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(Chapter 7) Article
ANSWERS TO FREQUENTLY ASKED QUESTIONS
ABOUT CHAPTER 7 BANKRUPTCY IN NEW JERSEY1 1. What is Chapter 7 bankruptcy? Chapter 7 offers a way out for debtors who cannot make ends meet. A qualified debtor will obtain a "discharge," which bars creditors from taking any and all action to collect debt.2 Chapter 7 petitions are administered by a bankruptcy trustee, who can take possession of a debtor's "non-exempt" property and distribute it among creditors. In most Chapter 7 cases, however, all property is exempt: the debtor keeps what little she has and walks away with a fresh start. 2. How does filing a Chapter 7 petition keep creditors away? Immediately after a Chapter 7 filing, the Court notifies creditors of the petition and, upon receipt of this notice by creditors, an "automatic stay" takes effect pursuant to 11 U.S.C. § 362. The stay prevents creditors listed in the petition from taking action to collect debt or otherwise enforcing their rights. Prohibited conduct includes making phone calls, sending collection letters, filing a lawsuit, pursuing a lawsuit in progress, repossessing property, garnishing wages, attaching bank accounts, evicting tenants, and foreclosing on real property. The automatic stay lasts for the duration of the bankruptcy unless the creditor has a basis for asking the court to lift the stay, and then files a motion that is granted by the Court. When the debtor is discharged at the end of the case, the automatic stay becomes, in effect, permanent. 3. What debts may be discharged? The policy behind United States bankruptcy law is to allow an honest debtor to start anew without financial burden. In Chapter 7, most debts are dischargeable including medical bills, loans, credit card purchases and cash advances, and many judgments. However there are exceptions (see below). An individual contemplating Chapter 7 must know what is dischargeable and what is not; otherwise valuable assets can be lost. 4. What debts cannot be discharged? As a general rule, certain debts (specified in 11 U.S.C.A. §523[a]) cannot be discharged. These include taxes (in many cases), alimony, child support, student loans, criminal fines, debts related to drunk driving, debts not listed in the bankruptcy petition, and certain debts incurred within 60 days of filing the petition. A few exceptions to the general rule of nondischargeability exist, but they are difficult to establish and typically require the debtor to file with the Court, in addition to the Chapter 7 petition, a Complaint to Determine Dischargeability. For example, 11 U.S.C.A. §523(a)(8) allows a student loan to be discharged if it is (1) not "insured or guaranteed by a governmental unit," and not "made under any program funded in whole or in part by a governmental unit or nonprofit institution." A student loan may also be discharged if repaying it will "impose an undue hardship on debtor and the debtor's dependents." But the "undue hardship" exception is difficult to establish. The debts discussed above are nondischargeable as a general rule and place the burden on the debtor to establish exceptions. Other debts, however, are assumed to be dischargeable unless a creditor objects and proves otherwise. 11 U.S.C.A. §523(a). These are debts arising from any of the following: fraud, willful and malicious injury, embezzlement, larceny, or a marital settlement agreement or divorce decree. If the trustee or the Court believe a petitioner is abusing the bankruptcy system, any one of them may move to dismiss the bankruptcy petition pursuant to 11 U.S.C.A. §707(b). Dismissal of a petition lifts the Court's protection thereby allowing creditors once again to take action such as filing suits, obtaining judgments, and collecting judgments by garnishment of wages. A debtor contemplating bankruptcy should avoid purchasing luxury items worth more than $1000.00 or taking cash advances on a credit card of more than $1000.00 within 60 days of filing a petition. 11 U.S.C.A. § 523(a)(2)(C). 3 Incurring debt well beyond one's ability to repay is a factor to be considered by a court in determining whether to dismiss a case for substantial abuse. In re Farrell, 150 B.R. 116 (1992). Credit card debt is dischargeable under the bankruptcy code, even where the debt is significant. But gross violation of credit card privileges might lead to dismissal of the petition and nondischargeability not only of the credit card debt in question but of all other debts too. 5. What property may I keep? Debtors keep all of their property in the vast majority of Chapter 7 cases, which typically involve limited assets. The Bankruptcy Code aims to give a fresh start, not to punish. Most furniture, appliances, television sets, old