CONSUMER GUIDE: HOW CHAPTER 7 BANKRUPTCY WORKS
CONSUMER GUIDE: HOW CHAPTER 7 BANKRUPTCY WORKS
Once a person has decided that a Chapter 7 filing is both possible and beneficial, the petition must be prepared.
What goes into my petition?
You'll see that the information required is extremely detailed. It is very important to have all of the information as up-to-date and accurate as possible. Leaving things out, if discovered, can, at a minimum, make people think that you are hiding things, and, at a maximum, be a bankruptcy crime.
The petition is filed with the appropriate Bankruptcy Court. The filing fee is currently $175 and it is generally paid at the time of filing.
Is this where the automatic stay comes in?
The filing of the petition automatically creates an injunction, called a "stay." That means that creditors are prohibited from trying to collect debts or to foreclose on property without specific authorization by the Bankruptcy Court.
How important is that stay?
The automatic stay is the primary reason many debtors file for bankruptcy. They believe that the extra time it gives them will allow them to work out their problems with creditors. Many petitions are filed the day before a scheduled auction sale of the debtor's property, or on the eve of an eviction. The stay puts the auction or eviction on hold, until either the creditor receives court permission to proceed or the property is abandoned by the trustee.
Subject to certain exceptions that will be mentioned shortly, the stay is extremely broad. In the words of the statute, it operates as a stay, applicable to all entities, of -
(1) the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under [the Bankruptcy Code], or to recover a claim against the debtor that arose before the commencement of the case ...; (2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case...; (3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate; (4) any act to create, perfect, or enforce any lien against property of the estate; (5) any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title; (6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case ...; (7) the setoff of any debt owing to the debtor that arose before the commencement of the case ... against any claim against the debtor; and (8) the commencement or continuation of a proceeding before the United States Tax Court concerning the debtor.
That was fascinating: what do I have to know?
There are sixteen exceptions to the automatic stay listed in the statute. That is, there are sixteen kinds of actions against the debtor that may continue despite the filing of the bankruptcy petition. The exceptions that are most important to individuals include:
1. The commencement or continuation of criminal actions against the debtor. 2. The commencement or continuation of action for the collection of alimony, maintenance, or support from property that is not property of the estate. 3. The commencement or enforcement of any action by a governmental unit under its so-called police powers, which generally concern public health and safety and environmental and related matters. 4. The issuance of a notice of tax deficiency. 5. If a landlord of nonresidential real estate has terminated the lease or other tenancy before the filing of the petition, the landlord may continue to enforce its rights to obtain possession.
Do the courts really use the stay?
Bankruptcy courts are generally quite ready to enforce the stay and levy penalties for contempt of court against those who violate it.
If I were a creditor, would I have any recourse?
Creditors may seek relief from the stay by filing an appropriate motion in the court. A hearing will be held at which the creditor must establish that it should be permitted to proceed. In the usual case, the creditor is a secured creditor who seeks permission to start or continue foreclosure proceedings, or a landlord seeking to evict a tenant.
Does the protection of the automatic stay ever break down?
If the creditor is able to show that the amount of the debt exceeds the value of the property, or that the debtor has continuously been unable or unwilling to make payments even though the amount of the debt is less than the value of the property, it may be difficult for the debtor to resist the motion to lift the stay. Some courts, in Chapter 7 cases, pay little attention to the debtor's objections on the theory that only the Chapter 7 trustee has the power to object (remember that equity in your property belongs to the bankruptcy estate and is administered by the trustee).
Are there any other circumstances?
Abandonment is the reason the automatic stay is not effective in many cases. If the trustee believes that there is no equity in a piece of property for the estate -- that is, that the total of mortgages and other valid liens exceeds the value of the property - the trustee may abandon the property. The reason is simple -- no equity in the property means that the trustee would be administering an asset from which the unsecured creditors would recover nothing; it would be a waste of effort.
Once the property is abandoned, the holders of mortgages and other liens are free to proceed. The automatic stay no longer applies.
I'm buying my car on time; is there anything special I have to do?
