In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act to amend the United States Bankruptcy Code (the “Act”). The changes made to the Act were designed to make it theoretically more difficult for people to file Chapter 7 Liquidation bankruptcy, forcing more filers into reorganization (repayment) through a Chapter 13 bankruptcy. While these changes had the intended effect in the short term, the 2007 financial crisis threw a wrench in the gears of Congress’s intent in amending the Act. According to the U.S. Bankruptcy Courts, the number of filings consistently increased from 2006 through 2011, and by 2010 had reached pre-2005 amendment levels. Since 2011, filings have steadily decreased. This decrease is good for both the economy and the collections industry, but as collection attorneys, knowledge of the Bankruptcy Act and Rules is necessary for a successful practice.
Generally speaking, the purpose of the Act is to provide a fresh start to debtors to ensure that debtors’ assets are distributed in an orderly way, and preserve and maintain said assets. This is accomplished through different types of bankruptcy filings. The filing that is most appropriate depends upon an individual’s or entity’s legal existence (individual vs. corporation), his/her income/asset situation, and his/her intentions (liquidation vs. reorganization). This guide will only address consumer bankruptcy filings.
Ohio has two (2) bankruptcy court districts. The Southern District covers the southern half of Ohio and has courts in Columbus, Dayton, Cincinnati, and Zanesville. The Northern District covers the northern half of Ohio, and has courts in Cleveland, Akron, Canton, Toledo, and Youngstown. Each district and judge have their own rules and general/administrative orders of which practitioners must be cognizant. These rules/orders can be found on the court’s website.
If an individual (or married couple) has an income level that is below the state median, the indivdual can file a Chapter 7 Bankruptcy. The income level is calculated by taking the debtor’s current monthly income (average of the last 6 months, excluding social security income) and comparing it to the state median income. If a debtor’s current monthly income is above the state median, the debtor must complete a means test to determine if he or she can file a Chapter 7 liquidation or if he or she will be forced into a Chapter 13 reorganization. The means test looks at a debtor’s disposable income to determine if there is a presumption of abuse.
In all consumer bankruptcy cases, a trustee is assigned to manage debtor’s assets and distribution of any non-exempt assets. This is accomplished through review of the debtor’s petition and by conducting a 341 hearing (meeting of creditors) wherein the debtor is questioned by the trustee about his/her petition, creditors and assets. In a Chapter 7 bankruptcy a debtor liquidates his/her assets. Certain assets can be exempted from the estate, but other assets (or amounts in excess of exemptions) can be taken by a bankruptcy trustee for distribution to creditors in a codified priority order. The ultimate goal of a Chapter 7 filing is to discharge consumer debt. There are exceptions to discharge that will be discussed herein.
A Chapter 13 bankruptcy, or reorganization, is where a debtor repays all or a portion of debts based on the type and age of the debt and the total non-exempt assets of debtor. In a Chapter 13, a debtor files a plan proposing repayment terms. The trustee or creditors can object to that plan. Creditors also file claims, setting forth the amount and type of debt to be repaid. Debtor and trustee can object to claims. Once all objections and responses are resolved or adjudicated satisfactorily, debtor’s plan is confirmed and debtor’s payments are distributed by the trustee to creditors in the aforementioned codified priority order.
I. Preference Payment Basics
A bankruptcy trustee may avoid any transfer of an interest of the debtor in property: 1) to or for the benefit of a creditor; 2) for or on an account of an antecedent debt owed by the debtor before such transfer was made; 3) made while debtor was insolvent; 4) made on or within 90 days before the date of the filing of the petition (or a year before if the transfer was by an insider); and 5) that enables such creditor to receive more than such creditor would receive if the case were a case under Chapter 7 of the Act, had the transfer not been made. Practically speaking, if a creditor receives funds from a debtor (voluntary or otherwise) within 90 days prior to debtor’s bankruptcy filing, the trustee can demand turnover of those funds. There are several exceptions to the trustee’s power, which include:
1) Contemporaneous exchange for new value given;
2) Payment of a debt incurred in the ordinary course of business;
3) Payment which creates a security interest given for new value;
4) Bona fide payment for domestic support;
5) Payment in an amount totaling less than $600 (in the aggregate if multiple payments over 90-day period.
The trustee can always exercise demand for turnover of a preferential payment, but a debtor can also make the same demand to the extent that such preference is exempted in debtor’s petition, and thereby abandoned by the trustee.
