Tom Scottt Law Indy

Bankruptcy Attorneys in Indianapolis Since 1980

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How Bankruptcy Affects Student Loan Debt and Car Loan Interest Rates

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How Bankruptcy Affects Car Loan Interest Rates

As a result of the recent rise of the prime rate, vehicle loans included in Chapter 13 bankruptcy plans can have a higher interest rate than in the past few years. Despite the resurgent economy, single mothers are still vulnerable to financial difficulties. Student loans cannot be eliminated by filing for bankruptcy, but one of several strategies can be used in conjunction with a Chapter 13 plan to pay them back.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including: how the recent rise of the prime rate has affected bankruptcy cases; which group of people are currently at risk of financial hardship; how student loan debt is treated in a Chapter 13 bankruptcy case; misconceptions about bankruptcy; and the ability of the Indiana Department of Revenue to implement an administrative garnishment.

Q: How has the recent rise of the prime rate affected bankruptcy cases?

Jess Smith, III: It has affected the interest rate on cars. There was a case years ago, which originated out of Kokomo, Indiana, that involved the interest rate a non-mortgage secured creditor would get on an asset being paid through a Chapter 13 bankruptcy plan. The local court came up with a ruling that was basically sanctioned by the U.S. Supreme Court in 2004 (Till v. SCS Credit Corp.), which stated the creditor would receive the prime interest rate plus a risk factor of 1% to 3%.

If the creditors become astute to the recent rise of the prime rate, it could affect bankruptcy plan agreements. Many of the car loans we see in bankruptcy cases may have had an interest rate of 19% to 23% when the contract was signed. The Till case that was decided by the Supreme Court involved a loan for a used pick-up truck that had a 21% interest rate.

For the past couple of years, I’ve been offering secured creditors or lenders 4.5% interest on their car notes. However, I recently saw a local case being handled by another attorney in which the creditor objected to a similar rate offered in the proposed plan for the debtor. The creditor demanded a 5.75% interest rate and the trustee seemed to think that rate was appropriate, based on the higher prime rate now in place.

Q: The economy has rebounded since the recession of a few years ago, which has caused a decrease in the number of bankruptcy filings. Is there still a particular group of people who are currently at risk of financial hardship and in need of relief through the bankruptcy court?

Chris Holmes: Unfortunately, single mothers who must raise one or more kids without receiving child support payments. If they are sued and are facing the garnishment of 25% of their take-home pay, then they’re unable to pay their rent or their car note, so they really have no choice but to file for relief through the bankruptcy court, to prevent the garnishment of their wages and to wipe the slate clean.

Q: When people come to see you for a free consultation, is there a common misconception about filing for bankruptcy, the benefits of bankruptcy protection, or the types of services you can provide?

CH: Sometimes people think they can’t get rid of a certain debt after they’ve been sued and there’s a judgment—or if a garnishment has already been implemented. They feel like it’s too late and they can’t stop those actions. But you can.

Q: Are there any types of debts that filing for bankruptcy won’t discharge?

CH: The big one is student loans. Occasionally we speak with people who have up to $100,000 worth of student loan debt. I recently spoke with someone who said they saw on the Internet that student loans are now going to be dischargeable, but that’s not true.

JS: I’ve spoken with other attorneys who also stated they’ve had people counting on that.

Q: If a student loan debt is not dischargeable, can it be rolled into a Chapter 13 bankruptcy plan?

JS: Yes.

CH: Let’s say a debtor can’t afford to make any payments. A student loan lender is the only lender that can leapfrog a legal process and go directly to a payroll department to garnish wages.

JS: The Indiana Department of Revenue can also do that, but obviously they’re not a lender. They can do what’s called an administrative garnishment and get 15% of your salary without a court order.

CH: Right. But a regular creditor must (1) file a lawsuit; obtain a judgment; (2) file a Motion for Proceedings Supplemental to Judgment; (3) have the court conduct a hearing; (4) determine if there is gainful employment; and (5) serve the employer with a Final Order in Garnishment. If your net pay is more than $217.50 per week, the creditor can garnish your wages. However, the maximum garnishment is 25% of your net income, which is your gross income minus taxes.

JS: I currently have a client in a Chapter 13 bankruptcy plan who makes about $80,000 a year, but who owes about $70,000 in student loans. The student loan lender was garnishing about 15% of his salary. We included the student loan debt in the plan to stop the garnishment, so he could take care of paying for his car and taxes, while keeping that loan on hold.

Q: When the Chapter 13 bankruptcy is filed, is that student loan debt treated like any other type of debt?

CH: Yes and no. Yes, it can receive a pro rata distribution along with the other general unsecured creditors. No, in that the amount that remains unpaid upon the conclusion of the case will not be discharged. Accordingly, I forewarn debtors that the total amount the student loan lender receives through the plan may not exceed the interest that’s accumulating while the case is pending. As a result, the total owed on the student loan may actually be bigger than when the debtor filed for bankruptcy because of the additional interest that accrued. However, it is often a cost worth bearing so the debtor need not make unaffordable monthly payments directly to the lender for the 3 to 5 years they are under the protection of the court.

JS: It’s just a temporary band-aid, not a cure for student loan debt.

CH: But that band-aid allows a debtor to resolve other debts and then, after the Chapter 13 plan is successfully completed, the debtor can focus his or her attention on paying back the student loan.

Q: If, during the bankruptcy plan, the debtor is in a position to pay back additional money on the student loan, is that possible?

