I’m sitting in my office discussing a prospective client’s financial situation and it is, indeed, grim. The prospective client blurts out that, “it looks like I can’t afford bankruptcy.”
Sometimes, that is exactly correct.
To be sure, bankruptcy can help most people but sometimes there are situations or folks with particular financial goals in mind for whom bankruptcy may not work. It can be a very disheartening and sober realization. So, what might these situations be?
Before we get to those, it might be helpful to brush up on the differences between a Chapter 7 and a Chapter 13 bankruptcy filing—the two most often filed by consumer debtors.
In a chapter 7 filing, the debtor will essentially give all of his or her non-exempt assets to the chapter 7 trustee. The trustee will then liquidate those assets and distribute the money to the debtor’s creditors. For example, if the debtor has a bass boat behind his brother-in-law’s shed that is free and clear and the boat cannot be exempted, the chapter 7 trustee is going to sell that boat and use the money to distribute to creditors.
In a chapter 7, if more money is owed to the creditors than what is distributed by the trustee, the balance of the debt is discharged which means the debtor is no longer legally responsible to pay it. A chapter 7 filing works well as long as the debtor passes the “means test” and usually has a lot of unsecured debt to be discharged. If there are secured debts, the debtor is either able to continue to pay those debts or is surrendering the collateral and discharging the debt. However, some debts entitled to priority and may not be discharged through a chapter 7 filing.
For a chapter 13 filing, there are a couple of typical situations for which a chapter 13 filing is more likely to meet the debtor’s goals. For example, if the debtor is behind on his house payment or car payment and does not have enough to catch up the payment fairly quickly, then a chapter 13 filing will allow the debtor additional time to cure the delinquency through the plan while continuing to make the payments on the house (a car could be subject to a “cram-down”). Also, if a debtor owes a fair amount of tax debts or other debts entitled to priority, a chapter 13 filing may be a good way to deal with those debts by paying the debts in full over the life of a chapter 13 plan.
Also, for a chapter 13 filing, if the debtor has assets over and above what may be exempt, the debtor will be allowed to keep those assets if the debtor can pay for the value of those assets over the life of the plan. For example, the debtor above wants to keep his bass boat. In this situation, the debtor can make payments for the boat through the plan which will then be distributed to his creditors by the chapter 13 trustee. This is called the “best interests of the creditors” test.
So now–back to our prospective client who “can’t afford bankruptcy.” What might this debtor’s situation be?
Asset Rich, Cash Poor
This situation occurs where the debtor has an asset that he wishes to keep but which would be sold in a chapter 7 case such as the bass boat behind the debtor’s brother-in-law’s shed. In our example, if the debtor’s non-exempt boat was worth $10,000.00 as liquidation value, the debtor could expect to have to pay $167.00 (approximately) over the life of a five-year plan. The chapter 13 plan will have to account for this asset in determining the chapter 13 plan payment. If the debtor cannot afford this extra money, then the plan will not be allowed to go forward. Either the debtor can surrender the boat or have to reconsider a bankruptcy filing.
Too Much In Priority Debt
Another fairly common situation is where the debtor owes a taxing authority a substantial amount of money. Say our debtor owes the IRS $15,000.00 and all of the debt is entitled to priority. Priority debts generally must be paid in full over the life of a chapter 13 plan. In calculating the plan payments, approximately $250.00 will have to be paid into the plan just for the IRS claim. If the debtor cannot afford $250.00 a month for this claim, the plan will not be allowed to go forward. In this instance, the debtor will have to make some adjustments as to his financial goals or work something out with the IRS outside of bankruptcy.
Trying To Keep More Secured Debt Than He Can Afford
Sometimes a debtor may be trying to keep too much “stuff” that is subject to a creditor’s lien. For example, if the debtor is behind on his house payment by $10,000.00 and his house payment is $1,000.00, the debtor is going to have to have enough income to make that $1,000.00 house payment and enough extra to catch up the $10,000.00 on his mortgage.
Also, if a debtor is trying to “cram-down” a car or two, the debtor has to have enough income to pay for the vehicles through the plan. If he really can’t afford to pay enough into the plan to pay for the vehicles at the reduced, “cram-down” value, then some alternative strategies are going to need to be considered such as, perhaps, giving up a vehicle and obtaining a less expensive one.
Not All Is Lost!
These are typical situations that arise where it seems to the debtor as if he cannot afford bankruptcy. It is not exactly that the debtor cannot afford bankruptcy but that, under the applicable rules, certain trade-offs will have to be made in order to salvage the debtor’s financial future. Bankruptcy may be an option but the debtor may have to re-evaluate what is important to him or her. For example, if the house is important, the debtor could consider surrending a car and obtaining a less expensive one. If the bass boat is very, very important, then a second job may be in order to earn enough money to pay for the boat (and not have time to ever fish).
An experienced bankruptcy attorney can help guide the decisions that have to be made in any of the situations as described above.
Adrian Lapas, Esq.
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Last modified: August 28, 2012