Why are there different kinds of bankruptcy? The United States Bankruptcy Code is broken up into several chapters, and each chapter was created to adapt to the circumstances of specific kinds of entities and individuals. The bankruptcy chapters that concern us here are for individuals and various kinds of business entities.
Chapter 7 – Straight Bankruptcy and Return of Exempt Properties Only
Chapter 7 individual bankruptcies allow the person filing for bankruptcy to keep all their exempt assets (assets so designated from being taken by creditors or the bankruptcy trustee) and discharges all their debts. For the bankruptcy trustee, the goal of Chapter 7 is to liquidate all of the nonexempt assets belonging to the bankruptcy estate. Specifically, the bankruptcy trustee is appointed to gather all the nonexempt assets and sell those assets and distribute them pro rata to the creditors.
Chapter 7 filings can also include corporations and limited liability companies, general limited partnerships and similar corporate businesses . The primary goal of the Chapter 7 is to discharge all of your outstanding debt that is eligible. There are a number of rules of the bankruptcy law that limit your ability to do this and we will discuss some of those limitations in later chapters.
The chief reason many people file bankruptcy is to stay a foreclosure action on their home or investment property. The bankruptcy forestalls action and gives the debtor time to work out solutions to the impending foreclosure. Another chief reason is to stay a lawsuit and to remove it into the bankruptcy court.
Chapter 13 – Reorganizations for Individuals Only With Limited Claim Amounts
Chapter 13 filing is for individuals only, but there are strict eligibility requirements. You cannot have more than $383,175 in general unsecured creditor claims, or you cannot have more than $1,149,525 in secured claims. If you have more debts in either of these categories, you’re not eligible for a Chapter 13 filing.
The primary goal of Chapter 13 is to keep significant nonexempt assets from being taken. For example, in Nevada, real estate prices in some cases fell as much as 50%. If you had relinquished these real estate assets in a bankruptcy near the bottom of their valuations, you would not have been able to reap the benefits of the significant rebound in the last 36 months. The assets would be gone and you would not have regained their value for sale at a later date.
Chapter 13 allows you to make partial payments to your creditors for 3 to 5 years, and it is aimed at discharging all of your remaining unpaid debts at the end of the repayment period. Chapter 13, in many instances, will allow you to retain some or all of your nonexempt assets, so long as you pay for the value of those nonexempt assets in your Chapter 13 repayment plan. Chapter 13 cases also allow for modification of secured debts, including lien stripping and lien strip downs under certain circumstances.
Chapter 13 is a filing that also allows protection from creditors’ collection actions pursuant to section 362 of the Bankruptcy Code, including a stay of any foreclosures pending at the time of the bankruptcy filing, until further orders of the bankruptcy court.
Since the rewriting of the Bankruptcy Code in October 2005, known as Bankruptcy Abuse Prevention and Consume Protection Act (BAPCPA), there have been significant changes in the Bankruptcy Code, making it harder for individuals to discharge their debt if they exceed certain income limitations. The 2005 bankruptcy law set up a requirement for “means testing”. It specified income limitations that dictated whether or not an individual must “means test” in a Chapter 7 or Chapter 13 filing.
The essential idea for means testing is that a formula determines whether you really can afford to pay some money to your creditors. If your “means test” indicates that you have surplus disposable income, your only option is to pay a portion of your debts in a three to five-year Chapter 13 plan. In Chapter 7, your debts are simply discharged by turning over any nonexempt property. If you failed to means test by earning too much to qualify for a Chapter 7, your Chapter 7 case can be dismissed by the court or alternatively, you may elect to convert to Chapter 13.
In the event of a single individual filing for bankruptcy, the limit of the dollar amount limitations on means testing is currently $42,988, which means that you will have to complete the means test analysis if you have annual gross income in excess of this amount.
For a family of two, the limitation is $56,160; for family size of three people, the limitation is $56,160; and for family of four people, the means testing amount is $62,636.
Social Security benefits are not counted for the purposes of the means test. Other income that is not counted toward the means test is payments to victims of war crimes or victims of terrorism. Just about everything else is considered income, whether it’s taxable or not, including wages, salary, fees, commissions, bonuses, retirement income, tax refund, income from business dealings, sale of assets, net rental income, your share of partnership income, inheritances, support payments, awards, prizes, gifts, insurance payments and services.
There is one major exception to the means test. That is, if more than 50% of your debt is for business debt, the petitioner does not have to comply with the means test. For example, I had an airline pilot who worked for a major airline, and he made in the neighborhood of $285,000 a year, and his annual expenses after taxes, were only about $80,000 to $100,000.
