| STRAIGHT BANKRUPTCY: CHAPTER 7
Q. What does Chapter 7 bankruptcy involve?
A. Straight bankruptcy under Chapter 7 is available if less drastic
methods will not solve
your financial problems. It allows you to discharge (extinguish) most
debts. A section
below describes some types of debts that you cannot avoid in any form
of bankruptcy.
About 70 percent of all consumer bankruptcy filings nationwide are under
Chapter 7.
Q. How does a Chapter 7 bankruptcy case begin?
A. It starts when you file a petition with the U.S. Bankruptcy
Court asking it to relieve
you (or you and your spouse) from your debts. As of the date you file
the petition, your
assets will be under the protection of the court. In addition, most collection
efforts against
you must stop. However, if someone has co-signed a loan for you, your
automatic stay
does not stop creditors for seeking payment from your co-signer.
When you file the petition, you also must file a Statement of Financial
Affairs and
schedules that, among other things, describe your financial history and
list your income,
all of your debts and your assets. These schedules are quite detailed:
Your liabilities:
• your priority debts (such as taxes);
• your secured creditors (auto dealers, home mortgages, and so on);
• your unsecured creditors (department store credit cards and the
like).
Be sure that you list all your creditors and their correct names and addresses.
If
you omit some, or provide incorrect addresses, you might not be discharged
from those
debts.
Your assets:
• all your real property, including any you own together with your
spouse or other
persons;
• all your personal property (such as household goods; clothing,
cash, retirement funds,
accrued net wages);
• all property, whether real or personal, that you claim exempt
from creditors.
Q. Will I lose some of my assets if I file for Chapter 7?
A. Under Chapter 7, you might well have to turn over many, if
not all, of your nonexempt
assets. What happens depends upon the classification of the asset:
Assets pledged as collateral on a loan (encumbered assets). When you have
borrowed to buy a car, boat, household furniture, appliance, or other
durable item, the
lender commonly has a lien (legal claim) on that property to secure the
debt until the loan
is fully repaid. You may also have given a lien on property you already
owned to obtain a
new loan, such as a second mortgage to finance home improvements. Some
creditors may
obtain liens without the debtor’s agreement, either because they
have won a lawsuit
against the debtor or because the law automatically provides a lien for
certain claims,
such as for duly assessed taxes.
In bankruptcy a claim is “secured” to the extent that it is
backed up by collateral.
Often the collateral is worth less than the amount of the debt it secures,
such as a $1200
car securing a loan balance of $3000. In that case, the lender is “undersecured” and is
treated as holding two claims, a $1200 secured claim and an $1800 unsecured
claim. On
the other hand, sometimes a debt is secured by collateral whose value
exceeds the loan
balance at the time of bankruptcy, such as a $65,000 home subject to a
$30,000 mortgage.
In that case, the lender is “oversecured.” The lender is entitled
to no more than the
$30,000 it is owed. The excess value of $35,000 is referred to as the
debtor’s “equity.”
If you cannot make the required payments on a secured claim (and also
catch up
on any back payments), the creditor has a right to take back the collateral
after having the
automatic stay lifted. However, you may be able to keep your car, boat,
or other durable
item by redeeming it or reaffirming your debt (as explained later in this
chapter) or by
continuing to make payments.
Unencumbered assets. For present purposes, these include (1) assets on
which
there is no lien at all and (2) the debtor’s equity in assets that
are collateral for
oversecured claims. The debtor retains unencumbered assets to the extent
that they are
exempt; otherwise they must be surrendered for distribution among those
holding
unsecured claims.
Exempt assets. These are assets that you must list on your Statement of
Financial
Affairs and schedules and that you may shield from your unsecured creditors.
The assets
that you may protect in this way are defined by federal and state law.
