Your Bankruptcy Rights vs. Creditors' Rights to "Not be Deprived of Property without Due Process of Law" under the Fifth Amendment

The U. S. Constitution doesn’t talk about it, so how does filing bankruptcy give you the power to stop a foreclosure?

As you’ve probably heard, bankruptcy is explicitly covered in the Constitution. But not much.  All it says is that Congress has the power “to establish... uniform laws on the subject of bankruptcies throughout the United States.”  (Article 1, Section 8, Clause 4.) Not a word about the rights and obligations of the person filing bankruptcy. Nor about the rights and obligations of creditors.

The Fifth Amendment talks about the rights of creditors when it says that a person shall not “be deprived of... property, without due process of law.”  So let’s say you have entered into a contract to pay a loan taken out on the purchase of your home, and that contract includes a condition that the creditor can take your home when you don’t maintain the payments on the loan.  If indeed you do not make payments, the creditor’s contractual ability to take your home is a property right it then owns. It bargained for that right with you when it lent you the money to purchase the home.

But you've heard that bankruptcy DOES have the power to stand in the way of your mortgage holder’s right to foreclose on the mortgage. Where does that power come from?

According to the U. S. Supreme Court, which dealt with this issue a number of times during the Great Depression in the 1930s, that power “incidentally to impair or destroy the obligation of private contracts... must have been within the contemplation of the framers of the Constitution.” Continental Bank v. Rock Island Ry., 294 U.S. 648, 680-81 (1935). The Court’s rationale was that because Congress was given “the express power to pass uniform laws on the subject of bankruptcies,” delaying the exercise of creditors’ rights “necessarily results from the nature of the power.”

But, showing this isn’t so straightforward, later that same year the Supreme Court struck down an amendment to the bankruptcy law that had been enacted in 1934 to address the massive number of farm foreclosures. One of the reasons the law was ruled unconstitutional is because it took away from the mortgage-holding bank a property right: the “right to determine when such [foreclosure] sale shall be held, subject only to the discretion of the court.” Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 594 (1935).

So Congress quickly changed the law that same year to try to meet the Court’s objections. When that new law came before the Court, this time it was upheld, in an opinion written by the same justice, the eminent Justice Louis Brandeis, who had written the above opinion striking down the earlier law.

This time the bank holding the farmer’s mortgage based its argument that the law was “unconstitutional... mainly upon the... assertion is that the new Act in effect gives to the mortgagor [the farmer filing bankruptcy] the absolute right to a three-year stay; and that a three-year moratorium cannot be justified.”

After listing numerous ways in which the three-year stay was conditioned for the protection and benefit of the creditor, Justice Brandeis concluded that this stay, and the entire new law, was constitutional, as follows:

The power here exerted by Congress is the broad power "To establish... uniform Laws on the subject of Bankruptcies throughout the United States." The question which the objections raise is... whether the legislation modifies the secured creditor's rights...  to such an extent as to deny the due process of law guaranteed by the Fifth Amendment. A court of bankruptcy may affect the interests of lien holders in many ways. To carry out the purposes of the Bankruptcy Act, it may direct that all liens upon property forming part of a bankrupt's estate be marshalled; or that the property be sold free of encumbrances and the rights of all lien holders be transferred to the proceeds of the sale. Despite the peremptory terms of a pledge, it may enjoin sale of the collateral, if it finds that the sale would hinder or delay preparation or consummation of a plan of reorganization. It may enjoin like action by a mortgagee which would defeat the purpose of [the new law] to effect rehabilitation of the farmer mortgagor. For the reasons stated, we are of opinion that the provisions of [the new law] make no unreasonable modification of the mortgagee's rights; and hence are valid.

Wright v. Vinton Branch of Mountain Trust Bank of Roanoke, 300 U. S. 440, 470 (1937)(emphasis added, internal case citations omitted).

That why your bankruptcy filing powerfully stops a home foreclosure, even though the Constitution doesn’t say anything directly about this, and even though stopping that foreclosure impinges on a property right of your foreclosing mortgage lender.

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.

Bankruptcy Can Solve Your Debt Problems Even If You Can't Write Off Every Debt

Don’t disregard bankruptcy as an option just because it does not write off the debt which is your immediate big headache. There’s likely some good medicine for that headache after all.

