September 1, 2014

Qualifying for a Chapter 7

When we evaluate a bankruptcy case to determine whether it qualifies for a Chapter 7, we first look at three major questions. We practice in Texas, but all three of the considerations below apply in every state. The only difference outside of Texas is that different exemptions apply, and that may change the answer to #2 a bit.

1. How much unsecured debt (credit card, medical, signature loans, personal lines of credit, etc.) does the debtor have?
It costs over $2,000 to file bankruptcy when you include all of the attorneys fees, filing fees, required classes, credit reports, etc. So, unless a debtor can discharge $10,000 or more, we generally don’t recommend filing bankruptcy.

2. Does the debtor have any non exempt property?
Exempt property is property that is exempt from levy by creditors. In other words, exempt property is property that can not be touched by creditors. Non- exempt property is anything you own that is NOT exempt. Thus, “non-exempt property” is the property that creditors CAN TAKE. If a debtor has a large amount of non exempt property, which will be taken if he files bankruptcy, then it is usually not advisable to file bankruptcy.

The determination of what is exempt and not exempt is complex. The first complexity is that some states are “choice states” and others are not.  Texas, where we practice,  is a choice state that allows you to choose between the state list and the federal list of exemptions.  Some states require you to use the state list, and other states require you to use the federal list.

Let me explain this “choice state” thing a bit further, using Texas as an example.  There is a list of exemptions in the Texas Property Code. And there is another list of exemptions in the Federal Bankruptcy Code. If they get sued in the ordinary course of life, outside of a bankruptcy context, Texans can only exempt the types of property listed in the Texas Property Code exemption list. However, a Texas resident who files bankruptcy gets to choose the Texas list or the Federal list.

Generally speaking, the Texas list is more generous (ex. unlimited homestead protection), but it contains no exemption for cash (which means the debtor has to have empty bank accounts on the filing date or lose his cash to the trustee) and the Texas exemptions also contain no “wild card exemption” (i.e. a kind of exemption that can be applied to anything up to a certain value limit).

The federal list is generally less generous than the Texas list, but contains approximately $10,000 per person of “wild card exemption” which can be applied to any kind of property, including cash.

So, choosing between the Texas list and the federal list is going to depend upon what assets the debtor has.  If he has a big house that is paid off (and thus he has a lot of equity in the house), he has to use Texas exemptions to protect his house.  If he has very little in the way of assets, he will probably use the federal list so that he can use wild card exemption on the cash in his bank account and avoid the hassle of having to schedule his bankruptcy filing for a certain date when he is out of money and before his next paycheck arrives.

3. What is your income level?
In order to file bankruptcy, a debtor must pass the Means Test. Generally speaking, your income can be at most 5-10% or so above the median income for your county and your household size. To give you an idea of what that means, the current Travis County, Texas (where Austin is located) median income for a household size of 1 is about $38,545, for a household size of 2 it is $54,908, for 3 it is $57,053, and for 4 it is $66,400. Keep in mind that if you are married and you and your spouse both work, then both of your incomes must be counted against this household median income level. As with everything to do with bankruptcy, the calculation of the Means Test is complex (certain deductions apply, and certain kinds of income such as Social Security are not counted). It is absolutely essential that you consult with an attorney before making any decisions.

The determination of whether someone qualifies for a Chapter 7 is a complex one and the above three factors are only the first level of analysis that we do.

Good summary of when you can file Chapter 7 Bankruptcy even if you fail the means test – the key is “special circumstances”

Read the whole article by Lori Patton here.  It’s a good overview of how bankruptcy lawyers think through the means test.
http://www.nationalbankruptcyforum.com/bankruptcy-myths/does-failure-to-pass-the-means-test-automatically-cut-off-chapter-7-eligibility/

Here is a small excerpt:

After all necessary income and expenses are plugged in, my software gives me either a green smiley face or a yellow frowny face at the bottom indicating whether going through the long form got us under median. Green is good. Yellow is not good. When I still have yellow after going through long form I still need to ask a few questions before giving up and telling a client they are ineligible for filing a Chapter 7 Bankruptcy. This is because we still have a couple escape hatches in 11 USC 707(b) “special circumstances” and “totality of the circumstances”.

Examples of “Special Circumstances” are given in the Code: “such as a serious medical condition or a call or order to active duty in the Armed Forces…  I will tell you now that a child needing braces or getting ready to go to college is not going to fly. A car on its last leg and the need to replace it has worked for me in the past.

“Totality of the Circumstances” is defined in the Code as “whether the totality of the circumstances of the debtor’s financial situation demonstrates abuse.” This is nice and vague, which gives us more options. Obvious situations that fit would be lost employment, reduction in income that is not expected to recover soon, divorce, recently ordered domestic support (child support or alimony) that was not factored into the means test, as well as the fact that the income calculation might include 401K or retirement draws, or other “nonrecurring income” that is not reasonably expected in the foreseeable future.

It is all so individually specific to each particular client that I hesitate to tell you that something will or will not work in your case.

If I see either a special circumstance or a “totality of the circumstances” event, and there is no other good reason to do a Chapter 13 (hey! Another good article topic!), then I will file the case as a Chapter 7, despite the yellow frowny face on my screen. What will happen then is I will get a phone call or email from a paralegal at the United States Trustee’s office about the filing and requesting support for the filing. I will then quickly email to them all the documentation and support I have. The paralegal for the UST will likely come to the creditor’s meeting (about a month after filing) and ask the clients some or a lot of questions about the special circumstances or change in circumstances. They are not being mean, but they have to get those answers recorded so they can justify to their bosses in Washington D.C. why they didn’t throw the book at us.
Filing a Chapter 7 when the presumption of abuse arises because of not passing the means test makes getting through it tougher, but not necessarily impossible. Another option to seriously consider, and is sometimes necessary, is waiting until the six month average is diluted.

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