Table of Contents
1. General Benefits. A bankruptcy filing under Chapter 7 allows individuals to eliminate most unsecured debts. The main reason for filing any bankruptcy case is to obtain a “discharge” or release of debts. In a Chapter 7 case, the debtor is not required to pay any of the debts owed to most unsecured creditors, but may elect to reaffirm (remain personally liable to pay) specific debts. Index
In approximately 99 percent of all consumer Chapter 7 cases, the debtor will keep all property, and eliminate most debts. The entire process is normally over, and the case is closed, within approximately 4 months after it is filed.
After the bankruptcy is over, the debtor is legally entitled to selectively pay any or all of her debts, if she feels a moral obligation to pay. However, the debtor can not be legally compelled to pay any discharged debt, and creditors are legally required to stop all collection efforts, including all collection calls, letters, lawsuits and garnishments.
2. Liquidation Proceeding. Chapter 7 is commonly known as a “liquidation” proceeding because the trustee is entitled to seize and sell the debtor’s non-exempt assets, and distribute the proceeds to creditors. However, in almost all consumer Chapter 7 cases, the debtor will keep all property because it is either: Index
(a) exempt from seizure under federal or state law; or
(b) so low in value that the trustee will elect to abandon it (i.e. not take it from the debtor).
Therefore, the term “liquidation” proceeding is a misnomer since approximately 99 percent of all individuals keep all of their property. See the page entitled “Exemptions” for a discussion of the property that can be protected from seizure in bankruptcy.
3.1. Virtually All Property is Included in the Bankruptcy Estate. The filing of a bankruptcy case creates a “bankruptcy estate.” All assets owned by the debtor on the date the case is filed become part of the bankruptcy estate.” It includes all land, vehicles, and other personal property. It also includes all intangible property, such as damage claims the debtor may have against others (e.g., the debtor’s right to sue people – even if the debtor has not already filed the lawsuit), accounts receivable (debts owed to the debtor by others) or the debtor’s right to receive commissions. Virtually everything of any possible value which the debtor owns, holds or may be entitled to receive is property of the bankruptcy estate. Index
3.2. Community Property Rules. In Texas (and several other states including Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Washington, and Wisconsin), state law classifies property owned by married persons as either “separate” (belonging to only one spouse) or “community” (jointly owned by both spouses).
(a) property owned or claimed by the spouse before marriage;
(b) property acquired by the spouse during marriage by gift or inheritance; and
(c) damage recoveries for personal injuries sustained during marriage, except any recovery for loss of earning capacity during marriage.
3.2.2. Community Property Defined. Community property is defined by Texas state law as all property, other than separate property, acquired by either spouse during marriage. Index
3.2.3. Name on Title Irrelevant. It is irrelevant how the property is titled. Property titled in only one spouse’s name, but acquired during marriage, is still classified as community property. For example, a house or car acquired during marriage are community property even if the title is placed in only one spouse’s name. Index
3.2.4. Bankruptcy Estate Includes All Community Property. The bankruptcy estate includes all community property, even if only one spouse files for bankruptcy. If only one spouse files for bankruptcy, the bankruptcy estate includes all community property, plus all of the filing spouse’s separate property. The filing spouse must disclose all community property, and it is subject to seizure and sale by the bankruptcy trustee unless it is exempt under applicable law. Index
For example, assume that during marriage, the husband purchases a house and car. The title to both the house and car are placed only in the husband’s name. The wife files for bankruptcy. The husband does not join in the bankruptcy filing. The house and car are both part of the bankruptcy estate and must be disclosed on the bankruptcy schedules. The bankruptcy trustee can seize and sell the house and car unless it can be lawfully claimed as exempt under applicable state or federal law.
3.3. Property Excluded from Bankruptcy Estate. The following types of property are excluded from the bankruptcy estate in any bankruptcy case. These type of property are not subject to seizure, and can not be administered in a bankruptcy case. Index
3.3.1. Trusts and Pension, Retirement and Profit Sharing Plans. The assets contained in, and ongoing contributions made to most trusts, and most pension, retirement and profit sharing plans, are not property of the bankruptcy estate and can not be seized by the bankruptcy trustee. If the trust or retirement plan has a provision preventing the proceeds from being transferred or assigned, and the provision is enforceable under federal or state law, the assets are excluded from the bankruptcy estate. Almost all retirement plans and trusts have such a provision. Index
3.3.2. Education IRAs and State Tuition Programs. Special rules apply to contributions made to Education IRAs (also known as an Coverdell education savings accounts) and State Tuition Programs (such as Texas Tuition Promise Fund and Texas Tomorrow Fund). Funds placed in Education IRAs and State Tuition Programs are excluded from the bankruptcy estate (and can not be reached by creditors or a trustee) if: Index
(b) Deposits between 1 Year & 720 Days of Filing. The deposit is made between 1 and 720 days before the bankruptcy petition is filed and are not in excess of the IRS deduction limits for that year ($2,000 in 2009).
