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Your Vehicle Loan Options in a Chapter 7 “Straight Bankruptcy” Case

For many people, no debt has more practical importance than their car or truck loan.

 

Whether you want to keep your vehicle or get rid of it, and whether you are current or behind on your payments, Chapter 7 bankruptcy strengthens your hand in every way.

The “Automatic Stay” Gives You the Chance to Decide to Keep or Surrender

As long as you file your Chapter 7 case before your vehicle gets repossessed, your lender can’t repossess it once you do file. The same “automatic stay” law that stops all your creditors from calling you, suing you, and garnishing your wages also stop your vehicle lender from repossessing your vehicle—at least for a month or so while you decide whether to keep your car or not, if you haven’t already decided one way or the other.

Surrendering Your Vehicle

If you decide to surrender your vehicle, Chapter 7 bankruptcy is often the best way to do so. The reason is because with most vehicle loans even after surrendering the vehicle you would still owe money to your lender after the surrender, often a much larger amount than you would think. This “deficiency balance” is the amount you owe after the lender repossesses the vehicle, sells it—usually at an auto auction, pays itself its costs of repossession and sale out of the proceeds of sale, and then pays the rest of the proceeds towards your loan’s interest, late fees, and principal balance.

Because of the relatively low sale price of your vehicle at an auto auction, and the relatively high repossession and sale costs, in the end you often have a very hefty debt, and no vehicle. Because at that point you’re understandably not all that motivated (or able) to pay this remaining debt, the lender would then usually sue you to make you pay it.  

 

Surrendering your vehicle during your Chapter 7 case allows you to legally and permanently write off (“discharge”) that entire remaining debt, instead of having it hang over you.

Keep Your Vehicle

If you want to keep your car or truck, whether you are current on your loan, and if not how quickly you can catch up, are crucial.

If You Are Current

If you want to keep your vehicle and are current at the time your Chapter 7 case is filed, and can keep making the payments on time (especially after discharging your other debts), it’s simple: you can essentially keep your vehicle loan out of your bankruptcy case. You’d usually sign a “reaffirmation agreement” stating that you intend to hang onto your vehicle and giving your consent to not discharging the vehicle loan in your Chapter 7 case.

If you owe more on the loan than your vehicle is worth, you should think twice about signing a “reaffirmation agreement.” That’s because doing so makes you continue to be liable on a debt you could be discharging in bankruptcy. Instead carefully consider whether you should surrender it and dump the debt. It’s your one chance to do so. Otherwise you would risk being unable to make your payments later, losing the vehicle to repossession, and owing a large deficiency balance because you had “reaffirmed” the debt in your bankruptcy case.

Unfortunately you can’t “have your cake and eat it too”: you usually can’t keep a vehicle that you owe on without reaffirming the debt. Most conventional vehicle loan creditors insist that you sign a “reaffirmation agreement” for the full balance of the loan, even if your vehicle is worth less than that.

But sometimes, especially with smaller lenders, you may be able to avoid “reaffirming” the vehicle debt, or can “reaffirm” at a lower balance. Talk with your attorney about what’s possible with your own lender.

If You Are Not Current

If you want to keep your vehicle and aren’t current on the vehicle loan at the time your Chapter 7 case is filed, your options are limited. You would usually need to get current very quickly to be able to keep the vehicle—usually within a month or two. Most vehicle lenders will not allow you to skip the missed payments or even to catch up on those payments over time—although a minority of them will allow some flexibility.

But for the majority of lenders who insist on a full “reaffirmation” of the vehicle loan balance, they’ll demand that you get current within weeks after you file your case. One reason is because for a “reaffirmation agreement” to be legally valid, it has to be filed with the bankruptcy court before the debt is discharged, which happens in most cases about three months after it’s filed. So the lender insists that you get current well before that so that the “reaffirmation agreement” can be prepared, signed, and filed at court in time.   

Again, talk with your attorney to find out if your lender is one of the uncommon more flexible ones.

