FREQUENTLY ASKED QUESTIONS

Can I still file bankruptcy under the new law? What is the means test, and how can it hurt my chances to file for bankruptcy?

Most people can still file for bankruptcy protection under the laws that went into effect on October 17, 2005. People seeking bankruptcy protection now have to "qualify" for bankruptcy under a "means test."

Many retirement age people and disabled people can actually qualify for bankruptcy relief more easily under the new law than they could under prior law.

The means test is not really a "test." It is an analysis of income and expenses, and it is based (in part) upon (1) an average of the person’s last six full months’ income, and (2) the person’s expenses. For some expense categories, the IRS collection standards are substituted for the person’s actual expenses.

The means test is used as a way to determine whether a person is abusing the bankruptcy laws, whether a person should be filing a Chapter 7 case, or whether a person needs to file a Chapter 13 case. Congress tried thereby to eliminate people who were taking advantage of the bankruptcy laws.

Congress also enacted the requirement that Individuals must also complete a credit counseling course before they are eligible for bankruptcy relief. After their case has been filed, individuals must also complete a second credit counseling course. Completion of the second course, called "financial management", is required before the bankruptcy court can grant a discharge to a person filing a bankruptcy.

The new bankruptcy laws are much stricter about enforcement of child support and domestic support obligations, and the survival of those debts after completion of a bankruptcy.

What is Chapter 7?

The different Chapters of the United States Bankruptcy Code provides for the different types of bankruptcy cases. Chapter 7 of the Bankruptcy Code contains the laws that apply to liquidation bankruptcy cases.

Here is the basic concept in Chapter 7: a person files for bankruptcy relief under Chapter 7, in order to obtain a discharge from all the person’s dischargeable debts. If no one (such as creditors or the trustee of the case) objects to the discharge of the debtor, then the court (usually) automatically grants the debtor a discharge.

The Chapter 7 debtor must complete paperwork that discloses all assets and debts, and provides information about current and past income, and financial history. From these filings, interested parties can determine what debts will be discharged, and whether the debtor has non-exempt assets that will be sold to pay debts.

The Chapter 7 debtor gives up non-exempt assets. These assets are sold by a trustee, who is appointed by the court, and the money is used to pay the claims of the Debtor’s creditors. Most Chapter 7 debtors in Texas do not have non-exempt assets, and are allowed to keep everything they own.

Simple Chapter 7 cases usually take from 90 to 120 days to complete.

What is Chapter 13?

Chapter 13 is a reorganization bankruptcy for individuals, in which the debtor pays payments to a trustee from future income.

Chapter 13 is similar to Chapter 11 business reorganization in concept, but very different in practice. Chapter 11 is a complicated and expensive reorganization proceeding. Most consumers do not need Chapter 11, and it will not be discussed further here.

Individuals filing Chapter 13 file all the same papers as the Chapter 7 debtor, but also file a plan, which provides for monthly payments to a Chapter 13 Trustee, who pays creditors according to the provisions of the plan.

The plan must be approved by the bankruptcy judge. The debtor’s creditors file claims with the court in order to be included in the distribution under the plan.

Chapter 13 plans last from 36 to 60 months. When the individual completes all the payments, then the court grants a discharge of all the dischargeable debts.

Why would someone file Chapter 13 when they could file a case under Chapter 7 and not have to make payments to a trustee and stay in bankruptcy from three to five years?

Chapter 13 can be an effective way to get caught up on back mortgage payments or back car payments, where Chapter 7 is not helpful.

Many people want to pay back as much as they can to their creditors, but they cannot afford to pay everything. Chapter 13 does not necessarily (and most often does not) require a person to pay back 100% of all debts in order to complete a plan and obtain a discharge. A person will pay creditors a certain required amount, which is determined by the means test, ability to pay, and the value of non-exempt property. The remaining, unpaid portions of the creditors’ claims are discharged.

