Chapter 1

What Is Bankruptcy?

 

Types of Bankruptcy................................................................................ 6

Chapter 7 Bankruptcy............................................................................... 7

Prefiling Credit Counseling Requirement.............................................. 7

The Automatic Stay............................................................................ 7

Lifting the Stay.................................................................................. 7

The Skeleton Petition......................................................................... 8

A Brief Description of the Chapter 7 Paperwork................................... 8

The Creditors’ Meeting....................................................................... 8

Which Debts Are Discharged ........................................................... 10

What Happens to Your Property?...................................................... 11

How Exemptions Help You Keep Your Property................................ 11

Houses and Cars............................................................................. 12

Costs and Fees............................................................................... 14

Issues That Must Be Decided by a Judge.......................................... 14

How a Chapter 7 Case Ends............................................................. 15

Changing Your Mind......................................................................... 15

Chapter 13 Bankruptcy........................................................................... 16

How a Chapter 13 Case Begins......................................................... 16

The Repayment Plan........................................................................ 16

Postconfirmation Increases in Income............................................... 17

Which Debts Are Discharged............................................................ 18

Which Property Is at Risk in Chapter 13 Bankruptcy........................... 19

Houses and Cars............................................................................. 19

Costs and Fees............................................................................... 19

The Meeting of Creditors.................................................................. 19

The Confirmation Hearing................................................................. 20

Other Common Reasons to Go to Court............................................ 21

How a Chapter 13 Case Ends........................................................... 21

Modifying the Plan and Alternatives to Full Discharge........................ 21

How Bankruptcy Stops Collection Efforts............................................... 22

Credit Card Debts, Medical Debts, and Attorney Fees....................... 23

Public Benefits ............................................................................... 23

Domestic Relations Proceedings...................................................... 23

Criminal Proceedings....................................................................... 23

Landlord-Tenant Proceedings........................................................... 23

Tax Proceedings.............................................................................. 24

Pension Loans................................................................................. 24

Foreclosures ................................................................................... 24

Utilities............................................................................................ 25

Special Rules for Multiple Filers........................................................ 25

The Bankruptcy Trustee.......................................................................... 25

The Bankruptcy Trustee’s General Duties........................................... 25

The U.S. Trustee’s Office.................................................................. 26

Chapter 7 Bankruptcy Trustee........................................................... 26

Chapter 13 Bankruptcy Trustee......................................................... 28

Business Bankruptcies........................................................................... 29

 

If you’ve picked up this book, you probably have more debt than you can handle. Most likely, your debt mush­roomed because of circumstances beyond your control—job loss, divorce, business failure, illness, accident, or perhaps the result of a car repossession, a home foreclosure, or even your use of too many credit cards that came your way, whether you asked for them or not.

You may feel overwhelmed by your financial situation and uncertain about what to do next. Maybe a friend, relative, or even a lawyer suggested bankruptcy, describing it as the best thing in the world for you. Someone else may have said the opposite—that bankruptcy is a huge mistake and will ruin your life.

This book will help you sort through your options and choose the best strategy for dealing with your economic plight. It explains:

•  how bankruptcy works

•  how filing for bankruptcy under Chapter 7 or Chapter 13 (the two bankruptcy options for consumers) will affect your debts, property, home, and credit

•  the procedures you’ll have to follow (and paperwork you’ll have to complete) to file for bankruptcy

•  some common mistakes people make before, during, and after bankruptcy, and how to avoid them, and

•  some alternative ways to handle your debt problems, outside of the bankruptcy system.

Armed with this information, you’ll be ready to decide whether you qualify for Chapter 7 or Chapter 13 bankruptcy and, if so, which Chapter makes the most sense.

As you consider the strategies available to you, keep in mind that you’re not alone. During each of the first five years of the new millennium, more than 1.5 million Americans filed for bankruptcy. So did thousands of companies. Although filings dropped dramatically just after the new law took effect in 2005, filings have once again mushroomed in these difficult times. Bankruptcy remains a necessary and pervasive part of our economic system.

And bankruptcy may be just the ticket for you. You can stop creditor collection actions (such as foreclosures, wage garnish­ments, and bank account levies) and:

•  wipe out all or most of your debts in a Chapter 7 bankruptcy while hanging on to your home, car, and other necessary items, or

•  use Chapter 13 bankruptcy to pay back a portion of your debts over three to five years and discharge the rest.

Bankruptcy may, in fact, seem like a magic wand, but it also has its drawbacks. And, because everyone’s situation is a little bit different, there is no one-size-fits-all formula that will tell you whether you absolutely should or should not file. For many, the need for and advantage of bank­ruptcy will be obvious. Others will be able to reach a decision only after closely examining their property, debts, income, and recent finan­cial transactions—and how persistent their creditors are. For some, simple nonbankruptcy options might do the trick—these are explained in Ch. 12 of this book.

This chapter provides some basic background information about the two types of bankruptcies most often filed by individuals: Chapter 7 and Chapter 13. In the chapters that follow, you’ll find more detailed information on the issues you are likely to be interested in, including:

•  whether you are eligible to file

•  which debts will and will not be cancelled

•  what will happen to your home, car, and other essential property items

•  how your postbankruptcy credit will be affected

•  how bankruptcy will affect your personal life, and

•  whether you need to be represented by a lawyer or can represent yourself, perhaps with some outside help.

 

Types of Bankruptcy

Consumers and small business owners can choose from among several types of bankruptcy “chapters,” including Chapter 7, Chapter 11, Chapter 12, and Chapter 13. Let’s look at each one quickly—more about Chapters 7 and 13 just below.

