The Process

Generally

For consumers, there are essentially 2 types of bankruptcy:  Chapter 7 and Chapter 13.  In a nutshell, Chapter 13 involves the filer making payments into a plan for usually 3 to 5 years, whereas Chapter 7 has no plan and no payments, and usually stays open for only 3-4 months.

Under either Chapter 7 or Chapter 13, the instant the case is filed, virtually all collection action must come to an abrupt halt.  A bankruptcy attorney can file a bankruptcy petition electronically 24 hours a day, which immediately prompts the court to issue an order known as an "automatic stay.”  As its name implies, the order is issued automatically and is effective instantly -- even if the case is filed in the middle of the night!

Garnishments are halted instantly, provided they are not for child support or spousal maintenance.  In many cases, some of the funds taken in an ongoing or recent garnishment can be recovered.

An individual or a Married Couple, jointly, can file bankruptcy.  A married person can file without his/her spouse, but both incomes and expenses will normally be taken into consideration in determining whether that one spouse qualifies for Chapter 7 relief or what a Chapter 13 plan payment will be.

Chapter 7

Chapter 7, officially known as "Liquidation" and unofficially called a "Straight Bankruptcy" or "Complete Bankruptcy" is the more common form of bankruptcy.  It is cheaper and faster than a Chapter 13 and should be the first choice of most people considering bankruptcy.

What Debts Don't Get Discharged Under Chapter 7?

  •  Some Taxes (but not all Taxes);
  • Domestic Support Obligations (Child Support; Spousal Maintenance);
  • Student Loans;
  • Court Fines (including Traffic Tickets and Parking Tickets);
  • Criminal Restitution; and
  • Debts Owing to an Ex-Spouse Arising from Divorce Proceedings (Domestic Support or Not).

Will I Lose All of My Property When I file?

The trade-off in Chapter 7 is that one does not necessarily get to keep all of his property (real and personal) when he files.  That stated, in over 90% of consumer bankruptcies, no property is taken from the person(s) filing.  All property that one owns must be disclosed in the bankruptcy filings; applicable laws called "exemptions" dictate what can be retained when filing Chapter 7.  In the overwhelming majority of cases, the exemptions are sufficient to allow a filer to keep all of his property

What happens to car and home loans when I file Chapter 7?

Generally, one can maintain car and home loans when filing chapter 7 as long as one is current on those loans when filing and keeps them current through and after the bankruptcy.  If one is substantially behind on payments on a car or home loan be desires to keep the car or home, a Chapter 13 bankruptcy should be explored, as it would allow more time for a person to bring current or pay off a car or home loan.

Do I Qualify for Chapter 7?

Qualifying for Chapter 7 involves passing two financial "tests."  Contrary to many oversimplifications of bankruptcy, qualifying is not determined solely by whether one's household income is above or below the median income (for the household size and state of the filer).

The myth that Chapter 7 eligibility depends solely upon income stems from a facet of one of the tests known as the "Means Test."  The Means Test was effected in 2005 when Congress reformed bankruptcy.  The Means Test looks at income derived for the 6-month period leading up to the bankruptcy filing.  Preliminarily, that income is compared to the median income (for the filer's household size in the filer's state).  If the filer falls below the median, he passes THIS test.  If the filer is above the median, then the second part of the test is applied.  In this second part, IRS Expense tables are consulted to provide "allowances" for one's expenses . These allowances are then deducted from the filer's income to determine how much money the filer would have left each month.  Depending upon the amount of debt owed, the filer would need to show between less than $125-$200 left each month in order to pass this test.

But, there is another test; it is known as the "Ability to Pay Test."  Here, the court looks at one's income and stated expenses as if that person has already filed bankruptcy.  It makes an initial determination as to whether the budget is reasonable and then determines the amount one would have left-over each month.  For this test, IRS Allowances are NOT used to determine reasonableness of expenses.  Moreover, the income used is truly "current income" as opposed to an average over the past 6 months.  As long as "not too much money" is left over each month, one would pass this test.  The threshold of having too much money will differ from case to case.  Indeed, it is the lack of clear lines offered by this test that causes many problems in Chapter 7 filings.  The determination of whether a budget is reasonable and how much left-over income is "too much" needs to be made by a bankruptcy attorney familiar with the application of this test.

Chapter 13

Chapter 13 is a type of bankruptcy where the filer commits to making payments typically for a period of 3 to 5 years.  It is officially known as "Individual Debt Adjustment" and is unofficially referred to as a "Wage Earner Plan."  The unofficial moniker is instructive in that it points out that in a chapter 13:
* The filer must have a regular source of income (although they need not be “wages”); and
* The filer must propose a "plan" of payment to creditors.

