E stands for exemptions in my Bankruptcy Alphabet. Exemptions describe the possessions you get to keep when you file bankruptcy.
E could also stand for Exception, since exemptions are the only place in bankruptcy law where the law is explicitly different from state to state.
The Bankruptcy Code gave the states the right to prohibit their citizens from using the federal exemptions and to limit them to the exemptions provided by state law. Most of them took the feds up on the offer.
California had it both ways: it denied residents the right to claim the federal exemptions, then enacted California bankruptcy exemptions that mirrored the federal exemptions. Go figure.
Funding a fresh start
The right to keep some assets away from your creditors is grounded in the idea that a debtor needs something with which to start over.
When a debtor designates some piece of property as exempt, it leaves the bankruptcy estate, that mythical pile of possessions that the debtor entered bankruptcy with. Neither the creditors nor the bankruptcy trustee can take exempt property from the debtor.
Exemptions protect the equity in an assets. So, the debtor may end up keeping a house worth lots more than the dollar amount of the exemption because a large part of the value of the asset has been pledged to secure a mortgage loan. The debtor doesn’t have to exempt that part of an asset charged with securing a debt.
There are also unwritten exemptions, or functional exemptions. The laws of economics say that the trustee will not gather up and sell assets with so little value that the costs of sale leave little for creditors. For that reason, debtors often keep more than the exemption system provides because it’s simply too expensive to sell things worth relatively little.
Exemptions trip up too many
Sadly, it is the choice of exemptions where many people who attempt to file bankruptcy without a lawyer get in trouble. It isn’t trouble with the system, it’s trouble in that they short change themselves and leave unprotected something they could have kept despite the bankruptcy, if they had done the exemptions right.
This discourse on Exemptions has been brought to you by the letter “E”.
More about exemptions
Image courtesy of takomabibelot.