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By: Michael Lehr

Lehr is an associate at Dunlap Bennett & Ludwig’s Richmond, Virginia office.

[06.05.2020] Bankruptcy is a process to alleviate the burdens of debt from an honest, but over-encumbered debtor, while giving fair and equal treatment to the debtor’s creditors. The Supreme Court stated this conclusion nearly one hundred years ago in Local Loan Co. v. Hunt, where it said that one of the primary purposes of the bankruptcy laws was to “relieve the honest debtor from the weight of oppressive indebtedness, and permit him to start afresh free from the obligations and responsibilities consequent upon business misfortunes. “Therefore, as long as you, the debtor, follow the prescribed rules and procedures of the bankruptcy process, the law offers you a fresh start by canceling, or “discharging,” much of your qualifying debts. Once discharged, your creditors cannot collect the remainder of debt which you originally owed them, and you may begin rebuilding your financial foundations.

Unlike some other areas of U.S. law, which developed over time through statutes or case law, the founders explicitly included bankruptcy in the U.S. Constitution, which provides Congress with the authority to enact “uniform Laws on the subject of Bankruptcies.” As it is applied today, Congress utilized this Section of the Constitution to enact the U.S. Bankruptcy Code. Under that law, there are three predominant types of bankruptcy, which you have likely heard of before: Chapter 7, Chapter 11, and Chapter 13. There are several others, but these are the pertinent ones that cover the vast majority of bankruptcy filings. Chapter 7 and Chapter 13 bankruptcies are for individual consumers, while Chapter 11 is primarily used for business debtors, although an individual with substantial debt and assets may also utilize Chapter 11.

The end goal for a Chapter 7 bankruptcy is to liquidate as much of the debtor’s assets as possible, use those funds to pay off as much of the outstanding debt as possible, and then discharge the remainder of the debts. Chapter 7 bankruptcies are therefore reserved for persons with lower annual income and little to no assets because they have less income to pay off the debt and fewer assets to liquidate. Due to certain exemptions that protect many assets, the majority of Chapter 7 bankruptcies are “no-asset-bankruptcies,” which tend to move quickly through the courts, wrapping up in just a few months. To determine if you qualify for a Chapter 7 bankruptcy, bankruptcy courts first look to your annual income, which it determines by calculating your prior six month’s income, then doubling it. If that number falls below the median household income for a household of the same size in your state, you may qualify, but you may also have to review your income under the “means test”.

Essentially, Chapter 7 requires that you make less than a certain amount of income per year, but the means test looks to whether your income is proportionate to your monthly expenses.

Meaning, even if your income is less than the Chapter 7 threshold, if your income is too high when compared to your monthly expenses, you may still fail the means test and thus will not be eligible for Chapter 7 bankruptcy. If you pass the means test, you will continue through the Chapter 7 process, which requires you to, in your initial filing, list all of your outstanding debts, creditors, and assets. Your creditors are alerted to the bankruptcy filing and allowed to attend a “341 Hearing,” which is conducted by a court-appointed bankruptcy trustee. At the 341 Hearing, the bankruptcy trustee reviews your filing and asks you questions regarding potentially unreported income or assets; any creditors in attendance may ask similar questions during the hearing. Once the meeting occurs, the trustee begins to liquidate any non-exempt property to pay off the outstanding debt. Once this happens—or if there are no assets to liquidate—the remaining portion of your qualified debts will be discharged, and you are therefore released from liability for these debts.

In contrast, a Chapter 13 bankruptcy is for individuals who have income/assets above the threshold for a Chapter 7 filing. Unlike Chapter 7 filings, Chapter 13 bankruptcies do not require the liquidation of assets and do not result in an immediate discharge of qualified debts. Instead, the outstanding debt of the debtor is paid (either in part or in full) over a structured repayment plan that is supervised by the court-appointed bankruptcy trustee. This repayment plan requires the debtor to make monthly payments to the bankruptcy trustee for three to five years. The bankruptcy trustee then distributes the debtor’s payments to the creditors in accordance with the repayment plan. While the plan is in place, the debtor is protected from lawsuits, garnishment, and other actions by his creditors. Then, as long as the debtor makes his regular monthly payments for the duration of the plan, at the repayment plan’s termination date, the remaining dischargeable debt is released. Chapter 13 bankruptcies are preferable for individuals with certain high-value assets that they wish to retain, such as a car or real estate with built-up equity, which may otherwise be forcefully liquidated under a Chapter 7 proceeding.

In sum, a good candidate for bankruptcy is someone whose debts and monthly payments servicing those debts have exceeded their capabilities to continue to pay feasibly. For lower-income individuals with little to no assets, Chapter 7 is likely the better filing process for you to consider. Whereas, for individuals with higher income, and/or a substantial amount of assets, Chapter 13 is likely the more appropriate filing process.

However, regardless of which method of filing you decide is best for you, please remember that while bankruptcy is intended to give you a fresh start, it is not purely beneficial. Due to your inability to pay your debts, creditors, lenders, etc. may hesitate or refuse to extend your credit or grant you loans. Or, if they do, they’ll do so at a substantially higher interest rate. The bankruptcy will also remain on your credit report for years to come – Chapter 7 remains for ten years; Chapter 13 remains for seven years. Additionally, while you may keep a substantial number of assets under a Chapter 13 bankruptcy, you are protected if you stay current with your payments under the plan. In contrast, under Chapter 7, you might be forced to sell a large number of your belongings, potentially including your car and/or house.

If you are considering filing for bankruptcy, it is highly advised that you speak to a qualified, experienced attorney to guide you through the process. For more information, visit our Bankruptcy page.

Contact us at 800-747-9354 or clientservices@dbllawyers.com.

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