Portland Bankruptcy Law Group

The part of bankruptcy law which seems to go most against common sense involves “preferences”—payments that you make to creditors (even if you don’t see them as creditors) within a certain amount of time before your bankruptcy case is filed. In most cases, if you understand and avoid preferences you will much more likely have a smooth bankruptcy case.

The idea behind the term “preference” is that it is a payment to a creditor in preference to your other creditors. You’re playing favorites with one of your creditors. If you do make such a payment, after you file your bankruptcy case the trustee may have the right—depending on the facts—to require that creditor to “return” the amount of that payment, not back to you but rather to the trustee. Then the trustee can distribute that money to all your creditors evenly.If you paid this person because you felt a strong moral obligation to do so—such as to a relative or close friend—then it may be a financial hardship to that person (and intensely embarrassing to you) when the trustee forces that person to “return” the money you paid. In fact, you may well feel like you must make up for that lost money by paying that person again. NOT a good situation.

We’ll tell you the basic rules about preferences in a moment, but first suggest that you’ll understand the term better if you start by disassociating the term from its usual meaning. A payment may be “preferential” even if you are not playing favorites at all. Indeed, the preference payment is often paid unintentionally, such as through a garnishment. The purpose behind the trustee’s right to undo a preferential payment is to discourage creditors from being overly aggressive against a person who looks like they may be a candidate for filing bankruptcy. If creditors know that money they grab may have to be returned, they will tend to be less aggressive about pursuing someone who is hurting financially. At least that’s the theory.

So here’s the basic rule. A preference is a payment (usually money, but it can be any asset) made on a prior debt to a creditor (anybody to whom you legally owe money) during the period of 90 days or less before the filing of a bankruptcy. However, that period is stretched out to a full year before filing for payments made to “insiders”—basically relatives and business associates.

There are a lot of exceptions. An important one is if the payment was made not on a prior obligation but rather to buy something new—say if you bought a used car for $1,500 right before filing bankruptcy, the payment of that amount would not be a preference. Also, if the payment to any particular creditor is less than $600 in a consumer case, or less than $5,000 in a business case, the trustee cannot pursue the preference.If you come in to see us about filing bankruptcy, we will definitely ask you about payments made to creditors in the past year. But we suggest that instead of waiting for us to ask, tell us at the beginning of our initial meeting if within the prior year (or longer if you have any doubt how long it’s been) you paid money (or made payment by transferring assets instead of money) to anyone—especially to relatives or business partners or other associates. We may decide to delay filing a bankruptcy to avoid a payment being a preferential one, but sometimes we may want to hurry the filing to enable the payment to be preferential. In the latter case, in the right circumstances money that you thought was long gone could be retrieved from a creditor and potentially used by the trustee to pay a debt that benefits you, such as paying a child support arrearage or income tax debt that would otherwise not be written off in your bankruptcy.
As you can see, preferences are an unusual aspect of bankruptcy. If we address them appropriately, we can either avoid some bad surprises or occasionally give you a good surprise.

If your income is low enough, you can pass the first part of the “means test” and don’t even have to take the second part. But even if your income is high, you may still be able to pass the test and file a Chapter 7 case. You just need to pass the second part, the expenses part.

In our last blog we explained what it takes to pass the first part of the “means test”—the income portion. Remember that “income” for the purposes of the means test include just about every source of money, not just taxable income. Also “income” has an odd definition, one that often results in your “income” going up or down every month. This means that the timing of the filing of your Chapter 7 case can affect whether or not your “income” is below your state’s “median income” and thus passes the means test. But if you have very steady and moderately high wages, or have little choice about when you must file your bankruptcy case, your “income” may be too high to pass the means test. Then you must pass the second—expenses—part of the test. If you don’t pass it, you will likely be required to file under Chapter 13 instead of 7.

Passing the expenses part of the means test involves 3 steps.

1. Deduct certain expenses to determine if you have any “disposable income.” If you don’t have any disposable income, then you pass the “means test.” Many of these expense amounts come from local and national standards established by the IRS, plus other necessary and actual expenses, including secured debt payments (on mortgages and vehicle loans). Generally speaking, the larger your expenses, the more likely you will not have “disposable income.” Also, your allowed expenses will more likely be larger if you are making payments on your home and vehicle(s).