What is a Chapter 13 Bankruptcy?

I often characterize Chapter 13 as a "Mini-Chapter 11."  Chapter 11 is typically a corporate reorganization filed by the likes of Chrysler and General Motors.  However, the procedure under Chapter 13 is far more defined and streamlined.  As a result, Chapter 13 Bankruptcies will typically cost much less than a typical Chapter 11 case.

How much must I pay each month?

In a Chapter 13, the filer must propose a "Plan" that involves paying a certain amount each month for the duration of the plan.  The amount to be paid will almost always be determined by the "Ability to Pay Test."  Simply put, the filer proposes a budget and proposes to pay whatever is left after the expenses in the budget are subtracted from the income, each month.

The plan is subject to approval by the court.  Additionally, the Chapter 13 Trustee may object if he believes the plan to provide insufficient payments or be otherwise flawed.

How long will the plan last?

The length of the plan will normally be 3 to 5 years.  Typically, one whose income is under the median will have a minimum imposed length of 3 years, whereas one whose income is above the median will have a minimum imposed length of 5 years.

During the 3 to 5 years, generally, not all of one's debt needs to be paid in full.  One simply needs to make all required payments for the 3 to 5 years.  Collection on the debts is placed "on hold" while the plan payments are being made, and, once the plan is completed, the balance remaining on each of the claims is discharged (no longer owing).

For those over the median, the Means Test will apply.  Similar to its application under Chapter 7, under Chapter 13 the Means Test will look at the filer's last 6 month's income and subtract from it IRS allowances in place of the filer's actual expenses.  Whatever is left under this test is effectively the minimum the filer must pay to his unsecured creditors each month.

Why choose a Chapter 13 Bankruptcy?

One files a Chapter 13 typically for one of 2 reasons.  The first reason is that he would somehow benefit from undergoing a payment plan rather than a straight liquidation (Chapter 7).  If one is behind on mortgage payments, a plan will allow the filer to bring his payments current over the life of the plan.  The same applies to car payments, with the added possibility that the total amount to be paid and the monthly payment may actually be adjusted in the filer's favor under certain circumstances.  One might also benefit from a payment plan in paying off a non-dischargeable debt over time (such as a tax debt) or effectively paying for the right to keep property that would have been taken under Chapter 7.

Additionally, Chapter 13 can, under certain circumstances, allow a filer to release entire mortgages from their real property.

The other reason to file Chapter 13 is that one does not qualify for Chapter 7 but still requires bankruptcy protection.  Remember that in order to qualify for Chapter 7, one must pass both the Means Test and the Ability to Pay Test.  Additionally, Chapter 7 bankruptcies can only be filed every 8 years, whereas Chapter 13 bankruptcies can usually be filed at any time.

Completing the Chapter 13 Plan

After a Chapter 13 Plan is approved (confirmed) by the Bankruptcy Court, the filer will normally continue to make payments in accordance with the plan.  However, should emergencies or change of circumstances arise, your bankruptcy attorney would remain on-call to address those.  Oftentimes the court will allow missed or reduced payments in the case of emergencies, and reduced payments going forward in the case of changed circumstances.

Again, the debts involved in the bankruptcy remain “on hold” while the payments are made.  Upon completion of the plan payments, these debts are permanently discharged – with no lapse in bankruptcy protection from collection actions.

How to Choose Between Chapter 7 and Chapter 13

Chapter 7 is the preferred remedy for most people.  But only a bankruptcy attorney can analyze your circumstances and advise you as to what you should file.

Under many circumstances, it may make sense to take some actions before filing bankruptcy, or to simply wait.  The reasons for this advice may range from keeping property that would otherwise have to be surrendered to assuring eligibility for the chapter chosen.

Many filers have special circumstances that would be overlooked without the guidance of a good bankruptcy lawyer.  These mistakes often result in property being lost or denial of relief altogether (dismissal of the bankruptcy case).

Other Considerations

As mentioned above, the best attribute that a bankruptcy attorney can provide is his ability to spot possible issues.  These may include:

  • Allegation of Fraud based on recent credit card usage;
  • Forced return of payments made to relatives near the time of filing;
  • Filing Chapter 13 where a short wait may have allowed one to file Chapter 7; and
  • Many, many other possible repercussions.

Issues giving rise to these possible undesired consequences may not be obvious to attorneys who do not exclusively practice bankruptcy and, certainly, to non-attorneys.  The bankruptcy attorney has to ask the right questions.