Taxes, Student Loans, and Other Non-Dischargeable Debt: What Chapter 13 Can Do for You

Chapter 7 is a fast process that results in the discharge of unsecured debts.  Common unsecured debts are credit card, personal loans, medical bills, and deficiencies on repossessed cars.  Chapter 7 doesn’t discharge secured debt (mortgages or car loans), but you have the option of surrendering the house or car to get rid of the debt.

Chapter 7 isn’t for everyone.  One reason is that if you’re behind on mortgage or car payments and are facing foreclosure or repossession, Chapter 7 can’t help you there.  At the end of a Chapter 7 case, your credit card debt will be gone, but you’ll probably still be behind on those secured debt payments, and the threat of foreclosure or repossession will still be there.

This is where Chapter 13 steps in.  Chapter 13 gives you the Court’s protection from debt collection actions for the duration of your Chapter 13 Plan (usually five years).  Since you’re not paying off unsecured debt, you can afford to start making your mortgage or car payments again.  And the amounts you’re behind get paid off through your Plan.

Another reason why Chapter 7 might not be right for you is that some kinds of unsecured debt are not dischargeable.  Those include most income taxes, student loans, and spousal or child support.  However, just because these debts aren’t dischargeable, doesn’t mean the Court can’t help you address them in a Chapter 13 case.

For tax debt, if the IRS is threatening a tax lien or won’t agree to a reasonable payment plan, you can pay them back through a Chapter 13 Plan over five years and at a relatively low interest rate, and they will have to accept it.

For spousal or child support, you will have to pay the full amount you are behind during the course of you Chapter 13 Plan and keep current with your ongoing payments.  However, as long as you do so, the Court protects your wages from being garnished.

As to student loans, Chapter 13 can provide a five-year “cushion” during which the lender will have to accept whatever amount you can afford, paid through your Plan.  The full loan will still be owed at the conclusion of your case (with interest), but you will have had that five-year breather to deal with your other financial issues.

Bankruptcy law provides many amazing tools for dealing with all kinds of debt, and this description barely scratches the surface.  If you’re having paying your bills or dealing with your debt, please contact me for a free initial consultation to see how the law can help you.

9th Circ. BAP: If You Can’t Pay Student Loans, Failure to Negotiate a Repayment Plan Not Bad Faith

The 9th Cir. BAP on student loans in bankruptcy: Where no payments are forecasted, failure to negotiate a repayment plan is not a factor showing bad faith.

More on student loans in bankruptcy: On April 16, 2013, the Ninth Circuit Bankruptcy Appellate Panel decided the case of Roth v. Educational Credit Management Corporation.  The case involved an analysis of the third, “good faith” prong of the “Brunner Test” (determining the dischargeability of student loans in bankruptcy), which requires:

  1. That the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for herself and her dependents if forced to repay the loans; and
  2. That additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and
  3. That the debtor has made good faith efforts to repay the loans.

Judge Renn, writing for the Court, laid out the factors considered in determining if a debtor has met the third prong: Had the debtor made any payments prior to seeking discharge? (No.) Had the debtor sought deferments or forbearances? (No.)  Was the action timed in a “rush to the courthouse”? (No.) Did the debtor’s financial condition result from factors beyond her control? (Yes.) Had the debtor tried to obtain employment, maximize income, and minimize expenses? (Yes.)  Had the debtor attempted to negotiate a repayment plan? (No.)

This last factor, which often tips the good faith balance against a debtor, was the most significant.  (Ms Roth had refused to enroll in ECMC’s “income-based repayment plan.”)  The Court concluded that this refusal should not count against her, given her age, poor health, and limited income or prospects:

‘[W]e see no real purpose in making Debtor jump through the hoops of applying for, and enrolling in, the IBRP and then reporting her income every year. The IBRP was set up to allow borrowers to pay an affordable amount toward retirement of their student loan debt. However, when absolutely no payment is forecast, the law should not impose negative consequences for failing to sign up for the program. This is consistent with the general maxim that the law does not require a party to engage in futile acts. … Congress could not have intended such a lengthy, empty commitment as a requirement for a determination of undue hardship.”

