When Relief from Debts is Essential

An earlier article discussed the priororitizing of debts, based on the severity of consequences if the debt remains unpaid or the payment is delayed rather than on the stridency of the bill collector. There may come as time when the aggregate of "must pay-top priority" debts is so large that there is no option other than starting over with a fresh start.

That process is bankruptcy. It may not be for everyone, but one of the several variations of bankruptcy may be the viable choice for many.

A very short bit of history.

Until the mid-19^th century, a person could be, and often was, imprisoned because of a failure to pay a federal debt. Shortly thereafter, the various states abolished the concept of debtor prisons, immortalized by Charles Dickens. Notwithstanding this, some prominent Americans were, in fact, incarcerated for debt, including Robert Morris, a signatory to the Declaration of Independence and a U.S. Senator from Pennsylvania. It is said that Morris' imprisonment was the impetus to the Congress' enactment of bankruptcy statutes to allow the legal relief from debts.

Do you have to file for Bankruptcy?

Maybe not. If you have no assets, rent living quarters, and have income only from non-attachable sources (as, for example, Social Security) there is no need to go through the relatively costly procedures involved in bankruptcy. You will not have to pay an attorney, court filing fees, trustee expenses. You will likely be sued, eventually, and you may be bothered by bill collectors, but most creditors will; not bother suing or going after the judgment proof. And if they do, there are no debtors' prisons anymore.

On the other hand, if bankruptcy protection is necessary, perhaps because of a pending home foreclosure suit, do not be afraid of it. Sometimes, people fear that the bankruptcy proceeding will ruin their future credit because it will be on a credit report for up to ten years. That is true, but assume by this time, your credit is already destroyed. What more bad things can anyone report?

Which type of bankruptcy relief is available and what is best for you?

While an article of this nature cannot discuss all of the variations and requirements of bankruptcy (after all, there are multi-volume treatises on the subject) there are essentially two types of bankruptcy protection commonly available to individual debtors. The first, is known as Chapter 7 bankruptcy, which is, essentially, a liquidation of most of a debtor's assets and property in return for which most, but not all, debts are cancelled. The second is known as Chapter 13, commonly known as Wage Earner's Bankruptcy, wherein a payment schedule is established hereunder all or a portion of debts are paid.

Not everyone is eligible for Chapter 7 proceedings. Under the new legislation passed in 2005, the law's aim is to force those who would be able to make payments to creditors over a reasonable period of time into Chapter 13.

Under the new rules, an individual must pass an income test, where income is measured against the average or median income applicable to the various states. If a person's income is more than the median, another test measures disposable net income after basic living expenses are met. If the income is greater than the median and means tests, Chapter 7 is not available; the theory is that you can afford to pay creditors at least something.

Assume Chapter 7 is available to you.

Chapter 7 bankruptcy is sometimes called "liquidation" bankruptcy -- it cancels your debts, subject to the exceptions noted below, but you might have to let the court sell some of your property for the benefit of your creditors.

The whole Chapter 7 bankruptcy process takes about four to six months, costs about $300 in filing and administrative fees, and commonly requires only one trip to the courthouse. Add to the cost in both Chapter 7 and 13 proceeding, the fees for your attorney. Do not attempt to navigate the procedures without counsel. Never!

Chapter 7 can be a powerful remedy for debt problems, but it isn't available to everyone. For example, you won't be able to use Chapter 7 if you already received a bankruptcy discharge in the last six to eight years (depending which type of bankruptcy you filed) or if you could feasibly complete a Chapter 13 repayment plan

Chapter 13 has potential for many debtors.

Many times, financial distress is caused by an anticipated loss of employment, medical expenses or other temporary financial reverses. In these cases, a Chapter 13 repayment plan may be the answer.

Chapter 13 bankruptcy, sometimes called reorganization bankruptcy, is quite different from Chapter 7 bankruptcy. In a Chapter 7 bankruptcy, most of your debts are wiped out; in exchange, you must relinquish any property that isn't exempt from seizure by your creditors. In a Chapter 13 bankruptcy, you don't have to hand over any property, but you must use your income to pay some or all of what you owe to your creditors over time -- from three to five years, depending on the size of your debts and income.

Chapter 13 bankruptcy isn't for everyone. Because Chapter 13 requires you to use your income to repay some or all of your debt, you'll have to prove to the court that you can afford to meet your payment obligations. If your income is irregular or too low, the court might not allow you to file for Chapter 13. By the sdame token, if your total debt burden is too high, you are also ineligible. Your secured debts, such as a home with a mortgage, or a car with a lien) cannot exceed $922,975, and your unsecured debts cannot be more than $307,675.

If there is a failure to make scheduled payments, the case will usually automatically convert to a Chapter 7 liquidation.

General rules and things to consider.

Be wary of transfers in contemplation of bankruptcy or made within a few months of bankruptcy filing. The federal law and the statutes of every state have laws that forbid the transfer of assets or even the preferential treatment of one creditor shortly before the filing of bankruptcy. The payment or transfer to, say your cousin, of all your assets prior to filing for Chapter 7 bankruptcy will cause you grief, cancel the payment or transfer and is treated as fraudulent. Do not attempt to hide assets or income, do not lie under any circumstances. People have been incarcerated for this. Don't be a wise guy.

If you have allowed your home to be the subject of a foreclosure action by the mortgage holder or if you are the subject of pending litigation or if a creditor is threatening to bring such an action, the filing of a petition for bankruptcy stops the suit or threat immediately and automatically. If one defaults on any obligation imposed by the bankruptcy court, however, the "stay" imposed by law will evaporate, forthwith and without too much notice. One should not commit oneself to a court authorized obligation if there is a reasonable possibility that the obligation will not be met.

Some debts will not be discharged. Among those that are going to continue are money owed for taxes owed to local, state or federal agencies, claims for money, property, services obtained fraudulently, alimony, maintenance, or support of an ex-spouse or child, in connection with a separation agreement, divorce decree or other order of a court, money owed for willful and malicious injury by the debtor to another person or property owned by another, some governmental educational loans and damages resulting from driving while impaired or drunk.

Some assets are protected. Each state has laws that determine which items of property are exempt in bankruptcy, or unavailable to creditors generally and in what amounts. These items cannot be seized by creditors or by the bankruptcy trustee. One's attorney is familiar with the exemptions, which can be extremely complex.

Many states exempt health aids, "personal effects" (things such as electric shavers, hair dryers, and toothbrushes), ordinary household furniture and clothing without regard to their value. Other kinds of property are exempt up to a limit. For example, in many states, furniture or a car is exempt to several thousands of dollars. This exemption limit means that any equity in the property above the limit isn't exempt. (Equity is the market value minus how much you still owe.) Moreover, in most states, reasonably necessary clothing (no fur coats) is exempt, as well as reasonably necessary household goods and furnishings, household appliances, some limited jewelry and other personal effects, life insurance (cash or loan value or proceeds), (the amount varies from state to state) a part of the equity in a residence (the amount varies from state to state as well as the effects of homestead statutes), pensions, public assistance benefits, tools of a trade or profession, up to a certain value, and unpaid but earned wages.

A final note.

You best friend in bankruptcy is a knowledgeable attorney who specializes in debtor relief cases and bankruptcy. The statutes and regulations are complex and the system treats those who do not comply fully harshly. Moreover, the federal bankruptcy law adopts and incorporates some provisions of state law. Thus if some of your property is, say, in Florida, your residence is in New York and your income comes from a Maryland employer, the laws of several states come into play. This is no place for an amateur.