Bankruptcy helps individuals and businesses struggling with overwhelming debt. Chapter 7 bankruptcy, also known as "liquidation" bankruptcy, allows the sale of the debtor's non-exempt assets to pay off as much debt as possible. The remaining eligible debt is discharged. The process can take three to four months to complete. On the other hand, Chapter 13 bankruptcy, also known as "reorganization" bankruptcy, allows debtors to retain their assets and create a repayment plan to pay back all or a portion of their eligible debts. The repayment happens over three to five years.
However, not all types of debt can be discharged in bankruptcy. Additionally, if a debt is secured by collateral, the creditor will repossess or foreclose on that collateral. This happens even if the debt is discharged in bankruptcy.
Understanding if Bankruptcy is a Solution for Your Needs
While bankruptcy can be a powerful tool for resolving debt problems, it is not a one-size-fits-all solution. The specific circumstances of your financial situation determine whether bankruptcy is the best course of action for you.
Bankruptcy can have both immediate and long-term consequences. While it can provide immediate relief from collection activities and eliminate many types of debt, it can also hurt your credit score. Thus, you will face difficulty obtaining credit in the future.
When you file for bankruptcy, you are essentially asking the court to help you manage your debts. Here are some of the reprieves that bankruptcy offers:
a) Stop Collection Actions
An automatic stay is a crucial feature of bankruptcy that goes into effect immediately upon filing. It is a court order that halts most collection activities and legal proceedings against the debtor, giving them some breathing room to address their financial situation.
An automatic stay is a powerful tool that can provide immediate relief to debtors. It stops creditors from pursuing collection activities, like phone calls, letters, lawsuits, wage garnishments, and bank account levies. It can also temporarily stop foreclosure proceedings, eviction proceedings, and utility disconnections.
b) Temporarily Stop a Repossession, Foreclosure, or Eviction
The automatic stay in bankruptcy can help temporarily stop specific actions, namely evictions, foreclosures, and repossessions. However, the stay is only effective if you are still in litigation. The automatic stay is not a permanent solution, and the creditor could continue with the action once the stay is lifted.
In the case of eviction, if the landlord already has a judgment against the tenant, bankruptcy cannot help, as the eviction process could already be completed under state law.
Similarly, if a debtor is behind on mortgage or car payments and cannot bring the account current, Chapter 7 bankruptcy cannot help them keep the property. However, Chapter 13 bankruptcy can provide a mechanism for catching up on past payments over time. This will allow the debtor to keep the asset.
c) Wiping Out Credit Card Debt and Other Non-Priority Unsecured Debts
Bankruptcy can effectively discharge or wipe out most non-priority unsecured debts. These debts include credit card debt, medical bills, personal loans, overdue utility payments, gym contracts, and more. Non-priority unsecured debts are obligations not backed by collateral and do not have priority status in bankruptcy proceedings.
In a Chapter 7 bankruptcy, the debtor's nonexempt assets are disposed of to pay off creditors, and any remaining eligible debts are discharged. If there are no nonexempt assets to sell, the debtor keeps all their property, and eligible debts will still be discharged. In a Chapter 13 bankruptcy, any remaining eligible debts are discharged at the end of the repayment plan.
Note: Not all debts are eligible for discharge in bankruptcy. Certain debts, including child support, alimony, and some taxes, are considered priority debts and cannot be discharged. Additionally, secured debts, for example, mortgages and car loans, cannot be discharged. However, bankruptcy can eliminate personal liability for these debts.
d) Wiping Out Secured Debt
If you cannot afford payments on a secured debt like a mortgage or car loan, filing for bankruptcy can eliminate your liability for the debt. However, it typically does not allow you to keep the property that secured the loan.
In bankruptcy, the secured creditor generally retains the right to repossess or foreclose on the collateral if the debt is unpaid. Filing for bankruptcy can discharge your obligation to repay the debt but does not eliminate the creditor's right to take back the property.
If you want to keep the property securing the debt, you should continue making payments and work out an arrangement with the creditor outside of bankruptcy. Alternatively, if you cannot continue making payments and wish to surrender the property, bankruptcy can provide a way to discharge the remaining debt and avoid further personal liability for the loan.
What Only Chapter 13 Can Do in a Bankruptcy Proceeding
Chapter 7 is ideal for low-income earners or people with limited assets. On the other hand, Chapter 13 is appropriate for individuals with regular income or high earnings. With that in mind, let us focus on Chapter 13 bankruptcy and what it can do:
a) Stop Foreclosure and Repossession
Chapter 13 bankruptcy allows you to propose a repayment plan to catch up on missed mortgage payments over three to five years. The repayment plan is based on your income and expenses and is designed to make your mortgage payments more manageable while addressing the arrears.
