Chapter 13s last either three (3) years or five (5) years depending on a households income at the inception. That is quite a long time and it can be easy to let it fade into the background of one’s mind after settling into the rhythm of monthly payments to a Chapter 13 trustee. A debtor in a Chapter 13 likely had considerable contact with their attorney at the very beginning of the case, but this becomes less and less frequent after the plan is confirmed and all the claims have come in. After a couple of years, some old habits can creep back in, and the debtor may never think to contact their lawyer when faced with certain financial decisions.
Many of my Chapter 13 clients come to me to help save their home from foreclosure. A Chapter 13 is a grand tool for just such a thing. Most of these clients got to the point of facing a foreclosure action in State court because they made choices between paying a house payment and getting needed car repairs or paying for a necessary medical procedure. That first time of missing the payment, they likely started getting some calls, but nothing earth shattering happened. Next thing they knew, several missed payments have racked up, they are served with a civil summons, and the only way to catch them up is through a five-year Chapter 13.
Then Christmas rolls around that second year into the Chapter 13 and the belt-tightening budget worked out with the trustee really only left room for macrame’ gifts for the children or perhaps a Chia pet or two. It is heartbreaking for a parent when their children’s friends are getting the newest iPhone or PlayStation 4. Perhaps the car broke down again or the refrigerator they had been nursing along for an extra 10 year lifespan finally goes out. Well, that old pattern kicks in and it seems pretty harmless to miss a house payment. After all, nothing bad happened before until a good six months down the line. Well, bankruptcy is a different world.
Most home loan creditors will file a motion for relief from the automatic stay (the law that precludes them from going ahead with the foreclosure once bankruptcy is filed) with just one or two missed payments post-petition. Being in Chapter 13 basically puts them on high alert and they are much quicker to pull the trigger.
This is not the end of the world – yet. Their attorney can object to the motion and almost always work out an Agreed Order to get caught back up again in about six (6) months. However, there is a hefty price to be paid. The creditor will add in their own attorney fees and they will also likely insist on a drop-dead provision where if those payments do not roll in on time, the stay will be lifted without filing another motion and they can then proceed with the foreclosure.
The better course of action is to call one’s bankruptcy attorney to do some problem solving when an unforeseen expense comes about. In the Eastern District of Kentucky, the Chapter 13 Trustee typically does not oppose a motion to suspend plan payments for a month or three if there is a good reason. That is often enough to get past some unexpected expense and get back on track making up the payments. The upside to this is that the debtor will not get hit with hundreds more in attorney fees or end up on a probation sort of situation. So, even if it has been a long time since you talked to your bankruptcy attorney, if things go awry, call them first and get help.
You home is an incredible source of collateral for loans when there is equity (value minus debt secured against it), but there is also danger in using your home this way. There are still lenders who will do rather large, short-term loans secured against a private residence. These loans can be tempting because they often will provide for relatively low-interest loans. However, they can be dangerous. especially when they are balloon loans. Such loans are seductive because they have low monthly payments with a final huge payment due at the end.
I have seen these often used by people trying to get a business venture off the ground. However, people sign up for them for many reasons. The business folks are essentially betting on having a solid and very profitable business going in three to five years. I admire their confidence, but most businesses that survive take three years just to start making a modest return. And so, many find their balloon payment looming without adequate resources to cover the debt. Sometimes banks will roll it into a new loan, but there is no guarantee of this. Therefore, it is wise to talk to a lawyer who knows about bankruptcy prior to that maturity date.
Banks like loans against your personal residence because the revisions to the bankruptcy code back in 2005 gave special treatment to loans secured solely against one’s residence. Basically, 11 USC Section 1322(b)(2) prevents such loans from being modified in a Chapter 13 bankruptcy. Therefore, the only thing one can do is cure the arrears through the bankruptcy, but the underlying agreement remains intact. There is a nice little exception, though, found in 11 USC Section 1322(c)(2) for loans that come due DURING the Chapter 13. So, if one times things right and files a Chapter 13 BEFORE the last payment on your short-term loan is due, a Debtor CAN modify that loan to some extent.