In a scathing concurrence, Judge Jim D. Pappas called the Brunner test “a relic of times long gone,” one that “is too narrow, no longer reflects reality, and should be revised by the Ninth Circuit when it has the opportunity to do so.”   He recommended that the Ninth Circuit craft an undue hardship standard that allows bankruptcy courts to consider all the relevant facts and circumstances on a case-by-case basis to decide if the debtor can currently or in the near future afford to repay the student loan while maintaining an appropriate standard of living.

7th Circuit Relaxes Requirements on Discharging Student Loans in Bankruptcy

No commitment to future repayment efforts, job seeking outside your field, or agreement to extended payment plans required to discharge student loans in bankruptcy cases.

Discharging student loans in bankruptcy: Susan Krieger is a 53 year old woman living in rural Illinois with her daughter and her 75 year-old mother.  She has not worked since 1986, and between 1978 and 1986 never earned more than $12,000 a year.  In 2001, she incurred some $26,000 in student loans to receive training as a paralegal, but never found work in that field despite job search efforts.  She is too poor to move, lacks internet access, and her 10 year-old car needs repairs.  Her mother and daughter receive only a few hundred dollars a month in government assistance.  In 2012, she filed a Chapter 7 bankruptcy case and sought a discharge of her student loans.

In the 7th Circuit (which includes Illinois), as in the 9th Circuit (which includes California), the standard for determining the dischargeability of student loans in bankruptcy is the so-called “Brunner Test,” which requires:

  1. The debtor cannot maintain, based on current income and expenses, a minimal standard of living for the debtor and dependents if forced to pay off student loans;
  2. Additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and
  3. The debtor has made good faith efforts to repay the loans.

In Ms Krieger’s case, the lender agreed that requirement #1 was met, but argued that #2 and #3 were not.  The Bankruptcy Court found in Ms Krieger’s favor.  The lender appealed to the U.S. District Court, which reversed.  On April 10, 2013, the Seventh Circuit reversed the District Court decision and reinstated that of the Bankruptcy Court (Susan M. Krieger v. Educational Credit Management Corp, 7th Cir., 2013).

In reaching its decision, the Court first held that the District Court had erred in holding that “good faith” (requirement #3) entails commitment to future efforts to repay.  If this were true, “no educational loan could ever be discharged, because it is always possible to pay in the future should prospects improve.”  The Court pointed out that the Bankruptcy Code allows for discharge where there is “undue hardship,” and one ought not allow caselaw such as Brunner to supersede the statute itself.

As to requirement #2, the Court held that Ms Krieger need not be required to seek employment in fields paying less than paralegal work, nor need she be required to accept a 25-year payment plan.  The likely indefinite persistence of her circumstances is a finding of fact made by the Bankruptcy Court judge, and without clear error, the Court declined to overturn that finding.

As a 7th Circuit case, Krieger has no binding authority over 9th Circuit courts.  However, it represents a reason to be optimistic that as people bring more and more cases seeking to discharge student loans in bankruptcy, we may see a gradual relaxing of the very harsh requirements of the Brunner test.

9th Circ: Excluding Social Security Income on Chapter 13 Means Test OK

On March 25, 2013, the Ninth Circuit Court of Appeals decided the case of In re Welsh. The debtors in the chapter 13 bankruptcy case owned a home and several vehicles, all encumbered by secured debt. They had income from multiple sources, including employment ($7,333), pension ($1,100), and Social Security ($1,165). They filed a Chapter 13 plan, proposing to pay off the vehicle loans in full, and paying some $245 per month to their unsecured creditors.

The Chapter 13 Trustee objected, arguing that it was bad faith for the debtors not to include the Social Security income in their Means Test calculation (which said the debtors could afford to pay $218 per month). The Bankruptcy Court rejected the Trustee’s argument and the 9th Circuit Bankruptcy Appellate Panel affirmed that decision.

