Avenues of Relief in Bankruptcy

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Mark Bromley
W5838 Greening Rd.
Whitewater, WI   53190
262-495-8530
262-495-8532

AVENUES OF RELIEF UNDER THE BANKRUPTCY CODE

by Mark Bromley

People in financial distress often inquire about the possibility of relief from their problems under the Bankruptcy Code or through debt counseling.

The Code offers four options, contained in Chapters 7, 11, 12, and 13 of the Code.

This article briefly describes the provisions of these chapters, and the debt counseling process. It is not intended as legal advice, but as general information. Do not rely on this information as anything more than a guide for discussion of your options with an experienced bankruptcy lawyer.

Chapter 7 Bankruptcy

Eligibility

Most people and business organizations are eligible for Chapter 7 relief: it is available to individuals, partnerships, corporations, limited liability companies and limited liability partnerships. There is no requirement that you have any certain amount of debt, or that your expenses exceed your income.

However, certain income and expense tests may preclude you from filing a Chapter 7. The required analysis is complex and should be performed by an experienced bankruptcy lawyer acting on your behalf.

If you are not eligible for Chapter 7 relief, you will probably still be eligible for Chapter 13 relief.

When you file bankruptcy, a bankruptcy estate is automatically created. That word, estate, means that a legal entity, separate from you, has come into existence. The estate legally owns everything you owned on the date you filed bankruptcy, as well as any inheritance or divorce settlement you receive or become entitled to receive within 180 days of the date you filed bankruptcy. You have the right to claim some things, like household furnishings, insurance policies, and homestead equity, free of the claims of your creditors. The items which you can keep for yourself in this way are called exempt assets, because they are exempted from the things which could be taken to pay debts.

Although the estate owns everything, it does not take possession of your things. You continue to possess and use them, and generally will not lose anything to the estate. That is because you are entitled to exemptions, and because some of your creditors have claims on your assets that are superior to the claims of the estate.

If you own a home, but have a mortgage on it, or if you own a car you are buying on credit, those lenders have a claim against the house or the car. The rights of these lenders against your house or car are called “security interests” and the lenders are called “secured creditors.”

The trustee can get money for your unsecured creditors if you have things which are not exempt, and which are not mortgaged for more than they are worth. The trustee very seldom is able to get any money for unsecured creditors.

The usual result in a Chapter 7 bankruptcy is that your exemptions and the claims of your secured creditors use up the value of everything you have, and so there is nothing for the trustee to get. The bankruptcy estate abandons any claim to your stuff, and you keep it all.

However, your right to keep the assets is subject to the rights of your secured creditors. They have the right to have you either pay them the value of the things they have claims against, or give those things up.

Although the things you own temporarily belong to the estate, the money you earn after filing does not go into the estate. Your right to have post-bankruptcy earnings free from creditors’ claims is the main benefit of filing bankruptcy.

The Bankruptcy Discharge

The object of a Chapter 7 bankruptcy is to obtain a court order eliminating the debts which existed on the date the bankruptcy court received the petition in bankruptcy. This order is called the Order of Discharge, or simply, the discharge.

If you received a discharge in another Chapter 7 case within the last eight years, you can file a Chapter 7 now, but you can’t get a discharge. If you received a discharge in a Chapter 13 case in which less than 70% of the claims were paid, and that case was filed less than 6 years ago, you can’t get a Chapter 7 discharge now. In either situation, you can file the case but you cannot get a discharge.

You must also complete a course in personal financial management before you can get a discharge.

The Automatic Stay

Another major benefit of a bankruptcy petition is freedom from telephone collection calls and lawsuits. When a bankruptcy petition is filed, the court orders all such activities stopped; a “stay” automatically goes into effect. The stay brings all claims against you and your assets before one court, and gives you a break from collection activity. Although it will take some time and effort to make all creditors aware that they can’t call you, the calls can be stopped.

If a creditor violates the stay, that violation is in contempt of the Bankruptcy Court’s order. The court may award you actual damages, including costs and attorneys’ fees, and in appropriate circumstances, punitive damages.

The stay is not permanent. If a secured creditor requests relief from the stay, and proves that their interests (in your house or car, for example) are not adequately protected, or that your have no equity in the property and that the property is not necessary to an effective reorganization, the Bankruptcy Court can grant relief from the automatic stay, which would then allow the creditor to repossess its collateral.

Most of the time, repossession is avoided by making an agreement with the creditor to treat the debt as though the bankruptcy had never occurred. An agreement like that is called a “reaffirmation agreement.”

If the creditor is willing, and the reaffirmation of the debt will not cause an undue hardship to you, a reaffirmation agreement can let you keep your house, car, or whatever else you have pledged as security. In exchange, you must pay the creditor for it, and you take the risk of default. That risk isthe possibility that you might fail to make the payments. The creditor could then take the house or car and sell it. If the creditor doesn’t get enough money from that sale, they might take a money judgment against you and garnishee your wages, for example.

