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From Dismemberment to Discharge: The History and Basic Law of Consumer Bankruptcy in Chapter 7

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From Dismemberment to Discharge: The History and Basic Law of Consumer Bankruptcy in Chapter 7

Beginning in Ancient Rome and journeying to modern bankruptcy law in the United States, this presentation offers an overview of the history and current substantive law of so-called straight consumer bankruptcy in the United States under chapter 7 of the United States Bankruptcy Code. In this course, we’ll walk through a typical chapter 7 case with Debbie Debtor, recently unemployed due to the COVID-19 pandemic. We’ll learn about the filing of the petition, the creation of the bankruptcy estate and automatic stay, the § 341 meeting of creditors, discharge, postdischarge issues, and more!

Presenters

Nick Quesenberry
Senior Staff Author
Quimbee

Transcript

Nick Quesenberry: Welcome to From Dismemberment To Discharge: The History and Basic Law of Consumer Bankruptcy in Chapter 7, produced with love and care here at Quimbee. I'm Nick Quesenberry, and I'll be your host for today's excursion into the wild, wonderful, and sometimes wacky world of consumer bankruptcy. This presentation comes alongside prolific course materials, including slides, presenter's notes, copies of relevant statutes and cases, and much more. You can follow along with the slides, if you like, or just sit back and enjoy the show.

  As Simone Weil observed in her brief essay on bankruptcy, "The payment of debts is necessary for social order. The nonpayment of debts is quite equally necessary for social order." This brief statement captures the two opposing ideals at the heart of any bankruptcy system.

  The first is this. In many ways, access to credit is the life's blood of our economy. But if everyone went around racking up prolific debt without paying it off, access to credit would dry up faster than a puddle in the Sahara. In that circumstance, hardly anyone would be dumb enough to lend money at all, except maybe at stratospheric rates of interest with rock solid collateral. The result? Average folks would have little, if any, access to capital to buy consumer durables, like cars and major appliances, to finance education, start businesses, and so on. In that case, much of the economic progress we've made since the nation was founded would be lost.

  On the other hand, well-meaning folks sometimes get in over their heads through no fault of their own. If these honest, but unfortunate, people had no way to escape the burden of oppressive indebtedness social order would blow apart quicker than a house of cards in a hurricane. Many people would throw up their hands, gather up their belongings, and skip town, leaving their creditors holding the proverbial bag. Others would take to the streets and engage in all sorts of unsavory behavior, not out of overt malice so much is sheer desperation. Still others would simply stop working, seeing little point if every nickel they make goes to creditors.

  So, we see that, on the one hand, a debt has to represent a serious and enforceable obligation or the economy collapses. On the other hand, a debt can't be an absolute and inescapable burden or social order collapses. Any stable economy must thread the needle between these two extremes, and one indispensable mechanism to do this is bankruptcy.

  This presentation offers an overview of the most basic form of bankruptcy for regular people. That, of course, is the time-honored process of collection and liquidation under Chapter 7 of the United States Bankruptcy Code. To that end, let's get going.

  Let's meet Debbie Debtor. It's late April in the year 2020. Debbie is a single mom with custody of her two kids, recently divorced from her ex-husband, living in a nondescript suburban home with a mortgage that's underwater. Debbie also has one compact car that secures a purchase money loan.

  Until recently, Debbie worked two jobs. By day, Debbie was a receptionist at a local law firm. In the evenings, Debbie worked as a waitress at a local cocktail bar. While Debbie was away working, her parents and ex-husband helped her out by watching the kids. The income from Debbie's two jobs, together with the alimony and child support she got from her ex-husband, was just enough to pay the mortgage and utilities, keep the refrigerator reasonably well stocked, maintain the car, and leave a little of cash for Debbie to go out with her friends and blow off steam once in a while.

  But then, around March of 2020, the coronavirus pandemic brought the whole world to a standstill. The governor in Debbie state issued a lockdown order due to which Debbie's law firm couldn't really receive clients at the office anymore. A law firm that doesn't see at the office has little need of a receptionist, so the firm laid Debbie off. Similarly, the cocktail bar couldn't have customers dining at tables anymore. Without customers sitting down to eat, there's no need for waiters and waitresses, so the bar laid Debbie off too.

  Debbie immediately set about looking for a new job as an essential worker. While doing so, she used credit cards to stay afloat, meaning to pay that debt off once she started earning a paycheck again. But the new job never came and the credit card debt kept piling up. Now desperate, Debbie broke down and filed for unemployment benefits, which fortunately started coming soon after. The unemployment benefits to be sure, but they were just a fraction of what Debbie had earned while she was working. So, Debbie kept relying on credit cards until finally all her cards were maxed out. Eventually, several credit card providers filed judgment liens against Debbie, which attached to her home.

  Despite all this, Debbie initially resisted calls from her ex-husband, friends, and former workers to declare bankruptcy. But every day, Debbie saw ads on TV and on the internet for local lawyers who stood ready to help her file for bankruptcy and obtain a financial fresh start. One of those lawyers is you. With a heavy heart, Debbie contacts you about declaring bankruptcy.

  In this presentation, we'll walk you through the history and basic law and mechanics of consumer bankruptcy in Chapter 7. To start, we'll indulge a brief history of bankruptcy law around the world and in the United States. After that, we'll cover Congress's constitutional power to make uniform national bankruptcy laws together with the intersection between federal bankruptcy law and state law. Next, we'll survey the life cycle of a fairly typical, albeit hypothetical, Chapter 7 case with Debbie Debtor as our main character.

  We'll start in the pre-bankruptcy stage and give you a working grasp of what goes into preparing and filing the petition, which is the pivotal document that formally commences the bankruptcy case. As we do this, we'll outline the eligibility requirements for Chapter 7, and we'll talk about some gatekeeping measures Congress has put into place to curtail abuse of Chapter 7's relatively quick and painless discharge procedure.

  Having done that, we'll talk about two pivotal events that occur the moment the petition is filed with the bankruptcy court. The first is the creation of the bankruptcy estate. Here's where we'll meet one of the key players in Debbie's bankruptcy, the Chapter 7 trustee, not to be confused with the United States trustee, that's a different animal. We'll outline the purpose of the estate, what property goes into the estate and stays out of it, what property Debbie can exempt from the estate, and just who's in charge of the estate anyway. Along the way, we'll see if we can help Debbie out with those pesky judgment liens. The second pivotal event is the imposition of the automatic stay, which will halt most collection activity against Debbie, once the petition is actually filed.