Where some of the property of the estate consists of consumer goods that are subject to liens, such as household goods or cars purchased on a "time payment" basis, the debtor generally files a statement of intention with regard to such property within thirty days of the original filing. Most debtors file the statement with the original petition.
"First meeting of creditors"' what's that all about?
Not long after the petition is filed (although it may be a few months in very busy courts) the debtor will be directed to appear at a meeting called under section 341 of the Bankruptcy Code. This is called a "341 meeting' or the "first meeting of creditors" in bankruptcy jargon.
The debtor must appear at that meeting and "submit to examination under oath." The debtor can be questioned by the trustee, the United States Trustee, or any creditor who is present.
All creditors listed in the schedules to the original petition will be notified of the 341 meeting and may attend to find out more about the debtor's circumstances. Sometimes the questioning gets hot and heavy, especially if the debtor is suspected of having concealed or disposed of assets. Typically, the questioning is not intense and the meeting very brief.
Do I have to appear at the 341 meeting?
If you do not appear at the 341 meeting, your case will probably be dismissed, and you will have wasted the filing fee, the legal fees, and a lot of effort. If the date that the court sets is not good for you because of your work schedule or for other reasons, it is possible to have it rescheduled. Any rescheduling should be done with the trustee's consent and just as soon as the notice is received. You may have to agree to send a new notice of the 341 meeting to all of your creditors and to extend the deadlines for filing objections to discharge or nondischargeability complaints in order to obtain a new date.
At least I'll have to go through that only once, right?
The section 341 meeting may not be the only time the debtor is required to testify about finances, property, and the like. The Bankruptcy Code permits the meeting to be continued, and it permits creditors to ask for permission to take further testimony from the debtor. Such questioning, called a 2004 examination after the number of the bankruptcy rule, is generally much more detailed than the proceedings at the section 341 meeting. Your lawyer will know what issues will be addressed if you are called for such an examination and can help you prepare for it. The debtor with nothing to hide has nothing to fear.
What happens next?
The United States Trustee will have appointed a trustee for the case. That person is generally an experienced bankruptcy lawyer who serves as a trustee in hundreds of cases.
What does a trustee do?
Under -the law, the trustee now "owns" all of the debtor's property, and the debtor is theoretically required to surrender all property and all records to the trustee. As a practical matter, little property actually changes hands without a specific request from the trustee to the debtor. The trustee cannot take over the debtor's home in the ordinary case. Some of the trustee's duties are:
- Reviewing the schedules and statements of affairs. If they are not filed on time, the court or the trustee may have the case dismissed.
- Examining the debtor at the section 341 meeting. If the debtor does not appear, the trustee may move to dismiss the case.
- Objecting to the debtor's discharge if that is appropriate, within sixty days of the section 341 meeting.
- Objecting to claimed exemptions if that is appropriate, within thirty days of the concluded section 341 meeting. If there are no assets to administer, abandoning any property; filing a no-asset report; and having the case closed.
- If there are assets, selling or otherwise disposing of them; bringing any appropriate actions to recover fraudulent conveyances or preferences paying creditors according to their statutory priorities; filing a report of receipts and disbursements; and having the case closed.
Is there anything else that may happen?
Once the case is underway, many things may happen. The debtor may attempt to avoid certain liens on property that impair claimed exemptions or for other reasons. Creditors may bring proceedings to determine the dischargeability of debts or to obtain a ruling that the debtor should not be discharged at all.
When all matters have been clarified, the assets of the estate are distributed and the case will be closed.
When you say the assets are distributed, what do you mean?
After the payment of secured creditors, assets are sold and the proceeds are generally distributed in this order:
1. Expenses of administration, including professional fees.
2. Certain claims in involuntary cases.
3. Unpaid wages, salaries, and commissions due to employees, and certain independent sales people, to a maximum of $4,000 per individual earned within ninety days of bankruptcy.
4. Contributions to employee benefit plans within specified limits.
5. Certain claims of farmers and fishermen against the debtor, up to $4,000 each.
6. Consumer deposits up to $1,800 per person.
7. Alimony, maintenance, and support obligations.
8. Most unsecured tax claims -- state, federal, and local. If there is a tax lien, the claims may not fall into this class.