All deposits that do not meet these requirements are property of the bankruptcy estate and are potentially seizable by the trustee or creditors.
3.4. Possession of Property in Bankruptcy Estate. As a technical legal matter, the bankruptcy trustee assumes legal control over all property of the bankruptcy estate immediately upon the filing of the case. The debtor can not lawfully sell or transfer any property unless: Index
(a) the court signs an order permitting the sale; or
(b) the trustee abandons the assets back to the debtor, which normally occurs at or shortly after the creditor’s meeting.
However, as a practical matter, in virtually all consumer cases, the trustee never takes actual physical possession of any property. The trustee will normally only take physical possession of property if it becomes clear that the property is not exempt and the debtor is not legally entitled to keep it.
3.5. Filing Date Rule. Index
3.5.1. General Rule. In a Chapter 7 case, the bankruptcy estate is limited to property owned by the debtor on the date the case was filed. Any property that the debtor obtains after the case is filed does not become part of the bankruptcy estate, and the trustee is not entitled to take it. Index
For example, assume that several weeks after filing for bankruptcy, the debtor buys a power ball lottery ticket with funds earned after the case was filed. He wins 75 million dollars. Debtor is not obligated to give any of the money to the trustee for distribution to creditors because the ticket was purchased after the case was filed, with funds earned after the case was filed.
3.5.2. Exceptions to Filing Date Rule. There are only three exceptions to the filing date rule. If within 180 days (6 months) after the date the case is filed, the debtor becomes entitled to receive any property: Index
(a) from an inheritance;
(b) from a property settlement agreement reached with a former spouse or contained in a divorce decree; or
(c) as a beneficiary of a life insurance policy or death benefit plan;
the property becomes part of the bankruptcy estate and can be taken and sold to satisfy the claims of creditors, unless it is exempt.
3.6. Trustee’s Right to Inventory Assets. In every bankruptcy case, the debtor is required to file a list of all property owned on the date the case was filed. The trustee also has a legal right to visit the debtor and personally count her assets. However, in consumer cases, the trustee will almost never physically make an inventory of assets to determine if the debtor accurately disclosed all of her property. There are several reasons why a trustee will not be inclined to verify the accuracy of a debtor’s property list: Index
(a) The trustee has no incentive to personally inspect assets. The trustee only receives a $60 flat fee for administering each Chapter 7 case, unless he locates and sells non-exempt assets, in which case he will receive a percentage of the amount received. The trustee does not have the time to inspect assets. In 99 percent of all cases the trustee would never receive any compensation for personally inspecting the assets.
(b) The debtor’s property list is made under penalty of perjury. A debtor can be criminally prosecuted for perjury and serve prison time if the property list is not accurate.
As of May 2009, I have handled approx. 2,500 bankruptcy filings for debtors. I have been involved in less than 10 cases in which the trustee or his representatives personally inspected a debtor’s assets. In almost all of those cases the debtor had possession of business assets and the trustee wanted to verify the fair market value of the property. I have only been involved in 2 or 3 consumer cases in which the trustee or his representatives personally inspected a debtor’s personal, non-business assets.
4. Secured Debts. Secured debts are debts on which the creditor holds a “security interest” or “lien” on specific property to secure payment of the debt. If the debt is not paid, the creditor can seize and sell the property to satisfy the debt. Most home loans, vehicle loans and department store purchases are secured debts because the contract documents will generally allow the creditor to repossess the property if the loan is not repaid. In business cases, the repayment of most bank loans are secured by a lien on the business assets, including the business equipment, inventory, furniture, vehicles and accounts receivable. Index
4.1. Liens Survive Bankruptcy. In a Chapter 7 case, a “lien” against property will survive the bankruptcy, but the debt will be discharged. This means that the creditor can never attempt to recover the debt as a personal liability of the debtor. However, after bankruptcy, if the debt is not paid, the creditor can enforce the lien by repossessing the property, selling it, and applying the proceeds to satisfy the debt. Index
4.2. Options for Dealing with Secured Debt. A debtor in a Chapter 7 case filed in Texas (or anywhere in the Fifth Circuit), the debtor will have four options for dealing with secured debt: Index
(a)) give the property back and owe nothing;
(b) keep the property and reaffirm the debt;
(c) redeem the property by paying the creditor, in cash, the full market value of the property; or
(d)) renegotiate the contract in an attempt to lower the payments or interest rate.