In the world of collection law, the preference issue is most prevalent when a judgment creditor is garnishing debtor’s wages or bank accounts just prior to a Chapter 7 bankruptcy filing. When this happens, you will often receive communication from the trustee, demanding turnover for a certain “preference” amount. As a practitioner, you should review your own records and the relevant court docket to confirm the accuracy of the amount being demanded. If there is disagreement over the preference amount, the trustee should be notified. More often than not, the trustee will negotiate if given a legitimate reason (e.g., payments received by the state court prior to the 90-day period, but sent to your office within that period). When a demand is made by a debtor, the amount demanded must also be exempted in a debtor’s petition. If it was not, a debtor does not have a right to turnover. Refusal to turnover preferential funds could lead to an action for turnover.
II. Automatic Stay
An automatic stay goes into effect upon the filing of any bankruptcy petition. The automatic stay stops all pending civil actions or executions including foreclosures and certification of foreclosure sheriff sales. In a Chapter 13 bankruptcy, a co-debtor stay applies to any non-filing debtor that is an individual co-debtor on a consumer debt. There are several exceptions to the automatic stay, which include:
1) Criminal proceedings;
2) Civil paternity, domestic support, child custody, domestic violence or dissolution of marriage (except for division of property) proceedings;
3) Driver’s license suspension; and
4) Continuation of eviction where lessor has obtained judgment for possession prior to bankruptcy (except damages cause of action).
The bankruptcy autostay naturally terminates when discharge is granted or denied, when the case closes or when the case is dismissed. A discharge could be denied for abuse or upon filing a case within the time frames set forth in the Act.
Additionally, the 2005 amendments to the Act created autostay limits/exceptions for multiple Chapter 13 filers. Specifically, if a bankruptcy is filed after another bankruptcy was pending within the previous year, debtor only receives a 30-day stay for the second filing. If a debtor files a third bankruptcy after two (2) others are pending within the previous year, there is no stay relief. A debtor can request an extension of the shortened 30-day stay, but must do so within 30 days of the bankruptcy filing. Creditors can get an order confirming the inapplicability of the autostay if it expires, but it is important to keep in mind that the shortened stay only applies to the individual, not property of the estate. Therefore, creditors will still need to get relief of stay as to real estate that is property of the bankruptcy estate, even if the in personum stay has expired on a serial filer.
Relief from stay is a method to request a lift or removal of section 362 autostay protections. Such a request can be made by any creditor under the following circumstances:
1) To pursue secured collateral;
2) Lack of adequate protection;
3) Lack of equity in property that is not required for reorganization (a 2nd or 3rd motor vehicle);
4) If evidence exists that the bankruptcy filing was part of a scheme to delay, hinder and/or defraud creditors that involve either a transfer of all or part ownership of interest in real property without consent of a secured creditor, or debtor has filed multiple filings to stop creditor’s civil remedies (i.e., multiple bankruptcy filings to stop foreclosure sales).
Additionally, creditors can request relief from the co-debtor stay on an unsecured debt where the claim will not be paid in the bankruptcy or on a secured debt in conjunction with a motion for relief from stay of the bankrupt debtor.
As discussed earlier, certain property of a bankrupt debtor is protected from being used to pay creditors in a Chapter 7 bankruptcy. Likewise, these same exemptions keep assets from being used as a basis for higher payments to unsecured creditors in a Chapter 13. The exemptions used in bankruptcy in Ohio are the same exemptions provided for in Ohio civil executions. Some of the most common exemptions/amounts are:
1) Cash – $450.00
2) Residential Real Estate – $132,900.00
3) Motor Vehicle (1) – $3,675.00
4) Household goods – $12,250.00 (up to $575.00 per item)
5) Jewelry – $1,550.00
6) Tools of Trade – $2,325.00
7) Wildcard – $1,225.00
8) Pensions, 401k, Unemployment, Workers’ Comp., domestic support payments and most IRA’s.
These exemptions can also be used as a basis to have liens set aside (discussed later).
IV. Protecting Your Claim in Bankruptcy
Creditors may file a proof of claim in Chapter 13 reorganizations and Chapter 7 asset cases. This must be done in order to let the trustee/debtor know that you have a claim, the amount of the claim, and the type of the claim. This will potentially determine how, when and/or if (and to what extent) you get paid in the bankruptcy. Generally, claims must be filed within ninety days of the first date set for the meeting of creditors. This period is extended for governmental units to one hundred and eighty (180) days. Creditors are paid in a Chapter 13 pursuant to rules of distribution as follows:
1) Domestic support obligations;
2) Administrative Expenses and attorney fees;
3) Secured Creditors;
4) Priority Creditors;
5) General Unsecured Creditors.
