Debts with Collateral–THE Fixation of Many Bankruptcies

May 11th, 2012

Your vehicle loan, home mortgage, account at the appliance or electronics store, and maybe a debt that’s resulted in a judgment lien—these debts with collateral are the ones that grab the most attention during a bankruptcy case. And that includes the attention of the creditors, very interested in “their” collateral.

General unsecured debts, which I talked about in the last two blogs, are pleasantly boring in most bankruptcy cases. In a Chapter 7 bankruptcy case, they are generally discharged (legally written off) without any opposition by the creditors, who usually get nothing. And in a Chapter 13 bankruptcy case, general unsecured debts are often just paid whatever money is left over after the secured and priority debts, and trustee and attorney fees, are paid. Nice and boring. That’s because the creditors don’t have much to fight about.

But with secured debts—debts with collateral—both sides have something to fight about—the collateral. The creditors know that the vehicle or house or other collateral is the only thing backing up the debt you owe to them, so they can get quite pushy about protecting that collateral.

The next few blogs will be about how you use either Chapter 7 or Chapter 13 to deal with the most important kinds of secured debts. Today we start with a few basic points that apply to just about all secured debts.

Two Deals in One

It helps to look at any secured debt as two interrelated agreements between you and the creditor. First, the creditor agreed to give you money or credit in return for your promise to repay it on certain terms. Second, you received rights to—and usually title in—the collateral, with you in return agreeing that the creditor can take that collateral if you don’t comply with your first agreement to repay the money.

Generally, bankruptcy will absolve you of that first agreement—your promise to pay—but the creditors’ rights to collateral survive bankruptcy (except in certain rare situations we will highlight later). Your ability to discharge the debt gives you some options, and can sometimes give you a certain amount of leverage. But the creditors’ rights about the collateral give them certain options and leverage, too. You’ll see how this tug-of-war plays out with vehicle and home loans, and few other important secured debts.

Value of Collateral

In that tug-of-war between your power to discharge the debt and a creditor’s rights to the collateral, how much the collateral is worth as compared to the amount of the debt becomes very important. If the collateral is worth a lot more than the amount of the debt, the creditor is said to be well-secured. It has a much better chance of having the debt be paid in full. You’ll really want to pay off the relatively small debt to get the relatively expensive collateral free and clear of that debt. Or if you didn’t make the payments the creditor will get the collateral and sell it for at least as much as the debt.

If the collateral is worth less than the amount of the debt, the creditor is said to be undersecured. It is much less likely to have this debt paid in full. You’ll be less likely to pay a debt only to get collateral worth less than what you’re paying. And if you surrender the collateral the creditor will sell it for less than the debt amount.

Depreciation of Collateral, and Interest

With the value of the collateral being such an important consideration, the loss of value through depreciation is something that creditors care about, a concern which the bankruptcy court respects. Also, in most situations secured creditors are entitled to interest. So, you’ll see that in fights with secured creditors, this issue about the combined amount of monthly depreciation and interest often comes into play.

Insurance

Virtually every agreement with a secured creditor—certainly those involving vehicles and homes—requires that you carry insurance on the collateral. If the collateral is damaged or destroyed, this insurance usually pays the debt on the collateral before it pays you anything. And, if you fail to get the required insurance—or sometimes even if you simply don’t inform the creditor about having the insurance—the creditor itself is entitled to buy “force-placed” insurance to protect only its interest in the collateral, AND charge you the often outrageously high premium.

With these points in mind, the next blog will tell you your options with your vehicle loan under Chapter 7.

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What Happens to Your “General Unsecured Debts” in Chapter 13?

May 9th, 2012

In most Chapter 7 “straight bankruptcies,” most debts are legally written off, especially debts that are not secured by any collateral and don’t belong to any of the special “priority” categories of debt. But how about in a Chapter 13 payment plan? What determines whether these creditors get paid, and if so how much?

The beauty of Chapter 13 is that it is both flexible and structured. Flexibility allows Chapter 13 to help people with wildly different circumstances. Structure—the set of rules governing Chapter 13 bankruptcy—is important because clear rules balancing the rights of debtors and creditors reduces disputes between them. There is only so much money to go around to the creditors, so less fighting means less precious money spent on attorneys and more available for satisfying the creditors. And then getting on with life.

How much the general unsecured debts get paid in any Chapter 13 case is a reflection of these two themes working together. These are illustrated through the following rules, and their impact on the payout to these creditors.

1. Creditors which are legally the same are treated the same. So, all general unsecured creditors get paid the same percent of their debt through a Chapter 13 plan.

2. For any creditor—including a general unsecured one—to share in the distribution of payments, it has to file a proof of claim on time with the bankruptcy court. A general unsecured creditor which fails to file this simple document stating the amount and nature of the debt will receive nothing through the plan, and the debt will be discharged at the end of the case if it completed successfully.