4.3. Reaffirmation Agreements. Index
4.3.1. Generally. For home and vehicle loans, a debtor that wants to keep the property may be required to sign a “reaffirmation agreement.” A “reaffirmation agreement” is a contract which waives the bankruptcy discharge with respect to a particular debt. A debtor that signs a reaffirmation agreement must continue making the contract payments and will remain personally liable on the reaffirmed debt if he fails to pay. The reaffirmed debt will be completely unaffected by the bankruptcy filing, and will survive the bankruptcy discharge, as if the bankruptcy had never been filed. Index
Unsecured creditors will often solicit a debtor to reaffirm all or a portion of an unsecured debt by offering to extend additional post bankruptcy credit. The unsecured creditor will usually try to sell the reaffirmation agreement by arguing that the additional credit will help the debtor to reestablish a positive post bankruptcy credit history and minimize the adverse impact of the bankruptcy on the debtor’s credit report. It is almost never a good idea for a debtor to reaffirm a completely unsecured debt. Almost all debtors will have numerous sources for obtaining post petition credit, and can reestablish a positive post bankruptcy credit history, without agreeing to pay any portion of the prior debt.
4.3.2. Rescission of Reaffirmation Agreements. The Bankruptcy Code permits a debtor to rescind a reaffirmation agreement at any time prior to the date the Bankruptcy Court issues a discharge order, or within 60 days after the reaffirmation agreement is filed with the court, whichever event occurs later. In other words, a debtor that signs a reaffirmation agreement can change her mind until the later of: Index
(a) the date the court issues a discharge order, or
(b) 60 days after the reaffirmation agreement is filed with the court.
The Bankruptcy Code states that a reaffirmation agreement can be rescinded merely by “giving notice of rescission” to the creditor. Written notice is not legally required; oral notice is sufficient. However, a debtor will find it virtually impossible to prove that she verbally gave notice of rescission. Therefore, as a practical matter, to properly rescind a reaffirmation agreement, the debtor (or her attorney) should always prepare and send a written notice to the creditor expressing her intent to rescind the agreement.
4.4. Redemption of Property. Redemption permits a debtor to obtain possession of (and title to) collateral for a loan by paying its market value instead of the contract price. The redemption procedure permits a debtor to avoid paying the full contract amount for property that has depreciated in value. Index
4.4.1. Informal Redemptions. An informal redemption occurs if the debtor and creditor reach an agreement concerning the value of the collateral and payment terms. Most department stores will negotiate with debtors concerning the amount and terms of payment, including the interest rate and amount of any monthly payments. Index
An “informal” redemption is informal because the debtor and creditor negotiate the deal between themselves. The bankruptcy court stays out of the process. All price and payment terms can be negotiated in an informal redemption.
Most redemptions are informal because both the debtor and creditor have an incentive to compromise. The debtor will usually want to keep the property if he can pay a reasonable price on fair terms. The creditor will gain little or nothing by taking the property. It is difficult for most creditors to profit from selling used consumer goods in a retail store. The repossession, storage and sale costs make it economically unwise for creditors to play hard ball in negotiating a redemption of consumer goods.
4.4.2. Formal Redemptions Index
(a) Basics. A “formal” redemption is a bankruptcy court procedure permitting the debtor to redeem the collateral. To start the procedure, the debtor’s attorney must file a written motion requesting the court to authorize the redemption. The court will determine the property value and enter an order requiring the creditor to deliver the property (and legal title) to the debtor when the debtor pays the money. Index
A formal redemption is useful only if the debtor and creditor can not agree on the property value. Most creditors understand (or should understand) that if the debtor and creditor agree on the property value, it is pointless to force a debtor through a formal redemption process because the right to redeem is automatic. The only real function of the court in a formal redemption is to establish the redemption amount (the market value of the property) and force the creditor to complete the transfer.
