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.  

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.

 

Debts You Really Care About, and WANT to Pay

In bankruptcy, are you allowed to favor: 1) creditors with collateral, so that you can keep the collateral; 2) creditors toward whom you have special loyalty; and 3) creditors who have extraordinary leverage against you?

When clients first talk with me about filing bankruptcy, they are often very concerned about what will happen to debts that they want to keep paying. In fact sometimes people believe that bankruptcy is not a serious option for them because they are afraid of what will happen with these debts that are so important to them. As their legal counselor, my job is to respect and understand these fears.  Then I can make recommendations about how to best deal with these debts.

These special debts fall into three categories.

1. Debts You Care About Because of Crucial Collateral

Before getting to the point of seriously considering bankruptcy, you may have been doing everything possible to keep current on your home or vehicle. You may have made the decision that holding on to your home for the sake of your family is your absolutely highest priority. Or you may feel the same way toward your vehicle, because you need to be able to get to work and/or to keep your family or personal life sane.

Chapter 7 and Chapter 13 both have ways that you can help keep your home and vehicles. Sometimes these involve not paying other creditors so that you can pay the mortgage or vehicle loan. In other situations you may be able to keep your home and vehicle while paying significantly less to do so. Overall, bankruptcy usually allows you to focus your limited financial resources on these kinds of debts if they are your highest priority.

2. Debts You Care About Because of Moral Obligation

Many of my clients feel different levels of loyalty to different creditors. Some even feel guilty about feeling that way. But it is perfectly human to feel differently about a personal loan owed to a family member than about a credit card balance owed to a national bank. Or how you feel towards a medical debt owed directly to your long-time family doctor compared to how you feel towards a debt that is now at a second or third collection agency and you don’t even know which medical provider they are collecting for. 

If you feel an absolute moral obligation to pay a debt regardless whether or not you file bankruptcy, there are safe ways to do so and very dangerous ones. I’ll tell you about this in an upcoming blog. In any event, be sure you tell your attorney about this because it can effect whether you file a Chapter 7 or a Chapter 13 case, and sometimes also the timing of your filing.

3. Debts You Care About Because of Extra Creditor Powers

Although one of the most basic principles of bankruptcy law is that your creditors must be treated equally, the more accurate version of that principle is that legally equal creditors must be treated equally. And because the law is filled with legal distinctions among creditors, some debts are more dangerous than others, both inside and outside of bankruptcy. You may well have heard about or directly experienced the extraordinary collection powers of the taxing authorities, support enforcement agencies, or student loan creditors, for example. You may also be aware that some debts cannot or might not be written off in bankruptcy. Understandably you’re concerned what will happen with these debts if a bankruptcy won’t help you with them.

The reality is that usually a bankruptcy will help you with even the most aggressive creditors, even those whose debts will not be discharged. Almost always there are sensible ways to deal with these special creditors. Sometimes it involves using the bankruptcy system’s own substantial powers to gain important advantages over these creditors. Sometimes it involves reasonable payment arrangements after completing a Chapter 7 case, when you have no other debts. Sometimes it involves directly favoring these creditors by paying them before or instead of other creditors in a Chapter 13 case, while under continuous protection from the bankruptcy court. Overall, usually bankruptcy provides you a manageable way to handle these legally favored creditors.

The next few blogs will give you specific information on how bankruptcy can help you keep valuable collateral, satisfy your moral obligations, and deal with your most aggressive creditors.

Debts from a Criminal Conviction Can't Be Written Off in Bankruptcy, But a Bankruptcy Can Still Help

Three ways bankruptcy can help: 1) write off debts to focus on defense costs, 2) pay only the most important debts and expenses, and 3) reduce chance of related civil liability.

 

As discussed in the last blog, criminal fines, fees and restitution are almost never discharged in any kind of bankruptcy case. And yet if you’re facing a serious criminal charge, or have already been convicted, bankruptcy can still be hugely helpful.