Let’s say you owe a dreadfully large income tax debt from a couple of years ago. The IRS is getting aggressive about collecting it. You know for a fact that bankruptcy doesn’t discharge (legally write off) income tax debts, so you’re not seriously considering that option and have not seen a bankruptcy attorney.

You may or may not be right about whether or not that tax debt can be discharged. That’s almost always a matter of timing. So if indeed you could not discharge your debt a few months ago, that might not be true today, or might not be true a few months from now.)But whether or not the debt can be discharged,  either way, you would probably be wrong about not getting legal advice about it.

Why? Whether that special debt that you know can’t be discharged is a tax debt, back child support, student loans, or some other troublesome debt, here are six reasons you should STILL get legal advice about the bankruptcy  option:

1. Some debts which look like they can’t be discharged actually can. Certain income taxes can be discharged in either a Chapter 7 or Chapter 13 case, depending on how old they are and a series of other factors. Sometime a portion of an otherwise not dischargeable tax debt—such as the penalties—can be discharged, sometimes significantly reducing the amount you need to pay. Student loans are difficult to discharge, but in some unusual situations can be. And even though true child support obligations are not dischargeable, in rare situations a debt which you thought was a support obligation might not fit the legal definition for bankruptcy purposes. It’s certainly worth finding out whether the debt you assume can’t be discharged actually might be able to be.

2. Some debts that can’t be discharged now may be able to be in the future. Almost all income taxes can be discharged after a series of conditions have been met. So your attorney can put together for you a game plan coordinating these tax timing rules with all the rest of what is going on in your financial life. Timing issues can sometimes also be important with student loans, especially if you have a worsening medical condition or are simply getting close to retirement age

3. Even if you can’t discharge a debt, bankruptcy can permanently solve an aggressive collection problem.  In many situations your primary problem is the devastating way a debt is being collected. For example, you may want to pay an obligation for back child support but the state support enforcement agency is about to suspend your driver’s and/or occupational license. A Chapter 13 case will stop these threats to your livelihood, and protect you from them while you catch up on the back support.

4. You have more control over the amount of the monthly payments on debts that cannot be discharged. Debts which the law does not allow to be discharged in bankruptcy also tend to be ones that give the creditors a lot of leverage against you. Chapter 13 takes most of this leverage away from them and puts their power on hold while you pay what your budget allows, not what these creditors would otherwise be gouging out of you.

5. Bankruptcy can stop the adding of interest, penalties, and other costs, allowing you to pay off a debt much faster. Unpaid income taxes and certain other kinds of debts are so much more difficult to pay off because a part of each payment goes to the ongoing interest and penalties. Some tax penalties in particular can be huge. Most of these ongoing add-ons are stopped by a Chapter 13 filing, allowing you to become debt-free sooner.

6. Bankruptcy allows you to focus on paying off the debt(s) that you can’t discharge by discharging those you can. You may have both a debt or two that can’t be discharged and a bunch of debts that can be. Even if bankruptcy can’t solve your entire debt problem directly, discharging most of your debts would likely make that problem much more manageable. Under Chapter 7, you would be able to pay off those surviving debts much faster, which is especially important if they are accruing interest or other fees. And under Chapter 13 you would have the benefit of a predictable payment program, one that focuses your financial energies on those nondischargeable debts while protecting your assets and income from them.

So don’t let the fact that you have a debt or debts that can’t be discharged in bankruptcy stop you from getting legal advice about how your overall financial life could still be much improved through one of the bankruptcy options.  

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.  

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.

Your Sole Proprietorship Business Rescued by Chapter 13

Do you have a small business in your own name that would be successful if it only got a break from its debts? A Chapter 13 case would likely greatly reduce both your business and personal monthly debt service while you continued to run your business.

Although Chapter 13 is sometimes called the “wage earner plan,” it is not at all restricted to wage-earning employees. In the Bankruptcy Code Chapter 13 is actually titled “Adjustment of Debts of an Individual with Regular Income.” That word “Individual” makes clear that a corporation cannot file under Chapter 13. But if you are a person who owns a business that is operated in your own name, or that of you and your spouse, then you and business are treated as a single legal entity. The business’ assets are just part of your personal assets; its debts are just part of your debts. This is true regardless if your business is operated under an assumed business name, as long as you have not gone through the formalities of creating a corporation, a limited liability company, or other separate legal entity for your business.