In about fifteen
states you may chose either of the two laws, while in most states you
may use only the
state exemptions. Exemptions vary widely. For example, under the federal
statute a
couple filing jointly may exempt a total of $32,300 in equity in their
home, $16,500 for
each of them. Thus, if the home is worth $65,000 and has a $30,000 mortgage,
creditors
can claim only $2,700 (the difference between the equity of $35,000 and
the $32,300
exemption). As a matter of practice, the couple would probably keep their
home—
perhaps at the cost of paying that $2700 in nonexempt equity to the trustee—rather
than
have it sold for the benefit of the creditors.
In contrast, Florida allows a homestead exemption that protects from creditors
a
debtor's home and property so long as it does not exceed half an acre
in a municipality or
160 acres elsewhere. Thus, an investment banker who filed bankruptcy has
been able to
retain a beachfront home reportedly valued at $3.25 million. In Georgia
the homestead
exemption is limited to $5,000. Similar variations among the states are
found concerning
a broad array of other exempt assets such as autos, jewelry, household
furnishings, books
and tools of the debtor's trade.
Congress has recently been considering proposals to introduce greater
nationwide
uniformity in exemptions, including a dollar cap on the most generous
state homestead
provisions.
In cases involving an individual married debtor or joint debtors, several
specific
points about exemptions are worth noting. First, in joint cases, each
spouse must claim
exemptions under the same law, either both relying on state law or both
relying on federal
law. Second, when federal exemptions are elected and often as well when
state law
applies, each spouse can claim the full exempt amount on his or her own
behalf, as
illustrated above with the doubling of the federal homestead exemption.
In questionable
decisions, however, some courts have followed state law in limiting joint
debtors to only
a single set of state law exemptions. Third, in more than fifteen states,
creditors of only
one spouse are barred either completely or in large part from reaching
real and/or
personal property owned by the debtor with a non-debtor spouse as joint
tenants or
tenants by the entirety. Those bars generally apply in any bankruptcy
case where state law
exemptions govern.
Finally, as mentioned above, exempt assets are beyond the reach of unsecured
creditors. Exemptions do not ordinarily affect the rights of creditors
with respect to assets
on which they have liens. For example, homestead exemptions generally
do not affect the
rights of a mortgage lender to foreclose on the debtor’s home. Under
some specific
circumstances, the Bankruptcy Code may permit the debtor to undo a lien
and then assert
exemption rights. This is a matter about which it is probably best to
consult an attorney.
Nonexempt unencumbered assets. The Bankruptcy Code requires that you give
all
these nonexempt assets to the bankruptcy trustee. The trustee will then
liquidate (sell off)
these nonexempt assets for the benefit of your creditors. However, in
actual practice, over
85 percent of Chapter 7 filings are "no-asset filings"—that
is, there are no assets left for
unsecured creditors after the exempt assets have been claimed.
Q. How may I keep certain possessions that I do not want the
trustee to sell?
A. If you are required to surrender some nonexempt property that
you wish to keep—for
example, a car—you may under certain circumstances arrange to buy
it back (redeem it)
for a price no greater than its current value. For example, if you owe
$3,000 on your car,
but its market value is only $1,200, you can recover the car by paying
$1,200 to the
creditor who has a lien on it. In the real world, of course, it may be
very hard to come up
with $1,200, which must be paid in a lump sum from the debtor’s
personal assets, not
property that has been set aside for the distribution to creditors. Possible
sources of funds
would include the debtor's post-petition salary, proceeds from the voluntary
sale of
exempt assets or loans from relatives or friends.
Alternatively, you may reaffirm some debts, if the creditor is willing.
By
reaffirming these debts, you promise to pay them (usually but not always
in full), and you
may keep the property involved, so long as you keep your promise.
You have the right to cancel a reaffirmation agreement within sixty days
after it is
filed with the court or prior to the discharge, whichever occurs later.
Reaffirmation is not
always in the best interest of the debtor, especially when the reaffirmed
debt relates to
property worth far less than the debt reaffirmed. Most reaffirmations
relate to mortgage
loans and the retention of personal property—car, boat, etc.—especially
valued by the
debtor.