If you’re charged with a crime, you need financial resources to pay for your legal defense. You need to be able to focus financially and emotionally on fighting the criminal charge. And then, if you do not win a complete acquittal, you have to figure out how you will pay whatever criminal fines, restitution, or other court and probation fees that the court orders as part of your criminal sentence. So you have to choose what your highest financial priorities are. Because of the grave potential consequences, that usually means paying for a defense attorney, and then paying whatever the criminal court requires of you.   Bankruptcy can help in this by re-prioritizing your debts and expenses, and protecting you from your creditors.

1. Bankruptcy can help by writing off all or most of your debts so that you can focus both your attention and your finances on the criminal charge(s) or their aftermath.

Right after you’ve been charged with a crime, unless you indigent and financially qualify for a public defender, your highest priority must be to pay for your criminal attorney and any related costs of your defense. That may mean selling assets, and/or surrendering collateral to creditors, like a vehicle with high monthly payments. And you may need to stop paying all your creditors.  Often the cleanest way to reduce your debt load is with a Chapter 7 bankruptcy. In the right circumstances it provides the financial relief you need.

After your criminal case is resolved, especially if you had to serve a jail sentence, you’ve probably had a gap in your income, or now have a job with lower income. You often have continuing financial obligations to the criminal justice system that you must absolutely pay because your release or probation is conditioned on you doing so. These can include restitution payments, probation/supervision fees, treatment costs, community service fees, and/or chemical and electronic monitoring charges. A bankruptcy can clean up your debts so you can pay these criminal fees and avoid re-incarceration. The last thing you need is some ancient creditor garnishing your wages or bank account so that you can’t meet your criminal obligations.

2. Bankruptcy can help you prioritize your debts and expenses so that you can keep paying the ones most important to the criminal conviction against you.

Sometimes the criminal court imposes other kinds of conditions on you which directly require you to keep current on certain of your debts or expenses, beyond the court and probation fees referred to above. Depending on the nature of your offense, you may be required to keep absolutely current on your child support payments, or file and pay income taxes on time, or always maintain vehicle insurance. A bankruptcy can make all the difference allowing you to fulfill such make-or-break commitments.

Also, your criminal sentence or terms of probation often require you to show up at certain scheduled events—to do your community service, attend probation meetings, or just maintain regular employment. All require reliable transportation. If you cannot make your vehicle payments or pay for vehicle insurance, or at least pay for public transportation, you will not be able to meet these conditions. A Chapter 7 or Chapter 13 bankruptcy may be the best way for you to be able to pay for these necessities.

3. Alleged criminal behavior often results in the threat of civil liability by the injured party. Filing bankruptcy might, under certain circumstances, dissuade that party from filing a lawsuit against you, or lead to a quicker settlement if a lawsuit has already been filed.

Bankruptcy law does make it difficult for you to discharge debts or claims that you may owe for personal injuries or financial damages resulting from certain kinds of allegedly criminal behavior. But, nevertheless, for the following practical reasons a bankruptcy may still help:

a. In a bankruptcy, you must present your financial circumstances in detail, in writing, under penalty of perjury. You are also questioned under oath about them, at least briefly, and potentially in depth. Although that may not sound like a lot of fun, taking the initiative to show that you have no assets may convince the other party—or may more importantly, his or her attorney—that pursuing you would not be financially worthwhile.

b. The other party has to jump through some relatively difficult hoops to establish that the debt or claim should survive beyond your bankruptcy case. Depending on the situation, this may dissuade him or her from spending lots of attorney fees on a difficult battle.  

c. With certain kinds of alleged damages, the other party has a very short amount of time to decide whether to pursue you or not. Some may simply miss the quick deadline. Or it may encourage a quicker settlement.

Whether a bankruptcy filing will give you an advantage along these lines is a very delicate tactical question that needs to be very carefully discussed with and analyzed by your attorney. But it is certainly worth considering.

Criminal Fines, Fees and Restitution Are Never Discharged in Bankruptcy, Right?

Obligations you owe related to your conviction of a crime cannot be discharged in bankruptcy. End of story? Usually, but not absolutely.