JS: Generally, in this district, if you want to propose to make your regular payments on the student loan directly to the lender, you can propose to do that.

Q: Can a debtor make additional payments to a student loan lender, on top of the monthly payments included in the plan, or is the debtor’s choice one or the other?

CH: It’s either the regular monthly amount paid directly to the lender or the amount paid through the plan.

Q: Is that situation similar to a car loan, in that you might advise a debtor to pay off the car loan outside of the plan, if the debtor can afford to do that?

CH: If a debtor can afford the original monthly payment to the student loan lender outside of the plan, it’s preferable to pay that directly to the lender, rather than having that money paid through the plan for the benefit of all of the creditors. As a result, the debtor gets more “bang for the buck” by having that payment go toward eliminating the student loan instead of distributing that amount amongst all creditors in the plan.

Q: What would happen if a debtor decided to try and pay off the student loan outside of the bankruptcy plan, but for some reason is not able to keep up with the full monthly payments? If the debtor only pays a portion of the monthly payment, or none of it, can the student loan lender then go back to the debtor’s employer to begin wage garnishment?

JS: The lender can’t go back to the employer, but a long time ago I did see a case in which the debtor was going to pay $350 a month directly to a student loan lender. A couple of years into the plan, the debtor stopped paying the lender. The student loan provider then moved to dismiss the debtor’s case for being in default of the bankruptcy plan.

I’ve seen a case in which the lender notified the trustee about missed student loan payments. The trustee demanded that if the debtor stopped direct payments for the student loan, then the amount due to the lender would be added to the monthly bankruptcy plan payment. Remember, a plan payment is based on projected income minus projected expenses. Therefore, if the debtor is not paying the amount due to the lender each month, then the debtor’s monthly living expenses are that much less, which means there is that much more to add to the Chapter 13 Plan payment.

Q: So, if a debtor falls into that type of situation, the trustee won’t adjust the plan so the debtor can pay only a portion of the monthly loan payment?

JS: Correct, but I did have a previous case in which the debtor was actually a married couple with two incomes and two student loans. When the plan began, one spouse was under-employed, so we parked the student loans in the plan along with all of the couple’s other debts. Two years into the plan, the under-employed spouse obtained a new job with a much higher salary. Instead of giving all of those additional earnings to the trustee, we amended the plan to start directly paying back the student loans, directly to the lenders, outside of the bankruptcy plan.

Q: And the trustee agreed to that amended plan?

JS: Yes. Every case is different.

CH: Here is another misconception about bankruptcy. I’ve spoken with a debtor who wanted to include a student loan in the bankruptcy plan, to hold off the lender for the duration of the plan. The debtor assumed the student loan would not bear interest while the plan was in place, which is not true. The automatic stay does not prevent interest from accumulating on the student loan.

JS: Whatever interest is allowable in the loan contract continues to accumulate on top of the loan amount during the three to five years of the bankruptcy.

Q: Here in Indiana, would the closing of ITT Technical Institute in September 2016 be an example of when a closed school discharge could be used to eliminate a student loan debt?

CH: Yes. If some of your money went to ITT and your circumstance meets the criteria established by the U.S. Department of Education, you can contact the lender and initiate an administrative procedure to apply a closed school discharge to that student loan debt.

Q: What would be an example of an undue hardship that could cause a student loan to be discharged?

JS: It’s a very high level of hardship. You basically need to show the court that you’re going to perpetually live below poverty level.

CH: Someone who is disabled or who is on Social Security, who has only enough money to pay their necessities, and who has no money left over for the benefit of a student loan lender.

JS: And no reasonable expectation of any of those circumstances changing. There has been litigation in other districts—in which people have made good faith efforts to pay back the student loan and they demonstrated what they could afford to pay—where some courts have discharged part of the debt. In our district, there has not been much reported litigation like that. It’s expensive to undertake that type of litigation.

Bankruptcy and Personal Injury Claims / Modifying a Chapter 13 Plan / Joint and Several Liability

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Bankruptcy and Personal Injury Claims

If you have a pending personal injury claim when you file for Chapter 7 bankruptcy, you relinquish to your trustee all control of the settlement of the case, but you retain some control with a Chapter 13 bankruptcy. In rare Chapter 13 cases, the cram-down method of reducing debt for an automobile can be used to reduce the first mortgage payments on a house.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including how a debtor’s pending personal injury claim affects a bankruptcy case; how the cram-down method of debt reduction can be used for a mortgage in rare instances; the willingness of bankruptcy trustees to modify a Chapter 13 payment plan; how the Rash decision affects a debtor’s ability to surrender a car in the middle of a Chapter 13 plan; and the circumstances during a bankruptcy in which divorced spouses can both be held jointly and severally liable for debt incurred during their marriage.

Q: How does a debtor’s pending personal injury claim affect a bankruptcy case?

Jess Smith, III: If a debtor files for a Chapter 7 bankruptcy, he or she loses all rights and control over that personal injury action. The Chapter 7 Trustee has complete authority to prosecute it, settle it, or abandon it. Also, the Chapter 7 Trustee will, in all likelihood, take all of the net proceeds and distribute them amongst those creditors who file a claim against the Debtor. In other words, none of the net proceeds will be turned over to the Debtor unless those net proceeds exceed the total amount of the claims filed against the Debtor.

