Exceptions to Discharge

When you file a personal bankruptcy, there are a few things that can go wrong.  They are fairly unusual, and if you used an attorney to file your bankruptcy it is pretty likely you had a good idea going in whether something was likely to go wrong.  The fact patterns that lead to trouble are fairly obvious to an experienced bankruptcy attorney.

First some background.  Congress deliberately made it difficult to interfere with a bankruptcy.  Bankruptcy is a safety valve for society.  Our economy is based on small businesses selling products and hiring employees.  A lot of people would never take such a risky step, so it is important to protect those entrepreneurial people.  If someone's first business fails but they are put in debtors prison or forced to repay the debts for the next 50 years, they won't start a second or third business that might be successful.  No less a source than the Wall Street Journal has called America's bankruptcy system the engine of its economic prosperity.  Since bankruptcy serves such an important social function, it should be hard to derail.  It is.

Some debts automatically survive bankruptcy.  These are debts that Congress (sometimes foolishly) has decided are more important than the goal of discharging debts in bankruptcy to give people a fresh start.  Examples are child support, alimony, taxes, criminal fines, criminal restitution, student loans and injuries inflicted on third parties while the debtor was driving under the influence of alcohol or drugs.  This post is not about these automatic exceptions to discharge (although there is more to it than I have mentioned so far).  This post is about debts in a gray area.  They might survive bankruptcy and they might not.  These are the so-called "misconduct" exceptions to discharge.

The three major misconduct exceptions to discharge are fraud (oral or written), breach of a fiduciary duty to someone, and willful and malicious conduct.  Congress has deliberately slanted the playing field in favor of debtors (people who file bankruptcy).  Creditors must prove their case specifically.  It is insufficient for creditors to prove you owe them money; that is very reason you filed a bankruptcy.  Congress was obviously aware that sometimes large financial institutions can put tremendous pressure on debtors simply because they have the financial resources to pursue them in Court; some consumer exception cases can result in the bank having to pay your attorney's fees if you defend the case successfully.

I have defended a lot of exceptions to discharge over the past 29 years, some in my own cases and some cases filed by other attorneys.  It is an interesting area of practice and important to the clients.

Chapter 13 cases

Chapter 13 is the most common type of reorganization bankruptcy.  Chapter 13 cases can last from 3 to 5 years, and involve the debtor making payments towards the debt they owe.

The first question most people ask about Chapter 13 is "how much will I have to pay each month?"  Sadly there is rarely an easy answer to this question.  The plan payment is affected by a number of factors.  First is the means test, a ten page document prepared by your attorney that sets the statutory minimum payment.  If your means test says you'll have to pay $300 per month, you aren't likely to confirm a plan with a $100 plan payment.  Second is your goals in Chapter 13.  If you aren't eligible for Chapter 7 and just want the quickest, cheapest Chapter 13 discharge possible, you won't care about this factor.  But if you are trying to save your home from foreclosure, this will be the most important factor affecting the amount of your plan payment.  Your plan must have enough money in it to pay all the missed mortgage payments to the mortgage company, even if your means test doesn't require such a large plan payment.  Your assets might also affect the amount of your plan payment.  If you have non-exempt assets (like equity in a rental home) you must pay at least the value of these assets into your plan.  One frustrating thing is that the amount of claims your creditors file in your case can affect the amount of your plan payment; the frustrating part is that they might not get around to filing those claims for 3-4 months after you file bankruptcy.

Chapter 13 is a marathon and not a sprint.  Anyone can tighten their belt for a couple of months, but adhering to a budget for five years is very difficult.  This is the most difficult aspect of Chapter 13.  The vast majority of Chapter 13 plans get court approval, but less than half are ultimately completely paid off.  Unexpected expenses or job loss can make a manageable budget impossible.  I like to think that the people that make it all the way through a Chapter 13 have acquired important life skills.  Sometimes these unexpected problems can be fixed with a modified plan.  The sooner your lawyer knows about the problem, the more likely he is to come up with a solution.  If a client misses a mortgage payment and calls me that month I can usually craft a solution.  If (as recently happened) a client misses a year of mortgage payments, they create a problem so large there are few solutions.  Stay in touch with your lawyer in a Chapter 13 case any time anything changes.

Types of Bankruptcies

Bankruptcies come in two flavors, liquidation and reorganization.  Most people who use the word bankruptcy are thinking of a simple Chapter 7 liquidation bankruptcy.  Chapter 7 cases are certainly the most popular type of bankruptcy; in New Mexico about 92% of all bankruptcies are Chapter 7 cases.  The national average is a little lower at 70%.  A Chapter 7 case is lightning quick by lawsuit standards; the whole thing takes about three months.

Reorganization bankruptcies are much less common.  The basic reorganization case is a Chapter 11 bankruptcy.  These cases are usually filed by large corporations or wealthy individuals.  This is the kind of bankruptcy filed by General Motors and Chrysler back in 2008, and locally by Doug Vaughan in 2010.  Streamlined and less expensive reorganizations exist for wage earners (Chapter 13) and family farmers (Chapter 12).  Reorganizations are also available for government units (Chapter 9) and foreign corporations (Chapter 15).  But those are pretty rare.  Most people, if they need a reorganization bankruptcy, choose Chapter 13, the cheapest and most streamlined version.