Much greater Flexibility through Chapter 13

If you need or want to keep your car or truck but are behind on payments and can’t catch up within a month or two after filing, consider the Chapter 13 “adjustment of debts” option instead of Chapter 7. Chapter 13 may not only give you more time to catch up on those back payments, but may even substantially reduce your monthly payments, the interest rate, and the total amount to be paid on the loan. I’ll discuss these Chapter 13 tools in my next blog post.

 

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What Happens to Most of Your Debts under Chapter 13 “Adjustment of Debts”?

In most Chapter 7 “straight bankruptcy” cases most debts are written off, so what happens to them in a Chapter 13 “adjustment of debts”?

 

The Advantages and Disadvantages of Chapter 13

Chapter 13 comes with many, many tools not available under Chapter 7. Many of these tools are helpful particularly if you have special debts or issues not deal with well in a Chapter 7 case—if you are behind on your mortgage, vehicle loan, or child support, if you owe income or property taxes, or if you have non-exempt (unprotected) assets you want to keep.

But these advantages come with what can be a significant disadvantage: you would usually have to pay something on your “general unsecured” debts—your run-of-the-mill ones without any collateral. That’s instead of paying nothing, as you likely would in a Chapter 7 case.

In some rare Chapter 13 cases you have to pay your “general unsecured” creditors in full—a so-called 100% plan. But on the other extreme, you may not have to pay those creditors anything—a 0% plan. Most of the time you have to pay them something, but often very little—only a few cents on the dollar.

How Much Do You Need to Pay Your “General Unsecured” Debts?

You must pay these debts whatever money is left over and available based on your budget after paying certain secured debts (home mortgage and vehicle arrearage, for example) and “priority” debts (recent income taxes, for example). So how much you have to pay on the debts that in a Chapter 7 case would be just discharged (written off without any payment) depends on your income, allowed expenses, and other debts, and sometimes also on the value of assets that you are trying to protect.

Here is a list of considerations in greater detail about how this works under Chapter 13.

1. Debts that are legally the same are treated the same. So, in a Chapter 13 plan all “general unsecured” debts are paid the same percent of the debt as are other “general unsecured” debts.

2. For any creditor to get paid anything out of what you are paying into a Chapter 13 plan, it has to file a “proof of claim”—stating the amount and nature of the debt—with the bankruptcy court, and do so by the stated deadline. If a creditor with a “general unsecured” debt does not file a “proof of claim” it will receive nothing through the plan. The debt will then be discharged at the end of the completed case.

3. If, as is often the case, other creditors do not file proofs of claim that usually, but not always, means more money available for the other creditors.

4. “0% plans” are those in which all of the money paid by the debtor into the plan is earmarked to pay secured and “priority” debts, plus trustee and attorney fees, leaving nothing for the “general unsecured” ones. Some bankruptcy courts frown on “0% plans,” either in general or especially when there does not seem to be good reason to be in a Chapter 13 case instead of a Chapter 7 one.

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

a. have enough disposable income (income minus allowed expenses) over the course of the case to pay off their debts in full; or

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

6. How much “general unsecured” debts are paid depends in part on how long the debtors are required to pay into their Chapter 13 case. Generally, if debtors’ pre-filing income is less than the published “median income” for their applicable state and family size, then they pay for 3 years into their plan. If their income is more than that amount, they must pay for 5 years instead.

7. Payments on “general unsecured” debts can also be affected by changes that happen during the case, such as income increases or decreases affecting the monthly plan payment amount, and unexpected tax refunds and employee bonuses paid into the plan.

8. Once the “general unsecured” debts are paid whatever the Chapter 13 plan provides for them (and the rest of the plan requirements are met), the remaining balances of those debts are discharged.

 

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What Happens to Most of Your Debts in Chapter 7 “Straight Bankruptcy”?

Your debts that are not secured by collateral and are not “priority” debts are discharged (written off) and paid nothing. Mostly.

 

In my blog post last week I introduced the three main categories of debts: “secured,” “priority,” and “general unsecured.”

