Providing Thoughtful and Effective Representation Through Challenging Times

Chapter 7 Bankruptcy

Table of Contents

Overview

Chapter 7 bankruptcy is a brief process designed to give you a “fresh start” by eliminating, or “discharging” credit card debt, medical debt, and personal loan obligations. Here is how it works.

After determining your eligibility, we assemble a “petition” seeking relief under chapter 7, and schedules which fully disclose your assets and liabilities, together with other financial information. These must be accurate and complete.

Chapter 7 bankruptcy is technically, a “liquidation”, which means that your non-exempt assets become available to your creditors, through a bankruptcy “trustee”, who is appointed by the court, in exchange for a release, or “discharge” of your personal liability. We claim exemptions to the greatest extent possible. The goal is to position your case as a “no asset” case, which really means that there are no non-exempt assets. Most of our clients lose nothing but debt.

Filing creates an “automatic stay” which prohibits creditors from taking any action to collect their debts from you, including suing or even contacting you. This is a federal injunction which is taken seriously by creditors. In almost all cases you will never hear from them again.

Upon filing, the court also schedules a “meeting of creditors”, which is also known as a “341”, after the section of the Bankruptcy Code which requires you to attend. Together, we will meet very briefly with the bankruptcy trustee in a meeting room (not in the bankruptcy court itself or before a judge) to verify the completeness and accuracy of the information we have provided. We prepare the case, and you, in advance to make this as stress-free as possible. In consumer cases, creditors almost never attend, despite the name of the meeting. The atmosphere is relaxed, and this is the only thing resembling a hearing that most clients have to attend.

At the meeting the trustee usually verifies that yours is, in fact, a “no asset” case. After the meeting the trustee usually notifies the court that there are no assets available for distribution. If we do not think this will be the outcome, we will discuss other bankruptcy and non-bankruptcy solutions with you before we file.

A few weeks later, your discharge will enter and the chapter 7 case usually closes. At this point, most filers are out of bankruptcy, and free of most or all their debt. The entire time from the petition date to the discharge date is approximately ninety days.

Together, the lawyers in our firm have over sixty years of experience in guiding clients through chapter 7 bankruptcy cases. While we understand your present situation is traumatic for you, chapter 7 representation is one of the most streamlined things we do, with one of the surest outcomes. We look forward to being of assistance.

Income-Based Eligibility

There is an income-based eligibility test for chapter 7 relief which can be tricky, and rather technical. It’s best not to make assumptions about this on your own before consulting with us. We have a lot of experience in qualifying even relatively high earners.

Initially, we determine whether your debt is mostly business debt or mostly consumer debt, based upon what the loan was used for. For example, if you obtained a second mortgage to start a business, that’s business debt. If you obtained a second mortgage for home improvements or any household or family purpose, that’s consumer debt. If your total debt is mostly business debt (at least 51%), you would normally qualify for chapter 7 relief, even if you are a high earner.

If your debt is mostly consumer debt there is a two-step process to determine whether you qualify based on your income.

The first step compares your “current monthly income” to the median income for your household size in the state in which you live, according to the U.S. Census Bureau’s most recent statistics, which are updated a few times a year.

This calculation is based upon the six-month period ending on the last day of the month preceding the month in which you file your bankruptcy case. This is called the “look-back period”. Income from most sources must be counted, including earned income of all types, investment income and unemployment compensation payments, but not social security or government disability benefits. If you are married, both you and your spouse’s income is included, even if your spouse is not filing for bankruptcy relief, unless you are living separately for reasons other than establishing eligibility, for example, if a divorce is pending.

Connecticut has one of the highest median income levels in the country, skewed upward by Fairfield County, so that comparison can be an advantage in qualifying. So, too, can timing. Filing is a voluntary process, which means that the filing date is also. We can sometimes choose when to file in order to include, for example, temporary periods of reduced income, such as from a layoff, in the look-back period.

If you are “under median” the inquiry stops there, you will usually be eligible for chapter 7 bankruptcy relief.