Here’s how Chapter 13 works to help your sole proprietorship business:

1) Chapter 13 deals with your business and personal financial problems in one package. In a sole proprietorship you are individually liable for all debts of your business, along with your personal debts. So as long as you qualify for Chapter 13 otherwise, you can simultaneously resolve both business and personal debts with that one option.

2) Stop both business and personal creditors from suing you and shutting down your business. The “automatic stay” imposed by the filing of your Chapter 13 case stops ALL your creditors from pursuing you, including both business and personal ones. Your bankruptcy case will stop personal creditors from hurting your business, and business creditors from taking your personal assets.

3) Keep whatever your business assets you need to keep operating. If you do not file a bankruptcy, and one of either your business or personal creditors gets a judgment against you, it could try to seize your business assets. Also, if you filed a Chapter 7 “straight bankruptcy,” under most circumstances you could not continue operating your business. However, Chapter 13 is designed to allow you to keep what you need and continue operating your business.

4) Keep critical business and personal collateral. If you are behind either on business or personal loans secured by either business or personal collateral, Chapter 13 will at least temporarily stop the repossession of the collateral, and often give you an opportunity to either lower the payments or at least have some time to catch up on your late payments. In certain limited situations—such as some judgment liens and some 2nd/3rd mortgages—the liens can be gotten rid of altogether. Overall, through Chapter 13 you are provided ways to keep collateral that you would otherwise lose, and often do so under much better payment terms.

5) Solve both business and personal tax problems. Business owners in financial trouble are often in tax trouble, which Chapter 13 addresses well. The program is designed so that at the end of a successful Chapter 13 case, you will have either written off or paid off all your tax debts and will be tax free.

 

Ten Terrific Tools for Saving Your Home through Chapter 13--Part 1

Powerful Chapter 13 gives you tools to solve your mortgage problems from a number of different angles.  Plus it gives you other tools to deal with tax, support, and judgment liens on your home.

In my last blog I showed how a straight Chapter 7 bankruptcy case can sometimes help you enough to save your home. Or at least it can help you hold onto your home for as long as you need to.  But Chapter 7 can only give limited help, sufficient only in limited circumstances. Chapter 13, on the other hand, provides you a much more powerful and flexible package, with a range of tools for addressing just about all debt issues involving your home.

Here are the first five of ten distinct and significant ways that Chapter 13 can save your home. I’ll give you the other five in my next blog.

A Chapter 13 case enables you:

1. ... to stretch out the amount of time you get for catching up on missed mortgage payments, giving you as long as 5 years to do so. A longer repayment period means that you can pay less each month, making it more likely that you will actually be able to catch up and keep your home. Throughout this catch-up period, you are protected from foreclosure as long as you stay with the payment program, one that you propose.

2. ... to slash your other debt obligations so that you can afford your mortgage payments. The mortgage debt—especially your first mortgage—is highly favored within Chapter 13. So you are usually allowed—indeed required—to pay most of your mortgage payments in full, while being allowed to pay only as much as you have left over towards your “general unsecured” debts—those without any collateral, such as most credit cards, medical debts, and many other types of debts.

3. ... to permanently prevent income tax liens, child and spousal support liens, and judgment liens from attaching to your home. This stops these special creditors from gaining dangerous leverage over you and your home.

4. ... to have the time to pay debts that cannot be discharged (legally written off) in bankruptcy, all the while being protected from those creditors messing with your home. That applies when the tax, support or other lien was not filed before the Chapter 13 is filed—the example immediately above. But this also applies if the lien is already in place, giving you the opportunity to pay the debt while under the protection of the bankruptcy laws, undercutting most of the leverage of those liens against your home. And at the end of your case, the debts are paid and those liens are gone.