With a Chapter 13 filing, the debtor maintains some control over the personal injury claim regarding settling it or taking it to trial. If money is paid to the debtor as a result of a trial or settlement, then there is a negotiation between the debtor and the trustee as to how much goes to the debtor’s creditors and how much the debtor is allowed to keep for his efforts to acquire that money. That is why sometimes a debtor will choose to file a Chapter 13 bankruptcy versus a Chapter 7.

Typically, a Chapter 13 trustee will allow a debtor to keep one-third (1/3) of the net proceeds, with the remaining two-thirds (2/3) of the net proceeds going to the creditors.

Q: Have you recently handled any bankruptcies that included a personal injury claim settlement?

JS: Yes. In a current Chapter 13 case, the trustee is allowing the debtor to keep 50% of the net proceeds, because his bankruptcy plan is paying all of his creditors in full; therefore, I was able to acquire a little extra money for my client.

Q: If there is an existing Chapter 13 plan in place, which pays back all of the debt to the creditors, and all of the creditors had already agreed to that plan, why does the trustee want 50% of that personal injury claim?

JS: Because it gives the creditors some money right away, in the event the plan fails down the road. For some unforeseen reason, the debtor might run out of money and won’t be able to pay the creditors according to the plan. The trustee has a duty to at least get some of that personal injury money and disperse it now, as opposed to waiting on the debtor’s good promise and good intentions to pay it.

Q: If the debtor maintains the payment schedule, does that shorten the length of the plan?

JS: Yes, in a full-repayment plan it will shorten the length of the bankruptcy. If the debtor is not in a 100% repayment plan, the money received from the personal injury claim, usually two-thirds (2/3) of the net amount, is extra money for the creditors of the debtor.

Q: What are some of the more common circumstances you encounter in which a debtor does not meet the original payment schedule obligation of the plan to pay back creditors?

JS: Job loss or significant decrease in income after approval of the plan. Also, the divorce or separation of joint debtors can cause a plan to fail. Also, any other significant change in circumstances that causes an interruption in income.

Q: If that occurs, what happens to the filing of the bankruptcy?

JS: The case is dismissed, the Chapter 13 case is converted to a Chapter 7 case, or the Chapter 13 plan is modified and the plan payments are changed to redress the problems caused by a change in disposable monthly income.

Q: Let’s expand upon those options. If a debtor is not able to meet the obligations of a bankruptcy plan, why would that case be dismissed?

JS: Because the creditors are not receiving what they are entitled to receive.

Q: If the bankruptcy case is dismissed, what happens to the debts?

JS: It is as if the bankruptcy proceeding never happened and the creditors can resume their non-bankruptcy actions to try to collect on the debts.

Chris Holmes: It usually is a situation in which the debtor is unable to make their bankruptcy plan payments and they are not eligible for a conversion to a Chapter 7 case. As a result, the case is dismissed and their creditors are free to resume their efforts to collect on the debts. The primary reason a debtor would not be eligible to convert a Chapter 13 to Chapter 7 would be if they filed the Chapter 13 within eight (8) years of the filing of a prior Chapter 7 case. As a result, the only option is to allow the case to be dismissed and the debtor may be able to refile under Chapter 7 if it has been more than eight years since the filing of the previous Chapter 7 case.

Q: In most cases, if you’ve never filed for a Chapter 7 bankruptcy and you’re having trouble meeting the obligations of a Chapter 13 plan, then that option to convert to a Chapter 7 still exists?

CH: Yes, provided the debtor qualifies for relief under Chapter 7 of the U.S. Bankruptcy Code, the debtor has no nonexempt assets that can be confiscated and liquidated by the Chapter 7 Trustee, and the debtor is prepared to deal with certain secured creditors or nondischargeable debts outside the U.S. Bankruptcy Court.

Q: Have you had any extraordinary situations arise that are resolved more effectively by a Chapter 13 case rather than a Chapter 7 case?

CH: Recently, I had a very rare situation in which a woman owned a home that is worth less than the balance due on her first mortgage and, as a result, her second mortgage was wholly unsecured. As a further result, Chapter 13 of the U.S. Bankruptcy Code allows us to, as we say, “strip off” or avoid a wholly-unsecured second mortgage because there is no equity in the home to which that second mortgage can effectively attach.

JS: In other words, the debtor can change a secured debt into an unsecured debt and, as a result, we can treat that debt just like we would treat credit card debt or a medical bill.

CH: What made this particular case extraordinary, however, was how we treated the partially secured first mortgage in the debtor’s Chapter 13 Plan. First, I asked the debtor: “Do you really want to pay off a mortgage that, with interest, totals more than twice the current value of the home?” Given her home is located in a neighborhood in which the value of homes is depressed, and her home is in a state of disrepair, we concluded that it was unlikely that the creditor would want to foreclose on its mortgage and take possession of a home that will be impossible to sell for more than what the debtor owes on the mortgage. Also, the home would be expensive to maintain until it is sold. As a result, the debtor offered to pay the holder of the first mortgage only the current value of the home, plus a reasonable rate of interest, through the plan, and treat the balance of the mortgage as an unsecured debt. (If you recall, we do something comparable with certain auto loans—what we refer to as a “cram-down.” When an auto loan is more than two-and-a-half years old and the payoff exceeds the retail value of the car, the debtor can force the creditor to accept only the retail value of the auto plus a reasonable rate of interest, and then treat the balance of loan and any unpaid interest as an unsecured debt to be discharged.)

