Bankruptcy does not solve all debt problems | When not to file bankruptcy

The idea of declaring bankruptcy, wiping out certain debts or repaying them over time with court protection—no more hassles or nasty phone calls from menacing creditors--and then moving on more or less debt free has undeniable appeal to anyone faced with overwhelming debt.

But be careful. Compelling as it may sound, bankruptcy has a lingering and far-reaching impact that touches every aspect of life. Bankruptcy can prevent you from getting the best rates and limits on credit, make it difficult to keep bank accounts and credit cards, can take some valued, and valuable, possessions.

But is bankruptcy really necessary? In other words, what alternatives and options have you thoroughly looked into? Oh, you haven't? Shame on you. It is important to speak with an experienced bankruptcy attorney before making any decisions on filing for bankruptcy. Some types of debt are exempted from bankruptcy discharge. For example, taxes may not be dischargeable, but some taxes may be dischargeable depending upon your situation. Also, if you file for chapter 7 bankruptcy, some of your assets may not be protected depending upon the types and amount of value of the asset(s). If you are considering filing for chapter 13 bankruptcy relief, your assets can still play a part in your repayment plan. Call for a free consultation with Mike to learn more.

What is not Dischargeable in Bankruptcy?

Not all debts are discharged in bankruptcy. The debts discharged vary under each chapter of the Bankruptcy Code. Section 523(a) of the Code specifically excepts various categories of debts from the discharge granted to individual debtors. Therefore, the debtor must still repay those debts after bankruptcy. Congress has determined that these types of debts are not dischargeable for public policy reasons (based either on the nature of the debt or the fact that the debts were incurred due to improper behavior of the debtor, such as the debtor's drunken driving).

There are 19 categories of debt excepted from discharge under chapters 7, 11, and 12. A more limited list of exceptions applies to cases under chapter 13.

Generally speaking, the exceptions to discharge apply automatically if the language prescribed by section 523(a) applies.

The most common types of nondischargeable debts are:

The types of debts described in sections 523(a)(2), (4) and(6) (obligations affected by fraud or maliciousness) are not automatically excepted from discharge. Creditors must ask the court to determine that these debts are excepted from discharge. In the absence of an affirmative request by the creditor and the granting of the request by the court, the types of debts set out in sections 523(a)(2), (4) and (6) will be discharged.

A slightly broader discharge of debts is available to a debtor in a chapter 13 case than in a chapter 7 case.

Debts dischargeable in a chapter 13, but not in chapter 7, include:

Although a chapter 13 debtor generally receives a discharge only after completing all payments required by the court-approved (i.e., "confirmed") repayment plan, there are some limited circumstances under which the debtor may request the court to grant a "hardship discharge" even though the debtor has failed to complete plan payments. Such a discharge is available only to a debtor whose failure to complete plan payments is due to circumstances beyond the debtor's control. The scope of a chapter 13 "hardship discharge" is similar to that in a chapter 7 case with regard to the types of debts that are excepted from the discharge. A hardship discharge also is available in chapter 12 if the failure to complete plan payments is due to "circumstances for which the debtor should not justly be held accountable.

Secured Debt

When a debt is secured, the creditor has rights in the security (or collateral) in addition to the rights against the debtor.   The debtor's personal liability may be discharged in Chapter 7 while lien rights in the collateral pass through bankruptcy unaffected unless they are avoided or stripped down.  When the lien cannot be avoided,  the debtor gets choices about how to provide for the creditor's rights in the collateral.

Long term secured debt like mortgages pass through the bankruptcy unaffected by the discharge.  Most creditors secured in real property are happy to continue receiving payments on the debt, so long as you are current.  See Chapter 13 for using that chapter to cure defaults in long term secured debts. 

Choices with respect to how to deal with secured debt in bankruptcy include:

Redemption
means that you pay the secured creditor the present value of the asset that is the collateral for the debt in a single cash payment.  Upon payment, the asset is yours, free of the secured debt. The balance of the debt is treated as an unsecured debt in the bankruptcy and discharged with your other debts.
Reaffirmation
is an agreement to waive the discharge as to the reaffirmed debt and to pay the debt according to the terms of the original agreement.   The reaffirmed debt is legally enforceable if you breach (stop paying) later on, and the creditor retains the security interest in the asset until the debt is paid.
Surrendering the collateral
renders the debt an unsecured debt in the bankruptcy.  The creditor can sell the asset to recover part of the claim.  Even if the asset isn't worth what was owed on it, the unpaid balance is discharged in the bankruptcy.

If the asset has a low value relative to the cost of repossessing it (such as used computers, major appliances, automobile tires) the debtor can simply decline to redeem, reaffirm or surrender and wait to see if the creditor will take action to recover the collateral after the bankruptcy.  In our experience, creditors threaten but do not pursue this kind of collateral after the bankruptcy.

Student Loan Debt

Student loans are not dischargeable in bankruptcy unless you can show that your loan payment imposes an "undue hardship" on you, your family, and your dependents. Non-dischargeable debts are those debts that you cannot totally eliminate when you file for bankruptcy and will have to be paid by you.