Secured and priority debts tend to be the ones with issues worth talking about. Secured debts often have liens against your important property and possessions—your home, your car or your truck, maybe your furniture and appliances. Priority debts are ones that are usually not secured but are favored in various ways in the law. They include child and spousal support, certain taxes, and such.

It’s worth paying a lot of attention to secured and priority debts because they raise questions that are likely important to you. Such as, how does bankruptcy help you keep your car if you are behind on payments? If you file a Chapter 7 case do you have to keep paying on your furniture loan to keep your bedroom furniture, and if so how much? How can filing bankruptcy enable you to get and/or keep current on your child support? Will you be able to write off any of your overdue income taxes?

We will look into these questions and more about secured and priority debts in upcoming blog posts. And yet, you probably have more of the third category of debts, “general unsecured” ones, than either secured or priority debts. So first let’s look at what happens to your general unsecured debts, covering today what happens if you file a Chapter 7, and then in my next blog post what happens under Chapter 13.

General Unsecured Debts  

First a reminder from last week: general unsecured debts are those that don’t belong in the other two categories. They are unsecured in that they have no lien on any of your property or possessions. They are “general” simply in that they are not one of special “priority” debts that the law has selected for special favored treatment.

General unsecured debts include all sorts of obligations. Besides the most common ones like (most) credit cards and medical bills, they include personal loans without collateral, checking accounts with a negative balance, bounced checks, most payday loans, claims against you for property damage and personal injury, for breaches of contract—again, just about any way that you can owe money without collateral.

What Happens to Most General Unsecured Debts in Most Chapter 7 Cases

All these kinds of general unsecured debts are usually just legally, permanently written off—“discharged”—in a Chapter 7 bankruptcy case. That means that once they are discharged—usually about 3 months after your case is filed—the creditors can take absolutely no steps to collect those debts.

The only way those debts are paid anything is if either 1) the debt is NOT dischargeable or 2) it is paid (in part or in full) through an asset distribution in your Chapter 7 case.

 1) “Dischargeability”

A creditor can dispute your ability to get a discharge of your debt. Very few general unsecured debts are challenged and so they get discharged. In the rare case that the discharge of one of your debts is challenged, you may have to pay some or all of that particular debt. That depends on whether the creditor is able to establish that the facts fit within some quite narrow grounds. That would usually involving allegations of fraud, misrepresentation or other similar bad behavior on your part. If the creditor fails to establish the necessary grounds, the debt is discharged.

There are also some general unsecured debts that are not discharged unless you convince the court that they should be, such as student loans. The grounds for discharging student loans are quite difficult to establish.

2) 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 what usually happens—you’ll hear it 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”— your “general unsecured creditors” may, but often don’t receive some of it. The trustee must first pay off any of your priority debts, as well as pay the trustee’s own fees and costs. The unsecured creditors get a pro rata share of the pool of whatever, if anything is left over.

Conclusion

In most Chapter 7 cases your general unsecured debts will all be discharged and most of the time will receive nothing from you. Rarely, a creditor may challenge the discharge of its debt. And if, again rarely, you have an “asset case,” the trustee may pay a part or—extremely rarely—all of the general unsecured debts, but only after paying all priority debts and his or her fees and costs.  

 

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Business Litigation that Continues After You File Bankruptcy

If you shut down your business, and file bankruptcy, that often ends business litigation against you. But not in these three situations.

 

Lawsuits against You that Bankruptcy Ends

Many legal claims against you or your closed or closing business are resolved by the filing of your bankruptcy case. They are resolved either legally or practically, or both.

Claims that are legally resolved by your filing of bankruptcy are those intended to make you pay money. Or, claims to determine how much money you must pay. The discharge (the legal write-off) in bankruptcy of whatever debt you owe will usually result in you not needing to pay anything on the claim under Chapter 7 “straight bankruptcy.” There’s not much point to a lawsuit to determine whether you owe money or about how much you owe if any such debt will just get discharged in bankruptcy. That’s true regardless how much the debt amount is, and regardless whether there’s a court-determination of the debt or not.

