Bankruptcy Law, Your Five Minute Simple Guide to Consumer Bankruptcy

YOUR FIVE MINUTE SIMPLE GUIDE TO CONSUMER BANKRUPTCY

A Quick Overview

Bankruptcy is an enormously important debt relief remedy for debtors. Most individuals will seek relief under what is called Chapter 7 or Chapter 13. Chapter 13 gives the debtor options which are unavailable under Chapter 7.

To best understand the differences between Chapter 13 and Chapter 7 and understand why to select one chapter or the other as a remedy, let's first take a look at Chapter 7 and what it does, what happens in the typical Chapter 7 case and what most debtors are expecting from the remedy. Then, we will compare it to the relief afforded under Chapter 13.


Chapter 7 - Discharging Debts

The basic premise behind Chapter 7 is that the debtor is deeply insolvent and wants to gain a discharge, that is a release of debts. Most Chapter 7 debtors today are primarily concerned with credit card indebtedness. It is not uncommon to see Chapter 7 cases for individuals of average annual income that have credit card debts exceeding their annual income, sometimes double even triple what their annual income may happen to be. For such an individual, Chapter 7 holds out the promise of gaining relief from those debts.


Exempt Property - Assets That Are Protected

Providing the honest debtor with a "fresh start" is the core principle of bankruptcy law. In order to make the "fresh start" a reality, the law is very generous about the assets that a person in bankruptcy is allowed to keep. The categories of protected property are called "exemptions", because such property is "exempt" from being taken to pay the creditors.

The Federal bankruptcy laws allow each state to determine which assets a person is allowed to keep when a bankruptcy case is filed. California is one of the most generous of all states when it comes to exemptions. The state exemptions are set forth in two separate lists, which are found in California Code of Civil Procedure (CCP) sections 703 and 704.

The debtor is allowed to use the exemptions from only one "list", either CCP section 703 or section 704. We cannot "mix and match" from the two. There are some similarities between these exemption lists, but also some major differences. Therefore, expert legal guidance is imperative for any person filing bankruptcy. The failure to correctly plan for the bankruptcy filing and use the correct exemptions can actually cause some people to lose property that they could have been protected.

Proper use of these exemptions is essential to successfully accomplishing the Debtor's goal of protecting assets. However, great care must be taken. Non-attorneys, such as the so-called paralegals, or other non-experts, cannot be relied upon to properly guide a person through the maze of bankruptcy and exemption laws.

Both CCP sections 703 and 704 have provisions to protect clothes and other common, ordinary household goods such as furniture, appliances, clothing and personal effects. Both have varying provisions for protecting jewelry, vehicle equity, retirement plans, insurance policies (including cash surrender value), tools of the trade, and claims for worker's compensation and personal injuries. However, it must be remembered that the two code sections vary somewhat in the values of such items that can be exempted.

Below is a comparison between the two sections for various kinds of assets. These are the most commonly used provisions. However, there are other exemptions in addition to those listed below. Always check with an expert before taking any action, as the laws sometimes change, and court rulings will occasionally affect the manner in which these laws are applied and interpreted:

*Varies depending on circumstances of debtor

** Exempt to amount reasonably necessary for support at retirement

The principal difference between the two exemption lists is in the amount of home equity that can be exempted. CCP section 704 contains the "homestead" exemption. This can be used to exempt a Debtor?s residence that has a large amount of equity (keep in mind that it is only the equity portion of the value that must be protected by the homestead).

The exemption protects $50,000 if the Debtor is an individual; $75,000 if the Debtors are married and filing together, or an individual who is head of the household; or $150,000 if the Debtor is over 65 years old, disabled, or over 55 years old with a gross annual income less that $15,000 ($20,000 if married). To take advantage of the homestead exemption, the property must be used by the Debtor as a residence.