The Ninth Circuit affirmed again, holding that its discretion to determine a debtor’s disposable income had been replaced by the Means Test formula, and in that formula, Congress had explicitly excluded Social Security income and included payments on secured debts. It joined the Fifth and Tenth Circuits in so holding.

The fact that the debtors were paying off debts secured by what the Trustee called “luxury items” (two ATVs and a trailer) instead of paying their unsecured creditors did not matter: “Congress did not see fit to limit or qualify the kinds of secured payments that are subtracted from current monthly income to reach a disposable income figure.”

In addition, the court went further and followed the Eighth Circuit, holding that a consideration of how much a debtor is paying to his or her secured creditors, versus the amount going to unsecured creditors, should not be part of the good/bad faith analysis.

Chapter 13 Debt Limits Increase

Section 109(e) of the Bankruptcy Code provides what are known as the “debt limits” for Chapter 13 bankruptcy cases. It provides that only a person whose debts are less than a certain amount may file a Chapter 13 case.

As of April 1, 2013, those limits have changed. For cases filed April 1, 2013 and later, the limits are now $1,149,525.00 for secured debt (up from $1,081,400.00) and $383,175.00 for unsecured debt (up from $360,475.00).

Usually, secured debts are mortgages and car loans, which are “secured” by the house or car. Unsecured debts are basically everything else. If you have debts in either category over the limits, you are ineligible to file a Chapter 13 Case.

The 109(e) debt limits play somewhat more of a role here in the San Francisco Bay Area than they do in other parts of the country, due to the comparably high housing values and mortgages. This increase in the limit should prevent a significant number of people from being forced into a different chapter.

If you are considering filing a bankruptcy case, but have debts that are still higher than the new limits, you should speak with a qualified attorney about your alternatives.

Feeling Guilty About Considering Filing a Bankruptcy Case? Don’t.

The biggest hurdle I face in my area of legal practice is this: Helping people come to the realization that they shouldn’t feel guilty about filing a case with the Bankruptcy Court.

I never use the phrases “declare bankruptcy” or “go bankrupt.” What I do is help my clients file a very specific kind of legal case and take advantage of very specific legal tools that exist to help them. And those kinds of cases happen to be heard by the Bankruptcy Court. There is no moral judgment in filing such a case. It doesn’t mean that you’ve failed somehow. All it means is that you need protection from the Court while you restructure your debts.

Not to be overly melodramatic, but modern America has in many ways become a system for extracting wealth from ordinary, hard-working people. The clients and potential clients I meet every day each have their own unique situations, but in one respect they are similar: they’ve found themselves in a financial situation that’s not entirely of their making. Maybe they’ve fallen behind on their mortgage after one spouse gets sick or loses her job. Maybe they put their retirement money into an investment property that has plummeted in value. Maybe in a time of desperation they took out an exorbitant title loan on their car. Maybe they’ve been trying to make payments to keep debt collectors at bay, but their salary just doesn’t go as far as it used to.

The individual doesn’t have too many weapons in such situations. Trying to fight them in the civil courts is expensive and often fruitless. Debt consolidators do little else but take your money. The big banks string you along with their promises of loan modifications, but in the end wind up foreclosing anyway.

The Bankruptcy Court is one of the very few places where an individual can go to get real, fast, and relatively inexpensive relief that carries the full force of law. When you file a case, the Court issues an Order telling your creditors they can’t try to collect from you. When your case closes, it issues another Order telling certain of your creditors that you don’t owe them anything else. Creditors take those Orders VERY seriously.

Big companies don’t get caught up with some kind of moral compunction about using the legal tools available to them. For them, filing a bankruptcy case is ultimately a numbers-based decision, and it should be for you too. Big companies know that after they emerge from bankruptcy, they will actually be more credit-worthy. Big companies know that they stand to be far more successful in a future free from bad debt.

Don’t listen to your creditors; they are not your friends. Of course they don’t want you to file. They’ve helped create a whole culture that makes you worry about your credit score and feel guilty about taking advantage of the legal system’s tools. Take your own counsel and decide what is best for you.