It is almost impossible to show an undue hardship unless you are physically or mentally unable to work and the chances of your obtaining any type of gainful employment in the future are non-existent.

Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, privately funded student loans are treated the same way that loans funded and guaranteed by the federal government or nonprofit institutions. Prior to the new law, if you had a loan from a private-sector lender that was not guaranteed, it could be discharged under chapter 7. The new law gives these loans the same protection as the guaranteed loans.

If you would like to discharge your student loans under the "undue hardship" exception, you must file a separate motion with the bankruptcy court and then appear before the judge to explain your hardship. This is not an easy task, so if your student loans are the main part of your debt, you would be better off not facing the harshness of bankruptcy as courts are extremely reluctant to discharge student loans.

Although you may not totally eliminate student loans in bankruptcy, you can consolidate them, with your other bills, in a Chapter 13 proceeding. Under this chapter, you can propose a repayment plan in which to pay your creditors over three to five years. For a Chapter 13 bankruptcy, you'll need a stable income with disposable income and must have no more than $1,010,650 in secured debt (debt involving property that your creditor might take if you don't make your payments) and $336,900 in unsecured debt. These amounts are adjusted periodically to reflect changes in the consumer price index. Chapter 13 will also stop collection action against you.

If you include your student loans in a Chapter 13 repayment plan, depending on certain factors such as the size of the loan, the number and amount of your other debts, and the amount of your disposable income, you might be able to make a dent in the loan balance over the life of your plan. However, you will still owe whatever student loan debt remains when you complete your plan.

Tax Debt

Generally debts owed to the Internal Revenue Service or a State’s equivalent agency are not dischargeable in bankruptcy unless very specific conditions apply.   Chapter 7 provides for full discharge of allowable debts. Chapter 13 provides a payment plan to repay some debts, with the remainder of debts discharged. Under the bankruptcy laws, tax debts are treated the same way in both Chapter 7 and Chapter 13 petitions. Most tax debts are not capable of being discharged in bankruptcy. The bankruptcy petitioner must have tax debts that meet five criteria for discharge and most people do not meet these criteria.

Tax debts are associated with a particular tax return and tax year. The bankruptcy law lays out specific criteria for how old a tax debt should be.

Five Rules to Discharge Tax Debts

If the income tax debt meets all five of these rules, then the tax debt is dischargeable in Chapter 7 and Chapter 13 bankruptcy petitions.

  1. The due date for filing a tax return is at least three years ago.
  2. The tax return was filed at least two years ago. 
  3. The tax assessment is at least 240 days old. 
  4. The tax return was not fraudulent. 
  5. The taxpayer is not guilty of tax evasion.

Some Tax Debts Not Dischargeable

Tax debts that arise from unfiled tax returns are not dischargeable. The IRS routinely assesses tax on unfiled returns. These tax liabilities cannot be discharged unless the taxpayer files a tax return for the year in question.
Other Tax Issues in Bankruptcy

Before a Chapter 7 or Chapter 13 bankruptcy can be granted, the bankruptcy petitioner is required to prove that the four previous tax returns have been filed with the IRS. The four previous tax returns must be filed no later than the date of the first creditors' meeting in a bankruptcy case.  Additionally, bankruptcy petitioners are required to provide a copy of their most recent tax return to the bankruptcy court. Creditors can also request a copy of the tax return, and petitioners must provide a copy to them.

For Additional Information about how Tax Debt can affect bankruptcy see this article: Bankruptcy And its Effect on Federal Tax Debt

Bankruptcy Alternatives

One viable bankruptcy alternatives is a debt consolidation loan. They don't actually hand the money to you though. Rather, they take your outstanding and overdue accounts, and you pay one monthly payment to them, which they in turn divide up to send to your creditors. Your creditors are happier than they've been in years because now timely payments are being made, and you credit rating does not hit the skids, at least not completely, because you were able to avoid bankruptcy.

Another option is to use a debt counseling services.  They can consolidate your monthly payments and obtain payment or interest reductions on your unsecured debts. The only problem with debt counseling is that many people are in such financial trouble that they will not qualify for debt counseling because they will not be able to repay their debt even under the better terms. And again this option could have a significant negative impact on your credit rating.

Lastly, rather than file bankruptcy, one may consider settling your unsecured debt at a reduced amount. It is unlikely that an individual could do this independently but there are companies that will help you negotiate with your creditors. It is important that these negotiations are handled properly and the consumer should seek professional help. As in all these actions there can be a negative effect on one's credit rating.

Check your alternatives and options before making such a critically important decision as filing for bankruptcy. You always have options, and the key to successful living is to acquire the knack for choosing the right one.


For further assistance call us to schedule a free consultation at 612-217-0529

This content is not meant to constitute advice of any kind, including without limitation, legal advice of any kind. If you require advice in relation to any legal matter you should consult an appropriately qualified lawyer.

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