Legally, we can’t force the creditor to accept a “cram-down” on residential real estate; however, the debtor decided to give it a chance in the hope that the creditor preferred to accept what she offered rather than assume the risk of a worse outcome if it took possession of the property…and the creditor accepted! And given the debtor’s plan payment is roughly equivalent to her first mortgage payment, she will be able to resolve all of her debts using the money the debtor would have otherwise used for only the first mortgage. And should she successfully complete her plan, the balance due and owing on her other debts will be discharged and the debtor will own her home free-and-clear.

Q: In regards to debtors who do not successfully complete their Chapter 13 plans, what circumstances do you encounter most frequently as the cause?

CH: The primary reasons why Chapter 13 Plans fail: The debtor fails to make regular monthly plan payments due to a reduction in income caused by a job loss, or the debtor must use the money earmarked for their plan payments to pay some unforeseen, extraordinary expense such as car repairs or uninsured medical bills that arise after the filing of the case.

Q: Are there situations in which you adjust the plan payment to make it easier for the debtor to continue to make their payments on time?

JS: Yes, sometimes. If the debtor’s disposable monthly income decreases, then we can reduce the monthly plan payments accordingly.

CH: Also, if the debtor fails to make a few plan payments, then we can ask the Judge to modify or amend the debtor’s plan. For example, if the plan life is shorter than 60 months, then we can extend the life of the plan by the number of months in which plan payments were missed, in order to make up for the shortfall.

Q: What would happen if the debtor’s plan is already set at 60 months?

JS: I’ve just been in communication with a debtor who has a motion to dismiss. Her current plan payment is $1000 per month and she is behind by two months. What we’ve agreed to do is tack on an additional $100 per month for the next 20 months to catch up on the total amount due. This will place her in kind of a probationary status. If she misses another payment, the trustee can then choose a quicker route to get the case dismissed.

Q: How willing are trustees to negotiate to modify plans?

JS: The longer you’ve been in the plan, and the trustee sees your making a sincere genuine effort, the more likely the trustee will be to work with you. For example, I have a married couple as a client and they have a plan that is supposed to be 60 months long. For most of the plan, the debtors were having a portion of the trustee payment deducted from their wages, but one them lost their job, so they fell slightly behind in their plan payments.

At the end of the 60 months, the trustee stated the payments were two months short of the total amount due and filed a motion to dismiss. I objected, because payments were still being made to the trustee. The hearing is now set in about month 63. As long as that money is still coming in, the trustee will agree to just continue the hearing on the motion to dismiss until all of the money due has been paid.

Q: Does the trustee need to go back to the creditors to get them to agree to the extended period of time it will take to fully pay the amount due?

JS: No, it’s within the trustee’s discretion. If a creditor wanted to show up at the hearing and voice their own displeasure, they could. But most of the time the unsecured creditors rely upon the trustee to have the more intimate knowledge of what’s going on with the case and the debtor’s situation.

Q: So in any circumstance where you try to go back and renegotiate the terms of the plan, is it strictly up to the trustee to accept the proposal?

CH: No, the creditors can object if the modification of the plan negatively impacts them. For example, if the debtor’s plan base (i.e., the total of all plan payments) is reduced and, as a result, the amount of money to be distributed amongst the creditors is decreased, then the creditors must be notified and given an opportunity to object if the creditor believes the modification will be unreasonable or unfair.

Q: Is it like you’re going back to the beginning of the bankruptcy filing process?

JS: Yes, if you’re reducing the plan base. There is some interesting case law out there, which fortunately doesn’t come up much in our district.

For example, let’s say a debtor had a $15,000 car that they were going to pay for through the plan. The debtor gets the benefit of driving the car while the trustee is giving the creditor who made the car loan a few dollars every month towards the car payment. Three years into the plan, the car breaks down and the debtor says, “I don’t want the car anymore. I’m going to change the plan, reduce the amount owed on the car by cutting it out of the plan, and have the lender come pick up this piece of junk.”

Most of the time, in this district, the creditor will not object. But there is case law in other circuits outside of Indiana, such as the Rash decision (In the Matter of Elray and Jean RASH; United States Court of Appeals, Fifth Circuit.; Decided: July 30, 1996), which deals with this type of situation. The Rash decision is a widely-followed decision that states if a bankruptcy case is approved and a secured creditor is to receive a specified amount for a car, the creditor can object to a plan modification that surrenders the car back to them, because the debtor is the person who drove the car into the ground, not the creditor.

Those are some issues in limited circumstances—where you try to give back a secured asset after it breaks—in which a creditor will sometimes object. And if the creditor would push it, they would probably win. At that point, the debtor would have to decide to either (A) give the creditor the money they’re entitled to and fix the asset, or (B) to convert to a Chapter 7 bankruptcy, if otherwise eligible, or (C) to let the case be dismissed and start all over. Those are all options, but fortunately we’re fairly lucky in this district that we don’t have a lot of secured creditors object when we try to surrender an asset after the plan has been approved.

CH: I can’t remember the last time a creditor objected to the surrender of a car midway through the plan.

JS: I’ve seen a few instances with certain lawyers based in Kentucky who cite the Rash decision.

CH: In our previous conversation we talked about a debtor who owed his ex-wife a property settlement debt based on their divorce agreement. Because the debtor filed a Chapter 13 bankruptcy, that property settlement debt was dischargeable; whereas, it would not have been dischargeable in a Chapter 7 case.