401(k) Contributions in Bankruptcy: A Debtor-Friendly Decision

A debtor-friendly decision on 401(k) contributions in bankruptcy came out of Washington state last week, but it requires some background to explain:

The Chapter 13 Means Test

One of the factors determining the size of your Chapter 13 Plan payments is your income; the more money you make, the more money your unsecured creditors need to be paid. The process of arriving at that number is called the Chapter 13 Means Test.

In the Chapter 13 Means Test, you start by taking your average income for the past 6 complete months. Then you subtract amounts that the government thinks people nationally and in your area spend on necessities, as well as amounts that you specifically spend on necessities (e.g. income tax, health insurance, mortgage, etc.). The result is your Disposable Monthly Income (“DMI”), the minimum amount that, based on this analysis, your unsecured creditors must receive per month through your plan.

In re Parks: Harsh Treatment for 401(k) Contributions in Bankruptcy

In August 2012, the Bankruptcy Appellate Panel (“BAP”) for the Ninth Circuit published an opinion in In re Parks. In Parks, the question was: Can a person’s ongoing 401(k) contributions be subtracted from income when calculating DMI? The BAP answered no, holding that post-petition 401(k) contributions are NOT excluded from the bankruptcy estate. Amounts that would otherwise have gone into a 401(k) must be paid to creditors, and cannot be deducted from income on the Means Test.

In re Bruce: Taking the Sting Out of Parks

In December 2012, the Bankruptcy Court for the Western District of Washington revisited the subject of 401(k) contributions and the Chapter 13 Means Test in the case of In re Bruce, and found favorably for the Debtor in two ways.

The Bruce Court’s first holding has to do with the different treatment of above and below-median debtors. You only have to go through the full Means Test process described above if your average income is above the median income for a household of your size in your state. If your income is below the median, then you are assumed not to have any disposable monthly income.

The Court held that the Parks prohibition on deducting post-petition 401(k) applies only to above-median debtors. For below-median debtors, whether those contributions are reasonable and necessary is still a question of fact for the court. And this Court, noting that modernly people primarily save for retirement not through pensions but through 401(k)s, held that these contributions were in fact reasonable and necessary.

Secondly, the Court held that when calculating income for the past 6 months, a debtor may subtract 401(k) contributions made during those 6 months. Thus, even though you can’t take future 401(k) contributions into account when calculating the Means Test, you can take past contributions in account. (Indeed, calculating it in this way may be much better for debtors as it may enable more of them to qualify for 3-year plans. But that’s a subject for a different post.)

This is a debtor-friendly decision that takes some of the sting out of Parks while still being consistent with it. As a Western District of Washington case, it’s not binding on the Northern District of California, where I practice, but the reasoning could very well be applied to cases here.  The opinion can be found here.

What Happens to HOA Dues In Bankruptcy?

The treatment of HOA dues in bankruptcy is quite different from the treatment of other types of debt. They might be secured (the HOA has recorded a lien) or unsecured (no lien).  And even if they are unsecured, they’re the only type of unsecured debt where you know you’re going to begin incurring again immediately once your case is filed. On top of that, Congress gave them special treatment as part of the 2005 revamp of bankruptcy law, so that you might have to keep paying them for a while, even if you surrender the property.

The main factors that determine what happens to them are: Under what Chapter is your bankruptcy case filed? Are you seeking to keep or surrender the property? Does the HOA have a lien? Here’s what happens to HOA dues in bankruptcy, broken down in chart form:

HOA Dues in Bankruptcy – Chapter 7

  No Lien Lien
Surrender the Property
  • Pre-filing dues: Discharged.
  • Post-filing dues:  You remain liable until bank takes title.
  • Pre-filing dues: Your personal liability is discharged. (HOA’s lien goes with the property.)
  • Post-filing dues: You remain liable until bank takes title.
Keep the Property
  • Pre-filing dues: Discharged.
  • Post filing dues: You keep paying them.
  • Pre-filing dues: You still owe them (and so probably consider filing a Chapter 13 case instead).
  • Post-filing dues: You keep paying them.