  After that, we'll finally get to the payoff, the discharge, the light at the end of the tunnel. Here, we'll survey which debts are dischargeable, which are not, and what creditors can and cannot do once the discharge order enters. In closing, we'll highlight some issues that Debbie will need to keep in mind as she moves forward from her time in bankruptcy court.

  Now, let's talk about the history of bankruptcy law, starting with ancient Rome. Of the earliest known codifications of debtor creditor law in the Roman empire, it is said that a debtor would have 30 days to pay a debt after either acknowledging it or having it satisfactorily proven in court. At that point, a creditor could forcibly take the debtor into custody and bind him with ropes and chains for 60 days, or weights and chains, excuse me. During the 60 day period, the creditor would bring the debtor to the public square in the hope that the debtor or someone else could pay the underlying obligation and set the debtor free. If the debt went unpaid for the entire 60 day period, then the creditor could sell the debtor into slavery.

  As an alternative, some say that the creditor could take the debtor to the public square, where all the debtor's creditors could convene and quite literally cut him to pieces. This latter alternative may have been rarely used in practice, which makes sense, because your average debtor was presumably worth more to his creditors as a living slave than he was as a dismembered corpse.

  Sometime later, Rome evolved a system that, in many ways, paralleled our modern Chapter 7. In that system, creditors could band together, appoint one among their number to act as their representative, and through that representative, seize all of a debtor's property and liquidate it. The proceeds would generally be divided pro rata among the creditors according to a system of lawful priorities, though a creditor with a security interest in specific property would generally get first dibs on the proceeds from his collateral. However, unlike our modern Chapter 7, the debtor remained liable for any deficiency in the unfortunate but all too likely event that the sale proceeds were not enough to satisfy all of his outstanding debts.

  Now, let's hit a little closer to home and talk about jolly old England whose law was, in many ways, a forerunner to our own. In the 16th century, English bankruptcy somewhat resembled that of Rome but without the bit about cutting the debtor to pieces in the public square. At this time, bankruptcy was involuntary. If a debtor committed what was called an act of bankruptcy, then his creditors could involuntarily place him in a proceeding in which everything he owned, except maybe some necessary clothing, would be sold to pay his debts. Worse yet, there was no discharge. So, if the liquidation of all the debtor's property was insufficient to cover all his debts, some creditors could continue exercising their remedies, such as capturing the debtor's future earnings, or worse yet committing him to debtor's prison.

  Now, a murderer, rapist, or thief would presumably be fed in prison at public expense, but not a debtor in debtor's prison. No, no. A debtor in debtor's prison had to find a way to pay for his food, rely on others' generosity to provide it, or utilize assets concealed from creditors to obtain food. And if he couldn't find a way to pay for food, he would starve. Because there was no discharge, a debtor had precious little incentive to cooperate with his creditors in this involuntary financial dismemberment.

  So over time, the old English laws got increasingly coercive against recalcitrant bankrupts. They featured enlightened penalties, such as cutting off a debtor's ear after making him stand in the pillories for a couple of hours. For those who may not know, a pillory was a wooden mechanism by which an offender was immobilized outdoors, in public, where passersby and onlookers would often hurl things, like rotten food, feces, and even stones or other blunt objects, at the offender.

  Over time, English lawmakers recognized the need to afford bankrupt debtors some positive incentive to cooperate with their creditors. This culminated in 1706, or so, when Parliament passed a bill that contained both the ultimate carrot and the ultimate stick to encourage and coerce debtors to be honest and cooperative in bankruptcy. The carrot was a discharge of any debts that remained unpaid after liquidation of the debtor's assets. The stick was execution by hanging, at least for more egregious bankruptcy offenses. In practice, it seems only maybe four people were actually hanged under the statute, though some might say that's four too many. In any case, the mere prospect of execution must have been a formidable one indeed for a debtor who found himself caught up in the old English bankruptcy system. In 1820, England finally dispensed with capital punishment for bankruptcy fraud. But the notion of a discharge persisted and helped set the conceptual foundation for virtually every modern bankruptcy system, including ours here in the United States.

  When the Constitution was ratified, it empowered Congress to establish uniform bankruptcy laws throughout the United States. Even so, the ensuing decades saw a scattershot series of enactments that were sometimes pro-debtor, sometimes pro-creditor, and virtually always marked by vigorous debate among the affected constituencies. Finally, Congress passed the Bankruptcy Act of 1898, the first serious attempt at a uniform federal codification of bankruptcy law. The Bankruptcy Act seemed to have the essential ingredients for our workable bankruptcy system, a discharge for the debtor and an orderly process of collection and liquidation of the debtor's assets.

  From that point, things were fairly quiet until the 1930s, when Congress amended the Bankruptcy Act extensively in the wake of the great depression. Things got fairly quiet again after the until early in the 1970s when Congress at last looked to modernize federal bankruptcy law. To that end, Congress created the National Bankruptcy Commission to propose much needed reforms.

  The commission's recommendations became the foundation for our modern Bankruptcy Code, which Congress finally enacted in 1978. Though the code has been amended quite a few times over the ensuing decades, the original Bankruptcy Code is more or less federal bankruptcy law as it exists today. Probably the most significant amendments to the Bankruptcy Code came in 2005 with the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, commonly called BAPCPA or BAPCPA. This legislation did not fundamentally change our bankruptcy system, but it did make the relatively quick and painless Chapter 7 discharge quite a bit harder to obtain for many debtors than it had been before.

  Now, let's return to the present and reconvene with Debbie. You've talked it over with Debbie and you believe that a Chapter 7 filing would be the best solution for her. But at this point, we have to answer a threshold question. Is Debbie even eligible for Chapter 7? The short answer is yes. The Bankruptcy Code defines basic eligibility for Chapter 7 in the negative. That is, any entity can be a debtor in Chapter 7, except for a railroad, a domestic insurance company, bank, credit union or similar institution, a foreign insurance company doing business in the United States, or a foreign bank, credit union or a similar institution with a branch or agency in the United States.

