Most consumers will be choosing between filing a chapter 7 (“fresh start”) case or a chapter 13 (“repayment plan”) case. In limited situations, a consumer might file a chapter 11 case (also a form of repayment) if the amount of debts exceed the debt limitations of chapter 13 (presently, $360,475.00 for unsecured debt such as credit card debt; and $1,081,400.00 for secured debt such as mortgages, etc.). There are no such debt limitations for filing a chapter 7 case.
Whether you decide to file under chapter 7 or under chapter 13, will depend on what you need to accomplish.
Chapter 7 should be your tool of choice if you are facing overwhelming credit card debt, personal lines of credit, unreimbursed medical expenses, or potential liabilities from personal guarantees on business debts, etc., and you’ve got no real reasonable expectation of being able to repay those obligations.
Let’s presuppose that if you own a house, you’re either current on your mortgage(s), or already working out some kind of deal with your lender(s) to restructure the loan outside of bankruptcy court, and so wouldn’t need the powers of chapter 13 (described below) to essentially force the restructuring. Or, maybe you just decided that because you’re so “upside down” on your home,or investment property, that you’ve decided to simply walk away from it. (Meaning, that the property is worth far less than the amount that you actually owe).
Chapter 7 is the most effective means of giving you a financial fresh start, in a relatively short period of time. The average case from start to finish, lasts about 4 months. When all goes well, you will receive a “Discharge Order” from the Court, clearing you of most if not all of your dischargeable debts.
Moreover, if you have experienced any kind of creditor harassment, dunning, aggressive collection tactics, or even if you are presently defending a lawsuit, most of these activities come to a complete stop, upon the filing of your chapter 7 bankruptcy petition. On the day that you declare bankruptcy, the Court enters what is called an “Order for Relief” which contains something called an “Automatic Stay.” You can think of the “Stay” as a freeze on all creditor activity.
From the time the Court enters its Order for Relief, almost all creditors (with very limited exceptions) are prohibited from taking any further action against you, without getting special permission from the bankruptcy court.
For many people, even though the Order for Relief is not the Order that clears you of your dischargeable debts, its importance cannot be overstated because it “quiets” creditor activity, restoring your peace of mind during the bankruptcy process.
If your goal is to save your home from a foreclosure because you fell behind on payments to your bank, a chapter 13 will be a much better fit than a chapter 7. This is because chapter 13 will permit you (with court approval) to restructure the arrears on the loan, by spreading it over a maximum of 5 year’s time. So long as the court approves your plan of repayment, you don’t need your lender’s approval to restructure the arrears. During this time, you will make periodic payments (usually monthly) to a trustee appointed to administer your case on behalf of your creditors. The trustee will then make periodic payments to your creditors, including your lender(s).
Chapter 13 was traditionally referred to as a “wage earner’s plan of repayment” because you generally need a recurring, dependable income stream each month to insure that you are able to make the promised chapter 13 monthly payment. There are limited exceptions where you might be able to propose an acceptable chapter 13 plan of repayment without such a recurring income stream, but your particular circumstances should be discussed with an experienced bankruptcy attorney. Most chapter 13 plans that wind up getting dismissed by the courts, do so for failure to make the promised payments.
In certain instances, you may be able to use chapter 13 to “strip” away second mortgages or HELOC’s (home equity lines of credit) if you are so upside down on your property, that there isn’t any equity securing that second mortgage or HELOC. The best scenario for “stripping” these secondary liens is when you’ve got a clear case of establishing that the value of your home is significantly LESS than the first mortgage encumbering the property. If you’re looking at your home’s depreciation as a lemon, your ability to strip away second and third mortgages, etc., might well be your cup of lemonade. Who knows? If the market rebounds in the future, the stripping away of those secondary mortgages might actually serve to put you back in the black if prices start to increase again.
Unfortunately, under the current state of the law, you are not permitted to strip away or modify your first mortgage on your primary residence under chapter 13. If you’ve got investment property, however, you may be able to “cram down” any loans (even first mortgages) to the fair market value of the property. The hard part here is that you have to be able to pay the entire reduced value over the life of the chapter 13 plan -a maximum of five year’s time. If the reduced value is still a large amount of money, you may find it economically infeasible to cram down over five year’s time. Alas, the courts will not permit you to pay cram-down installments outside of the five year’s time.
Unsecured creditors such as credit card companies, are given a low priority in chapter 13 cases. They may receive mere pennies on the dollar. It generally depends on the amount of funds left over, after the obligations of higher priority creditors such as mortgage holders are satisfied, and your other reasonable living expenses are paid. At the completion of your chapter 13 plan, whatever amounts you still owe your unsecured creditors, generally gets wiped out, much as it would under a chapter 7 case.
