Since bankruptcy is provided by the federal government in the federal statutes, many people wonder why bankruptcy may work differently in different parts of the country. I hear the very logical questions: Bankruptcy is federal, shouldn’t the law be the same throughout the country? What difference should it make if I live in Chicago and someone else lives in New York, isn’t this federal law?

The answer is yes and no. The Bankruptcy Code is the federal law that creates bankruptcy, defines terms, and specifies how it works to a large degree. There are a few ways location makes a difference, however. First, there are many instances where state law and interpretation under courts of a state control the application of the bankruptcy laws to a person within the state. Also, every district court is authorized to implement the bankruptcy code via local rules and local rules can sometimes vary widely. Thus, the application of the law and the rules can be applied differently from one place to another. Finally, there are some locations where trustees are much more aggressive than in others.

One example is bankruptcy exemption law. “Exemptions” define what property can be protected from creditors. 11 U.S.C. Section 522 provides federal exemptions. Section 522 allows states to “opt out” of the federal exemption statutes if they choose. Most states have elected to “opt out.” This means that debtors that file cases within a state must use the state’s exemption statutes to protect property and can not use the federal exemptions. There are a few states where the debtor can choose either the federal exemptions or the state exemptions. In Illinois, for instance, debtors can only use state exemptions. Illinois is an “opt out” state. A single debtor in Illinois can only exempt $7,500 of equity for real estate she lives in from creditors. If the debtor were able to use federal exemptions as provided under 11 U.S.C. Section 522, she would have been able to protect $18,450 in equity!

Another example can be found in different local court rules. In the Northern District of Illinois, for instance, motions are handled differently than they are in the Northern District of Indiana. In Illinois, the moving party automatically schedules the date the motion is to be heard and the Notice of Motion would contain the actual hearing date. In the Northern District of Indiana, the moving party sends a general Notice of Motion giving the respondent a certain number of days to respond. If the respondent does not object to the motion within the time period, the moving parties’ order is automatically signed by the Judge with no need for anyone to appear at a court hearing.

There are many other examples of state and local law and practice changing the way bankruptcy cases work from one place to another. Don’t be fooled, location still matters, even when operating under “federal law.”

I received an email from a person asking me some very good questions about what would happen in a Chapter 13 bankruptcy if the person moved during the Chapter 13, whether the payments in the Chapter 13 would have to change if income changed, etc…

All of these concerns would require a detailed analysis of the particular facts of the case to answer properly, but I can provide some general rules about this. It is not necessary to obtain court permission if you decide to move to a different state during your Chapter 13. Chapter 13 does not put you in prison or on probation. You are free to seek economic opportunity in another state or move with your family, etc… You should, of course, continue to make your Chapter 13 payments and provide your attorney with your new address. The attorney should file a change of address with the court. This insures that you continue to get notice of anything that happens in your case.

The issue of an income change is more complicated. Basically, you have to show proof of income to the trustee at the meeting of creditors and at that time the trustee verifies your income and makes a determination as to whether the trustee can recommend to the judge that your case meets all the requirements for confirmation. Most income and expense issues are ironed out by your attorney, your creditors and the trustee before the confirmation hearing and after the meeting of creditors.

Once the plan is confirmed by the judge, it runs on auto pilot. Something has to happen before someone begins to look at the case again. Either a creditor could claim you haven’t kept up with your payments outside of the bankruptcy, assuming there are any, or the trustee will notice that you aren’t making your payments on time or something like that to call attention to your case. Technically, when your income changes, your plan should change. The bankruptcy law says that debtors must provide all “disposable” income over the life of the plan to repay creditors. This is known as the “best efforts test.” A debtor must use his or her best efforts to repay as much debt as he or she can afford over the plan term.

