Is bankruptcy the right option for you?
As a lawyer, I am accustomed to my profession getting a bad rap.
In my experience, filing bankruptcy gets the same bad rap, but it shouldn’t. It is an opportunity provided under the federal laws of our great nation to prevent an individual or business from drowning in bills that cannot possibly be repaid. It encourages entrepreneurship. The forgiveness of debts is even mentioned in the Bible.1
The average human does not arise in the morning and run to the mirror and declare, “Hey, good looking, it’s a great day to file bankruptcy!” It just doesn’t happen. But, there are times when it should. And if you are one of the many Americans drowning in debt, you need to recognize that this may be one of those times. But, before you make a cursory decision about bankruptcy, there are some things you need to know.
THE DIFFERENCE IN CHAPER 7 AND CHAPTER 13 BANKRUPTCY CASES
There are generally two options available under the Bankruptcy Code for individuals: Chapter 7 and Chapter 13. Chapter 7 bankruptcy is often the short-and-sweet version of bankruptcy. The first important thing to know about a Chapter 7 is that you must pass the Means Test2 in order to qualify. The Means Test is simply a device to weed out people who might be abusing the system to get out of debt that they really could pay. But for most people legitimately contemplating bankruptcy, the means test is rarely an obstacle. If you pass the Means Test, you can receive a discharge of your unsecured debts. The most common unsecured debts discharged in bankruptcy include credit cards, medical bills, old utility bills, deficiency balances on repossessed vehicles, and judgments obtained for these debts. Any debts on secured items you are willing to walk away from can be surrendered in a Chapter 7 and the creditor cannot later attempt to collect on the deficiency balance. This is a good option if you are significantly upside down in your vehicle.
Although Chapter 7 bankruptcy is referred to as “liquidation,” the process rarely occurs in an average Chapter 7 case. So long as your assets fall within the exemption limits, no liquidation will occur. Another thing to know about Chapter 7 is that you may retain and continue to pay for certain secured debt. You can discharge unsecured debts but continue to make regular mortgage payments and payments on a car note. Of course, there is more to know, but this is a simple explanation. Your bankruptcy attorney can get into the nitty-gritty and explain it all to you in detail.
Chapter 13 bankruptcy is referred to as “reorganization.” This chapter of bankruptcy can be used to help you if you have fallen behind on mortgage payments or car notes. While the Means Test does not determine whether you qualify for Chapter 13, the test is used to determine if your unsecured creditors will receive any payments on their claims. A Chapter 13 is very different from a Chapter 7 in that you must make regular monthly payments to the Chapter 13 Trustee for a period of no less than 36 months and no more than 60 months. These monthly payments are payroll deducted. You must have a regular source of income to qualify for this chapter of bankruptcy. A Chapter 13 case is filed with a plan of repayment indicating the amount each creditor or group of creditors will be paid during the course of the bankruptcy. The trustee follows this plan to make the payments indicated. So long as each payment is made as proposed in the plan, all of your unsecured debts will be wiped out and any arrearage amounts on secured claims will be brought current at the end of the bankruptcy period. Because life goes on, even in bankruptcy, you may be permitted to incur new debt for the purchase of a home or vehicle.
Here’s where I want to dispel the myths surrounding bankruptcy. First, filing bankruptcy does not mean someone is going to come and take away all of your possessions. In fact, 11 U.S.C. 522 provides a list of exemptions available under the bankruptcy laws. A brief list of the exempt assets includes equity in a home and vehicles, household goods and furnishings, jewelry and wedding rings, retirement accounts and 401(k) plans, life insurance policies, tools used in the business, and many other assets you own or have an interest in. If you have a pending personal injury or wrongful death lawsuit that will potentially be bringing in a settlement, the bankruptcy laws allow you to keep up to $21,6253, as of 2014. That figure is subject to change and tends to rise with the cost of living. More details on that later. The point here is that you do not “lose” anything just because you file bankruptcy. If you do have assets that exceed the exemption limits, your bankruptcy attorney will discuss your options with you.