Spreading out arrears over five year’s time, and/or stripping away secondary mortgages, are perfectly good reasons to choose filing a chapter 13 bankruptcy case over a chapter 7 case. Chapter 7 does not provide for either of these features. It is an entirely different animal, so to speak.
In October of 2005, some sweeping changes to the United States Bankruptcy Code went into effect under The Bankruptcy Abuse Prevention and Consumer Protection Act, otherwise known as “BAPCPA” (pronounced “BAPSEEPAH”). One requirement under BAPCPA, is that persons filing for consumer bankruptcy relief are required to fulfill a budget and credit counseling briefing, by a budget and credit counselor, pre-approved by the U.S. Department of Justice.
Fear not! No one is sending you back to school. You’ll find that the briefing session itself is rather “brief” (pardon the pun) – usually about 30 or so minutes to complete, from the privacy of your own home. Most providers will offer you the option of doing the briefing by telephone or over the internet. Pricing for this course typically runs anywhere from about $25.00 to $50.00.
This course must be taken before the bankruptcy case is actually filed. The provider will issue a certificate that is usually filed at the beginning of the bankruptcy case. For a listing of pre-approved service providers, check out the US Department of Justice/U.S. Trustee Program website at:
Note that there is an additional debtor education course (somewhat more comprehensive than the “briefing”), that must be completed shortly after your case is filed. You will NOT receive your discharge order from the court unless the second course is timely completed.
Another important requirement under BAPCPA, is establishing your eligibility to file for bankruptcy relief, by meeting the established income and expense guidelines. This is otherwise referred to under BAPCPA as “the means test.”
Most consumer bankruptcy lawyers will simply refer to it as a “mean” test (i.e., leaving off the “s”) in recognition of the fact that BAPCPA was largely a political ploy – the result of strong creditor lobbyists that wanted to make it more difficult for consumers to obtain chapter 7 (“fresh start) relief. Indeed, the thrust of the means test looks to steer consumers into filing chapter 13 plans of repayment for their debt, rather than simply discharging their debt in a much more expedited chapter 7 case.
The law has been around for several years now, and the dust is starting to settle. Statistics are proving that most people that were eligible to file for chapter 7 relief under the old law, still would qualify for chapter 7 bankruptcy relief under BAPCPA.
Now, let’s boil the means test down:
This is a three-part test, where you are only required to pass one part, in order to pave the way to filing a case under chapter 7. The first part of the test, simply asks the question whether your gross income received for the six month period just prior to the month of filing, is below or above the state’s median income level for a household of your particular size. The six month period is often referred to as the “look-back” period.
So here’s how it works: Let’s say you are a household of three individuals. In Florida, the state’s annual gross median income for a household of three persons is $58,574.00, or monthly, $4,881.00 (effective 11-1-2009). If your gross income for the last six months averaged LESS than $4,881.00 per month, then you pass under stage one of the means test, and no further analysis of your income and expenses is necessary. You get in “under the radar” so to speak, with no presumption of abuse in your bankruptcy filing.
If your six month look-back income exceeds median income, you will then need your attorney to try to qualify you for chapter 7 relief, by possibly satisfying the requirements of stage two or stage three of the means test.
Stage two will take a closer look at the monies coming in each month and the monies going out each month, to see what is or hypothetically should be left over, to pay claims of unsecured creditors such as credit card companies. Be aware that this is not a strict analysis of your actual monthly expenses, but moreso a hodgepodge of some actual expenses, coupled with some IRS standardized deductions (i.e., what the government believes is a reasonable expense for a particular item).
Say you are a three person household living in Palm Beach County Florida, and you are renting a home for $1,500.00 per month. Under stage 2 of the means test, you will not be able to deduct the entire $1,500.00 from your gross income. Rather, the law requires us to look to the IRS standardized deduction for housing in Palm Beach County. Presently, its $1,132.00 per month and that’s the amount you can deduct for your housing. If, however, you own a home and you have mortgages encumbering the property, you can deduct the full amount of the mortgages (over and above the IRS standardized deduction).
Another example is automobile expenses. You can claim an operational expense of $201.00 for each of two cars (maximum) and an ownership expense of $489.00 for each of two cars (maximum). Moreover, you can claims these deductions even if your actual costs of operating the vehicles is LESS than the standardized deduction.
When all is said and done, the hodgepodge of expenses/IRS deductions are netted off of your gross income, to arrive at your hypothetical “disposable monthly income” or “DMI” as it is commonly referred to. This disposable monthly income is the hypothetical amount of money you should have available to pay your unsecured creditors each month.