Many of the categories of debt that are generally not discharged (legally cancelled) in bankruptcy leave some wriggle room.  So, income taxes can be discharged under certain conditions. Some student loans can as well. Certain other categories of debts involving alleged fraud or other inappropriate behavior by the debtor are still completely discharged if the creditor simply fails to file an objection to the discharge in time with the bankruptcy court.

But with criminal fines, fees, or restitution it’s pretty clear-cut—NO discharge.

If you’ve heard otherwise you might actually be hearing correctly—especially about restitution—but most likely you’re reading or listening to information that’s now a couple decades outdated. For a long time criminal fines and restitution have not been able to be discharged under Chapter 7, BUT until the early 1990s criminal restitution COULD be discharged under Chapter 13. In fact a 1990 United States Supreme Court opinion, Pennsylvania Dept. of Public Welfare v. Davenport, clearly stated that criminal restitution was dischargeable under Chapter 13, based on the language that Congress had used in the Bankruptcy Code. However, in direct reaction to that Supreme Court opinion, Congress quickly amended Chapter 13 to make clear that criminal restitution could not be discharged. A few years later Congress tightened up the law again, this time to say that criminal fines could not be discharged under Chapter 13 either. So ever since then the law about this has been quite clear.

But still, complications can arise.

Take the situation where the same conduct by a debtor can result in either civil or criminal liability, or both. Examples are an alleged embezzlement, personal injury caused in a bar fight, or even an alleged murder/wrongful death. Everybody’s favorite example of the last one—O.J. Simpson. Remember he was acquitted of murder. on the criminal side, but then was held liable for wrongful death in the civil lawsuit against him. In most cases it’s clear as day whether a case against a person and the liability that results from it is civil or criminal. And so it's usually clear whether or not the debt is subject to bankruptcy discharge (though in these three examples the debt may still not be dischargeable for other reasons).

But every once in a while, whether an obligation is a criminal fine or instead a civil penalty might not be so clear.  If you own an auto repair shop and the state water quality agency fines you for illegal disposal of waste fluids, that obligation may be a criminal or civil one.

Or in some rare cases under Chapter 13, even some obligations arising directly from a criminal court's judgment might be considered not to be “restitution, or a criminal fine,” and so can be discharged. That’s because even though Congress tried to “fix” the problem tossed in its lap by the Supreme Court’s Davenport opinion referred to above, it did not use language as broad as it had used under Chapter 7 to make clear that all criminal-related debts aren’t dischargeable. So some very limited kinds of criminal court-based obligations might still be discharged in a Chapter 13 case.  

Here is real life illustration of this—although I must warn that this may or may not be the way our local bankruptcy courts would interpret the law. The case is worth mentioning to show how courts wrestle with—and can disagree about—these kinds of issues.

A guy named Joseph Elliott Ryan was convicted in Alaska of the federal crime of possession of an unregistered firearm. He did nearly 5 years of prison time and paid a $7,500 criminal fine. But his criminal conviction also included obligations to pay $750,000 in restitution and $83,420 for “costs of prosecution.” On appeal, this huge restitution obligation was overturned and eliminated. He then filed a Chapter 13 case in Idaho and included his remaining obligation for the "costs of prosecution." When his Chapter 13 case was completed, he had paid less than $3,000 of that $83,420 obligation. But he asked the bankruptcy court to order that the remaining $80,000 or so be discharged. The court refused, saying that “costs of prosecution” are a “criminal fine” excluded from discharge under Chapter 13.

But the bankruptcy court was overturned on appeal, and so that $80,000 “costs of prosecution” obligation was discharged.  As described in more detail in this article, the appellate court carefully analyzed the meaning of the term “criminal fine” as used in this context and elsewhere, and concluded that this term does not include “costs of prosecution.” It did not matter to the the appeals court that the "costs of prosecution" had been part of a criminal court’s criminal sentence.  So Mr. Ryan did not have to pay any more or that criminal court obligation, and was completely debt-free.

To be clear, just about all criminal fines, fees, and restitution CANNOT be discharged under either Chapter 7 or 13. But as Mr. Ryan’s unusual case illustrates, there can still be limited exceptions. In his case, for less than 5 cents on the dollar, and as a result of some smart lawyering, he got a bankruptcy discharge of a criminal court obligation.

