Consumer Bankruptcy: Understand the Law and Choose the Right Attorney

October 23, 2010

The 2005 changes to the U.S. Bankruptcy Code were designed to make it more difficult for Americans to file for bankruptcy. Specifically, the changes were intended in part to push more individuals away from Chapter 7 Bankruptcy and toward Chapter 13 Bankruptcy.

The 2005 changes, however, seem to be no match for the current economic realities facing many Americans. Nor have the changes in the law substantially altered an individual's ability to file for bankruptcy protection.

In passing the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), Congress wanted to curtail perceived abuses of the bankruptcy system and force individuals to make more responsible financial decisions. To meet this end, Congress attempted to make fewer people eligible to file for Chapter 7 Bankruptcy, which allows debtors to eliminate their consumer debts. Chapter 13 Bankruptcy, on the other hand, was favored in the new law because Chapter 13 requires debtors to create repayment plans to pay back at least a portion of their debt.

Bankruptcy Filings Are Soaring

Contrary to Congress' intent, Chapter 7 Bankruptcy filings continue to increase.

According to statistics from the United States Courts, the total number of bankruptcy filings increased 20 percent in the 12-month period ending June 30, 2010 over the same 12-month period ending in 2009. Over 1.1 million Chapter 7 bankruptcies were filed in spite of the 2005 overhaul that was supposed to make it harder for individuals to seek this type of relief.

In New Jersey, the total number of bankruptcies filed over the 12-month period ending August 2010 increased by 21 percent over the same 12-month period ending August 2009. Over the same 12-month period ending August 2010, Chapter 7 Bankruptcies increased to 31,028 filings, an increase of 25 percent over the same 12-month period ending August 2009.

The high foreclosure and unemployment rates are being credited for the highest number of bankruptcy filings since 2005, proving that it is still possible to declare bankruptcy for many of the individuals wishing to do so.

Understanding Consumer Bankruptcy

Those considering bankruptcy should have a basic understanding of the two main types of consumer bankruptcy (also known as personal bankruptcy): Chapter 7 and Chapter 13 (referring to the chapters of the federal Bankruptcy Code setting them out).

The Means Test

Prior to determining which bankruptcy chapter is appropriate for an individual, a means test will be applied. The test is used to determine which debtors have the capacity to repay some of their debts. The means test first looks at the Debtor's income against certain allowable deductions established by the Internal Revenue Service (IRS). The individual must file for Chapter 13 protection if the means test calculation shows that the individual does not qualify for Chapter 7 protection.

Many expenses can be considered by the means test. So, even if an individual is determined not to qualify for Chapter 7 Bankruptcy relief the first time the means test is applied, once all expenses and other financial considerations are incorporated into the formula, the individual may actually qualify for Chapter 7 Bankruptcy.

The means test applies a six-month look-back period to determine income. The means test will use an average of the debtor's income over the past six months in the calculation.

A second part of the law looks at the individual's assets to see if there is some equity in them over the permitted exemption. Thus, if there is equity in a house after deducting the mortgage and the permitable exemption, then the debtor must file a Chapter 13 bankruptcy.

Chapter 7 Bankruptcy

The majority of people who file Chapter 7, only own exempt property -- that is, property that the individual is, by statute, allowed to keep -- and do not lose any of their assets during the bankruptcy process. Examples of exempt property include the family car and equity in the family home. In New Jersey, an individual can exempt $21,625 in equity in the home; a husband and wife can exempt $43,250 in equity in the home.

The advantage of filing a Chapter 7 Bankruptcy is that it is fast and there is no repayment plan. Once a debt has been discharged, the creditor cannot seek future repayment from the debtor.

It is important to note that not all types of debt are dischargeable in bankruptcy, including unpaid child support and alimony, and student loans. Examples of dischargeable debt include credit-card debt and medical bills.

It is important to remember that if an individual is not current in their payments on secured debt, such as a house or car, and they wish to keep those assets, they cannot file a Chapter 7 Bankruptcy but must utilize the protection afforded by a Chapter 13 Bankruptcy.