  But wait, there's more. For any individual to be a debtor, under any chapter of the Bankruptcy Code, she must, within 180 days before filing the petition, do a little homework. Namely, she must receive, from an approved nonprofit agency, a briefing that outlines opportunities for credit counseling and assist her in performing a budget analysis. For ease of reference, we'll call this briefing the credit briefing. There are exceptions to the requirement for a credit briefing, including mental or physical disability, as well as military deployment. And the bankruptcy court can permit the debtor to complete the credit briefing within a predetermined time post petition in appropriate circumstances.

  As for Debbie, she's not a railroad, she's not a financial institution, and she's certainly not an insurance company. She's an individual. So, to make sure she's eligible to be a debtor in bankruptcy, you'll need to have her complete the credit briefing before you file her petition. Once Debbie completes the credit briefing, the provider should promptly send her a certificate of completion, which you'll then need to file with the bankruptcy court along with the petition. The cost of the credit briefing seems to range from $15 to $30 or so, depending on the particular provider.

  But not so fast. Congress has set up other more formidable barriers to relief in Chapter 7 beyond the basic and, frankly, very lenient eligibility requirements. Perhaps the most intimidating of these is the so-called Means Test. The Means Test is not framed as an eligibility requirement. Rather, Section 707 of the Bankruptcy Code gives the bankruptcy court discretion to dismiss a Chapter 7 case or with the debtor's consent convert it to a different chapter, such as 11 or 13, if the bankruptcy court finds that two requirements are met.

  First, the debtor's liabilities consist primarily of consumer debts. Second, granting a discharge would be an abuse of Chapter 7. There are multiple grounds upon which a court might find that a Chapter 7 discharge would be abusive, which would subject the case to dismissal. But the Bankruptcy Code instructs the court to presume abuse if a debtor with primarily consumer debts fails the Means Test. Thus, whenever you're thinking about advising a client to file for Chapter 7, you'll need to determine whether the client's debts are primarily consumer debts, and, if so, whether the client passes the Means Test. To oversimplify, if the Means Test applies, then the case is presumed abusive, if the debtors statutorily determined the current monthly income exceeds allowable expenses by more than a predetermined amount. That's a lot of math.

  All right, moving on in general, the Bankruptcy Code defines consumer debts as debts that an individual incurs for personal, family, or household purposes. In applying this somewhat opaque definition to concrete facts, courts often focus on the primary purpose for which the debt was incurred. In this regard, it doesn't matter whether the debt is secured or unsecured. What matters is why the debtor incurred the debt.

  So, if a debt was incurred primarily to meet personal living expenses or for personal consumption, then it's probably consumer debt. For instance, rent on a residential apartment or mortgage debt incurred to purchase or improve the home is consumer debt, as is a loan to buy a personal vehicle or credit card debt to buy groceries and meet similar living expenses. Domestic support obligations, like alimony and child support, are also usually deemed to be consumer debts.

  On the other hand, any business debts will fall outside the definition of consumer debt. Broadly speaking, business debt is any debt incurred primarily to make a profit, such as amounts due on a commercial lease, invested in a business venture, or borrowed to pay off losses and to reinvest in hopes of recouping them. These are not consumer debts.

  Although debt incurred with profit motive is not consumer debt, it doesn't necessarily follow that all debt incurred without profit motive is consumer debt. Income tax debt is a prime example. Though most people do not incur income tax debt hoping to make a profit, most courts seem to view this type of debt as non-consumer debt. That's because income tax debt isn't incurred in the course of personal consumption. Indeed, it's not incurred at all. Rather, it's imposed from outside to facilitate the public welfare.

  Now, it's one thing to determine that a debtor has consumer debts. It's quite another to determine that these debts are primarily consumer debts. In answering whether the debtor's debts are primarily consumer debts, most courts focus on the total ratio of consumer debt to non-consumer debt. If consumer debt exceeds 50% of total debt, then the debtor has primarily consumer debt. If consumer debt is half or less of total debt, then the debtor doesn't have primarily consumer debt.

  Now, let's apply these rules to Debbie. Let's assume that the outstanding mortgage debt on Debbie's house is $250,000. And the outstanding secured purchase money debt against her car is $5,000. Let's also assume Debbie owes $15,000 in credit card debt, all of which she incurred to pay bills and necessary living expenses for herself and her kids. And let's assume Debbie owes the IRS $3,000 in back taxes, because she had some self-employed income a while back and forgot to pay taxes on it. The $250,000 in mortgage debt and the $5,000 purchase money debt against the car are obviously consumer debt, as is the $15,000 in credit card debt, because it went to living expenses. The $3,000 in tax debt is not consumer debt, although it's not technically business debt either. Here then, Debbie has a total of $270,000 in consumer debt and a measly $3,000 in non-consumer debt. So, it's a pretty safe bet that Debbie's debts are primarily consumer debts.

  Now that we know Debbie has primarily consumer debts, it's finally time to talk about the Means Test. As we mentioned, if Debbie fails this test, then the bankruptcy court will presume that granting her relief would be an abuse of Chapter 7, which in turn would subject her case to dismissal or conversion to another chapter. Fortunately, even once it's determined that a debtor has primarily consumer debts, the Bankruptcy Code offers one last chance for a Chapter 7 debtor to escape even having to undergo the Means Test in the first place. Namely, the means test will not apply if the debtor's current monthly income multiplied by 12 is less than the applicable median annual income for the relevant number of people in the debtor's household. The applicable median income figures are taken from the most recent tables from the United States Census Bureau.

  In most cases, the Bankruptcy Code defines current monthly income as the debtor's average monthly income from all sources, with limited exceptions, received during the six month period ending on the date the debtor files her bankruptcy petition. It doesn't matter whether the income is taxable.

  Now, the code excludes five very specific types of income from current monthly income. All but one are exceedingly unlikely to apply to most debtors. The one exclusion that may apply to a goodly number of debtors is the exclusion for benefits received under the Social Security Act.