The stay ends when the case ends, but that does not eliminate your protection from creditors; the court enters an order of discharge at the end of the case, which enjoins any act to collect, recover, or offset any discharged debt.

The Usual Course of Events in a Chapter 7 Case

A Chapter 7 begins when you consult an attorney, and the two of you consider your goals and the available means of achieving those goals. Common goals are to escape collection calls and lawsuits, eliminate debt so far as possible, continue ownership and possession of home and car, and sometimes, to preserve a business.

You and your attorney should consider alternative ways to achieve your goals, such as settlements with the problem creditors, deferment of payments, surrender of assets, and requesting an informal forgiveness of debt. Sometimes creditors will have violated your rights, so that claims can be brought against the creditor under the Federal Fair Debt Collection Practices Act, or laws like the Wisconsin Consumer Act.

The benefits of Chapter 7 in comparison to other bankruptcy options must also be considered. While the details of Chapter 11, 12, and 13 remedies will be discussed later, in general the advantages of each are: Chapter 7 is the quickest, shortest, cheapest remedy: Chapter 13 discharges more debts than does Chapter 7; and Chapter 11 may be only remedy available if Chapter 7 will not meet your reorganization needs, and you are ineligible for 12 or 13.

When the Chapter 7 option is selected, you complete a questionnaire which provides most of the information I need. You participate in debt counseling with an independent agency and receive a certificate that you did that.

In the meantime, I search certain public records to obtain recording information regarding your chattel and real estate mortgages. When this information is gathered and your questionnaire is complete, I will consult with you regarding any significant issues involved in choosing between state and federal exemptions. I will help you convert non-exempt assets to exempt assets where permitted.

After your assets have been protected as much as possible, I prepare your bankruptcy papers, including the petition, schedules and statement of affairs. Then I review the schedules with you, revise them as needed, and we sign them. After that, we file them in bankruptcy court.

When the Bankruptcy Court receives the papers, it enters the Order for Relief. The automatic stay is imposed, the trustee is appointed, the First Meeting of Creditors is scheduled, and the last day to object to discharge is established.

The week after the court gets the bankruptcy petition, the bankruptcy noticing center mails the notice of the meeting to everyone listed on the your mailing matrix; the meeting is usually about 30 days later. The Trustee receives a complete copy of the filed documents.

At the First Meeting of Creditors, the trustee presides; the bankruptcy judge is prohibited from attending, by law. The trustees hold 8 or 9 meetings per hour. At the meeting, the Trustee swears you in and questions you about your financial affairs.

After the First Meeting the trustee will sell any available assets for the benefit of unsecured claims, attempt to recover preference payments and redistribute the money among holders of unsecured claims, and attack any questionable exemption claim we made. In rare cases, the Trustee might object to your discharge if any legal basis for objection appears.

The Trustee will question any transfers of property to friends or relatives in the preceding 12 months, and transfers to any creditors in the preceding 90 days. The Trustee is empowered to reverse any such transaction that is improper. Creditors may also question you, but ordinarily they don’t even attend the meeting.

Caution:

The trustee will advise you that if you receive a right to a gift or inheritance within 180 days of the date you filed your bankruptcy proceeding, that money belongs to the bankruptcy estate, not to you. If someone dies within that 180 day period, and you are an heir or beneficiary, you must report that death and amend your schedules to show your rights in the dead person’s estate within 10 days of the date you become aware of those rights. If you are aware that someone may leave you money, and you don’t want to lose that to your creditors, you should consult your attorney about steps to be taken before that person dies. Once the death occurs, there is nothing you can do to change your duty to include those rights of inheritance in your bankruptcy estate for the benefit of your creditors.

A bankruptcy will not discharge every debt. Some debts are automatically excepted from discharge, including certain income taxes, unfiled taxes, student loans, some restitution orders, child support, and damages for death or personal injury caused by intoxicated operation of a motor vehicle.

Other debts may be excluded from the discharge by bankruptcy court order, such as debts incurred under false pretenses or by fraudulent financial statements.

If you are considering the possibility of filing bankruptcy, there are some steps you should take now. For example:

• Stop using your credit cards immediately. • Save all the bills you can find for the past several months.

REORGANIZATION UNDER THE BANKRUPTCY CODE

Chapter 13

The purpose of Chapter 13 cases is the rehabilitation of wage-earners who can pay back all or a portion of their debt if given time and protection from their creditors. It is not available to partnerships, corporations, or other business organizations: only individuals and couples may file Chapter 13.

In a Chapter 13, you make payments to creditors out of your earnings or other income for three to five years after filing bankruptcy, and creditors receive more money than they would get if you filed under Chapter 7.