I had a similar situation recently in which our client told me she had a car loan from the marriage that both her ex-husband and she had co-signed. In the divorce decree, the judge ordered our client to pay that debt and to hold her ex-husband harmless (that is, to protect the ex-husband from any liability thereon).

As it turned out, our client couldn’t make the loan payments, the car was repossessed, and the car was sold for less than the unpaid principal balance on the loan. As a result, there is a deficiency balance—the unpaid portion of the debt—for which both her ex-husband and she are jointly and severally liable.

In a Chapter 7 bankruptcy, her obligation to hold him harmless is a nondischargeable debt. That means the ex-husband could ask the divorce court judge to hold our client in contempt for not holding him harmless, should that car creditor sue him for that deficiency balance. According to Chapter 13 of the U. S. Bankruptcy Code, our client can list her obligation to the ex-spouse—to hold him harmless on that debt—as a debt to be discharged, which is another compelling reason why some people opt for a Chapter 13 case rather than a Chapter 7 case. As a consequence, our client will be able to discharge her personal liability on this $12,000 deficiency balance, and her ex-husband will not be able to go to ask the divorce court judge to hold our client in contempt for not holding him harmless on the underlying debt.

Q: It sounds like the husband thought he was going to be protected, but ended up not being protected. Did he make some sort of a mistake in his negotiation of their divorce agreement?

CH: Sometimes divorce lawyers will insert language into a property settlement agreement that asserts that such obligations are in the nature of alimony or maintenance and, therefore, nondischargeable. Whether such a provision is enforceable is a matter for the Judge of the U.S. Bankruptcy Court to resolve.

Car Loan Payments in a Chapter 13 Bankruptcy

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If you will be filing for bankruptcy protection, you have a few options regarding the best way to pay off a car loan or to buy a new vehicle before or during the period of a Chapter 13 bankruptcy.

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Key Points of This Article:

  • If your vehicle loan is over two-and-a-half years old and the remaining loan balance is greater than the car or truck’s current value, Chapter 13 could provide an opportunity to lower the remaining loan amount and interest rate, and then pay the loan off as part of your approved bankruptcy plan monthly payment. The amount you ultimately pay for your vehicle could then be significantly less than your current total loan amount—and you would own the car or truck outright when the case is successfully discharged.
  • If your vehicle loan is less than two-and-a-half years old and the interest rate is already 5% or less, to keep the car or truck you would need to continue to pay off the loan on your vehicle outside of a bankruptcy plan.
  • A sudden need to acquire a new vehicle during an approved bankruptcy plan presents a potential need to submit a request to modify the plan. The trustee of the plan would need to approve that new additional debt as part of your monthly plan payments.
  • A bankruptcy plan trustee’s job is to retrieve money for creditors, so they may consider a monthly vehicle loan payment above a certain amount inappropriate as part of a Chapter 13 bankruptcy plan. If you file for bankruptcy, you may need to switch from an expensive luxury vehicle to a model with lower monthly payments.
  • In addition to your transportation costs, a Chapter 13 trustee will use established federal standards to determine what they consider as your reasonable monthly “cost of living” expenses, including housing, utilities, food, clothing, and out-of-pocket health care expenses.

We recently discussed some aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including the affect of paying off a car loan during a Chapter 13 bankruptcy, buying a new vehicle before or during a bankruptcy, what is a “cram-down,” modifying a bankruptcy payment plan, and means testing. Below is the transcript of that conversation.

 