CCP section 703 does not contain this homestead provision. Instead, this code section contains what is commonly referred to as a "grubstake" or "wildcard" exemption. This allows the Debtor to protect up to $15,800 in cash, or any equivalent value of property. It can be used to protect any property of the Debtor that would not be exempt under another provision of the statute. Further, it can be divided up to exempt various real or personal property, as long as the items value does not exceed the exemption limit of $15,800. For instance, the grubstake can be used to protect real property with little equity, and does not require the Debtor to reside at the property. Or it could be used to exempt tax returns, excess vehicle equity, and bank account balances.

Possible Denial Of Chapter 7 For Substantial Abuse

With respect to a debtor's eligibility to file Chapter 7 we have to look to Section 707 of the Bankruptcy Code which sets forth a basis for the bankruptcy court to deny relief to the prospective debtor where the court determines that granting the relief under Chapter 7 would be an abuse of process. The standards the court looks at in making that kind of determination is primarily going to be the debtor's ability to pay all or a substantial portion of their debt over a reasonable period of time as an alternative to Chapter 7. Courts frequently will compare the likely result of a hypothetical Chapter 13 case when examining a prospective Chapter 7 debtor in order to determine whether or not an abuse of Chapter 7 is likely to occur.

Chapter 7 Effect On Liens

One of the most fundamental protections for creditors under Chapter 7 is the fact that liens normally pass through Chapter 7 unaffected by the debtor's discharge.

A lien is a security interest affecting some type of property owned by the debtor. Most typically in a bankruptcy case it is going to be a lien or a mortgage secured by the debtor's residence or other real property owned by the debtor. Also extremely common in the Chapter 7 case is an automobile encumbered with liens usually securing the purchase price of the motor vehicle.

Reaffirmation Of Debts

A reaffirmation is a legal agreement in which the debtor and a creditor in effect make a new contract to take a certain debt obligation and agree that it is not going to be discharged in the bankruptcy. This is most typically accomplished with obligations that are secured.

It is very unlikely that you are going to see a reaffirmation of an unsecured indebtedness. Reaffirmations most often come into play concerning a purchase money lien on household goods and furnishings. A typical debtor comes into a Chapter 7 case with a house full of furniture a lot of that furniture and appliances in the house are going to be encumbered with purchase money liens, for the big screen T.V., the washer and the dryer and all the other possession of modern life. The Chapter 7 provides that all of these kinds of liens pass through the bankruptcy unaffected by the grant of a bankruptcy discharge. The effect of that is the debtor is going to still have to pay the debt securing those liens in order to keep or retain the property. Many times this is going to be accomplished by a reaffirmation agreement.

The debtor's attorney or frequently the court itself does not want a debtor to be burdened with a reaffirmation following the discharge of debts under Chapter 7.

One of the reasons why is under Bankruptcy Code Section 524 a reaffirmation has to be approved by the debtor's attorney of record and the debtor's attorney has to sign a declaration under penalty of perjury stating that the reaffirmation would not produce an undue hardship upon the debtor. Most attorneys are very reluctant to sign such a declaration and saddle their client with such obligations. Even if it is presented to the court for approval such as in the case of a debtor that is not represented by counsel, the courts will closely scrutinize such an agreement.

In a case where the debtor is not represented by an attorney, Bankruptcy Code Section 524 requires that the bankruptcy court must hold a hearing in order to approve any proposed reaffirmation and the bankruptcy court during that hearing process is going to inquire as to the circumstances surrounding the obligation and to determine whether or not approving the reaffirmation would be an undue hardship upon the debtor or any dependent of the debtor.

Reaffirmation Not Always Required

Case law concerning reaffirmation agreements under Section 524 (at least in the 9th Circuit Court), teaches us that the court should not approve the reaffirmation of a secured debt where the debtor has been able to keep the payments current on that obligation. For example: the debtor proposes to reaffirm an automobile loan, the reaffirmation comes before the court for approval of the reaffirmation, but the court finds that the debtor is current, virtually every Judge in this District is going to instruct the debtor that so long as they remain current on the debt the creditor is not going to be entitled to repossess the collateral, the vehicle, the furniture whatever it happens to be so long as the payments stay up to date and particularly in the case of the vehicle so long as the collateral is kept insured by the debtor.

