Whenever I’m meeting for the fist time with someone considering filing for Bankruptcy, the conversation usually begins with the following statement from the potential client, “I want to file a Chapter 7.” This is similar to walking into a gas station and asking the clerk for not just any lotto ticket, but the winning one!
Chapter 7 of the Bankruptcy Code deals with liquidation. Under Chapter 7, all your unsecured debt, such as credit cards, medical bills, and personal loans, is discharged or forgiven, under most circumstances. Assuming you qualify to file under Chapter 7, it may not be as easy or painless as you’d like it to be. Liquidation is not always the right choice for many individuals or families.
If you own a car, or a luxury item such as a boat or other water craft, or if you have an investment property, even one that doesn’t generate any positive net income, you could be putting those at risk, or potentially have to pay money to keep them.
Here is how it works:
When you file for Bankruptcy, what you are telling the Court is that your current monthly income isn’t enough for you to pay all your monthly debts. Your current monthly income is usually calculated by taking an average of the last six months. Of course, if you have been unemployed, or your income has been substantially lower over the past six months than it is now, or you foresee receiving additional income now coming from a raise or new job, that must be taken into consideration as well. However, it isn’t only about income.
The other thing you are telling the Court, specifically in a Chapter 7, is that if you were to sell or “liquidate” everything you own, all your assets including cars, personal items such as clothing, jewelry, collectibles, guns, etc., what you would receive from the sale of those items, is not enough to pay your debts.
The problem arrises when the value you attribute to some of those assets, is not exactly correct, or differs with how the Trustee in Bankruptcy will value them.
The Law, both at a State and Federal level, has certain constitutional protections as to what assets are “exempt” from your creditors. Exempt really means protected, as assets that are exempt cannot be taken away from you by creditors, and then sold to pay a portion of your debt. Florida specifically, has a Homestead exemption that under most circumstances protects your home from being taken from you by all creditors except the lender or lenders that hold mortgages on the property, or other creditors that have liens by statute or judgments such as homeowners and condominium associations. I wont discuss the Internal Revenue Service and tax liens from the County Tax Collector; that’s a whole other topic. But a credit card cannot take your home away if you stop paying the credit card.
The issue with exemptions is that they were written years ago, and protect much less than you would expect them to by today’s standards. Florida, for example, exempts $1,000 worth of value in a car per person. So if you have a car that is worth $12,000, and you owe $14,000 on it currently, you’re safe, as you have no real value in that car, since you owe more than it is worth. However, if that same $12,000 car, is almost paid in full, or you owe $8,000 on it, the remaining $4,000 is your value in that car, and only $1,000 of it is protected from creditors under Florida law.
If you were to file a Chapter 7, under that scenario where $3,000 of value in your car is not protected, the Trustee appointed by the Court could force you to surrender that car, or give you the option to pay that value towards your debt as part of a compromise. It is called “purchasing an asset from the estate,” and many Trustees require lump sum payments.
What your car is worth, is another uncertainty. Many trustees use valuation estimates such as NADA Clean Retail , which you may also find overvalues that hunk of junk you have parked in your driveway.
This is just one example of how filing a Chapter 7, simply because you may think it is the Holy Grail of bankruptcies, is sometimes not the right choice.