Filing for Bankruptcy: What you need to know

Sections:

1) The Means Test

2) Creditors' Meeting

3) Foreclosures and Short Sales

Many people come to me asking about the new bankruptcy laws, and whether it is true that most people can no longer file for bankruptcy. The truth is that nearly all of the people who have come to me still do qualify for chapter 7. The difference between bankruptcy laws prior to October 2005 and bankruptcy laws after October 2005 are that people now have to go through additional hurdles, including the "means test," before they may file their bankruptcy petition.

Under current California bankruptcy laws, the "Means test" is used to determine whether a person may file a chapter 7 bankruptcy case. The means test takes into consideration your gross income, as well as most of your monthly expenses.

The test only applies to people who have consumer-related debts. Thus, people who mostly have business-related debts, including tax debts, do not have to take the Means test.

The Means test was designed to prevent people with higher incomes from filing for bankruptcy. However, as explained below, in certain circumstances, even people with higher incomes often end up qualifying for chapter 7 anyhow.

The Means test consists of 2 steps:

First Step: What is your income?

The first step requires you to evaluate all gross (not net) income that you have received from all sources, including your wages, rental income, retirement income, unemployment income, etc., for the last 6 months. So, for example, if you are considering filing a chapter 7 bankruptcy in July 2009, then you would need to list out, month by month, all income you received from January through June 2009. Add up the total gross income for that time period, divide it by 6 to get a monthly average for those 6 months. Lastly, multiply the monthly average figure by 12 to get your average yearly income. This is the figure you'll use to determine whether you pass the first step of the Means test. If you live in California, and if that figure is below the amounts listed below, which are the "median income" levels for Californians according to family size (as of March 15, 2011), then you do pass the first step, and you do not need to proceed to the Second Step:

• 1 person family: $47,683
• 2 person family: $61,539
• 3 person family: $66,050
• 4 person family: $74,806
• each additional person, add $7,500

Now, if your income is above the median family income, proceed with the Second Step.

Second Step: What are your monthly expenses?

The second step permits you to deduct certain monthly expenses. Some of the monthly expenses are based on formulas set by the Internal Revenue Service. And some of the monthly expenses, such as the amount that you pay for your health insurance, out-of-pocket health expenses, child care, life insurance, and your payroll taxes, are also deducted from your monthly income. This step also permits you to deduct the amount that you pay for your home mortgage each month. In order to be able to deduct your mortgage payment, it is not necessary for you to be current on your home payments, but you must still own your home.

It is really only after completing the second step that most people know whether they qualify for chapter 7. If not, it is possible that chapter 13 is still an option for you. It is advisable that you speak with an experienced bankruptcy attorney to help you determine whether you qualify for chapter 7 under the Means test.

When filing for bankruptcy, you must attend the creditors' meeting.  In chapter 7, this meeting is generally set about 4-6 weeks from the date the bankruptcy case is filed.  The reason that you must appear at this meeting is that the Bankruptcy Code requires your trustee to examine you under oath as to whether the information that you listed in your bankruptcy schedules is true and correct, and regarding your finances in general.  I like to think of the creditors' meeting as an administrative hurdle you have to get through, along with the pre- and post-bankruptcy courses, before the court agrees to issue the order discharging your debts.

You MUST bring the following to the creditors' meeting:

1. Valid proof of your social security number, such as your social security card or a W-2 form
2. A government-issued photo identification card, such as your driver's license or a California identification card

This meeting is held in an office, not in a courtroom.  Thus, it is not necessary to wear a suit or business attire.  You can dress casually, or wear whatever you normally wear to work.

In San Francisco, creditors' meetings are set every half-hour.  Generally, 5-8 people are scheduled for the same meeting time.  When you arrive for the meeting, you enter the waiting room area and sit down and wait for your attorney to arrive.  I recommend arriving 10-15 minutes early, because your attorney may have a few administrative tasks for you, such as a few forms to review or sign.