If you are “over-median”, you must “pass” the “means test” to be eligible for chapter 7. The means test starts with your current monthly income, as described above. We then maximize a series of standard deductions (derived from Census Bureau statistics) and actual deductions (based on some of your actual and projected expenses). The existence and amount of household obligations that will still be paid notwithstanding the bankruptcy, like taxes, mortgage loans, car loans, daycare, private school tuition, out-of-pocket medical expenses, and the debt of non-filing spouses can help. If your remaining monthly income is not enough to pay 25% of your unsecured debt, then you qualify.

The complexity of the means test is like that of a long-form income tax return, so its result can sometimes be counter-intuitive. If you think that a chapter 7 bankruptcy can benefit you, you should not assume you cannot qualify because you earn too much without consulting with us. We have had great success in qualifying borderline cases for chapter 7, and we are prepared to discuss other bankruptcy options with you.

Credit Counseling (Pre-Filing Briefing)

In 2005 Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act, which made major revisions to the Bankruptcy Code, including requiring a “briefing” with an approved non-profit credit counseling agency as a prerequisite for filing for bankruptcy relief. The enactment of this legislation was spearheaded by lobbyists for large banks and credit card companies. It was mainly intended to make it just a little harder to obtain bankruptcy relief. Fortunately, a host of on-line providers quickly sprang up to offer this service, so this part of the process is quick and inexpensive. This is not a substitute for consulting with a bankruptcy lawyer. I will give you information on how to complete the briefing. It takes about an hour and a half. Most clients complete the briefing on-line, although a quick phone chat with an agency representative is required. Telephonic briefings are also available. As soon as you complete it the agency sends me your certificate of completion, which we file with the court. Easy.

Exemptions

Every state in the country has its own set of statutory exemptions which are designed to protect basic living essentials from creditors’ collection actions. Exactly what types of property and the dollar value varies from state to state.

In chapter 7 bankruptcy you can choose between the exemption scheme of the state in which you reside and the “federal exemptions” set forth in the Bankruptcy Code. The choice is “either or”, not “mix and match”. We help you select which exemptions are most beneficial to you.

In the popular imagination, bankruptcy is synonymous with “losing everything”, so many chapter 7 clients are pleasantly surprised to find how much they can keep. First, keep in mind that it is only necessary to exempt the value of your interests, that is, your “equity” in property. So, for example, claiming an exemption in your house or car is unnecessary to the extent you have a mortgage or a car loan. It may be possible to exempt up to $75,000.00 in equity in your principal residence, up to $150,000.00 if you are married and own the property jointly with your spouse. Pensions and retirement accounts are exempt in their entirety. This is one of the reasons that filing for chapter 7 relief is usually a better alternative than cashing out retirement funds to pay debt. If you are like most people, your biggest financial assets are your home and your retirement savings. We can usually protect these in their entirety. And, although much depends on how your assets are arrayed, you may be able to exempt cash or non-retirement investments in the low five-figure range.

Most, nearly all chapter 7 clients come through the process without losing any of their property. We will present your case to maximize the value of your exemptions.

Choosing Whether To File Singly Or Jointly

If you are married, you can elect to file by yourself or with your spouse. If only one of you is liable for substantially all the unsecured debt, then a single filing is usually be a clear choice. If both spouses have significant debt it is usually better to file jointly, however, to eliminate as much debt service from the family budget as possible. Your spouse’s individual preference will ultimately be the deciding factor. Some factors that should be considered in making that decision are as follows.

In chapter 7 there is no protection for co-debtors during the case, and the liability of a co-debtor is not affected by a spouse’s bankruptcy discharge. For personal loans you would have to be either a primary obligor or a guarantor to be liable, but under Connecticut law authorized users are also liable on credit card debt. Even if a spouse is not an authorized user, he or she may become liable just by using the card under the “account stated” doctrine. So, these potential liabilities should be considered by the prospective non-filing spouse.

If spouses are divorcing the allocation of responsibility for credit card, medical and other unsecured debt, if it exists, is always an issue to be resolved, and can be an impediment to resolving the case. The many economic challenges of divorce often boil down to a single mega-issue, that of “one household becoming two”. Although the possibility is frequently overlooked, bankruptcy can be part of the solution. A joint chapter 7 filing before the divorce judgment enters can be helpful, depending on the unique circumstances of the case. In this way, higher earning couples who are still married but already maintaining separate households can sometimes use that fact to advantage, thereby “passing” the means test, and qualifying for chapter 7.