Claims that are practically resolved by your bankruptcy filing are those that are simply not worth pursuing any further. For example, if you file a Chapter 13 “adjustment of debts” case in which the creditors are slated to receive only a few pennies on the dollar, that fact would hugely reduce the benefit of litigation to prove that you owe more money. A simple cost-benefit analysis would show that the very slight possible benefit of further litigation is not worth the addition time or money spent by the creditor.

Lawsuits that Bankruptcy Does NOT End

However, there are certain types of debts that would still need to be resolved by a court. In these situations the creditor would likely get permission from the bankruptcy judge to start a lawsuit or to continue one already started. Here are three types that need court resolution.

1) Determining the Amount of a Debt

If a debt is being discharged in a no-asset Chapter 7 case—one in which all assets of the debtor are “exempt” and protected—then, as indicated above, the amount of that debt makes no practical difference. Whatever the amount of the debt, it is getting discharged without payment of anything towards that debt.

But in an asset Chapter 7 case, in which the bankruptcy trustee is anticipating a pro rata distribution of the proceeds of the sale of assets, the amounts legally owed on all the debts need to be known for that distribution to be fair to all the creditors.  The same holds true in most Chapter 13 cases, in which the creditors are being paid a portion of their debts. That’s because the established amount of any single debt affects the amounts received by all the creditors. So litigation to determine the validity or amount of a debt needs to be completed, even if by a relatively quick settlement (acknowledging the reduced benefit of further litigation because of the reduced stakes at issue for any individual creditor).

2) Possible Insurance Coverage of the Debt

If a claim against a debtor may be covered by insurance, then the affected parties likely want the dispute to be resolved legally.

That’s because a court needs to determine 1) whether the debtor is liable for damages, 2) whether those damages are covered by the insurance, and 3) whether the policy dollar limits are enough to cover all the damages or instead leave the debtor personally liable for a portion. The following types of business litigation tend to involve insurance coverage issues:

  • vehicle accidents involving the business’ employees or owners, especially those with the complication of multiple drivers (and thus, multiple possible insurance coverages)
  • claims on business equipment damaged by fire or flood, or stolen

In these situations the bankruptcy court will likely give permission for the litigation to continue outside of bankruptcy court, while not allowing the creditor to pursue the debtor as to any amount not covered by the insurance policy limits.

3) Nondischargeable Debts

Some of the biggest fights about business-related debts occur when a creditor argues that its debt should not be discharged in the bankruptcy case.  The grounds for objecting to discharge are quite narrow—in general the debtor must have defrauded the creditor, embezzled or stolen from the creditor, or intentionally and maliciously hurt the creditor or its property.

These discharge fights can happen in both Chapter 7 and Chapter 13. Chapter 13 in the past did not let creditors raise discharge challenges that were allowed under Chapter 7. That changed with the last major changes to the bankruptcy law (in 2005), which for the first time allowed those challenges to be raised in Chapter 13 as well. Since Chapter 13 is often a better solution for debtors who have closed a business (it’s often a better way to deal with business-related debts like payroll and income taxes, for instance), many of the dischargeability challenges by creditors now happen in Chapter 13 cases.

 

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If You Owe Lots of Business Debt You Can Maybe Skip the “Means Test” and Qualify for Chapter 7

One benefit of owing more business debt than consumer debt is that it gives you a largely free pass into a Chapter 7 bankruptcy case. 

 

The Role of the “Means Test”

If your income is too high, you have to pass a “means test” to discharge—legally write off—your debts through a Chapter 7 “straight bankruptcy.” The point of this test is to prevent you from discharging your debts if you have the “means” to pay a meaningful portion of them. So it’s essentially an income and expenses test.

If you don’t pass the “means test,” you could be found to be under a “presumption of abuse” of the bankruptcy laws. If so, you would not be allowed to continue with your Chapter 7 case.  

One way to get out of the “means test” is by having less income than the permitted “median family income” for your state and family size. Most people who file under Chapter 7 have low enough income to avoid the “means test.” But the “median family income” amounts are quite low. If your income is above permitted amount, you have to go through the “means test.” As a result you may be forced into a lengthy and relatively expensive 3-to-5-year Chapter 13 payment plan instead of a usually-less-than-four-month Chapter 7 case.