2. If you do have “disposable income” after deducting your allowed expenses, then you still pass the “means test” if the amount of “disposable income” is low enough. If the amount of monthly “disposable income” is less than $117, you pass. If the amount is $195 or more, you don’t pass this part of the test (but may still pass with the next step). If your monthly “disposable income” is somewhere from $117 to $194, then we apply a formula: multiply the monthly “disposable income” by 60, and compare that amount to 25% of your “general unsecured debts” (debts without collateral which don’t belong to a special set of “priority” debts). If 60 months of your “disposable income” is less than this 25% amount, then you pass the “means test.”

3. If you’ve still not passed the “means test,” you may still do so “by demonstrating special circumstances,” meaning either a) additional reasonable and necessary expenses which are not otherwise allowed in the step above, or b) adjustments to income reflecting a reality not shown by the standard calculation of income.

As shown above, there are a number of ways to meet the “means test.” The practical truth is that most people who want to file a Chapter 7 case can do so. But as you can also see, it can get complicated, and much more so than we can show here. On one level, the “means test” involves the application of some relatively simple mathematical formulas. But on a deeper level, it also gets into a myriad of evolving rules and judgment calls about what expenses are allowed, what qualifies for “special circumstances,” and other issues.  This is not a do-it-yourself project.

Before we end we have to add that the “means test” only applies in Chapter 7 cases when the person’s “debts are primarily personal debts.” This means that if more than 50% of your debts are business debts, then you don’t even need to take the “means test” to qualify for Chapter 7. That’s also true for certain disabled veterans, and for other military servicemembers who served in active-duty under specific conditions. At your initial consultation, we’ll discuss the details of these exceptions to see if they apply to you.

If you have the “means” to pay a meaningful amount to your creditors in a three-to-five-year Chapter 13 payment plan, you ought to be disqualified from being able to file a “straight bankruptcy” of Chapter 7.  That’s the theory of the “means test.”

In practice, for many people it is quite an easy hoop to jump through. For most, it ultimately does not stop them from filing Chapter 7 if they want to do so. Yet, for a small percentage of bankruptcy filers, it does indeed disqualify them from Chapter 7. Where do you fall?

It’s basically a two-part test. First, the income portion, second the expenses portion. We’ll tell you the first part in this blog, the “easy hoop” we just mentioned. You should be able to calculate with a fair amount of accuracy whether you beat this part of the means test. If you do, you win—you very likely get to do a Chapter 7 case without even needing to take the second, lots more complicated part of the test. We’ll tackle that second part of the test in our next blog for those who can’t avoid it.

The first part of the means test compares your income to a published “median income” for a household of your size in your state. If your income is less than the median, you’re done with the test—you get to file under Chapter 7.

Your income for this test is based on the precise amount of income you received (from every source, not just taxable income, except social security-related benefits) during the six full calendar months before your case is filed. So, for example, if your case is filed on October 7, we look at every dollar you received in the six-month period from the prior April 1 through September 30.

Notice that if you have some flexibility about when your case is filed, and if your applicable income is not precisely the same all the time, then you may well be able to adjust the timing of your filing to reduce your income during the applicable 6-month period. Remember we’re including ALL income, including irregular ones like bonuses, unemployment benefits, and support payments.

Once you know when your Chapter 7 is being filed, and therefore know what income your household received during the prior 6 full calendar months, that income is essentially multiplied by two to arrive at an annual income. If you live in Oregon, compare that annual income amount to the following table of median incomes:

* Add $7,500 for each individual in excess of 4.

If your income, as calculated in this precise fashion, is no more than the amount applicable for your family, then you can file a Chapter 7 case without having to do the expense side of the means test.

If your income is higher, don’t despair—once we go through the rest of the means test you may well still qualify. We have to tackle that in our next blog.

If you have a loan against your vehicle, and this is a vehicle you want to keep, you definitely want to know whether you qualify for a cram down.

A cram down on your vehicle loan could allow you to keep your vehicle while paying thousands of dollars less for it, often while also reducing the monthly payments on the loan. The term comes from the basic concept that you are essentially allowed to pay for the value of the vehicle instead of the contract balance, assuming that the vehicle is worth less than the balance. You “cram down” the debt to the value of the vehicle. But how much you actually save altogether, and how much you save each month, depends on the facts of the case. Don’t worry; we won’t leave you hanging. We’ll explain in a moment, so you’ll be able to at least get some idea how much money a cram down might save you.