Chapter 7. Chapter 7 bankruptcy is by far the most popular. In Chapter 7 bankruptcy, you fully disclose your property, debts, and financial activities over the past several years. Three months later you receive a discharge (cancellation) of most types of debts and emerge with all or most of the property you owned going in—luxury items and investment real estate (in which you have equity) commonly excepted.

Chapter 11. Chapter 11 bankruptcy helps a business stay afloat by encouraging nego­tiation and compromise by all concerned, so that the business can keep going and at least pay the creditors something (as opposed to a Chapter 7 liquidation, in which creditors frequently get nothing). While individuals may file under Chapter 11, the process is unaffordable for most primarily because attorney fees can easily surpass $100,000. Even a business that starts off in Chapter 11 will typically end up in Chapter 7, where the business is liquidated. Having run out of money trying to reorganize in Chapter 11, the business can’t propose a feasible plan that will pass muster under Chapter 11 guide­lines. Because this book is intended primarily for individual consumers, I don’t discuss Chapter 11 further (except briefly in Ch. 12).

Chapters 12 and 13. Chapter 12 and Chapter 13 are reorgani­zation programs designed for individuals, except that Chapter 12 is especially designed for owners of family farms, while Chapter 13 is designed for everybody else, including farmers if they wish. Here I discuss only Chapter 13. As used in Chapter 13, the term “individual” includes sole proprietors and independent contractors, but not business entities such as corporations or limited liability companies (LLCs).

In a Chapter 13 bankruptcy, you prepare and file the same basic forms as you do in a Chapter 7 bankruptcy. However, you also propose a three- or five-year plan under which you typically must repay certain types of debt in full (such as back child support) and usually some portion of your unsecured debt (from 1% upwards) even though some judges will approve of plans that pay 0% of unsecured debt. Chapter 13 provides some remedies that aren’t avail­able in Chapter 7—such as the oppor­tunity to pay off missed mortgage payments over the life of the plan—but usually isn’t the bankruptcy of choice because of the extra legal fees it entails, and because people would rather get their fresh start in three months instead of three or five years. However, 10% to 15% of the people who file under Chapter 7 are required by the bank­ruptcy court to convert to Chapter 13, because they have sufficient income to fund a Chapter 13 plan.

 

Chapter 7 Bankruptcy

As I mentioned just above, Chapter 7 is a three-month process that usually only requires the filing of some paperwork and one brief appearance before the bankruptcy trustee, the official appointed to handle the case for the court. You may have to make additional brief appearances before a bankruptcy judge if you seek to waive the bankruptcy filing fee or seek approval of a reaffirmation agreement you signed in order to keep a car or other property you are making monthly payments on.

 

Prefiling Credit Counseling Requirement

Before you can file your papers, you must have completed a two-hour credit counsel­ing session from a nonprofit agency, which typically costs about $50 or less, depending on your income. The agency provides a certificate of completion that you file with your other papers. There are a couple of exceptions to this prefiling counseling requirement, discussed in Ch. 2. The counselor is available online, over the telephone, and through the mail.

 

The Automatic Stay

After completing the credit counseling, your next step is to obtain a bankruptcy filing number. You can do this by filing what’s known as a skeleton or emergency petition, or by filing all the required paperwork at the same time. Either way, once you have a filing number, you have a powerful shield—called the automatic stay—against any efforts by your creditors to collect their debts. All you have to do if a creditor calls you after you file is to produce your case number, the date of filing, and the name of the court in which you filed. The creditor will immediately back off. All proceedings to garnish wages, repossess cars, and foreclose homes will also grind to a halt.

There are a few exceptions to the automatic stay, as you might guess. Collection of child support and alimony and certain enforcement actions by the IRS can proceed, and the stay may expire sooner than you would want if you have had a bankruptcy case dismissed in the previous year. Still, as a general rule, filing for bankruptcy will give you almost total relief from your creditors while the bankruptcy is pending. For more information about the automatic stay, see “How Bankruptcy Stops Collection Efforts” later in this chapter.

 

Lifting the Stay

In some situations, creditors can successfully request that the court remove (lift) the stay as to their particular situation. For instance, if the automatic stay derailed a foreclosure action, the mortgage owner can request permission from the bankruptcy judge to proceed with the foreclosure. Other common reasons for lifting the stay are car repossessions and evictions of month-to-month tenants. 

 

The Skeleton Petition

Sometimes it’s important to obtain a filing number pronto. For instance, if you’re faced with an immi­nent foreclosure or car repossession, you’ll need the automatic stay to keep things as they are so you can figure out a way to keep your house or car. But a complete bankruptcy filing involves a lot of forms and disclosure of infor­ma­tion, and you may not have the time to prepare them all. Fortunately, you can file a skeleton petition, which requires just a few forms, and file the rest of your paperwork within 15 days. The required forms in a skeleton filing are:

•  the petition (three pages plus exhibits)

•  a mailing list of your creditors

•  a form showing your complete Social Security number, and

•  the certificate showing you’ve completed your credit counseling.

 

A Brief Description of the Chapter 7 Paperwork

Ch. 9 gives you a more detailed look at these and other official forms, and in Appendix C you’ll find a sample of the paperwork involved in a typical Chapter 7 case. The text that follows is just an overview.  