9. General creditors.
And that's it?
The debtor is discharged from all liabilities not reaffirmed or determined to be nondischargeable. Creditors whose claims have been discharged are forbidden to take any further action against the debtor.
WHAT ABOUT EXEMPTIONS UNDER CHAPTER 7?
When you file a petition under Chapter 7 of the Bankruptcy Code, it creates an "estate" to be administered by the trustee. With only the exceptions given below, the estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case."
What is in that "estate"?
Although that broad language should cover everything, the law is also specific that the following types of property, which may come into existence or be recovered after the start of the case, are also property of the estate:
If only one spouse files, and the couple has community property that is under the sole, equal, or joint management of the filing spouse, the property is probably included. Certain recoveries by the trustee in avoiding sales or fraudulent transfers are included. The following are included if the right to receive them occurs within 180 days of filing:
Inherited property Property settlements in divorce proceedings Funds receivable as beneficiary of a life insurance policy or death-benefit plan. Any other interest in property that the estate acquires after filing.
Does that mean I can't keep any of my property?
Even if property is included in the estate, it may be possible to exempt it under applicable state or federal law. Exemptions are allowances that you are entitled to claim in your bankruptcy petition. --They are called "exemptions" because the property you claim as exempt is property that you can keep, without regard to the distribution of your other assets to creditors in the bankruptcy proceeding. Exempt property cannot be sold by the Chapter 7 trustee for the benefit of your creditors.
When should I figure out my exemptions, and why?
Although it is possible to file your list of exemptions up to fifteen days after you file your petition, you should really know what exemptions you will be claiming before you decide to file. The nature and amount of exemptions available may affect your decision to file a petition in bankruptcy in the first place.
All right, how do exemptions work?
The types of property you may claim as exempt are governed by state and federal statutes. In some states you can only choose the state exemptions. In those states where you can take either the state or federal exemptions, the decision you make may be just as important to your economic fresh start as your decision to file for bankruptcy protection in the first place.
What exemptions apply to me?
The location of the Bankruptcy Court where you must file is generally within the state where you have lived for the longest time within the six months (actually, 180 days) before filing your bankruptcy petition. In the thirty-seven states on the first list below, you must use that state's bankruptcy exemptions. However, even if you must use state exemptions, you may also claim exemptions available under certain federal laws, such as:
- Foreign Service Retirement and Disability payments Social Security payments
- Injury or death compensation payments from war-risk hazards
- Wages from your job as a fisherman or seaman Civil Service retirement benefits
- Railroad Retirement Act annuities and pensions Veterans' benefits
- Longshoremen's and Harbor Worker's Compensation Act death and disability benefits.
Note: The federal exemptions are available to you only if the proper place for you to file your petition is one of these states:
District of Columbia
In these states you can choose either the following federal exemptions or the appropriate state exemptions. It is all or nothing. You cannot pick some federal exemptions and some state exemptions. If husband and wife file jointly, they must agree on which exemption to adopt.
- Alimony, child support needed for support
- Real property or mobile home or cooperative used as a residence, up to $15,000
- Unmatured life insurance contract
- Life insurance policy with loan value up to $8,000
- Disability, illness or unemployment benefits
- Life insurance payments for person you depended upon as needed for support
- ERISA-qualified needed for support
- Personal Property
- Motor vehicle up to $2,400
- Animals, crops, clothing, appliances, books, furnishings, household goods, musical instruments to $400 per item; $8,000 total
- Jewelry to $1,000
- Health aids
- Wrongful death recoveries to $15,000, not including pain and suffering and pecuniary loss
- Lost-earnings payments
- Public Benefits
- Unemployment compensation, Social Security benefits, others
- Tools of the Trade
- Implements, books, and trade tools to $1,500
- Wild Card
- Any property to $800, $7,500 in any property less any amount of homestead exemption
Your attorney will help you if any of these apply.
Am I limited to state law exemptions?
The following states require that you choose the exemptions available to you under state law only:
|New York||North Carolina||North Dakota|
|South Carolina||South Dakota||Tennessee|
The remaining states permit you to choose either the state or federal exemptions. These states are:
District of Columbia
In the states that permit you to choose between the exemptions set forth in the Bankruptcy Code and those provided by state law, you must remember that you can't pick and choose. It's an all or nothing proposition -- you can get either state or federal exemptions, not some of each.