5. ... to discharge debts owed to creditors which could otherwise attack your home. For example, certain income tax debts are discharged, leaving you owing nothing. But if instead you had not filed the Chapter 13 case, or delayed doing so, a tax lien could have been recorded on that tax debt. That would have required you to pay some or all of the balance to free your home from that lien. Even most conventional debts can turn into judgment liens against your house after a lawsuit is filed. And certain judgment liens may or may not be able to be taken care of in bankruptcy.  If instead you file a Chapter 13 case to prevent these liens from happening, at the end of your case the debt is gone, and no such liens ever attach to your home.

Again, see my next blog for the other five house-saving tools of Chapter 13.

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.

 

How Quickly Will Bankruptcy Stop My Wage Garnishment?

Wage garnishments are stopped instantaneously... except that different state laws and procedures can effect what happens to the current paycheck.

Bankruptcy is a federal proceeding governed by federal law, but state law often plays into it as well. This question about stopping wage garnishments is a good example of the mix of federal and state law.

Except in rare circumstances (mostly involving income taxes and student loans), your wages cannot be garnished for repayment of a consumer debt before the creditor sues you in court and gets a judgment. That lawsuit will almost always be in state court, because the jurisdiction of federal courts is limited. The vast majority of the time debtors do not respond to such lawsuits by the legal deadlines, so the creditors win their judgments by default. Once your creditor has such a state court judgment in hand, it must then follow state law in collecting on it.

But states’ garnishment laws vary widely. Most states permit wage garnishment in some form, but a few restrict it to only very select kinds of debts (like child support, taxes, and/or student loans). Other states which do allow wage garnishment for conventional debts often have special garnishment statutes favoring some of those same select debts. State laws also differ on what part of a paycheck is subject to garnishment compared to the part that is “exempt,” or protected. And laws differ on the details of garnishment procedure, which can become critical as we return to the topic of this blog—how fast a bankruptcy stops a garnishment.

The moment your bankruptcy is filed, the “automatic stay” goes into effect. The filing itself operates as a “stay,” or a stopping, of virtually all collection activity. It operates as an immediate and one-sided court order against creditors, made effective by the very act of filing the bankruptcy case.  So the bankruptcy filing and the automatic stay stops a wage garnishment in its tracks.

But what if the bankruptcy is filed within just a day or two after the money has been taken out of your wages under a state court garnishment order but not yet turned over by your payroll office to the creditor? What does the Bankruptcy Code’s automatic stay require here when it says that the bankruptcy filing stops “the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the [bankruptcy] case”? (Section 362 (a)(2) of the Bankruptcy Code.)  Money that was taken out of your paycheck before your bankruptcy case was filed is not “property of the estate,” which consists of all your assets as of when your case is filed. But arguably it’s not your money either as of the time when your case is filed because it was already legitimately taken from you by the garnishment order. So can the creditor get that money that your employer is holding, or would that be a violation of the automatic stay?  

Because different state laws may have different answers to the question of who owns money that has been garnished from your wages but not yet forwarded to the creditor, whether the automatic stay prevents that money from going to the creditor can turn on those different state laws.

Overall, reputable creditors tend to be cautious about violating the automatic stay, and so will usually err on the side of caution to prevent doing so. But other creditors may be more willing to be aggressive, especially if the state’s statutes and/or courts have given them some cover to do so.

The bottom line is that your experienced bankruptcy attorney will be able to tell you two things:

1) what the interplay between the bankruptcy code’s automatic stay and your state’s garnishment law means for a particular paycheck of yours; and

2) whether your specific garnishing creditor tends to be cautious or aggressive about garnishments stopped by bankruptcy.

The Bankruptcy Consequences of the National Mortgage Settlement

The bankruptcy world played a quiet but significant role in bringing about this controversial $26 billion settlement. So, fittingly, the settlement terms require the banks to make significant changes in their behavior in bankruptcy court.

Before leaving my current series of blogs on this mortgage settlement, I had to tell you about its bankruptcy angles.

The bankruptcy courts are where some of the earliest signs of bank misconduct appeared. For many years before the “robo-signing” scandal broke in the fall of 20010, mortgage lenders had been making a bad name for themselves in bankruptcy court with shoddy accounting and loose paperwork. Unlike most foreclosures—judicial or non-judicial—in which homeowners do not have attorneys representing them, the majority of homeowners in bankruptcy do have attorneys. So when, for example, mortgage lenders try to get “relief from stay”--permission to foreclose on a home under bankruptcy protection—the homeowner has both a convenient forum—the bankruptcy court—and an advocate who can point out to the court that the lender has not credited all the payments, that it has misplaced payments in some “suspense account,” and/or that it hasn’t even provided its own attorney with accurate accounting information or documentation.  