cars, and computer equipment will remain in the debtor's possession. Only when the debtor's assets exceed in value what the debtor may legally keep will property (the excess) be subject to confiscation and distribution by the trustee. That which the debtor may keep is known as exempt property or "exemptions." These are set forth in 11 U.S.C.A. § 522. Other property need not be exempt because it is not owned in the first place. A leased car is not part of the petitioner's estate. Payments on leased personal and real property should simply be continued if the debtor wishes to keep possession. If not, the property should be given back to the lessor, and money owed on the lease should be declared as a debt in the petition. The following property may be exempt pursuant to 11 USC § 522 4 :
The trustee will only take possession of property if it will be profitable. Because the trustee earns a commission based upon the size of the estate, she will collect, sell, and distribute only non-exempt assets of significant value. The trustee's commission may reach 25% on the first $5000.00 or less; 10% on recoveries greater than $5000.00 but less than $50,000.00; and 5% on assets greater than $50,000 up to $1,000,000.00. 11 U.S.C.A. §326(a). Commissions, however, are based solely upon money distributed to creditors and do not necessarily reflect the amount of time and effort expended by the trustee. In re Lan Associates, 192 F. 3d 109 (1999). A trustee will not earn a commission on the full value of a house sold for $150,000.00 if the unpaid loan is $100,000, the real estate commission is $9000.00, and the homestead exemption totals $34,850.00. This leaves $6150.00 to be distributed, out of which the trustee would receive at most $1365.00. When the value of a house prior to sale is uncertain, the trustee (as in the situation described) risks undertaking much work for possibly no commission at all. 6. Is it possible to lose the protection of the automatic stay? It is possible but unlikely, and unless the debtor is guilty of fraud, the consequences tend to be minimal. The automatic stay lasts throughout the proceedings unless a creditor has grounds for lifting it, and then files a motion that is granted by the Court. This is unusual in most Chapter 7 cases. The main basis for creditor relief arises when the petitioner has given a creditor a security interest in property that is rapidly losing value. A security interest is a right to property that a creditor can, by way of contractual agreement, repossess if the debtor defaults on payments. Examples include leased cars, houses, and, in some cases, furniture and jewelry. Lifting the stay only entitles one creditor to possession of secured property, not to other remedies. The majority of bankruptcy debt involves credit cards and medical bills, which are, for the most part, unsecured. Only credit cards issued subject to a purchase money security interest (some department store cards) are secured. And even if secured property is devaluing, often it will not be worth a creditor's time and effort to set aside the stay. 7. How do I deal with consensual security interests? A consensual security interest is a right to property voluntarily given to a creditor by a debtor. There are two types: (1) purchase money and (2) non-purchase money. A purchase money security interest is created when a debtor takes goods on credit (such as furniture or a car) and agrees to relinquish them if there is a default. A non-purchase money security interest arises when property owned by the debtor is pledged as collateral for a loan, as when a diamond ring is pledged as collateral for a $5000.00 loan. A security interest amounts to a "lien" on property, which, in some cases, gives the creditor additional rights in bankruptcy. A purchase money security interest cannot be eliminated in bankruptcy. For example, assume a debtor buys furniture for $5000.00 giving the seller a purchase money security interest. One year later, the debtor files for bankruptcy still owing $3500.00 on the furniture now worth $1000.00. The debtor, in this instance, may surrender the furniture, "reaffirm" the contract and continue making payments, or "redeem" the property. When property is redeemed, it is purchased at its current value ($1000.00) rather than the amount left on the contract of sale ($3500.00). Reaffirmation is a poor choice in this example when the property can be kept for so much less. To redeem property, however, the debtor must pay everything up front. Non-purchase money liens often may be eliminated if the property pledged stays in the debtor's possession. Assume that a debtor pledges a $5000.00 ring for a loan of the same amount, defaults one year later owing $3500.00, and files for bankruptcy. If the ring stayed in his possession, he may keep it so long as it may otherwise be exempt under the wild card exemption. The $3500.00 debt will be fully discharged in bankruptcy. But if the ring already is in the creditor's possession, it will remain there. 