HOA Dues in Bankruptcy – Chapter 13

  No Lien Lien
Surrender the Property
  • Pre-filing dues: HOA gets portion of your Plan payments; remainder discharged at Plan’s completion.
  • Post-filing dues: You remain liable until bank takes title
  • Pre-filing dues: HOA gets portion of your Plan payments; remainder of your personal liability discharged at plan’s completion (HOA’s lien goes with the property)
  • Post-filing dues: You remain liable until the bank takes title.
Keep the property
  • Pre-filing dues: HOA gets portion of Plan payments; remainder discharged at Plan’s completion.
  • Post-filing dues: You keep paying them.
  • Pre-filing dues:  If you are under water on the mortgage, HOA lien is “stripped” and pre-filing dues are treated as unsecured debt.  If you are not under water on the mortgage, you get five years to repay full amount at 0% interest and no collection attempts allowed.
  • Post-filing dues: You keep paying them.

See those boxes where the phrase “until bank takes title” is in italics?  That’s the special treatment the HOAs received in the 2005 law, and is unlike the treatment of any other debt by the Bankruptcy Court: Even if you’re no longer living in the property, don’t have a tenant there, and have indicated to the Court your intent to surrender it, you still have to pay HOA dues until the bank takes title, which unfortunately, the banks are not always in such a hurry to do.  I wouldn’t let this fact discourage you from surrendering the property in you bankruptcy case if that’s the best thing for you to do.  However, it’s something you need to be aware of going in.

Also, take another look at that bottom right box, where you’re filing Chapter 13, there’s a lien, and you want to keep the property.  That situation is where a bankruptcy case really stands to do an enormous benefit for you.  If you’re under water on your mortgage, the Court “strips” the HOA lien, and the HOA gets treated like any other unsecured creditor (i.e. they only get a portion of your plan payments, and the remainder is subject to discharge).  Even if you’re not under water, you still get five years to get caught up, during which time the HOA can’t try to foreclose or otherwise try to collect on the debt.

Finally, Chapter 13 offers an additional benefit to people who are behind on their HOA dues: If, as in the Cisneros case, the HOA’s debt collection/foreclosure company is charging YOU (not the HOA) for fees that you never knew about or agreed to, in a Chapter 13 case you have an opportunity to challenge those fees.

HOA dues in bankruptcy are complicated, but as in so many other areas, the Bankruptcy Court provides very powerful tools to homeowners with HOA issues.  Yes, you have other options for challenging HOA dues (including special assessments), but if you have other debt issues as well, the fastest and most effective way to resolve them all may well be through a bankruptcy case.

Who should file a Chapter 7 bankruptcy case? Who should file Chapter 13?

The appropriateness of a type of case to your particular situation is the single most important determination in filing a bankruptcy case.  From the moment you begin your conversation, your bankruptcy lawyer will be thinking about whether your situation is Chapter 7 or Chapter 13.

By numbers alone, Chapter 7 cases are more common.  They’re what you typically think of when you think about bankruptcy cases.  You file your case, and (usually) three months later, the Court issues an Order “discharging” your unsecured, non-priority debts (e.g. credit cards, personal loans, medical bills, payday loans, deficiencies on repossessed cars, second mortgages on foreclosed homes).  “Priority” debt (e.g. recent income tax) is not discharged; you still owe it at the conclusion of your case.  With secured debt (usually car loans or mortgages), you have two basic choices: keep the car or house, and keep the debt, or get rid of the car or house and get rid of the debt.  (“Redemption” is a third option, but it’s not practical in most consumer cases.)

However, in Chapter 7, if you have certain types of assets over certain amounts (which varies from state to state), the Trustee is empowered to liquidate those assets and distribute them among your creditors.

Additionally, in Chapter 7, you have to pass something called the “Means Test.”  What the Means Test basically comes down to is, if you make too much money, you can’t file Chapter 7 and have to go to Chapter 13 instead.