Chapter 13 Bankruptcy

Chapter 13 Bankruptcy is a much more flexible type of debt relief tool and with the assistance of their attorney the debtor's repayment plan can be flexible and creative. In a Chapter 13 Bankruptcy, the debtor restructures his or her debt by creating a repayment plan designed to pay off some or all of his or her debts within a three-to-five-year period. If the debtor successfully completes the Chapter 13 repayment plan, the Bankruptcy Court will discharge all of the debtor's remaining unsecured debts at the end of the payment period.

Chapter 13 Bankruptcy may be a good fit for a debtor who is at risk of losing his or her home to foreclosure. The debtor is allowed to catch up on any past-due mortgage payments over the course of the repayment plan period.

Additionally, if the debtor has more than one mortgage on the house, the second mortgage (or "junior" lien or mortgage) may be subject to being reclassified as unsecured debt and paid back for a far lesser amount. This is possible only if the value of the home is less than what is owed on the first mortgage. For example, if the house is valued at $300,000 and the debtor has a first mortgage for $325,000 and a second mortgage for $100,000, then there is no value left in the home to secure the second mortgage. In effect, the second mortgage becomes an unsecured debt and can be discharged (or "stripped-off ") by the Bankruptcy Court at the end of the repayment plan.

Thinking About Filing? Get a Good Lawyer

Choosing the right bankruptcy attorney is a lot like choosing the right doctor; you wouldn't just go to a generalist for a specific, complex ailment, nor should you go to a lawyer who "is not fully knowledgeable" bankruptcy.

In light of the increased complexity of filing for bankruptcy, it is has become more important for individuals to have their financial future handled by an experienced bankruptcy attorney. Finding the right lawyer, however, takes more than a simple flip through the phonebook or casual online search. Below are some tips for choosing an attorney to handle your case.
- Ask for recommendations. If you have any attorney friends or know any accountants, ask them if they can recommend a bankruptcy attorney. Those with legal and financial backgrounds are in a better position to give you a reliable recommendation.
- Look at the attorney's credentials. Find out if the lawyer has been certified in bankruptcy by any bar-association-approved agencies. Ask if the attorney belongs to professional bankruptcy organizations such as the Association of Consumer Bankruptcy Attorneys or the American Bankruptcy Institute. Bankruptcy is a complex area of the law with specific rules and procedures. You want to make sure the lawyer you choose has the experience to handle your case.
- Look at the attorney's staff. Is the staff knowledgeable and experienced in bankruptcy? Are they dedicated to answering client questions? Is the staff focused on clients' issues and concerns?
- Check out the Internet. If you decide to go online for your search, make sure you are looking in the right places. Attorney directory services, and your local or state bar association are good places to start, but also check the websites of the Association of Consumer Bankruptcy Attorneys and the American Bankruptcy Institute for members who practice in your area.
- Know which questions to ask. Once you begin speaking with prospective attorneys, make sure to ask them about their experience. How much of their practice is devoted to bankruptcy? How many bankruptcies do they handle on average? How many of those are consumer bankruptcies? Business bankruptcies?
- Do not let money be the deciding factor. While cost is a factor for everyone, it should not be the controlling one. When looking for a bankruptcy attorney, you do not necessarily want to pick the cheapest one to handle your case. It is more important to find an attorney you can trust and feel comfortable with -- an attorney who has the experience to guide you effectively and efficiently through your bankruptcy.

Conclusion

Many Americans are finding that due to their financial positions filing for Bankruptcy is the best option. While the 2005 changes to federal bankruptcy law were designed to make it more difficult for individuals to file for bankruptcy, the reality is that most people desiring to file Chapter 7 or Chapter 13 still will be able to do so.

The first step in the bankruptcy process is finding the right attorney. It is important for individuals to begin this search as soon as possible, not only to give themselves enough time to find an attorney, but also to give the attorney enough time to prepare their case.

Article provided by Klein & Radol, LLC
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