Many Americans are now reflecting upon the holiday season while visions of bankruptcies dance in their heads! Polls report that one-third of Americans admit overspending on holiday gifts, and almost one-fourth of those with holiday bills do not know how long it will take to pay them off (National Foundation for Consumer Credit, January 1997).
Suddenly, some of these typical American consumers find themselves also bearing burdens of massive, unexpected medical bills, failed entrepreneurial ventures, unemployment, or judgment debts, none of which ever happens at a convenient time. During the cold, cruel winter, and throughout the entire year, make it your New Year’s resolution to understand the fundamentals of bankruptcy law so you can advise your clients on whether to file, and when to file, a petition for bankruptcy relief.
This article is intended to provide you with the options available to debtors under the Bankruptcy Code, and to identify issues you will want to consider when advising a client on whether to file for bankruptcy relief. For more complex matters, consult a qualified bankruptcy professional.
Over the years, public policy considerations of compassion, financial responsibility, and fairness among competing claims have guided the formation of U.S. bankruptcy laws. As a debtor’s remedy, the primary goal of bankruptcy law is to provide a financial "fresh start" for "honest but unfortunate debtors" (Local Loan Co. v. Hunt, 292 U.S. 234 (1934).
The United States Bankruptcy Code (Title 11 of the U.S. Code) provides several types of bankruptcy options designed to achieve this balance for different types of debtors. These laws include bankruptcy liquidation under Chapter 7 and personal debt reorganization under Chapter 13. From April 1998 through March 1999, 97.13% of the total new cases filed were personal bankruptcies filed under Chapters 7 and 13 of the Bankruptcy Code (Sherri L. Pascale, "Quarterly Bankruptcy Filings Drop Once Again." American Bankruptcy Institute, press release, August 9, 1999). Other forms of bankruptcy which will not be extensively discussed here include bankruptcy for municipalities under Chapter 9, reorganizations for individuals and corporations under Chapter 11, and debt relief for family farmers under Chapter 12.
Bankruptcy liquidation under Chapter 7 attempts to orderly liquidate assets of an individual or corporation to its creditors, subject to several exemptions and exceptions to discharge. About 72% of the personal bankruptcies filed each year are Chapter 7 cases (id). In a Chapter 7 case, all the debtor’s assets become part of the bankruptcy estate upon filing. The trustee, a federal official appointed by the U. S. Department of Justice, disposes of estate property and returns exempt property to the debtor.
Although debtors stand to lose property in a Chapter 7 case, certain types and amounts of property are protected from creditors by state exemption statutes (§ 522(a)), or by default provisions of the Bankruptcy Code in states without exemption statutes (§ 522(d)). In Illinois, debtors are entitled a homestead exemption of $7,500 (735 ILCS 12/901) and personal property exemptions for such items as (a) clothing, bible, school books, family pictures, (b) $2,000 of equity in any other property, (c) up to $1,200 of the debtor’s interest in any one motor vehicle, (d) $750 worth of the debtor’s books or trade tools, (e) prescribed health aids for the debtor and dependents, (f) certain life insurance proceeds, and (g) entitlements including social security, veteran’s, disability, and unemployment benefits, as well as alimony, maintenance, or support and up to $7,500 in damages recovered from personal injury claims (735 ILCS 5/12-1001).
On the other hand, the Bankruptcy Code includes several exceptions to discharge. Among these debts excepted from discharge are: debts incurred through fraud, debts owed for certain luxury goods or services obtained within 60 days of filing, debts not properly disclosed by the debtor, any administrative costs, legal fees and expenses related to the bankruptcy case, and claims for alimony, maintenance, or child support (§ 523).