Second, you will be relieved to know that when you file a bankruptcy case, your creditors can no longer contact you. Your mailbox will no longer be filled with threatening letters from debt collectors, and you can answer the telephone without fear of being chastised for failure to make a payment on a bill. This perk to filing bankruptcy can be very enticing if you’ve reached your emotional limit.
Third, if you are having financial difficulties, you should schedule a consultation with a bankruptcy attorney so you can make an educated decision on how to deal with your financial problems. Dilks Law Firm offers a free consultation. Call for an appointment to meet with an attorney who can explain all your options.
WHEN SHOULD YOU FILE BANKRUPTCY
So, when do you need to file bankruptcy? Here’s the short list:
- When you have nothing to lose
- Before a divorce
- When you have a lot of medical bills
- When your credit cards are out of control
- When you’re having mortgage problems and facing foreclosure
1) NOTHING TO LOSE
Say, for example, you have been injured in an accident and have a modest settlement coming your way, but you have so many medical bills and liens, you may never see even a penny of the proceeds. In addition, the time you missed from work has caused you to fall behind on credit card payments. Perhaps you even put some of your living expenses or medical bills on your credit cards during your recovery period. While you may have managed to keep your mortgage and car note current, you can’t see the light at the end of the tunnel. This is when you need to talk to a to a bankruptcy attorney.
If you are an individual or couple with modest assets and income but a significant amount of credit card debt or medical bills, you will likely qualify for a Chapter 7 bankruptcy. The bankruptcy case can be filed, and at least $21,6254 can flow into your pocket. Any unused portion of your “Wildcard” exemption could increase this amount.5. This is money that otherwise would have gone to medical providers.
However, be warned, no clear law exists in Arkansas regarding whether any Medicare, Medicaid, and subrogation liens can be wiped out in bankruptcy. In some cases, a lienholder may be able to contest including this type of debt in your bankruptcy, in which case it would come out of the proceeds of your settlement. The important thing to remember is if you stand to walk away from the settlement with empty pockets, you have nothing to lose by filing bankruptcy.
2) BEFORE DIVORCE
It’s a well known fact that financial problems often lead to marital problems and ultimately to divorce. In these instances, you and your spouse will have to come to an agreement as to who should pay which debt. You might successfully obtain a divorce and enter into a property settlement agreement, but afterward one of you might decide to file bankruptcy. This will create a hornet’s nest for the non-filing spouse. The bankruptcy spouse has discharged debt obligations through the bankruptcy court, but a property settlement agreement may indicate he or she is responsible for those debts. The filing of one ex-spouse will often push the other into also filing bankruptcy. A better solution: file bankruptcy as a couple before filing for your divorce.
If you and your spouse are suffering from financial problems and your marriage is on the rocks, consult with a bankruptcy attorney prior to obtaining the divorce. One reason for doing this is to save money. A couple can file bankruptcy for the same cost as an individual. If you can remain amicable for just the short period of time, usually six months, it takes to get through a Chapter 7 bankruptcy, you can discharge your debts and then go on to obtain your divorce without the overhanging debt problems. This will have the added benefit of simplifying the property settlement in your divorce.
3) MEDICAL BILLS
If you don’t have medical insurance, you will quickly find yourself in a significant amount of debt after treatment for an illness or injury. Unpaid medical providers will often obtain judgments against you and collect on the judgments through garnishments of wages and bank accounts. A Chapter 13 or Chapter 7 bankruptcy filing will immediately stop a garnishment. Successfully completing either chapter will eliminate all of your medical bills.