The Automatic Stay In Chapter 7

The filing of a bankruptcy petition creates a “stay”, automatically, of collection activities and legal proceedings against you. Technically, this is a temporary injunction under federal law, and it is a very powerful tool for providing blanket relief from the pressure brought by your creditors until your chapter 7 case can be fully administered and a discharge enters, ridding you of personal liability for good. As the name indicates, the stay is automatic, which means that nothing need be done to obtain it, other than filing a bankruptcy petition. The stay is also comprehensive, prohibiting all attempts to collect debts as your personal liabilities. This means that dunning calls, letters from collection agents, the initiation or continuation of lawsuits, and post-judgment wage and bank executions all must stop. Any judgment obtained in violation of the stay is void. With few exceptions, creditors scrupulously observe the automatic stay, because there are stiff penalties under federal law for violating it. This gives you breathing room early in the case. Even before we file, while we are preparing your chapter 7 petition, we will handle creditor inquiries for you. We are better equipped for dealing with them than you are. You will get relief from their pressure right away.

Credit Cards, Personal Loans And Medical Bills In Chapter 7

From the creditors’ perspective, it’s “every man for himself” when they are owed money. They don’t know or care about your overall situation. They just care about getting paid. From your perspective it can feel like a free-for-all, accosted from all angles and “robbing Peter to pay Paul” attempting to stay afloat.

Part of the way that bankruptcy addresses this is by classifying and treating alike similarly situated claims. Viewed through the lens of bankruptcy, credit cards, personal loans and medical bills are all the same. Such creditors hold “general unsecured claims”. In those relatively few chapter 7 cases in which there will be a distribution, unsecured creditors are entitled to receive a pro rata share after any higher-ranking claims, like taxes, are paid by the bankruptcy trustee. They are low on the “totem pole” in such cases.

Of more significance to most clients is that credit cards, personal loans and medical bills are unsecured by nature. They are not collateralized. In a chapter 7 bankruptcy such debt is simply discharged. Other than any distribution to which they might be entitled, general unsecured creditors will have no possible remaining claim against you or your property. It’s fair to say they are not favored.

This is part of the reason why I think it’s a shame when folks tap much-needed family resources in a good-faith attempt to pay debts which can easily be eliminated. Banks and credit card lenders have already factored default rates into their lending practices. As aggressive as they are outside bankruptcy, after a bankruptcy is filed these creditors invariably write off the debt for accounting purposes and move on. They really have no choice, because such debt is easily discharged.

Your Mortgage In Chapter 7

If you own a house and have debt problems, it is natural to wonder whether you can keep the house and get rid of the debt. The answer is usually “yes, if you want to”. Here is why.

Every secured loan has a dual nature. There is a personal obligation to re-pay the loan (for example, the mortgage note) and there is also a transfer or conveyance of property as collateral (in our example, the mortgage itself). In legal parlance a mortgage loan is known as a “quasi-in rem” obligation, because of this dual nature. Bankruptcy law cannot deprive a mortgage lender of its collateral (your home), but chapter 7 can, and does, discharge your personal liability on your home mortgage. This is useful in different ways, depending on your situation.

If your home is “underwater”, you are exposed to a potential “deficiency judgment”- after the bank forecloses it can obtain a judgment against you in the amount of its debt, minus the value of the property. Particularly in a declining real estate market this can be a substantial liability. A chapter 7 bankruptcy discharges that personal liability, no differently from credit card debt.

However, under well-established federal law the bank holding your mortgage cannot foreclose simply because you obtained a chapter 7 discharge, if the mortgage loan is otherwise current. Most chapter 7 filers just keep paying their mortgage. While it is sometimes necessary to change the payment method (for example, most banks won’t continue automatic withdrawals), I have never seen a client who was able to make current mortgage payments have a problem. Most of my chapter 7 clients keep their house and lose only their credit card debt, medical debt, and debt from unsecured personal loans.