In addition to the paperwork required for a Chapter 7 skeleton petition, you’ll need to file forms that:

•  describe all your personal property and real estate, including where it is located and its approximate value

•  provide information about your debts and creditors

•  describe certain economic and financial transactions that occurred within the previous several years, such as property you sold or gave away within the previous two years

•  state how you want to handle debts concerning cars and other property that is collateral for a loan (called secured debts)

•  disclose your monthly income and monthly expenses

•  state whether you want to keep any leases and contracts you have in effect or cancel them, and

•  summarize your assets and liabilities.

In addition, you’ll need to complete a form in which you provide your average monthly gross income for the six months prior to the month in which you plan to file. As I explain in Ch. 2, that income figure will be your starting point for deciding whether you are eligible to file a Chapter 7 bankruptcy or whether you’ll have to use Chapter 13. This form is popularly known as the “means test” and must be filed in every Chapter 7 case.

 

The Creditors’ Meeting

About 30 days after you file your bank­ruptcy papers, you will be required to attend a hearing known either as the “creditors’ meeting” or the “341 hearing.” You and your spouse (if your spouse is filing with you) are required to attend. You both must bring photo identification and official proof of a Social Security number. This event is held in a hearing room in the courthouse or federal building, but not in the bankruptcy court itself. A bankruptcy trustee, the official appointed to handle your case for the court, conducts the meeting. Another official known as the U.S. Trustee may also attend your meeting and may ask you questions that bear on your possible ineligibility for Chapter 7 because of your income level (see “The Bankruptcy Trustee” later in this chapter).

The primary purpose of the creditors’ meeting is to have you affirm under oath that the papers you filed were honest, complete, and accurate to the best of your ability. The trustee may also question you about property you’ve described in your paperwork, to see whether you gave it a proper value and whether you have equity that could be used to make some payment toward your unsecured debt (debt that isn’t attached to collateral). In addition, the trustee may inquire further about:

•  anticipated tax refunds

•  recent large payments you made to creditors or relatives, if applicable

•  methods you used to arrive at the value of big-ticket property items you are claiming as exempt, such as a house or car

•  whether you should be required to proceed under Chapter 13 rather than Chapter 7

•  your failure to file any of the required documents, if applicable

•  inconsistencies in information you provided that might indicate you are being less than honest, and

•  if you didn’t have a lawyer prepare your papers, how you got the infor­mation necessary to make certain choices, such as which property is exempt (your answer would typically be the Internet, a Nolo book, or a telephone advice lawyer).

If you’ve done a good job on your paper­work, your income and expenses clearly qualify you for filing under Chapter 7, and you filed all required documents, your particular “moment of truth” in the creditors’ meeting will likely be brief. Creditors rarely show up at these meetings, and the bankruptcy trustee is typically the only one asking the questions. The trustee may simply ask whether all the information in your papers is 100% correct and end the meeting if you say, “Yes.”

 

 

The Big Choice: Use a Lawyer or Handle Your Own Case?

When you file your bankruptcy, your case will automatically fall within one of two categories: •  You will be represented by a lawyer who will sign your petition as your represen­tative. •  You will be representing yourself (that is, you’ll be acting as your own lawyer). If you are represented by a lawyer, the lawyer’s responsibility is to help you get the right infor­mation in your forms and make the choices that will be most appropriate for your situa­tion. If, on the other hand, you are acting as your own lawyer, you will be responsible for these same tasks. While print and online resources will give you the information you need to make informed decisions and properly complete the paperwork, you will be solely responsible for the outcome of your case. The court wants to make sure you under­stand these duties. It requires you to sign a form that explains: •  the different types of bankruptcies (discussed earlier) •  the services available from credit counseling agencies •  the penalties for knowingly and fraudulently concealing assets or making a false statement under penalty of perjury, and •  the fact that all information you supply is subject to examination by the employees of the U.S. Department of Justice.

 

 

The Role of Lawyers in Creditors’ Meetings

Many people hire lawyers to represent them because they don’t want to attend the creditors’ meeting on their own. This fear is based on a misunderstanding of how the creditors’ meeting works. When the trustee questions you, you—not your lawyer—must answer the questions. That’s because you are required to cooperate with the trustee and are expected to be knowledgeable about the information you provided in your papers. Rarely does the lawyer do anything except sit there like a potted plant and maybe take some notes if the trustee requires additional information to be submitted after the meeting. Because the creditors’ meeting is typically the only personal appearance you need to make in a Chapter 7 bankruptcy, hiring a lawyer just to be represented at this meeting may be a waste of money. You’d do better by bringing paper and a pencil and taking your own notes, in case the trustee wants additional documentation.

 

Which Debts Are Discharged

In approximately 60 to 90 days after the creditors’ meeting, you will receive a discharge order from the court. The discharge order won’t refer to your specific debts, but instead will say that all legally dischargeable debts are discharged in your case. In a Chapter 7 bankruptcy, absent a successful objection by a creditor (which is rare), most credit card, medical, and legal debts are discharged, as are court judgments, deficiencies owed because of a foreclosure or repossession, and personal loans. For many filers, this means that all of their debts are discharged.

Some types of debts are not discharged in Chapter 7 bankruptcy. The most common of these are:

•  debts incurred to pay nondischarge­able taxes (see Ch. 3)

•  court-imposed fines and restitution

•  back child support and alimony

•  debts owed to an ex-spouse as a result of a divorce or separation

•  loans owed to a retirement plan, such as a 401(k) (because you are the creditor as well as the debtor in this situa­tion, bankruptcy doesn’t discharge the debt)

•  student loans (unless you can show that repaying the loans would be an undue hardship, which is tougher than you might think and requires a separate trial in the bankruptcy court)

•  federal and state taxes that first became due less than three years before your bankruptcy filing date (for example, taxes due on April 15, 2008, for tax year 2007 will not qualify for discharge until April 16, 2011), and

•  debts for personal injuries or death resulting from your drunk driving.

