August 3, 1998 98-R-0905
FROM: Helga Niesz, Principal Analyst
RE: Chapter 7 Bankruptcy
You asked for a summary of the rights of individuals who file for Chapter 7 bankruptcy protection in Connecticut. You want to know what options exist under federal and state law that allow lenders to recover any loans from a person who has filed for bankruptcy. You also want a summary of what the federal government and other states have been doing to assist lenders in recovering monies from individuals who declare bankruptcy.
SUMMARY
Bankruptcy is governed by federal law, but states can establish their own lists of property that can be exempted from the bankruptcy process. People have to file for bankruptcy in the U.S. Bankruptcy Court for the area they live in and, if the state allows it, as Connecticut does, they can choose either the state or federal exemptions, whichever is most advantageous to their situation.
Chapter 7 is the most common form of bankruptcy used by individuals. It lets them liquidate their nonexempt assets to pay back a portion of what they owe and thus have most of their unsecured debts cancelled. Alternatively, they can choose to file bankruptcy under Chapter 13, where they can keep their assets but have to agree to a three- to five-year court-supervised plan to pay back creditors.
Bankruptcy gives people overburdened by debt they cannot pay a “fresh start.” One of the advantages is that after the papers are filed, the “automatic stay” prevents creditors from trying to collect debts the individual owes, garnishing his wages, or continuing with mortgage foreclosures until the bankruptcy case is settled. The federal law and most states allow the individual to keep personal possessions, clothing, household furnishings, Social Security payments, and other items. Connecticut, like many other states, has an exemption for the equity in the debtor's principal residence (his “homestead”) of $75,000 per individual ($150,000 for a married couple). The nonexempt assets must be sold to pay at least a portion of the money owed. The rest of the unsecured debts are cancelled (discharged) in Chapter 7 bankruptcy. Debts that cannot be discharged are generally secured debts (such as a mortgage on a residence), child/spousal support, taxes, student loans, and criminal penalties. The court can also make certain other kinds of debts nondischargeable if the creditor files an objection to their discharge because of some alleged misconduct.
Congress has been considering bankruptcy reform this year. The House passed H.R. 3150 on June 10. That bill would force more debtors who meet certain income tests to repay at least a portion of their unsecured debts and make other changes. The Senate Judiciary Committee has approved a similar, though not identical, bill (S. 1301) but the Senate has not voted on it yet. At the state level, the only direct authority states have is to vary their state exemptions and to opt out of the federal exemptions. Most states exempt the same kind of items, but differ considerably in the dollar amounts exempt. For instance, states allow a wide range of exemption amounts for homesteads, from only $2,500 in Arkansas to an unlimited amount in Florida, Iowa, Kansas, South Dakota, and Texas.
BACKGROUND AND INDIVIDUAL'S RIGHTS
Bankruptcy is a procedure that takes place in federal court and is governed by federal bankruptcy law (11 U.S.C.A. § 501 et seq.). The only direct input that states have is that federal law lets them establish their own list of types of property exempt from the bankruptcy proceeding and either require that debtors use the state exemptions only or give them the choice of using the state or federal exemptions.
Chapter 7 bankruptcy, the procedure most used by individuals, derives its name from the chapter of the federal statutes (the Bankruptcy Code) that contains the provisions relating to it. It is sometimes called “straight” bankruptcy. It cancels most of the individual's debts, but he might have to surrender some non-exempt property. The debtor usually initiates the process voluntarily, although it can be involuntary if three creditors petition the court. The process takes about three to six months, costs $175 in filing and administrative fees, sometimes as little as $500 in attorneys' fees, and usually requires only one visit to court. On the required forms, the petitioner has to list his property; income and its sources; monthly living expenses; debts; property he claims is exempt; and a two-year history of property owned, sold, or given away and money spent.
