More about Dealing with Very Aggressive Creditors in Bankruptcy

Most creditors don’t challenge your write-off of their debts in bankruptcy. But if one does, the system is poised to resolve that challenge relatively quickly.

 

The last blog, and this one, are about what happens when a creditor raises one of the few available arguments to try to prevent its debt from being legally discharged. (This is separate from debts that by their very nature are excluded from being discharged—child support, most student loans, for example.) As emphasized last time:

• Most potentially dischargeable debts DO in fact get discharged. In most consumer bankruptcy cases, no creditor raises any challenges. To avoid any particular debt from being discharged, the creditor has the burden of establishing that the debt arose out of a very specific sort of bad behavior by you, one that is on a list that is in Section 523 of the Bankruptcy Code.
• Your creditors have a very firm deadline—usually about three months from the filing of your bankruptcy case—for formally raise such a challenge, or else lose the ability ever to do so.
• The challenge is raised by filing a “complaint” stating the facts and law under which the debt should not be discharged. This starts an “adversary proceeding,” a lawsuit focused only on this question.

Avoid Losing by Default

After a creditor files a complaint, THE most important thing to realize is that it will automatically win if you and your attorney do not file a formal answer at the court within the stated deadline. So contact your attorney immediately if you receive a complaint. Depending on the circumstances, you may have discussed this in advance and so could be expecting it. But sometimes it will come as a total surprise. Either way, get in touch quickly with your attorney to determine your game plan and begin acting on it.

Most Discharge Challenges Don’t Go to Trial

The adversary proceeding can go through all the steps of a regular lawsuit. After filing the answer, there can be “discovery”—the process of requesting and exchanging any pertinent information and documents, and holding depositions (questioning witnesses under oath, usually focusing on you and your alleged behavior in incurring the debt). And there could be various kinds of motions, pre-trial hearings, and a full trial. But these kinds of adversary proceedings rarely go through all these step and get to trial, because the amount of money at issue usually does not justify the cost involved for either side to pursue it that far.  So after both sides get a clear picture of the facts, there is usually a settlement. Sometimes one side or the other sees that the facts are not looking good and mostly or completely gives in. The debtor may concede that his or her actions fit the legal standards to prevent the debt from being discharged, or the creditor sees that it’s wasting its time and will dismiss the adversary proceeding. Or else the two sides come up with some sensible compromise.

But if there is enough at stake, or else if one or both sides are unreasonable and insist on getting a decision from the judge (these cases do not go to a jury), the dispute does go to trial. These trials usually last a half-day, or a day, or two, very seldom longer. At the end of trial the bankruptcy judge decides whether the debt is discharged or not. Extremely rarely, this decision can be appealed, in fact theoretically all the way up to the United States Supreme Court!

What’s So Quick and Efficient about All This?

Any litigation is very expensive, so you hope to avoid any discharge challenges. But bankruptcy court is a relatively fast and efficient forum for a number of reasons:

1) Because creditors have the opportunity to review your finances beforehand, much of the time they will not bother to raise challenges at all, avoiding the issue altogether, along with avoiding that additional cost to you.

2) If a creditor does raise a challenge, the issues are narrow and so the fight is usually focused on just a few critical facts. Less facts to dispute makes for a less complicated process.

3) Adversary proceedings move along fairly quickly. Compared to most state court and regular federal court litigation which often takes a couple of years, these kinds of adversary proceedings tend to be resolved in a matter of few months

4) Because bankruptcy judges deal with these kinds of challenges all the time, they are extremely familiar with these legal issues. Compared to conventional trial courts where the judges often have to get into unfamiliar territory, and often deal with multiple parties with huge dollar amounts at stake, these adversary proceedings are quite straightforward.

Having a creditor object to the discharge of a debt can significantly complicate a Chapter 7 or Chapter 13 bankruptcy case. But these disputes are usually settled relatively quickly. Help this happen by informing your attorney about any threats made by creditors before your bankruptcy is filed, and then working closely with your attorney if a creditor follows through on its threat by filing a complaint.