Some types of debt will survive your bank­ruptcy, but only when the creditor seeks and obtains an order from the bank­ruptcy court excluding the debt from your bank­ruptcy. These are: debts arising from your fraudulent actions, recent credit card charges for luxuries, and willful and mali­cious acts causing personal injury or property damages. (For more on which debts are and are not discharged in a Chapter 7 bankruptcy, see Ch. 3.)

 

What Happens to Your Property?

With few major exceptions, as of your filing date all the property you own or are entitled to receive becomes part of your bankruptcy estate and is technically owned by the bankruptcy trustee. In addition, property you unloaded within the previous two years for significantly less than its value, and certain types of property you have come to own within the six-month period after you file, are also considered part of your bankruptcy estate. Marital property in community property states is also part of the bankruptcy estate, even if only one spouse files. There are other categories of property that may belong in your estate, but these are the main ones. See Ch. 4 for more on what property belongs in your bankruptcy estate.

What does the bankruptcy trustee do with the bankruptcy estate? He or she is looking for any property that, when sold, will generate a profit that can be used to pay your creditors. In fact, that’s how these trustees earn a living—from commissions on property from the bankruptcy estate that they sell to benefit creditors. For this reason, the trustee has no interest in property that you legally own but that lacks equity. That’s because property without equity won’t produce any proceeds for your creditors. For example, if you owe more on your house or car than it’s worth, you have no equity and the trustee won’t be interested in selling them because proceeds from the sale would, by law, all go to the lender. On the other hand, if you have equity in your house or car (or any other property, for that matter), the trustee will evaluate the property’s worth and consider selling it for the benefit of the creditors (and the trustee).

 

How Exemptions Help You Keep Your Property

Fortunately, all states have laws that allow you to keep a substantial portion of your property when you file for Chapter 7 bankruptcy. This is accomplished through laws—called exemptions—that let you protect the equity you have in various property items from being used by the trustee to benefit your creditors. In some instances, property is exempted regardless of its equity value. For instance, under one of the two California exemption systems, your furniture is exempt regardless of what it’s worth. In the other California exemption system, furniture is only exempt up to $550 per item (as are appliances, animals, musical instruments, personal effects, and clothing). You can keep up to $50,000 worth of equity in your home in New York, and up to $500,000 in Massachusetts.

Most people who file for bankruptcy use the exemptions in the state where they file. But if you haven’t been residing in that state for at least two years, you may have to use the exemptions from the state from which you came.

In 15 states, you have a choice of exemptions —you may use your state’s exemptions or a list of federal exemptions. To find out whether your state gives you this choice, turn to the exemption chart for your state in Appendix A and look at the entry just below your state’s name. It will say either that federal exemptions are allowed or (in most cases) that they are not. If your state allows the federal exemp­tions, you can find those exemptions after Wyoming in Appendix A. In California, you have a choice of two state exemption systems—System 1 and System 2. If you are using the California exemptions, check out the two California charts in the appendix.

 

Houses and Cars

People often ask whether they can keep their home and car in a Chapter 7 bank­ruptcy. The answer is yes in the following circumstances:

•  You are current on your mortgage or car note.

•  You have no significant nonexempt equity in the house or car.

 

Mortgages

In many cases these days, people are upside down (or underwater) on their primary residence and, therefore, have no nonexempt equity in the house. Because there is no nonexempt equity, the trustee won’t be interested in selling the house, which means you can keep it—unless you are behind on your mort­gage payments. If you’re behind, although the trustee won’t be interested in selling the house, your mort­gage lender may initiate foreclosure proceedings and will probably be able to get permission from your bankruptcy judge to proceed.

If you have a second mortgage and are so upside down that the value of the house doesn’t even cover the first mortgage, you’ll probably be able to keep your house even if you aren’t current on your second mortgage (but you must be current on the first mortgage). The reason is that if there is no equity available to pay off the second mortgage, the second mortgage holder will have no economic incentive to attempt a foreclosure.

 

What Happens If You Have Nonexempt Equity in Property?

If your equity in property is worth signifi­cantly more than an applicable exemption allows, the trustee can: •  seize and sell the property at auction •  pay any lender in the picture the amount that’s owed on the property, if any •  give you the amount you are entitled to under the exemption system you are using •  distribute what remains to your unsecured creditors, and •  put in for a commission on the sale. Frequently, before selling property with nonexempt equity, the trustee will give you an opportunity to buy it back at whatever amount you can agree upon. For instance, if you have a motorcycle that could be sold for $8,000 and you only have $3,000 worth of exemption (meaning $5,000 is nonexempt), the trustee might let you buy it back for the amount the trustee would end up with after a sale. Since sales of personal property cost time and money, the trustee might let you buy the motorcycle back for as little as $2,500–$3,000.

 

Car Loans

Cars and car notes work pretty much the same way as houses. If you have no non­exempt equity in your car, you can keep it as long as you are current on the note, but if you are behind, the lender will attempt to get permission from the judge to proceed with repossession.

 

Your Car or Home After Bankruptcy

If you’ve met the requirements for keeping your home or car as described just above, you can’t assume that your bankruptcy will end your obligation to the mortgage holder or bank. To understand what happens next, let’s back up a little bit.