Once the trustee calls out your meeting time, you and your attorney will leave the waiting room and enter the creditors' meeting room.  The trustee will say a few words, and then will call each case for that meeting time, one by one.  When the trustee calls your name, you and your attorney sit at the table in front of the trustee, and you must give your 2 forms of identification to the trustee.  After the trustee verifies your identity, s/he will swear you in, and then ask you a set list of questions that she asks each and every person.  These questions are generally as follows:

1. Your bankruptcy attorney filed the Petition, Schedules A through J, and Statement of Financial Affairs for you - are you familiar with these documents?
2. At the time they were filed, was the information contained in these documents true and correct?
3. Did you list everything you own?
4. Did you list all of your debts?
5. Has your income changed since the bankruptcy filing date?
6. Have you owned any real property in the last 5 years?
7. Do you expect to inherit anything in the next few months?

If you are self-employed, have your own business, have owned real estate in the last few years, are married but not filing jointly or have been recently divorced, then the trustee may have a few additional questions for you.  But in general, these meetings last anywhere from 1-4 minutes.  After the trustee has finished asking questions, you are done and may leave.

Although creditors have the right to appear at creditors' meetings, they rarely do.  Creditors are more likely to appear when the person filing for bankruptcy is in the middle of a nasty divorce (and the ex-spouse is just there to be spiteful), owes millions of dollars, or has complex business issues.  In the unlikely event that a creditor does show up at your creditors' meeting, you should know that the creditor may ONLY ask you questions about the information contained in your bankruptcy schedules and statement of financial affairs, or about other financial information.

A lot of people who come to me want to know about the impact of filing for bankruptcy on an upcoming foreclosure of their home.  The type of impact will depend on the type of bankruptcy chapter that person files:

Chapter 7:

A bankruptcy filing initiates something called the "automatic stay," which prevents all creditors from taking any further actions, including foreclosure, to collect on a pre-existing debt.  Thus, filing a chapter 7 bankruptcy will stop a pending foreclosure.  However, a mortgage lender seeking to foreclose on a home will simply file a motion with the bankruptcy court, asking the court to lift the automatic stay so that the mortgage lender can proceed with the foreclosure.  If the mortgage lender moves quickly, the chapter 7 bankruptcy filing will generally result in the debtor having an additional couple of months in their home until the foreclosure date.  Unless the chapter 7 debtor can pay the entire amount in arrears to the mortgage lender, either in one lump sum, or over a few payments, then, generally speaking, the bankruptcy court will grant the motion.  Bottom line: for the vast majority of people, a chapter 7 bankruptcy case only temporarily delays a home foreclosure.

Chapter 13:

The automatic stay also halts a foreclosure in chapter 13 cases.  If you wish to keep your home, then in chapter 13, you must pay the total amount in arrears over the course of the life of the plan (either 3 or 5 years).  But you must stay current on the regular monthly mortgage payments from the date that the case is filed.  So, for example, if you are behind on your mortgage payments in the amount of $10,000, then you may pay back the $10,000 over either 3 years or 5 years (depending on the term of your plan), AND you must also stay current on your mortgage payments from the date the case is filed.  This scenario can be very helpful for people who were behind on their mortgage payments due to loss of a job or income, but now find themselves employed again.  If you do not wish to keep your home, then, just as in a chapter 7 bankruptcy case, the mortgage lender will file a motion for relief from the automatic stay to begin foreclosure proceedings on your home.

Short Sales and Chapter 7:

When a person files a chapter 7 bankruptcy case, all of that person's property becomes "property of the bankruptcy estate" for about 4-6 weeks, until the chapter 7 trustee has issued her report that there are no unexempt assets to liquidate.  During those initial 4-6 weeks, the debtor may not transfer, sell, or do anything with their property.  Thus, short sales are also temporarily halted during that time.  Practically speaking, however, a chapter 7 bankruptcy often leaves the mortgage banks for both the buyer and the seller a bit skittish about proceeding with the short sale, which can result in the short sale being delayed for the entire 3 months or so that the chapter 7 bankruptcy case is open.  Bottom line: if you're in the midst of a short sale and you're thinking about filing a chapter 7 bankruptcy case, then finish the short sale first - this will prevent the bankruptcy case from derailing and slowing down the sale.  Either way though, if you find that you still owe a balance to the mortgage lender after the short sale, that balance is discharged along with all of your other debt in the chapter 7 bankruptcy case.