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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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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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How Come My Attorney Cannot Always Tell me Which of My Debts Will be Discharged under Chapter 7?

Most of the time your attorney will know which debts will be legally written off in your bankruptcy. But not always, for two reasons.

 

A couple of blogs ago I made the point that the discharge order entered on your behalf by the bankruptcy judge will write off all of your debts, EXCEPT for those types of debts which are on a list in Section 523 of the Bankruptcy Code. The most common ones on the list include:

a. most but not all taxes

b. debts incurred through fraud or misrepresentation, including recent cash advances and “luxury” purchases

c. debts which were not listed on the bankruptcy schedules on time

d. money owed because of embezzlement, larceny, or through other kinds of theft or fraud in a fiduciary relationship

e. child and spousal support

f. claims against you for intentional injury to another person or property

g. most but not all student loans

h. claims against you for causing injury or death to someone by driving while intoxicated (also applies to boating and flying)

These different types of debts each deserve a closer look, which I will do in upcoming blogs. But let’s go back to the question in today’s title. Most of the time your attorney can reliably tell you whether a particular debt will be discharged in your bankruptcy case. But sometimes he or she will not know because:

1. With some types of debts—the ones described in items b, d, and f of the list above—the debt is discharged unless that creditor raises an objection by a specific deadline (which is usually 60 days after your meeting with the trustee). If you are candid with your attorney about the facts at the beginning of your case, he or she can tell you if there is a risk that a particular creditor will object to the discharge of its debt. Your attorney may even be able to tell you roughly how much of a risk you have, depending on the facts, and sometimes on the reputation of that creditor to object under similar facts. But whether the risk is high or low, with these types of debts neither your attorney nor you will know for sure whether that debt will be discharged until either the creditor objects or the deadline for objection passes without objection.

2. With the other types of debts—the ones described in items a, c, e, g, and h of the list above—at the beginning of the case sometimes either the facts are not sufficiently clear or how the law should be applied to the facts is not clear, or both. You might think that the attorney should get all the necessary facts before filing the case. But sometimes the facts are simply not available, the additional work to get them is not worth the cost, or there is no time to do so because of the need to file the case quickly. Add in the consideration that the bankruptcy statutes often use broad language that can be and is in fact interpreted differently by different judges. As a result, in these situations there is simply no absolute way to know at the start of the case whether a particular debt will be discharged.

Take as an example one of the types of debt listed—a claim against you for causing personal injury to someone by driving while intoxicated. You might think that sounds relatively clear. But not necessarily. What if the accident occurred in a rural area so that the police did not arrive on the scene until well after accident, making unclear whether you were “intoxicated”? What if there wasn’t enough evidence for a criminal conviction but possibly enough for a civil verdict against you? What if the injured driver was also arguably intoxicated? Under these kinds of circumstances, the pertinent facts may not be known until a possible future trial. And even if the facts were clear, the law may not be settled about how to apply those facts to come to a decision. So you can see that in these “gray areas” your attorney may well not be able to tell you in advance whether that particular debt will be discharged.

I need to finish by emphasizing again that most situations are not gray but are black and white, or at least close to it. So usually your attorney CAN tell you with a high degree of confidence whether any particular debts will or will not be discharged. Indeed, in a large percentage of Chapter 7 cases all debts that you want will be discharged. And if you have debts that won’t be discharged—such as support obligations or recent income taxes—that will be quite clear. The point of this blog has been to explain why there are some situations when it is not so clear, when your attorney must make a judgment call based on the likelihood of an objection by a creditor, or based on imprecise facts and/or law.

 

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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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Here’s What You Need to Know about the Discharge of Your Debts under Chapter 7

The point of filing bankruptcy is to get relief from your debts. So, when and how DO those debts get “discharged”—legally written off—in a regular Chapter 7 bankruptcy?