When you take out a mortgage or car loan, you are actually doing two things:

•  signing a promissory note for the amount of the loan, and

•  agreeing that if you default on the loan the lender can foreclose or repossess.

When the mortgage is recorded at your local land records office, it becomes a lien (a claim) against the house. Similarly, when you take out a car loan, you are signing a promissory note and a “security agreement” that allows the car to be repossessed in case you default. When the seller records the security agreement, it becomes a lien against the car (unless you agree to reaffirm the debt—see Ch. 6).

When you file for bankruptcy, the prom­issory note part of a secured debt is cancelled. However, the lien securing your pay­ment remains like the fabled smile of the Cheshire Cat. For example, if you owe $400,000 on your house when you file, the $400,000 promissory note is cancelled. However, that doesn’t mean that you can stop paying on your mortgage. If you default, the mortgage lender still has the lien—which hasn’t been affected by your bankruptcy—and can foreclose on the lien. Similarly, for secured debts involving a car, your Chapter 7 bankruptcy will cancel the amount you owe on the promissory note but it won’t affect the lien—which means the lender can repossess the car if you default.

Especially in the case of car notes, many lenders don’t like the idea of your not owing anything after bankruptcy. Their right to repossess the car in case of nonpayment isn’t enough for them. They want you on the hook for the underlying debt so you don’t, at some point in the future, give the car back and walk away from the whole thing. Fortunately for the lender class, bank­ruptcy gives them the option of requiring you to sign an agreement reaffirming the under­lying promissory note, so you can’t just walk away from the debt after bankruptcy.

 

Example: Marisol owes $25,000 on her GMC Denali when she files for Chapter 7 bankruptcy. If she doesn’t reaffirm the debt, the bankruptcy will cancel the $25,000 debt and just leave the lender with the lien—which means she’ll still have to make her payments under power of the lien but won’t owe the actual debt. If, after her bankruptcy, Marisol decides to turn in the car, she won’t owe a cent on it. On the other hand, if Marisol reaffirms the debt, she will continue to be liable under the underlying debt after bankruptcy. Clearly, Marisol is better off not owing the money (that is not reaffirming), but the lender will be better off having her owe the money to prevent her from escaping scot-free if the car is repossessed or she gives it back.

See Ch. 6 for more on reaffirmation agree­ments and how secured debts are treated in Chapter 7 bankruptcy.

As for houses, reaffirmation is rare. Instead, the lenders have historically relied on foreclosure as their enforcement remedy and haven’t worried about your walking way from the house. This may all be changing as more and more people decide to pack in their mortgages and let the foreclosure happen. See Ch. 5 for more about houses in bankruptcy.

 

related topic

Later chapters include detailed information on exemptions. Ch. 4 covers exemp­tions in general, Ch. 5 explains exemptions for a home, and Ch. 6 covers cars and other property that secures a loan.

 

Costs and Fees

The filing fee for a Chapter 7 bankruptcy is $299. If you can’t afford the fee, you can apply for a fee waiver or permission to pay in installments. You’ll have to file an Application for Waiver (or payment in installments) when you file your bank­ruptcy papers. The court clerk will set a hearing date for you to appear before the judge—who will decide whether you qualify for the waiver. The form, rules, and eligibility guidelines for getting a fee waiver are available at www.uscourts.gov/bankruptcycourts/resources.html. If you want to be represented by a lawyer, you will likely have to pay an additional $1,500 to $2,000 in attorneys’ fees.

If you decide to handle your own case, you will probably want to buy some outside help. This will typically consist of one or more of the following:

•  one or more do-it-yourself books on bankruptcy (roughly $30 a pop)

•  telephonic legal advice from a lawyer (roughly $100 an hour, although many lawyers provide free consultation as a marketing device), and

•  clerical assistance with your forms from a bankruptcy petition preparer (between $100 and $200).

See Ch. 11 for more on resources you can use to file for bankruptcy.

 

Issues That Must Be Decided by a Judge

Chapter 7 bankruptcy is designed to run on automatic, and very few bankruptcies require a decision by an actual judge. Instead, the bank­ruptcy trustee runs the show for the most part. However, you and your attorney (if you have one) will have to appear before a judge if:

•  your income appears to make you ineli­gi­ble for Chapter 7 bankruptcy and you want to argue that an excep­tion should be made in your case

•  a creditor contests your right to file for Chapter 7 bankruptcy or discharge a parti­cular debt (which is rare)

•  you want the judge to rule that you are entitled to discharge a particular type of debt (such as taxes or student loans—see Ch. 3 for more information on debts that can be discharged in Chapter 7 bankruptcy only with the judge’s approval)

•  you want to eliminate a lien on your property that will survive bankruptcy if the judge doesn’t remove it (see Ch. 10), or

•  you are handling your own case, are making payments on a car or other personal property, and want to keep the property and continue the contract after bankruptcy. This is called “reaffirming” the contract. (See Ch. 6 for more on reaffirmation agreements.)

See Ch. 10 for more on these and other types of issues that require action by a judge.

 

How a Chapter 7 Case Ends

Chapter 7 bankruptcy ends with a discharge of all the debts you are entitled to discharge. (For information on which debts can be discharged in Chapter 7, see Ch. 3.) When a debt is discharged, the creditor is forever barred from trying to collect it from you or reporting it to a credit bureau. Government entities may not discriminate against you simply because you’ve received a bank­ruptcy discharge, but private companies can and do in some circumstances. (See Ch. 9 for more on the consequences of receiving a bankruptcy discharge.)