The bankruptcy system also had another player with a major role, as U.S. Attorney General Eric Holder highlighted when he announced the settlement last month:

The U.S. Trustees Program, which serves as the watchdog of all bankruptcy court operations, was one of the first federal agencies to investigate mortgage servicer abuse of homeowners in financial distress.  As part of their investigation, Trustees reviewed more than 37,000 documents filed by major mortgage servicers in federal bankruptcy court – and took discovery in more than 175 cases across the country. 

Accordingly, the Complaint filed against the banks as part of this settlement documentation includes a major section on “The Banks’ Bankruptcy-Related Misconduct,” listing 15 distinct types of misconduct. (See pages 34-38 of the Complaint.)

And each bank’s Consent Judgment contains a series of requirements related to their bankruptcy procedures. (See the Ally Financial/GMAC Mortgage/Residential Capital ”Consent Judgment” here, along with its exhibits, totaling more than 300 pages. The other banks’ Consent Judgments can be found here.)

Here is an example of some of the requirements, as applicable to the banks’ filing of proofs of claim (“POC”) in bankruptcy court, which they file to establish the nature and amount of a debt:

The lender “shall ensure that each POC is documented by attaching:

a. The original or a duplicate of the note, including all indorsements; a copy of any mortgage or deed of trust securing the notes (including, if applicable, evidence of recordation in the applicable land records); and copies of any assignments of mortgage or deed of trust required to demonstrate the right to foreclose on the borrower’s note under applicable state law  ... .

....

f. The POC shall be signed (either by hand or by appropriate electronic signature) by the responsible person under penalty of perjury after reasonable investigation, stating that the information set forth in the POC is true and correct to the best of such responsible person’s knowledge, information, and reasonable belief, and clearly identify the responsible person’s employer and position or title with the employer.”

These requirements strike at the rampant problems with insufficient documentation and authorization, including assignments and recordings.  There are similar rules applicable to motions for relief from stay, about fees charged by lenders during Chapter 13 cases, and their loss mitigation behavior during bankruptcy.

Remember that this national mortgage settlement does NOT settle or waive any “claims and defenses asserted by third parties, including individual mortgage loan borrowers on an individual or class basis.” (See the Federal Release, Exhibit F, p. 42, and the State Release, Exhibit G, p. 10, in the Ally Financial “Consent Judgment,” by way of example.) In effect that means that debtors in bankruptcy are not limited by the settlement from pursuing mortgage lenders for their violations of bankruptcy law, including those laws referred to in this settlement. These lenders simply also have their feet to the fire for the next three and a half years while the settlement is in effect and they are being monitored for compliance with its requirements.

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.

Three Big Ways Bankruptcy Helps with Income Taxes

Bankruptcy CAN 1) legally write off some income taxes; 2) stop IRS wage garnishments, bank account levies, and tax liens; and 3) enable a faster payoff of the taxes you must pay, by avoiding most ongoing interest and penalties.

In the last two blogs I explained what happens to tax refunds in Chapter 7 and 13. But what if instead you owe income taxes? The treatment of tax debts in bankruptcy is a complicated subject, but here today I’m covering the most basic and important powers of bankruptcy over taxes.

1) The ability to “discharge” (write-off) income taxes:

I’m not going into the detailed rules here, but let me clear up any possible confusion: income taxes can be discharged if they meet some very specific conditions. Among those conditions:

• the age of the particular tax
• whether and when the tax return was filed
• whether there was any effort to enter into an “offer in compromise”
• whether there is evidence of tax evasion

Generally the older the tax, the more likely it will be discharged, although some of the conditions are not time-based.  If you owe more than one year of income taxes, then each year of tax debt is analyzed separately. In fact portions of each tax year’s debt—tax, interest, and penalties—are treated differently in many situations. To be clear, taxes can be discharged under either Chapter 7 or Chapter 13. So determining which of these two options is better requires carefully comparing how each treats your tax debts, as well as all your other debts.