People with large debts cannot file Chapter 13; the debt limit (as of 2007) for unsecured debt is $336,900, and secured debt cannot exceed $1,010,650.

There are significant differences between Chapter 7 and Chapter 13. For example, Chapter 7 frees future income in exchange for possible (but not likely) liquidation of present assets: in Chapter 13 you give up future income for greater power to retain present assets and to get a broader discharge.

Chapter 13 offers a broader discharge than is available in other bankruptcy chapters. This benefit is given only if you complete your plan: if the plan is not completed, only the Chapter 7 discharge is given.

No Chapter 13 discharge can be given if you have received a Chapter 7 discharge in a case filed in the last 4 years, or in a Chapter 13 filed within the last 2 years. You must complete a course in personal financial management before you can get a discharge, and you must be current on domestic support obligations.  If the plan is completed, a few debts can be discharged that can't be discharged in a Chapter 7.

Chapter 13 plans cannot be confirmed unless distributions under the plan to unsecured creditors equal the amount they would have received in a Chapter 7 case. Unsecured creditors do not get whatever trustee collects: they get the net, the gross reduced by the trustee’s costs of collection and any taxes the trustee owe. This serves to reduce the required payout for confirmation of a Chapter 13 plan.

Rights of creditors who hold liens only on the debtor’s homestead may not be modified, except to cure a default on the debt. Such loans may only be reinstated through a Chapter 13 plan. The Plan often serves to bring homestead debt current and keep a mortgage foreclosure from occurring.

The primary use of Chapter 13 is the rehabilitation of small businesses, farms and wage-earners; it saves a house or a car that is being lost due to short-term financial reverses.

In a Chapter 13, the debtor files all of the paperwork required for Chapter 7, plus a plan detailing the proposed treatment of taxes and secured claims and the amount debtor proposes to pay on unsecured claims. The plan must be filed within 15 days of the filing of the petition, and payments must begin within 30 days of the filing of the petition.

The case is automatically assigned to a “standing trustee” who performs the functions of a Chapter 7 trustee, and serves as receiving and disbursing agent for plan payments. The trustee retains 10% of every payment that passes through the trustee's office.

Caution: If you receive a right to a gift or inheritance while your plan is in effect, that money belongs to the bankruptcy estate, not to you. If someone dies within the plan period, and you are an heir or beneficiary of the person who died, you must report that death to the bankruptcy court and amend your schedules to show your rights in the dead person’s estate within 10 days of the date you become aware of those rights.

If you are aware that someone may leave you money, and you don’t want to lose that to your creditors, you should consult your attorney about steps to be taken before that person dies. Once the death occurs, there is nothing you can do to change your duty to include those rights of inheritance in your bankruptcy estate for the benefit of your creditors.

After the first meeting of creditors, the trustee recommends confirmation or denial of confirmation of the plan based on feasibility, compliance with the chapter 7 “hypothetical dividend” test, compliance with the Chapter 13 disposable income test, and the good faith of the debtor in proposing the plan.

Creditors may object to confirmation of the plan for failure to comply with the standards for confirmation, also.

If the plan is confirmed, but circumstances change, the court can modify the plan to take account of the new developments in the case.

Chapter 11

Few clients need relief under Chapter 11, and for that reason I discuss it only briefly here. Chapter 11 is a proceeding for the reorganization of a debtor engaged in business. Under some circumstances, it is available to consumers as well. Under chapter 11, a debtor may propose a plan which modifies the rights of one or more classes of creditors. The rights of the creditors may be impaired either by consent of a majority in number or 2/3 in amount of the class affected. A liquidation plan results in creditors being “deemed” impaired.

Chapter 12: Family Farmer

Chapter 12 is designed to permit family farmers to repay their debts over a period of times and is in many ways similar to chapter 13. The eligibility requirements are restrictive, limiting its use to those whose income and debt arises primarily from family-owned farm operations.   The overall debt limit for Chapter 12, effective April 1, 2007, is $3,544,525.  Since October 15, 2005, Chapter 12 has offered eligible farms some tax relief that is available nowhere else, with respect to capital gains.

Services Provided by Credit Counseling Agencies: If you are a person rather than a corporation or partnership, you are ineligible for relief under any chapter of the Bankruptcy Code unless, within 180 days before the bankruptcy filing, they receive an individual or group briefing from a non-profit budget and credit counseling agency approved by the United States trustee.

The agency must provide its services without regard to the debtor's ability to pay any fee. The service may be provided personally, telephonically or on the Internet and must outline opportunities for credit counseling and assist in performing a related budget analysis.

Services provided by credit counseling may include evaluation of alternatives to bankruptcy, including, but not limited to debt management plans. Such plans require concurrence by creditors and this might not be possible in all cases. The Credit Counseling requirement under 11 USC § 109 must be met prior to filing the petition (unless petition is accompanied by a motion for extension for exigent circumstances or a declaration/certification of waiver).