on the table. Your attorney’s job is to present options to you for meeting your goals, including that of paying this special creditor. He or she will only be able to do that for you if you make clear that you want to pay off this creditor and explain why.

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Can I Do a “Cramdown” on Collateral Other than My Home or Vehicle?

If you buying something on time and want to keep it, you often can do so for less money IF you bought it more than a year ago.

 

Background:

  • A creditor which has rights to collateral is called a “secured creditor.” Your obligation to pay what you owe to this creditor is secured by rights it has to take possession and ownership of the collateral if you don’t make your payments on the debt. 
  • In bankruptcy, secured creditors have a lot more leverage against you because of the collateral than do creditors without any collateral—“unsecured creditors.”
  • If you want to keep the collateral, Chapter 7 is sometimes is your best choice, but in many circumstances Chapter 13 can give you more options.
  • Secured debts in which the collateral is your home or your vehicle are governed by special rules because of how important those kinds of collateral are to most people. See my blogs of last week and earlier about some of these special rules.
  • But you will not find many blogs talking about secured debts where the collateral is something other than your home or vehicle. The main secured debts of this type are probably furniture and appliance purchases, money loans secured by your own personal assets, and business loans secured by business and/or personal assets.

Cramdown:

  • This tool applies only to Chapter 13—it can’t be done in Chapter 7.
  • If the collateral securing a secured debt is worth less than the balance on that debt, then you may be able to divide that debt into two parts: the secured part—the amount of the debt up to the value of the collateral, and the unsecured part—the rest of the debt beyond the value of the collateral. An example will make that clear. Let’s say you owed $1,000 on a refrigerator, in which the purchase contract gave the creditor the right to repossess that refrigerator if you didn’t make the agreed payments. If the present value of that refrigerator is $600, then the secured portion of that debt would be $600, and the remaining $400 of that debt would the unsecured portion.
  • In a Chapter 13 “cramdown” you pay not the total debt, but only the secured part of the debt. You pay the unsecured part of the debt only at the percentage that all the rest of your regular unsecured creditors are paid. That is usually less than 100% and can sometimes be a low as 0%. In the above example, the $1,000 total refrigerator debt is crammed down to $600, and the remaining $400 part of the debt is lumped in with the rest of your unsecured creditors. So if in your Chapter 13 plan your unsecured creditors are receiving 0%, then you would pay only the $600 secured portion, the remaining unsecured portion would get nothing and would be discharged (written off) at the end of your Chapter 13 case. Or if your unsecured creditors are receiving 50%, then you would pay $200 of that unsecured portion of $400, and the rest would be discharged at the end of your case. Note that you would still pay interest, but only on the secured portion instead of on the entire balance.  

THE cramdown rule with collateral other than your home or vehicle:

  • “[I]f the debt was incurred during the 1-year period preceding [the bankruptcy] filing” then you cannot do a cramdown on collateral that is neither your home nor your vehicle. See the last sentence of Section 1325(a) of the Bankruptcy Code (tucked in right after subsection (a)(9)). This means that if the debt is any older than 1 year, you CAN do a cramdown.

So, if you have a debt, more than 1 year old, secured by something other than your home or vehicle(s), in which the collateral is worth less than the debt, you can cram down the debt to the value of the collateral. If so, then because this can only be done under Chapter 13, that would be one factor in favor of filing under Chapter 13 instead of Chapter 7. Talk to your attorney to see if this applies to you, and to find out all the other Chapter 7 vs. Chapter 13 factors to weigh in your situation.

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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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