But we don’t want you to get all excited about it if you don’t qualify. And the rules for qualifying are—for a change—really straightforward.

Vehicle cram downs apply only in Chapter 13. There’s no such thing in Chapter 7. If you have your heart set on a straight Chapter 7—a get-your-debts-discharged-in-three-months bankruptcy, don’t even think about a cram down on that vehicle loan. In Chapter 7, it’s take it or leave it. Keep that vehicle and sign on for the rest of the full loan, or surrender it and (almost always) owe nothing. Only Chapter 13, the pay-for-three-to-five-years bankruptcy, lets you keep your vehicle and not pay the full loan balance.

That is, you get a cram down if you also meet the second condition: the vehicle loan was originated more than 910 days (about two and a half years) before you file the Chapter 13 case. If your vehicle loan is not that old, no cram down.

So let’s assume you qualify—you’re in a Chapter 13 case with a vehicle loan that’s old enough. How much money are you going to save with a cram down?

The first part of the answer is pretty easy. We mentioned it above—the new cram down amount you would pay is the fair market value of the vehicle.  Your savings is the difference between that value and your contractual loan balance. Of course the value of any vehicle can be open to some dispute, but that’s usually resolved with some simple negotiations. There’s usually not enough money in it to waste everybody’s attorney fees on litigating this.

Then calculating the amount of the new monthly payment on that new reduced balance is a matter of simple math. We re-amortize the loan, meaning we calculate what payments are needed to pay off the new value-based balance within the life of the Chapter 13 Plan. The cool thing is that often not only is the balance to be paid reduced, the length of the remaining term of the loan can be stretched longer than it would have been under the contract, and often the interest rate is reduced, all potentially greatly reducing the new monthly payment.

The last part of the “how much do I save question?” is the tricky part. The part of the loan balance that isn’t being paid—the amount beyond the value of the vehicle—is treated like an unsecured debt. That means it is lumped in with the rest of those bottom-of-the-barrel debts, which are all paid however much your Chapter 13 Plan says those debts get paid. Sometimes that pool of unsecured debts is paid a little, sometimes a lot, sometimes it is paid nothing, sometimes (rarely) it is paid in full. It depends on your whole financial picture–your income and expenses, assets and debts—and how that all interrelates with all the rules of Chapter 13 as applied to your case. Hint—in most Chapter 13 cases with a vehicle cram down, the unsecured portion of the vehicle loan gets paid little or nothing.

A Chapter 13 vehicle cram down is usually a very good deal, if you qualify for it.

You are about to file a Chapter 7 or Chapter 13 case. You know in a Chapter 7 that your bankruptcy trustee is the person who looks over your paperwork and talks with you for a few minutes, mostly to decide whether or not everything you own is exempt so that you can keep it all.  In a Chapter 13 case you know that this trustee helps determine whether the Plan we submit meets legal requirements, and then gets my monthly Plan payments and distributes them to my creditors. The “Office of the United States Trustee” is a different player altogether.  It CAN cause major problems especially in a Chapter 7 case, so it helps to know its role, even though in most cases it mostly works in the background.

The U. S. Trustee is part of the United States Department of Justice, and does mostly two things: 1) helps the Bankruptcy Court administer bankruptcy cases, and 2) enforces bankruptcy law. These are reflected in this agency’s stated mission: “to promote integrity and efficiency in the nation’s bankruptcy system by enforcing bankruptcy laws, providing oversight of private trustees, and maintaining operational excellence.”

In its administrative role, the U. S. Trustee appoints and supervises the Chapter 7 and Chapter 13 trustees. It keeps an eye on bankruptcy cases so that they are administered efficiently. It reviews and can object to fees charged by attorneys and other professionals.

In its enforcement role, the U. S. Trustee can spell trouble in two ways. 1) In a Chapter 7 case, it can try to “convert” your case into a Chapter 13 case. And 2) it can accuse you of providing inaccurate information on your bankruptcy documents or while you are under oath during your hearing with the trustee.

In most cases it’s not all that hard to make sure that you don’t hear from the U. S. Trustee.

First, as for not having your Chapter 7 cases being challenged as belonging under Chapter 13, this is mostly a matter of your income and expenses—whether your case meets a complex set of rules called the “means test.” Avoid this kind of objection by the U. S. Trustee by working closely with your attorney before your case is filed to make sure you clearly meet this test.