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Paying Your Special Creditor After Filing Bankruptcy

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

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

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

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

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

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

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

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

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

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

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

 

Background:

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

Cramdown:

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

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

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

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

A Patriotic Fresh Start

If you’re financially hurting during this 4^th of July, you may not exactly be feeling like this is a great country. But it is.

Here’s why:

• We are the fresh-start nation of the world. We’ve all heard the famous words from the poem at the base of the Statute of Liberty:

Give me your tired, your poor,
Your huddled masses yearning to breathe free,
The wretched refuse of your teeming shore.
Send these, the homeless, tempest-tost to me,
I lift my lamp beside the golden door!

Emma Lazarus, 1883

• Much of our history is one of migration within or beyond the edges of the country in hopes of finding a better life:
  • in the late 1700s, following Daniel Boone’s route through the Cumberland Gap of the Appalachian Mountains from Virginia to Kentucky
  • during the first half of the 1800’s, pouring into and throughout the Ohio Valley and the Great Lakes region, and across the southeast into Texas
  • from the 1840s through the 1860s, trekking 2,000 mile along the dangerous Oregon, California , and Mormon Pioneer Trails
  • populating the Great Plains as encouraged by the Homestead Act of 1862 which distributed free land  to those who “have resided upon or cultivated the same for the term of five years,” and the Oklahoma Land Run of 1889
  • in the first half of the 20^th century, 6 million African Americans participating in the “Great Migration” from the rural South to the urban North and West
  • since the end of World War II, the consistent shift in population from the northeast and Midwest Rust Belt to the southern and western Sun Belt.

• The spirit of a fresh start is woven into our history and culture, as expressed in our laws, starting with our foundational law, the Constitution: “The Congress shall have Power... To establish... uniform Laws on the subject of Bankruptcies throughout the United States” According to a famous commentary on the Constitution, this clause was not in the original draft, but was added after a vote of 9 states in favor and 1 against.

• In spite of this clear Constitutional mandate, it took Congress more than 100 years-- until 1898—to pass a bankruptcy law that wasn’t repealed within a few years!  We’ve managed to have a comprehensive bankruptcy law in effect ever since then.

• Property exemptions—your right to keep a certain amount of your property when filing bankruptcy--is the result of a 200-year-old Constitutional battle of states’ right versus federal power.  Throughout the 1800s, the country waged a political and economic war between Northeastern bankers and Western and Southern farmers and small merchants. Because of reoccurring devastating financial “panics” during that century, the farmers and merchants had good reason to worry about losing their homes and farms to out-of-state creditors. As a result, the first law exempting property from the collection of debt was adopted in 1839 in the Republic of Texas, and spread quickly through the South and the Midwest during the 1840s and 1850s. Exemption laws continue to protect our property from creditors today.

• In spite of huge efforts over the years by creditors to make bankruptcy less accessible to consumers, the Chapter 7 and Chapter 13 options do continue to provide tremendous relief for most people who need them. Although not perfect, they give you a relatively flexible, balanced, and effective way to personally take part in the centuries-old and sometimes necessary American tradition of a financial fresh start.

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.

 

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.

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.

 

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

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

 

Here’s what you need to know:

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

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

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

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

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

What Happens to Your "General Unsecured Debts" in Chapter 7?

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

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

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

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

“Dischargeability”

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

Asset Distribution

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

 

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

 

The Most Basic Concept in Bankruptcy: Debts

The most practical questions you likely have if you are considering bankruptcy is what it will do to each of your debts. Will you still owe anything to anybody? What about debts you want to keep like a vehicle loan or mortgage? How to handle special debts like income taxes and child support?

To understand bankruptcy you need to understand debts. One of the most basic principles of bankruptcy is that it treats all creditors in the same legal category the same as all the other creditors in that category. So the first step in understanding debts is to understand the three main categories of debts. Not everybody has debts in each of these categories, but lots of people do. At the end of this blog, you should be able to at least start dividing your debts among these three categories. From there, bankruptcy and how it deals with each of your creditors will start making more sense.

The three categories are “general unsecured debt,” “secured debt,” and “priority debt.”