The most likely use for this exception is to move the maturity date of the loan out for the duration of the Chapter 13 plan and thus provide for the cure of arrears on that loan. The Debtor still has to show that the lender is adequately protected, but that hurdle is usually overcome easily with real estate that is either holding its value or increasing in value. This is NOT a complete remedy, but it can buy more time for a Debtor to either find alternative financing that has no balloon payment or make those profits they hoped for that would cover the debt.
I posted awhile ago about a neighboring high-volume bankruptcy firms TV advertisements to “get your bankruptcy started for just $71.00”. I speculated on how they did that, but I have since learned what the deal is from a client who went to them first. She clearly was a candidate for a Chapter 7: below median income, no secured debt arrears, no priority debt, and nothing else that would lend itself to Chapter 13. However, she could not come up with the attorney fees to do the Chapter 7 right then. So, they offered to put her into a Chapter 13 with just $71.00 up front.
This seems like an acceptable approach. Basically the attorney is using the ability to have their fees paid through the Chapter 13 as administrative expenses. The up side for the debtor is that they get the relief from creditors including garnishment right away. The downside is that this is a much more expensive and involved process than the Chapter 7. Debtors need to be made aware of how much more they would pay in the long run for the Chapter 13 as compared to the Chapter 7 – sort of fair credit act kind of disclosure. Perhaps my colleague is giving that kind of disclosure – I have no reason to doubt that they are. If so, then I give them props for giving another option for debtors that needs relief from debt right away, but whom cannot afford the attorney fees.
The trustee’s office appears to be taking a closer look at expenses in Schedule J of Chapter 13 cases. Specifically, they appear to be pushing for decreasing recreational/entertainment expenses and miscellaneous expenses. Previously, this trustee’s office tended to utilize the standardized amounts provided for in the means test as a gauge. As a result, if a debtor reported a particular expense in excess of those amounts, I would encourage them to engage in “belt-tightening” in that area.
The interesting thing about those standardized expenses is people who make less money have lower expenses while people who make more money have higher expenses even when the family size is the same. In the prior approach, the trustee’s made some allowance for this dynamic. The trustee’s current approach seems to be to cram those relatively higher income families into the expense structure of the lower-income Chapter 13 families. Now, even if expenses fall within the standard allowance of the means test, the trustee is looking for deeper cuts.
On the surface, this seems fair – after all, why should richer people get to have higher expenses and still discharge their debts at the end? The problem comes down to human nature. Once people develop a set point of expenses, then it is extremely hard for them to do substantial cuts in those expenses. When one is talking about the extended timeframe of five years in a bankruptcy, well the likelihood of successfully maintaining extensive cuts drops dramatically.
So, what is the goal of Chapter 13? I suggest that we are best served when people successfully complete Chapter 13 plans. This will not happen when budgets are made so tight as to be unwieldy over time. Debtors will get into a tight spot with unexpected expenses and be unable to make their payments. This is not to suggest that people should get to engage in lavish lifestyles in a Chapter 13; rather, I suggest a balance between belt-tightening and sustainable budgets. Clothing makes for a good analogy: a really tight dress may look really trim and neat, but no one can wear it day in and day out. Rather, one needs slightly roomy clothes to go about their day-to-day business. Such an approach will increase Chapter 13 successful outcomes and, thus, increase the overall return to unsecured creditors.
I am often asked by Chapter 13 debtors if they can pay their Chapter 13 off early. This is a problematic question with no one clear answer. It is problematic because certain property of the debtor continues to come into the Chapter 13 estate while the bankruptcy is pending. This is different from a Chapter 7 where the property of the estate is established and remains static at the moment the bankruptcy is filed. The clearest example of this ongoing inclusion in a Chapter 13 are wages and other earned income of the debtor.
Since ongoing wages and earned income of the debtor comes into the estate of the Chapter 13 so long as the case is pending, then one cannot use those wages to pay your plan off early IF you were not below the median income on the means test OR you are paying 100% of unsecured debts in the Chapter 13. This makes sense because the idea with a Chapter 13 is that you repay creditors to the extent that you reasonably can. So, if you end up getting promotions or a better paying job during the bankruptcy, then you could reasonably pay a higher percentage of your unsecured debts.