And second, as far as avoiding allegations of misrepresentation, again it’s a matter of appropriate preparation. Diligently provide your attorney with the paperwork and information needed so that all of the documents prepared for the Bankruptcy Court and for the Chapter 7 or 13 trustee are accurate and consistent.

The fact is that a fair amount of the bankruptcy process operates under the honor system. The U. S. Trustee is there, looking over your shoulder, to keep it honest.

In June, a bankruptcy court in Los Angeles emphatically declared that a legally married gay couple could file their bankruptcy case jointly, even if doing so was in direct violation of the controversial federal Defense of Marriage Act (“DOMA”).

The Bankruptcy Code allows a “joint case” to be filed by “an individual . . . and such individual’s spouse.”  DOMA defines the term “spouse” as “a person of the opposite sex who is a husband or a wife.” thus disallowing same-sex person to be a “spouse.”  However, the bankruptcy court determined that DOMA was unconstitutional because “no legally married couple should be entitled to fewer bankruptcy rights than any other legally married couple. “  Under their constitutionally derived equal protection rights, the legally married gay debtors were entitled to be treated the same as married heterosexuals because preventing them from doing so advanced no “important governmental interest.”

A single bankruptcy court opinion such as this one usually has a limited effect—it is only legally binding on bankruptcies filed within that federal district.  Granted, the bankruptcy court in that Southern California federal district has more consumer bankruptcy cases filed each year than in any of the other 93 federal districts in the country.  But still, this same issue was being simultaneously fought out in bankruptcy courts in other parts of the country, with the definite possibility that other bankruptcy judges could have reached opposite results.  So normally it would be years before a definite answer came out of the appeals process, perhaps even needing an eventual decision by the U. S. Supreme Court.

But because of an extremely unusual combination of legal and political events, this one bankruptcy court’s opinion IS for practical purposes the law of the land.  How could that be?

1. The opinion of the bankruptcy court, which is virtually always signed by a single bankruptcy judge, was also signed by 19 other bankruptcy judges, presumably all from that bankruptcy court (where they have many more judges than usual because the huge population and the number of bankruptcy filings).  This is an almost unheard of emphatic showing of support for a judge’s decision by his local colleagues.

2. The federal government, through the U.S. Trustee, filed an appeal of the bankruptcy court’s opinion in late June.  But then shortly after, in early July, the U.S. Trustee cancelled that appeal.  It did so because earlier in the year, President Obama had announced that his Administration would not enforce DOMA, for the same reason as the Los Angeles bankruptcy judge, that it was unconstitutional.  In this unusual situation the U.S. House of Representatives had the option of enforcing the law, and in this very case it had signaled that it would do so.  But then the House changed its mind and informed the U.S. Trustee that it would not try to enforce DOMA in this context of joint-filed bankruptcies.

3. As a result, not only did the U.S. Trustee dismiss its appeal in the California bankruptcy court case, it immediately also stopped fighting the issue in other bankruptcy courts throughout the country.

So it sounds like this one bankruptcy court opinion allowing legally married gay couples to file bankruptcy jointly is functionally the law throughout the country.  That’s even though the Los Angeles opinion was never reviewed or decided by a higher court, nor were any other bankruptcy court opinions.  Technically, that opinion’s ruling is legally binding only for the bankruptcies filed in the seven counties in that federal district.  But practically, its ruling is applicable everywhere. Unless the House of Representatives changes its mind.  Or if some bankruptcy judge raises an objection even without the U.S. Trustee doing so.

In the American legal system, when there are hundreds of millions of dollars at stake, and both sides ready to fight to the death, litigation can drag out for many years. In Anna Nicole Smith’s extreme case, it dragged on for 16 years, and finally got resolved in the United States Supreme Court a few weeks ago, more than four years AFTER her death. She fought to the death and way beyond.

After all that, the deciding Supreme Court opinion was 100% about bankruptcy–the power of the federal bankruptcy courts over state courts.

