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What is the difference between Chapter 7 and Chapter 13?

Chapter 7 s generally referred to as “liquidation,”and Chapter 13 as “reorganization.”  That means that, in Chapter 7, the trustee is charged with the responsibility of marshaling and liquidating the debtor’s non-exempt assets, selling them and distributing the proceeds pro rata to the debtor’s creditors.  Chapter 13 is the reorganization of the debts of an individual debtor (or joint debtors) with a regular source of income.

What is a “Trustee?”

A trustee in bankruptcy is an individual appointed by the Court, through the United States Department of Justice Bankruptcy Trustee program to administer the Bankruptcy Estate for the benefit of creditors and the Bankruptcy Court.  He is not acting in the capacity of a lawyer, although many trustees are, or have been, lawyers.  Since much of the bankruptcy process is based on statements made in writing and documents submitted to courts, there is a need for some mechanism to monitor what happens in the process. Basically to keep everyone honest. The job description varies somewhat depending on whether your case is a Chapter 7 or Chapter 13, but the DOJ describes the overall mission as follows:

The United States Trustee Program is a component of the Department of Justice that seeks to promote the efficiency and protect the integrity of the Federal bankruptcy system.  To further the public interest in the just, speedy and economical resolution of cases filed under the Bankruptcy Code, the Program monitors the conduct of bankruptcy parties and private estate trustees, oversees related administrative functions, and acts to ensure compliance with applicable laws and procedures.  It also identifies and helps investigate bankruptcy fraud and abuse in coordination with United States Attorneys, the Federal Bureau of Investigation, and other law enforcement agencies.

Your trustee may be friendly or in some cases may feign some degree of officious hostility.  (I suspect–but don’t know–that the personality profile of an average bankruptcy trustee is pretty similar to that of an IRS tax collector, and am not sure what it is that makes people want either job. But I digress.)  The point is that they are not your friend, but nor are they the enemy:  They have a job to do, and with the DOJ and hostile creditors looking over their shoulder, they want to make sure they do it right. Also, since their compensation is partly based on a percentage of what they recover to distribute to creditors, to the extent that they can recover assets they will be paid more.

But the job is the same under Chapter 7 or Chapter 13:  Make sure the debtor is staying on task, that assets and liabilities have been thoroughly and accurately reported, that recoverable assets are marshaled and liquidated, and that all of the various bureaucratic requirements of the Bankruptcy Code have been satisfied.

Can I keep my car in Chapter 7?

Generally, yes.  That is, if you don’t drive a high end luxury car that you own outright, you can afford the payments going forward, and you stay current on those payments, then you are more than likely to be able to keep your car. But there are twists in this issue that require further explication, and you should talk to your lawyer if you’re particularly concerned.

Can I keep my house in Chapter 7?

This is a bit dicier than a car.  However, generally, if you don’t have an equity interest that exceeds the homestead exemption (see California homestead exemptions) are current on the mortgage(s) loan and stay current on the mortgage(s), you have a pretty good chance of keeping your house.   There is a lot of really bad advice kicking around out there on home retention and bankruptcy, so be very , very careful about getting advice on this issue.  Make sure that lawyer you’re talking to knows both real estate and bankruptcy law.  And that would probably not include the guy who got your cousin Ted off on his DUI charge, or the gal who helped you through your divorce a few years ago.   Believe it or not, even some bankruptcy specialists don’t really get this are of law, so just make sure you’re getting good advice.   But remember that current means current.  Not 30, 60 or 90 days, and not “I’ll pay it when I have it.”  Current is current and it only has one meaning:  No arrearages.

What does it cost to “go bankrupt?”

Obviously, that varies with the complexity of the case and the amount of work your attorney is going to have to do. Filing fees are the easiest part, as they fixed by the Court (currently, $274 for a Chapter 13, $299 for a chapter 7 and $1,039 for  a Chapter 11), but attorneys fees are negotiable between attorney and client.  All debtor’s bankruptcy fees are subject to the review by the court, however, so if the trustee or the debtor feels that the attorney has changed an excessive fees, this can be taken up with the Court.

Chapter 7 fees are usually determined pre-filing, and can range anywhere (here in Northern California) between $1,000 and $5,000, depending on the complexity of the case. (But I’d be very careful of anyone who says they can do a competent job for $1,000.  That’s pretty bare bones.) If you own real estate or have a business, expect the fee to exceed $2,000, and probably be closer to $3,000.  The fixed fee will also not include fees that could be incurred if something unexpected happens, like a complaint for non-dischargeability is filed, or the US Trustee notices up an audit of the file, or there are motions that require opposition or attendance in court.