I see two main reasons why people choose Chapter 13 cases instead of a cheaper, quicker, easier Chapter 7 case.  First, they aren't eligible for Chapter 7.  This could be because they filed a previous Chapter 7 case within 8 years, or because their income is too high for Chapter 7 and they fail the "means test".  I could talk about the means test for days, but that is the subject of another post.  The second reason is people who are behind on their mortgages but still want to save their homes from foreclosure.  Chapter 13 allows you to force the mortgage company to let you catch up slowly.  Given the horrible abuses of the well intended mortgage modification programs by the big banks, and the generic unresponsiveness of large financial institutions, it can be extremely appealing to file a Chapter 13 and force the mortgage company to follow your instructions for once.

All bankruptcies start out the same way, with 50-60 pages of disclosure about your finances.  The price of a bankruptcy discharge is full disclosure.  We will list everything you own, everyone you owe, answer a lot of narrative questions, provide a projected future budget and complete the means test.  For Chapter 7 cases, that is almost everything you have to do (there is a brief meeting of creditors to attend, and the rare possibility of a challenge to your discharge).  For reorganization cases you start with these disclosures, but then you have to file a plan and start making payments into the system.  Those payments are used to repay creditors in part or sometimes in full according to a complicated formula of priority.  So the main difference between Chapter 7 cases and Chapter 13 cases is three to five years of payments.

Chapter 7 is clearly the most bang for the buck.  Even a modest plan payment under Chapter 13 of $500 per month is a total payout to creditors of $30,000 over five years.  If it is a close call whether you are eligible for Chapter 7 or not, you can see that the stakes can be pretty high.  Chapter 13 cases are particularly hard on self employed people or folks with seasonal changes in income because Chapter 13 really is intended for steady, regular income earners.  But properly designed, a Chapter 13 reorganization is an invaluable tool for people in certain situations. 

Civil Debt Collection

Before you can make an informed decision to file a bankruptcy, you should be aware of what could happen if you don't.  I'll assume if you're reading this that you owe more money than you can repay.  What can your creditors do to you when you don't pay them?

Generally the first step in the collection process is telephone abuse.  This is the cheapest alternative for the creditors, obviously; staffing a call center is inexpensive, and a minimum wage employee with a headset and a PC can probably call 200-300 people per day.  Catch phrases like "when can I expect a payment" and "if you don't pay I will garnish your salary" are classics of course.  The garnishment reference of course is highly misleading.  Collectors are limited in what they can say and how they can say it by the Fair Debt Collection Practices Act, a federal law that (predictably) got watered down in Congress from the original concept advocated by the consumer rights advocates who wrote it.  The FDCPA only governs collection agencies, so some creditors make collection calls themselves or spin off a "collection division" of their corporation in an effort to avoid compliance.  I would say most collectors obey the FDCPA, which is a good thing, but some outliers exist.  If anyone threatens to arrest you or put you in jail they are (1) lying and (2) violating the FDCPA.  A consumer rights attorney is going to want as much information as possible about whoever makes that call to you.  My favorite story in this vein is the Atlanta collector who wore a uniform that looked just like a Fulton County Sheriff, only instead of a badge they had a patch with the initials of their collection agency.  That guy actually got sentenced to a couple of years in jail for impersonating a police officer.

It is common for defaulted credit card accounts to be sold to junk debt buyers at this point.  Most, not all, credit card companies will nag you on the phone for a few months and then sell the defaulted account to a junk debt buyer for pennies on the dollar.  The junk debt buyer has the same array of collection methods available to it as the original creditor, but a lot less ability to prove you owe them money (these transactions are generally electronic).  That may be useful if the case ends up in court.

The second step is sending an astonishing variety of mail to a defaulted debtor.  Collection notices, demand letters, the flood is never ending.  If you do end up filing a bankruptcy make sure you collect all of these notices and get them to your bankruptcy attorney.

The most aggressive step a creditor can take in America is to file a lawsuit against you.  Generally you learn of a lawsuit when someone knocks on your door and hands a complaint and summons to you.  Many people tell me they are sued and never find out about it; if they are renters who frequently change addresses the risk is certainly higher.  Sometimes the process server hands the complaint and summons to someone else who lives at your house; a teenager, guest or relative, who fails to tell you about it.  Usually, however, you get handed the complaint and summons.  Get this to your attorney right away to preserve your options.  It may be that your best outcome of such a lawsuit is buying a few months time to plan a bankruptcy or settlement, but you definitely want as much time as possible.  I could talk for a long time about this process, but that is the basics.

If a creditor or junk debt buyer sues you and wins (which takes 30 days if you ignore it, and maybe 6 months if you respond and participate) they get a judgment.  The judgment gives them the right to record a lien on your real estate, but the most lucrative collection right they earn is garnishment.  Garnishment is intercepting money somebody else owes to you.  If a creditor garnishes a bank account, they get whatever is in there the day they garnish.  If they garnish an employer they can get 25% of your net income IF it exceeds the minimum wage for a full time position.  Pension payments, social security benefits, unemployment benefits cannot be garnished at all.  If your only form of income is exempt from garnishment, you are "judgment proof" and may not need a bankruptcy at all.

Hopefully this helps you understand the process.