(b) Legal Requirements. The formal redemption procedure is not available unless the debtor can prove the following: Index
(ii) Dischargeable Debts Only. The property must secure a dischargeable debt. A debtor can not formally redeem property securing a debt that is non-dischargeable in bankruptcy, such as a student loan, divorce settlement, or non-dischargeable tax debt.
(iii) Exempt Property Only. The property must be exempt from seizure under applicable federal or state law. See the “Exemptions” page for a discussion of federal and state exemptions.
(c) Disadvantages. The formal redemption procedure is rarely used because of two major limitations: the legal cost and the requirement of a cash payment. Index
(i) Legal Cost. A major draw back of formal redemption is the legal cost. To complete a formal redemption, the debtor’s attorney will need to prepare a motion and proposed order, and appear at a court hearing. The hearing may involve a small trial on the valuation issue. The debtor may also need to hire an expert to appraise the property and appear in court to testify about the value.
(ii) Cash Payment. Formal redemption also requires the debtor to pay the full amount in cash. The court may not allow the debtor to pay the redemption amount in installments. Most debtors do not have the funds available to pay for the property in cash.
5. Priority Debts. The Bankruptcy Code contains a list of 9 different types of unsecured debts which have “priority” status over other unsecured debts. If money is available for distribution to creditors (a rare occurrence in a consumer Chapter 7 case), creditors holding priority claims will receive payment before any other unsecured creditors. All priority debts are “unsecured” because no specific property secures repayment of the debt. Priority claims receive payment in accordance with their rank in the priority scheme. Priority claims with a higher rank must be paid in full before priority claims of a lesser rank will receive any payment. Index
Most priority classifications are not relevant in consumer Chapter 7 cases. The most important types of priority debts, and their rank, are as follows:
5.1. Domestic Support Obligations. First priority: debts for child support, spousal support or alimony. The definition of a “domestic support obligation” is very broad, and includes debts: Index
(a) owed to a spouse, former spouse, child of the debtor, such child’s parent, legal guardian, or responsible relative, or a governmental unit;
(b) for alimony, maintenance, or support (including assistance provided by a governmental unit) of such spouse, former spouse, or child of the debtor or such child’s parent,
(c) assessed either before or after the case is filed;
(d) not assigned to a nongovernmental entity, unless voluntarily assigned by the beneficiary of the support for the purpose of collecting the debt.
5.2. Administrative Expenses. Claims for expenses incurred by the trustee or debtor in preserving estate property, including wages, salaries or commissions for services rendered after the case has been filed. This category includes attorney’s fees incurred by the trustee or debtor in preserving estate property, or bringing property into the estate. Index
5.3. Tax Claims. Debts owed to governmental units for certain unpaid taxes. The following tax claims are considered priority debts: Index
5.3.1. Income Taxes. Any income tax if: Index
(a) less than 3 years elapse between the date the bankruptcy is filed and the date the tax return was last due, including all extensions;
(b) the tax is assessed within 240 days of the date the bankruptcy is filed; or
(c) the tax has not been assessed, but is legally assessable after the bankruptcy is filed (e.g. additional taxes assessed as a result of an audit).
5.3.2. Employment Taxes. Most employment taxes owed by employers. Index
5.3.3. Sales Taxes. A sales tax owed to a governmental entity. Index
5.3.4. Property Taxes. A property tax more than one year in default before the bankruptcy petition is filed. Index
See the page entitled “Discharging Tax Debts in Bankruptcy” for a more detailed discussion of the classification and dischargeability of tax claims in bankruptcy.
6. General Unsecured Debts. All debts other than secured and priority debts are classified as “general unsecured debts.” Unsecured debts are debts which do not entitle the creditor to repossess any specific property if the debt is not paid. A “general” unsecured debt is an unsecured debt which is not entitled to priority. Index
Most credit card debts and medical bills are general unsecured debts. Debts obtained through the entry of a court judgment are also general unsecured debts, but can become secured against specific property if the judgment holder takes steps to secure the judgment in accordance with state law.