You can include the delinquent mortgage payments (arrearages) and spread them out over the repayment period through the repayment plan. It lets you gradually make up the missed payments and become current on your mortgage. In addition to addressing the missed payments, you must continue making regular mortgage payments during the Chapter 13 bankruptcy process. Staying current on your ongoing mortgage obligations is essential to prevent further defaults.
Chapter 13 bankruptcy allows you to reorganize your finances and create a manageable repayment plan. By consolidating your debts and addressing your financial obligations, you can regain control of your finances and work toward resolving the mortgage arrears.
b) Protecting Non-exempt Assets
In bankruptcy, filers are allowed to keep certain assets through bankruptcy exemptions. Bankruptcy exemptions vary by state, and they determine which assets you can protect from being liquidated or sold to repay creditors.
In Chapter 7 bankruptcy, non-exempt assets can be liquidated by the bankruptcy trustee to satisfy your debts. However, Chapter 7 filers can still utilize bankruptcy exemptions to protect specific assets essential for work and daily living. These exemptions typically cover items including a primary residence, a vehicle, household goods, clothing, and tools of trade.
On the other hand, Chapter 13 bankruptcy does not involve liquidating nonexempt assets. Instead, individuals create a repayment plan to repay creditors over a designated period. The repayment plan considers your income, expenses, and the value of your nonexempt assets. Chapter 13 filers must pay creditors an amount equal to the value of their nonexempt assets over the repayment plan. This ensures creditors receive at least as much as they would have in a Chapter 7 liquidation. This means that if you have nonexempt assets with significant value, the plan could require you to make higher payments to creditors to satisfy the equivalent value of those assets.
c) Cram down a Secured Debt
One of the advantages of Chapter 13 bankruptcy is the ability to "cram-down" a secured debt when the property securing the debt is worth less than the amount owed.
Cram-down refers to a legal mechanism available in Chapter 11 and Chapter 13 bankruptcies that allows a debtor to modify the terms of a secured debt. The modification involves reducing the outstanding balance or adjusting the interest rate. It is a means of restructuring the obligation to make it more manageable for the debtor while still providing some recovery for the creditor. Here is how it works:
When you have a secured debt, like a car loan or a mortgage, the debt is tied to collateral (the property itself). In a cramdown scenario, the property's value is less than the outstanding balance of the debt. Chapter 13 bankruptcy allows you to adjust the loan terms to match the collateral's current value.
Let us look at how a cramdown typically works for different types of secured debts:
Car Loans
If you owe more on your car loan than the vehicle is worth, you can cram down the loan in Chapter 13 bankruptcy. The process can reduce the loan to the current fair market value of the car and adjust the interest to a more favorable rate. The remaining balance is treated as unsecured debt and paid off through the Chapter 13 repayment plan.
Bankruptcy Code Section 1325(a)(9) includes a provision restricting the ability to cram down car debts if you purchased the car within 910 days (approximately 2.5 years) before filing for bankruptcy. In such cases, the debtor cannot reduce the principal balance of the car loan to match the car's current value. However, other aspects of the car loan, including interest rate adjustments, could be available.
Mortgages
While cramdowns are generally unavailable for primary residence mortgages, they can be utilized for specific investment properties or second homes. In a mortgage cramdown, the outstanding balance of the mortgage can be reduced to match the property's current value, and the interest rate can be modified. Any remaining balance becomes unsecured debt, included in the Chapter 13 repayment plan.
Not all secured debts are eligible for cramdowns. Additionally, cramming down a secured debt requires meeting specific criteria, for example, having the loan for a certain period or using the collateral for personal, family, or household purposes.
What Bankruptcy Cannot Do
While bankruptcy is a viable option, there are limitations to what it can achieve. Here are some key points about what bankruptcy cannot do:
a) Prevent Repossession or Foreclosure on Property You Cannot Afford
Bankruptcy eliminates the debtor's personal liability for a secured debt but does not remove the lien itself from the property. The lien remains attached to the property until the debt is satisfied or resolved.
In the case of a Chapter 7 bankruptcy, while the debtor's personal obligation to repay the home mortgage debt could be discharged, the lender's lien on the property remains intact. If the debtor fails to make the mortgage payments, the lender can still exercise its rights under the lien and proceed with foreclosure once the automatic stay is lifted.
Similarly, in other types of secured debts, for example, car loans, bankruptcy eliminates the debtor's obligation to repay the debt, but the lien on the vehicle remains. If the debtor cannot make the required payments, the lender can repossess the car per their rights under the lien.
b) Eliminate Alimony Obligations and Child Support
Child support and alimony obligations are not dischargeable in bankruptcy. Whether you file for Chapter 7 or Chapter 13, these obligations will generally remain in effect and must continue to be paid.