When your income changes, then technically the plan is supposed to change too. However, the change does not happen automatically. If your income goes down, your attorney must file a motion with the court to “modify” the plan. You will have to provide a new budget and defend the new budget. Of course, there are limits to how low a plan payment can be reduced based on the amount of debt covered in the plan and what your original plan term was (36 months or 60 months). If it is possible to reduce the payments and your circumstances have changed for the worse and you can prove that to the judge, than it is likely the judge would approve the reduction in the plan payments.

If your income has increased and a creditor, the court or the trustee finds out that your income has increased, they could file a motion to dismiss your case claiming that you are no longer doing your “best efforts.” At that point, you’d likely have to file a motion with the court to increase your plan payments to comply with this bankruptcy requirement. As a practical matter, it may not be easy for the trustee, a creditor or the judge to find out your income has increased, so rarely does a debtor face this problem.

Interestingly, the new bankruptcy reform legislation that will go into effect on October 17, 2005 will require debtors to file “annual financial statements” upon request (I guarantee you trustees will request) of a party in interest. Basically this will mean that every year debtors in Chapter 13 will have to provide new budget information. Unless the debtor can show that his/her budget shows the exact same amount of disposable income to demonstrate the debtor’s “best efforts” this could require the debtor to adjust his/her plan payment each year to fit within his/her new budget. This is a new requirement and one that I think was part of the new legislation to try to force debtors to cough up more money in Chapter 13 plans if their financial situation improves during the plan. Again, nothing happens automatically, there would have to be some sort of motion to increase the payments or to decrease the payments.

Sometimes I get calls from people asking me about the benefits of debt settlement over bankruptcy. My answer, as always, depends on the individual’s situation, but usually bankruptcy is going to be the best way to go. Let me explain.

Let me make it clear that I’m not talking about consumer credit counseling when I use the term “debt settlement.” I’m talking about someone hiring an attorney to act on his behalf to contact creditors and negotiate settlements directly with the creditors. I’m not talking about contacting a credit counseling agency that negotiates lower interest rates and administers a “debt repayment plan” or “DRP.” I’m referring to negotiating the entire account at a percentage on the dollar.

Not everyone is a candidate to negotiate a settlement with creditors. Negotiating settlements requires the payment of a lump sum of money. If you are a person that doesn’t have any access to some cash, then you are not a candidate for debt settlement negotiation. You’ve got to have access to some cash, obviously your access to cash would not have to be enough to pay off 100% of your balances. If you could do that, you wouldn’t need any help. I’m talking about a situation where you might have a family member who can give you a limited amount of money, or maybe you have a pension plan you could take some money out in the form of a loan. No matter the source, you have to be able to get your hands on some cash that you can use to pay lump sum payments to your creditors for the negotiated amount.

A “lump sum” payment could be a payment over two or three installments in a relatively short amount of time, so it may consist of more than one payment, but you’re not going to be able to get a creditor to reduce it’s principal balance and eliminate the interest if you are proposing to pay payments over 5 years or something, the creditor would just as soon force you to file for bankruptcy than agree to that. The point is that you must be able to get the cash to the creditor in a very short amount of time, usually within 30-45 days.

If you are a person who could qualify for a debt settlement negotiation because you have some quick access to a limited amount of cash, then you can sometimes have your debts successfully negotiated down to $.35-.70 on the dollar. Every creditor is different as far as how much they are willing to take so there isn’t going to be a set result you can count on. That’s one of the disadvantages of debt settlement. If all your creditors agree and the last one won’t take any settlement, that can often blow your plans out of the water and force you to file for bankruptcy anyway, after you’ve wasted thousands of dollars paying the other creditors. So, there is a risk associated with settling the debts. No one can guarantee you the result and you’re just trying to get the best deal you can. The bottom line is you can expect to have to pay around $.50 on the dollar so you’ll need enough cash to cover that.