Q: Does the fact that a debtor who is planning on filing for bankruptcy protection is currently making car loan payments, but the loan will be paid off within a year or two, affect the plan you propose to the bankruptcy court?
Chris Holmes: When I meet with clients in that situation, in a Chapter 13 case where the plan life is anywhere from 3 to 5 years, we weigh the pros and the cons of them either paying for the car directly outside the bankruptcy court versus throwing it into the plan and paying for it over the life of the plan. What we’ll look at is how old is the vehicle loan. If a car loan is more than two-and-a-half years old on the day of filing, and if the payoff on that loan exceeds the fair-market value of the vehicle by a significant amount, then we do this thing we call a “cram-down.” We take the higher payoff and reduce it—cram it down—to what the vehicle is worth. The debtor pays that amount, saving all of that extra principal. Often times, these loans have a very high rate of interest, so we can effectively cram that interest rate down, within the plan, from the high rate to the prime rate plus 1.5%.
As an example, if someone owes $20,000 on a car only worth $15,000, and that loan is supposed to be paid at 21% interest, what we say to the car creditor is that we’re only going to pay the value, $15,000, at perhaps 5% interest through the plan, saving the extra principal and extra interest on that loan. That’s a clear win for the debtor.
If the car loan is less than two-and-a-half years old. we can’t cram the payoff down in value. In that situation, the only thing we can do is reduce the interest rate, so a debtor would payoff the loan through the plan at perhaps 5% interest, to save a considerable amount of interest.
If the loan is less than two-and-a-half years old and the interest rate is already 5% or less, there’s no real advantage to paying it off through the plan, so then we would make arrangements for that debtor to continue to pay on that vehicle outside of the bankruptcy court.
If the bankruptcy plan life is 60 months, but the car loan is going to be paid off in, for example, 36 months, that scenario creates a potential problem. Previously, we would tell the trustee that, when the car was paid in full, the car loan payment would be used to purchase a replacement for that car or maybe a second car for the debtors. The trustees used to accept that at face value, but evidently they have recently learned of too many circumstances, after the car loan was paid in full, in which debtors weren’t using that monthly car payment for the purchase of a replacement or second vehicle. Now trustees don’t trust debtors anymore, so we’re compelled to sign agreements whereby the monthly bankruptcy plan payments increase, for the remaining months of the plan, by the amount that was being paid monthly for the car loan.
In those types of cases, we will go back to the bankruptcy court and ask the judge to allow the debtor to renege on that pledge when the debtor presents to the judge a tentative car loan for a replacement or needed second vehicle. We have the burden to go back into court to request permission to modify the plan back to what we intended, so we can use that extra money for the purchase of another vehicle.
Q: What happens to an individual who has (1) already filed bankruptcy, (2) set-up a plan, (3) their income is such that they are just able to take care of their current bills and monthly payment to the trustee, (4) they haven’t had a car payment during the plan, and then (5) all of a sudden their car breaks down beyond repair and they need to buy a replacement vehicle? Can you modify their bankruptcy plan mid-stream to account for their need to take on a new monthly car payment they did not have before the plan started?
CH: That creates another dilemma, because when we filed the case we submitted a budget that showed all of the debtor’s different monthly living expenses. If the debtor doesn’t have any money allocated for a regular monthly car payment at the start of the plan, the trustee will not approve a loan for that car unless we amend their budget to show the debtor now has the money available for the vehicle loan payment.
What we might have to do is go through the other budgetary items to determine if possibly the debtor is no longer paying so much for child care or perhaps their rent went down. We try to find cuts in their budget. Sometimes, if we don’t find cuts in their monthly budget that equal the amount of the proposed monthly vehicle loan payment, we’ll look at their paycheck to see if they’ve received a cost-of-living adjustment or maybe the withholding for medical insurance has gone down a little bit.
Between a little more disposable monthly income and a few less monthly expenses we night find the extra income needed to pay for the car loan. We’ll then put that amount in an amended budget, submit that to the court along with a copy to the trustee. Then, when the debtor goes to the trustee for permission to the car, the trustee can look at the amended schedule, see that the necessary funds are available each month to pay for the vehicle, and approve the loan.
Q: Would it be in the best interest of someone who was planning on filing for bankruptcy to buy a new car or reliable used car before filing.
Jess Smith III: The bankruptcy code states that we cannot counsel a client to incur new debt on the eve of bankruptcy.
Q: What period of time constitutes “the eve of bankruptcy?” In other words, how much time does someone need to wait between buying a new vehicle and filing for bankruptcy?
CH: I don’t advise clients about that type of activity. What I tell people is that I’ll put $350 in the monthly budget, even though they’re not currently spending that for a car loan, but that they’ll have to go out immediately after filing the case and start shopping around for a vehicle. If the trustee doesn’t receive that request he or she is going to want that $350 each month to give to the creditors.
JS: I told a client to dump his big fancy truck and its $750-a-month payment, which the trustee would think is excessive, and to go get a $350-per-month replacement. The trustee is now demanding proof of that $350 monthly payment, otherwise he is going to want that money for the creditors. We recently met with the creditors, who asked if my client had bought the replacement truck yet. The client said, “No, I need to save my previous monthly payments to accumulate enough money for a down-payment on a replacement.” The creditors stated that unless he does that by the claim bar date, they’re going to ask for that money to go into the plan.
CH: The trustee’s job is to squeeze as much money out of a debtor as possible for the benefit of the creditors.  That’s why they look at projected income and projected expenses. Sometimes they will scrutinize the budget and find there’s some “fat” in it. Maybe we put too much money in there for food or clothes or some other expense—and the trustee will say that’s excessive. We then have to reduce that number to free up some money for the plan payment, which will increase by the amount of “fat” we cut out.
Q: Is there a schedule or chart published by the State of Indiana that shows the average household expenses for a single person, a married couple, and families of different sizes?
JS: There are federal standards (Dept. of Justice Means Testing) that are loosely based on if the IRS is considering going into an installment arrangement with you to pay federal taxes. The IRS publishes amounts they consider to be reasonable for the cost of housing, utilities, transportation, food, clothing, and out-of-pocket health care expenses. The trustees have adopted those figures, but on occasion they’ll take a harder line on a case-by-case basis.
CH: The computer program we use to determine a client’s budget has those regular monthly living expenses built right into it.
Q: Is the IRS standard different for each state?
JS: There are housing allowances listed for each county in every state. For median incomes, the allowances are listed state-by-state, and there are national allowances for food, clothing, transportation, etc.

 

Property You Can Protect When You File for Bankruptcy (Interview Part 2 of 3)

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Retirement accounts are exempt from creditors when filing for bankruptcy, but an inherited IRA is not. A recent ruling extending the time to cure arrearage might help you save your house after a tax sale.

Editor: We recently discussed the changes in the bankruptcy laws with Christopher Holmes, Jess M. Smith, III, partners at Tom Scott & Associates, P.C., along with associate attorney Andrew DeYoung. Below is Part 2 of 3 of the transcript of the conversation.

Q: Can you mention some of the things you can protect and some that you cannot protect when filing for bankruptcy?

Chris Holmes: Real estate. If it is your residence, you can protect up to $19,300 of equity. If it’s a joint filing and the property is owned jointly by a husband and wife, they can protect up to $38,600. Sometimes, when only one of them files, the property owned by a husband and wife is totally off limits to the creditors. That comes in handy sometimes.