If You Owe More Non-Consumer Debts than Consumer Debts

Because the “means test” was intended for consumer bankruptcies not business ones, it only applies to consumer cases. What’s critical is how the law distinguishes between the two.

You can avoid taking the “means test” altogether—including the “median family income” step—if your debts are not “primarily consumer debts.” That’s the standard. If your debts are not “primarily consumer debts,” you would be eligible for a Chapter 7 case regardless of your income, even if it’s above the “median” amount.

In fact if you don’t have “primarily consumer debts,” you avoid other kinds of “presumptions of abuse” as well. You can avoid not just the income-and-expense “means test,” but also other ways that your Chapter 7 case could be challenged in a consumer case. Congress has apparently decided that if your debts are mostly from a failed business, you should be permitted an immediate Chapter 7 “fresh start” without the precautions in the law supposedly designed to prevent abuse of the bankruptcy laws by consumers.

What’s “Consumer Debt”?

To determine whether you can avoid the “means test,” we need to be clear what a “consumer debt” is. The Bankruptcy Code defines a “consumer debt” as one “incurred by an individual primarily for a personal, family, or household purpose.” (Emphasis added.)

The focus is on the purpose for which you initially incurred the debt, even if the debt would otherwise seem like a consumer debt. Small business owners often finance their business’s start-up and ongoing operation with their consumer credit—credit cards, home equity lines of credit and such. Given their purpose, these might qualify as non-consumer debts in calculating whether you have “primarily consumer debts.” This is definitely something to discuss with your attorney to learn how the local bankruptcy judges are interpreting this issue.

 What Does “Primarily Consumer Debts” Mean?

If the total amount of your “consumer debt” is less than the total amount of your debts that are not “consumer debts,” then your debts are not “primarily consumer debts.”

So you have to decide (with the help of your attorney) separately for each one of your debts whether it is a “consumer debt” or not. Then you add up the two columns of debts, and if the total for those that are not “consumer debts” is larger than the total for those that are “consumer debts,” then you do not owe “primarily consumer debts.” And you can skip the “means test.”

Some Business Debts May Be Larger Than You Think

Even after looking closely to see if some of your seemingly “consumer debts” may have actually had a business purpose, you may still believe that you have more of the “consumer debts.” But sometimes business owners have business debts that end up being larger than they thought they were. That could push their not-“consumer debt” higher than their “consumer debt.”

For example, if you had to break a commercial lease for your business premises when you closed your business, the unpaid lease payments projected out over the intended term of the broken lease could be huge. Same thing with a business equipment lease.

Or closing your business may have left you with other hidden or unexpected debts, such as obligations to business partners or unresolved litigation, with potentially large damages owed (and to be discharged in bankruptcy).

Conclusion

The potential good news about such larger-than-expected business debts is that they may result in your non-“consumer debts” outweighing your “consumer debts.” That would enable you to skip the “means test” and avoid other “presumptions for abuse.” That would allow you to discharge all your debts through a Chapter 7 case instead of being forced to pay all you could afford to pay of those debts under a lengthy Chapter 13 case.

 

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Practical Considerations about Accusations of Business Fraud and Bankruptcy

When a small business fails, allegations of fraud against the owner are not uncommon. But they are often handled well in bankruptcy.

 

There are practical reasons why the owner of an unsuccessful small business tends to be accused of causing or contributing to the failure through fraud or misuse of funds. If you are considering closing down your business or have already closed it down, and are getting such accusation or you fear getting them, you want to know how are those accusations going to be handled if you file a bankruptcy case.