 

Mandatory Budget Counseling

In addition to the requirement that you obtain credit counseling before you file for bank­ruptcy, you must also participate in a two-hour course on budget management before you can get your discharge. Most filers use the same agency for the budget counseling as they used for the prefiling credit counseling. See Ch. 2 for more infor­mation about this requirement.

 

Changing Your Mind

If you file for Chapter 7 bankruptcy and then change your mind, you can ask the court to dismiss your case. As a general rule, the court will do so unless it would not be in the best interests of your creditors. For example, your request to dismiss might be denied if you have significant nonexempt assets that the trustee could sell to raise money to pay your creditors.

 

Example: Jake files for Chapter 7 bank­ruptcy, thinking all of his property is exempt. Shortly after he files, Jake’s mother tells him that he is on the deed for a 20-acre ranchette that he, his sister, and his mother inherited from his father. Under the exemption laws applicable to Jake’s bankruptcy, his share of the ranchette is not exempt which means the trustee can sell the property and distribute Jake’s share to his unsecured creditors. Jake wants to hold on to the property, and so requests that his case be dismissed. His request is denied because it would not be in the best interest of Jake’s creditors. The moral? Don’t file Chapter 7 unless and until you know what property you own and what will happen to it in bankruptcy.

If you do dismiss your case, you can file again later, although in some circumstances you may have to wait 180 days and pay a new filing fee. Instead of dismissing your Chapter 7 case, you can always convert it to another type of bankruptcy for which you qualify (typically Chapter 13 for consumers). In Jake’s case, for example, he could convert to a Chapter 13 bank­ruptcy in order to save the Ranchette. However, in his plan, Jake would have to pay his unsecured creditors at least as much as they would have received had Jake filed under Chapter 7—essentially, the market value of his share of the Ranchette, less sale costs and the trustee’s commission. (See below, to learn more about the Chapter 13 Repayment Plan.)

 

Chapter 13 Bankruptcy

Chapter 13 bankruptcy works quite differ­ently from Chapter 7 bankruptcy. In Chapter 13, you use a portion of your income to pay some or all of what you owe to your creditors over time (anywhere from three to five years, depending on your income and how much of your debt you can afford to repay). The trick to successfully using Chapter 13 to get out of debt is to make sure you have enough income to meet all of your payment obligations under the Chapter 13 laws. (See Ch. 2 to learn about the eligibility requirements for filing under Chapter 13.)

 

How a Chapter 13 Case Begins

To file a Chapter 13 bankruptcy, first you must complete a credit counseling course, then fill out and file a packet of forms—mostly the same forms as you would use in a Chapter 7 bankruptcy, and also provide the court with:

•  a feasible plan to repay some or all of your debts over the plan period (either three or five years, depending on your income and Chapter 13 legal requirements)

•  proof that you’ve filed your federal and state income tax returns for the previous four years, and

•  a copy of your most recently filed IRS income tax return (or transcript). (See Ch. 10 for more on Chapter 13 paperwork.)

 

The Repayment Plan

Under a Chapter 13 repayment plan, you make pay­ments, usually monthly, to the bank­ruptcy trustee, the official who over­sees your case. The trustee uses that money to pay the creditors covered by your plan and to pay his or her own statutory fee (usually 10% of the amount distributed under your plan).

Under Chapter 13, you are required to devote all of your “projected disposable income” to your plan (essentially, the amount left over after paying your expenses). Your repay­ment period may be as short as three years if your gross average income over the six months before you file is below your state’s median income, and five years if it is above. (See Ch. 2 for more on making this calculation.) In some cases, the filer needs a five-year plan to make all required payments regardless of whether his or her income is above or below the median income.

 

Postconfirmation Increases in Income

If your repayment plan is based on an income level that increases after the court confirms your plan, the trustee can request the court to order a jump in your monthly payments due to your new ability to pay this extra amount. The basic idea in Chapter 13 is that you have to devote all your disposable income to your plan payments.

In Chapter 13, some creditors are entitled to receive 100% of what you owe them, while others may receive a much smaller percentage or even nothing at all. For example, a Chapter 13 plan must propose that any child support you owe to a spouse or child (as opposed to a government agency) will be paid in full over the life of your plan; otherwise, the judge will not approve it. On the other hand, the judge legally could approve a plan that doesn’t repay any portion of your credit card debts if you won’t have any projected disposable income left after paying your back child support obligations and other obligations that must be paid in full under the Chapter 13 laws.

To have your debts fully discharged under Chapter 13, you must usually make all payments required by your plan and:

•  remain current on your federal and state income taxes

•  remain current on any child support or alimony obligations

 

Why File a Chapter 13 Bankruptcy?

Most people who have a choice between Chapters 13 and 7 choose Chapter 7. After all, it lasts three months instead of three to five years, it’s easy to do yourself and much cheaper than Chapter 13 if you do hire a lawyer, and you don’t have to pay down any of your debt. So, why would you choose to file a Chapter 13 bankruptcy? Here is a brief list of some reasons (all of these are discussed in more detail throughout the book): •  In Chapter 13 you can get rid of a second mortgage lien on your real estate—called a lien strip-off—if the market value of the house is less than the amount owed on the first mortgage. a $10,000 car note on a $5,000 car to $5,000, which lowers the payments). •  Chapter 13 lets you make up for missed payments on a house, car, or other collateral over a three- to five-year period. •  Chapter 13 gets rid of certain types of debts that aren’t discharged in Chapter 7 (for instance debts owed because of divorce or a separation agreement). •  Chapter 13 allows you to operate a business while you are in bankruptcy (unlike Chapter 7, which may require that you close the business). See Ch. 7 for a mock conversation between a bankruptcy lawyer and client in which they discuss whether the client should file a Chapter 7 or Chapter 13 bankruptcy. • Chapter 13 sometimes provides a way to reduce your secured debts to the value of the collateral (for instance, reducing

