A Consumer's Overview of Bankruptcy
Why is there Bankruptcy protection?
- The bankruptcy code is designed to protect you and help you regain your life after financial disaster.
Bankruptcy is NOT failure.
- It is a tool for success and getting back on track.
Bankruptcy is NOT irresponsibility.
- The vast majority of bankruptcy cases do not involve people who were simply frivolous with their finances.
- Most common causes of bankruptcy are: job loss, divorce, high medical bills from injury or serious illness, death of a supporting family member, poor economic conditions.
Bankruptcy does NOT simply protect debtors.
- While the Bankruptcy code does help debtors get rid of debt, it also protects creditors to make sure all creditors are treated fairly.
- If you have a customer who owes you money and is filing for bankruptcy, the Bankruptcy code can help you get the most money you can toward what you are owed.
Bankruptcy does NOT leave you destitute.
- Most people who file for bankruptcy can keep their house, car, and other personal belongings. The Bankruptcy code is designed to leave you with the tools necessary to begin a new financial life.
Types of Bankruptcy
For individuals there are two ways of filing for bankruptcy:
- Chapter 7 “Liquidation” Bankruptcy
- Chapter 13 “Debt Reorganization” Bankruptcy
“Chapter 7” Liquidation Bankruptcy
Liquidation Bankruptcy is governed by Chapter 7 of the Bankruptcy Code.
v In a Chapter 7, all of your non exempt assets are “turned over” to the Bankruptcy trustee and are sold and distributed to the creditors. With a couple exceptions, any new assets acquired after the bankruptcy petition is filed belong to the debtor and are out of the reach of pre-bankruptcy creditors. This gives the debtor their “fresh start.”
What Chapter 7 Does and Does Not Do.
Chapter 7 DOES:
- Discharge almost all of a debtor’s debt:
ü Credit card bills
ü Hospital bills
ü Certain taxes
ü Department store bills
ü Bills for personal services
- Reduce the amount of secured debt to the market value of the secured debt
- For example, if you have $300,000 left on a home mortgage, but the market value of the home is only $250,000, the amount due on the mortgage gets “stripped down” to $250,000. The $50,000 deficiency is discharged. However, the bank can still foreclose when the case is discharged.
Chapter 7 DOES NOT:
v Discharge debts secured by a lien or a mortgage:
ü Mortgage on property
ü Purchase money lien on a vehicle
ü Judgment liens
ü Tax liens
v Discharge certain “priority” debts
ü Child support
ü Alimony
ü Damages owed on a drunk driving case
ü Income taxes assessed within 3 years of filing
ü Condo assessments
“Chapter 13” Debt Reorganization Bankruptcy
Unlike a Chapter 7, a Chapter 13 reorganizes the debt. This means the debtor keeps all their property and does not turn any over for liquidation. Most debtors who file Chapter 13 are attempting to stop a foreclosure and/or catch up on a mortgage. In Chapter 13 you enter into a payment plan generally for 5 years where you pay off your secured debt and a fraction of your unsecured debt. Debtors MUST have a steady stream of income to file for Chapter 13. If there is no steady stream of income, a Chapter 13 plan cannot be confirmed.
Chapter 13 DOES:
v Give the debtor time to pay off non-dischargeable items secured by:
ü Mortgages
ü Tax liens
ü Judgment liens
v Allow a debtor to catch up on past due mortgage payments
v Allow the debtor to pay off only a portion of most debt with the remainder discharged
o For most debts usually ten cents on the dollar
v Force all creditors to accept the payment plan approved by the Bankruptcy judge
Chapter 13 DOES NOT:
· Reduce the amount due on a home mortgage or car loan to the market value of the property
o If you have $300,000 left on a home mortgage but the market value of the property is $250,000, you will still owe the $300,000 and do not get the “strip down” offered in Chapter 7
· Get approved unless ALL of the debtor’s disposable income goes to the payment plan for the entire 5 year period.
The Automatic Stay
Regardless of which way you file bankruptcy, you will have the protection of the automatic stay. The automatic stay becomes effective immediately upon the filing of a bankruptcy petition.
What is the automatic stay?
- The automatic stay is like an impenetrable steel door slamming down between the debtor and all the creditors. Once the automatic stay is in effect, ALL creditors (including governmental creditors like the IRS) must immediately stop ALL actions to collect debts from the debtor. The automatic stay generally remains in effect until the case is discharged.
While the automatic stay is in effect:
Ø Creditors are not allowed to call the debtor or send letters;
Ø Any foreclosure actions and collection lawsuits are halted;
Ø Creditors cannot repossess property AND sometimes must GIVE BACK property recently repossessed:
Ø Utilities, including cable and internet service providers must continue service to the debtor
Ø Creditors who violate the automatic stay can be fined, lose their priority or even be imprisoned by the Bankruptcy court!!
BE WARNED: Sometimes creditors can argue that they are not receiving “adequate protection” under the bankruptcy case and will ask the court to lift the automatic stay for their claim. Courts will sometimes do this if a debtor missed scheduled payments during the bankruptcy case or the debtor has no equity in the property. However, generally the automatic stay will remain in effect until the discharge of the case.
Which Chapter DO I choose?
Why would people choose to enter into a five year payment plan under Chapter 13 rather than file a Chapter 7 immediate discharge of the debt??
Ø Most people who file for Chapter 13 are trying to save their home from a foreclosure. In Chapter 13, you can catch up on mortgage payments and get the mortgage reinstated.
o In Chapter 7, if you cannot come up with all the past due mortgage payments by the time of discharge (generally 60-90 days after filing), the lender will often continue with the foreclosure when the case is over.
Ø Some debts, like recent income taxes, are not dischargeable. Entering Chapter 13 lets you pays those taxes over the 5 year plan, AND, the IRS only gets the interest rate allowed by the Bankruptcy Code, not the IRS preferred penalty rates.
Which Chapter CAN I choose?
The Bankruptcy Code now limits who may file for Chapter 7 and who must file for Chapter 13 based on the debtor’s income and the number of dependents in their household:
· If your income is below a certain median income set by the Bankruptcy code, you may automatically file for Chapter 7.
For example in Illinois the median income levels are
| STATE | 1 earner | 2 people | 3 People | 4 People |
| Illinois | $45,606.00 | $57,829.00 | $66,189.00 | $78,182.00 |
· If your income is above the median, then you must go through the Bankruptcy Code’s “Means Test”. If you are above the Means Test limit, you may not file for Chapter 7 and may only file for Chapter 13.
Can I do both?
The so called “Chapter 20”
- Some people will enter a Chapter 7 bankruptcy to discharge all the unsecured debt, and then immediately file a Chapter 13 bankruptcy to get a payment plan for paying off all the non-dischargeable debt.
- Under current bankruptcy law, generally this is harder to do because the law sets a minimum amount of time between filing a Chapter 7 and then a Chapter 13.
- However, some courts will allow a debtor to file a Chapter 13 while a Chapter 7 is pending, but this is a rare circumstance.
Disclaimer
This is a passive blog and the materials contained herein are provided for informational purposes only. Nothing contained in this blog should be interpreted as a solicitation of business and none of the information contained herein constitutes legal advice. The law is subject to change without notice, and the local laws of your residence may be different from the general information displayed on this blog. You should not rely on the information provided on this blog without first consulting an attorney. Contacting this website does not establish and attorney/client relationship between you and its publisherChristopher W. Matern.
An attorney/client relationship can only be established with Christopher Matern by engaging in direct person-to-person contact with Christopher Matern. ChristopherMatern does not intend to practice law in any jurisdiction in which he is not licensed.
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