Let's get specific; can I avoid liens that would hurt my exemption in certain property?
The Bankruptcy Code allows you to avoid certain liens that impair your exemption in specific property if you meet the appropriate tests. These liens include judicial liens resulting from judgments that may have been entered against you, as well as nonpossessory, non-purchase-money security interests in household furnishings, wearing apparel, appliances, books, animals, crops, musical instruments, or jewelry. In order to avoid a lien on those types of goods, you or one of your dependents must own and use the goods for personal, family, or household purposes. You may need to consult your attorney to understand whether or not you should file a motion to avoid any liens that impair exemptions to which you are entitled.
And what does that mean to me?
Until the 1994 amendments, the effect of avoiding a lien to preserve an exemption varied considerably from court to court. The Bankruptcy Reform Act of 1994 made two things clear. First, if a lien impairs an exemption it can be avoided completely. Second, you can avoid a lien even if you have no equity in that property.
Now, what is the importance of exempting property?
Property that you exempt is not normally liable for payment of any costs associated with your bankruptcy estate. Additionally, unless your case is dismissed, property that you exempt is not liable for any prepetition debts. Exceptions include certain tax debts, alimony and child support obligations, debt secured by liens that you fail to avoid, and debts owed to certain federal depository institutions resulting from willful and malicious injuries, fraud or misconduct while acting in a fiduciary capacity, embezzlement, or larceny.
How much room to maneuver do I have?
Although you must proceed with caution, the Bankruptcy Code does not prevent you from selling nonexempt assets prior to your filing and using the proceeds either to pay your creditors or to buy exempt assets. If you choose the first route and decide to pay unsecured creditors or a family member or friend to whom you owe money, you may have to wait to file bankruptcy for at least ninety days and perhaps as long as one year. Moreover, there is no good reason for you to pay debts that are dischargeable in bankruptcy, unless you want to maintain a relationship with a store that you use frequently to buy necessities on credit, or you want to pay a joint obligation to avoid causing a friend or relative to be saddled with paying the entire debt when you file for bankruptcy protection.
The second route, buying exempt assets, also involves some risk. If you frequently have been unemployed from your construction job and are thinking about changing your career, it may be proper for you to sell exempt "tools of your trade" and invest the proceeds in a reliable automobile that will enable you to commute to school and a part-time office job. However, if you use the proceeds to buy brand-new living room furniture and an oriental rug, you are inviting trouble down the road.
To be sale from the type of trouble such manipulations can get you into, you should be careful to sell and buy property that has approximately the same value and is reasonably priced. Avoid last minute transfers of property before you file. Transfers made with personal greed as a motive and with the intention of defrauding creditors rarely withstand the scrutiny of competent Chapter 7 trustees and irate creditors. The filing of a Chapter 7 petition is traumatic enough without the grief you can cause yourself by improvidently trying to convert nonexempt assets into exempt assets.
So I do have some flexibility; how much exempt property do I have?
Computing the extent of your exempt property requires a multistep analysis:
1. Determine if your state allows you to take the federal exemptions. If so, perform the following steps two ways - as if you had selected the federal exemptions and as if you had picked the state statute.
2. See if you have any property of the kinds that are exempt.
3. Take the value of each piece of property, less all mortgages and unavoidable voluntary liens on it (the net value), and compare that with the maximum amount of the exemption allowed.
4. Your exemption for that item is the lesser of its net value and the amount of exemption allowed.
WHAT ABOUT REAFFIRMATION?
How do I keep property?
There are three techniques for retaining property:
1. reaffirming the obligation to pay for the property;
2. claiming the property as exempt and redeeming it; and
3. claiming the property as exempt and avoiding liens on it.
What is reaffirmation? Why reaffirm a debt when I'm trying to get my debt discharged?
Suppose you owe $3,000 on a car that is not worth that much. You may wish to keep the car and structure an agreement with the creditor so that you can continue to make payments as if there had been no bankruptcy. That is called "reaffirmation" under the Bankruptcy Code.