  Now, speaking of current monthly income, this obviously includes wages, salaries, and other earnings as an employee or self-employed person, as well as alimony and child support. What is not so clear, though, is whether current monthly income, excuse me, current monthly income includes unemployment benefits. The confusion stems from the peculiar and convoluted manner in which unemployment benefits are administered. Unemployment benefits aren't social security income, as most people understand that term, and it is indeed the individual states that administer unemployment benefits. However, the federal government funds a healthy portion of unemployment benefits nationwide under, you guessed it, the Social Security Act. Most courts dealing with the issues seem to conclude that unemployment benefits are not made under the Social Security Act and therefore must be included in current monthly income. But a few cases do hold the other way. The way current monthly income takes a spouse's income into account is, to say the least, pretty confusing. Fortunately, Debbie's not married, so we don't need to worry about that here.

  With these rules in place. Let's figure out Debbie's current monthly income, assuming she'll be filing her bankruptcy petition within the next day or so. To be on the safe side, we'll include Debbie's unemployment income in current monthly income. To keep the math easy, let's suppose that Debbie's income over the past six months has been uniform consisting of $1,000 per month in unemployment benefits, $800 per month in alimony, and $1,200 per month in child support. So, we'll see that Debbie's current monthly income totals, $3,000 even.

  Now, it's time to determine whether that equals or exceeds the applicable median income for a household of three, seeing Debbie's household consists of herself and her two children. Let's assume Debbie and her kids live in Tennessee. According to the most recent tables available when this presentation was prepared, annual median income for a household of three in Tennessee is $69,734. Debbie's current monthly income of $3,000 multiplied by 12 equals $36,000. Thus, Debbie's current monthly income is well below median, which is probably the case with most Chapter 7 debtors. Thus, in Debbie's case, we don't even need to worry about applying the Means Test. It's full speed ahead to Chapter 7.

  Now, let's talk about the petition. In the hit TV comedy series, The Office, hapless manager, Michael Scott, once found himself in financial trouble due to which his employees and friends kept advising him to declare bankruptcy. Michael resisted at first, but as his financial woes multiplied, his resolve began to waiver. Finally, Michael stood up in his office, spread his hands, and said with a loud voice and great authority, "I declare bankruptcy."

  Now, we have no doubt that Michael's oral declaration was sincere. Unfortunately though, it had no legal effect. To formally declare bankruptcy, one must file a written petition with the bankruptcy court seeking relief under the relevant chapter of the Bankruptcy Code. It's impossible to overstate the petition's importance. It's the filing of the petition that commences the bankruptcy case, brings the Bankruptcy Code into play, gives the bankruptcy court jurisdiction, creates the bankruptcy estate, and, at least in the case of a voluntary bankruptcy, imposes the automatic stay. Now, if any of these terms leave you scratching your head, don't worry. We'll hit them all before we are done.

  There are two types of petitions, voluntary and involuntary. A voluntary petition is one that the debtor files to seek bankruptcy relief. An involuntary petition is one that a debtor's creditors file to put a debtor in bankruptcy against her will, though the debtor may certainly can test the petition if she wants to. Because Debbie wants to file bankruptcy, and because the procedures surrounding involuntary petitions can be a bit arcane, we'll focus here on voluntary petitions.

  Usually, the petition itself will be Official Form 1 of the official bankruptcy forms available at the website of the United States courts, uscourts.gov. Official Form 1 by itself is pretty straightforward. But in addition to Official Form 1, the debtor must file numerous schedules, setting forth prolific information about her finances, assets, liabilities, and personal history, sometimes in excruciating detail. Indeed, most individual debtors will put more time and effort into completing their bankruptcy schedules than they do into completing their tax returns, although debtors are typically required to file copies of their most recent tax returns with the bankruptcy court too, so make sure to have those tax returns handy.

  To give you a feel for the type and volume of information that the debtor must furnish to the bankruptcy court, let's run down a list of the schedules and some of the other forms that often accompany the petition.

  Consolidated Schedules A and B listing to the debtor's property, schedule C listing exempt property, Schedule B listing secured claims and who holds them, consolidated Schedules E and F listing unsecured claims and who holds them, Schedule G listing any executory or unperformed contracts and unexpired leases, Schedule H listing any co-debtors or people liable for the debt along with the debtor, Schedule I listing the debtor's income and the sources for it, Schedule J listing the debtor's expenses. The Statement of Financial Affairs, which calls for all sorts of information about the debtor's financial history and other matters. The Statement of Intention for Individuals Filing Under Chapter 7, which we'll hit later. The Chapter 7 Statement of Current Monthly Income, which pertains to the Means Test and whether it applies. The Chapter 7 Means Test Calculation, if indeed the debtor has to undergo the Means Test. And the certificate indicating that the debtor has completed the credit briefing we talked about earlier.

  If all this sounds like a lot, it is. Putting it together, can take a lot of time to make matters. Worse. A debtor may not have time to gather all the information at a leisurely pace. That's because some debtors file for emergency reasons, for instance to stop a foreclosure against their home on the eve of foreclosure. To acknowledge all this and to accommodate these concerns, the federal rules of bankruptcy procedure give debtors 14 days after filing the petition to file most of the required schedules or other documents. However, some documents are subject to different timing rules, and a handful typically must be filed with the petition no matter the circumstances. Of course, the bankruptcy court may grant an extension of time for cause shown.

  Let's assume that Debbie's reasonably honest and cooperative with you, as you gather all the necessary information and fill out all the forms. After a couple of weeks of asking Debbie probing questions, pestering her with requests for documents, filling in all the blanks and checking all the boxes, you're finally ready to file. This begs the question, where do you file the petition? Fortunately, for an individual, the venue rules in bankruptcy are pretty simple. In most cases, proper venue for an individual debtor will be the federal district of the debtor's domicile, the debtor's residence, the debtor's principle place of business in the United States, or the location of the debtor's principle assets in the United States.

  Tennessee has three federal districts, the Eastern, Middle, and Western Districts of Tennessee. Let's assume Debbie and her children have lived in Bristol, Tennessee for the past 10 years. Bristol is in the Eastern District of Tennessee. Thus, the Eastern District of Tennessee is where we will file Debbie's bankruptcy petition. Three, two, one, go.

  When a debtor files a bankruptcy petition, two wondrous things happen. The creation of the bankruptcy estate and the imposition of the automatic stay. These two events converge to bring all the debtor's assets, liabilities, creditors, obligors, and legal proceedings together in one forum, the bankruptcy court for efficient and orderly resolution. In doing so, the estate and the automatic stay halt the financial cannibalization of the debtor that often occurs at state law, as creditors rush to be the first to enforce their rights and get first dibs against the debtor's likely limited assets. This, in turn, benefits not only the debtor but also creditors who, at least in theory, make out better overall in bankruptcy's orderly scheme than they would if left to their own devices. We'll talk about the estate now and we'll hit the automatic stay a little later.