Student Loans Are a Cash Cow for the Federal Government?

The federal government is making billions of dollars on student loans every year. So why double the interest rate on the loans next year? To boost those profits.

 

The federal government pays tons of money to run its student loan programs, right? The interest rate on those loans is doubling next year from 3.4% to 6.8% in order for the taxpayers not to need to subsidize student loans as much, right?

Not according to law professor Alan White, who says that “Congress’ dirty secret is that the government makes a huge annual profit on student loans.” In his latest blog on the highly respected blogsite, Credit Slips, he cites as his main source “the scrupulously nonpartisan Congressional Budget Office.” According to its data, “$37 billion will flow IN to [the U.S.] Treasury from student loans made this fiscal year at the 3.4% rate.” And that’s after accounting for about $1.5 billion to administer those loans. So the interest rate doubling dispute “is about whether to increase this annual profit next year.” The two parties “are arguing about how much of the federal deficit to plug with student loan interest money.” If the interest “rate will jump up to 6.8% for 2013 loans, [that would yield] another $30 to $40 billion return to Treasury.”

But wait a minute. How about all the money that is lost because of all the borrowers who can’t or don’t pay on their student loans? Prof. White acknowledges that many loans do go into default, but because student loan creditors have “supercreditor powers, especially wage garnishment and tax refund intercepts. . . [, t]here is no statute of limitations... , and even bankruptcy discharge is difficult. The $37 billion Treasury profit for [fiscal year] 2012 is after allowing for estimated credit losses in the $5 billion range.”

So how can there be such a huge amount of profit? “In two words, yield spread. ....  Treasury can borrow money at 0.5% or less, and lends it to students at 3.4%.   Administrative costs are well below 1%.”

The bottom line: $37 billion profit for taxpayers in 2012, and about twice as much as that in 2013 if the interest rate doubles.

I don’t know if this law professor is right. My head started spinning when trying to figure out the pages and pages of accounting tables in the Congressional Budget Office’s report. But even if he is right, is it such a bad thing for the federal government to be making a profit with its investment of taxpayer money on student loans? After all, we have a huge deficit hole to plug.

But it seems important when making tough choices to frame the issues honestly. It’s one thing to talk about doubling the student loan interest rate so that borrowers are then paying more of, or even all of, the taxpayers’ cost of those loans. It’s an entirely different story if we’re doubling the interest rate from a level where it’s already raking in billions of dollars in profits, making way beyond paying the taxpayers’ cost.

A study by the Brookings Institute concluded that the “United States spends 2.4 times as much on the elderly as on children, measured on a per capita basis, with the ratio rising to 7 to 1 if looking just at the federal budget.” Is it fair to add this additional deficit-paying burden on the younger generation?

And beyond the question of fairness, we are a nation in which the income gap between the well-off and the poor is widening, opportunities for improving one’s economic status are reducing, and the middle class is being squeezed from all directions.  So doesn’t adding yet another burden on people’s efforts at economic advancement hurt the nation as a whole?

The Widening Circles of Harm from Student Loan Debt

Student loans are not just burdening recent graduates. They’re now directly hurting people you wouldn’t expect. And dragging down the whole economy.

 

Recent college graduates are clearly hurting in this economy as they come out of school and enter the job market. The national unemployment rate has come down from the Great Recession high of 10.0% in October 2009 to 8.2% in May 2012. But it’s the persistence of extraordinarily high unemployment that is hurting young graduates. Only one other time since the Great Depression of the 1930s had the unemployment rate hit 10%, during the recession of 1981-82. But then, like in most other modern recessions, a strong recovery reduced the unemployment rate quite quickly, in that case down to 7.2% in less than two years. In contrast the current recent graduates are trying to claw their way into their first career jobs in the midst of a “jobless recovery.”

And they are forced to do so saddled under the most student loan debt ever.  You’ve probably heard the news of the past few months that total student loan debt now exceeds $1 trillion and is more than the nation’s total credit card debt. Realize that most of these graduates started college before the Great Recession hit, many heading into careers that looked relatively sensible back then but are now disaster areas. Public school teachers, anyone?