Chapter 13 is quite different from Chapter 7.  You propose a Plan to the Court (which the Court either rejects or “confirms”) saying you will pay a certain amount every month to a Trustee for the next five (or sometimes three) years.  The Trustee takes that money and pays off certain debts in full, such as mortgage arrears, car loan balances, and recent taxes.

As to the aforementioned unsecured, non-priority debt such as credit cards, the Trustee pays something to those creditors too, but the amount is usually less than 100%.  Whether your unsecured creditors get 1%, 100%, or somewhere in between is determined by several factors, the most significant of which is income (as determined by the Chapter 13 Means Test, a cousin to the Chapter 7 version).  Upon successful completion of your Plan, any remaining unpaid unsecured debt is discharged.

So if Chapter 13 lasts so long, and only provides a partial discharge, why would anyone chose it over Chapter 7?

For starters, people who stand to lose property in a Chapter 7 case might opt for Chapter 13 instead because you never lose property in Chapter 13.  Another reason might by that you don’t pass the means test.  However, for most Chapter 13 filers, Chapter 13 is simply better for them.  For example, if you’re behind on your mortgage payments, a Chapter 13 case enables to you to get caught up those arrears over 5 years, at 0% interest, during which time you’re protected by the Court from foreclosure.

Here’s another benefit: If you have two mortgages, and your house is worth less than the first mortgage (i.e. you are “under water” on the first), in Chapter 13 you can “strip” that second mortgage.  The second mortgage then gets treated just like other unsecured debt.

If you’re behind on your car payments, Chapter 13 gives you five years to pay off the loan in full, during which time you’re protected by the Court from repossession.  And if you’ve had the car for more than two and a half years, you can do a “cram down.”  That means you don’t pay what you owe under the contract; instead you pay what the car is worth.

If you have recent, non-dischargeable tax debt, Chapter 13 gives you five years to pay that off, too.

Thus, generally speaking, lower income, few assets, and mostly dischargeable debts are factors pointing toward a Chapter 7 case.  Higher income, mortgage arrears, and the possibility of a lien strip or a cram down are factors pointing toward a Chapter 13 case.  People trying to stop foreclosures are almost always Chapter 13 cases.

Of course, no one’s actual situation is this simple.  People’s lives are complex, and there are many more factors than the ones I’ve briefly outlined here.  It is your lawyer’s job to consider and balance those factors and to determine which Chapter (if any) stands to provide you the greater benefit.  Regardless of the complexity of your situation, at the end of an initial consultation your lawyer should be able to recommend one Chapter or the other to you.

See our other blog post for more information on the difference between Chapter 7 and Chapter 13 bankruptcy.

Cisneros: Court Rejects HOA Collection Fees in Chapter 13 Case

On October 1, 2012, Judge Jaroslovsky of the Santa Rosa Division of the U.S. Bankruptcy Court for the Northern district of California issued an opinion in the matter of In re Cisneros (Case No 12-10468).  Mr. Cisneros was the owner of two condominiums in Santa Rosa.  He had fallen behind in his HOA payments, and proposed to cure those arrears through his Chapter 13 plan.  He did not dispute the HOA’s claim for unpaid dues or actually incurred collection fees, which together amounted to approximately $19,093.  What he did dispute, however, was an additional $14,744 in further collection fees tacked on by the HOA’s collection/foreclosure company.

Judge Jaroslovsky found that the HOA had never paid the collection company’s fees, and under the terms of their contract, it was under no obligation to pay them.  The collection company’s fees were not incurred by the HOA, and were not necessary to defray costs incurred by the HOA.  The fees were thus unenforceable under California law, and so were not allowable as claims against the Debtor in his Chapter 13 bankruptcy case.

As to the rights of the collection company itself against the Debtor, Judge Jaroslovsky found that it had none: “It is not in privity with Cisneros.  Any rights it has against Cisneros stem from the HOA, so it cannot have more rights than the HOA against Cisneros.”

This decision represents a substantial victory for homeowners against HOAs and their collection companies, an area which, sadly, remains vulnerable to considerable abuse of the kind represented here.