On the other hand, if you cannot make the current mortgage payments (or if it is unwise, financially, to continue to do so), chapter 7 provides a way to walk away, without fear of a substantial deficiency judgment entering against you. Of course, if there has already been a foreclosure and a deficiency judgment has entered, that can be discharged just like any other unsecured debt. Chapter 7 also provides an “insurance policy”, of sorts, should the unexpected happen and you become unable to maintain mortgage payments in the future. Although chapter 7 is a fairly quick process, once your discharge enters your personal liability remains discharged, so you are protected even if your circumstances change (for example, because of unemployment or illness) and you become unable to keep your mortgage current despite your best intentions and expectations.

If your mortgage loan is not current, chapter 13 provides other ways for you to keep your house.

Your Car Loan In Chapter 7

If you have a car loan, it is natural to wonder whether you can keep the car while discharging your debts in a chapter 7. The answer is usually “yes, if you want to”. Here is why.

With respect to secured debt, like car loans, bankruptcy law requires you to indicate whether your intention is to “continue current payments”, “reaffirm” the debt, “surrender” the collateral, or “redeem” the collateral.

Most, but not all, clients elect to continue making their current car loan payments. Connecticut law prohibits holders of car loans from repossessing the vehicle and seeking a deficiency judgment (for the difference between the amount the vehicle brings them at auction and the amount you owe) merely because you have obtained a chapter 7 discharge. So, most of my bankruptcy clients simply continue paying their car loans, while discharging credit card debt, medical debt, and debt from unsecured personal loans.

Many people think that it is necessary to reaffirm your car loan in chapter 7 in order to keep your car. This means signing a “reaffirmation agreement”, which excepts your personal obligation on the car loan from your bankruptcy discharge. In some states, reaffirmation agreements are required, to keep the car. In this jurisdiction, however, reaffirmation agreements are unnecessary.

As with continuing to pay a home mortgage, there is little downside to giving it a try. If, due to unforeseeable circumstances it turns out you cannot make your current car loan payments, you will still be protected from a deficiency judgment by your bankruptcy discharge.

Although everyone needs transportation, surrendering the car is another common option. In recent years I have seen “mega” car loans become increasingly common. The bankruptcy process is all about reassessing your finances. Some clients decide it is an opportune time to lose one or more car loans with a large monthly installment that is strapping their budget, an unfavorable interest rate, or if the loan balance greatly exceeds the value of the car. Once again, because your personal liability will be discharged, you need not fear a deficiency judgment if you choose this option.

If there is an unfavorable interest rate, or if the loan balance greatly exceeds the value of the car, then redeeming the car may be an option to consider. This means buying out the creditor, not for the full amount of the debt, but for the fair market value of the vehicle, which is usually much less. The balance of the liability is discharged. A common problem with pulling this option off is that many bankruptcy clients are strapped for cash. To address that situation there are niche lenders who specialize in offering loans to chapter 7 filers at more favorable interest rates, for this purpose.

Reaffirmation Agreements

A “reaffirmation agreement” is a supposedly voluntary contract by which a chapter 7 bankruptcy filer agrees to continue to have personal liability on a secured debt, despite receiving a bankruptcy discharge, in exchange for keeping the collateral, typically, their house or car. Reaffirmation agreements are seldom beneficial. In Connecticut, they are almost never necessary, and, fortunately, have become something of a historical footnote in modern practice.

Reaffirmation agreements can have serious negative consequences. Once a debt is reaffirmed it can never be discharged, even in a subsequent bankruptcy. Almost no one ever agrees to re-obligate themselves on a debt, but circumstances change, in ways that cannot always be foreseen, for example, if you suffered a loss of employment or a catastrophic health condition that prevented you from working.

Reaffirmation agreements were once common in Connecticut. Over twenty years ago, however, the Second Circuit ruled that the holder of a mortgage cannot foreclose because a bankruptcy is filed, so long as payments are kept or are brought current, even without a reaffirmation agreement. Connecticut’s legislature quickly followed suit, passing a similar law which applies to car loans. Today, these laws are unquestioned. Reaffirmation agreements ordinarily are of no benefit to our bankruptcy clients, and it would be very difficult to get a bankruptcy judge to approve one.

In many parts of the country, however, reaffirmation agreements remain the norm, and bank employees, particularly of national banks, sometimes request reaffirmation agreements from chapter 7 filers, oblivious that we just don’t do that here. We will quickly disabuse them of that notion.