If your DMI is less than $109.58 per month, then you pass the means test under stage 2 and you can file your case without any presumption of abuse. If your DMI is more than $182.50 per month, you are knocked out of the chapter 7 box, and your only recourse would be to file a chapter 13 case, assuming you meet the additional filing requirements of chapter 13.
If your DMI is something in between, let’s say, $150.00 per month, you are in a kind of financial purgatory. You will move on to stage 3 of the means test, which will be your final opportunity to qualify for chapter 7 bankruptcy relief.
Stage 3 of the test, simply asks, if you were to pay your DMI into a hypothetical chapter 13 case for a maximum of 5 years time (i.e., the most amount of time you can be in chapter 13), would that result in a payment of at least 25% of your unsecured debts? If the answer is YES, then you are relegated to filing for chapter 13 assuming you meet all other chapter 13 filing requirements. If the answer is NO, then you will pass the means test under stage 3, and will be able to file for chapter 7 bankruptcy relief without a presumption of abuse in your filing.
Regardless of whether you will be filing a chapter 7 (“fresh start”) bankruptcy case, or a chapter 13 (“repayment plan”) bankruptcy case, both are initiated the same way: by the filing of a voluntary petition in bankruptcy.
The petition gives the court some basic information about you – including your name, address, social security number, as well as some statistical data, i.e., your estimated liabilities and assets. If you were facing an emergency situation and needed to file bankruptcy in order to immediately stop creditor activity (i.e., a foreclosure sale, a car repossession, a wage garnishment), you could simply file the voluntary petition, a listing of your creditors, a verification of your social security number and the certificate you received from your budget and credit counseling provider (discussed above). This would be enough for you to “declare bankruptcy.”
Upon the filing of this voluntary petition, the Court enters its Order for Relief implementing the Automatic Stay against creditor activity. Usually within ten days of your filing, the Clerk of the Court will mail out an official notice to all of your creditors telling them that you have declared bankruptcy, telling them that they are prohibited from taking further action(s) against you without bankruptcy court permission, and advising them of two very important dates that will govern your case.
The first important date, will be for your Meeting of Creditors – sometimes referred to as a “341 Meeting.” This is an opportunity for your creditors to examine you, if they so choose to participate in the proceeding, but more times than not, is usually just an examination of you by the appointed standing Trustee. The Trustee is empowered to represent all of your unsecured creditors in a general capacity, irrespective of whether or not they choose to actually participate in your case. The Trustee will want to make sure that you’ve faithfully listed all of your assets and liabilities, and that you haven’t engaged in any pre-bankruptcy fraud tactics, such as secreting assets by transferring them to friends or relatives.
Keep in mind that if the Trustee discovers assets that should have been listed in your case, if your actions are found to be criminal, you can spend some serious jail time in a federal prison and/or may have to pay substantial criminal fines. Those same assets will likely be sold off for the benefit of your creditors.
The axiom “crime doesn’t pay” is particularly fitting here. There is precious little you can think of in terms of trying to “circumvent” the bankruptcy rules,that hasn’t been thought of before. Forget about transferring assets to friends or relatives – you will be asked about this on your bankruptcy petition and by your case Trustee.
In a chapter 7 context, though “asset” cases are more rare than “no-asset” cases, our office routinely handles asset cases. Basically, you’ve got to take a look at the bigger picture. If you’ve got to forfeit some assets in order to wipe out what might be an enormous amount of unsecured debt, you may find that it is still worth filing your case in order to obtain a fresh financial start. There’s also the possibility that you might bargain with your case Trustee, to keep the asset, by paying some agreed upon sum in lieu of the asset being liquidated.
In chapter 7, for the most part, if you can make it past the appointed Trustee at the Meeting of Creditors, you are almost – but not entirely – home free. Creditors will normally have 60 days from the first date set for the Meeting of Creditors, to file an objection to your discharge, if the particular creditor believes it can prove you committed either a fraud upon it or a fraud upon the court.
In some instances, your conduct will make it easier or harder for a creditor to prove fraud. That’s because specific conduct by you, usually within a relatively short period of time before your bankruptcy filing, may give rise to a presumption of fraud. If the creditor is entitled to this “presumption” – the court will assume you’ve committed fraud, unless you can affirmatively disprove it.
Keep in mind the most common scenarios that will give rise to a presumption of fraud:
- your purchase of luxury goods or items over $550.00 during the 90 day period prior to bankruptcy filing;
- cash advances over $825.00 during the 70 day period prior to bankruptcy filing.
If no creditors file an objection to your discharge within the 60-day deadline set by the Court, generally, your Discharge Order should be issued by the Court within a relatively short period of time thereafter (i.e., approximately ten days thereafter).