Q: Based on cases you’ve dealt with, what are examples of the types of property people will include in their bankruptcy filing?

Jess Smith, III: The cash value of life insurance polices.

Andrew DeYoung: 401k accounts. IRA accounts. It can be as general as the clothing on your back. It’s what the exemptions apply to.

CH: But inherited IRAs are not exempt.

JS: It’s complicated and that’s why you should consult with an attorney.

CH: In general, retirement accounts—IRAs, 401Ks, defined benefit pension plans—are exempt, off-limits, no matter how much money is in there. But there was a recent decision where someone inherited a person’s IRA. The person who had the IRA died; someone inherited the IRA. The person who died could have protected that in its entirety from his or her creditors, but when it was inherited by the recipient—the debtor— it wasn’t off-limits to the creditors. It became subject to being taken and liquidated for the benefit of the debtor’s creditors.

Q: Was this decision a case you worked on or a precedent-setting case?

CH: It was a precedent-setting case in the 7th Circuit Court of Appeals in 2013, Clark (debtor) v. Rameker (trustee), in which a decision was made by the judges that an inherited IRA is not exempt in certain circumstances. (ed., The Supreme Court affirmed this decision by unanimous vote in 2014: Funds held in inherited Individual Retirement Accounts are not “retirement funds” within the meaning of 11 U.S.C. §522(b)(3)(c) and therefore not exempt from the bankruptcy estate.)

JS: And there was the case of someone buying a new car on the eve of bankruptcy to protect the lien, or affecting the lien. If the creditor does not affect the lien on the title, sometimes the trustee can take the car itself.

CH: Right. I recently had a case where right before the people came in to sign the paperwork, just two days before, they went out and bought two cars. So I had to change the paperwork and their list of creditors, but then the problem was that we had to know for certain that the creditor had put their lien on the title to each vehicle—and they had to do that within 30 days of whenever the people got the car. Otherwise, in a Chapter 7 bankruptcy, or even in a Chapter 13, the trustee could void the lien, take the car and liquidate it. Unless we did something else to prevent that, we would have to wait 91 days from the transfer of the title to file the bankruptcy. Otherwise, it creates what’s called a “preferential transfer.” With that situation, a trustee could set aside that preferential transfer and try to confiscate and liquidate that car.

There is another recent precedent-setting case that has changed in bankruptcy law. Previously, when a house had been sold by the county treasurer for delinquent taxes, the debtor had one year to redeem the property—pay the taxes plus a rate of interest—to keep the house from going to the tax sale purchaser. In the bad old days, we would have to tell people, "You’ve got to file a Chapter 13 bankruptcy before the tax sale to get the benefit of the three- to five-year Chapter 13 plan, to cure that real estate tax arrearage and save the house. If the tax sale had occurred, we couldn’t use a Chapter 13 plan to give them three to five years to cure that problem. They still had this one-year statutory redemption period, but luckily one of our judges, Judge Carr, ruled that you can now use a Chapter 13 plan after the tax sale has taken place to force everyone to back off for three to five years, to give that debtor ample time to cure that arrearage. So that is a new development we can use to save houses after tax sales.

Part 1 of Interview: What’s New in Bankruptcy Law in Indiana

Part 3 of Interview: Accruing Post-Petition Interest on Unpaid Federal Taxes

Auto Loans and Bankruptcy: How to Avoid Repossession of Your Vehicle

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We Can Help You Keep Your Car

Are you behind in your monthly car or truck payments to the point where you are unable to satisfy your bank or financial institution and they’ve placed the loan in default? If you answered “Yes,” there may be a way out of your tough situation.

If you’re having financial troubles and are desperate to avoid repossession of your car or truck, filing for a Chapter 13 bankruptcy may be the solution that can help you keep your vehicle. In this type of situation, you would be consider the “debtor” and the lender would be considered the “creditor.”

How Your Auto Loan Became Upside-Down

Let’s assume the loan is more than 2 ½ years old (at least 910 days before filing date) and the debt is “upside-down,” which means the unpaid balance of the loan is more than the value of the vehicle. Also, we’ll assume the loan is at a high rate of interest, perhaps 18-21%.

An example of this type situation could be that you bought a new $35,000 car three years ago on a six-year loan. The value of the car has since depreciated to only $12,000. However, because of the high interest rate, you still owe a loan principal amount (i.e., balance before monthly interest is added) of $22,000. In this case the “secured” value of the vehicle is only $12K, because that is the current replacement value if the car was repossessed and sold by the creditor.

Thanks to Chapter 13 of the U.S. Bankruptcy Code, you can force the bank to let you keep your car and, in effect, refinance the loan for the current replacement value. This process is known as a “cramdown” and it is not available in a Chapter 7 bankruptcy.

How a Cramdown Helps You Keep Your Vehicle

In a cramdown, the creditor would need to accept only the value of the vehicle as the principal amount for the refinanced loan ($12K in the example described above), plus only about 4.75% interest per month. This would significantly reduce your monthly auto loan payment.

The lending institution would then discharge the additional amount you owed, as well as the interest due based on the original higher rate. The court will determine the actual interest rate you’ll pay, which will be based on the current prime rate when that is determined.

The remaining amount of the loan principal that is not crammed down will be lumped into the pool of your other nonpriority unsecured debts ($10K in the above scenario). You will only pay back pennies on the dollar of the discharged amount, as part of your monthly payment to your bankruptcy trustee, which is distributed to all of your creditors.