7. Chapter 7 Process – From Start to Finish. The following is a chronological summary of the Chapter 7 bankruptcy process, the events which occur in a Chapter 7 case, and the time periods at which these events occur. Index
7.1. Office Interview with Attorney. The first step for most debtors is to consult an attorney. The debtor should meet with an attorney for between 30 to 60 minutes on the first visit. The initial meeting should normally include a discussion of whether a bankruptcy filing is appropriate, the form of bankruptcy relief which is proper (normally either Chapter 7, 11 or 13), alternatives to bankruptcy, the bankruptcy process, and credit considerations of a bankruptcy filing. Index
The initial meeting should include a personal consultation with a licensed attorney. Do not hire a law firm that does not permit you to meet with an attorney on the first visit. Paralegals are indispensable to the law practice of most bankruptcy attorneys. Paralegals can also be very helpful in screening potential clients and relating basic legal information. However, paralegals are not licensed to practice law nor permitted to give individual legal advice. Paralegals, even very good ones, are never an acceptable substitute for a qualified, licensed attorney.
7.2. Bankruptcy Paperwork. A debtor will be required to file several documents with the court If he decides to file a bankruptcy case. These documents contain disclosures of essentially everything about the debtor from a financial standpoint for several years before the case is filed. These documents are called the bankruptcy “schedules” and “statement of financial affairs,” and contain the following information: Index
7.2.1. Petition. The bankruptcy petition is a document filed with the bankruptcy court to begin a bankruptcy case. The petition contains basic identifying information about the debtor, including her name, address, telephone number, social security number, and the chapter under which bankruptcy relief is sought. Index
7.2.2. Property List. The property list must disclose all property the debtor owns on the date the case is filed, and give an estimated value for each item. The property list must be itemized, showing each item, and an estimated market value for each item. See “3. Bankruptcy Estate” for a discussion of the property which comprises the bankruptcy estate and must be disclosed on the property list. Index
7.2.3. Creditor List. The creditor list must disclose the name and address of all creditors. There are 3 separate creditor lists which categorize the creditors according to whether the debt is a secured, priority or general unsecured debt. Index
Approx. 25 percent of all debtors intend to pay one or more of their unsecured debts, even after their bankruptcy has been completed. Many debtors believe that they will be able to keep a credit card and/or rehabilitate their credit report if they omit one or more credit cards from the creditor list. Not only is this is very poor strategy from a financial standpoint, it violates the bankruptcy laws. The debtor is legally required to disclose and list all creditors, regardless of whether she debtor intends to continue paying the debt.
7.2.4. Budget. The debtor must list and disclose her current monthly income and expenses, and disclose any anticipated changes in income of more than 10 percent within one year after the case is filed. Index
7.2.5. Statement of Financial Affairs. The statement of financial affairs is a list of 25 questions inquiring about the debtor’s financial transactions over the past several years. Almost all significant financial transactions over the past several years must be disclosed on the statement of financial affairs. Index
7.2.6. Means Test. This document contains an inflexible calculation of the debtor’s average income during the 6 months prior to the date on which the case is filed. It then compares the debtor’s average income with the median income of similar households for the same state and IRS expense allowances for the area in which the debtor lives. It also lists several categories of the debtor’s actual ongoing monthly expenses such as mortgage and car payments, tax payments, medical expenses, insurance payments, child support and alimony payments, and child support payments. Index
The purpose of the test is to attempt to determine whether the filing of a Chapter 7 case is abusive. The calculations are very complicated. They are similar to calculating a tax return, but in many respects are much more difficult. A means test should never be attempted by an individual without the assistance of a qualified attorney.
7.3. Filing Petition and Schedules. The filing of the bankruptcy petition is the event which commences a bankruptcy case. When the petition is filed, the court clerk will assign a case number, judge and panel trustee. Index
In most Chapter 7 cases, the bankruptcy petition will be filed at the same time as the other required paperwork (the bankruptcy schedules and statement of financial affairs). However, the debtor may elect to file only the bankruptcy petition and list of creditors, and file the other documents later. This is normally done if the filing needs to be done quickly to prevent an impending foreclosure or repossession, or the collection of a court judgment. If the debtor elects not to file the schedules and statement of financial affairs along with the petition, these documents must be filed within 15 days after the bankruptcy petition is filed. The court will dismiss the case if these documents are not promptly filed.
7.4. Trustee Index
7.4.1. Appointment. Immediately upon the filing of the bankruptcy petition, a bankruptcy trustee will be randomly assigned from a pool of “panel trustees.” Panel trustees are individuals that have been pre-screened and hired to act as Chapter 7 trustees by the U.S. Trustee of the district in which they serve. The panel trustee will receive a copy of all bankruptcy paperwork after it is filed. Index
In the Houston Division of the Southern District of Texas, there are approximately 10 persons that serve as Chapter 7 panel trustees. All of these persons are bankruptcy attorneys, except one, who is a Certified Public Accountant.