The Meeting Of Creditors

For the vast majority of chapter 7 clients the closest they ever come to a courtroom is the “meeting of creditors”, also known as a “341 meeting” after the section of the Bankruptcy Code which requires your attendance at the meeting as a requirement for obtaining a discharge.

Some clients get anxious about this. But…it doesn’t take place in a courtroom, although, technically, it is a hearing. You won’t be required to testify to a judge (not that there’s anything wrong with that), but to the chapter 7 trustee (a lawyer appointed from a standing panel to administer your case and review whether there are non-exempt assets). And…although creditors receive notice of the meeting and have a right to attend and ask a limited amount of questions, they almost never attend, especially in consumer cases.

The creditors meeting is usually brief, and, although certain formalities must be observed, the mood is friendly and relaxed. Routine chapter 7 cases can be life-changing for you. Legally, they are not adversarial or dramatic, and that’s a good thing. Most of the legal work in a typical chapter 7 involves pulling together a great deal of financial information and presenting it to the trustee for review.

This is done behind the scenes, so that, by the time we arrive at the meeting the trustee already knows all about your case. When we arrive, I will review with you the general types of questions you are likely to hear. When your case is called we will both step forward and be seated at a table. Usually the trustee’s questions are routine, to verify the information contained in your bankruptcy schedules and other information we have given him. There can be a little waiting, but once your case is called the duration of the meeting is usually about five minutes.

Following the meeting of creditors the trustee usually notifies the court that there are no assets for creditors. A few weeks later your discharge enters, and the case closes. That’s it. It’s not an ordeal.

The Financial Management Course

Just as Congress, through the bankruptcy reform act, imposed the requirement of a pre-filing briefing as a prerequisite for individuals to file chapter 7, it also requires the completion of a “financial management course” as a prerequisite for your discharge. This can be done anytime after you file. I will give you all the information you need to register. Like the briefing, the cost is nominal, and most people complete the course on-line. The financial management course has a lot of information about smart ways to manage your finances that can be interesting and useful.

Receiving Your Discharge

Receiving a discharge is the goal of your chapter 7 bankruptcy case. Technically, it is a permanent injunction under federal law which generally prohibits any attempt to collect a debt that existed on the petition date as a personal liability of yours. Certain types of debt are excluded from discharge, including most tax debt and student loans. Payments on secured loans become voluntary, and will still have to be made if you want to keep the collateral, like your house and your car. Even so, you will no longer have to worry about credit card debt, personal loans and medical bills. A chapter 7 discharge is a “fresh start” which, for most clients, removes an enormous burden, and helps make your ongoing budget manageable. If chapter 7 is a good fit for you, we make this result very reliable. The bankruptcy court enters your discharge approximately ninety days after filing, and most cases close, administratively, at about the same time. You are then out of bankruptcy, and will hear only “crickets” from your prepetition creditors. If a creditor does intentionally violate the discharge injunction, you may be able to sue them for money damages. Because the vast majority of creditors observe the discharge injunction scrupulously, this happens only rarely.

Your Credit After Bankruptcy

After learning to cope with “robbing Peter to pay Paul” many people start to normalize ongoing consumer debt. Eventually you will realize that carrying substantial unsecured credit card, medical debt and personal loan obligations is not normal, and that the first step toward getting out of this hole is to stop digging. By filing chapter 7 bankruptcy you will enhance your ability to accumulate some degree of real wealth. For some, part of normalizing the existence of debt presents as an overstated concern about protecting one’s credit rating. Even when the credit is totally maxed out. But, consider. Even if you are current with minimum monthly credit card payments chances are your credit is already damaged as a result of too many open lines. Even though bankruptcy is reported, most clients notice a steady improvement in their credit score following bankruptcy. Many chapter 7 clients obtain car loans, and are eligible for some mortgage programs within a relatively short period of time after filing. It can be empowering to create a budget and stick to it.

F.A.Q.s

Resources

United States Department of Justice/U.S. Trustee means testing information (latest Census Bureau median income tables and related information):

https://www.justice.gov/ust/means-testing

United States Bankruptcy Court, District of Connecticut website:

https://www.ctb.uscourts.gov/

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