Finally, as for personal property securing a loan, you may simply continue
to
make payments. The law in this area is not particularly clear, but as
a practical matter
lenders will often not take action if they continue to receive full payment.
Q. Can I protect some assets, such as a vacation home, by transferring
title to
relatives prior to filing for bankruptcy?
A. No. You will be asked whether or not you have transferred
property within a year prior
to filing. The trustee can cancel the transfer and recover the property
for your bankruptcy
estate. If the trustee discovers that you made the transfer with the intention
of defrauding
any creditor, you may be denied discharge and face charges of committing
a fraudulent
act.
Q. What happens after I submit all the above information to the
court?
A. The bankruptcy court clerk will notify your creditors that
you have filed a petition.
They must immediately stop most efforts to collect the debts you owe.
A trustee will be
appointed, usually a local private lawyer who does this kind of work in
the normal course
of practicing law.
You will be required to appear at a first meeting of creditors, where
the trustee
will examine our under oath about your petition, Statement of Financial
Affairs, and
schedules. Later he or she will determine whether to challenge any of
your claimed
exemptions or your right to a discharge. If you disagree with the trustee's
decision, you
may protest to the court, which will make the final decision.
After determining your exemptions, the trustee will assemble and distribute
your
nonexempt assets (if there are any). The trustee will first distribute
to secured creditors
the value of their collateral. Next, the trustee will pay unsecured priority
claims, such as
most taxes. If any funds are left, there is then a distribution among
your general unsecured
creditors on a pro rata (proportionate) basis. Say, for example, that
after the payment of
secured and priority claims, the proceeds from the sale by the trustee
of your nonexempt
assets equal 20 percent of your remaining debts. Then the trustee will
pay each general
creditor 20 percent of what you owe. In return, the court will discharge
you from paying
any remaining balance on your general unsecured debts.
Q. May I use bankruptcy to get rid of all my debts?
A. No, bankruptcy does not discharge all types of debt. If a
debt is excepted from
discharge you remain legally responsible for it. Exceptions include most
tax claims,
alimony, and child support, many property settlement obligations from
a divorce or
separation, most student loans, fraud debts, and debts from a drunk driving
problem.
Chapter 7 bankruptcy also will not release you from damages for "willful
and malicious"
acts such as assaulting another person. Many debts incurred though the
debtor’s fraud are
also non-dischargeable. In this regard, there is a presumption of fraud
in last minute credit
card binges involving more than $1075 in either cash advances or luxury
purchases
within sixty days before a bankruptcy filing.
Q. Should husbands and wives file jointly for bankruptcy?
A. They are permitted to, but whether it is to their advantage
depends on many factors,
such as how closely entwined their finances are and whether they live
in a community
property or separate property state (see the chapter, "Family Law.)
They're best
advised to seek the counsel of a bankruptcy lawyer well versed in the
law of
their state. If they both file bankruptcy at the same time, only one case
filing fee with
required changes (in all about $200) will have to be paid to the court
in a Chapter 7 or 13
case.
Chapter 13 of the Bankruptcy Act
Q. What does a Chapter 13 bankruptcy case involve?
A. Chapter 13 allows individual who have steady incomes to pay
all or a portion of their
debts under protection and supervision of the court. Under Chapter 13,
you file a
bankruptcy petition and a proposed payment plan with the U.S. Bankruptcy
Court. The
law requires that the payments have a value at least equal to what would
have been
distributed in a Chapter 7 liquidation case. An important feature of Chapter
13 is that you
will be permitted to keep all your assets while the plan is in effect
and after you have
successfully completed it.
Chapter 13 is available only to those borrowers with regular income who
have less
than $269,250 in unsecured debts (such as credit cards) and less than
$807,750 in secured
debts (such as mortgages and car loans). Anyone with greater debts usually
must declare
bankruptcy under Chapters 7 or 11 of the Bankruptcy Code. In a joint Chapter
13 case
those limits are not doubled, instead they are applied to the total amount
owed by the
debtors.