Reasons Why Creditors of Business Owners Raise Fraud Objections

A bankruptcy filed after the failure of a business can stir up more objections than a regular consumer bankruptcy case for a number of practical reasons:

  • The relationship between the former business owner and his or her creditor is often more personal and emotional than a simple debtor-creditor relationship. Consider the relationships between the former business’s partners, between the owner and investors who were friends or relatives, or between the owner and an ex-spouse. Because of the mix of business and personal in these relationships, the business failure is taken more personally, with more of a tendency by the creditor to feel cheated. So the decision whether to fight the discharge (legal write-off) of the debt in bankruptcy is made less as a cost-benefit business decision than an emotional one.
  • The business context tends to provide many all-too-convenient opportunities for the debtor to blur the rules or act unscrupulously, especially when financially “desperate.”
  • If a business owner takes certain actions in good faith which could have resulted in success, but the business does not succeed, those same actions can look questionable in hindsight.
  • In these kinds of disputes, there is often more money at stake than in a consumer bankruptcy. At the same time these kinds of creditors, unlike conventional commercial creditors, may not feel that they just can take the loss and walk away. So they tend to fight even if it’s not such a wise business decision to do so.

What Happens in Bankruptcy?

So if you have been accused by a former business partner, investor, or similar business creditor of some sort of business fraud, or fear that you will be so accused, does this mean that you should avoid filing bankruptcy?

You need to discuss your unique circumstances thoroughly with your bankruptcy attorney, likely together with your business or litigation attorney if you have one.

But in general, perhaps surprisingly, for some practical reasons these kinds of accusations often go away, or at least are resolved relatively quickly, when you file bankruptcy.

Reason #1: The “Automatic Stay”

The filing of your bankruptcy case stops, at least temporarily, any litigation against you that is already in progress. And it stops, again at least temporarily, a new lawsuit from being filed against you (and against your business if it is a sole proprietorship). This pause in the litigation gives your creditor the opportunity to reconsider whether continuing to pursue you would really be worthwhile.

Reason #2: Much Harder to Make a Case against You

Your bankruptcy filing changes the legal issues in your favor. It’s more difficult for your creditor to prevail against you. It’s usually easy enough outside of bankruptcy for a creditor to prove that you owe money. But once in bankruptcy, the debt or claim will be discharged—forever written off—unless the creditor establishes much more: that the debt is based on some rather serious bad behavior by you. The creditor has to convince the bankruptcy judge that you owe the debt because you engaged in fraud, misrepresentation, embezzlement or theft, fraud in a fiduciary capacity, or by intentionally and maliciously injuring the creditor or his or property. Much more difficult to do, and unless there is a good case against you most creditors will realize that they are wasting their time and money to try.

Reason #3: Revealing Your Actual Finances

The documents you file under oath in your bankruptcy case should show your disgruntled creditor that even if the case against you succeeded, you don’t have the money to pay a judgment. Perhaps more important, it should show his or her attorney that it’s not economically sensible. Sensible people would think twice paying thousands of dollars in attorney fees and cost on a case that could be very hard to win, and then at best gets them a judgment that could never be collected. Or if it could be collected, it would be so slowly that the risk and effort would simply not be worthwhile.

Conclusion

Although there are reasons for some small business bankruptcies to be contentious, filing bankruptcy can give you big advantages if you are being pursued for an alleged business fraud. You decrease your creditor’s chances of winning and give him or her good reasons to stop pursuing you.

 

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Business Disputes that Follow You Into Your Bankruptcy Case

A creditor can challenge the discharge of its debt in bankruptcy. This is not common, but is more so after a debtor closes a business.

 

Why Creditor Challenges Are More Common in Closed-Business Bankruptcies

For the following reasons, creditors tend to object more to the discharge of their debts in bankruptcy cases that are filed after the debtor has operated and closed a business:

  • The amount of debt owed, and thus the amount at stake, tends to be larger than in a conventional consumer case, making objection more tempting to the creditor.
  • In the business context some debtor-creditor relationships can be very personal, so when the business fails, these creditors take it personally. Consider debts between former business-partners who are blaming each other for the failure of the business, or between a business owner and the business’ primary investor who believes the owner drove the business into the ground, or between the contract buyer of a business and its seller in which the buyer feels that the seller misrepresented the profitability of the business. In these situations the aggrieved creditor is more personally motivated to fight the discharge of its debt.
  • The owners of businesses in trouble find themselves desperate to keep their businesses afloat. So they make questionable decisions which then expose them to objections about fraud and such once they file bankruptcy.
  • In the kinds of close creditor-debtor relationships mentioned above, the creditor often has hints about the business owner’s questionable behavior, and so is more likely to believe it has the legally necessary grounds to object.