8. What can be done about judgment liens? A judgment lien is a lien obtained as a result of a money judgment and recorded against property such as a house or a car. If the lien applies to exempt property, it may be eliminated. To avoid a judgment lien, a motion must be filed in addition to the Chapter 7 petition. Liens related to child and spousal support judgments may not be avoided. 9. What information is needed to file a Chapter 7 Petition? A Chapter 7 petition requires a broad variety of information about the petitioner's financial status. A complete list of the names and addresses of all creditors, along with account numbers where applicable, will be required. If collection agencies are involved, information about the original creditor still must be included. Debts are listed in various categories called 'schedules" on the petition: unsecured claims (credit cards, medical bills, certain loans); secured claims (mortgages, liens, security interests, judgments); unsecured priority claims (including alimony and taxes); unexpired contracts and leases (apartment leases, car leases, and other contracts still in the process of being performed). A prospective Chapter 7 petitioner must also prepare a list of his ownership interest in real estate. Information must be provided about the location of the property, the nature of the interest involved (sole ownership, co-ownership, etc.), the amount of any secured claims such as mortgages, and fair market value. A catalogue should also be prepared stating the value and location of personal property including bank accounts, household goods and furnishings, furs, jewelry, cars, pensions, IRAs, stocks, and the cash value of life insurance policies. Financial information is required because the Court determines if the debtor can pay some or all of what is owed. Money to repay debt can be taken from existing assets such as the real and personal property items discussed above. A debtor's ability to pay can also be based on future earnings over and above living expenses. Hence the petition also requires a compilation of monthly income and expenses. If monthly income substantially exceeds monthly expenses, the trustee may recommend that the debts be paid. The petition also contains a Statement of Financial Affairs: a set of 25 questions about personal and business finances. Though many of these questions may not be applicable, each debtor must specify income and sources of income for the year the petition is filed and the two preceding years. Employment, the operation of a business, and governmental assistance all constitute sources of income. The Statement of Financial Affairs requests information about payments to creditors of more than $600.00 made within 90 days of the filing of the petition, and about payments to family members within the past year. The trustee can set aside preferential payments. For instance, a debtor repays a $10,000.00 loan to her brother four months before filing a petition but pays nothing to various credit card companies owed a total of $25,000.00. The trustee will likely proceed against the brother to recover the $10,000.00 payment and distribute it proportionally among the creditors. Similarly a large payment to any one of the credit card companies two months before the petition is filed might also prompt the trustee to set it aside. The Statement of Financial Affairs additionally asks about lawsuits or potential lawsuits. If the debtor possesses a legal right to collect a large sum of non-exempt assets, the trustee may intervene and collect it for the benefit of creditors. Not all lawsuit recoveries, however, are subject to appropriation by the trustee. Workers' compensation awards are fully exempt under 11 U.S.C.A. §§ 522(d)(10)(c) and (d)(11)(E). Evans v. Casarow, 29 B.R. 336 (1983). And personal injury recoveries may be exempt too under 11 U.S.C.A. §§ 522(d)(5), (d)(11)(D) and (d)(11)(E). In the Matter of R. Scotti, 245 B.R. 17. These exemptions stem from a general policy that a debtor should be allowed to keep enough money for her own support. Pursuant to this policy, awards for injury or disability are deemed compensate for the loss of ability to support oneself. 