4) CREDIT CARDS
Oh, those credit cards; they are so tempting! They lure the unknowing into their web and treat them so, so well! That is, until one payment is missed or sent late. When that happens, watch out! The interest rate will jump from 5 percent to 33 percent overnight, not to mention the late fees that will be added. If making the minimum payments created a hardship before, this new exorbitant amount will send things right over the edge. Calling the credit card companies is a waste of time if you can’t bring a lump sum amount to the table. Debt consolidation companies may sound appealing, but there is no guarantee that the creditors will agree to participate, and the phone calls, hate mail, and lawsuits will continue. Instead, see a bankruptcy attorney.
If you have significant income, you may not qualify for Chapter 7, but not to worry; the benefits of Chapter 13 can often cure your financial headaches. In a Chapter 13 bankruptcy, the Means Test is used to determine how much you can afford to repay to unsecured creditors. Taking into account your necessary living expense and secured debt payments, your remaining monthly income is considered disposable income. The monthly disposable income is applied to the unsecured debt. A Chapter 13 bankruptcy may only last a maximum of 60 months. If disposable income is calculated to be $500 a month, you will only pay $500 per month for 60 months. Your unsecured creditors are paid a proportion of this amount. From the time the bankruptcy case is filed, your unsecured creditors are no longer allowed to add interest to the debt, or to charge late fees or other expenses. This means the amount you owed on the date of filing is the maximum amount you will ever repay on the debt. As long as you make each of the payments for 60 months, any unpaid amounts will be wiped out.
Your creditors can never again attempt to collect on the remaining debt. You will also find satisfaction in knowing you have done the right thing and repaid some or all of your debt. Most people want to pay their debts; they simply lack the income to do so.
5) MORTGAGES and FORECLOSURES
You have seen the headlines and heard the news reports; a great many people are struggling with their mortgage payments. In addition, it has been discovered that an increasing number of mortgage servicers have misapplied payments, especially when a homeowner has fallen behind at some point during the repayment process. When the mortgage payments are behind, either actually or because of misapplication, the lender will send the home into foreclosure. A homeowner may defend a foreclosure action without filing bankruptcy. But if the homeowner is experiencing any other financial problems, a bankruptcy filing can eliminate all of your financial burdens at once.
A Chapter 13 bankruptcy will allow you up to 60 months to bring the mortgage current. It is important to know, however, that the Bankruptcy Code does not change the terms of the mortgage, other than to allow a period of time to bring the arrears current. If you’ve bitten off more than he can chew, you may not be able to keep a home with mortgage payments beyond your income level. In addition, while few other creditors are allowed attorney fees and expenses for the cost of dealing with your bankruptcy, a mortgage creditor will be allowed to add these fees to its claim for payment.
WHEN BANKRUPTCY MIGHT NOT BE THE RIGHT OPTION
While bankruptcy may appear to be a fix all for debt problems, certain debts will not be eliminated at the completion of the process: 6Here is the short list:
- Child support and alimony
- Student loans
- Debts arising from Really Bad Stuff
But, hold your horses; there is always an exception to the exception. Don’t be too quick to assume that bankruptcy will not help you with your problems. Run it by an experienced bankruptcy lawyer.
We all know the government is going to get its money. For the most part, this is true. Honestly, I pay my taxes each year so I am glad it cannot easily be discharged. Recent tax debt, generally that which was incurred in the three years before filing, cannot be wiped away through bankruptcy7. Tax debt incurred prior to those three years, and for which returns were filed by the client in a timely manner, might possibly be discharged. However, if the client has entered into a compromise and settlement with the IRS, there is a possibility the debt will have to be paid. Even if the tax debt must be paid, a bankruptcy case filing may prevent additional interest and penalties from being added. In some situations, some tax debt can be eliminated or reduced through bankruptcy.
2) CHILD SUPPORT and ALIMONY
You and I call it child support and alimony, among other distasteful descriptions, but the bankruptcy code uses the phrase “domestic support obligation8.” A domestic support obligation may be more than simply child support or alimony. A debt owed to a spouse, former spouse, or child of a debtor that is incurred by the debtor in the course of a divorce or in connection with a divorce decree or property settlement agreement may not be dischargeable9. The important thing to understand is the likelihood that these debts must be paid. If you have fallen behind in your domestic support payments, a Chapter 13 bankruptcy may give you up to 60 months to bring those arrears current. Talk to your bankruptcy lawyer about how this debt will be handled when you file.
