- Filing for bankruptcy – difficult decision
For most people, the decision to file for bankruptcy is a difficult one, as they struggle to balance financial and ethical realities. Facing insurmountable debt, one must consider the bankruptcy filing against known or perceived disadvantages such as impact on credit rating, difficulty to secure housing or future credit, as well as the bankruptcy moral implications. The bankruptcy code is offering a reconciliation of two opposing goals: offering the chance of a new start to the honest debtor while equitably distributing insufficient assets among the creditors. The Coronavirus pandemic triggered almost 300,000 bankruptcy filings in June 2020 alone, and over 67% of those filings were Chapter 7. Since March 2020, a total of 946,581 bankruptcies have been filed in US according to the American Bankruptcy Institute published statistics.
- Non-bankruptcy alternatives
The debtor may want to consider all non-bankruptcy before making the final decision to file for bankruptcy. Support from an accountant of bookkeeper in situations of positive cash flow on a monthly basis may provide money management support that would allow the debtor to avoid filing for bankruptcy. Credit counseling and debt repaying services or debt negotiation, refinancing, sale of assets or efforts to increase income may also offer alternatives to filing for bankruptcy. One word of caution on income taxes – each time debt is reduced or cancelled by a creditor, that cancellation translates in an equal amount of taxable income. A bankruptcy discharge is an exemption to this general rule and no taxes are due for the discharge of debt in bankruptcy.
- Bankruptcy chapters – 7, 9, 11, 12, 13
The Bankruptcy Code, codified at Title 11 of the United States Code. Different chapters govern the filing available to individuals, organizations, family farmers, municipalities, and other local governments.
- Chapter 7
Chapter 7 offers a straightforward path to discharging debts for most individuals. A Chapter 7 filing is in essence a liquidation of all of debtor’s non-exempt assets to equitable satisfy the creditors’ claims. Married couples may decide to file jointly or separately. California, as a community property state allows for a married person to file individually, yet, provides the ability to discharge all community property debts without requiring the other spouse to file for bankruptcy. An individual is eligible to refile for Chapter 7 bankruptcy 8 years after a prior case has been discharged. Another requirement is that the filer has resided in California for 2 years prior to filing for bankruptcy, or a minimum of 180 days after moving to California.
- First steps
Any consideration for Chapter 7 filing must start with an analysis of the type and amount of debt, the income generated by the debtor, as well as the assets owned by the debtor. Not every type of debt is dischargeable, just as not every type of asset if exempt.
The “means test” reflects the intent of the Bankruptcy Code to allow discharge of consumer debt only for those who cannot afford to repay any portion of the amount owed. This is accomplished by comparing the debtor’s “currently monthly income” to the state’s median. Most types of income are considered for the calculation of disposable monthly income, the few exceptions include social security benefits, and some payments made to victims of war crimes or terrorism victims. Whether wages, business profits, interest, dividends, rental income, child or spousal support, unemployment compensation, workers comp insurance or disability payments, they all fall under the definition of income for purposes of the means test.. Debtors whose income is above the median must continue the calculations in order to determine the “disposable income”. The disposable income is determined by subtracting monthly expenses from the debtor’s “current monthly income”. Median income for a family of 4 in California is approx. $8,400 at May 2020 levels. The amount of allowed expenses depends on whether the expenses is considered under the national standard used by the IRS, or if the actual expenses are allowed for the calculation of the disposable income. Any income left after payment of allowed monthly expenses can therefore be used to pay at least a portion of the debt and the debtor does not qualify for a Chapter 7 filing. In such instances, the debtor must consider filing for Chapter 13 instead. An exception to the means test is afforded to certain members of the military. Further consideration is given to the debtor’s income and expenses based on the schedules filed with the court, and a debtor may still be ineligible for Chapter 7 filing if the income exceeds the expenses.
A detailed and careful analysis is required to determine if the debtor qualifies for Chapter 7 filing, and to decide if the timing of the filing. Sometimes a filing must be submitted right away, for example if there is threatened collection action from a collector. Other times, it might be wiser to wait, especially if the passage of time might allow the debtor to discharge income taxes. The discharge of income taxes is very technical, and it considers multiple time frames that must all be met.