Q. What is this proposed payment plan?
A. Under Chapter 13, if a creditor or the trustee objects to
your plan, your payments must
represent either (1) full satisfaction of your debts or (2) all your disposable
income for a
three-year period, that is, whatever is left over from your total income
after you have paid
for taxes and necessary living expenses. If there is no objection, the
plan may be more
flexible. The plan that you prepare for review by your lawyer should take
into account
your income from all sources and your necessary expenses. What is left
from your income
after paying living expenses will be available for disbursement to your
creditors. Your
plan must provide for payment in full of all priority claims, such as
taxes, although you
can arrange to pay them over the life of the plan.
You submit your plan to the court and a Chapter 13 trustee, who is appointed
by
the United States Trustee to handle Chapter 13 cases. The trustee will
verify the accuracy
and reasonableness of your plan and distribute your proposal to the creditors.
They will
have the opportunity at a hearing to challenge your proposal if they believe
that it is
unreasonable. With that in mind, the trustee will want to be sure that
your plan provides
enough for you to live on, but will also challenge expenses that are unreasonably
high.
The issue is whether you are making a "good faith" effort to
repay your debts, even if it
means a reduction in your living standards such as cutting your entertainment
expenses
down from five hundred dollars per month. Since the trustee's recommendation
will carry
considerable weight with the court, it pays to be honest and open with
the information
that you provide. Once the payment plan is approved by the court after
the hearing, you
make regular monthly payments to the trustee, who in turn splits up the
money among
your creditors according to the plan. A Chapter 13 discharge is granted
after completion
of the payments in the plan. If the payments are not completed, there
are some
circumstances under which a more limited discharge may be granted.
The role of Chapter 13 trustees varies among judicial districts. Some
trustees
work with debtors to help them learn to manage their finances, and may
arrange for
automatic payroll deduction of the monthly payments to be credited directly
to the
trustee's account for disbursement to the various creditors. A small part
of the monthly
payments goes to the trustee for these services.
A repayment plan under Chapter 13 normally extends your time for paying
debts.
The permitted repayment period usually is up to three years or, with special
permission of
the court, up to five years. Typically, the amount that you repay under
a Chapter 13 plan
is determined by the total of your planned monthly payments over three
years, given your
good faith effort to do the best that you can. A Chapter 13 repayment
plan often results in
your repaying less than you owe.
Q. What happens if I can’t keep up the payments under my
Chapter 13?
A. There are several possibilities depending on the circumstances.
For example, if you
have an accident that causes you to lose time from work temporarily, you
may be able to
arrange a moratorium so that you can miss a payment and catch up later.
Further, if there
is a major permanent reduction in your income, for example, from lost
hours due to a
chronic illness, your trustee may support a modification in the plan if
you meet certain
legal requirements. This might involve either stretching payments out
over a longer
period and accordingly reducing the amount of each one or perhaps giving
up some asset
for which you had planned to make payments. If you complete performance
of your
modified plan, you are entitled to a full Chapter 13-type discharge, described
below.
If there is no modification but the default on your plan payments has
resulted from
circumstances for which you “should not justly be held accountable,” and if the unsecured
creditors have already received as much as they would have received under
Chapter 7,
you may qualify for a “hardship discharge,” a Chapter 7-type
discharge limited by the
exceptions described above.
If there is neither a modification nor a hardship discharge, you may instead
choose
to convert your case to Chapter 7. Following conversion, you would presumably
receive a
Chapter 7 discharge unless you have received one within the preceding
six years. (Of
course, in a Chapter 7 case you are obliged to surrender your nonexempt
unencumbered
assets.) If you fail to take the initiative in dealing with defaults under
your Chapter 13
plan—whether by modification, hardship discharge or conversion—a
creditor may seek to
have your case either converted to Chapter 7 or dismissed outright. If
the case is
dismissed, the collection calls will begin again and your may have your
car repossessed or
your home foreclosed upon.