 

Here’s what you need to know:

1.      You WILL receive a discharge of your debts, as long as you play by the rules. Under Section 727 of the Bankruptcy Code, the bankruptcy court “shall grant the debtor a discharge” except in relatively unusual circumstances:

  • If you’re not an individual!  Corporations and other kinds of business entities do not receive a discharge of debts, only human beings do.
  • If you’ve received a discharge in an earlier case too recently. You can’t get a new discharge of your debts in a Chapter 7 case if:
    • you already received a discharge of debts in an earlier Chapter 7 case filed no more than 8 years before your present case was filed, or
    • you already received a discharge of debts in an earlier Chapter 13 case filed no more than 6 years before your present case was filed (except under limited conditions).
  • If you hide or destroy assets, conceal or destroy records about your financial condition.
  • If in connection with your Chapter 7 case you make a false oath, a false claim, or withhold information or records about your property or financial affairs.

2.      ALL your debts will be discharged, UNLESS a particular debt fits one of the specific exceptions. Section 523 of the Code lists those “exceptions to discharge.” I’m not going to discuss those exceptions in detail here, but the main ones include:

  • most but not all taxes
  • debts incurred through fraud or misrepresentation, including recent cash advances and “luxury” purchases
  • debts which were not listed on the bankruptcy schedules on time
  • money owed because of embezzlement, larceny, or through other kinds of theft or fraud in a fiduciary relationship
  • child and spousal support
  • claims against you for intentional injury to another person or property
  • most but not all student loans
  • claims against you for causing injury or death to someone by driving while intoxicated (also applies to boating and flying)                                                                                                                   

3.      A discharge from the bankruptcy court stops a creditor from ever attempting to collect on the debt. Under Section 524, the discharge order acts as a court injunction against the creditor from taking any action—through a court procedure or on its own–to “collect, recover, or offset any such debt.” If a creditor violates this injunction by trying to pursue a discharged debt, the bankruptcy court may hold the creditor in contempt of court and, depending on the seriousness of its illegal behavior, can require the creditor to pay sanctions.

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What Happens to Your “General Unsecured Debts” in Chapter 7?

Your “left-over debts”—those which are neither secured by collateral nor belong to any of the special “priority” categories—often don’t drive the decision about whether to file Chapter 7 or 13. But you still need to know how these “general unsecured debts” are handled under these two options.

Your secured debts often are tied to your most important possessions—home, vehicles, and sometimes business equipment. So it’s understandable that your bankruptcy decisions will focus on how you can hold on to the collateral you need. And your “priority” debts tend to involve your most aggressive creditors and often can’t be discharged in bankruptcy, so these also grab our attention. And yet, in the list of all your creditors you probably owe “general unsecured debt” to more of them than the other two categories combined. So what happens to these “left-over debts”?

I’ll cover this for Chapter 7 today, and then for Chapter 13 in my next blog.

What happens to your “general unsecured debts” in a Chapter 7 case depends on two very different considerations: 1) “dischargeability,” and 2) asset distribution.

“Dischargeability”

This term refers to whether your creditor will dispute your ability to get a discharge–a legal write-off—of that debt. The vast, vast majority of “general unsecured debts” ARE NOT challenged and so they are in fact discharged. In the rare case that your discharge of the debt is challenged, you may have to pay some or all of that particular debt, depending on whether the creditor is able to show that you fit within some rather narrow grounds for “nondischargeability.” That would usually involving allegations of fraud, misrepresentation or other similar bad behavior on your part.

Asset Distribution

If everything you own is exempt, or protected, then your Chapter 7 trustee will not take any of your assets from you. This is commonly referred to as a “no asset” case. But if the trustee DOES take possession of any of your assets for distribution to your creditors—an “asset case”—that does not necessarily mean that your “general unsecured creditors” will receive any of it. The trustee must first pay off any and all of your “priority” debts, AND pay the trustee’s own fees and that of any liquidating agents or other professionals used. Only if any funds remain will the unsecured creditors get to share in these “leftovers.”

 

To summarize, in most Chapter 7 cases your “general unsecured debts” will all be discharged, preventing those creditors from ever being able to pursue you for them. Also in most cases, this category of creditors will receive nothing from you, as long as all your assets are exempt. Relatively rarely, a creditor may challenge the discharge of its debt. And if you have an “asset case,” the trustee may pay a part or—very rarely—all of the “general unsecured debts.” But these can happen only if the “priority” debts and trustee fees do not exhaust all the funds being distributed by the trustee.

 

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