Most people understand that by filing for bankruptcy a person can eliminate certain kinds of debt, like credit cards or medical bills. However, what is seldom understood is that the most important question in any bankruptcy case is whether a Debtor (the person filing for bankruptcy) is required to pay anything back to his or her Creditors (the people or entities to whom money is owed).
In every single bankruptcy case, the Court will examine three areas to determine whether any funds must be paid to creditors: Income, Assets, and Transactions. When Debtors are not required to pay anything, then their case will most likely be a simple, routine Chapter 7, which normally lasts 3-4 months from the time it is filed until the time it is discharged and closed. If an amount needs to be paid back, then the question becomes how much and over how much time. This analysis determines whether the Debtor can still file the quicker Chapter 7 bankruptcy or if the Debtor’s only option is to file a Chapter 13, which involves a monthly repayment plan of up to 3-5 years.
Income
The last 6 months of the Debtor’s income is examined and compared to IRS standard median income figures based on the Debtor’s county of residence and household size. If the Debtor’s income is less than the IRS standard amount, then the Debtor is not required to pay anything back based on income and the Debtor is eligible to file a Chapter 7 bankruptcy.
If the Debtor’s income is higher than the IRS standard amount, there is still a chance for Chapter 7 eligibility, but a much more thorough analysis of income and expenses must be completed in what is called the Means Test. In the Means Test, IRS standard expenses are used in some areas of the budget and a Debtor’s actual expenses in others. Once all the applicable expenses are subtracted from the monthly income, the remaining amount is called the “disposable monthly income” which represents the amount the Debtor has available to pay creditors monthly. If the disposable monthly income is less than approximately $160-175/month then Debtors are still eligible to file for a Chapter 7 bankruptcy. If the disposable monthly income is higher than that amount, then the only available bankruptcy option for most people is Chapter 13, where monthly payments are made to creditors for a period of 5 years based on the Debtor’s disposable monthly income.
Assets
Debtors are entitled to certain protections on their assets called “exemptions.” The type of exemptions that are available depend on the state where the Debtor resided over the 2-year period prior to filing the bankruptcy. Some common examples of exemptions are retirement accounts, social security income, homestead, motor vehicles, personal property, and life insurance policies. Please note that some of these protections, like vehicles and personal property have limits on the amount that you can claim as exempt. To the extent that the value of a Debtor’s assets exceeds the limits of their exemptions, the Debtor would be required to pay creditors the difference between those amounts.
For example, if the Debtor owned a vehicle free & clear (i.e., no liens, loans or encumbrances) that had a value of $5,000 but the Debtor only had $2,000 in available exemptions to claim on the vehicle, then the Debtor would be required to pay the difference ($3,000) to the creditors. In Chapter 7 cases, Debtors may have approximately 3-6 months to pay this amount back, depending on the circumstances. Debtors may also choose to surrender their non-exempt assets in Chapter 7 cases. The assets would be liquidated and the proceeds distributed amongst the creditors. Debtors may also opt to file a Chapter 13 to pay for their assets over a 3-5 years plan.
Transactions
There are two types of transactions that can cause a distribution to creditors: Fraudulent Transfers and Preferential Payments. Fraudulent Transfers can come in many different forms as they include any transfer that occurred 2 years prior to filing the bankruptcy (some states likes Florida extend this timeframe to 4 years) in which a Debtor intended to “hinder, delay, or defraud” any creditors.
The most common example of a Fraudulent Transfer is when a Debtor transfers a vehicle to a friend or family member prior to a bankruptcy in exchange for nominal or no money. In many cases, the transfer is not completed with any ill intent, but rather an attempt to help out a family member in need. But because the transfer lacked proper consideration it is deemed constructive fraud. The Court’s remedy would be to “avoid” the transaction and treat the vehicle as if it were still in the Debtor’s name.
Preferential Payments occur when creditors are paid within a certain period prior to filing the bankruptcy. The Court considers these payments as “preferential” to the creditors that received payment and that they are done at the expense of the other creditors. To remedy the situation, the Court takes back the money from the creditor who received the Preferential Payment and then distributes the funds equally amongst all creditors in the bankruptcy case.
If an aggregate total of over $600 is paid to any ordinary creditors within 90 days prior to filing the bankruptcy, it is deemed a Preferential Payment. For creditors who are considered “insiders” (e.g., family members, business partners, etc.) the 90-day period is extended to 1-year. This is why it is extremely important to make sure that you do NOT repay loans to family members prior to filing for bankruptcy.
Conclusion
During your initial consultation with a bankruptcy attorney, you should expect the attorney to conduct an analysis of your income, assets, and transactions. Only then will the attorney be able to tell you whether any funds must be paid and whether you belong in a Chapter 7 or Chapter 13 case.