Court decisions in the 9th Circuit say very clearly that so long as the obligation has been kept current by the debtor even after the discharge, a creditor is not entitled to repossess the collateral for the mere fact that the debtor would not agree to a reaffirmation. One of the unfortunate results of this for creditors is going to be that debtors may not take such very good care of the collateral. In the case of a motor vehicle a lender could be rightly concerned that the debtor is going to abuse the vehicle, or is not going to maintain it adequately, will just use it up and then throw it away and "walk" from any resulting deficiency balance following a voluntary repossession.

Debts Not Affected By Discharge

One of the other important aspects to understand about Chapter 7 bankruptcy is that under a Chapter 7 we have a scheme of debt relief which does not discharge every kind of debt.

If we look at Section 523 of the Bankruptcy Code, Section 523(a) sets forth a laundry list of different types of obligations that are not dischargeable. The best way to understand the likely difference between the dischargeable debts and the non-dischargeable debts are to think of acts committed by the debtor which amount to intentional wrongs or intentional torts.

Other types of debts which are not going to be dischargeable are debts that have a very important social and societal aspect to them separate and apart from the monetary debt which the obligation represents.

What are we talking about here? Taxes, student loans, alimony, spousal support, child support-these are all obligations that are evidenced by monetary debt, yet they also have extreme social, societal importance separate and apart from the money that is owed. The public policy of every State in the United States is that persons must support their children. They must support the spouses when ordered to do so.

They must pay their taxes. They must pay back their student loans. In fact, the Bankruptcy Code very clearly provides that most of those kinds of societal obligations are not going to be discharged.

There are some minor exceptions; income taxes can be discharged in some situations if the tax debt has become fairly old and in situations where the debtor has filed honest tax returns, and has not willfully evaded the collection of the tax debt.

Also student loans although normally non-dischargeable can in fact be discharged upon a showing that if the debt is not discharged the non-discharge of the debt would produce an undue hardship upon the debtor and any dependents of the debtor.

Such situations are extremely rare in this day and age at least in terms of court decisions finding that student loans should be discharged under the hardship provision.

A review of the court cases in this area will disclose that most student loan undue hardships which have been granted typically fall to individuals that suffer from some type of very severe permanent and total disability or some sort of permanent disability that drastically effects their ability to engage in earning a meaningful livelihood.

The Automatic Stay

This is probably the most important feature of Chapter 7 Bankruptcy separate and apart from the ability to grant a discharge. The commencement of a bankruptcy case imposes an immediate automatic restraining order upon all creditors, regardless of the chapter. The source of this law is Section 362(a) of the bankruptcy code which sets forth a list of the different types of actions against a debtor which are automatically stayed by commencement of the bankruptcy case.

For example: the commencement of lawsuits against the debtor for the collection of money, enforcement of judgment, collection letters, demands for payment these are all ordinary examples of the kinds of actions that are stayed by the filing of the bankruptcy case. Perhaps even more drastic is that the automatic stay stops foreclosure and repossession so this is an extremely powerful component of the bankruptcy laws and any debtor who is faced with the imminent repossession of a vehicle or the imminent foreclosure of real property will often resort to Chapter 7 if for no other reason then to gain time to try and resolve the debt problem and come up with a method of curing a default.

Why Chapter 13?

Chapter 7 provides a fairly wide range of debt relief for a prospective debtor but it does not do all things for all people. There are a lot of situations that Chapter 7 just does not help.

A Chapter 7 case will temporarily stay a foreclosure but the filing of the case and the imposition of that stay does not give the debtor any mechanism to force a cure of the default. When the Chapter 7 is discharged the automatic stay normally ends. This frees a secured creditor to proceed with lien enforcement and pick up where they left off and finish the foreclosure. In a case of an automobile loan that is delinquent, the vehicle will be repossessed. Thus, Chapter 7 is really an imperfect remedy for individuals who have defaulted security obligations and who are desirous of keeping the collateral.