Some Chapter 13 trustees require a new budget (Schedules I & J) to be submitted each year. If they see a substantial bump up in disposable income, they then require the plan to be modified to pay a higher percentage of the unsecured debts. In the Eastern District of Kentucky, the trustee does not automatically require this. However, if you begin to pay ahead on your Chapter 13 plan, they well may pay attention and decide you must be making more money. This can trigger a demand from the trustee for a new budget and probably a higher plan payment.
There are some things that clearly and unquestionably CAN be used to pay off a Chapter 13 plan early. If you use property of the estate that was exempt at the inception of the bankruptcy, such as a 401k account, then there should be no issue if you fell below the median on the means test. However, there are other things that need to be investigated and carefully considered by your attorney. Therefore, I must abstain from listing those things that are in the grey area here lest I miss some peculiarity of your situation.
Since I do not focus on a volume practice in bankruptcy and because I have become known as someone who is able and willing to tackle some unusual situations, I get to consult with debtors that have really tough circumstances. A recent case led me down a path of seeing just how creative I could be in a bankruptcy situation to forestall and ultimately pay their home loan lender. Anyone who has talked to me or read many of my posts know that I am quite fond of Chapter 13 bankruptcies. This is partly due to the flexibility afforded by them to accomplish many things, such as saving one’s house from foreclosure. So, I fully expected to find that a Chapter 13 would be the best vehicle to solving this client’s issue where they were nigh on losing their home.
In the scenario presented to me, the debtor had a sizable asset they had not been able to touch which was in trust but not much in ongoing income. The trust was not a spendthrift trust, or else we would not even venture far down this path. However, the debtor hoped that in bankruptcy, the trust assets could be obtained in order to pay their debts – likely at 100%. There are many twists and turns to this matter which I simply cannot go into here. Negotiating this one particular twist will just bring us to another turn and so the analysis is far more complicated than I am putting forth. Other issues involve the couple being unmarried and looking at who actually owns what. There are issues related to the automatic stay when a foreclosure has already been granted, but on appeal. And, just how tight the trust actually is will determine much. However, this particular issue I am focusing on may be helpful to others. In theory, the debtor’s notion of satisfying their debts with this currently unattainable asset is appealing.
We must look at 11 USC Sect. 1322(b)(8) to start the analysis. This section allows the plan proposed by the debtor to provide for payment of all or part of a claim from their property or property of the estate (let’s not worry about that distinction too much – it is often one and the same, but not always). The debtor can do this, in part, because under 11 USC Sect. 1306(b), the debtor remains in possession of all property of the estate. In other words, if you have property you cannot cover with exemption and you really want to keep that property, the way to be assured of that and file bankruptcy is in a Chapter 13. In a Chapter 7, what you cannot exempt is subject to being liquidated.
So far, so good – the debtor keeps the trust assets and keeps the house. Oh, but then we have to look at other provisions of the code. Next, we turn to 11 USC Sect. 1325 which requires that they are able to make payments. If my debtor’s only means to make payments on the plan is accessing their trust, then we run into a problem because there is no reasonable certainty that they will get into that trust in bankruptcy. After all, they were unsuccessful before considering bankruptcy. Because of this uncertainty and the absence of regular income, the plan may not get confirmed. The second barricade the debtor hits is the dreaded “adequate protection” called for in 11 USC Sect. 361. If they cannot protect the secured creditor’s interest in the Chapter 13, then they have no right to keep the asset securing the debt. In essence, this is a carve out of the Section 1306 provision.
Oh, but the secured property is land which typically increases in value; it does not decrease in value. However, in our situation, the amount owed on the property is far more than the value of the land under current market conditions. Still, we may be able to show adequate protection if we show that the value of the land is increasing faster that the debt is accruing interest and other allowed charges. Let us leave this one alone then, since it is driven by things I do not wish to get mired in.
The real problem I find myself up against is caused by the very provision that usually helps people out so much in a Chapter 13: Section 1306. When we combine the fact that the debtor keeps possession of their assets with the other nicety of Chapter 13s: the debtor has an absolute right to convert to a Chapter 7 or dismiss their Chapter 13 case, that is where get to the rub. My debtor cannot show that she can and will make payments to unsecured creditors as required by Section 1325 when she could dismiss the case as soon as she gets hold of the trust assets. Such a plan is unlikely to get confirmed.
