This blog is in response to a question I received from a reader. She asks what happens to a leased car in bankruptcy? The reader doesn’t indicate whether she wants to keep the car or not, so I’ll talk about both situations.

Assuming you want to get rid of the car, you can. Chapter 7 will eliminate any remaining “deficiency” balance, or Chapter 13 will allow you to repay the deficiency balance at pennies on the dollar, depending on what you can afford. The finance company will get possession of the car, usually through a repossession, but you won’t be obligated to pay.

If you want to keep the car, this situation works like most any other secured debt situation. You must continue to make the payments. Technically, you wouldn’t “reaffirm” the debt, as you might with a financed vehicle. But, you would “assume” the lease through a lease assumption. A reaffirmation and a lease assumption work very much the same way. Typically when a vehicle is involved the debtor would assume the lease at the same terms she had before she filed.

The benefit of the bankruptcy in a situation where you wanted to get out from under the car loan is only apparent if you understand what happens if your car was repossessed and you were not filing for bankruptcy. In that situation, the finance company would repossess the car and eventually auction the car at the auto auction. Typically the finance company does not get enough money from the auction to pay off your loan. The proceeds it does get would go toward your contractual balance owed. The difference is called a “deficiency” and you would still be legally obligated to pay the creditor the deficiency balance.

Car repossessions are a very common event that may lead a person into bankruptcy. Think about it, you can’t afford to pay the car notes, that is why you are behind to begin with, so the finance company repossesses the car. You now don’t have transportation and then you get a double whammy because the finance company can still sue you for the deficiency balance!

From time to time I get questions from potential clients asking about the benefits of credit counseling and whether they should be pursuing credit counseling instead of bankruptcy.

The attraction of credit counseling to people is they think that credit counseling doesn’t adversely impact their credit rating as bad as bankruptcy. Unfortunately, this is only partially true. Once a person is behind on payments, the person’s credit rating is already “ruined.” See my prior post last month when I discussed this issue of credit ratings.

A lot of these credit counseling companies claim they can negotiate deals with creditors to reduce your payments. Typically debt management programs offered by credit counseling agencies are only able to reduce interest rates. They can’t save you any money on the principal that you owe (of course this principal has ballooned because of past interest and late charges that are now part of the principal). Also, the fact that you went through credit counseling or a debt management program appears on your credit history and it does adversely impact it. Debt management programs typically offer 5 year payment plans where you have to pay the full principal balance plus interest (even if it is lower than the contractual interest rate and there are rare cases where debt management programs have successfully eliminated interest). Most people can’t afford those payments.

I always tell my clients that the first step to rebuilding credit once the credit report shows the delinquent payment history is to get out of debt. Of course, a Chapter 7 bankruptcy takes only about 3-6 months to complete and it involves paying nothing to any of the creditors. Also, a Chapter 13 bankruptcy can save you not only interest, but a significant portion of the principal balance on your debt. Thus, in my years of practice I don’t think I’ve ever seen a situation where credit counseling benefits someone more than filing either a Chapter 7 or a Chapter 13 bankruptcy.

Either a debt management program or bankruptcy adversely affects your credit. But, as I’ve said before, late payments and no payments also adversely affects your credit. Bankruptcy typically gets you out of debt quicker and allows you to rebuild faster than paying all of your debt back through credit counseling. Finally, it’s cheaper! You end up paying a lot less money, even factoring in legal fees.

I’ll try to make this blog posting shorter than the last.

Chapter 13 Changes:

1. Curbing Lien Stripping - One of the advantages of filing Chapter 13 is that Chapter 13 allows debtors to “cramdown” liens of some secured creditors. In many cases, debtors owe a lot more on secured items than the items are worth. Chapter 13 laws allow a debtor to obtain title to collateral by paying only the “fair market value” of the collateral plus interest as a secured claim and the balance of the claim (the unsecured portion) would only have to be paid the same percentage on the dollar as other unsecured claims like medical bills and credit cards. For example, if the debtor owed $20,000 on a car loan and the car was only worth $10,000, the debtor only has to pay the value of $10,000 plus interest and a small percentage of the remaining $10,000 (if a 10% plan, then only $1,000) as an unsecured debt. Debtors, therefore, can pay a lot less for their secured debts than what they owe under the contract.