Also, the fee is likely to be just for the actual bankruptcy case itself.  It is possible that there is a alot of work to be done before the actual bankruptcy case can be filed, as is usually the case with individuals and entities with business affairs and debts. I have been involved in cases where the bankruptcy was just the end result of what the client needed to accomplish to unwind the complexities and business affairs that needed attention.  This might require a fair amount of work before the client is really “ready” to file bankruptcy.

In Chapter 13, a Court’s local rules may dictate a fee schedule for Chapter 13’s, and that is the case here in the San Francisco Division of the Northern District of California. (Link to Fee Guidelines for San Francisco Chapter 13 cases.)  The scale is sort of an “a la carte” system, which starts with a base fees, and adds up as items and issues are included. If the fees are within these guidelines, they are presumptively “reasonable.”  But if the fees are outside the guidelines, the attorney may have to justify the fee.  Of course, the guidelines in the link are just for cases filed in San Francisco, and don’t apply on the other courts, but they are still useful as a guideline.

Can I omit certain debts and income from my bankruptcy case disclosures?

No.  That’s a really bad idea. I often tell my clients that we can fix anything but a lie, because once you get caught in a lie, your credibility is shot. And once your credibility is shot, then almost anything can happen. Why? Because the bankruptcy process is largely a matter of good faith and assumed honesty. And we also know that not everything we own is completely disclosed on the schedules, and that that which is disclosed, is probably not wholly accurately described or valued. So once the trustee gets it into his head that you’re not being completely honest–or that you don’t appear completely honest–then the real digging starts. And once that happens, you’re in for a very long haul indeed.  And if the trustee decides and confirms that you’re not being honest, then you’re facing an action to dischargeability, or worse, possible criminal prosecution.

And you’re also likely to be having to face these trial and tribulations all on your own, and without legal counsel. Why? Because most bankruptcy attorney do not factor the possibility of their clients getting sued for fraud into their fixe fee estimates, and as soon as it appears that the client is lying, the attorney is going to seek to withdraw from further representation. Courts routinely grant such motions.

Do yourself a favor. Fully disclose and let your lawyer help you work through the consequences and find other solutions.

I recently read another blog where it was stated that the only property you shouldn’t disclose is that which you want to lose in the bankruptcy process, because the consequences of non-disclosure are about that dire. (Apologies to the author as I don’t remember where I read it. But if you send me an email I’d be happy to give due credit.)

What if I want to pay someone specific, like a family member?

Don’t confuse the obligation to disclose with the desire to pay.  Just because you intend to pay a particular debt does not mean that you can exclude it from your schedules. The Bankruptcy Code doesn’t care if you decide later, for whatever reasons you choose, to repay a debt that was discharged in bankruptcy. Once you’re out of bankruptcy–subject to some exceptions that I won’t go into here–you can generally do whatever you want with the money you make, even pay off debts that you no longer owe.

But just because you harbor an honorable intention to repay Aunt Tilly that $1,000 you borrowed in college when your car broke down doesn’t mean that you can just fail to disclose it.  If you have one of these situations, call Aunt Tilly, tell her what’s going on, that you have to disclose the debt and that shell be getting some mail that may seem confusing, but that you fully intend to make it good to her when you’re out of the woods. And probably even faster, because now you’ll be free of the rest of the crippling debt that brought you to where you are now anyhow.

Definitions of Useful Terms

Below is a list of definitions of terms frequently used when discussing real estate, bankruptcy and related issues in the law. It is by no means comprehensive, nor are these definitions to be used or relied on except in an informal conversational context.  This is a cheat sheet more than anything.

“Anti deficiency statute.” A law that prohibits a lender from pursuing a borrower for a “deficiency” after foreclosure or short sale. The primary anti deficiency statutes in California are the “purchase money anti-deficiency rule,” (CCP §580b), the “private sale” (or non-judicial foreclosure) anti deficiency rule (CCP §580d) and the new (as of January, 2011) “short sale” anti deficiency rule. (CCP §580e) These rules apply on in California.

“CCP” is the California Code of Civil Procedure, the body of procedural laws that governs all legal procedure in California state courts.

“COD” or “Cancellation of Debt.” Term usually used in conjunction with an income tax liability for debt that is “cancelled.” A foreclosure may result in COD tax because the bank is taking the property back for less than the amount owed on the loan. This is a very complex area of law with a lot of unresolved questions. If you suspect that you may have a COD problem, make sure you consult with a qualified accountant who understands the issues. (Hint: Most lawyers do not understand these issues so advice from an accountant is better.)