7.4.2. Role of the Trustee. The basic purpose of the panel trustee is to serve as an investigator for the court. In 99 percent of all Chapter 7 cases, the debtor will never see a bankruptcy judge. The debtor will appear before a judge only if a serious question is raised about the case. In virtually all Chapter 7 cases, the trustee (or the trustee’s staff) is the only person that will review the case. The trustee has two basic investigatory roles: Index
(a) Asset Investigation. The trustee’s main role is to determine whether the debtor has any non-exempt assets which the trustee is entitled to seize from the debtor. If the debtor has non-exempt assets, the trustee may seize and sell the assets, and distribute the proceeds to creditors on a pro rata basis. Index
(b) Income / Expense Investigation. A second important role of the trustee is to determine if the debtor is abusing the bankruptcy process. A Chapter 7 case involving mostly consumer debts will be considered abusive if the debtor has sufficient income to pay a significant portion of the unsecured debt. Index
7.5. Creditor’s Meeting. In every Chapter 7 bankruptcy case, the debtor is required to make one appearance at a “creditor’s meeting.” The meeting for any given case will be grouped with approximately 30 other similar cases. The group of cases, commonly referred to as a “trustee panel” of cases, are all given to a single trustee. Index
7.5.1. Location. The creditor’s meeting for cases filed in the Houston are currently held at the U.S. Trustee’s office, located at the U.S. Courthouse. Index
7.5.2. Date. The creditor’s meeting is normally held between 20 and 40 days after the bankruptcy petition is filed. The meeting can never be scheduled at the convenience of the debtor or his attorney. The court will issue a notice specifying the date and time of the meeting. The debtor must attend on the scheduled date and time. If the debtor can not attend on the scheduled date, the trustee will normally agree to reschedule the meeting at least once. However, the new meeting date will be reset to one of the next available panels for that particular trustee. The trustee will never agree to appear at the courthouse and conduct a meeting for a single case. Index
7.5.3. Length of Meeting. Most creditor’s meetings last between 4 and 30 minutes, depending on the trustee and complexity of the case. Simple cases normally last 5 minutes or less. Complex or contentious cases can last 30 minutes or more. The meeting for each case on the panel will be scheduled to start 5 minutes apart from one another. Index
7.5.4. Presiding Officer – Who Comes to the Meeting? The Chapter 7 trustee will preside at the creditor’s meeting. All creditors are invited to attend and ask the debtor questions about his debts and assets. In 99 percent of all cases, no unsecured creditors will appear at the meeting. Unsecured creditors normally come only if they believe that the debtor is guilty of misconduct sufficient to warrant a denial of discharge. The only creditors that will normally appear with any frequency are secured creditors seeking to determine the debtor’s intentions with respect to their collateral, and whether the debtor will sign a reaffirmation agreement. Index
7.5.5. Focus of Trustee’s Investigation. The trustee will begin the meeting by asking the debtor various questions about his debts, assets and budget. The trustee’s questions are normally focused on two areas: Index
(a) Sufficient Property to Administer? Does the debtor have any non-exempt property, and if so, is the property valuable enough for the bankruptcy estate to realize a substantial dividend for creditors? In other words, does the debtor own sufficient non-exempt property to justify taking it, selling it, and distributing the proceeds to creditors. The panel trustee may ask questions directed at verifying whether the debtor has disclosed all of his property, and the accuracy of the estimated values given for the property. Index
(b) Substantial Abuse of Bankruptcy Process? The second major focus of inquiry is whether the debtor is abusing the bankruptcy process by filing a Chapter 7 case instead of proposing a repayment plan under Chapter 13.
There are many ways that a debtor can abuse the bankruptcy process. However, the main inquiry is usually whether the debtor’s budget shows that he can afford to pay at least some of the unsecured debt. If the debtor’s income exceeds her monthly expenses, the trustee may conclude that the debtor is abusing the process by attempting to discharge her debts without making any payment, rather than proposing a repayment plan under Chapter 13. Index
Most court opinions on this subject agree that if the debtor’s monthly income exceeds her reasonable monthly expenses, the case should be dismissed as an abuse of the bankruptcy process. The only way to avoid this result is if the debtor’s reasonable monthly expenses, as shown on the budget submitted to the court, equal or exceed monthly income. High income debtors (doctors, lawyers, engineers, etc.) attempting to file under Chapter 7 pose a much greater challenge for the debtor’s attorney, and have a much higher risk of drawing scrutiny from the trustee.