Chapter 7 does not discharge all debts. For example a lot of debtors go through Chapter 7 who owe taxes and they come out of the Chapter 7 usually still owing their taxes and facing tax collection once the bankruptcy case is finished. That brings us around to the subject of Chapter 13 and the reasons that Chapter 13 is going to be an important alternative for many debtors instead of Chapter 7.

There is probably one Chapter 13 case filed for every three or four Chapter 7 cases. However, the typical Chapter 13 case filed is probably for an individual or joint filing for husband and wife who are trying to stop and cure the real estate foreclosure of their family home that is the type of case scenario that probably accounts for 60 to 70 percent of all the Chapter 13 bankruptcies. The balance of Chapter 13 cases are probably filed by individuals who are trying to manage tax debts that would be non-dischargeable under Chapter 7 or perhaps to deal with a default situation on motor vehicles.

Chapter 13 Can Cure A Default

In the case of a real estate foreclosure the way the Chapter 13 is going to operate is that upon commencement of the case, the debtor going to the bankruptcy court or going to an attorney who prepares and files the Chapter 13 case which imposes an immediate automatic stay which stops the foreclosure.

This can be done right up until the foreclosure auction takes place and the giving of notice of the automatic stay stops the creditor action. But here is what happens now to the debt and how it is going to be handled in the Chapter 13.

The debtor has to do something in the case to cure the default on the loan. The court is not going to simply let the debtor sit there and enjoy the benefits of ownership without the burdens of making payments. So what actually happens is under the Chapter 13 law and the local rules of the bankruptcy court the debtor is required to commence making regular monthly payments again on the mortgage. Payments must commence with the next payment that comes due following the filing of the bankruptcy case. Now in additional to paying regular monthly payments the debtor has to do something to catch up the default.

The best way to understand the process is that the debtor is drawing the line in the sand and says, "I am buried up to my neck in debt and delinquent payments; I am not going to go any deeper in the hole; I am going to start making regular monthly payments and in addition to that I will pay some extra money to gradually catch myself up". It's the payment of those extra monies that will allow the debtor to cure the default on their property over a reasonable period of time. The concept is really fairly simple although in practice it can become quite complicated.

Chapter 13 Example - Motor Vehicles

In the case of an automobile suppose the debtor possesses a car worth $5,000.00 but there is $10,000.00 owed against it. Lets also suppose the debtor is running two, three, four months behind on their automobile payments and the car is about to get repossessed.

Again the filing of the Chapter 13 case will immediately protect the debtor's possession of the collateral and in the debtor's plan the debtor is entitled to propose payments to the creditor for the current market value of that automobile without regard to the actual contractual balance.

Assume we have a car that is worth $5,000.00 but there is $10,000.00 owed on the car, the debtor may propose a plan to pay the creditor the $5,000.00 that represents the current market value of the vehicle and to pay that to the creditor in installments over a period that usually is going to be 36 months. The law does require that the debtor must pay some interest to the creditor. Interest will be paid to compensate the creditor for the value of the delay in collecting the current market value of the automobile that exists on the day that the bankruptcy is filed. Now one of the contentious points in Chapter 13 cases is over the valuation of collateral.

The Chapter 13 Plan

Lets move on to the Chapter 13 Plan itself because this is really the fine work of the Chapter 13 case, it's the road map that tells the court and the creditors where this case hopefully is going at least as proposed by the debtor. The bankruptcy code requires that every debtor file a plan under Chapter 13 and that plan must be filed within 15 days after commencement of the case. The plan must describe in some detail the method by which the debtor proposes to handle the debts.