Some people have non-exempt property that they would lose if they filed Chapter 7. Chapter 13 allows for the retention of non-exempt property, if the debtor is willing to pay as much to creditors as they would have received if the Chapter 7 trustee had actually sold the asset.

Some individuals simply make too much money to file Chapter 7. Chapter 13 is often an effective way to make orderly payments to creditors of as much as possible, and still receive a discharge from debts after completing a plan.

Some individuals file Chapter 13 in order to deal with some types of income tax debt that would not be dischargeable in a Chapter 7 case.

What is the difference between Chapter 13 and debt consolidation?

In Chapter 13, the debtor and the bankruptcy laws decide how much the creditors will be paid. In debt consolidation situations, the creditors are in control. They decide how much they will accept to settle outstanding debt.

Chapter 13 is a proceeding in the United States Bankruptcy Court. Everything that happens in a Chapter 13 case is dictated by the provisions of Chapter 13 of the United States Bankruptcy Code. When a person files Chapter 13, the debts owed to creditors become "claims" in the bankruptcy case.

The claims are then paid according to the provisions of Chapter 13, which may or may not provide for full payment. In Chapter 13, creditors/claimants do not decide how much they get paid. They have no vote on whether they approve of the Chapter 13 plan.

Instead, the court decides whether the plan proposed by the debtor complies with Chapter 13. If the court approves a plan that, for instance, provides for nothing to the unsecured creditors, then the unsecured creditors get no money.

Of course, secured creditors with collateral, such as mortgage lenders and car lenders, and some other debts such as recent taxes and child support arrearages will still get preferential treatment, because Chapter 13 provides for preferential treatment for those types of debts.

"Debt consolidation" describes a couple of different ways to deal with outstanding consumer debt. First, a person can take out a new loan that will be used to pay off other, existing debt. This involves no negotiation, and the person simply pays off the new loan.

The term "debt consolidation" can also describe programs where a "debt settlement" company will accept payments from a debtor and use the payments to negotiate settlements with the creditors. Again, the creditors are in control of this process, and may refuse outright to settle. The debtor must pay the debt settlement company a fee to settle the debt.

What is a meeting of creditors, or §341 meeting?

The debtor is required to attend a meeting of creditors. The meeting is not held in a courtroom. It is usually held in a meeting room in an office building or in a Federal building. The case trustee presides at the meeting—not the bankruptcy judge. The debtor’s attorney will usually ask the debtor some standard questions. The Trustee will verify the debtor’s identity and ask questions about assets and whether the paperwork requirements have been completed.

Creditors are not required to attend the meeting of creditors, and many choose not to attend. In most cases, those in attendance will include only the presiding trustee, the debtor and the debtor’s attorney. If creditors are present, they are allowed to ask questions, as well.

Will there be a trial to determine whether I get to file bankruptcy?

There is a common misconception about how the court procedure works for Chapter 7 and for Chapter 13. Most people think that there is a hearing in front of the bankruptcy judge, where the judge will determine whether you get to file for bankruptcy protection, at all.

This type of hearing does happen occasionally, such as when the debtor does not pass the means test, or when the debtor does not cooperate by providing needed information. However, in most Chapter 7 cases, if the person filing for bankruptcy "passes" the means test, and no one otherwise objects, the only hearing will be the creditors meeting.

Many bankruptcy cases are dismissed, but my observation is that these dismissals usually occur because the person seeking bankruptcy protection has failed to fulfill technical requirements for document filings in the case, failed to appear when required, or failed to make required payments (in Chapter 13).

Is my debt really forgiven in a bankruptcy? What is the "discharge"?

Yes, if the Bankruptcy Code provides for the discharge of certain debts, then they are legally forgiven, or "discharged." A person is legally excused from paying a debt that was discharged in a bankruptcy case.

When the debtor receives a discharge in bankruptcy, the court enters a permanent injunction that prevents creditors from trying to collect discharged debt.

Not all debts are dischargeable, or subject to the legal forgiveness in the bankruptcy.

What does "debt forgiveness" actually mean?