3) STUDENT LOANS
Student loans are readily available to those seeking to further their education, as perhaps they should be. While these loans can provide an otherwise impossible opportunity to receive an education, a large number of recipients fail to complete their degrees. Without the anticipated increased income that follows having earned the degree, a borrower is unable to make even low monthly payments toward the debt. Once the forbearance and deferment options run out, the borrower is put into default. A government-backed education loan provider may set off the amount owed from your tax refund. If this has happened to you, you may be looking for options.
For the most part, education loans cannot be wiped away like credit card debts under the bankruptcy code10. However, relief may be available through bankruptcy if the debt imposes an undue hardship on you. The Eighth Circuit applies a totality of the circumstances approach to determine whether you will be allowed to discharge student loan obligations11. In making its determination regarding undue hardship, the Court will consider your past, present, and reasonably reliable future financial resources, your reasonable and necessary living expenses, and any other relevant facts and circumstances12. If your reasonable future financial resources will sufficiently cover payment of the student loan debt while still allowing for a minimal standard of living, then the debt will not be discharged13.
4) REALLY BAD STUFF…
I’ll bet Bernie Madoff wishes he could file bankruptcy. Unfortunately, he has more than one area of the bankruptcy code acting against him. A debt for fraud or defalcation (misappropriation of funds)while acting in a fiduciary capacity, embezzlement, or larceny will not be wiped away in bankruptcy14. Nor will a debt for willful and malicious injury by the debtor to another15. Criminal fines can generally not be wiped out in bankruptcy16. This is not to say you do not qualify for any bankruptcy relief, only that these types of debts will remain.
Bankruptcy may still be a valid option for you. In lieu of wage garnishment to collect on the judgment against you in the types of cases described above, you may be allowed up to 60 months to repay the judgment. If the legal fees and expenses associated with paying the judgment have prevented you from meeting other obligations, a Chapter 7 or Chapter 13 bankruptcy may help eliminate the rest of your financial problems.
I have provided you with the quick and dirty on when you should file bankruptcy. Certainly, these few words do not cover every situation. But, if financial trouble is looming, meet with a bankruptcy attorney to discuss your options. If you qualify to file bankruptcy, it will be like a burst of brilliant sunlight at the end of a long, dark, tunnel. Your stress will evaporate, your creditors will disappear, and you can begin to look toward a debt-free future. Contact the law office of Little Rock, Arkansas, bankruptcy attorney Lyndsey Dilks to learn more.
1 Deuteronomy 15:1-2 provides: “At the end of every seven years you shall grant a release. And this is the manner of the release: every creditor shall release what he has lent to his neighbor, his brother, because the Lord’s release has been proclaimed”.
2 11 U.S.C. § 707; I am compelled to ensure you that although the Means Test has gathered a plethora of hype among the bankruptcy illiterate since its October 2005 debut, the Test often will not prevent the average family from qualifying for the debt relief afforded in a Chapter 7 Bankruptcy case.
3 11 U.S.C. § 522(d)(11)(D)
4 11 U.S.C. § 522(d)(11)(D)
5 11 U.S.C. § 522(d)(5)
6 11 U.S.C. § 523
7 11 U.S.C. § 523(a)(1) and (7)
8 11 U.S.C. § 523(a)(5)
9 11 U.S.C. § 523(a)(15)
10 11 U.S.C. § 523(a)(8)
11 Educational Credit Mgmt. Corp. v. Jesperson, 571 F.3d 775, 779 (C.A.8 (Minn.), 2009)
14 11 U.S.C. § 523(a)(4)
15 11 U.S.C. § 523(a)(6)
16 11 U.S.C. § 523(a)(7)