Secured Debts

All debts are either secured by collateral or not. Whether or not a debt is secured is often very straightforward, such as with a vehicle loan in which the vehicle’s title specifies your lender as the lienholder. That lien on the title, together with the documents you signed with that lender, gives that lender certain rights as to that collateral, such as the right to repossess it if you fail to make payments.

In the case of every secured debt, there is a legally prescribed way to attach the debt’s collateral to the debt. In the case of the vehicle loan, the lender and you have to jump through certain hoops for the lender to become a lienholder on the title. If those aren’t done right, the vehicle might not attach as collateral to your loan.

Debts can be fully secured or only partially secured. If you owe $10,000 on a vehicle worth only $8,000, the debt is only partially secured—secured as to $8,000, and unsecured as to the remaining $2,000 of the debt.

Debts can be voluntarily or involuntarily secured. Examples of the latter are judgment liens on your home, IRS income tax liens on all your personal property, and a mechanic’s or repairman’s lien on a vehicle that’s been repaired and the repair bill not paid.

General Unsecured Debts

All debts that are not legally secured by collateral are simply unsecured debt. And “general” unsecured debts are simply those which do not belong to any of the categories of “priority” debts (discussed below). So general unsecured debts are the default category—if a debt is not secured and not a priority debt, it’s a general unsecured one. They include every imaginable type of debt or claim. Common ones include most credit cards, essentially all medical bills, personal loans without any collateral, bounced checks, most payday loans (although those sometimes have collateral), unpaid rent and utilities, balances left over after a vehicle is repossessed, many personal loans, and uninsured or underinsured motor accident claims against you.

Sometimes debts which were previously secured can become general unsecured ones, and vice versa. An example of the first: once you’ve surrendered all the collateral—such as a vehicle on a vehicle loan—any remaining debt is general unsecured. And an example of the second: a general unsecured medical bill can become secured after a lawsuit is filed against you and a judgment entered, resulting in a judgment lien attached to your real estate.

Priority Debts

Just like it sounds, priority debts are special ones that the law has selected to be treated better than general unsecured debts. In fact, there are very specific levels of priority among all the priority debts.

It’s all about who gets paid first (which often means who gets paid at all). This comes up in two main ways.

First, most Chapter 7 cases don’t involve the trustee receiving any of your assets for distribution to your creditors. But in those cases where there are non-exempt assets, the priority creditors are paid in full before the general unsecured ones receive anything. And the higher priority creditors are paid in full before the lower priority ones.

Second, in a Chapter 13 case, your formal plan has to show that you will pay all priority debts before the completion of your case, and then you must in fact do so before you are allowed to finish it.

The most common priority debts for consumers or small business owners are the following, in order starting from the highest priority:

• child and spousal support—amounts owed as of the time of the filing of the bankruptcy case

• the administrative costs of the bankruptcy case—trustee fees and costs, and in some cases attorney fees

• wages and other forms of compensation owed to employees—maximum of $10,000 per employee, for work done in the final 180 days before the bankruptcy filing or close of business, whichever was first

• certain income taxes, and some other kinds of taxes—some are priority but others are general unsecured if they are old enough and meet some other conditions

In the next blog I’ll get more into how debts in each category are treated in Chapter 7 and Chapter 13.

 

Business Litigation Worth Fighting About in Bankruptcy

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

What is No Longer Worth Fighting About

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

What IS Worth Fighting About

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

1) Determining the Amount of a Debt

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

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

2) Potential Insurance Coverage of the Debt

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

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

• claims on business equipment damaged by fire or flood

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

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

3) Nondischargeable Debts

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

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

 

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

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

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

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

Debtors with More Non-Consumer Debts than Consumer Debts

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

What is a “Consumer Debt”?

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

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

“Primarily Consumer Debts”?

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

Seemingly Consumer Debts May Not Be

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

Unexpectedly High Business Debts Can Help

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

 

Getting Just Enough Help for Your Home through Chapter 7

When does filing a Chapter 7 “straight bankruptcy” case help you enough so that you don’t need a 3-to-5-year Chapter 13 case?