Filing a Chapter 13 case provides relief to debtors based on their efforts toward repayment, reorganization, and rehabilitation. To be eligible to file under Chapter 13, the debtor must be "an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $250,000 and noncontingent, liquidated, secured debts of less than $750,000 (§ 109(e)). By filing for bankruptcy under Chapter 13, debtors may keep non-exempt assets, but to do so the Bankruptcy Court must confirm the debtor’s proposed plan for full or partial repayment of pre-petition debts, usually over three years. After the debtor proposes this plan, the U.S. Bankruptcy Trustee assigned to the case examines facts about the debtor and bankruptcy estate and conducts the meeting of creditors, required by §341 of the Bankruptcy Code. Throughout the life of the plan, the trustee’s office supervises collection of plan payments and distributes funds and/or property to creditors.
While creditors may object to confirmation of a Chapter 13 plan, creditors must follow its terms when the plan either provides for full payment of unsecured claims, or when all of the debtor’s disposable income (after necessary living expenses) is applied toward repayment for three years (§ 1325(b)(2)). In limited circumstances, the plan may extend to five years for cause, as determined by the court (§ 1322(d)).
Once the debtor successfully completes all payments under the plan, the court will discharge all debts provided for in the plan, subject to exceptions (§§ 502, 1328). Although rare, the court may grant a "hardship discharge" under § 1328(b) only where (1) "the debtor’s failure to complete plan payments is due to circumstances for which the debtor should not justly be held accountable," (2) the value of property distributed under the plan is more than would have been paid out to creditors in a Chapter 7 liquidation, and (3) modifying the plan would be impractical.
In addition to the § 523 exceptions from discharge discussed earlier, the following are excepted from discharge in a Chapter 13 case: personal injury damages from a debtor’s unlawful operation of a vehicle while under the influence of alcohol or drugs, (§ 1328; § 523(a)), and debts for restitution or a criminal fine included in a sentence upon debtor’s conviction of a crime (§ 1328(a)(3)).
One of the most significant benefits for debtors in filing a bankruptcy petition is the automatic stay against the collection activities of creditors on pre-bankruptcy debt. From the time the petition is filed through discharge, "a creditor may not act, or commence or continue any civil action, to collect all or part of a consumer debt of the debtor from any individual that is liable on such debt with the debtor, or that secured such debt," unless the debtor "secured the debt in the ordinary course of business" or if the case is closed, dismissed or converted to Chapter 7 or Chapter 11 (§ 1301(a)). Most often, creditors obtain relief from the stay when the debtor defaults on post-petition payments.
Much to the consternation of creditors, debtors often seek the services of a bankruptcy attorney and file the petition on the eve of the foreclosure or sheriff sale. However, the automatic stay operates even when creditors receive no notice that the debtor filed bankruptcy. As a result, it is common practice for debtors to bring motions to vacate actions taken in violation of the automatic stay. Wherever possible, avoid this hassle and state court fees by immediately contacting creditors with a pending actions against the debtor, and notify them that your client is protected by the automatic stay.
With the increased numbers of bankruptcy filings in recent years, the stigma of the general public toward filing for bankruptcy relief has been gradually diminishing. Still, many debtors dread the bankruptcy process, sometimes unfairly perceiving their financial setbacks as personal failures. Especially among the elderly who lived through the Great Depression, many still view a bankruptcy petition more as a scarlet letter burned into one’s chest than as a form of relief from unmanageable debt.
Consequently, by the time some debtors seek the advice of an attorney, it may already be too late to protect their assets. Unfortunately for debtors, a "winning case" for Chapter 13 repayment can quickly become a hopeless cause upon entry of the state court’s final order approving a sheriff’s sale on the debtor’s home.
Since many of your clients will be asking about their options for bankruptcy relief, be prepared in the coming years to assist them with these issues by developing and maintaining a good working knowledge of bankruptcy law and practice.
John Peter Devona is a sole practitioner in Lemont. His practice is concentrated in Bankruptcy Law, Estate Planning, and Real Estate Practice. He received his Undergraduate Degree in Marketing from the University of Notre Dame and his Juris Doctor from Chicago-Kent College of Law in 1998.