Filing for bankruptcy triggers an “automatic stay,” which immediately stops creditors from trying to collect debts owed them, prevents wage garnishments, and delays foreclosures and other types of court actions until the bankruptcy case is completed. The automatic stay does not affect criminal proceedings. If someone has a bank loan and a checking account at the same bank, the automatic stay triggered by filing for bankruptcy prevents the bank from removing the money from the checking account, but it can freeze the amount that is owed until the bankruptcy court decides what will happen to the debt. Bankruptcy does not interrupt the obligation to make current child support or alimony payments. And the automatic stay does not stop proceedings to establish, modify, or collect back support. These debts survive bankruptcy and have to be paid once the case is closed.
While the case is pending, the bankruptcy court assumes legal control of the individual's debts and property (except the exempt property). The court appoints a bankruptcy trustee, who gathers the non-exempt property, sells it, and apportions it among the creditors according to certain priorities. Generally, secured debts take priority over unsecured debts and certain kinds of debts discussed below are not dischargeable. At the end of the bankruptcy process, the court discharges most of the individual's unsecured debts and he is no longer legally liable for them. The individual then cannot file for bankruptcy again for another six years. The bankruptcy is listed on the debtor's credit report for 10 years.
Another option the debtor can choose is Chapter 13 bankruptcy. This is useful for debtors who have enough income to pay off all or a substantial portion of their debts over a period of three to five years. In this option, the debtor does not have to lose his nonexempt property, but must fulfill the court-scheduled repayment plan. One advantage of this plan is that usually credit reporting agencies list it on the credit report for seven instead of the full 10 years. The minimum amount the individual must pay is about the same as his nonexempt property's value. People who have already filed for Chapter 7 bankruptcy can still switch to Chapter 13 later if they find it more to their advantage, as long as their secured debt is not more than $807,750 and their unsecured debt is under $269,250 (Federal Register, 2/12/98, p. 7179).
FEDERAL EXEMPTIONS
Federal law allows the individual filing for bankruptcy to choose either the federal exemptions, if the state allows such a choice, or state exemptions, such as Connecticut's exemptions from postjudgment executions and attachments. The federal law allows states to “opt out” of the federal exemptions by specifically prohibiting their residents from choosing them (11 U.S.C.A. § 522 (b)). Since Connecticut has not done so, people filing for bankruptcy here can choose either the state or federal exemptions. Connecticut is one of only 17 states that have not opted out of the federal exemptions, according to the Commerce Clearing House's Federal Bankruptcy Reporter. Under the federal law, a debtor has to have lived in the state for at least 180 days before filing, or for a longer portion of the 180 days than he lived anywhere else, in order to benefit from the state exemptions.
The federal exemptions listed in the U.S. Code are as follows (as of April 1, 1998, these amounts have been administratively adjusted for inflation, as indicated in parentheses):
1. an interest, up to $15,000 in value (adjusted to $16,150), in real property or personal property that the debtor uses as a residence, including an interest in a co-op apartment, or in a burial plot for the debtor or for his dependent;
2. the debtor's interest in a motor vehicle, up to $2,400 (adjusted to $2,575) in value;
3. the debtor's interest, for up to $400 (adjusted to $425) per item and $8,000 (adjusted to $8,625)in the aggregate, in household furnishings, household goods, apparel, appliances, books, animals, crops, or musical instruments that are primarily for the personal, family, or household use of the debtor or his dependents;
4. the debtor's aggregate interest, up to $1,000 (adjusted to $1,075) in jewelry held for his or his dependents' personal, family, or household use;
5. the debtor's interest in any property, up to $800 (adjusted to $850) plus up to $7,500 (adjusted to $8,075) of any unused amount of the residence or burial plot exemption on No. 1 above;
6. up to $1,500 (adjusted to $1,650) in the aggregate in any implements, professional books, or tools of the debtor's or his dependent's trade;
7. any unmatured life insurance contract owned by the debtor, other than a credit life insurance contract;