Child support and alimony are considered priority debts, which means they receive special treatment in bankruptcy proceedings. The bankruptcy code explicitly excludes these obligations from discharge to ensure that individuals remain responsible for their children's and former spouses' financial support.
Section 523(a)(5) states that a bankruptcy discharge does not discharge an individual from any debt for child support or spousal support (alimony) that is owed to or recoverable by a spouse, former spouse, or child of the debtor.
Filing for bankruptcy can relieve other types of debt. However, it does not absolve individuals of their legal obligations to support their children or ex-spouses financially. You should prioritize these obligations and continue making the required payments even if you are going to declare bankruptcy.
c) Eliminate Tax Obligations
Bankruptcy does not eliminate most tax debts. While some tax debts can be discharged in bankruptcy under certain circumstances, the general rule is that tax debts are non-dischargeable.
Tax debts are typically considered priority debts in bankruptcy. This means they receive special treatment and are given a higher priority for payment than other debt types. You must meet specified requirements to have tax debt discharged in bankruptcy. These include:
- The tax debt must be income-based, that is, federal or state income tax
- The tax return for the debt must have been due at least three years before filing for bankruptcy
- The tax return must have been filed at least two years before filing for bankruptcy
- Any tax assessment must be at least 240 days old
- The debtor must not have engaged in fraudulent or willful tax evasion activities
Tax debts that do not meet the criteria for dischargeability will remain non-dischargeable in bankruptcy. This includes recent tax obligations, tax debts resulting from tax fraud or willful evasion, certain payroll tax debts, and tax liens.
d) Eliminate Student Debts
Student loans are generally not dischargeable in bankruptcy unless the debtor can demonstrate "undue hardship" through an adversary proceeding. Discharging student loans based on undue hardship is challenging and requires meeting strict criteria established by the bankruptcy courts.
To have student loans discharged, the debtor must file a separate legal action known as an adversary proceeding within the bankruptcy case. In this proceeding, they must prove to the court that continuing to repay the student loans would impose an undue hardship on them and their dependents. The standards for proving undue hardship vary depending on the jurisdiction but often involve showing that:
- The debtor cannot maintain a minimal standard of living if required to repay the student loans.
- The financial difficulties will likely persist for a significant portion of the loan repayment period.
- The debtor has made good-faith efforts to repay the loans before seeking bankruptcy relief.
- The criteria for proving undue hardship are stringent, and courts generally have a high threshold for granting a discharge of student loans. As a result, discharging student loans through bankruptcy is relatively rare and limited to specific circumstances where the debtor can demonstrate exceptional hardship.
e) Discharge Other Nondischargeable Debts
Bankruptcy does not eliminate other types of nondischargeable debts. While bankruptcy can relieve many debts, certain obligations are considered non-dischargeable and will remain the debtor's responsibility even after bankruptcy.
Some common examples of nondischargeable debts include:
- Debts not listed in the bankruptcy papers — If a debtor fails to document a particular obligation in their bankruptcy filing, it will not be discharged unless the creditor becomes aware of the bankruptcy case.
- Debts for personal injury or death caused by intoxicated driving — Debts arising from personal injury or death caused by the debtor's intoxicated driving are typically not dischargeable in bankruptcy.
- Fines and penalties imposed as punishment — Certain fines and penalties imposed by governmental entities as punishment, including traffic tickets or criminal restitution, are generally not dischargeable in bankruptcy.
In Chapter 7 bankruptcy, these nondischargeable debts will generally remain the debtor's responsibility after the case is concluded. In Chapter 13 bankruptcy, the debtor must pay these debts in full through their repayment plan.
f) Eliminate Fraud-Related Debt
Bankruptcy will not discharge a debt if it is determined to be fraud-related, and a creditor files an adversary proceeding to challenge the dischargeability of that debt. Fraudulent debts can include situations where the debtor has engaged in fraudulent activities, including providing false information on a credit application or using the borrowed property as collateral for a loan while misrepresenting ownership.
If a creditor believes that a debt should not be discharged due to fraud, they can initiate an adversary proceeding within the bankruptcy case. In the adversary proceeding, the creditor must present evidence and convince the bankruptcy judge that the debt should survive the bankruptcy and remain the debtor's responsibility.
If the court determines that the debt is indeed fraud-related and the debtor engaged in fraudulent activities, it could be deemed non-dischargeable. Therefore, even though you receive a bankruptcy discharge, you will remain responsible for repaying the debt.
Find a Los Angeles Bankruptcy Attorney Near Me
The decision to file for bankruptcy is often a difficult one. Further, the bankruptcy process is also complex. However, with the assistance of a bankruptcy expert, you will be guided and maneuver the process smoothly. Contact the Los Angeles Bankruptcy Attorney at 424-285-5525 for more information.
