BANKRUPTCY - CHAPTER 7, 11 or 13?
Updated: Oct 1
The fundamental purpose of any bankruptcy is to obtain a "discharge". "Discharge" means the debt is no longer enforceable.
A Chapter 7 is the simplest and least expensive form of bankruptcy. In a Chapter 7 case a Trustee is appointed. The Trustee’s job is to look for non-exempt assets that can be liquidated to pay creditors. Some of the hurdles in a Chapter 7 case are qualifying under the “Means Test” and protecting your assets from liquidation. The Means Test is designed to ensure that the debtor is not making “too much money”. The consequence of failing the Means Test is the dismissal of the case. The Means Test is a complicated formula which is tied to Dept. of Labor median incomes and expenses. A Means Test is the first thing that must be done when evaluating a client’s suitability for Chapter 7. If more than half of the debtor’s debts are non-consumer debts, then the Means Test doesn’t apply at all. The time to protect your assets is before filing bankruptcy, not after. Forget about transferring valuable property to your kid sister; it just doesn’t work. Converting non-exempt assets into exempt (protected) assets is serious work and should be left to professionals. Particularly valuable types of exemptions are the California homestead $75,000 - $175,000; qualified retirement plans (ERISA Plans); and IRAs. The bottom line is that most of these exemptions cannot be acquired over night. As an attorney who regularly represent creditors and Chapter 7 trustees as well as debtors, I am uniquely qualified to evaluate what “works” and what doesn’t. One should be especially mindful that a fraudulent transfer of assets can be avoided by the trustee; even worse, it might be grounds for losing your discharge - the very thing you filed bankruptcy to obtain. Chapter 11 is a complicated and expensive bankruptcy. It requires a lot of paperwork and reporting to the U.S. Trustee. Ultimately, the purpose of a Chapter 11 is to propose a plan of reorganization and disclosure statement to the creditors and obtain approval by the bankruptcy court. A Chapter 11 can be especially valuable when the client wants to retain control of its assets and business, while shedding unsecured debt and onerous leases. Many clients think they can save their home in an individual Chapter 11. I think that is a long shot, and the cost of such a bankruptcy is rarely worth it. If an attorney tells you he can file a Chapter 11 for $5,000 or even $10,000, it is likely that attorney doesn’t really understand what is involved in a Chapter 11 case. Chapter 13 is a repayment plan over time. It is far simpler than a Chapter 11 and considerably less expensive. A Chapter 13 may be helpful if the client is trying to save a property from foreclosure, or for a few other select reasons. Otherwise, I discourage them. I think of Chapter 13 as akin to indentured servitude. You will be put on a budget for a period of years (3 - 5) that you will be hard pressed to maintain. The Chapter 13 Trustee’s job is to extract every last dollar per month possible. Not exactly a recipe for success, is it? In my experience, more than 85% of all Chapter 13 cases fail; in other words, after paying attorneys fees and plan payments, it is all for naught. I have filed Chapter 13 cases where the plan has been confirmed and the plans completed. I have removed junior mortgages from residences where there was no equity to support the mortgage. Chapter 13s in my opinion should be used sparingly. How often can you file bankruptcy? You are entitled to obtain a Chapter 7 discharge every eight years. This means that you cannot file a second Chapter 7 case any earlier than eight years after the date you filed your previous case. You can also follow a Chapter 7 with a Chapter 13. If you obtained a discharge in Chapter 7, you must wait four years and one day before you can file a Chapter 13 and expect to obtain another discharge. What will bankruptcy do to your credit? You must distinguish between how long a bankruptcy is reported on your credit report versus how long it will adversely affect your FICO score. How a FICO score is calculated is a trade secret. I can only share my experience. Generally speaking, a client should have good credit within two to two and one-half years after discharge. This assumes that the client has either maintained some form of existing credit and kept payments current, or has obtained new credit and performed timely on that new credit. In the case of home loans, Freddie Mac or Fannie Mae generally decline new home loans within 4 - 4 ½ years after bankruptcy. In my experience, credit is vastly overrated. I tell my clients not to make financial decisions based primarily on credit because the economy depends on readily available credit.
I hope you find this discussion helpful. You should not rely upon this information without first seeking professional legal counsel from a licensed attorney concerning your particular circumstances or case. I am required under federal law to disclose that my firm may be considered a debt relief agency that helps people file for bankruptcy relief under the Bankruptcy Code. The transmission or receipt of this information, or any correspondence arising therefrom, will not create or constitute an attorney-client relationship.
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