8. up to $8,000 (adjusted to $8,625) in accrued dividend or interest under, or loan value of, any unmatured life insurance contract owned by the debtor under which he or his dependent is the insured;
9. professionally prescribed health aids for the debtor or his dependent;
10. the debtor's right to receive (a) a social security benefit, unemployment compensation, local welfare benefit, or veterans' benefits; (b) disability, illness, or unemployment benefits; (c) alimony, support, or separate maintenance, to the extent reasonably necessary; or (d) a payment under a stock bonus, pension, profitsharing, annuity, or similar plan or contract on account of illness, disability, death, age, or length of service, to the extent reasonably necessary for the debtor's or his dependents' support, with certain exceptions; and
11. the debtor's right to receive, or property that can be traced to:
a. an award under a crime victim's reparation law,
b. a payment for the wrongful death of someone on whom the debtor was dependent, to the extent reasonably necessary to support the debtor and his dependents,
c. a payment under a life insurance contract that insured the life of someone on whom the debtor was dependent, to the extent reasonably necessary to support the debtor and his dependents,
d. a payment of up to $15,000 (adjusted to $16,150) for personal bodily injury (not including pain and suffering) or compensation for actual pecuniary loss, of the debtor or of someone on whom the debtor is dependent; or
e. a payment in compensation for loss of future earnings of the debtor or of someone on whom the debtor is or was dependent, to the extent reasonably necessary to support the debtor and his dependents (11 U.S.C.A. § 522, Federal Register, 2/12/98 p. 7179).
CONNECTICUT EXEMPTIONS
In Connecticut, certain types of property are exempt by statute from execution or attachment as a result of a civil court proceeding. Federal law allows individuals filing bankruptcy to also use these exemptions in that process instead of the federal bankruptcy exemptions. If they choose the state exemptions, federal law also entitles them to make use of various federal nonbankruptcy exemptions.
The Connecticut exemptions include:
1. necessary apparel, bedding, foodstuffs, household furniture, and appliances;
2. tools, books, instruments, farm animals and livestock feed that the individual needs for his occupation, profession, or farming operation;
3. a burial plot for the individual and his immediate family;
4. welfare payments and wages the welfare recipient earns under an incentive earnings or similar program;
5. health and disability insurance payments;
6. health aids the individual needs to work or sustain health;
7. workers' compensation, social security, veterans' and unemployment benefits;
8. court-approved child support payments;
9. arms and military equipment, uniforms and musical instruments owned by someone in the United States armed forces or militia;
10. one motor vehicle worth up to $1,500 (fair market value minus all liens and security interests on it);
11. wedding and engagement rings;
12. one residential utility deposit and one residential security deposit
13. an individual's assets or interests in a retirement, Keogh, individual retirement account, or similar plan or arrangement;
14. alimony and support, other than child support, but only to the extent that wages are exempt from execution;
15. an award under a crime reparations act;
16. benefits allowed by any association of persons in this state for the support of its members who are incapacitated by sickness or infirmity;
17. money due to the individual from an insurance company on any insurance policy issued on exempt property, to the same extent that the property was exempt;
18. an interest in any property that does not exceed $1,000 in value;
19. an interest of up to $4,000 in any accrued dividend or interest under, or loan value of, any unmatured life insurance contract the individual owns under which he, or someone whose dependent he is, is insured;
20. the individual's homestead (owner-occupied real property or mobile home used as a primary residence) up to a value of $75,000 in equity (fair market value minus any statutory or consensual lien on it); and
21. irrevocable transfers of money to an account held by a bona fide licensed nonprofit debt adjuster for the benefit of the individual's creditors (CGS § 52-352b).
NONDISCHARGEABLE DEBTS
Under the federal law, certain categories of debts cannot be discharged in Chapter 7 bankruptcy (nondischargeable debts), such as:
1. back child support and alimony and related debts, such as an obligation to pay attorney's fees for a child support hearing or an obligation to pay marital debts instead of alimony;
2. student loans that first became due less than seven years ago;
3. court-ordered restitution;
4. certain past due taxes;
5. certain court judgments for injuries or deaths.
