Looking around the pandemic-ravaged economy, the financial distress is palpable. It doesn’t take a crystal ball to know that debt-ridden small business people and just plain consumers will soon be looking for relief from untenable balance sheets.
So, what should every lawyer know about bankruptcy, regardless of the focus of their practice? Here’s my list of basic bankruptcy truths that every lawyer should know to guide clients to better outcomes.
1. Debtors keep everything in 97+% of cases
In the overwhelming number of cases, those filing Chapter 7 give up nothing to the bankruptcy trustee. While Chapter 7 is called a liquidation proceeding, most filers have no equity in their possessions or those possessions are protected by an exemption.
Exemptions are the one area of bankruptcy law that varies on its face from state to state. Confining debtors to state exemptions, at the election of the state, was the great compromise when the Bankruptcy Code was first enacted in 1978.
2. High income individuals can file bankruptcy
The means test does not disqualify above-median debtor from bankruptcy. Rather, the means test is an exercise to determine whether high income households have disposable income to pay their debts. After crunching numbers, the means test doesn’t bar very many from Chapter 7.
3. The automatic stay rocks
For the price of the filing fee, debtors get the benefit of an injunction that protects the debtor and the debtor’s assets from collection action. The stay is broad, powerful, and effective whether or not creditor parties have notice of the stay.
The stay lasts at least until the debtor gets a discharge, or until the court, after a hearing, lifts the stay as to an asset or a creditor. Actions taken in violation of the stay are void ab initio.
4. Taxes can be discharged
Properly aged, income taxes can be discharged in bankruptcy. Both state and federal taxes are susceptible to being wiped out. Three rules sketch the taxes that can be discharged: the 3 year rule, the two year rule, and the 240 day rule.
The formulation is involved, but the outcome is simple. Older taxes for which a truthful return was filed are dischargeable. Trust fund payroll taxes, however, are not.
5. Support can’t be discharged
Family support, child support, maintenance or alimony. Whatever it’s called in your practice and whereever you live, it is not dischargeable in bankruptcy.
Plus, support gets the very first priority for payment in a bankruptcy case. So, if there is money flowing through a bankruptcy case, support gets paid first and in full, before any other unsecured creditor gets anything.
6. Informal notice of bankruptcy binds
Creditors’ rights in bankruptcy revolve around deadlines: to file a proof of claim or to contest the discharge of their claim against the debtor. The notice from the court clerk of the filing of the case sets out those deadlines.
But if, somehow, a creditor doesn’t get formal notice from the court, but learns of the bankruptcy informally, they are still bound to the deadlines. And miss the deadline to object to the discharge of your claim, and you’re dead in the water.
7. Community property gets its own discharge
When the debtor lives in a community property state, the bankruptcy discharge protects the couple’s community property even when only one spouse filed bankruptcy. Debts of the non filing spouse existing when the case was filed cannot be collected post discharge.
Creditors need to know whether either spouse has filed bankruptcy and received a discharge before proceeding with collection action. PACER allows online access to nation-wide bankruptcy dockets.
8. Corporate bankruptcy is risky
A failed business doesn’t need to file Chapter 7 to wind up its affairs, and doing so presents risks to management and shareholders of the entity. Entities don’t get discharges in Chapter 7 (only in Chapter 11), so the benefits of filing bankruptcy are limited.
The downside of a corporate Chapter 7 is a trustee who may sift through the entity’s records, looking for loans made to insiders or preferential transfers that can be recovered. Sometimes it’s better to just shut the doors, pay the bills as far as possible, and move on.
9. Action is required to except bad-behavior debts from discharge
Creditors whose claim against the debtor (or the debtor’s non filing spouse) arose through some sort of fraud, intentional tort or breach of fiduciary duty have to file suit in the bankruptcy case to prove up their right to be excluded from the discharge.
The deadline for filing those actions come up quickly after the commencement of the case. Even if the creditor has a state court judgment, an action in the bankruptcy court is required to establish non dischargeability.
10. Bankruptcy can boost credit score
Filing bankruptcy does not doom the debtor to being without credit for 10 years. Instead, the proximity of the discharge affects the price of credit, and bankruptcy becomes less and less significant in the lending decision with the passage of time.
Recent studies show that credit scores actually improve immediately after discharge. More importantly, the debtor’s balance sheet, the actually important marker, improves on the spot.
Bankruptcy practice is a specialty
While the existence of official forms to initiate a bankruptcy case and software to fill out those forms make bankruptcy look routine and mechanical, that’s not the case.
Bankruptcy is no place for the do-it-yourself debtor or the attorney who dabbles in bankruptcy. The 2005 amendments to the Bankruptcy Code created hurdles to get over and traps where a blunder results in automatic dismissal or the loss of valuable assets.
Several states offer specialization certification for bankruptcy lawyers, including California. The ABC certifies specialists, and NACBA, the national organization of consumer bankruptcy attorneys offers a nationwide attorney finder.