Only if her income could pay an amount equal to the non-exempt asset could she get confirmed because there is one other hurdle not yet mentioned. The final hurdle is back in Section 1325 which basically says that creditors have to come out at least as well as or better than if the debtor filed a Chapter 7. This is the creditor’s “best interest” test that balances out the debtor’s benefits in Chapter 13s. In our case, if the debtor filed a Chapter 7 which cannot be converted dismissed without permission and where the assets of the estate go into the trustee’s hands, my debtor cannot pass this test.
Oddly enough, given many facts that I did not go into, this case is actually one where Chapter 7 gives a better likelihood of saving the house. The trustee would be vested with the ability to crack open that trust and has more resources with which to do it than the debtor in a Chapter 7. And, if successful, the home loan would still likely be paid in full even after the commission and other expenses.
I write about this every year because it is a recurring issue for people facing bankruptcy. Taxes have a bearing on bankruptcy whether you are owed a refund or whether you owe the IRS. Therefore, they must always be taken into account, but it is especially important during this first handful of months each year.
The first thing to remember is that if you are owed a refund at the time of filing, that refund is an asset of the estate and must be reported in Schedule B and hopefully exempted in Schedule C. If you owe taxes, they are reported on either Schedule F or E depending on whether they are priority debts or not. Your attorney can help sort that out. Tax debt and tax refunds arise on December 31st each year. So, if you file a bankruptcy on January 1st, then you must account for the tax situation that arose from just the day before. So, even if you do not file your tax return until April 15th (or October if you file an extension) you either owe taxes for the year that just ended or you are getting a refund (rare indeed is the person who lands right at zero, but I suppose it happens).
If you owe taxes for the preceding year, they will be considered a “priority” debt and a debt that cannot be discharged. In a Chapter 7, the IRS and any state agency you owe taxes to will begin collection activity after your Chapter 7 is closed. In a Chapter 13, you will have to make sure you pay enough into the plan for those taxes to be paid in full over the life of the Chapter 13 along with 4% interest for federal income taxes and 5% interest on Kentucky income taxes.
If you are owed a refund, you need to report the refund as accurately as possible in your schedules of assets. This means you will likely have to run at least a rough draft of your tax return to get a good faith estimate of what is due back to you. Then, you will attempt to cover the entire amount in “wild card” exemptions. If you cannot exempt the entire amount, you will need to make a determination with help from your attorney as to whether you should wait until you receive the refund or press on.
If you decide to wait until you receive the refund, then the smart thing to do would be to pay for the bankruptcy and spend the money on necessities, such as food or needed repairs to you car. Do NOT use it to pay unsecured debt, especially not to relatives. Your attorney can help you know how much you can hold onto and exempt.
Your attorney can also help you determine if older income tax debts, such as those that arose a few years prior to the bankruptcy, will be discharged in your Chapter 7 or 13. All of this is acceptable pre-petition planning to make the most of the fresh start bankruptcy allows.
I was wrapping up final preparations on a Chapter 13 petition and proposed plan today for filing next week. As I ran through the plan and made provisions for the adequate protection payments (in this region they are typically 1% of the value of depreciating assets), I realized it would be some time before I began getting paid for my work. You see, in a Chapter 13, one can put much of the attorney fees into the plan to be paid as administrative costs. This is a priority class of creditors that can be paid in full through the course of the plan. As a priority class, that also means they can be paid ahead of many other kinds of debt.
However, they do not get paid ahead of adequate protection payments. I had been very diligent in this person’s plan to make their budget workable so they could keep their family running while still saving their house and paying off the family car. That car, a family vehicle worth over $10k, meant that adequate protection payments would be over $100 per month right out of the gate. However, due to repaying some retirement plan debts (allowed to avoid tax penalties) their first several months of plan payments would not be much more than the adequate protection amount.
I breathed a sigh and reassured myself that it was just a matter of time and I would be compensated for the post-petition work. I felt good that I was helping the family and that they would be able to cover the arrears on their house and stave off foreclosure. And, I made a mental note that in the future I needed to be mindful of high value cars and tight budgets so that I asked for a smidgen more in up front fees on such matters.