Debt forgiveness is not the same thing as a bankruptcy discharge, where the court permanently excuses payment and then orders creditors to refrain from ever trying to collect. It is an action by the court.

"Debt forgiveness" is an action by a creditor. This means the creditor voluntarily decides not to seek payment from the debtor.

There can be negative tax consequences from "debt forgiveness." Many creditors actually report forgiven debt as income to the IRS, and send Form 1099 to the person whose debt has been forgiven. Many individuals are required to pay income taxes on the amount of the forgiven debt. A bankruptcy filing can often help individuals avoid having to recognize this "phantom income." Warning: this is not tax advice. If you have a problem in this area, you are strongly encouraged to consult with an accountant or an attorney!

Which debts are discharged? Which ones aren’t discharged?

The Bankruptcy Code lists certain types of debts that are not dischargeable in a bankruptcy case. Any debt that is not on the list of non-dischargeable debts in Section 523 of the code is discharged.

The following are some of the types of debts that are not dischargeable:

  • Student loans, except in very rare circumstances pertaining to physical or mental disability.

  • Domestic support obligations, such as child support and alimony.

  • Taxes—

    • where the return has been due for less than three years
    • where no return was filed (not dischargeable in a Chapter 13)
    • where the return has been on file for less than two years (not dischargeable in a Chapter 7)
    • fraudulent tax returns are never dischargeable and employer withholding taxes are never dischargeable

  • Debts arising from fraud or embezzlement, especially by a trustee for someone else.

  • Some unsecured debt, such as credit card debt, that was taken out a short period of time before a bankruptcy is presumed to be non-dischargeable. This would include recent charges on an existing card.

  • Some debt that would not be discharged in a Chapter 7 can be discharged in a Chapter 13. For instance, if a person has not filed an income tax return for a year where the return has been due for more than three years, that tax return would not be dischargeable in Chapter 7 because the return has not been on file with IRS for more than two years. However, if the person actually files the income tax return before filing Chapter 13, the amount owing to the IRS for the year in question would be treated just like a credit card. When the debtor finishes the Chapter 13 plan and receives a discharge, the tax debt is discharged.

What property can I keep if I file bankruptcy? What property is exempt?

Many people of the people who file for bankruptcy relief in Texas are allowed to keep everything they own. Why is this? The bankruptcy laws allow individuals to keep certain property to help them start over after filing bankruptcy. Legally, the individuals claim the property as their exempt property under the laws of the State of Texas, or under the exemption law in the U.S. Bankruptcy Code.

Without going into all of the intricacies of the exemption statutes, exemptions are typically allowed for most debtors. This list is not meant to be complete, and cannot be applied to individual situations. There are always exceptions to this list, and you should get advice on your particular situation. Here are some standard exemptions:

Most debtors are allowed to keep their homestead. Of course, the debtor has to continue to pay any mortgage debt if the property is to be retained. Under the 2005 changes to the Bankruptcy Code, the homestead exemptions have been limited. For instance, if a debtor has made a substantial paydown on the mortgage within a certain period of time, or fraudulently diverted funds to pay down on the mortgage, the homestead exemption may not be allowed. For most homeowners, this is not an issue.

  • Most debtors are allowed to keep a car for each driver, subject to existing debt.
  • Most debtors are allowed to keep their household goods and furnishings and hobby equipment. Sometimes debtors can avoid, or get out of a non-purchase money lien for consumer, household goods.
  • Most debtors are allowed to keep their retirement funds and pensions.
  • Sometimes debtors may keep their cash in the bank, but oftentimes cash is NOT exempt.
  • Most debtors are allowed to keep their household pets, and some small numbers of livestock may be exempt.
  • Most debtors are allowed to keep two firearms.
  • Most debtors are allowed to keep their jewelry, if the liquidation value is not too large.