“Chapter 13.” A form of bankruptcy that allows a debtor to make payments to a trustee over a period of time, usually 3 to 5 years, with any unpaid amounts of unsecured debt being discharged when the case is completed. Can provide some opportunity for “lien stripping.” Not available to debtors with more than $1,010,650 in secured debt, or $336,900 in unsecured debt.  For more information, review my blog post “Chapter 13:  What is it and why should you care?”

“Chapter 7.” Sometimes called “straight bankruptcy,” this is the process that allows a debtor to discharge most unsecured debts. Faster and more efficient than Chapter 13, but not everyone is eligible for it, and there are other significant advantages to Chapter 13 that are not available in Chapter 7.

“Deed of Trust.” The document that you signed giving the bank a security interest in your property. This is the source of the bank’s rights to foreclose.

“Deed in lieu.” Short for “deed in lieu of foreclosure.” This is where the borrower deeds the property to the lender as an alternative to formal foreclosure (or short sale). It is not a common occurrence these days, but not impossible. Generally this is not an option if there is more  than one deed of trust against the property because if the holder of the first take title, then it’s obligated to pay the junior encumbrances. Foreclosure wipes the juniors out. Sometimes referred to in slang as “jingle mail,” as in the keys jingle when they’re sent to the lender.

“Deficiency.” The amount by which the loan balance exceeds the amount paid to satisfy the loan. Using the below example of the house that is “under water,” the deficiency would be $50,000.  ($150,000 loan secured by property worth $100,000.)

“Equity.” The amount of fair market value in a property that is not encumbered by a mortgage or lien. If the property is worth $150,000, and all liens against the property total $125,000, then the owner is said to have a $25,000 equity interest in the property.

“Foreclosure.” The process by which the lender enforces its right to take the property back when a borrower defaults.

“Homestead exemption.” The amount of “equity” that a borrower may keep protected from creditors above and beyond most types of consensual liens. The amount varies under California law from the basic amount of $75,000 for a single homeowner, up to a maximum of $175,000 for certain seniors and low income persons.

“Junior deed of trust.” Any deed of trust or security instrument that is “junior” to, or of lower priority than the “First Deed of Trust.”

“Lien.” A recorded security interest in property. A deed of trust creates a lien. Other types of liens are mechanics liens, attachment lien, etc.

“Means test.” The test created by the Bankruptcy Reform Act of 2005 that requires consumer debtors to pass a test of their means in order to determine eligibility for Chapter 7.

“Non-Recourse loan.” A loan where the lender may not pursue the borrower personally for any “deficiency” but can only exercise its rights to the real property collateral. A “purchase money” loan is generally “non-recourse,” whereas credit card debt, refinance debt , is almost always “recourse”

“Notice of Default” or “NOD.” The formal notice that the bank send to the borrower and records with the County Recorder, which starts the foreclosure process. Recordation of this document starts a three month clock ticking during which the Bank cannot complete the foreclosure, and the borrower retain a “right of reinstatement.”

“Personal property.” All property that is not “real property.”

“Promissory Note.” The document that creates the loan and obligation to repay. It is a different document than the Deed of Trust, and is enforceable even if the Deed of Trust is not.

“Purchase money loan.” A loan obtained for, and used for, the purchase of real property that is occupied ion whole or part by the borrower. Subject to “anti-deficiency rule” of CCP 580b.

“Real property.” Real estate, land, house, factory, etc. The law treats “real property” and “personal property” very differently form one another.

“Recourse loan.” A loan which allows a lender to recover a deficiency from a borrower personally.

“Right of Reinstatement.” The right of the borrower to reinstate the loan according to its original terms. The borrower retains this right up to five business days before the scheduled “trustees sale.”

“Secured debt.” A loan that is secured by a lien on property.

“Short sale.” The sale of a property for less than the amounts outstanding on all existing loans. Not possible without bank’s approval because borrower cannot deliver marketable title unless existing liens are released.

“Strategic default.” A term used to describe a situation where a borrower chooses to stop paying a mortgage due, not to financial hardship, but due to a drop in property values. Studies have determined that when a homeowner’s negative equity position exceeds 25% of the loan balance, the occurrence of market wide strategic default increases significantly.

“Trustee’s Sale.” The process of actually selling the property at auction. The final step in the foreclosure process.

“Unsecured debt.” Debt that is not secured by a “lien” on any property of the borrower. Most credit card, personal loans and student loan debt is unsecured.

“Underwater.” This is the term used to describe a situation where the loan balance exceeds the current fair market value of the property. If the loan balance is $150,000, and the property is worth $100,000, the property may described as being “underwater” by $50,000.

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