10. Will Chapter 7 affect my spouse or ex-spouse? A spouse or former spouse will be affected if he or she is also liable for debts. If a spouse guarantees payment on a loan or cosigns on a credit card, the creditor will look to that spouse for payment when a petition is filed. Where the parties are divorced but jointly liable on obligations, the bankruptcy of one may compel the other to file too. If married partners are liable on debts, and none individually owns non-exempt property such as a house (where equity exceeds $34,850.00), a joint bankruptcy petition should be filed. Filing a joint petition can be advantageous because it allows the joint debtors to double exemptions. Doubling is especially valuable when the petitioners want to keep a house because it allows them to retain home equity up to $34,850.00, as opposed to $17,425.00, the exemption amount applicable to an individual homeowner. Alimony and child support are not dischargeable. Where one spouse agrees at the time of divorce to pay a greater share of marital debt in exchange for lesser support payments, the obligation to pay marital debt will be considered nondischargeable support. 11. What about my house? Residents of New Jersey may elect the federal exemptions, which allow an individual to keep up to $17,425.00 in equity and a married couple to exempt twice that amount or $34,850.00. Where less than the exempt amount is put down to purchase a house, it can take years for equity to build up beyond the amount of the exemption because the bulk of payments in the first several years of a mortgage are charged to interest. Take, for example, a married couple who purchase a $120,000.00 house with a $10,000.00 down payment and a $110,000.00 thirty-year loan. Ten years later, if the value of their house remains stable, assume they have paid $15,000.00 in principal, the rest of the payments being interest . Now they have $25,000.00 in equity in the house, which is less than the $34,850 they may exempt. In Chapter 7, this couple may keep their house because the full amount of their equity is exempt. But if in the example above the home owner is a single individual, the equity ($25,000.00) exceeds the allowable exemption ($17,425.00) by $7575.00. Here the trustee may sell the house, give the debtor $17,425.00, and distribute the remainder to the creditors In this example, however, the trustee would probably choose not to get involved because the administrative costs of selling the house could easily eat up the remaining $7575.00 in equity above the exemption. But if this debtor's equity were $80,000.00 instead of $25,000.00, the trustee would certainly sell and make appropriate distributions. This would also hold true in the married couple example above. Note that Chapter 7 does not excuse homeowners from paying the mortgage. A debtor who wants to keep her home must continue to pay the mortgage, which is a secured debt. Filing a Chapter 7 petition will not ultimately prevent a bank from foreclosing if payments are delinquent. For certain debtors, Chapter 13 is a way to catch up on mortgage payments. But Chapter 13, unlike Chapter 7, requires debtors to repay a percentage of their debts. 12. If I do not qualify for Chapter 7, what are my options? Chapter 13 is available to some debtors for whom Chapter 7 may not be appropriate because, for example, they stand to lose a house, or they owe taxes or money on debts that cannot be discharged in Chapter 7. Under Chapter 13, the debtor submits a plan to pay off a percentage of debt over the course of three to five years. However only debtors who have a regular source of income (as from a steady job) and money left over after expenses may qualify. Certain debtors find neither Chapter 13 nor chapter 7 appropriate to their circumstances. For instance, an individual with an unsteady work history who filed a Chapter 7 petition three years prior will not be able to file a Chapter 7 petition again for three years. Or a debtor with more cash in the bank than can be exempted may not want to turn it over to the trustee. For such debtors, one option is negotiation with creditors. A good negotiator often can reach agreements with creditors to reduce the amount owed in return for the security of payments. Another option is simply to do nothing. 13. How will bankruptcy affect my credit? Though bankruptcy puts a bad mark on one's credit rating, the overall effect of it can be less harmful than a record of debts and/or judgments that cannot be paid. Many individuals discharged in bankruptcy obtain (or are offered in the mail) new credit cards shortly after discharge. A person has no debt after bankruptcy and may not file again for another six years. 