And many others made the tough decision to stay in school to ride out the recession, maybe shifting into more reliable fields, only to be confronted with one of the most anemic recoveries in modern history.

But it’s not just these twenty-something year olds who are hurting. Two other populations are being hugely impacted.

First, middle-aged students have gone back to school in a scramble to shift with the rapidly changing economy to more marketable careers. Their gamble has included taking on a huge amount of student loan debt. As the title of this Reuters article says, "Middle-aged borrowers [are] piling on student debt.” It states that in the last three years, average student loan debt has gone up 47% for the 35-to-49 year old age group, more than for any other group.

Second, just as dramatic, parents of students are taking on more and more student loan debt on behalf of their children. According to this Bloomberg article, “Loans to parents have jumped 75 percent since the 2005-2006 academic year... .  An estimated 17 percent of parents whose children graduated in 2010 took out loans, up from 5.6 percent in 1992- 1993.”

Hopefully the retrained, re-schooled middle-aged workers will find work that justifies taking out the loans. After all, the labor force has to adjust to the changing realities of the labor market, and if it does so efficiently the whole economy benefits.

And hopefully the parents’ investment in their children’s education will also be worthwhile. Their kids’ increased earning power over their lifetimes may well make it so. And you’d think that if a college student knows that his or her parents are mortgaging their home or their retirement, that student would be motivated to make good use of the education!

But the bigger question is whether this cycle of increased student loan debt is sustainable. What would the consequence be for all of us if student loan defaults increased significantly, like subprime mortgage defaults did at the beginning of this Great Recession?  A title of a recent report by the National Association of Consumer Bankruptcy Attorneys asks the question squarely: “The Student Loan ‘Debt Bomb’: America’s Next Mortgage-Style Economic Crisis? 

I’m a bankruptcy attorney who looks across my desk just about every day into the faces of clients whose investment in higher education did not pan out. I know that in my line of work I don’t tend to hear the success stories, but from where I’m sitting it feels like we’re heading in a dangerous direction.

Are Creditors Going to Challenge the Discharge of Debts in My Bankruptcy Case?

Every creditor has the right to challenge your ability to write off your debts in bankruptcy. But none of them likely will. Why not?

 

For most people filing bankruptcy, every debt they intend to discharge (write off) will in fact be discharged.

There are two categories of debts that are not discharged in bankruptcy. The first category includes those special ones that Congress has decided for policy reasons simply should not be subject to a bankruptcy discharge. Among the most common ones are spousal and child support, most student loans, and many tax obligations. Assuming you are represented by a competent bankruptcy attorney, you will know before your case is filed if any of your debts fall into this category.

The second category of debts includes those that are discharged UNLESS the creditor files a formal objection to the discharge. Any creditor can raise an objection. But creditors very seldom do, for these reasons:

1. Although any creditor can challenge your discharge of its debt, it can only win such a challenge if it can prove that you acted inappropriately in certain very specific ways.  In essence, the creditor has to show that you cheated it in how you incurred the debt. I won’t go into the details here of exactly what kind of dishonest behavior qualifies, but just be aware it simply does not apply to most people and their debts.  So a creditor would just be wasting its time to raise a challenge when it had no legal grounds for doing so.

2. It would not just be wasting its time, but also a fair amount of money. The creditor’s objection has to be in the form of a lawsuit filed in bankruptcy court, which means paying a filing fee and at least hundreds of dollars for its attorney fees. Most creditors are sensible enough to not throw the proverbial good money after bad chasing a hopeless cause.

3. On top of that, bankruptcy law discourages creditors from raising challenges in two ways:

a. Debts are presumed to be dischargeable—at least if they do not fit any of the special nondischargeable debts in the first category referred to above. So the creditor has the burden of proving that the debt is not dischargeable, and the debt is discharged if it fails to provide the necessary evidence to meet that burden.

b. The creditor risks being ordered to pay YOUR costs and attorney fees for defending a challenge if you defeat the challenge. This is an added disincentive for a creditor to push a challenge when it has weak facts against you.