It came down to a fight between a Texas probate court and a California bankruptcy court. The Texas court had ruled in favor of the heirs of Anna Nicole Smith’s deceased husband, J. Howard Marshall II, shutting Anna Nicole out of any inheritance. The bankruptcy court in California had ruled in favor of Anna Nicole, at one point awarding her $474 million, later reduced to $89 million. (Apparently this was still enough to keep fighting about!) The Supreme Court decided in favor of the Texas court and against the bankruptcy court. Anna Nicole’s heirs lost and get nothing. Her long-deceased husband’s heirs get his whole estate. About $1.6 billion.

But in the long run, the real losers might well be the bankruptcy courts, and the people who file bankruptcy. At least those relatively few of them who end up in litigation in the midst of their bankruptcies.

That’s because in its 5-to-4 split decision, the Supreme Court decided that the bankruptcy court had accurately followed the statute which effectively gave it power over the state probate court, BUT that statute was unconstitutional—it gave the bankruptcy court more power than the Constitution allowed.

In doing so the Supreme Court upset a very careful balancing act that Congress had created and the courts have been following for several decades. Simply put, some cases that would have been resolved in bankruptcy court, now no longer will be. Why this matters for some of our clients is that bankruptcy court is usually the most efficient—meaning least expensive—place to resolve legal disputes with their creditors. It can take two or three times as much attorney time—so, that much more in attorney fees—if we need to jump out of bankruptcy court into state court or federal district court. If our clients have a strong argument—a “counterclaim”—why they don’t owe a debt, it may well become much harder to raise that argument, and so in practical terms, raising that counterclaim may just not be worth it. When justice is just too expensive, justice is denied.

But the Supreme Court, at least the narrow majority that decided this case, doesn’t think it needs to think in practical terms. It paid no attention to this argument by the dissenting justices:

[U]nder the majority’s holding, the federal district judge, not the bankruptcy judge, would have to hear and resolve the counterclaim. Why is that a problem? . . .  . Because under these circumstances, a constitutionally required game of jurisdictional ping-pong between courts would lead to inefficiency, increased cost, delay, and needless additional suffering among those faced with bankruptcy.

Think what you will about the sad story of Anna Nicole Smith. It is maddening that her epic legal battle for a share of her deceased husband’s estate slapped down by the highest court in the land deciding to make it that much harder for the already oppressed to find justice.

Child and spousal support obligations are treated with great respect in bankruptcy.  This is true about both ongoing support payments and any back support payments you might have accrued.

The hard truth is that bankruptcy can only provide limited help in this area. HOWEVER, that help may be just what you need.

First, what bankruptcy CAN’T do:

1) It can’t reduce your ongoing monthly support obligation.  You have to go back to divorce court to do that.  The bankruptcy court has virtually no power here.

2) It can’t write off (“discharge”) any back support, under either Chapter 7 or 13. Once you owe a particular month of child or spousal support, that amount has to be paid one way or the other.   That is why if you have grounds for reducing your support obligations, you should address that in divorce court as soon as possible.

Now, what bankruptcy CAN do:

1) If you owe back support, a Chapter 13 case allows you to catch up on that arrearage WHILE being protected from all the very aggressive collection methods that can be used against you to repay that arrearage.  This is a tremendous advantage, stopping not only garnishments of wages and bank accounts, but also preventing or undoing suspensions of drivers’ and occupational licenses. Also, paying this support through Chapter 13 in many situations simply reduces what you would otherwise be paying to your other creditors during your case.  In other situations your back support adds to how long you must pay into your Chapter 13 Plan, but even that is usually a good deal for you because of the protection you get while you are in your Chapter 13 case and complying with the terms of the Plan.  NOTE: This protection does NOT apply to Chapter 7—these kinds of collections can continue against you during a Chapter 7 case.

2) If you owe back support, and you have an “asset” Chapter 7 case, then that back support obligation will be paid by the trustee first, before any of your other creditors.  Even before taxes.  These “asset” cases are unusual because most Chapter 7s are “no-asset”: the trustee does not take any of your assets to liquidate and distribute to your creditors because everything you own is “exempt.”  But IF you DO have an asset case, and owe back support, some or all of that may be paid by the trustee.

Support obligations have to be treated very carefully in bankruptcy. Otherwise these very special debts can create havoc with the rest of what your bankruptcy is trying to accomplish.  So your support situation is a critical part in deciding whether to file Chapter 7 or 13, and how to proceed with either option.  So even if your ex-spouse or the state is not currently enforcing an ongoing support obligation or is not chasing a past-due one, be sure to tell your attorney all about it.