 

Not All Disposable Incomes Are Equal

One of the oddities of the Chapter 13 law is that your projected disposable income may be different than your actual disposable income. Your projected disposable income is initially based on your average gross income over the six-month period prior to your filing date. For example, if your income was $8,000 a month for the first three months of that period and $4,000 for the second three months, your projected monthly disposable income will be $6,000—the six-month average—even though your actual income through the life of your plan will only be $4,000. (Ch. 2 explains projected disposable income in more detail, as well as how these figures and requirements might be juggled to come up with a workable repayment plan that a judge will approve.)

 

•  annually file your federal income tax return or transcript of the return with the court, and

•  annually file an income and expense statement with the court.

You also have to provide your creditors with copies of the income tax returns or transcripts you file with the court, if they request it.

 

 

Chapter 13 Plan Must Pay Unsecured Creditors as Much as They Would Receive in a Chapter 7 Bankruptcy

People sometimes choose to avoid Chapter 7 bank­ruptcy because they stand to lose certain property that isn’t exempt. Chapter 13 bank­ruptcy initially looks like a good altern­ative, because in Chapter 13 you don’t have to give up any property. Rather, your obliga­tions under your plan are based on your disposable income. Not so fast. Even though Chapter 13 won’t take your property, it does require that you pay your unsecured creditors the value of what they would have received in Chapter 7. For example, if you have $50,000 equity in your home that isn’t protected by an exemp­tion, you wouldn’t lose the home in Chapter 13 bankruptcy, but you would have to propose a plan that pays your creditors at least $50,000 less sale costs and the trustee’s commission. This rule often makes it difficult to propose a feasible Chapter 13 plan, due to the size of the required payment.

 

Which Debts Are Discharged

If your Chapter 13 bankruptcy pays your unsecured debts in full, then you will receive a complete discharge of those debts no matter what type they are. If your plan pays less than 100%, the balance will be discharged unless they are the type of debts that aren’t discharged in Chapter 13 bankruptcy.

As a general rule, most credit card, medical, and legal debts are discharged, as are most court judgments, deficiencies from a foreclosure or repossession, and personal loans. Debts that have to be fully paid in a Chapter 13 bankruptcy are:

•  court-imposed fines and restitution

•  back child support and alimony owed to an ex-spouse or child

•  student loans

•  recent back taxes

•  unfiled taxes, and

•  debts you owe because of a civil judgment arising out of your willful or malicious acts or for personal injuries or death caused by your drunk driving.

Debts arising from your fraudulent actions or recent credit card charges for luxuries will not be discharged if the creditor gets a court order to that effect. Ch. 3 explains which debts are discharged in a Chapter 13 bankruptcy.

 

Which Property Is at Risk in Chapter 13 Bankruptcy

As mentioned, you are not required to give up any property you own when you file your Chapter 13 bankruptcy case. In Chapter 13, your income is used to pay off some portion of your debt, not your nonexempt property. However, as mentioned earlier, the value of your non­exempt property can be the determining factor regarding your ability to propose a valid repayment plan.

 

Houses and Cars

Filing for Chapter 13 bankruptcy lets you keep your house and car as long as you stay current on the payments. You can also pay off arrearages you owe when you file. For instance, if you are $5,000 behind on your mortgage payments, you can pay an extra amount into your plan to pay it off in a reasonable amount of time. That’s why Chapter 13 has typically been the remedy of choice for people facing foreclosure. (See Ch. 5 for more on what happens to your home when you file for either type of bankruptcy.)

 

Costs and Fees

The filing fee for a Chapter 13 bankruptcy is $274. If you can’t afford the fee, you can apply for a fee waiver. If you want to be represented by a lawyer, you will probably have to pay $2,500 to $4,000 in legal fees, some of which can be paid through your plan.

If you decide to handle your own case (as some do), you will want to buy some outside help. This will typically consist of one or both of the following:

•  one or more self-help law books on Chapter 13 bankruptcy (roughly $40 a pop), and

•  telephonic legal advice from a lawyer (roughly $100 an hour).

Unlike the situation in Chapter 7, bank­ruptcy petition preparers are seldom, if ever, willing to handle Chapter 13 cases. See Ch. 11 for more on resources you can use to file for bankruptcy.

 

The Meeting of Creditors

When you file your Chapter 13 bankruptcy petition, the court schedules a “meeting of creditors” (usually within about a month), and sends an official notice of the bank­ruptcy filing and the meeting to you and all of your creditors. You (and your spouse if you have filed jointly) are required to attend. You’ll need to bring two forms of identification—a picture ID and proof of your Social Security number.

A typical creditors’ meeting in a Chapter 13 case lasts less than 15 minutes. The trustee will briefly go over your paperwork with you. No judge will be present. The trustee is likely to be most interested in whether your repayment plan meets all legal requirements and whether you will be able to make the payments you have proposed. (See Ch. 2 for more on Chapter 13 requirements.) The trustee has a vested interest in helping you successfully navigate the Chapter 13 process because the trustee gets paid a percentage of all payments doled out under your plan.

The trustee will also make sure you have filed your tax returns for all taxable periods during the four prior years. If not, the trustee will continue the creditors’ meeting to give you a chance to file these returns or provide proof of filing if you’ve already done so. You cannot proceed with a Chapter 13 bankruptcy unless and until you bring your tax filings up to date.