These items are typically not exempt (although SOMETIMES debtor may exempt part or all of any one of these items under a wild card exemption that is SOMETIMES available):

Boats
Airplanes
Coin collections, many other types of collections
Timeshares
Investment, or non-homestead real estate
Interests in sole proprietorship businesses
Interests in closely held corporations or LLCs
Partnership interests
Business assets
Stocks
Mutual funds

In Chapter 13, a debtor is allowed to keep non-exempt property if the debtor’s plan payments account for the value of the non-exempt property.

What is the automatic stay?

The "stay" is an injunction against creditors, who are "stayed" from trying to collect their debts when a person files for bankruptcy relief. The stay is "automatic" because it becomes immediately effective against creditors, whether they know about it or not. The automatic stay effectively stops foreclosures, repossessions, lawsuits, IRS levies, bank account garnishments, and many other types of collection efforts.

There are some exceptions to the automatic stay (see below), but generally, a creditor can only resume collection efforts after getting court permission to do so.

I have been sued. What happens to the lawsuit if I file bankruptcy?

Most lawsuits, such as collection lawsuits or personal injury lawsuits, against the debtor will be stopped by the bankruptcy filing because of the automatic stay. Such cases are usually dismissed, and the plaintiff then has a claim in the bankruptcy case.

Most lawsuits in family court are not stopped.

Criminal proceedings are not stopped.

What is secured debt? Why are secured creditors treated differently from unsecured creditors?

Secured debt is debt where a creditor has "collateral", such as a house, a car, or money in a bank. If the debtor fails to pay the debt, the creditor can take, or foreclose on, the collateral.

Creditors with secured debt get preferential treatment in a bankruptcy. In many cases, they are allowed to be paid in full, and in others they are allowed to be paid in full, up to the value of their collateral.

What is priority debt?

The Bankruptcy Code provides for payments of debts in a certain order. Highest priority debts get paid first. In Chapter 13, priority debts must be paid in full.

Will I ever be able to get another house or car if I file bankruptcy?

Surprisingly, many people are able to qualify for mortgages and car loans within a relatively short time after receiving a bankruptcy discharge.

Many people qualify for good mortgage and car loan rates in as little one year after receiving their discharge. If someone is willing to pay a higher interest rate, these loans may be available within weeks after receiving a discharge.

Important points for getting the best post bankruptcy credit:

  • post-bankruptcy credit rating must be good;
  • financing terms will usually be better after more time passes after the discharge is granted.
  • credit reports must correctly show the discharged debt (many times the bankruptcy filing will result in an improvement in the debtor’s credit rating). This is VERY important.

What are some ways I can drive a car after filing bankruptcy?

Sometimes friends or family are willing to co-sign on a car loan. Many people buy older cars for cash, and wait until they can obtain a car loan under favorable conditions.

For those who qualify, Ford Motor Credit Company has a program to loan to people who have successfully completed a bankruptcy. Most people who have a source of income to pay the loan payments will qualify, unless Ford has previously taken a loss on the applicant.

Will a bankruptcy halt me for the rest of my life? What will my life be like?

Experience with our own clients leads us to say that financial recovery after a bankruptcy is very possible. The bankruptcy will remain on a credit report for seven to ten years after the filing, but if that is the only "derogatory" entry on a credit report, it is not that damaging.

A bankruptcy will not be common knowledge, and discharged debtors may sometimes be required to disclose this information—such as when applying for certain jobs. A prior bankruptcy may sometimes prevent a person from obtaining a high security clearance. Some employers may be reluctant to hire persons who have filed for bankruptcy, but they may be just as reluctant to hire persons with bad credit ratings.

Will I be able to rent an apartment?

Some landlords will check credit ratings and bankruptcy will show on the credit report. This may cause some landlords to back away. However, many landlords are willing to rent to people who are in a bankruptcy. Sometimes a higher deposit is required.

In many cases a bad credit rating makes it more difficult to rent than a bankruptcy does.

What are my obligations after completing a bankruptcy?

Legal obligations to pay non-dischargeable debts remain after completion of the bankruptcy and granting of the discharge. The discharged debtor is still legally obligated to pay the non-dischargeable debt, as well as any debts incurred after the bankruptcy is filed.

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