The new laws limit the ability of debtors to take advantage of this part of the Chapter 13 laws. Under the new legislation, debtors will not be allowed to cramdown a car that was purchased within about 2 1/2 years of the filing. Also, debtors will not be able to cramdown other secured debts incurred within 1 year of the filing. Thus, debtors are only able to take care of these “cramdown” rules for older secured claims under the new laws. Recently incurred secured debt must be repaid in full at the contractual interest rate!

2) Disposable Income and Plan Length - Remember the means test from the last post? The means test is the test used to determine whether or not a debtor could qualify for Chapter 7 given the person’s median income for the same family size and certain “allowed” expenses. The new Chapter 13 laws provide that if a debtor’s income exceeds his state’s median income, certain restrictions also apply in Chapter 13.

First, if the debtor’s income exceeds the state’s median for the same family size and he is proposing to pay less than 100% with interest to his unsecured creditors, he must remain in Chapter 13 for five (5) years. This debtor could not file a 10%, 36 month Chapter 13 as he could have under the “old” law. Instead, this debtor will have to pay the proposed monthly payments over five years. For example, assume a debtor who has over the median income owes $50,000 to his unsecured creditors. Further assume this debtor only has $300 per month remaining in his budget after deducting living expenses. This debtor could not just pay $300 per month for three years and get a discharge, as he could under the “old” law. Under the “old” law this means he would have paid $10,800 and discharged the other $39,200 plus interest in Chapter 13. Under the “new” law, he’d have to pay $300 per month for five years, or $18,000 before he could get discharged from Chapter 13. This debtor would have to pay $7,200 more into Chapter 13 under the “new” law than he would have been required to under the “old” law.

Second, if the debtor’s income exceeds the state’s median income for the same family size, the debtor’s expenses she must use in determining what money the debtor has available to pay creditors, will be the means test expenses. Remember, those are the expenses provided by the IRS Collection Standards. Basically, this debtor will be treated under the bankruptcy laws as a tax cheater! She can only deduct from her income those expenses allowed under the means test. Her actual expenses, under the “new” law, are irrelevant!

3) Chapter 13 “superdischarge” - Another effect of the “new” legislation is to reduce the types of debts that can be discharged in Chapter 13. Currently, there are approximately 25 types of debts that can’t be discharged in Chapter 7 and 6 types of debts that can’t be discharged under Chapter 13 (thus the term “superdischarge”). Under the new legislation there will be 5 more types of debts that won’t be discharged under Chapter 13 bringing the total non-dischargeable debts in Chapter 13 to 11.

The expanded list of non-dischargeable debts in Chapter 13 includes credit card debts incurred through fraud or misrepresentation, death or personal injury caused by debtor’s willful or malicious conduct, late-filed debts arising from unfiled, late-filed or fraudulently filed tax returns, debts to creditors who were not notified in time for the creditor to file a proof of claim, and debts incurred by embezzlement or breach of fiduciary duty. Believe it or not, these types of debts could have been discharged in Chapter 13 under the “old” laws after the debtor did her best efforts to repay as much as possible.

Once again, this blog is just a brief overview of some of the changes and how they might affect you or someone you know. Of course, you should contact an attorney and discuss the specifics of your case and not just rely on general information published in this blog, but I hope you find the blog informative.

I’m sure many of you have heard discussions in the media or an advertisement from an attorney about the new bankruptcy legislation signed into law by President Bush on April 20, 2005. Most of the provisions of this legislation will go into effect on October 17, 2005. Below are some highlights of some of the new provisions. Of course, you want to speak with experienced counsel directly about your particular situation if you want to find out how this legislation might affect you. The other option is to try to get in under the wire and contact someone right away!