  As you learned in law school, in a common law trust, legal title to specific property, called the res, is transferred to a trustee for the benefit of one or more beneficiaries with equitable title to the res. The trustee possesses and controls the res, but must administer it in the beneficiary's best interest and consequently owes fiduciary duties regarding the res.

  Similarly, when a bankruptcy case commences, a specialized statutory trust called the estate is created. The res is, among other things, all the debtor's property, as of the case's commencement. The fiduciary in charge of the res is the appointed by bankruptcy trustee in Chapter 7, the debtor in chapters 11 and 12, unless the court orders otherwise and appoints a trustee, and pretty much always the debtor in chapter 13.

  Once the estate forms, the debtor will lose some or all control over whatever property becomes part of the estate. If a bankruptcy trustee is appointed, then the debtor effectively loses all control, even though the property previously belonged to the debtor. For instance, Bankruptcy Code Section 521 requires the debtor to turn over to the trustee all estate property and all documentation relating to it. If the debtor refuses, then the court may direct her to comply, hold her in contempt, or even direct the US Marshall to assist the trustee in taking possession of estate property.

  Here, because Debbie's filing for Chapter 7, a bankruptcy trustee will take charge of the estate. In general, Chapter 7, trustees are private attorneys who sit on a panel from which they are selected to serve in individual cases by a division of the Department of Justice called the Office of the United States Trustee. Speaking very generally, the trustee's job in Chapter 7 is, as expeditiously as feasible, to gather up all non-exempt property of the estate, liquidate or otherwise administer it, and make distribution to creditors. For this to work, the trustee... Or excuse me, for this work, the trustee will get a statutorily determined percentage as a commission, if there is indeed a distribution, along with a small fixed statutory fee that all trustees get in all cases.

  All this begs the question, what property is included in the estate? With exceptions, estate property includes every conceivable interest in property that the debtor holds as of the case's commencement. This includes any legal or equitable interest in tangible or intangible property. For the most part, the estate's interest in property will be equal to, not greater than, what the debtor had at the case's commencement. Thus, if the debtor had absolute ownership of property, then so will the estate. But if the debtor had a more limited interest in specific property, such as a mere leasehold or fractional interest as a co-owner, then the estate's interest will be so limited.

  Examples of estate property include outright ownership of real property, intangible personal property. Intellectual and intangible property, including patents, trademarks, copyrights, and licenses. All manner of vested or contingent, present or future, interest in property, including life estates, remainders, executory interests, lease holds, and so on. Any debts owing to the debtor, including accounts receivable, unpaid salaries and commissions, and so on, the right to receive tax benefits, such as unpaid tax refunds, the debtor's rights as the beneficiary of any insurance policy, the debtor's interests in any contract, any legal or equitable causes of action accruing to the debtor, for instance, claims for personal injury or breach of contract, and the debtor's ownership interest in an LLC, corporation, or other entity.

  Usually, property interests that a Chapter 7 debtor requires postpetition are not estate property. This general rule, though, has some pretty major qualifications and exceptions. For one, if the debtor acquires property postpetition, but the acquisition is traceable to some debt or claim that accrued to the debtor prepetition, then the acquisition is property of the estate. Relatedly, offspring, products, proceeds, rents, or profits from estate property are themselves estate property, even if acquired postpetition.

  But there are exceptions to the rule about offspring products, proceeds, rents, and profits being estate property. For an individual debtor, probably the most important exception, by far, is this. In Chapter 7, an individual debtor's earnings from services performed postpetition are excluded from the estate. Courts construe the exception stingily though, so that it covers only earnings directly attributable to postpetition services the debtor performs personally.

  Earnings only indirectly traceable to the debtor's post petition services are probably not covered. For instance, payments made on account of a debtor's inability to work wouldn't qualify for this exclusion. For instance, payments under a disability insurance policy or presumably unemployment benefits. That's because these kinds of payments aren't attributable to any postpetition services by the debtor, but rather to the debtor's inability to perform services.

  In addition, three specific types of property will become estate property if the debtor acquires them within 180 days postpetition, provided they would've been estate property had the debtor held them on the petition date. The first is any property interest acquired by devise, bequest, or inheritance. In this case, the interest is generally deemed to be acquired on the date of the decedent's death.

  The second is any interest acquired due to either a property settlement with the debtor's spouse or an interlocutory or final divorce decree. But postpetition alimony or spousal support is typically not deemed to be estate property, regardless when received, unless it relates to alimony that came due before the filing of the petition. Similarly, postpetition child support is not estate property, because it's generally deemed to belong to the child, not the debtor parent. The third is any property interest received as the beneficiary of a life insurance policy or other death benefit plan.

  Oftentimes, property proves to be a net drain on the estate. Bankruptcy Code Section 554 provides for these cases by permitting, or if the court orders requiring, the trustee to abandon property if certain requirements are satisfied. Namely, the trustee may or may be ordered to abandon property if either the subject property is burdensome to the estate or the property's value and benefit to the estate are inconsequential. Upon abandonment, the property will usually revert to the debtor.

  There are two archetypal situations in which courts typically order or permit abandonment. The first relates to property that is encumbered beyond its value. The reason for this is that, if the trustee liquidates property subject to a valid security interest like a mortgage, the trustee must generally pay the secured claim in full before distributing any of the proceeds to unsecured creditors. By and large, the estate exists to make maximum distribution to unsecured creditors. Thus, if property is encumbered beyond its value, it can't really benefit unsecured creditors. Here then, the trustee might as well abandon the property. Second, courts typically order abandonment or authorize it if, to realize value from the property, the estate would have to pursue costly litigation that may or may not produce any recovery, especially if the estate lacks the resources to pursue the litigation.

  Now, if the debtor lists an asset in her schedules and the trustee hasn't administered it by the time the case is closed, then the estate, or excuse me, the asset is automatically abandoned to the debtor by operation of law, unless the court orders otherwise. Generally, an asset is administered once the trustee reduces it to money, such as by selling it or pursuing a cause of action. Unless the court orders otherwise, estate property remains estate property until it's either abandoned or administered. If the case is closed and it's later discovered that there remains estate property to be administered, then the bankruptcy court can reopen the case for that purpose.