But Objections to Discharge Are Still Not Very Common

When former business owners hear that any creditor can raise objections to the discharge of its debt, they figure an objection would very likely be raised in their case. But in reality these objections occur much less frequently than might be expected, for the following reasons:

  • The legal grounds under which challenges to discharge must be raised are quite narrow. To be successful a creditor has to prove that the debtor engaged in rather egregious behavior, such as fraud in incurring the debt, embezzlement, larceny, fraud as a fiduciary, or intentional and malicious injury to property. These are not easy to prove, so creditors do not tend to try unless they have a strong case.
  • In his or her bankruptcy case the debtor publically files a set of papers containing quite extensive information about his or her finances, and does so under oath. The debtor is also subject to questioning by the creditors about that information and about anything else relevant to the discharge of his or her debts. If the information on the sworn documents or gleaned from any questioning reveals that the debtor truly has no assets worth pursuing, a rational creditor will often decide not to throw “good money after bad” by raising an objection.

Conclusion

In a closed-business bankruptcy case there are these two opposing tendencies. Challenges to discharge are more likely, especially by certain kinds of closely related creditors. But these challenges are still relatively rare because of the narrow legal grounds for them and the financial practicalities involved. A good bankruptcy attorney will advise you about this, will prepare your bankruptcy paperwork to discourage such challenges, and will help derail any such challenges if any are raised.   

 

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When Chapter 7 “Straight Bankruptcy” is Not So Straightforward

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

 

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

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

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

1) Income

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

2) Assets

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

3) Creditor Challenges to the Dischargeability of a Debt

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

4) Trustee Challenges to the Discharge of All Debts

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

No Surprises

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

 

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Discharge of Your Debts: THE Goal of Bankruptcy

Most debts are “discharged”—written off—in bankruptcy. But some may not be. Can we know in advance which will and will not be discharged?

 

 

Bankruptcy is about Discharge

The point of bankruptcy is to get you a fresh financial start through the legal discharge of your debts.

Both kinds of consumer bankruptcy—Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts”—can discharge debts. But most Chapter 13s tend to have other purposes as well, and the discharge usually occurs only 3 to 5 years after the case is filed.

In contrast, most Chapter 7 cases are filed for the single, or at least primary, purpose of discharging debts. Furthermore, in most Chapter 7 cases all debts that the debtors want to discharge are in fact discharged, and this happens within just three months or so after the case is filed.

This blog post focuses on Chapter 7 discharge of debts.

What Debts Get Discharged?

Is there a simple way of knowing what debts will and will not be discharged in a Chapter 7 case?

Yes and no.

We CAN give you a list of the categories of debts that can’t, or might not, be discharged (see below). But some of those categories are not always clear which situations they include and which they don’t. Sometimes whether a debt is discharged or not depends on whether the creditor challenges the discharge of the debt, on how hard it fights for this, and then on how a judge might rule.

Why Can’t It Be Simpler?

Laws in general are often not straightforward, both because life can get complicated and because laws are usually compromises between competing interests. Bankruptcy laws, and those about which debts can be discharged, are the result of a constant political tug of war between creditors and debtors over the last few centuries. There have been lots of compromises, which has resulted in a bunch of hair-splitting laws. 

To give some perspective, believe it or not the original bankruptcy laws in England—from which our bankruptcy laws came—did not include ANY discharge of debts. Bankruptcy was originally designed as a procedure to help creditors collect from debtors, not at all as a legal means of protecting debtors from creditors. So there was no perceived need for a discharge of debts—the creditors could just continue chasing their debtors after the bankruptcy procedure was done!

But Let’s Get Practical

The present reality is much more positive, and usually pretty straightforward:

#1:  All debts are discharged, EXCEPT those that fit within a specified exception.