This is a round about way to explain why, in discussing a Chapter 13 with your attorney, she or he may seem to waffle a little on the attorney fees. There is a $3,500.00 “no-look” fee in the Eastern District of Kentucky. This does not mean that is a set, required fee. Rather, if your attorney charges that much or less, the court is not going to ask your lawyer to prove up the time she or he spent as an attorney. If more is charged, then an application detailing the work must be produced. Most attorneys will charge the $3,500.00. Where the waffle comes in is how much will be required to be paid up front prior to filing. I tend to go on the low-end because I know things are so tight for people and I make it as affordable as a Chapter 7, but I have to off-set that with the demand of my own expenses.
I have written in the past about the ability to “force” down interest high interest rates on car loans in a Chapter 13 and even to decrease the principal mount due on cars purchased over two and a half years prior to the bankruptcy. These are tremendous benefits to a Chapter 13, but there is a downside to including your vehicle to be paid through the plan. That is, at least in the Sixth Circuit which includes Kentucky.
The case, In re Nolan, 232 F.3d 528 (6th Cir. 2000) is the prevailing law in Kentucky on surrendering a car after a Chapter 13 plan has been confirmed. Whereas some other courts have adopted only a “good faith on the totality of the circumstances test” as to whether surrendering a car post-confirmation allows the claimed debt to become an unsecured debt, the Nolan case precludes such judicial discretion.
Nolan dictates that if a debtor seeks to surrender a car that is being paid through a confirmed Chapter 13 plan, the creditor still gets paid in full through the plan. The creditor gets to seize the car and auction it, applying the sale price to the debt owed. However, cars rarely auction for much and so most of the debt remains. Since that debt, which outside of bankruptcy would become an unsecured deficiency debt, must be paid in full, then debtor will likely not be able to decrease their plan payment much if at all. All the other unsecured creditors realize no benefit, nor any noticeable harm.
The debtor’s position is harmed even though they will be making the same plan payment as before. This is because they are likely having to purchase a new vehicle which will NOT be paid through the plan. This makes the debtor budget all the tighter and possibly untenable.
Often, when approaching a Chapter 13, a legitimate concern that the potential debtor faces is having reliable transportation during the Chapter 13. The debtor may have fallen behind and had a car repossessed just prior to the bankruptcy filing. Or, more commonly, they are driving a junker of a car that is on its last legs (or wheels). Considering that most Chapter 13 bankruptcies are for five years (some people qualify for a three-year Chapter 13), having a junker car at the start is problematic.
First, it is very hard to predict how much one will have to expend to keep a junker car running for five years. Second, although debtors can apply to the court to incur additional debt during a Chapter 13, it is a tad more complicated to buy a car during the Chapter 13. So, it is entirely legitimate planning to buy a car prior to filing the Chapter 13. If there is sufficient disposable income, buying a dependable car before a Chapter 13 can direct some of that income away from paying unsecured debts towards paying for a legitimate need of reliable transportation. After all, transportation allows for employment and having regular income is necessary for a Chapter 13.
If, after talking to your lawyer about it prior to Chapter 13, you decide to buy a car then there are some things to be careful about. Foremost, you want to buy a car that is reasonable. Forget the Rolls Royce or Jaguar and look for the Corolla or Focus. In other words, do not get a luxury vehicle but get one that is functional. Now, it does not have to literally be a Corolla or a Focus, but the idea is to minimize fuel and repair costs while having enough car to meet your families needs.
Second, you need to be aware of the timing of the purchase. Under 11 USC Sect. 546(c)(1), the seller of goods appears to be allowed to have a right to reclaim the car within 45 days (or 20 days of the petition date if within that 45 days). There appear to be no cases in the Sixth Circuit addressing this issue, but it has come up elsewhere. In one case from Alabama I reviewed, the seller of the car claimed 546(c)(1) gave them the right to take the car back and moved the court to lift the stay to do so. Ultimately the court ruled in favor of the debtor because they found no exception for reclamation in the automatic stay of bankruptcy for the seller, but who wants to go through the hassle of unnecessary litigation. So, if possible, it is best to make the purchase 45 days prior to filing the bankruptcy.
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- Lessons Learned the Hard Way
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