Q. Compared with straight bankruptcy, what advantages may there
be to filing for
Chapter 13?
A. There may be several advantages.
First, you will be able to retain and use all your assets as long as you
make
payments to the trustee as agreed. There is an important difference between
the treatment
under Chapter 13 of two types of your secured creditors: those who have
a lien on your
home and those who have a lien on some other asset. For example, say that
you have an
unpaid balance on your car loan of $8,000, but that the car is worth only
$5,000. In that
case, the court will approve the "cram down" of the loan to
$5,000 as the secured claim,
with your monthly payments reduced to reflect that lower balance. In most
cases the law
requires that little or nothing be paid on the car lender’s $3,000
unsecured claim. (If you
cannot make the required monthly payments on your car, you must return
it, unless the
creditor agrees otherwise.)
However, the story is quite different for your home mortgage. Even if
the market
value of your home has fallen below the unpaid balance on your mortgage,
the court
generally cannot "cram down" the amount you owe on your mortgage
to the market value
of your home. While you can put accumulated past delinquent mortgage payments
(with
interest to account for your delay) under the Chapter 13 plan, you must
make future
monthly payments on your home mortgage loan, or turn your home over to
the lender.
Second, the discharge of debts under Chapter 13 is broader than it is
under
Chapter 7. Once you successfully complete a repayment plan under Chapter
13,
individual creditors cannot require you to pay them in full, for example,
even if you gave
them false financial information when you applied for the credit, or if
you used some
other fraudulent means to get credit. The story is different if you file
for straight
bankruptcy. Then any credit grantor to whom you gave false or fraudulent
information
may object to discharging you from repaying the debt you owe it.
Third, under Chapter 13, if you had people co-sign any of your loans or
other
credit, your creditors cannot collect from these co-signers until it is
clear that the Chapter
13 plan will not pay the entire amount owed to the creditors. In contrast,
if you file a
straight bankruptcy (Chapter 7) petition, your creditors have the right
to demand payment
from your co-signers immediately.
Fourth, you may discharge debts under Chapter 13 more often than under
Chapter
7. The law forbids you from receiving a discharge under Chapter 7 more
than once every
six years. However, Chapter 13 allows you to file repeatedly, although
each filing will
appear on your credit record and all Chapter 13 plans have to be filed
in good faith. Note,
however, that after you have been discharged under Chapter 13, you must
wait six years
you are eligible for Chapter 7 discharge. That six year rule does not
apply if your Chapter
13 case paid your unsecured creditors at least 70 percent of their allowed
claims and your
plan was proposed by you in good faith and was your best effort.
Q. Why might some debtors fare better in straight bankruptcy
than in Chapter 13?
A. There are several circumstances in which straight bankruptcy
may be preferable.
First, there are many debtors for whom the advantages of Chapter 13 do
not
matter: debtors with no nonexempt assets they particularly wish to keep,
no debts
excepted from discharge in Chapter 7, no history of receiving any bankruptcy
discharge
within the last six years and no co-signers on their loans.
Second, the benefits of Chapter 13 may come at the price of committing
the
debtor’s disposable income to creditors for as long as three or
even five years. In Chapter
7, the debtor can keep post-petition earnings from personal services free
and clear from
discharged pre-bankruptcy debts.
Third, some debtors are legally ineligible for Chapter 13, either because
their
income is not sufficiently regular to fund payments under a plan or because
the amount of
their debt exceeds the limits mentioned above.
Q. If debtors are legally eligible for either Chapter 7 or Chapter
13, may they choose
between them solely on the basis of their own interests?
A. The choice between chapters is generally left to any eligible
debtor. However, courts
have on grounds of “substantial abuse” dismissed some consumer
Chapter 7 cases filed
by debtors with significant incomes but minimal unencumbered assets. The
reason for
those dismissals is primarily that such debtors should be committing some
of their
income to unsecured creditors rather than leaving them with a minimal
Chapter 7
distribution based solely on the debtor’s heavily mortgaged assets.