Ch. 13 Plan - Classification Of Debts

The typical plan should divide the debts into logical categories, for example, certain debts which are required under the bankruptcy code to be satisfied in full such as non-dischargeable tax obligations are typically going to be put under a priority classification. Debts for things like taxes and arrearages on alimony or child support are usually isolated to their own class.

This class of debts might also contain a provision for payment of the debtor's attorney fees.

A large percentage of debtors will pay all or most of their attorney's fees for their legal representation as a component of the Chapter 13 plan. The plan also will divide debts into other logical categories such as a category for unsecured claims, a category for secured claims which are secured by the debtor's principal residence, perhaps a category for secured claims secured by collateral other than the debtor's principal residence perhaps a category of secured claims for debts that are secured by personal property such as the motor vehicles and the big screen TV's and the appliances.

A general requirement is that whenever a debtor is going to be paying back secured claims the debtor is required to pay interest to the creditor on the secured portion of the claim. In fact, secured claims may actually be broken down into sub-components.

Ch. 13 Plan - The "Cram-Down"

Using the example of a vehicle that is worth $5,000 but is encumbered with a $10,000 debt the debtor's plan should break that claim down into its secured and unsecured components. For example, the plan should provide that the current market value of the vehicle, $5,000, is going to be paid in deferred cash payments though the plan over a period of usually not more than 36 months and that the creditor is going to receive interest on the secured portion of the claim; that is the value of the car. The unsecured portion of the claim is what you would probably refer to as the deficiency component. For example, in the event of a repossession and commercial sale of this $5,000 vehicle, then following repossession, there would be a deficiency of $5,000. Under the debtor's plan the deficiency component is going to be treated as an unsecured claim and an unsecured claim usually will not receive any interest.

Ch. 13 Plan - The Confirmation Process

One of the key threshold issues for every debtor in proposing a Chapter 13 is to provide the court some convincing evidence or proof that the plan is ?feasible? and that the plan is proposed in good faith. Feasibility and good faith are extremely important components of the adjudication of a Chapter 13 plan. For example: if the debtor does not have sufficient regular income in order to meet his or her own regular ordinary living expenses and to make the payments that are called for under the plan, there is a serious problem; that plan is not feasible.

There is no reason why the court should delay the creditors any longer from taking possession of collateral when the debtor has no ability to fund the plan that is being proposed. Typically debtors are required to present the court with copies of pay stubs and other documents to establish current regular income.

Sometimes a debtor will propose funding of the plan with sources of income that come from third parties, commonly debtors will sometimes rely upon the income of roommates, domestic life partners, other individuals or family members who perhaps live with the debtor and contribute to the expenses of the common household. In situations such as this the court will usually require that the debtor present some sort of evidence usually in the form of a declaration signed by the third party attesting to the fact that they do intend to make the financial contributions that are called for in the plan and also, typically requiring that they too present some evidence of current regular income, to show where their income is derived from so that the court will be certain that there is every reasonable prospect that the payments being proposed are actually going to be paid by the debtor.

Another key requirement of every Chapter 13 plan is that the debtor is eligible for the relief available under Chapter 13. Section 109(e) of the bankruptcy code establishes the criteria for debtor eligibility. Debtor eligibility under Chapter 13 is limited to individuals with regular income who have limited non contingent liquidated unsecured debt.

Creditor's Rights-Protecting the Creditor's Position

A) Secured creditor

While we know that secured creditors are secured by some type of collateral in the debtor's property we know that the plan must provide for payment of the secured portion of the creditor's claim. Creditors that need protection in Chapter 13 are usually going to be creditors that are the beneficiary of a mortgage on the debtor's real property and the creditor's remedy is going to depend on what stage the Chapter 13 case happens to be at.

For example: in the period of time immediately after the commencement of the case but prior to confirmation of the plan, if the debtor has defaulted in making mortgage payments the secured creditor might bring a motion for relief from the automatic stay although it is usually more productive to simply file an objection to the confirmation of the plan on the grounds that the debtor is now post-petition delinquent.