A regular Chapter 7 bankruptcy normally takes approx. 4 months from filing to discharge, but every case is different, and the length of time might changes depending on the specific circumstances of the case.
- Gathering facts and documents
Once the decision to file for Chapter 7 has been made, and a determination that the debtor is eligible has been made, it is par for the course to review all bills, ownership documents, credit reports. The client must go through the hard work of providing details on income, assets, debt, as well as documenting each amount and valuing the assets, in order to ensure that all debts have been captured and all assets have been valued properly. In addition, the client must collect the most recent tax returns and paystubs.
- Existing debt
A summary of all debts will allow the attorney to classify the debts to determine which debts are dischargeable and which are not. For the purpose of bankruptcy filing debts are grouped into secured (such as loans used to purchase home, and where the home is used as collateral for the loan), or unsecured (medical or credit card bills, etc). A special group of the unsecured debts is represented by the priority debts (alimony, child support, certain income, or payroll taxes, etc). It is usually the unsecured debt that can be discharged. However, there is still some unsecured, non-priority debt that cannot be discharged, student loans being such non-dischargeable debt.
- Retaining property
California offers Chapter 7 filers two options when it comes to selecting assets exempt from liquidation. The choice depends on whether the debtor intends to protect equity in a home, or would rather protect any other asset, including cash up not to exceed $30,825 (wildcard exemption). One system protects home equity of $75,000 of single debtor, $100,000 for debtor with at least one family member, $175,000 if debtor is 65 years old or disable, or if a creditor is trying to force the sale of a home owned by a 55 year old debtor, with income less than $35,000 if married, or $25,000 if single. For a complete list of exemptions please click here.
While all debt must be disclosed to the bankruptcy court, even debt that the filer intends to repay, there are options to do so and keep the assets (for example the car with a loan balance
at the time of filing). Such options include reaffirming the loan (while hopefully being able to negotiate better terms due to the condition of the asset securing the loan), or redeeming the asset by paying off the value of the collateral (paying lender the value of the car). The redemption required the payment to be made in one lump sum. There are specialty lenders making such loans, but care must be given to the terms of such loans (interest rate, prepayment penalties, etc). The reaffirmation or redemption requires the filing of a motion with the court.
- No preferential payments to creditors prior to filing Chapter 7 petition
The bankruptcy laws reflect the principle no creditor must be given preferential treatment by the debtor. Payments of $600 or more for consumer debt made to creditors prior to filing, that would allow the creditor to receive more than what he would be able to recover in bankruptcy are considered preferential. The preferential classification applies regardless of the payment being made voluntarily, or through a levy or wage garnishment. The trustee is allowed to go back 12 months to identify such preferential payments made to “insiders” (family members or friends), and 90 days for non-insiders.
- Pre-filing course
Prior to filing the bankruptcy petition and paying the fee of $335, the debtor must complete a pre-bankruptcy counseling course and provide proof of completion to the court. The petition together with all the schedules (assets, debt, income, expenses, etc) is filed via Electronic Case Filing with the bankruptcy court within the one of the four districts, depending on the county where the debtor resides. Filing the petition triggers the “automatic stay” of any collection efforts against the debtor. The automatic stay on any collection activity usually remains in place until the discharge is entered by the court, or until a creditor persuades the court there is a good reason to lift the automatic stay.
- Filing and meeting of creditors
Once the petition and schedules are filed with the court and the fee is paid (unless the court waives it), the court will schedule a meeting of the creditors, usually approximately 30 days later. The client and the attorney attend the meeting, where the client answers questions by the trustee, and any creditors who might attend the meeting.
- Post-filing course
The client must attend a second course, this time a personal financial management course, and file proof of completion with the course. Discharge
Absent any objections from the creditors, and provided no assets are available for distribution to the creditors, the case will be dismissed approximately 3 months after the meeting of creditors.