11 U.S.C.A. §§ 727. From the point of view of many prospective lenders, a recently discharged debtor is a better credit risk than one mired in debt. Assume a person with debts totaling $25,000.00 immediately prior to filing Chapter 7. Many of these debts may be in collection. Lawsuits may have been filed, and there may even be judgments outstanding, with wages already garnished or about to be garnished. This individual will not easily obtain credit. On the other hand, the recently discharged individual is debt free and may not, for at least six years, file for bankruptcy again. Of course, there are no guarantees that prospective creditors such as banks, landlords, or mortgage lenders will not frown upon a bankruptcy. Whether this will count more, however, than a debt-ridden credit report is hard to say. And though recently discharged debtors may be offered new credit cards, it is in their best interests to decline or at least limit the acceptance of such offers so as to avoid the recurrence of financial overload. 14. Should I stop paying creditors once I decide to file for bankruptcy? Yes. Debts that can be discharged in bankruptcy such as credit card and medical obligations should not be paid once an informed decision is made to file a Chapter 7 petition. Monthly bills such as rent, mortgage payments, telephone, and utilities, however, still must be paid. 15. Must I appear in Court? Yes. Upon the filing of a Chapter 7 petition, a Meeting of Creditors is scheduled by the Court, which takes place one to two months after the petition is filed. The Meeting of Creditors is conducted by the trustee at the Federal Court in Trenton, Newark, or Camden. If the petitioner is represented by counsel, the attorney will sit next to the petitioner and provide assistance when needed. The trustee turns on a tape recorder, swears in the debtor, and asks if the debtor read the petition before signing it and if the signature on the petition belongs to the debtor. Additional questions such as the following may be asked:
16. What Happens after the Meeting of Creditors? In "no asset" cases (the usual Chapter 7 where all assets are exempt), a few months after the Meeting of Creditors, the Court grants a discharge. The case at this point ends with the debtor free and clear of dischargeable obligations listed in the petition. 17. What problems can arise after the petition is filed? Problems can arise if information on the petition is inaccurate or if material information is withheld. Submitting false information to the court or withholding material information can lead to dismissal of the petition, or even to criminal prosecution. Problems can also crop up if creditors or the trustee suspect fraud. This can occur where debtor living at poverty level runs up large debt on luxury goods or an expensive vacation shortly prior to filing for bankruptcy. Suspicion may also arise if the debtor transfers assets to relatives or friends in the days leading up to filing. A creditor suspecting fraud may commence an adversary proceeding, which can lead to full-blown and costly litigation. Prior to filing a petition, the debtor should make sure there are no signs of fraud that would likely trigger a denial of the petition or an adversary proceeding. 18. Should I retain an attorney? It takes much determination, patience, and time, plus some intelligence, for a person inexperienced in bankruptcy law to prepare and file a Chapter 7 petition. Chapter 7 can be done without an attorney, but there are risks, especially when the debtor has assets that can be lost if wrong decisions are made. Time and competence are valuable . An attorney with a computerized bankruptcy program and a wealth of experience can take a debtor through the process quicker, easier, and with much less anxiety than would otherwise be encountered if the debtor proceeds alone. NOTES 1. This article draws from my experience with Chapter 7 cases in New Jersey. In many respects, Chapter 7 practice is similar throughout the country because much of it is based on federal law equally applicable to all states. In other respects, though, there are differences. Federal bankruptcy law, for example, allows states to offer their own exemptions instead of the federal exemptions. Some state exemptions are more generous than the federal ones; others are not. The federal exemptions are nearly always used in New Jersey. Also local rules and the interpretation of federal law varies from district to district. 2. A discharge voids judgments of personal liability against the debtor. But it is the responsibility of the debtor or his attorney to avoid judgment liens during the course of the bankruptcy proceedings so as to prevent the right to foreclose on property. Johnson v. Home Savings Bank, 501 U.S. 78 82-83 (1991). 3. Luxury goods and services do not include "those acquired for the support or maintenance of a debtor or a dependent of the debtor." Nevertheless it is still a good idea to stop using a credit cards in the 60 days before filing the petition. 4. The State of New Jersey also offers exemptions, but these are far less useful than the federal exemptions and are rarely used. Home
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