Useful bankruptcy tools

Useful Tools that Rhode Island General Practitioners Should Know about Bankruptcy

Useful Bankruptcy Tools for the Rhode Island General Practice Attorneys
By Joseph F. Hook

Consumer debtors facing financial struggles may come to you seeking advice as to how they may obtain protection from creditors
by filing a petition in the United States Bankruptcy Court. When a debtor in financial stress comes into an attorney’s office and is
considering bankruptcy, he and his attorney will have to make a determination as to which chapter of the Bankruptcy code is appropriate
and most beneficial for the debtor, or even whether the debtor should file for bankruptcy at all. This article discusses the relief available
to debtors under chapter 7 and chapter 13 of the Bankruptcy code, which are the generally practical provisions that should be considered
by consumer debtors and their attorneys. The article provides specific examples of how debtors may use either chapter 7 or chapter 13
to achieve their goals of obtaining financial relief and protecting assets from creditors claims.

I. Differences between a chapter 7 and chapter 13 petition.

The Bankruptcy Abuse and Prevention Act of 2005 was designed to encourage debtors that can afford to pay part of their debt back to file a chapter 13 plan that provides for payments to a trustee who collects the money for distribution to the creditors. The act developed a means test to determine whether a debtor’s their income and expenses are such that it would be considered abuse if the debtor filed chapter 7. The means test considers the debtor’s income, family size and the expenses in the area where the debtor resides that are allowed by IRS regulations to determine whether the debtor is eligible to file under chapter 7 or whether such a filing is considered abuse. Even if the
debtor’s income and expenses are at a level where it would not be abuse, the attorney and his client must make a determination whether it is appropriate to file a chapter 7 petition or a chapter 13 petition and plan to get the relief that the client is seeking.

Chapter 7 of the Bankruptcy code allows debtors to discharge general unsecured debt in bankruptcy court. This discharge is
essentially an injunction that prevents the creditors from pursuing the debtor to collect on the debt. 11 USC 727. There are some debts, including recent taxes, most student loans and child and spousal support that generally are not dischargeable and the debtor will remain responsible for these debts even after obtaining a discharge under 11 USC section 727. A complete listing of the exceptions to discharge to a chapter 7 are set for at 11 USC 523. In some instances a creditor alleging that the particular debt is not dischargeable must bring an adversary proceeding in the bankruptcy court to establish that claim.

In a chapter 7, all nonexempt assets are sold by the trustee and used to pay the creditors of the debtor. However, in the great
majority of consumer chapter 7 petitions there are no assets recoverable by the trustee for distribution to creditors.

Chapter 13 Bankruptcy allows distressed debtors with regular income to reorganize their debt. A Chapter 13 bankruptcy petition
and plan can provide debtors with the opportunity to catch up on any arrearage on their mortgage payments and to pay a portion of their unsecured debt back based upon what they can afford over a period of three to five years. The specific contents of what is required under a Chapter 13 plan are set forth in 11 USC 1322. Typically, the plan requires the debtor to pay his disposable income to the trustee over a
three to five year period. Also, the amount paid into the plan must cure any arrears on the secured debts, including home mortgages,
and must pay priority claims including taxes in full. The general unsecured claims receive a percentage of their claims based upon the debtor’s ability to pay. These general unsecured creditors must receive in a chapter 13 at least the same amount of recovery that they
would have received in a chapter 7.

A successful completion of a chapter 13 plan will provide the a debtor a discharge that is larger in scope then the discharge in a
chapter 7. 11 USC 1328. This super discharge may make the filing of a chapter 13 plan desirable advantageous to the particular client depending upon his or her circumstances and the nature of the debt that the debtor holds.

Chapter 13 may also be desirable to a debtor because it can provide an opportunity to protect non exempt assets, if the debtor presents a plan that is approved and provides for payments to creditors in an amount that is equal to or greater than the value of the asset that is not exempt.

II. Protected property under the code/Property exemptions:

Many debtors worry that they will lose their property if they file for bankruptcy protection under either chapter 7 or chapter 13. It is
true that the debtors must in their Bankruptcy petitions disclose all of their assets under 11 USC section 541. However, most assets of typical consumer debtors are entitled to protection and are not subject to creditors claims under state and federal law. 11 USC 522. In
the petition, the debtor must elect to claim either state or federal exemptions under the bankruptcy code. The specific federal exemptions
are set forth in 11 USC 522. The federal homestead exemption is currently $20,200.00 per debtor. In addition federal law provides for a
wild card exemption of up to $11,200.00 per debtor of any unclaimed portion of the debtor’s federal homestead exemption, the federal exemptions also protect pension and retirement accounts. For a complete listing of the federal exemptions see 11 USC 522.

Under Rhode Island law the property that debtors may protect are set forth in RIGL section 9-26-4 and 9-26-4.1. The Rhode Island exemptions include: wearing apparel, working tools valued at up to $1,200.00, household furniture, money contained in a qualified
individual retirement accounts, a motor vehicle valued up to $10,000.00 and jewelry valued up to $1,000.00. In July 2008 Rhode Island added a wild card exemption, which allows the debtor to protect any assets that are not otherwise covered an exemption up to $5,000.00. RIGL 9-26-4 (16). Perhaps, the most significant exemption under Rhode Island law, is the homestead exemption which allows debtors
to protect up $300,000.00 in equity in their home. In order to qualify for the homestead exemption the property must be either occupied
by the debtor or the debtor must intend to occupy the property as the debtor’s principal residence. In re Franklino, 329 B.R. 363 (Bank D. RI 2005). In some cases recently acquired property the homestead exemption can be reduced. See, 11 USC 522 (o)(p) and (q).