1) Debtor Education: There are two levels of debtor education that will be required under the new legislation (not so affectionately referred to by some in the profession as BARF).

a) Pre-filing education: In order to qualify for either Chapter 7 or Chapter 13 bankruptcy relief, the new law requires debtors to file with the bankruptcy petition a certificate from an approved credit counseling agency certifying that the debtor has completed a credit counseling session. The good news is that this pre-filing requirement can typically be completed online or in a 30 minute phone call, so this provision shouldn’t be too daunting.

b) Post-filing education: Before a debtor can obtain a discharge under either Chapter 7 or Chapter 13 the debtor must attend a financial management course administered by an approved provider. The US Trustees Office is charged with the responsibility of either administering the course or outsourcing the administration of the course to approved agencies. I’ve heard through the grapevine that in some jurisdictions, the US Trustee will set up the 341 meeting in the morning and then offer the course for all of the debtors that attended their meetings later that afternoon. I hope most jurisdictions administer it this way as it will make it easier for debtors to comply.

2) Waiting period between cases: A debtor in a Chapter 7 case can be denied a discharge if the debtor was a debtor in a prior Chapter 7 case that was filed within 8 years of the second case. The date of filing is the important date, not the discharge date. Currently, the rule is 6 years. The new legislation also imposes a waiting period for a Chapter 13 discharge if the debtor received a discharge in a Chapter 7 case within 4 years of the filing of the Chapter 13. Currently there is no waiting period.

3) Dischargeability: Dischargeability refers to the types of debt that can be eliminated in bankruptcy.

a) Student loans - The new legislation changes current legislation expanding protection for creditors who loan money for educational benefits. The current rule is that if the money is owed to a “not for profit” institution or to a “government insured student loan program” then the debt would be non-dischargeable, absent a showing of undue hardship. The new legislation will no longer draw a distinction between a “for profit” and a “not for profit” institution. Basically, ALL loans for educational benefits will not be discharged in bankruptcy, absent a showing of undue hardship.

b) Credit card debts - The new law expands protection to credit card companies. First, if a debtor incurs a cash advance within 90 days of filing of more than $750 or buys a “luxury” item of more than $500 within 90 days of filing, this credit card use creates a presumption of fraud. Current law doesn’t create that presumption unless the use was more than $1,500 and within 60 days of the filing. Also, if the court finds that credit card debt was incurred by false pretenses, actual fraud, or with the intent to file bankruptcy, such charges wouldn’t be discharged under Chapter 13! Currently, these types of debt wouldn’t be discharged in Chapter 7 provided the creditor filed a successful objection, but could still be discharged in a Chapter 13 payment plan (after the debtor completes the plan payments paying whatever percentage the debtor could afford).
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This does not mean that debtors can’t discharge credit card obligations, just obligations that were incurred fraudulently.

4) Means Testing: This is probably the most talked about provision to the new legislation. Under current law, a debtor’s Chapter 7 case can be dismissed for substantial abuse. The Bankruptcy Code doesn’t define substantial abuse and over the years case law developed defining the term, much to the dismay of the credit card industry that didn’t agree with most of the court opinions on the subject. This led to the huge lobbying effort in Congress and it appears the credit card industry got its payday with this new legislation.

The current legislation would allow the dismissal of a Chapter 7 case for abuse, not substantial abuse. The new legislation creates a presumption of abuse when a debtor fails the means test. The means test is complicated, but let me see if I can give you a short explanation.

Basically, the debtors’ average monthly gross income for the last 6 months (excluding social security benefits and certain victim’s payments) is multiplied by 12 and compared to the state’s median income for the same family size. If the debtor’s income is below the state’s median income for the same family size, no presumption of abuse is found and the debtor does not have to apply the rest of the means test. If the debtor’s income exceeds the state’s median, then the means test must be applied and the debtor’s case can be challenged by any party in interest (creditors, the interim trustee, the US Trustee, or the Judge).

The means test imposes a “reasonable” budget onto the debtor’s income and determines whether the debtor, under the means test has an ability to repay unsecured debts in a Chapter 13 case. The frustrating part of this is that the means test is taking a lot of discretion away from judges to weigh individual circumstances on a case by case basis to determine abuse. The means test also imposes artificial income and expenses on the debtor in determining whether the debtor has “means” to repay creditors. Even worse, the budget numbers the new law requires the debtor to use for expenses are the numbers the IRS uses when it determines a tax cheaters ability to pay delinquent taxes. As you can imagine, the expense allowances are fairly minimal because those standards are meant to punish tax cheaters for cheating on taxes.

I’ll end this post here, despite the fact that there are many more provisions to the new legislation I could discuss and I will discuss in future blogs, but I don’t want to put you to sleep.