#2:  There are quite a few of exceptions, and they may sound like they exclude many kinds of debts from being discharged. It may also seem like it’s hard to know if you will be able to discharge all your debts. But it’s almost always much easier than all that. As long as you are thorough and candid with your attorney, he or she will almost always be able to tell you whether you have any debts that will not, or may not, be discharged. Most of the time there are no surprises.

#3:  Some types of debts are never discharged. Examples are child or spousal support, criminal fines and fees, and withholding taxes.

#4:  Some other types of debts are never discharged, but only if the debt at issue fits certain conditions. An example is income tax, with the discharge of a particular tax debt depending on conditions like how long ago those taxes were due and when its tax return was received by the taxing authority.

#5:  Some debts are discharged, unless timely challenged by the creditor, followed by a judge’s ruling that the debt met certain conditions involving fraud, misrepresentation, larceny, embezzlement, or intentional injury to person or property.

#6:  A few debts can’t be discharged in Chapter 7, BUT can be in Chapter 13. An example is an obligation arising out of a divorce other than support (which  can never be discharged).

The Bottom Line

#1: For most people the debts they want to discharge WILL be discharged. #2: An experienced bankruptcy attorney will usually be able to predict whether all of your debts will be discharged. #3: If you have debts that can’t be discharged, Chapter 13 is often a decent way to keep those under control. More about that in my next blog post about Chapter 13.

 

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Why Can’t a Creditor Chase You After Your Bankruptcy?

What makes it illegal for your creditor to pursue a discharged debt? What penalties may get awarded to you if a creditor breaks the law?

 

Chasing a Discharged Debt is a Violation of Federal Law

The Bankruptcy Code makes it perfectly clear that for a creditor to try to collect on a debt after it is discharged under either Chapter 7 “straight bankruptcy” or Chapter 13 “adjustment of debts” is illegal. Section 524 of the Bankruptcy Code is about the legal effect of a discharge of debt. Subsection (a)(2) of that section says that a discharge of debts in a bankruptcy “operates as an injunction against” any acts to collect debts included in that bankruptcy case. Acts explicitly stated as illegal include:

the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor.

In other words, the creditor can’t start or continue a lawsuit or any legal procedure against you, and can’t act in any other way to collect the debt.

What If a Creditor Violates This Injunction?

Nowhere in Section 524 of the Code does it say anything about what happens if a creditor violates the law by disregarding that injunction. The section does not clearly say what, if anything, the penalties are for a creditor caught doing so.

However, even though no penalties are specified in THAT section, there is a strong consensus among courts all over the country that bankruptcy courts can penalize creditors for violating the discharge injunction through another section of the Bankruptcy Code, Section 105, titled “Power of Court.” The idea is that the injunction against pursuing a discharged debt is a court order, and so a creditor violating it is in contempt of court. So the usual penalties for those who act in civil contempt of court apply.

Penalties Assessed Against Violating Creditors

These penalties for civil contempt can include “compensatory” damages and “punitive” damages.

Compensatory damages are intended to compensate you for harm you suffered because of the creditor’s violation of the injunction. These potentially include actual damages such as time lost from work or other financial losses, emotional distress caused by the illegal action against you, and attorney fees and costs you’ve incurred as a result.

Punitive damages are to punish the creditor for its illegal behavior. So the judge looks at how bad the creditor’s behavior was in determining whether punitive damages are appropriate and how much to award.

Conclusion

The vast majority of the time creditors in a bankruptcy case write the debts off their books and you never hear about those debts again. But even though it’s illegal for creditors to try to collect on a debt that’s been legally written off in bankruptcy, once in a while they do try. Some creditors don’t keep good records or simply aren’t all that serious about following the law.

So after you receive your bankruptcy discharge, if you hear from one of your old creditors trying to collect its debt contact your attorney right away.  This needs immediate attention. If the creditor’s behavior is particularly egregious, you and your attorney should discuss whether to strike back at the creditor for violating the law. There might possibly even be some money in it for you.

 

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