The courts disagree
over the meaning of “substantial abuse” and the issue has
come up relatively infrequently,
perhaps because it can be raised only by the court itself or a public
officer known as the
United States trustee—not by creditors. Congress is currently considering
more stringent
restrictions on the use of Chapter 7 by debtors whose incomes would fund
a significant
payment to creditors.
Q. It is very important that we keep our home. To summarize,
what are the relative
merits of Chapter 7 and Chapter 13 for this objective?
A. First, under either type of filing, you will be able to keep
your home only if you
continue to make the required monthly payments on your mortgages. If you
file for
Chapter 7, you must make arrangements acceptable to your mortgage lender
to catch up
on any delinquent payments; if you file for Chapter 13, you may be able
to include the
delinquent payments in the payment plan and pay those off over, for example,
three years,
while maintaining ongoing monthly mortgage payments. As will be seen below,
a
willingness to make monthly payments on the mortgage will not assure that
you can keep
your home. But not making monthly payments in the future will make it
likely that you
will not keep your home.
Chapter 7
A willingness to continue making the agreed monthly payments may not prevent
you
from losing your home if you file for Chapter 7. Under a Chapter 7 filing,
your unsecured
creditors may also have an interest in your home if it is worth more than
the total of the
mortgage debt and any applicable homestead exemption. The trustee may
take possession
of your home and sell it for the benefit of the creditors; that is, it
may become part of the
collection of your assets taken by the trustee for the benefit of your
creditors. Whether the
trustee will actually take your home will depend upon two basic factors:
• The applicable exemptions. As discussed above, these vary greatly
from state to state;
but the debtor’s home generally enjoys some legal protection from
creditors. Often
there is a “homestead” exemption with a dollar limit. For
example, assume that the
market value of your home is $90,000, and you have a mortgage of $55,000.
Your
equity is the difference between those two figures, or $35,000. If your
homestead
exemption were $30,000 (as in Colorado), the creditors could seek to claim
the
$5,000 left over from your exemption. As a practical matter, the trustee
would
probably not go to the expense and trouble of taking over the property
and selling it
for the benefit of the unsecured creditors, but you could be called upon
to pay the
$5,000 to the trustee.
In a few states, such as Florida, there is no dollar limit on the homestead
exemption, only a limit on the acreage that can be shielded from creditors.
In Texas
unsecured creditors cannot seek payment from a homestead, so long as it
is not more
than one acre in a city or 200 acres elsewhere, regardless of the value
of the property.
However, the homesteader will still have to make the required monthly
payments to
the bank that is financing his $2 million townhouse in downtown Dallas
or his home
in Palm Beach. As mentioned above, apart from the homestead exemption,
many
states completely block or seriously limit unsecured creditors of one
spouse from
reaching property the debtor owns together with his or her non-debtor
spouse.
• The difference between the value of your equity and your exemption.
The greater the
spread between the market value of your home and your mortgage debt, the
more
likely is it that the trustee will find it worthwhile to take over your
home and sell it for
the benefit of creditors. Take the example given above, but assume that
the market
value is $190,000, not $90,000. Now, if the house is taken over by the
trustee and
sold for the benefit of the bankruptcy estate, the funds available for
unsecured
creditors would amount to $105,000:
Selling price $190,000
Less: Mortgage loan 55,000
Value of your equity 135,000
Less: Homestead exemption 30,000
Available for unsecured creditors $105,000
Chapter 13
Under a Chapter 13 plan, your basic choice is either (a) to agree to continue
your lender's lien on
your home and to make the required ongoing monthly payments, in addition
to curing the default,
or (b) to turn the property over to the lender. A lender who recovers
less from the sale of the
house than the amount that you owe will have an unsecured claim for the
difference, which may
be asserted and usually discharged in your bankruptcy case. It is possible
that if housing values
are greatly depressed, a lender might be willing to lower the monthly
payments in order to gain
some income and keep the house occupied. But don't count on it.
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