Also, what many people don’t realize is that the portion of the debt you don’t pay back to your creditors you must include on your tax return as taxable income, arguably, in the year of the settlement. Thus, if you negotiate an average of 50% settlements, you actually are paying that 50% to the creditors directly AND you are paying the IRS taxes on the “forgiven” portion at your tax rate. Also, depending on how much debt is involved the amount of the “forgiven” debt could be high enough to bump your tax bracket up forcing you to repay more.

Debts you discharge in bankruptcy are NOT taxable income. Also, bankruptcy, even a Chapter 13 repayment plan, doesn’t require you to come up with lump sums of money. Bankruptcy also can FORCE creditors to accept payments involuntarily, whereas a settlement negotiation requires the creditor to voluntarily agree. For these reasons, in most situations, filing bankruptcy is going to be better than negotiating a settlement.

I always find it odd and almost humorous when people ask me “how will the court know I own a piece of property?” “This telephone call is confidential isn’t it?” “You don’t have to tell the court that I own that property, do you?”

You get the picture. Someone is calling me asking about ways I can help the person get out of debt. I start asking some questions to ascertain a general idea of the person’s income, assets and debts, as I always do, so I can begin to offer some solutions. The client tells me they own a piece of investment real estate and it has equity over and above what I can protect in Chapter 7. I begin to discuss Chapter 13 options to protect the property from creditors when this prospective client stops me and asks me the questions I mentioned above.

While there is attorney-client privilege in legal representation, that privilege does not extend to information that is going to be public as part of a bankruptcy filing. Of course, if the person never actually files a case in court, the privilege would apply, but once the case is filed, the debtor is subjecting himself to the jurisdiction and rules of the court. This means if a person wants relief from their debts, they must play by the rules. The rules of the court require the debtor to testify, under oath, that the information on the schedules is true and accurate.

More importantly, people must understand that attorneys are officers of the court and that we lawyers have obligations to the Court and to the public at large not to assist in criminal activity, not to perpetuate a fraud on the court, etc… Lawyers can sometimes be put in very difficult situations when they know their client is trying to commit a crime, yet they want to preserve confidentiality. Most decisions and ethical opinions I’ve read indicate that the lawyer must make a “noisy” withdrawal in this situation. This means that your lawyer can’t represent you anymore and must seek the court’s permission to withdraw. The Court, before granting permission, is going to want an explanation from the attorney about the withdrawal. Judges are very intelligent people, they can read between the lines even if the attorney doesn’t come out and say “my client is committing a crime.”

It is a federal felony to commit bankruptcy fraud and this includes lying on the bankruptcy petition and schedules. Bankruptcy fraud carries a maximum penalty of $250,000 in fines, 5 years in jail and the debtor would also not receive a discharge of debts. Also, the government might prosecute a debtor for destruction, falsification of records in Federal investigations and bankruptcy and that carries a maximum sentence of 20 years. Depending on how many acts of fraud the debtor commits, he can also be prosecuted under the RICO (Racketeer Influenced and Corrupt Organizations) statutes. The bottom line: DON’T DO IT! It’s not worth the penalties.

The IRS and FBI both assign agents to investigate bankruptcy filings. The US Trustee’s office is a branch of the Department of Justice. Believe me, there are paper trails of property ownership that these organizations have more than enough resources to find out about.

You should be open, honest, and truthful about all of your income, assets and debts. Tell your attorney the truth so the attorney can give you the proper advice for your situation and review your paperwork for accuracy. I admit that I get a bit taken aback by these folks and whenever someone asks me these types of questions the hair on the back of my neck stands up. The client is not only putting themselves in jeopardy, but they are also putting my law license in jeopardy, so it’s just not a good situation to be in.

The US Trustee’s office, in fact, circulates a publication among the different branch offices congratulating their litigation teams and investigators who discover and successfully prosecute fraud! They brag about it. They relate stories of debtors who they’ve put away in federal penitentiaries for a long time and I just find myself saying: “Who would try to do such a thing and how could they not realize the power of the federal government and the multi-billion dollar creditors they owe to find out about this stuff?” Anyway, I hope you get the point…