  Now, let's talk about exemptions. Every state has, by statute, exempted certain property from creditors' claims. The Bankruptcy Code incorporates the concept of exemptions in Section 522. This provision allows individual debtors to exempt certain property from the estate. If the debtor properly exempts an item, then that item does not become part of the estate. In general, Section 522 allows a debtor to choose between the exemptions available in her home state and the federal exemption set forth in Section 522(d).

  However, the code also permits states to effectively opt out of the federal exemptions, which many states have done. In these states, debtors are for most purposes restricted to the state exemptions. Even so, Congress has carved out some items that are exempt by federal law, even if a debtor is otherwise limited to state exemptions.

  For homeowners, the homestead exemption is crucial. Section 522(d) and many state statutes exempt a certain dollar amount of the debtor's equity in any home that she owns. For instance, the federal homestead exemption, as of April 1, 2019, was $25,150. Any equity in the home exceeding the exempt amount is estate property. Thus, the trustee can sell the home, pay the dollar value of the exemption to the debtor, and distribute whatever is left creditors.

  In addition, section 522(d) exempts, as of April 1, 2019, up to $4,000 of the debtor's equity in a motor vehicle. Here again, any equity exceeding that amount belongs to the estate. In practice though, trustees are loathe to sell debtor's vehicles, because most individuals need their vehicles to commute to work and do other needful things. To that end, the trustee may effectively sell the vehicle back to the debtor for an amount equal to the estate's equity in it. The estate's equity in turn is generally the vehicle's total value minus the exemption and minus the value of any secured claims against the vehicle. If the debtor can't come up with the cash to pay the estate's equity, the trustee could permit her to pay the repurchase price over time. And this is what often happens.

  Still another exemption will prove vital to many in the wake of the economic devastation of the coronavirus, namely that for social security benefits, unemployment compensation, and local public assistance benefits. Section 522(d)(10) exempts these kinds of benefits, as do many state exemption laws. Another crucial exemption is that for spousal support or alimony, to the extent reasonably necessary for the support of the debtor or her dependents. Still another, the so-called wild card exemption allows the debtor to exempt up to a certain amount of the value of any property, whether otherwise exempt or not, plus a limited amount of any unused homestead exemption. The bit about the unused homestead exemption is a small nod to debtors who rent their homes for whom the homestead exemption is otherwise worthless.

  Of course, exemptions generally don't apply to creditors with legitimate security interest in property. Thus, the debtor's equity and the estate's equity, for purposes of any exemption, are calculated by subtracting the value of any legitimate secured claims against the property.

  With these rules in place, let's figure out the extent to which the big ticket items of Debbie's property are part of the estate. As with most individual Chapter 7 debtors, we're mainly concerned with Debbie's home, car, and sources of recurring income. For simplicity's sake, we'll assume Debbie is using the federal exemptions in section 522(d).

  Let's start with the home. Debbie owned the home when she filed for bankruptcy. So, the home is property of the estate. There's a mortgage against Debbie's home of $250,000. And let's assume the home is worth $200,000. In this case, neither Debbie nor the estate has any equity in the home. Thus, the trustee will likely abandon the home.

  Now is as good a time as any to talk about those pesky judgment liens against Debbie's home, because the Bankruptcy Code will let us do something about them. Namely, Section 522(f) permits the debtor to avoid most types of judgment liens against exempt property to the extent a given lien impairs an exemption to which the debtor would otherwise be entitled but for the lien. Technically, the debtor isn't entitled to an exemption if consensual secured debt against the property exceeds its value, because in that event there's no equity to support the exemption. Even so, most courts permit debtors to use Section 522(f) to get rid of judgment liens, even against property that's entirely underwater. To simplify the cumbersome language in Section 522(f), a judgment lien impairs an exemption to the extent there's no equity in the property to support the judgment lien in excess of the sum of any debt secured by consensual security interest and other superior liens plus the amount of the exemption. Here, it's easy. Debbie's home is entirely underwater, so there's no equity to support the judgment liens. Thus, Debbie may avoid the judgment liens against her home in their entirety.

  How about the car? We've established that there's $5,000 of secured debt against the car. Let's assume the car is worth $6,000. That leaves $1,000 of equity in the car, all of which is now subject to Debbie's exemption. Thus, there's no equity available for the estate, so the trustee will likely abandon the car too.

  Finally, let's talk about Debbie's sources of income, namely the unemployment benefits, alimony, and child support. Between the general exclusion of alimony and child support from the estate and the available federal exemption for these payments it's very unlikely that any meaningful portion of these payments will be part of the estate. Similarly, even if the unemployment benefits would ordinarily be part of the estate, Debbie can't exempt them under section 522(d)(10). Thus, no significant portion of Debbie's regular sources of income will be part of the estate.

  Most of Debbie's miscellaneous personal belongings are probably either exempt or just not worth the effort to go after. Thus, as with most Chapter 7 cases, there probably won't any nonexempt property to liquidate for the benefit of Debbie's creditors. In that case, the trustee will most likely file a report of no distribution, after which the bankruptcy court will issue the discharge order and close the case.

  The creation of the estate is just one of two major events to occur upon the filing of a petition. The other is the imposition of the automatic stay under section 362(a). The automatic stay is a self-executing statutory injunction that prohibits most types of collection activity during the pendency of the bankruptcy against the debtor, the debtor's property, and property of the estate.

  In particular, the automatic stay prohibits the commencement or continuation of any proceeding against the debtor that could have been commenced prepetition or to enforce any claim against the debtor that arose prepetition, the enforcement of any prepetition judgment against the debtor or against estate property, any act to exercise control over estate property to obtain possession of estate property or to obtain property from the estate, any act to create, perfect, or enforce any lien or security interest against estate property, any act to create, enforce, or perfect any lien or security interest against property of the debtor, insofar as the lien or security interest secures a prepetition claim, certain set offs, and interestingly, commencing or continuing certain proceedings in the United States Tax Court.