When the trustee is finished asking questions, any creditors who show up will have a chance to question you. Secured creditors often come, especially if they have any objections to the plan you have proposed as part of your Chapter 13 filing. They may claim, for example, that your plan isn’t feasible, that you’re giving yourself too much time to pay your arrears on your car note or mortgage, or that your plan proposes to pay less on a secured debt than the replacement value of the collateral property. (See Ch. 6 for more information on collateral and other property that secures a loan.)

An unsecured creditor who is scheduled to receive very little under your plan might show up, too, if that creditor thinks you should cut your living expenses and thereby increase your disposable income (the amount from which unsecured creditors are paid).

Come to the meeting prepared to ­nego­tiate with disgruntled creditors. If you agree to make changes to accommodate their objec­tions, you must submit a modified plan and have it served on all of your creditors. While any objections raised by credi­tors won’t be ruled on during the creditors’ meeting (because the judge won’t be there), the trustee may raise these objec­tions on behalf of the creditors at your confirmation hearing ­before the judge, which will be scheduled for a couple of weeks later.

 

The Confirmation Hearing

Unlike Chapter 7, Chapter 13 bankruptcy requires at least one appearance in court. At this appearance, called the confirmation hearing, the judge either confirms (approves of) your proposed plan or sends you back to the drawing board for various reasons—usually because your plan doesn’t meet Chapter 13 requirements in one or more particulars. For example, a judge might reject your plan because you don’t have enough projected disposable income to at least pay your priority creditors in full and stay current on your secured debts—such as a car note or mortgage. For more information on Chapter 13 confirmation hearings, see Ch. 10.

You are entitled to amend your proposed plan until you get it right, or the judge decides that it’s hopeless. Each amendment requires a new confirmation hearing and appropriate written notice to your creditors.

 

Challenging the Legality of a Mortgage in Chapter 13 Bankruptcy

When you file Chapter 13 bankruptcy, creditors are supposed to file a proof of claim setting out how much they think you owe. This proof of claim will determine how much they get paid as part of your Chapter 13 plan. If a secured creditor fails to file a proof of claim, you can file one on their behalf. In recent months some bankruptcy judges have found serious legal deficiencies in some mortgage lenders’ claims and have refused to approve them. In theory, if the court does not approve the claim, you might get out from under the mortgage entirely. In practice, it’s much more likely that legal defects in lenders’ claims will result in negotiated settlements reducing the amount of your mortgage principal and interest. This area of Chapter 13 bankruptcy law is changing daily. To stay current, be sure to check for Legal Updates to this book on Nolo’s website (at www.nolo.com/update) as well as periodically check Nolo’s Bankruptcy and Foreclosure Blog (also found on Nolo’s website).

 

Other Common Reasons to Go to Court

In addition to attending the confirmation hearing, you may need to go to court to:

•  amend your plan after it has been confirmed (if necessary)

•  value an asset (if your plan proposes to pay less for a car or other property than the creditor thinks it’s worth)

•  respond to requests by a creditor or the trustee to dismiss your case or amend your plan

•  respond to a creditor who opposes your right to discharge a particular debt (perhaps because you engaged in fraud when incurring the debt)

•  discharge a type of debt that can be discharged only if the judge decides that it should be (such as discharging a student loan because of hardship)

•  eliminate a lien on your property that will survive your Chapter 13 bank­ruptcy unless the judge removes it, or

•  oppose a secured or unsecured claim filed by a creditor.

These procedures are described in Ch. 10.

 

How a Chapter 13 Case Ends

If you complete your full three- or five-year repayment plan, are current on your income tax returns and your child support or alimony payments, and complete a budget management course approved by the U.S. Trustee, the remaining unpaid balance on any of your debts that qualify for discharge will be wiped out. If any balance remains on a debt that doesn’t qualify for discharge, you will continue to owe the unpaid amount. (The debts that qualify for discharge in a Chapter 13 bankruptcy are explained in Ch. 3.)

 

Modifying the Plan and Alternatives to Full Discharge

If you can’t complete your Chapter 13 plan as written, you can ask the court to modify it. As long as it’s clear that you’re acting in good faith, the court is likely to approve your request. If it isn’t feasible to modify the plan, you may still be able to get what’s called a “hardship” discharge if:

•  you failed to complete your plan due to circumstances “for which you should not justly be held accountable” (like a job loss), and

•  your unsecured creditors have received at least what they would have gotten if you had filed for Chapter 7 bankruptcy (that is, at least the value of your nonexempt property less sale costs and the trustee’s commission).

 If the bankruptcy court won’t let you modify your plan or give you a hardship discharge, you can:

•  convert your Chapter 13 bankruptcy to a Chapter 7 bankruptcy, unless you received a Chapter 7 discharge in a case filed within the previous eight years (this is explained in Ch. 10), or

•  dismiss your Chapter 13 case. This means you’ll owe your creditors the balances on your debts from before you filed your Chapter 13 case, less the payments you made, plus the interest that accrued while your Chapter 13 case was open.

As you can imagine, Chapter 13 bankruptcy requires discipline. For the entire length of your case, you will have to live strictly within your means—and even more strictly if your income exceeds the state’s median income. The Chapter 13 trustee will not allow you to spend money on anything deemed nonessential. In past years, only about 35% of Chapter 13 plans were successfully completed. Many Chapter 13 filers dropped out early in the process, without ever submitting a feasible repayment plan to the court. Nevertheles