Many clients ask about the differences between the various chapters in bankruptcy and whether they have a choice in determining under which chapter they will file. The answer is, as in many things in life, it depends. Qualifying for a Chapter 7 case (liquidation) will require that either:
- the debtor’s household income falls below the median income for the area,
- if the income exceeds the median, whether the debtor can pass the “means test,” or
- the majority of the debtor’s obligations are business debt.
Let’s just assume that the debtor qualifies for liquidation. Should he or she move forward with a Chapter 7? Let’s take a look at some benefits of Chapter 7 bankruptcy.
In our office, it usually takes around three months from our filing a case to a debtor receiving their order of discharge that permanently releases his or her debts. This is far less time in bankruptcy than your typical Chapter 13 bankruptcy case. Chapter 13 cases customarily last between three and five years. This brief period makes Chapter 7 bankruptcy an attractive option for most below-median debtors.
Once a case is filed, an automatic stay of all collection efforts means that any efforts to collect on any debt. This includes garnishments or attachments of bank accounts that have been ordered by local judges. As a result, employers are required to cease deducting funds from the paychecks of filing debtors. If any money is collected or transferred after the bankruptcy case has been filed, those amounts must be returned to the debtor.
Ends Creditor Calls
The automatic stay also applies to creditor calls. Any creditor continuing to pester a debtor following the filing of a bankruptcy case may be subject to a contempt motion in bankruptcy court. Moreover, any collector intentionally violating the automatic stay may be subject to claims under the Fair Debt Collections Practices Act and other laws.
Even if a foreclosure judgment has been obtained and a sheriff sale is imminent, a Chapter 7 filing will operate to halt the sale and allow a debtor the time necessary to file a loan modification packet or make other arrangements to keep the property. This is only a temporary measure. However, a discharge of competing unsecured debt can lower monthly bills and expenses. This therefore can free up cash to apply either to a modified loan or a plan payment in a Chapter 13 case. Either way, the benefits of Chapter 7 when it comes to facing foreclosure are clear. Chapter 7 can be vital in retaining a family home.
Exemptions Protect Most Property
In Ohio, exemptions for everything from a house and car to an engagement ring and Dad’s old hunting rifle usually result in debtors retaining all of their property. Common exceptions to this rule are found in older vehicles with more than $5,000 in equity and non-retirement investment accounts. Property is reportedly liquidated in about 4 percent of all cases filed.
Discharge Most Obligations
At the end of a Chapter 7 case, the vast majority of debts should be subject to discharge. This includes most credit card balances, medical bills, divorce lawyer statements, remaining liabilities on repossessed vehicles and lines of credit. Not included in the discharge will be, among other things:
- most taxes,
- most student loans,
- domestic support and property settlement obligations,
- most fines and penalties, and
- injuries caused intentionally or while intoxicated.
Eliminate Some Tax Debt
While most tax debt cannot be purged through bankruptcy, there are exceptions. Certain income taxes that are more than three years old may be purged under rather arcane rules. Whether or not this is possible is usually a separate analysis requiring some special knowledge and tools.
Student Debt Reduced, But Rarely
Given the staggering amount of student loan indebtedness carried by an increasing number of Americans, it is only natural that we are asked increasingly whether there is any potential for a debtor’s student liabilities to be reduced or completely eliminated. Unfortunately, there are few bankruptcy attorneys out there who are willing to take on student loan discharge cases. They are difficult because, generally speaking, one must prove that paying off the loans would prove an “undue hardship.” This standard is not an easy hurdle to clear. But good counsel and evaluation of prior cases within a particular courtroom may lead to a favorable result.
Wipe Out Mortgage Deficiencies
One trap that has tripped up many good-faith debtors has to do with a lender’s treatment of mortgage deficiencies. When a lender gets a judgment in a foreclosure case and the court subsequently issues an order to the county sheriff to place the property for sale, the property may not sell for enough money to pay off the mortgage. If that happens, the lender has two options:
- Get a deficiency judgment and continue to pursue the debtor, or
- Write off the balance and take a loss deduction on its next tax return.
The problem for the debtor is that both options have serious downsides. The first is that the debtor is not yet off the hook, despite being out of the house and into new lodgings. The second is that the lender may issue a 1099-C and create taxable income for the debtor. With some deficiency balances, this can mean a huge tax hit!
Bankruptcy allows the debtor to wipe out the mortgage deficiency without the tax obligation. Even if the debtor receives the 1099-C, a tax preparer can submit a Form 982 that makes it clear there was no forgiveness-of-debt income since the debtor had no obligation to forgive. The debt had already been discharged in the bankruptcy case.
Lower Vehicle Payments
A Chapter 7 case provides an opportunity to revisit car and truck loans to see if redemption is an attractive option. Redeeming a vehicle allows you to replace your existing loan with a new loan based on the actual value of the vehicle. For example, a late-model midsized car valued at $12,000, that the debtor purchased for $30,000 two years earlier, may be a good candidate for redemption. The debtor would secure a loan for approximately $12,000 from a redemption lender. Then that lender would send funds to the original lender in exchange for holding title. The debtor then pays a lower monthly amount to the new lender and carries the lower balance forward.
Jettison Business Debt
Many small business owners give personal guarantees in order to secure a loan for the business. If the business either goes south or suffers a serious cash-flow crunch, the owner may be called on to pony up for the obligations of the business. In the event that this happens, a Chapter 7 may be an attractive option for ridding the owner of the debt.
If more than 50 percent of the owner’s total debt is business-related, he or she may qualify automatically for a Chapter 7 and unload the burden. This has been a very popular strategy for small businesses. It sometimes allows owners and their businesses to survive and push forward to profitability.
Avoid Unwanted Leases
Chapter 7 gives debtors the opportunity to look at all leases and other contracts to determine whether proceeding with those arrangements is in their best interest. It may be that a car lease payment is too expensive or a furniture contract was unwise. As a result, the option to terminate can vastly improve a debtor’s monthly bottom line.
Likely Never Face a Judge
While a 10-minute meeting with a Chapter 7 panel trustee is a necessary customary visit to the courthouse, very few debtors have to appear before a judge. To date, none of my clients have had to attend a court hearing or visit a judge’s chambers.