You should enter into a reaffirmation agreement with your creditor quickly. In most courts it must be filed within forty-five days of your original bankruptcy filing. A statement of the amount owed and the value of the collateral, if any, as well as the creditor's agreement and signature are necessary, as shown on Form B240, which follows this chapter. That form is not required so long as the document you do use contains all of the points covered in the official form.
CAUTION: Some creditors will send a representative to the section 341 meeting who will try to persuade you to reaffirm a debt. You should never reaffirm a debt unless you know exactly what you are doing. Ask your attorney for advice on the particular contract you are thinking about reaffirming.
The lawyer will explain the nature of the agreement to you and sign the form, indicating that he or she has provided the explanation. The lawyer must also certify that the reaffirmation does not impose an undue hardship on you or your dependents.
Am I stuck if I reaffirm and realize I was stupid to do so?
If you have signed a reaffirmation agreement and later change your mind, you can get out of the agreement, but only within sixty days of the time that the agreement is filed in court or at any time prior to discharge, whichever is later.
You said if I didn't reaffirm I could redeem exempt property: what does that mean?
Earlier you were able to determine the items of your property are exempt under the laws, federal or state, applicable to the place where you would file a bankruptcy petition. To the extent that there is a lien on such property, and that property is tangible personal property intended primarily for personal, family, or household use, it can be redeemed by paying the creditor the present value of the property within forty-five days.
You can also redeem that kind of property if it is abandoned by the trustee.
Notice that it is only the present value of the property that must be paid. Even if you owe more, you get to pay off the lien at the present value of the property. After all, that is all that the creditor would get if you surrendered the item.
Is that as good a deal as it sounds?
The difficulty with this option is that you have to pay cash within forty-five days. Also, you have to agree with the creditor on the value of the property, although that seldom appears to be a problem.
The third choice you mentioned, "lien avoidance on exempt property," sounds complex; what is it?
"Lien avoidance" is a technique under the Bankruptcy Code to preserve the value of exemptions. The property must be of the kind in which you can claim an exemption.
Judicial liens can be "avoided" in any exempt property. Nonpossessory, non-purchase-money security interests can be avoided only in
1. household furnishings, household goods, wearing apparel, appliances, books, animals, crops, musical instruments, or jewelry that is held primarily for the personal, family, or household use of the debtor or a dependent of the debtor;
2. implements, professional books, or tools of the trade of the debtor or the trade of a dependent of the debtor; or
3. professionally prescribed health aids for the debtor or a dependent of the debtor.
Do you have a simplified example of this one?
Here's an example of a somewhat simple case:
John's-house is exempt-type property and is now worth $200,000.
John owes a mortgage on the house of (150,000).
If that were all, John's exemption would come out of the $ 50,000.
BUT there is a judgment lien on the house of (50,000).
which eats up the equity, leaving the exemption at O.
This is an obvious case where John's exemption (which we'll say is $15,000) is wiped out by the judicial (judgment) lien. Prior to the Bankruptcy Reform Act of 1994, some judges would simply reduce the judicial lien to $35,000, which results in John's having his $15,000 exemption preserved. Still other judges formerly would have said that, on a sale of the property, John must get $15,000 before the holder of the judgment lien gets anything, but the lien would remain and eat up any equity if the property gained value over time.
Since October 22, 1994, the effective date of the amendments, it is clear that the entire judicial lien is wiped out, even though that means John is left with $35,000 in equity over and above his exemptions.
It is also clear that John could have avoided the lien even if his mortgage balance had been equal to or greater than the value of the property, something that most judges felt was not permitted before the amendment.
You said it was complex; are those three methods the only ways I can keep property?
Most lawyers and courts have the opinion that your personal liability for the debt has been wiped out by the bankruptcy, and all that the secured creditor has is the lien on the property. Under that view, the worst thing that can happen is that the property will be repossessed at some time in the future. However, there is at least one decision that says that failure to use one of the three techniques in the Bankruptcy Code preserves personal liability on these facts. If there is not a binding decision in your jurisdiction, the informal route can be a most dangerous one.