Therefore, he had about $4,000 to $6,000 a month in surplus income to pay creditors. Since more than 50% of his debt was business-related, he did not have to comply with the means test requirements, which means he had $4,000 to $6,000 surplus income per month with which he did not have to pay his creditors.
The first thing that you need to know is that the odds are you probably won’t have to take the means test at all, provided you pass the “median test”. The median test says if your income for the six months preceding bankruptcy is less than the median income for your state, then you’re home free. The basic theory behind the median test is that a debtor earning more than the median income should not be able to simply walk away from his or her debts in Chapter 7, if they can pay a significant amount under a Chapter 13 repayment plan for three to five years.
If you earn less than the median income, you don’t have to worry about the means test. Again, the number one goal of means testing is to force debtors to repay a portion of the outstanding debt by forcing them into a Chapter 13 bankruptcy, which requires some repayment over 3 to 5 years.
After you calculate your income for purposes of means testing, you just need to figure out what expenses are allowed by the court. There are certain IRS national and local standards that set forth standard expenses to determine how much expense is allowable. The allowable expenses are the amount you get to keep before making repayments of your surplus to your creditors.
Passing the Means Test by Showing Special Circumstances
Special circumstances include health insurance, disability insurance, health savings accounts, expense necessary to protect your family from domestic violence, home energy cost in excess of IRS standards, expense for food and clothing for children above IRS standards, etc. If you have any of these, you might be exempt from the means test requirement.
Ways Around the Means Test
You might avoid the means test because of serious medical condition, call to the armed forces or special consideration for losing a high paying job.
Chapter 11 – Reorganizations for Individuals and Entities
Chapter 11 filings allow for individuals and business entities to file for reorganization, therefore allowing the petitioner to repay their general unsecured debts and their priority unsecured debts (such as taxes), over a period of time, such as five years.
Chapter 11 filings are usually for business debtors, either individuals or business entities, with business entities such as corporations, limited liability companies, partnerships etc. Chapter 11 filings are extremely complicated and time-consuming, but may be the way to go if you have substantial assets and you still want to exercise control them and survive financially.
Good example of Chapter 11 bankruptcy was General Motors, in 2008. They wanted to continue in business but needed time to reorganize their business to solve their businesses problems that lead to the downfall. They were able to reorganize their business under the Bankruptcy Code and now are profitable organizations, employing thousands of direct employees and many more thousands of suppliers. Another example would be Enron. Its objective was different. Enron desired to totally liquidate the company and its assets.
Of course, your company is probably not a massive multi-billion dollar enterprise, but you could still use the bankruptcy law to regain your financial balance, solve your creditor problems and continue in business. You can successfully use Chapter 11 bankruptcies as a strategic business tool.
Chapter 11 filings are a specialty unto their own. Most attorneys who concentrate on consumer bankruptcies have little experience in Chapter 11 cases. It is wise to seek out an attorney who has extensive experience in Chapter 11 business reorganization cases.
Experienced Chapter 11 attorneys need to be well versed in the “cram down” provisions of the Bankruptcy Code, also called a “forced acceptance,” which is found in 11 U.S.C. §1129(b). Not only are “cram down” situations involved, but an attorney must know the bankruptcy law and the bankruptcy judge to approach to contested confirmation hearing, in order to pursue reasonable loan extensions and adjustments in the interest rate. Without knowing the relevant case law, the facts and the bankruptcy previously confirmed cases, it is impossible for an inexperience bankruptcy attorney to attempt a Chapter 11 and navigate a Chapter 11 case through the “Rocky Shoals” of Bankruptcy Law.
In summary, the course of action involving cram down or a forced acceptance under certain terms and conditions are set forth in section 1129(a)(b) of the Bankruptcy Code. The provisions of the Bankruptcy Code governing Chapter 11 filings also allow for repayment of tax debt over a five year period commencing on the date of the assessment of the tax.
Further, the bankruptcy court has the authority under section 507 to determine the validity, extent and amount of tax claims. In the instance of an individual filing Chapter 11 relief, a partial discharge of debt is allowed if the individual debtor contributes their disposable income over a five-year plan.
This may seem like a lot of information but it is designed to protect you. Give us a call at (775) 786-7600 or (775) 690-9120 for a free and confidential consultation to discuss your financial situation, alternatives to bankruptcy and the many details of filing for bankruptcy whether it be chapter 7, chapter 11 or chapter 13.