In addition, the court has the option of ruling any of the following debts nondischargeable if the creditor objects in court to their discharge:
1. debts resulting from fraud, such as lying on a credit application or writing a bad check;
2. debts from willful or malicious injury to someone else or their property, including assault, battery, false imprisonment, libel, and slander;
3. debts from larceny (theft), breach of trust, or embezzlement;
4. consumer debts to a single creditor of more than $1,000 (administratively adjusted to $1,075 on April 1, 1998) for “luxury goods or services” or credit card cash advances incurred within 60 days before the bankruptcy;
5. debts arising out of a marital settlement or divorce decree that are not otherwise automatically nondischargeable (11 U.S.C.A. § 523 Federal Register, 2/12/98, p. 7180).
FEDERAL PROPOSALS
In 1994, Congress passed the Bankruptcy Reform Act. One part of it created the National Bankruptcy Review Commission, which was to evaluate the U.S. bankruptcy system and recommend changes. The commission completed its work in 1997 and submitted a 1,300-page report to Congress, the product of two years of hearings. The commission found that the system was basically sound and not in need of major changes, but it did suggest 172 improvements. In its final report (117-44, H.R. 2500), the commission proposed making exemptions more uniform and suggested a new commission to further study the issues.
Creditors appear to have been dissatisfied with the report and urged more serious changes than the commission had recommended. In the fall of 1997, several bills they supported were introduced in Congress.
CONSUMER HIGHLIGHTS OF H.R. 3150
The House passed H.R. 3150 on June 10. The bill would force more people who declare bankruptcy to pay back at least part of their debts, depending on their ability to pay. Supporters of tightening the bankruptcy laws include retailers and lenders such as banks, credit card companies, and credit unions. They are opposed consumer groups.
The most important part of the bill is a means test that would limit who could file for bankruptcy under Chapter 7, which lets individuals liquidate their assets and eliminate many unsecured debts, especially credit card debt. The bill would require anyone who earns at least the national median income (around $51,000 for a family of four) to instead go through bankruptcy under a Chapter 13 repayment plan if he has income available to repay creditors, that is, can repay at least 20% of the unsecured debts over five years. The bill also requires anyone filing bankruptcy to repay debts incurred within 90 days before filing. It also requires that people be informed of alternatives before they file bankruptcy, and creates a pilot program on financial management for some filers. The bill originally contained a $100,000 cap (which was removed by amendment) on “homestead exemptions”, which states have instituted at various levels to protect at least part of the equity in a residence from creditors (Congressional Quarterly 6/13/98, p. 1608).
The bill also makes several other significant changes. Debts for family support obligations would have first priority in distribution, before the bankruptcy case's administrative expenses. Debtors could generally not apply for bankruptcy until they first try to negotiate a voluntary repayment plan through an approved consumer credit counseling service. The bill would increase the time period after bankruptcy during which the individual could not file again under Chapter 7 from six years to 10 years. Secured creditors would receive payment on secured claims at least at the collateral's retail value. Creditors could also get relief from the automatic stay in situations where the individual files for bankruptcy repeatedly. Condominium association fees that accrue after bankruptcy would be a nondischargeable debt, even if the debtor does not actually occupy the premises. There would be an unlimited exemption for tax-exempt retirement funds. Bankruptcy court decisions could be appealed directly to the circuit court of appeals.
H.R. 3150 tries to minimize debtors changing their state of residence to obtain more liberal exemptions. It addresses the problem of debtors converting nonexempt property to exempt property just before bankruptcy. It prohibits exemption for otherwise exempt property that was bought with proceeds from a nonexempt property within one year of disposing of the nonexempt property. The bill also makes a number of changes to Chapter 13.
Senate Bill 1301's provisions are similar though not identical to the House bill. The Senate Judiciary Committee has approved it, but the Senate has not yet voted on it. Most likely there will be a need for more changes and negotiations before passage of legislation.
HN:pa