In a Chapter 7, secured creditors are paid if the collateral secured is being sold. Otherwise, assets are distributed as follows:
1) Domestic support obligations;
2) Administrative Expenses;
3) Priority Creditors;
4) General Unsecured Creditors.
Claims can be filed late if notice was not properly given to a creditor. Otherwise, late claims may be paid if there is enough to pay them, but will be put last on the distribution list.
In addition to filing a proof of claim in a Chapter 13 bankruptcy, creditors must object to debtor’s payment plan if it does not provide for the creditor’s claim properly (balance, interest or otherwise). Interest can often be compromised on general consumer debts in a Chapter 13. Additionally, some secured debts can be “crammed down” based upon the value of the collateral at issue (secured vs. unsecured portion of debt). This cram down option applies to car loans, mortgages on investment property, and second mortgages. A debtor cannot cram down debt on a first mortgage on primary residential real estate or car loans that were incurred within 910 days of the bankruptcy filing. A debtor can still compromise interest per Till. Finally, interest cannot be compromised on tax claims if set by statute.
In 2011, changes were made to the Bankruptcy Rules regarding the filing of proofs of claim. Specifically, while Rule 3001 always required written support for claims, now a creditor must also attach information relative to the principal, interest, fees, and other expenses incurred pre-bankruptcy. The rule also deals with the finality of Chapter 13 cases and requires principal residence mortgage creditors to file and serve the debtor, debtor’s counsel, and the trustee a notice of any change in payment amount, post-petition fees, expenses, and charges. Finally, at the end of a Chapter 13 plan, the trustee shall file and serve on creditor, debtor, and debtor’s counsel a notice stating that the debtor has paid in full the amount required to cure any default on the mortgagor’s claim. Failure to comply with these provisions can result in sanctions.
If a creditor is given notice of, and fails to file a proof of claim in a Chapter 7 bankruptcy, the creditor will not receive distribution of any assets. If the debt is otherwise dischargeable, it will be discharged. If the debt is otherwise non-dischargeable, the failure to file claim in a Chapter 7 asset case will not affect its post-discharge status. If a creditor is given notice of, and fails to file a proof of claim in a Chapter 13 case, the debt will discharge if debtor receives a discharge order (unless the debt is taxes or student loans, which are otherwise non-dischargeable). If a creditor is not given notice of a bankruptcy, the creditor can file a late proof of claim in either a Chapter 7 or 13. Security interests and liens will pass through a bankruptcy, even if the underlying debt discharges, unless the court specifically orders a lien to be set aside.
Debtors must file a notice of intent for any secured collateral they possess at the time their bankruptcy petition is filed. This must be done within 45-days of the 341 hearing. Debtor can surrender collateral, redeem collateral for its fair market value on the date of the bankruptcy petition, or reaffirm the underlying debt that is secured by the collateral.
V. Avoidance Actions
Trustees (and sometimes debtors) can file avoidance actions to set aside liens, demand turnover of preferences (as discussed earlier), and set aside fraudulent transfers of property. Generally, liens pass through any bankruptcy, regardless of whether or not the underlying debt is discharged. However, judicial liens can be avoided under specific circumstances (except for nonpossessory, nonpurchase money liens on household goods, tools of the trade or professionally prescribed health aids). Statutory liens cannot be avoided. Lien avoidance differs from lien stripping, insofar as lien stripping avoids even voluntary liens if there is no value in collateral for the lien to attach (with the exception of mortgages on debtor’s principal residence, as mentioned earlier).
In addition to lien avoidance and lien stripping, a trustee can avoid a bank security interest if the creditor failed to properly perfect the security interest (e.g., UCC-1 statement that fails to identify the debtor correctly). Trustees can avoid fraudulent transfers, which generally follow the laws of the state where the transfer was made.
VI. Dischargeability of Debts
The goal of a consumer bankruptcy is generally to obtain a discharge of all dischargeable debts. The discharge is a statutory injunction against the commencement or continuation of an action to collect, recover, or offset a debt. Generally, it eliminates a debtor’s legal obligation to pay a debt. However, there are several exceptions to the bankruptcy discharge , which include:
1) Domestic support obligations;
3) Student Loans unless debtor can show undue hardship/inability to repay ;
4) Criminal fines, penalties, forfeitures or criminal restitution obligations;
5) Personal injury or death resulting from an accident while intoxicated;
6) Debts not properly listed in Chapter 7 asset or Chapter 13 cases;
7) Debts deemed non-dischargeable; and
8) Debts owed to certain retirement plans for certain types of loans to these plans.