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.

About us

This blog is being written by Mike Daniels.  I've been an attorney in Albuquerque, NM since 1986.  I primarily limit my practice to bankruptcy work, although once in a while someone convinces me to take on some civil litigation.  I don't do any family law or criminal defense work, partly for lack of expertise in the subjects and partly to reduce the stress in my daily life.  Bankruptcy is a pretty interesting area of practice filled with difficult legal issues, which I enjoy, and also with pragmatic and specific benefits to clients, which I also like.  Certainly you can't help everyone, and our bankruptcy laws in this country took a sharp turn backwards with the enactment on October 17, 2005 of the Bankruptcy Abuse Prevention and Consumer Protection Act.  It sure sounds benign, doesn't it?  Sadly it isn't.

I'm a sole practitioner, and have one employee.  I like to keep things simple.  I try to adopt the efficiencies available in new technologies, and so I keep a web presence (mdanielslaw.com) and interact with clients via email if they prefer that method.  Our office can be a pretty busy place, but please be patient and we'll do our best to provide all the information our clients need.  There are some legal and ethical restrictions on what I can post here, but I'll try to provide useful information and updates on the law when they are available.