  Subsection (b) to section 362 carves out at least 28 discreet exceptions to the automatic stay, most of which usually don't apply to individual debtors. Some of the more important stay exceptions for individual debtors are those for criminal proceedings against the debtor under section 362(b)(1), certain family law matters under section 362(b)(2), and certain eviction proceedings against residential real estate under section 362(b)(22) and (23).

  In addition, creditors can move the bankruptcy court to grant relief from the automatic stay, inappropriate circumstances. To the extent that the court grants relief from the stay, creditors can exercise their rights and remedies without regard to the pendency of the bankruptcy. Finally, the scope of the automatic stay may be limited if the debtor has previously been in bankruptcy and had the case dismissed. In general, the automatic state expires as to an act against estate property when the property is no longer part of the estate. In other context, for individual debtors in Chapter 7, the estate expires when the case is closed, or dismissed, or when a discharge is granted or denied, whichever happens earliest.

  In a typical Chapter 7 case like Debbie's, discharge usually enters within a few months after the petition date. And with the discharge entered, the automatic stay ceases to apply, and the discharge injunction slides in to replace it.

  Before we get into discharge, let's take a moment to talk about the meeting of creditors. Bankruptcy Code Section 341 requires the office of the United States trustee to convene and preside at a meeting of creditors within a reasonable time after the case commences. The purpose of the meeting is to give the United States trustee, the bankruptcy trustee, and creditors a chance to examine the debtor in a somewhat formal setting about the debtor's financial dealing or other circumstances surrounding the bankruptcy.

  The debtor must attend the meeting. Debbie, this means you. The debtor must attend the meeting. At the meeting creditors, the bankruptcy trustee, and the United States trustee, among others, may examine the debtor under oath. Except in the most extenuating circumstances, bankruptcy courts will typically dismiss the case if the debtor fails or refuses to attend the meeting.

  In a no asset Chapter 7 case like Debbie's, you won't see too many actual creditors attend the meeting of creditors. Since creditors don't get a distribution in these cases, they've got no reason to appear, unless perhaps they think there might be a basis to object to discharge or something in that vein. In a business case with significant amounts of money at stake, though, you had better believe creditors will show up and give voice to everything that's on their minds. As an attorney, I once attended a meeting of creditors in a business case where I feared things might come to blows. It gets heated sometimes.

  If an individual Chapter 7 debtor has consumer debt secured by estate property, as many do, then within a certain period of time after filing the petition, the debtor must file with the court a so-called statement of intention, Official Form 108. In the statement of intention, the debtor must indicate whether the collateral is claimed as exempt and whether she intends to reaffirm the secured debt, redeem the collateral or surrender the collateral to the secured creditor. We'll talk more about reaffirmation and redemption very shortly.

  Within a certain time after filing the statement, the debtor must perform her intention, whether it be reaffirming the secured debt or redeeming the collateral. If the collateral is personal property, such as a car, then there will be consequences if the debtor fails to either timely file a properly completed Statement of Intention or timely perform her intention. Namely, the automatic stay will cease to apply to the collateral and the collateral will no longer be property of the estate, unless the debtor states her intention to reaffirm on the original contract terms but the creditor refuses to agree.

  The discharge injunction. Now, let's get to the discharge injunction. This discharge injunction is considerably narrower than the automatic stay, but it generally operates forever after the entry of the discharge order, unless perhaps the discharge is revoked because the debtor engaged in some kind of shady conduct in connection with the bankruptcy. With respect to any discharged debt, the discharge injunction generally voids any judgment of personal liability against the debtor and prohibits all attempts to collect that liability as a personal liability of the debtor.

  The key language here is as a personal liability of the debtor. Unlike most debts, interest in property, including security interest, survive the discharge. Thus, even though the discharge extinguishes the debtor's personal liability on the secured debt, the secured creditor will retain any security interest in the collateral. The result, even after discharge enters, the secured creditor may foreclose against the collateral if there's a default on the debt. Put differently, the discharge effectively converts secured recourse debt into secured nonrecourse debt. The secured party loses all personal remedies against the debtor, but retains all rights against the collateral itself.

  Unless, that is, the debtor reaffirms the debt. To the extent the debtor validly reaffirms any debt secured or unsecured, that debt survives bankruptcy, unphased and wholly immune from the discharge injunction. So, if the debtor reaffirms secured debt, the secured creditor will retain both its personal remedies against the debtor and its in rem remedies against the collateral.

  Secured creditors may insist on reaffirmation as a condition to abstain from foreclosing on the collateral once discharge enters. Reaffirmation is generally done by agreement between the debtor and the affected creditor. For the reaffirmation to have any legal effect, the bankruptcy court sometimes must approve it after holding certain proceedings and making certain findings. But in other cases, the agreement can simply be filed with the court and approved automatically without further ado. In any case, because the reaffirmation agreement is a new and distinct contract, it may impose terms additional to or different from any relevant prepetition contract.

  Of course, reaffirmation isn't the only way for a Chapter 7 debtor to retain collateral post-discharge, namely in Chapter 7. If the collateral is exempt or abandoned, tangible personal property, or the collateral secures dischargeable consumer debt and the collateral is intended for personal family or household use, then the debtor may redeem it under Section 722. To redeem collateral, the debtor must pay the secured creditor the amount of the allowed secured claim in full, in cash, at the time of the redemption. The amount of the allowed secured claim is typically the full amount of the secured debt up to the value of the collateral.

  Thus, reaffirmation can be very beneficial. Excuse me, redemption can be very beneficial if the amount of the secured debt exceeds the collateral's value. Because in that case, the debtor can redeem the collateral for less than the out outstanding debt. In the likely event that the debtor can't come up with the cash to redeem the collateral, the debtor may take out a loan from a third party.

  So, how do all these rules apply to Debbie? She's got two big ticket items serving as collateral for purchase money debt, her house and her car. Thus, she'll need to file a statement of intention concerning both, indicating that she claimed both as exempt and whether she intends to surrender, reaffirm, or redeem with respect to each.

  Let's start with the car. As we've mentioned, the secured debt against the car is $5,000 and the car is worth $6,000. Thus, the secured creditors allow secured claim is the full amount of its debt, $5,000. You talk things over with Debbie and she decides to redeem the car. Not having the $5,000 to redeem the car, Debbie borrows that amount from her uncle and promptly transmits it to the secured creditor. Thus, the car is redeemed.