Under current practice, this function (determining if the bankruptcy filing is abusive) has been taken over completely by the U.S. Trustee’s office. The panel trustees generally do not concern themselves with abuse issues. The attorneys and paralegals at the U.S. Trustee’s office independently review the schedules and other documents. The focus is on the means test and the budget (Schedules I and J) to determine if the case shows an ability to repay a portion of the debt. If the U.S. Trustee has questions or believes that the case is abusive, an attorney or paralegal will request the debtor’s attorney to produce additional documents before or at the creditor’s meeting. A U.S. Trustee representative will also appear at the creditor’s meeting and ask the debtor additional questions concerning his income, expenses or other issues that could establish abuse.
(a) No-Asset / No Abuse Cases. In most cases, at the conclusion of the creditor’s meeting, the panel trustee will announce that he will allow the exemptions claimed by the debtor, abandon all non-exempt property, and close the case as a “no asset” case. This means that the trustee is satisfied that the debtor does not have any assets worth administering and the debtor has not abused the bankruptcy process. The panel trustee’s investigation will then end. Index
(b) Asset or Abuse Cases. In a small portion of cases, at the conclusion of the creditor’s meeting, the panel trustee will announce that he intends to keep his file open and continue the investigation. This can be done for several reasons: Index
(i) Potential Asset Recovery for Creditors. If the panel trustee believes that significant non-exempt assets may be available for creditors, he will keep the case open and further investigate the debtor’s assets. This could include requesting additional documents from the debtor, a personal inspection of assets, or any other action the trustee believes is necessary to properly investigate the debtor’s assets.
(ii) Abusive Filings. If the U.S. Trustee believes that the bankruptcy filing might be abusive, he may keep the case open to further investigate the debtor’s budget. If there is a question concerning the accuracy of any income or expense numbers on the budget, he may request the debtor to provide proof that they are accurate. If the trustee, after further investigation, believes that the debtor can afford to repay a portion of the unsecured debt, he will file a motion to dismiss the case.
7.6. Dismissal Hearing. Under current law, the U.S. Trustee, any creditor, or the court on its own initiative, may request a case to be dismissed as an abusive filing. If the U.S. Trustee or a creditor files a motion to dismiss the case, the court will conduct a hearing. The U.S. Trustee and the debtor will present evidence at the hearing. If the court believes that the filing was abusive, the debtor will normally have two options: (a) convert the case to a Chapter 13 case, and propose a plan to repay some or all of the unsecured debt; or (b) the case will be dismissed. If the case is dismissed, the debtor will be back in the same position he was in before the case was filed. Index
7.7. Discharge Contest. A discharge contest is a lawsuit filed by the U.S. Trustee, panel trustee, or a creditor seeking to prevent the debtor from receiving a discharge of one or more debts. A discharge contest must be filed within 60 days after the creditor’s meeting is first scheduled to start. A discharge contest may not be filed after the 60 day time period, unless an extension of the deadline is requested before the deadline expires. Index
A discharge contest must allege specific misconduct on the part of the debtor justifying the denial of a discharge. See the page entitled “Non-Dischargeable Debts” for a summary of the various forms of misconduct which will justify denial of a bankruptcy discharge. If a timely discharge contest is filed, the bankruptcy case will be kept open until the discharge contest has been decided.
Most discharge contests are filed by a single creditor claiming that the debtor should not receive a discharge of the debt owed to him. For cases filed by my office, the average likelihood of a drawing a discharge contest from a creditor or panel trustee has been less than 1 percent.
It is unusual to get more than one discharge contest in any given case. In the over 2,500 cases handled by my office, I have only encountered one case in which more than one creditor filed a discharge contest in the same case.
The panel trustee has a right to file a discharge contest which seeks to completely bar the debtor from receiving a discharge of all debts. This type of case is very unusual indeed. I have never encountered such a case in my practice.
7.8. Discharge Order. After the creditor’s meeting is adjourned, the debtor must wait for 60 days the court enters a discharge order. If neither a dismissal motion nor discharge contest are filed, the court will enter a discharge order declaring that all of the debts have been discharged (i.e. released, forgiven). At the same time the court issues the discharge order, it will also normally issue and order closing the case. The order closing the case is the last event that will occur in the case. Index