The courts in this district are not going to confirm a plan with the debtor who is delinquent on mortgage payments post-petition and if at the confirmation hearing the payments have not been brought current, the case is going to get dismissed. Sometimes it will be dismissed with prejudice where some egregious circumstances can be shown such as where there have been a series of repetitive Chapter 13 or other bankruptcy filings or where multiple bankruptcy cases concern the same real property such as multiple bankruptcies filed by co-owners or perhaps where fractional transfers of the property have occurred.

After a plan is confirmed, a secured creditor wants to monitor the debtor's tender of the regular monthly mortgage payment. If a default occurs after confirmation, the creditor's best remedy is to file a motion for relief from automatic stay. The courts in the 9th Circuit make it very clear that the post-petition default of payments is a material breach of the debtor's plan and constitutes "cause" under Bankruptcy Code Section 362(d) for relief from the automatic stay.

All creditors should file a proof of claim. The bankruptcy code and the bankruptcy rules of procedure provide that most claims must be filed within 3 months after the debtor's 341(a) meeting of creditors. A creditor that neglects to file a proof of claim should not expect to receive payment in the case.

The 9th Circuit Court of Appeals in the case of Firemans Fund vs. Hobdy made a very important ruling; where a secured creditor neglects to file a proof of claim the debtor's property is still encumbered by the lien, even the arrearages that were provided for in the debtor's plan do not go away just because the creditor overlooked or neglected to file a proof of claim and participate in the case. The lien will survive the discharge.

B) Unsecured Creditors

It is much more important for an unsecured creditor to file a proof of claim. An unsecured creditor that neglects to file its proof of claim is not only going to not participate in the Chapter 13 payment process, but if the debtor completes the plan and receives a discharge, then the unsecured creditor will have received nothing even though the plan might have provided to pay all or part of unsecured claims. If there is some type of post-petition default on plan payments, an unsecured creditor might choose to file a motion seeking dismissal of the Chapter 13 case, although this is a procedure that is really more in the province of the Chapter 13 trustee who is monitoring the debtor's payment status.

Creditors that have large unsecured claims are typically the losers in the Chapter 13 process because so may Chapter 13 plans are going be approved that provide for payment of little or nothing to unsecured creditors. There are some tactics though that can be employed by an unsecured creditor in order to object to the confirmation of the plan. The best line of attack for an unsecured creditor is to fall back on the eligibility and good faith requirement for Chapter 13 debtors. If an unsecured creditor can establish for example, that the debtor is not eligible or the plan is not feasible, debtors are not regular wage earners or more importantly show that the debtor's plan has been proposed in bad faith.

Bad faith may be shown by a variety of factors. One example would be where there have been repetitive Chapter 13 filings in order to frustrate the collection of legitimate state court judgment. Another example would be the commencement of a Chapter 13 case which is strategically timed to interrupt an ongoing state court trial, prevent the entry of a judgment, or prevent the deliberation of a jury. Still other examples would be where the debtor was seeking to discharge significant kinds of debts that would be non-dischargeable in a Chapter 7 case such as those set forth under Section 523 (debts resulting from intentional wrong doing, such as intentional torts, fraud, conversion, embezzlement, etc.).

These kinds of factors might permit an unsecured creditor to be able to build a convincing case that the plan is proposed in bad faith and should not be confirmed resulting in the dismissal of the case or sometimes even the conversion of the case to Chapter 7.

Confused? Have a question? Email us at info@bayerwishmanbankruptcylaw.com 

Prepared Especially For Handel On The Law By:

LEON D. BAYER*
Partner: Bayer, Wishman & Leotta

JEFFREY WISHMAN*
Partner: Bayer, Wishman & Leotta

*Certified Specialist, Personal and Small Business Bankruptcy Law by the Committee for Legal Specialization, State Bar of California

Emphasis on Bankruptcy Practice in California
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Copyright 2004

BAYER, WISHMAN & LEOTTA
Attorneys at Law
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