3. The failure of one or more creditors to file its proof of claim usually, but not always, means that there will be more money available for the other creditors. Two exceptions: a “0% plan,” in which the general unsecured creditors are receiving nothing; or a “100% plan,” in which these creditors are being paid the entire amount of their debts.

4. “0% plans” are those in which all of the money paid by the debtor through the Chapter 13 trustee is earmarked to pay secured creditors, “priority” creditors (such as taxes and child/spousal support), and/or trustee and attorney fees. Some bankruptcy courts frown on “0% plans,” especially in certain situations, such as when there does not seem to be good reason to be in a Chapter 13 case instead of a usually much less expensive Chapter 7 bankruptcy.

5. “100% plans” are those in which all of the general unsecured creditors’ debts are paid in full through the trustee. These happen primarily for two reasons. The debtors:

a. are required to make payments based on their budget, which provides enough money over the course of the case to pay off their debts in full; or

b. own more non-exempt assets which they are protecting through their Chapter 13 case than they have debts, which requires them to pay off their debts in full.

6. A major consideration for how much the general unsecured creditors receive is how long the debtors are required to pay into their Chapter 13 case. Generally, if debtors’ pre-filing income is less than the published “median income” for their applicable state and family size, then they pay for 3 years into their plan. If their income is more than that amount, they must pay for 5 years instead. The length of the case obviously affects how much is paid in, and so usually affects how much the general unsecured creditors receive.

7. Payments to general unsecured creditors can be affected by changes which occur during the case—income increases or decreases adjusting the plan payment amount, unexpected tax refunds and employee bonuses paid over to the trustee, and even additional allowed debtors’ attorney fees reducing what is available to the creditors.

8. Once the general unsecured creditors receive whatever the Chapter 13 plan provides for them (and the rest of the plan requirements are met), the remaining balances are legally discharged. The result is that all general unsecured creditors receive the same pro rata share, and that’s the end of the story for them. The exception is the relatively rare creditor which succeeds during the case in convincing the court that its debt should not be discharged at all. This only applies to situations involving a debtor’s fraud or other similar significant wrongdoing, and only if the creditor raises the issue by a very strict deadline just a few months into the case. This creditor still shares in the distribution of payments to all the general unsecured creditors. But at the end of the case, there is no discharge of its remaining debt, which the creditor can then pursue against the debtor.

Clearly, a lot of considerations go into how much the general unsecured creditors will be paid in any Chapter 13 case. There are many interacting rules to be applied to the unique financial and human factors of each case.

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What Happens to Your “General Unsecured Debts” in Chapter 7?

May 7th, 2012

Your “left-over debts”—those which are neither secured by collateral nor belong to any of the special “priority” categories—often don’t drive the decision about whether to file Chapter 7 bankruptcy or a Chapter 13 bankruptcy case.  But you still need to know how these “general unsecured debts” are handled under these two options.

Your secured debts often are tied to your most important possessions—home, vehicles, and sometimes business equipment. So it’s understandable that your bankruptcy decisions will focus on how you can hold on to the collateral you need. And your “priority” debts tend to involve your most aggressive creditors and often can’t be discharged in bankruptcy, so these also grab our attention. And yet, in the list of all your creditors you probably owe “general unsecured debt” to more of them than the other two categories combined. So what happens to these “left-over debts”?

I’ll cover this for Chapter 7 today, and then for Chapter 13 in my next blog.

What happens to your “general unsecured debts” in a Chapter 7 case depends on two very different considerations: 1) “dischargeability,” and 2) asset distribution.

“Dischargeability”

This term refers to whether your creditor will dispute your ability to get a discharge–a legal write-off—of that debt. The vast, vast majority of “general unsecured debts” ARE NOT challenged and so they are in fact discharged. In the rare case that your discharge of the debt is challenged, you may have to pay some or all of that particular debt, depending on whether the creditor is able to show that you fit within some rather narrow grounds for “nondischargeability.” That would usually involving allegations of fraud, misrepresentation or other similar bad behavior on your part.

Asset Distribution

If everything you own is exempt, or protected, then your Chapter 7 trustee will not take any of your assets from you. This is commonly referred to as a “no asset” case. But if the trustee DOES take possession of any of your assets for distribution to your creditors—an “asset case”—that does not necessarily mean that your “general unsecured creditors” will receive any of it. The trustee must first pay off any and all of your “priority” debts, AND pay the trustee’s own fees and that of any liquidating agents or other professionals used. Only if any funds remain will the unsecured creditors get to share in these “leftovers.”

To summarize, in most Chapter 7 cases your “general unsecured debts” will all be discharged, preventing those creditors from ever being able to pursue you for them. Also in most cases, this category of creditors will receive nothing from you, as long as all your assets are exempt. Relatively rarely, a creditor may challenge the discharge of its debt. And if you have an “asset case,” the trustee may pay a part or—very rarely—all of the “general unsecured debts.” But these can happen only if the “priority” debts and trustee fees do not exhaust all the funds being distributed by the trustee.

 

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