  As for the home, let's assume that Debbie's mortgagee is feeling especially generous in the wake of the coronavirus pandemic and consents to enter a reaffirmation agreement with Debbie, reducing the monthly mortgage payments, and giving her more time to pay. The bankruptcy court approves the reaffirmation agreement. Thus, Debbie gets to keep her house, for now at least. Though, keep in mind that special rules sometimes apply to homes, and Debbie wouldn't necessarily have had to reaffirm the debt in order to keep her home.

  Of course, Congress has exempted quite a few specific types of debt from discharge. And these are listed in Section 523 of the Bankruptcy Code. General unsecured debt, such as credit card debt, usually is discharged, though it may be exempted from discharge, if it was incurred to pay down nondischargeable tax debt. In any case, if a debt is nondischargeable, then it survives entry of discharge order as though the debtor had never even filed for bankruptcy.

  Examples of nondischargeable debt include, but certainly aren't limited to, most tax debts, certain debts obtained by specific types of fraud or deception, many debts that the debtor did not list in her schedules, domestic support obligations like alimony and child support, as well as certain spousal property settlements, student loans, at least in most cases, and debts arising from personal injury caused by the debtor's illegally operating a boat, motor vehicle, or aircraft while intoxicated.

  It looks like the only possibly nondischargeable debt that Debbie has is the $3,000 in tax debt to the IRS, putting aside the reaffirmed mortgage debt. The tax debt then may survive bankruptcy. Debbie's personal liability for her other debts, including the 15,000 in credit card debt, but excluding the reaffirmed mortgage debt, will vanish like the morning dew in the hot midday sun.

  In addition to exempting certain types of debt from discharge, Chapter 7 sets forth quite a few grounds upon which a debtor may be denied discharge altogether. If this happens, then none of the debtor's liabilities will be discharged. Yet, she may have to remain in bankruptcy and deal with all the attendant burdens and limitations until the case is closed. Total denial of discharge then really is the worst of both worlds. For an individual in Chapter 7, most of the basis for total discharge denial revolve around some misconduct by the debtor, such as fraud, concealment, refusal to obey a order, and such like. An individual may also be denied a discharge if she obtained a prior discharge in Chapter 7 or 11 in a case commenced within eight years before the filing of the petition commencing the current case. Fortunately, nothing here indicates that Debbie has engaged in any unsavory conduct or has ever filed for bankruptcy before.

  One ground for total denial of discharge, however, is relevant not only to Debbie but to nearly every individual in Chapter 7. Recall back when we filed Debbie's petition, how she had to complete the credit briefing and include the certificate of completion with her petition. Well, before Congress will allow Debbie a discharge, it'll require her to complete yet another bit of homework. Namely, in most cases, the code denies a discharge to an individual Chapter 7 debtor if she doesn't, sometime after the petition, complete an instructional course in personal financial management. Thus, as a good lawyer, you'll need to do all you feasibly can to make sure Debbie completes the postpetition financial management course while her case is pending.

  Let's assume everything goes smoothly and Debbie gets her discharge. Congratulations. You've navigated Debbie through her first and hopefully last bankruptcy filing. As a result, she's gotten rid of the $15,000 in credit card debt, retained her home and car, and jettisoned those pesky judgment liens against her home. All in all, a very good result for Debbie and her family.

  One thing you may be wondering at this point is how the bankruptcy will affect Debbie's credit rating. The answer is not beneficially. Though bankruptcy's specific impact on credit ratings will vary from case to case, most people find their credit ratings in tatters, as they emerge from bankruptcy. According to Market Watch, it's not strange at all to see a debtor's credit score plunge by more than 200 points in the wake of bankruptcy. Perhaps the most obvious consequence of a devastated credit score is difficulty obtaining credit. And when debtors do obtain credit, it's usually on notably less generous terms than those applicable to their non-debtor counterparts. Thus, if Debbie wants to refinance her home mortgage loan or open up another credit card account, for instance, she may have a tough time.

  But wait, there's more. True, Section 525 of the Bankruptcy Code affords debtors some protection from discrimination owing solely to the fact that they've been in bankruptcy and met various other requirements, but these protections are limited and courts tend to construe them narrowly. For instance, Section 525 prohibits governments and private employers alike from taking adverse action against someone who's already employed with them due solely to the fact that the employee was in bankruptcy, was insolvent during or before any bankruptcy case, or failed to pay a discharged or dischargeable debt. Thus, no employer can fire or demote an employee on these grounds. But these kinds of protections don't help someone like Debbie, because she's still looking for work.

  For whatever reason, these days employers are perhaps more inclined than ever to scrutinize a candidate's credit history before making a hiring decision. In this regard, and with exceptions, Section 525 prohibits any government employer from refusing to hire someone just because she was a debtor in bankruptcy, was insolvent, or failed to pay a discharged or dischargeable debt. But the majority view among the courts is that the statute imposes no such restrictions on private employers. Thus, a private employer, unlike a government agency, may decline to hire someone like Debbie solely because she has filed for bankruptcy.

  Fortunately for Debbie, the Fair Credit Reporting Act limits how long a bankruptcy can appear on somebody's credit report. In general, a bankruptcy can remain on an individual debtor's credit report for up to 10 years. However, the bankruptcy can apparently be reported after the 10 year period in connection with specified transactions, such as a credit transaction involving a principal amount exceeding a certain threshold. But the credit reporting agencies, at least in some instances, appear to have adopted a practice of removing bankruptcies from credit reports after seven years.

  In conclusion, today we've walked through the lifecycle of a fairly typical consumer bankruptcy in Chapter 7. We will end things with a poignant observation from Ken Poirot. "At that darkest moment, while drowning in the abyss of emotional bankruptcy, reflect on this universal truth: the difference between success and failure is one more time." Thanks to the consumer bankruptcy system, Debbie and millions like her can have a new start and try one more time to build stable financial futures for themselves and their families.

  Thank you for joining us for this Introduction to Chapter 7 Consumer Bankruptcy by Quimbee. To learn more about the content of today's presentation, please check out the accompanying course materials, which include today's slides and presenter notes. Thanks for choosing Quimbee. And we hope you'll join us again soon. Cheers. Nostrovia. Salude.


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1h 3m 25s

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