At the end of the Chapter 13 plan, which will last 3-5 years, the creditor must provide you with a lien-free title to your car or truck.

Learn More Auto Loan Cramdowns and Bankruptcy

To learn more about how filing for bankruptcy and pursuing a cramdowm can help you avoid having your car or truck repossessed, and the other ways it can you relieve the pressure of your financial situation, submit the form above or contact us to schedule a free consultation.

Cars and Other Collateral: Basics of Bankruptcy – Chapter 13 vs. Chapter 7 – Part 3

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In the previous installment of our series “Basics of Bankruptcy,” we discussed some of the reasons to file a Chapter 13 bankruptcy rather than Chapter 7 as they relate to mortgages.
This post looks at reasons why Chapter 13 might be the better choice for personal bankruptcy than Chapter 7 in relationship to cars and other personal collateral.

Cramming a Car

Summary: Provisions exist that can exclude any vehicle acquired for personal use or any other personal property purchased within 910 days of filing.
The ability to cram a recently purchased vehicle (or other personal property) has been limited by the BAPCPA (Bankruptcy Abuse Prevention and Consumer Protection Act) amendments (11 U.S.C. §§ 526–528 (2006)1), referred to as the 910-Rule). The unnumbered (hanging) paragraph at the end of §1325(a)1 excludes any vehicle acquired for personal use or any other personal property purchased within 910 days of filing from the application of §506.
In short, this means that if the personal automobile was purchased within 910 days of the filing date, the claim may not be bifurcated and the entire payoff balance shall be the secured value. However, because Section 1325(a)(5) gives debtors three options for confirmation of secured claims (creditor’s acceptance of the plan, satisfaction of enumerated terms, or surrender of the collateral), arguably, if the plan provides for the payment of only the fair market value for a 910 claim, and the creditor fails to object, upon confirmation the creditor is deemed to have accepted the plan and is bound by the terms of the plan.
In the past when cramming a car in a plan, it was advisable to include language that required that the title be released upon payment of the value offer. However, pursuant to the revised §1325(a)(d)(B), a secured creditor may object and the plan can not be confirmed unless the secured claim holder retains their lien until the debt is paid in full or the case is discharged.
However, because paragraph (5) gives three options (acceptance, satisfaction of enumerated terms, or surrender), arguably, if the plan specifies that title will be released upon payment of the secured portion of the claim, and the creditor fails to object, upon confirmation the creditor is deemed to have accepted the plan and is bound by the terms of the plan.
If a value agreement cannot be reached at the §341 meeting, the matter will be set over for a hearing before the Court. The Courts have generally favored concrete evidence of the value, but have recently indicated a willingness to look at “book” values, preferring the NADA guide.

Cramming other personal property

Summary: In an attempt to keep personal property, debtors may, within one year of filing, offer the fair market value on virtually any piece of personal property, including furniture, appliances and boats.
Subject to the same hanging paragraph limitation addressed above, debtors may offer the fair market value on virtually any piece of personal property, including furniture, appliances and boats. For any other collateral acquired for the personal use of the debtor, however, the time limitation is lowered from 910 days to one year.

  • If no objections are received, the trustee will pay the value offer with interest, and will treat the remaining balance of the claim as unsecured.
  • Interest should be offered as §1325(a)(5) requires that the creditor must receive “present value” of the collateral.
  • However, it would seem that if interest were not offered and the creditor failed to object, the value could be paid at a flat rate (no interest).

Use caution when “cramming” the debtor’s personal property in a plan however, as the “Best Efforts” test will have some bearing. That is, if the debtors are attempting to retain collateral that is not “reasonable and necessary” as contemplated by §1325(b), the trustee may raise an objection to the utilization of estate funds to retain an unnecessary item. This objection may be resolved by either a surrender of the collateral in question, or by a modification of the plan that will increase the amount offered to general creditors by the amount of funds necessary to retain the property.
Some items that may merit a trustee’s best efforts objection include additional or luxury cars, a big screen TV, a boat, or a baby grand piano.

Lowering Interest Rates on Cars (and other collateral)

Summary: Plans can be set up to lower interest rates on collateral to the “Till rate,” which is determined by the national prime rate plus a risk factor.
Regardless of whether the collateral is eligible to be crammed or not, the plan may lower the interest rate to the Till rate. In re Till, 541 U.S. 465, 124 S.Ct. 1951, 158 L.Ed.2d 787 (2004)2 is still assumed to be the appropriate standard for establishing the interest rate to be offered on secured claims.
Till, using the formula approach, established that the interest rate should be the national prime rate plus a risk factor (between 1 and 3%) depending on the circumstances of the particular debtor. A recent decision out of the Southern District of Illinois by Judge Coachys of the Indianapolis Division, In re Rushing (05-37004), applied Till to both cram downs and 910 vehicles. Other judges have since followed suit.
The last article in this series will take an in-depth look at liquidating tax debt, as well as discuss how to protect co-debtors.

Sources:
(links open in new windows)
1. Cornell University Law School Legal Information Institute
2. Bulk.Resources.org

Can I keep my car or truck?

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Yes, there are several different chapters of bankruptcy and we will make sure that you are able to keep your vehicle whether you are current on payments, whether you are behind on payments, or even if you own it outright.
A vehicle is necessary for your “fresh start” and both courts and creditors agree that you will be allowed to keep it.
Related articles: Creditors