If you are behind on your mortgage payments but want to keep your home, you have likely heard that a Chapter 13 “payment plan” is what you need. And that IS a powerful package, with an impressive set of tools to deal with a wide variety of home-related problems—everything from the mortgages themselves to property taxes, income tax liens, and judgment liens.

But what if you need to discharge other debts to get a fresh financial start, and have managed to fall only a couple of months behind on your mortgage? Or what if you are not keeping the house, but just need a little more time to find another place to live?

Then you may well not need a Chapter 13 case, and can maybe avoid the disadvantages it comes with—mostly, that it takes so much longer and generally costs lots more than Chapter 7. This extra time and cost can be well worthwhile when you need the great advantages of Chapter 13, but let’s look at ways that Chapter 7 can do enough for your home:

In a Chapter 7 case:

1. The “automatic stay”—the bankruptcy provision that stops virtually all actions by creditors against you or your property—applies to Chapter 7 just as it does to Chapter 13. So the filing of a Chapter 7 case STOPS a foreclosure in its tracks, just as quickly as a Chapter 13 filing. But if you are just trying to buy time to save money for a rental, the tough question is HOW LONG that break in the mortgage company’s foreclosure efforts will last, and how much extra time it’ll buy you. An aggressive creditor could quickly ask the court for “relief from the stay”—permission to resume the foreclosure process—thus potentially getting you only a few extra weeks. Or on the other extreme, a mortgage creditor could just do nothing for the 3 months or so until your Chapter 7 case runs its course and the “automatic stay” expires with the completion of your case. So, Chapter 7 often does not come with much predictability about how much time you’d gain. On the other hand, your bankruptcy attorney may well have experience in how fast certain mortgage lenders tend to ask for “relief from stay” under facts similar to yours.

2. Chapter 7 stops—at least briefly—not only mortgage foreclosures, but also prevents other potential liens from being placed against your house, including the IRS’s tax liens and judgment liens. But why would the few weeks or months that Chapter 7 gains make any difference with these kinds of creditors? In the right set of facts, it can make many thousands of dollars of difference.

• A timely filing of a Chapter 7 case can prevent you from having to pay a debt that would otherwise have become a lien against your house. For example, let’s say you have an older IRS debt that meets the necessary conditions for discharge, and you also have a little equity in your home but not more than your homestead exemption allows. If you waited until after the IRS recorded a tax lien for that debt against your house, that lien would continue being attached to your house even if you filed a bankruptcy and would eventually have to be paid. However, if your Chapter 7 filing happened before the IRS recorded a tax lien, the “automatic stay” would prevent that tax lien from being filed, the tax debt would be discharged forever, and your home’s equity would be preserved.

• Or if instead let’s say you have a debt that is NOT going to be discharged in bankruptcy—say a more recent tax debt—but you also had some assets that you were going to have to surrender to the Chapter 7 trustee, what we call an “asset case.” If again you filed the bankruptcy case before the recording of the tax lien, your Chapter 7 trustee could well pay those taxes as a “priority” debt in front of any of your other debts, potentially leaving you with no tax debt at the completion of your case.

3. Chapter 7 allows you to concentrate on your house payments by getting rid of your other debts. If you’ve managed to keep current on those mortgage payments, but don’t know how long you will be able to do so, the relief you get from discharging your other debts greatly improves your odds of staying current on your home long term. Or if you have missed only a few mortgage payments, AND can reliably make future ones, PLUS enough to catch up on your arrearage within year or less, then Chapter 7 would like very likely do enough for you. Most mortgage creditors will let you enter into an agreement –often called a “forbearance agreement”—to catch up the missed payments by paying a sufficient specific amount extra each month until you’re caught up, again, as long as that period of catch-up time is relatively short. Otherwise, you may well need a Chapter 13.

 

Reasons to Do a Short Sale? Maybe Not

Besides avoiding a foreclosure and its hit on your credit record, you may have other sensible reasons for looking into a short sale of your home. Let’s consider those other reasons.