2) The “automatic stay” applies to the IRS, and to the state and local taxing authorities:

Changes in the law tend to cause confusion, to get blown out of proportion. The last major overhaul of the bankruptcy laws by Congress in 2005 allowed the IRS and other tax agencies to do certain very limited things in spite of the taxpayer having filed a bankruptcy. These limited exceptions to the automatic stay include:

• conducting (or continuing) a tax audit (but not taking any action outside the bankruptcy court to collect the tax resulting from the audit)
• issuing a notice of deficiency
• assessing the taxes
• issuing a “notice and demand” (although again without taking any collection action)

Otherwise, just like all other creditors, the IRS and its state and local cousins cannot pursue collection of any liabilities while your bankruptcy case is pending, except in the unusual event that the bankruptcy court gives special permission to do so.

3. As for taxes that cannot be discharged, Chapter 13 usually provides a way to avoid most ongoing interest and penalties, reducing the total amount of taxes to pay:

Back taxes often take a long time to pay off because interest and penalties keep accruing while you are making the payments. Especially if your payments are relatively small, the additional interest and penalties can greatly increase the total you end up paying. But in a Chapter 13 case, the penalties stop accruing as soon as soon as your case is filed. Even the earlier penalties are treated like normal debt and so are often paid little or not at all. And interest does not get added unless that tax debt is covered by a recorded tax lien.  In combination these benefits can save lots of money. This lack or reduction in accruing interest and penalties also allows you to pay other important debts before paying the taxes—such as vehicles or home mortgage arrears. This allows you to better protect those valuable possessions by paying their debts faster.

Taxes in a Closed-Business Bankruptcy Case

Dealing with taxes from a failed business through a bankruptcy—that sounds complicated. But I’m going to keep it simple here. What are your basic options if you owe taxes after closing down a small business?

You have two choices (once it’s clear that you need to file a bankruptcy because of the amount of your debts):

1. File a Chapter 7 case to discharge (legally write-off) all the debt that you can, perhaps including some of the taxes, and then deal directly with the taxing authorities about the remaining taxes.

2. File a Chapter 13 case to discharge all the debt that you can, perhaps including some of the taxes, and then pay the remaining taxes through that same Chapter 13 case.

In real life, especially after a messy situation like the shutting down of a business, many factors usually come into play in deciding whether a Chapter 7 or 13 is better for you. But focusing here only on the taxes, it comes down to this core question: Would the amount of tax that you would still owe after completing a Chapter 7 case be small enough so that you would reliably be able to make reasonable arrangements with the Internal Revenue Service (or other applicable taxing authority) to satisfy that obligation within the following two years or so?

Chapter 13 protects you from the collection powers of the taxing authorities during the usual three to five years while you are fulfilling your obligations under the case.  You should be in a Chapter 7 case only if you don’t need that protection. That means your attorney needs to be able to tell you 1) what tax debts will not be discharged in a Chapter 7 case, and 2) what payment or other arrangements will you likely be able to make to take care of those remaining taxes.  

How reliably anyone can predict how a particular taxing authority will respond about a surviving tax debt depends on the circumstances. For example, the IRS has some rather straightforward policies about how long a taxpayer has to pay off income tax obligations below a certain amount. In contrast, predicting whether or not the IRS will accept a certain “offer-in-compromise” can be much more difficult to predict.  If you cannot get rather strong assurances that you will be able to reasonably handle what the taxing authorities will require, you may well be better off within the protections of Chapter 13.

Not only does Chapter 13 give you protection from the tax authorities, you would likely be permitted to pay less to them per month towards the not-discharged taxes. That’s because your living expense budget in a Chapter 13 case will likely be more reasonable than when you’re dealing directly with the IRS after a Chapter 7 case. Furthermore, unlike the after-Chapter 7 situation, penalties would not continue to accrue, and in most cases neither would interest. As a result, in a Chapter 13 case most likely you would pay less money to finish off the tax debt.

Again, the bottom line: once you know how much tax debt will survive a Chapter 7 case, do you have a reasonable and reliable means of paying it off or settling it within about two years? If so, do the Chapter 7 case. Otherwise, take advantage of the greater protection and likely more reasonable budgeting in Chapter 13.