So no matter what a bill collector told you to try to get you not to file bankruptcy, creditors will usually not raise challenges because they usually don’t have legal grounds to do so. And even when a creditor believes it has some facts in its favor, the creditor takes significant financial risks in pushing the challenge.

However, creditors sometimes DO genuinely think your behavior in incurring the debt gives them grounds for filing a challenge to the discharge of its debt. Also the law can favor them when it comes to certain actions by you such as incurring credit card debt or cash advances in the months before filing bankruptcy, writing bad checks even inadvertently, and similar actions which might not seem very egregious.

Also, you may have a creditor who is motivated less by economic good sense than by a desire to cause you trouble, say an ex-spouse or former business partner.

The best way to deal with these situations is, first, to be completely honest with your attorney in answering every question he or she asks you, whether during a meeting or when providing information in writing. Be thorough in your responses. And second, if you have ANY concerns along these lines, make a point of voicing your concerns, and do so early in the process. Never hide the ball from your attorney. Particularly, if you wonder whether you’ve acted inappropriately with any of your creditors, or if you have any personal creditors who are carrying a grudge, discuss it with your attorney. Not only will you be much better protected from rude surprises. Often you’ll feel the relief of learning that you have much less to worry about than you had feared.

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.

Is Discharging a Student Loan Possible in Bankruptcy?

What does it take to write-off a student loan in bankruptcy? An “undue hardship.” And that is a very tough standard to meet.

 

Student loan debts have hit the national consciousness like a ton of bricks. More like the weight of $1 trillion dollars ($1,000,000,000,000.00), the total amount of student loan debt as of a few weeks ago

The part of the Bankruptcy Code which says whether or not student loans can be discharged is a prime example of statutory ambiguity. All the pertinent law says is that a student loan is not discharged unless it “would impose an undue hardship on the debtor and the debtor’s dependents.” See Section 523(a)(8).

“Undue Hardship”

What does that mean-“undue hardship”? Congress did not define “hardship,” nor did it say what more it would take to turn a mere “hardship” into a qualifying “undue” hardship.

What a curious choice of words. “Undue” means “excessive, going beyond the limits of what is normal.” So Congress seems to be saying that you cannot discharge a student loan even if it is causing you a hardship, it has to be causing you a more than normal, excessive hardship.

But how does such a vague standard get applied in the real world of student loan borrowers in bankruptcy and unable to make their student loan payments?

Three-Part Test

In the last few decades as bankruptcy courts all over the country have struggled to figure out when an “undue hardship” exists or does not. There are some differences among regions of the country. But there is a general consensus that to meet this “undue hardship” hurdle, you have to show that you meet three conditions:

1. Under your current income and expenses, if you were required to repay the student loan, you would be unable to maintain even a minimal standard of living.

2. This inability to maintain a minimal standard of living while repaying the student loan would likely stretch out over all or most of the loan repayment period.

3. You had made a meaningful effort at repaying the loan, or to qualify for appropriate forbearances, consolidations, and administrative payment-reduction programs.

Some Important Practicalities

Unlike some debts in which the burden is on the creditor to challenge the discharge of the debt, with a student loan the burden is on the borrower to establish “undue hardship” during the bankruptcy case. Otherwise the debt survives your bankruptcy case.

In some situations, if you qualify later for an “undue hardship” after your bankruptcy case is completed, because of a subsequent disability, for example, you may be able to reopen your bankruptcy case for the court to make that determination.

Or if you are working now but have progressively worsening medical condition, so that you don’t qualify for an “undue hardship” now but expect to in the future, filing a Chapter 13 case may be the best choice. It may allow you to avoid making any ongoing student loan payments for the next few years while you focus on other more pressing obligations. And then you would have the opportunity to attempt to qualify for “undue hardship” just before the Chapter 13 case is completed 3 to 5 years later.

Conclusion

Although bankruptcy law does not provide a very easy way to deal with most student loans, more and more people in financial distress have these loans as part of their problem. Because student loans are challenging to deal with, that is all the more reason to get good legal advice about your whole situation to determine your best way forward.

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.

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.

 

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.