In my last blog I showed how a short sale may be harder to pull off than expected, and how they can be dangerous if you do not get advice from knowledgeable professionals looking out for your interests. Simply put, you should not assume that any particular solution is the right one without knowing all your options. And that means asking whether the reasons you are pursuing one option might or might not actually be better served through a different option.

So here are some sensible reasons to consider doing a short sale:

1. You can’t afford the house anymore and so believe you have no choice but to get out.

If your income has been cut or the mortgage payments have gone up so that you cannot keep up those payments, and yet you can’t sell your house in the normal fashion because it’s worth less than the mortgage balances, then a short sale may be a good way to escape the house and its debt.

But maybe you have important reasons to stay in your home. Your family may benefit from staying for deep personal reasons—such as not leaving your kids’ school district or maintaining family stability. If you leave this home it may be a long time before you would have the financial means to buy again. So there may be ways to lower the cost of keeping your home. A mortgage modification may now be more available than in the last few years because of the recent large mortgage fraud settlement with the major banks, and other improved programs. A Chapter 13 case in bankruptcy court may enable you to eliminate or drastically reduce a second mortgage balance, and either eliminate, reduce, or delay payments on other liens on the house. And either a Chapter 7 or 13 could reduce or eliminate other debts so that you could better afford to pay the home obligations.

2. You’ve heard that bankruptcy does not allow “cram downs” of mortgages on your home. So you see no way out of your second mortgage other than getting them at least a partial payment through a short sale in return for writing off the rest of that debt.

You’ve been doing your homework if you understand that mortgages secured only by your primary residence cannot be “crammed down,” reduced in bankruptcy to the value of that residence, unlike lots of other kids of secured debts.

But there’s a big exception, one that keeps getting bigger as home values continue to decline in many areas. If your home is worth less than the balance of your first mortgage, so that there is no equity at all in your home for the second mortgage, then through a Chapter 13 case you can “strip” this lien off your home. That means that your second mortgage debt can be paid very little—sometimes even nothing—during your 3-to-5 year Chapter 13 case, and then written off completely. This not only saves you from paying the 2nd mortgage payment from then on, it reduces your debt on your home forever, making hanging onto your home economically more sensible. If this second mortgage strip applies to your situation, then you will pay less each month for a home with less debt on it.

3. You may be induced to do a short sale not just because of your voluntary mortgage debts on your home, but because of various other usually involuntary ones which have attached to your home’s title, like one or more tax, judgment, support, utility, or construction liens.

You may have found out that your title is saddled with other obligations, and in fact you may well be under a great deal of pressure to pay one or more of these obligations. The IRS and support enforcement agencies can be especially aggressive. So you would understandably feel that you have no choice but to sell your home to get that aggressive creditor paid. And since you have no equity in your home, you can only sell it on a short sale. But the problem is that the more lienholders you have, the more challenging a short sale becomes. And even if it does succeed, the troublesome lienholder may agree to sign off for less than the balance, leaving you still being pursued by it.

I can’t cover here how a Chapter 7 or Chapter 13 case would deal with each of these kinds of lienholders. That’s a many-blog discussion, and would depend on each person’s circumstances. But often you would have options that would give you more control over your home and over your financial life than would happen in a short sale. Considering what is at your stake, it certainly makes sense to consult an attorney who is ethically bound to explain all the options in terms of your own goals and best interests.

Study Shows Chapter 7 Debtors Represented by an Attorney Are "Almost Ten Times More Likely to Receive a Discharge" of their Debts

My own professional experience about the dangers of filing bankruptcy without an attorney is validated by carefully analyzed data.

In my work as a bankruptcy attorney, I spend a fair amount of my time attending Chapter 7 “341 hearings” with my clients. That’s the usually straightforward 10-minute or so meeting with the bankruptcy trustee that everyone filing bankruptcy gets to go through a month or so after their case is filed. As I wait for my clients’ turn and listen to other hearings, I see the bad things that happen there to people who file bankruptcy without an attorney. I won’t go through a litany of horror stories here, but let me just say I’ve seen countless examples proving how dangerous it is to file a Chapter 7 bankruptcy without an attorney. Besides, I know how complicated bankruptcy laws and procedures are because that’s what I deal with day in and day out. Yet, I’ve always wondered: in actual fact, beyond my own professional knowledge and experience, how much more dangerous is it going without an attorney?