The Bankruptcy code does allow debtors to obtain relief from any judgment that has become a lien that impairs the debtor’s exemptions. To the extent that creditors have obtained judgment liens against against assets of the debtor, the debtor may obtain an order from the bankruptcy court avoiding judgment liens on the property. 11 USC section 522 (f) (1).

III. Specific applications.

A. Spendthrift Trusts.

Property contained in a spendthrift trust of which the debtor is a beneficiary is not considered an asset of the debtor’s estate,
provided that it is not a self settled trust, and the debtor does not have control over the disposition of the trust. RIGL Section 18-9.1-1; .Aylward v. Landry (In re Landry), 226 B.R. 507 (Bankr.D.Mass.1998), and In re Cowles, 143 B.R. 5 (Bankr.D.Mass.1992) (concluding that in order for trust assets to be included in the bankruptcy estate there must be a "finding that the trust was self-Settled
and that certain powers were reserved by the settlor/beneficiary or settlor/trustee); 11 USC 541( c ) (2) (providing that a “restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.”)

B. Divorce:

The divorce attorney must be careful to consider the homestead exemption and its application, particularly if he represents a
debtor that no longer resides in the home, or is considering vacating the marital home. A divorce client who no longer resides in the home may not not be able to protect his or her interest in the home by using the homestead law exemption, inasmuch as he or she no longer
resides in the home or intends to reside in the home.

C. Taxes:

The debtor may be able to discharge in bankruptcy, taxes owed to the IRS and to the state provided that the IRS does not have a lien on the debtor’s real estate, the debtor files his/her tax returns in a timely fashion, the period for filing the taxes is more than three years
old or filed late but filed at least three years ago. Such old unpaid taxes are no longer priority claims and can be discharged . The
exception is when the debtor willfully evades taxes. However, even in these cases, the debtor may be able to obtain a discharge in a
chapter 13 petition as long as the plan makes some provision for the payment of these taxes.

IV. Specific advantages to Chapter 13.

In addition to providing the debtor with a method to resolve or reduce outstanding debt through a payment plan and providing a
debtor with a method to debtors to cure defaults on their mortgage payments so that their home is saved from a foreclosure, the following
some specific examples as to how a debtor could be assisted by the filing of chapter 13 bankruptcy petition.

A. The Upside Down House with a Second Mortgage:
In today’s market of declining house prices, some debtors owe more on their home loans than their home is actually worth. In
some of these cases, the debtor may have a second mortgage that is wholly unsecured, which under the bankruptcy code means that the amount that is owed on the first mortgage is equal to or greater than the value of the home. In these cases, the debtor may be eligible to
strip down the second mortgage as part of their chapter 13 petition. The stripped down mortgage is treated a general unsecured claim, and the lien is avoided. 11 USC 1322 (a); 11 USC 506 (a); In re McDonald, 205 F3rd 606; In re Griffey, No. Co 05 (10th Cir. 2005).
Debtors with unfavorable interest rates on their first mortgages on their homes should, however, make efforts to modify their loan
with the lender prior to filing bankruptcy, because under current law debtors may not compel a modification of the terms of their first mortgage on their home in bankruptcy courts. 11 USC 1322 (b)(2). This may factor into the debtor’s decision as to whether they will seek to keep the home at all.

B. The Upside Down Car:

Some debtors have large car payments and the value of their car is much less than the
the amount of the loan that is secured by the car and that debtor may also be paying a high interest rate. Under the cram down provisions
of the Bankruptcy code, the secured portion of the loan is reduced to the value of the car at the time of the filing of the petition.
11 USC 506. Additionally, the loan can be modified so that the debtor can obtain a more favorable interest rate on the remaining secured portion of the claim. 11 USC section 1322 (b) (2). However, a car loan that was obtained in the 910 days before the filing of the petition cannot be crammed down to its actual value, because the entire whole loan is treated a secured claim. 11 USC 1325 (9 ) providing that
“For purposes of paragraph (5), section 506 shall not apply to a claim described in that paragraph if the creditor has a purchase money security interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day preceding the date of the filing
of the petition, and the collateral for that debt consists of a motor vehicle (as defined in section 30102 of title 49) acquired for the
personal use of the debtor, or if collateral for that debt consists of any other thing of value, if the debt was incurred during the 1-year
period preceding that filing. Hence the debtor and his attorney must be aware of this 910 day rule and the age of the car loan if the
debtor is seeking to cram down the loan that is secured by by the vehicle.

Conclusion

The purpose of the Bankruptcy Code is to provide a fresh start to honest but unfortunate debtors. In these difficult economic times, general practitioners should be familiar with Bankruptcy basics so that they may properly advise their clients who may be distressed
debtors, or who may be creditors seeking to pursue a claim against a distressed debtor.

Joseph F. Hook has a general practice located at 294 Valley Road in Middletown, Rhode Island. He can be reached at 401-619-5940 or by e mail at joe@josephhooklaw.com. His practice areas include: civil litigation; personal injury, products liability, medical malpractice, workers’ compensation, employment litigation, unemployment compensation, civil rights, bankruptcy, family law, probate, condominium and real estate law.