bankruptcy code; debts

Most people have many more options for handling debt problems than they realize. Bankruptcy is an important factor that influences negotiations with creditors. But there are many situations where bankruptcy can be avoided if the matter is handled with intelligence and integrity.

There are no fixed guidelines, but there are factors to take into account (such as a certain dollar amount of debts, or a certain percentage of income going to loan payments, or even a ratio of assets to debts) that can be used for deciding when bankruptcy makes sense. All of these factors must be considered, of course. But in every case, there is the balancing of pluses and minuses of a bankruptcy proceeding and the possibility of negotiations that can be undertaken rather than filling a proceeding.

• What kind of debts are involved? Some, such as taxes, back alimony and child support, or student loans that became payable less than five years previously, can't be discharged in bankruptcy.
• What else would be affected? Family members or friends who have cosigned loans may be drawn into the situation.
• Are any inheritances, trusts, or life insurance proceeds about to be received? Anything of this nature received within six months of filing for bankruptcy will be subject to creditors' claims. In some cases, it pays to have a benefactor change his/her will to leave only a small income for the debtor and the balance held for the children.
• What are the future consequences? In one recent case, a banking executive had been involved with a side business that failed. If he had filed for bankruptcy, his career would have been stymied. Point: Even without special situations, out of court negotiations with creditors can frequently lead to a settlement that is quicker and less public than a filing for protection under the Bankruptcy Code.

1. Liquidation. It's possible to simply turn everything over to a bankruptcy trustee (Chapter 7 of the Bankruptcy Code). The debtor is allowed to keep exempt assets. Under federal laws, the most important exemption is up to $7,500 worth of equity in a home or, for those who don't own a home, $7,500 worth of any other assets or a combination of equity in a home and personal property. This is sometimes called the wild-card exemption. Exemptions exist for equity in an auto and household furnishings, tools used to earn a living, etc.

Any property not exempt is turned over to the bankruptcy trustee, along with a list of creditors and the amount each is owed. The trustee converts the assets to cash, establishes the legal priorities among the creditors, and distributes what he has collected in accordance with these priorities.

As long as the debtor has been honest in dealing with creditors and with the bankruptcy court, his debts are then discharged, except for those in the categories (referred to above) that aren't eligible for discharge. The debtor cannot file for relief under Chapter 7 or Chapter 11 for six years after the initial filing.

• Installment plans . Under Chapter 13, a debtor who has a regular income may pay off his debts over a period of three to five years. Nondischargeable debts must be paid in full. But other creditors may be forced to accept a percentage of what they're owed. The debtor must make a good-faith effort to meet his obligations, and creditors must receive no less than they would get in a straight liquidation bankruptcy. And even the nondischargeable debts are spread out over a manageable period. Bonus: IRS interest and penalty charges on tax debts stop running once the bankruptcy petition is filed.

• Reorganization . Most people think of reorganization under Chapter 11 of the Bankruptcy Code as something that applies only to corporations. But there's nothing to stop an individual from filing under Chapter 11. There may be advantages, particularly if he has a business worth continuing.

In order to continue essential services such as utilities, the debtor must post a new deposit (usually 50% of the average monthly bill for the last three months). If any mortgaged property is involved, the mortgage does not become due, and foreclosure is barred if the debtor has any equity or if the property is needed in business. The court may set a monthly payment for the use and occupancy of premises or assets covered by a valid lien.

Next, the creditors are organized into categories, usually secured and unsecured. Then a compromise plan is worked out. Generally it calls for a portion of the debt in each category to be paid off, dependent on the liquidation value of the assets. Once the plan is confirmed, and payment is made, the balance of the debt is forgiven.

To win acceptance, the plan must be accepted by at least one class of creditors wherein a majority in number and two-thirds in amount of those voting have consented to the plan. If these guidelines are met, all of the creditors are bound by the plan.

First, the creditor and his attorney must take stock of the entire financial situation, listing assets, liabilities, pending court actions (if any), extra resources and so forth. The next step is to work out a compromise offer that's fair both to the creditors and to the debtor---something the debtor can live up to that will give the creditors more than they would get in bankruptcy. A full disclosure of the assets, liabilities, and prospects for the future must be made.

Unless a major creditor is irrationally vindictive, it should be possible to make an offer attractive enough to win over the bulk of the creditors. Reason: Bankruptcy is a lengthy and expensive process. Trustees' fees, attorneys' fees, and other administrative expenses are high. And, in effect, these expenses are borne by the creditors. Administrative expenses are treated as first-priority debts. They must be paid in full before anything is paid toward any other debts. Also: In making a compromise offer, the debtor can often draw on resources, such as borrowing from a relative, that wouldn't be available to the creditors in a bankruptcy.

One or two small creditors may feel an offer in compromise isn't worth accepting. Usually if 90% or so of the debt can be compromised, the other 10% can be taken care of. To maintain leverage, the offer is generally set up so that it must be accepted by enough of the creditors to make a compromise worthwhile or enforceable in a Chapter 11 proceeding utilizing consents in proper form. Otherwise it is automatically withdrawn. In that case the creditors are likely to end up with a bankruptcy that gives them even less. Even the IRS has been known to accept a compromise of back taxes under these circumstances.

For a simple wage earner with relatively few assets and an overwhelming debt load, a simple, straight liquidation bankruptcy may be the best course. Such a debtor is likely to lose little or none of his property because of the exemption rules. And he will be freed of creditors harassment. But most people should first explore other options with a competent attorney. The public embarrassment and damage to reputation that bankruptcy entails can often be avoided.

At the time of revision of this article, Congress is considering a number of amendments to the Bankruptcy Code. Some of the amendments are technical, but a large number are substantive and cannot be dealt with in an article of this length. Briefly, there is a reasonable chance that a new Chapter 10 for mini reorganizations may be passed which will result in an expedited process and much smaller legal fees for small businesses, whether corporate partnership or individual. Also, the dollar limits on Chapter 13 wage earner qualification may be raised substantially (possibly to $1.0 million) which will give the beleaguered wage earner debtor another alternative to liquidation under Chapter 7. Single asset Chapter 11's particularly real estate, will probably be made more difficult than they already are under existing case law. See your local bankruptcy specialist for your options, as we are nt a legal law advisor.