This question is addressed, among many others about the current state of bankruptcy, by a book that was published just a few weeks ago, Broke: How Debt Bankrupts the Middle Class. A compilation of articles by respected scholars, one of the chapters focuses on “pro se” filers (those without attorneys). The author of this chapter, Asst. Professor Angela K. Littwin of the University of Texas School of Law, analyzed data from the Consumer Bankruptcy Project, “the leading [ongoing] national study of consumer bankruptcy for nearly 30 years.” She concluded “that pro se filers were significantly more likely to have their cases dismissed than their represented counterparts.”

I haven’t yet gotten my hands on that book for the statistical details there, but in another closely related study from last year, Prof. Littwin concluded that “17.6 percent of unrepresented debtors had their cases dismissed or converted” to Chapter 13, [while] only 1.9 percent of debtors with lawyers met this fate.”  Even after controlling for other factors such as “education, race and ethnicity, income, age, homeownership, prior bankruptcy, whether the debtor had any nonminimal unencumbered assets at the time of the filing,” “represented debtors were almost ten times more likely to receive a discharge than their pro se counterparts.”

In her carefully understated and scholarly appropriate way, Prof. Littwin concluded that “there may always be additional unobservable factors for which I cannot control... [b]ut this analysis suggests that filing pro se dramatically escalates the chance that a Chapter 7 bankruptcy will not provide a person with debt relief.”

Special Protection for Your Co-Signers Under Chapter 13

Chapter 7 protects you and your assets with the automatic stay. Chapter 13 goes a big step further by also protecting your co-signers and their assets.

The first three chapters of the Bankruptcy Code—chapters 1, 3, and 5—include code sections that tend to apply to all of the bankruptcy options. In contrast, the code sections within chapters 7 and 13 apply only to cases filed under those chapters. Because the automatic stay—your protection from collection by creditors that kicks in as soon as your bankruptcy case is filed—applies to all bankruptcy cases, it is found in one of the earlier chapters of the code. It’s in chapter 3, section 362.

But the very first section of chapter 13—section 1301—also deals with the automatic stay, and adds another layer of protection that only applies to cases filed under Chapter 13.

The core of section 1301 states that once a Chapter 13 case is filed, “a creditor may not act, or commence or continue any civil action, to collect all or any part of a consumer debt of the debtor from any other individual that is liable on such debt with the debtor.”

This means that a creditor on a consumer debt, who is already stopped by the general automatic stay provisions of section 362 from doing anything to collect a debt directly from the debtor, is also stopped from collecting on the same debt from anybody else who is co-signed or otherwise also obligated to pay that debt.

If you think about it, that’s rather powerful. You are given the ability to protect somebody—often somebody your really care about—who is not filing bankruptcy and so is not even directly in front of the court. The person being protected may not even know that you are protecting them from the creditor.

This “co-debtor” protection does have some important conditions and limits:

1. It applies only to “consumer debts” (those “incurred by an individual primarily for a personal, family, or household purpose”).

2. For purposes of this code section, income tax debts are not considered “consumer debts.” So spouses on jointly filed tax returns or business associates with whom you share a tax liability are NOT protected.

3. This protection does not extend to those who “became liable on... such debt in the ordinary course of such individual’s business.”

4. Creditors can ask for and get permission to pursue the otherwise protected co-debtor to the extent that:

(a)  the co-debtor received the benefit of the loan or whatever “consideration” was provided by the creditor (instead of the person filing the bankruptcy), or

(b)  the Chapter 13 plan “proposes not to pay such claim.”

5. This co-debtor stay evaporates as soon as the Chapter 13 case is completed, or if it’s dismissed (such as for failure to make the plan payments), or converted into a Chapter 7 case.

Choosing between Chapter 7 and 13 often involves weighing a series of considerations. If you want to insulate a co-signer or someone liable on a debt with you from any adverse consequences of your bankruptcy case, that is one consideration that will likely push you in the Chapter 13 direction because of the co-debtor stay.