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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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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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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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Business Litigation Worth Fighting About in Bankruptcy

The closing of your business, followed by your personal bankruptcy filing, often ends threatened or ongoing business litigation against you. But here are three situations where that litigation could well continue regardless of the bankruptcy.

What is No Longer Worth Fighting About

Most debts or claims against you at the time of your bankruptcy filing are resolved for all legal purpose by the filing of your bankruptcy case. Now there is no longer any benefit for the creditor to initiate previously threatened litigation or to continue the pending litigation. If you filed a Chapter 7 bankruptcy case, most if not all of your business and personal debts which you want to discharge will in fact be discharged. The creditors will either receive nothing or will receive a pro rata portion of any of your non-exempt assets. If you filed a Chapter 13 case, your creditors will receive whatever your court-approved plan provides, often pennies on the dollar of whatever you owe. There is usually not much worth starting or continuing to fight about.

What IS Worth Fighting About

But there ARE some types of debts or claims that DO still need court resolution. In these situations the creditor or adversary would likely get permission from the bankruptcy judge to either continue the pending litigation or initiate it.

1) Determining the Amount of a Debt

If a debt or claim is being discharged in a no-asset Chapter 7 case, the amount of that debt makes no practical difference. But in an asset Chapter 7 case, in which the bankruptcy trustee is anticipating a pro rata distribution of assets to the creditors, the amounts of all the debts need to be determined in order for that distribution to be fair to all the creditors. Same thing occurs in Chapter 13 cases in which the creditors are being paid a portion of their claims but not in full, since the amount of any allowed claim affects the distribution received by all the creditors.

Usually disputes about the amount of a the claims are resolved in bankruptcy court, by the creditor or trustee objecting to a proof of claim filed by the creditor. But in relatively complex disputes, especially ones already pending in another court, , the bankruptcy court may allow the amount of the debt to be resolved in that other court.

2) Potential Insurance Coverage of the Debt

If a claim against the debtor is potentially covered by insurance, then often all the affected parties want the dispute to be resolved. Issues needing resolution include whether the debtor is liable for damages, whether those damages are covered by the insurance, and whether the policy limits are enough to cover all the damages or instead leaves the debtor personally liable for a portion. Examples include:

• vehicle accidents involving the business’ employees or owners, especially those with multiple drivers

• claims on business equipment damaged by fire or flood

• various business losses potentially covered by your business owner’s policy, such as an employee’s embezzlement, or an injury to a non-employee on the business premises

In these situations the bankruptcy court will likely give permission for the litigation to proceed outside of bankruptcy court, with appropriate conditions about not pursuing the debtor for any amount not covered by insurance.

3) Nondischargeable Debts

The biggest fights about business-related debts arise when a creditor or claimant argues that its debt or claim should not be discharged in the bankruptcy case. This challenge goes to the heart of the bankruptcy case—the debtor’s desire to get a fresh start without being burdened any longer by the debts connected to the failed business.

These discharge fights apply to both Chapter 7 and Chapter 13. In the past, Chapter 13 did not allow creditors to raise many of the kinds of challenges to the dischargeability of debts allowed under Chapter 7. But the major 2005 bankruptcy amendments for the first time opened the door in Chapter 13 to many of those same challenges. Because Chapter 13 is often a better solution for debtors who have closed a business (for example, it is often a better way to deal with certain business-related debts such as nondischargeable taxes), in the last few years there have been a significant number of dischargeability challenges by creditors in Chapter 13.

 

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A Big Benefit to Owing Lots of Business Debt: Skip the “Means Test” and Qualify for Chapter 7

If you owe more business debt than consumer debt, then you avoid not only the “means test” but also some other roadblocks to a successful post-business Chapter 7 bankruptcy case.

What’s the “Means Test” and Why it Matters?

Bankruptcy law says that if your income is more than a certain amount, you have to pass a “means test” to be able to go through a Chapter 7 case successfully. One way to avoid this “means test” is by having less income than the permitted “median family income.” But the “median family income” amounts are relatively low. If your income is at all above the applicable median amount, you have to go through the “means test,” with a significant risk of being forced into a 3-to-5-year Chapter 13 payment plan instead of three-month Chapter 7 “liquidation.”

Debtors with More Non-Consumer Debts than Consumer Debts

You can skip the “means test” altogether if your debts are NOT “primarily consumer debts.” This way you could be eligible for a Chapter 7 case even if your income is above the median level. Indeed, you avoid other kinds of “presumptions of abuse” as well, not just the formulaic “means test,” but also the broader “totality of circumstances” challenges. Congress has seemingly decided that if your debts are mostly from a failed business venture, you should be permitted an immediate Chapter 7 “fresh start,” regardless of your current income and expenses.

What is a “Consumer Debt”?

The Bankruptcy Code defines a “consumer debt” as one “incurred by an individual primarily for a personal, family, or household purpose.”

The focus is on the purpose for which you incurred the debt in the first place. If you made a credit purchase or took out the loan exclusively, or even mostly, for your business, then it may well not a “consumer debt.” That is a factual question that must be decided separately for each one of your debts.

“Primarily Consumer Debts”?

The Bankruptcy Code does not make this crystal clear, but generally if the total amount of consumer debt is less than the total amount of non-consumer debts, your debts are not “primarily consumer debts.” And then you do not have to mess with the “means test.”

Seemingly Consumer Debts May Not Be

Small business owner often financed the start-up and ongoing operation of their businesses with what would otherwise appear to be consumer credit—credit cards, home equity lines of credit and such. Given their purpose, these may qualify as non-consumer debts in calculating whether you have “primarily consumer debts.” This is definitely something to discuss with your attorney to consider how the local judges are interpreting this issue.

Unexpectedly High Business Debts Can Help

Sometimes business owners have business debts larger than they thought they had, which could push their non-consumer debt higher than their consumer debt. For example, if you had to break a commercial lease when you closed your business, the unpaid lease payments projected out over the intended term of the broken lease could be huge. Or your business closure may have left you with other hidden debts, such as obligations to business partners or unresolved litigation, with tremendous damages owed. The silver lining to these larger-than-expected business debts is that they may allow you to skip the “means test” and other grounds for dismissal or conversion to Chapter 13, allowing you to discharge all your debts through a Chapter 7 case when you could not have otherwise.

 

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