Exemption Planning and the Conversion of Non-Exempt Assets to Exempt Assets

John Doe has $50,000 locked up in stocks.  John Doe needs to file for bankruptcy, but given his available exemptions, the stocks are wholly non-exempt.  John Doe’s attorney advises John Doe to sell his stocks and use the cash to pay down his mortgage, because even with the increase in equity, John Doe would still have enough exemptions to protect his home.
This sort of “exemption planning” and conversion of assets from one form to another happens all the time.  The question is whether such conversions are permissible under the bankruptcy code.
11 U.S.C. § 522(o) / Relevant Parts:

[…] The value of an interest in […] real or personal property that the debtor or a dependent of the debtor claims as a homestead shall be reduced to the extent that such value is attributable to any portion of any property that the debtor disposed of in the 10-year period ending on the date of the filing of the petition with the intent to hinder, delay, or defraud a creditor and that the debtor could not exempt, or that portion that the debtor could not exempt […] if on such date the debtor had held the property so disposed of.

Here again, whether such conversions will be permitted is going to depend on the facts of the case and the court where such an objection to exemptions is brought.
In re Lacounte, 342 B.R. 809 (Bankr. D. Mont. 2005) – involved a conversion of $42,500 and the exemption was partially denied.
In re Anderson, 386 B.R. 315 (Bankr. D. Kan. 2008) – involved a conversion of $240,000 and the exemption was permitted.  The court noted that this was a “close case”, but pointed out that it was unable to find that the debtor acted with intent to hinder, delay, or defraud his creditors, and that he apparently “did nothing more than take advantage of an exemption to which he is entitled.”

A Double Standard on Missing Creditors

A general rule in bankruptcy is that you are required to disclose all creditors on your bankruptcy schedules as a matter of due process.  All creditors – whether their debts are dischargeable or non-dischargeable, whether you intend to reaffirm their debts or not – have certain rights and responsibilities when the bankruptcy case is filed and the stay goes into effect, and therefore, they are entitled to notice so they can act appropriately.
11 USC 523(a)(3) generally makes debts non-dischargeable if they are not disclosed on your bankruptcy schedules, however, only under certain conditions.  Specifically, each one is predicated on the creditors ability to timely file a proof of claim.
Except… creditors of debtors in Chapter 7 Bankrputcy don’t file claims unless the trustee seizes an asset or recovers a preference for the benefit of creditors.  So unless there is an asset to liquidate in Chapter 7 or if the debtor files Chapter 13, there are no proofs of claim to file.
Combine this with Judge Kelley’s decision in Guseck, which holds that a case need not be reopened to add a garden-variety creditor that was inadvertantly ommitted from the debtor’s schedules.
The end result?  A debtor who forgets to list a debt in a no-asset Chapter 7 generally suffers no penalty if they forget a creditor.  They simply need to provide notice of the bankruptcy to the creditor after-the-fact, and – at worst – pay a filing fee to amend their schedules.  The debt is still discharged.
A debtor who forgets to list a debt in an asset Chapter 7 or in a Chapter 13 case will be stuck with a non-dischargeable debt if the error is not caught before the deadline for creditors to file claims.
It’s easy to know which chapter you’re filing under, but not always easy to know if a Chapter 7 case will be an asset case or a no-asset case.
The lesson?  Read your schedules of creditors (Schedules D-H) very carefully before your bankruptcy case is filed.  A credit report does not always reveal all debts.  Make sure that no debts are missing from the schedules.

What is the “Bankruptcy Estate”?

Last week, I had a client who had just recently filed for bankruptcy under Chapter 7.  Her intention was to reaffirm on her mortgage so that she could retain her home.  When she contacted her creditor to make arrangements for the reaffirmation agreement, she heard an automated message that sent her into a panic.
She called my office to ask me what they meant.  I set-up a conference call with the number she had called so we could both listen to the message together.  The number turned out to be a special number that people who had filed bankruptcy were supposed to call, and the automated message warned the callers that all of the client’s assets were part of the bankruptcy estate.
Technically, there was nothing inaccurate about the automated message.  When a debtor files for bankruptcy, all of their assets do indeed become part of the bankruptcy estate.  The problem was how the message was worded, and the fact that the message made any reference to the bankruptcy estate at all.  The message was worded in such a way (and in retrospect, I think it was done so intentionally) to prey on the relative naiveté of a typical debtor in bankruptcy and cause unnecessary panic.
First of all, most people filing for bankruptcy struggle with making distinctions between assets and debts, and  understanding the difference between disclosing a debt and having a debt discharged.  In fact, most people refer to it as “including or not including” debts, and they think that including a debt is synonymous with disclosure and discharge, when in fact, it is not.
So, as a result of that common misconception mixed with the cryptic automated message, my client believed that her mortgage lender was telling her that she had forfeited her home in the bankruptcy.  She hadn’t, of course.  But that brings us to today’s topic.  What is the “bankruptcy estate”?
The bankruptcy estate is one of those concepts that most people remain oblivious to because – in 99% of cases – its effects are not readily observable.  It’s a sort of behind-the-scenes concept, but one that plays a very crucial role in bankruptcy.
When a bankruptcy case is filed, all assets of the debtor (including real estate, motor vehicles, personal property, financial accounts, and legal ownership interests of all other kinds) become property of the bankruptcy estate (with a few exceptions).  This is laid out at 11 U.S.C. § 541.
The reason most debtors are unaware of this is because there is very rarely any manifestation of this transfer.  Debtors retain physical possession of all of their assets, including the ability to use and dispose of said assets (although technically, because of the bankruptcy estate, they are not supposed to dispose of assets – this is really only relevant when it comes to larger assets).
The bankruptcy estate is analogous to a probate estate, which is the legal entity or “thing” that owns the stuff of a dead person until the probate process runs its course and the assets of the decedent have been passed on to his/her heirs.
In fact, the existence of the bankruptcy estate is one of the key components necessary to making the automatic stay function at all.  One of the reasons that your creditors cannot garnish wages and repossess vehicles or foreclose property while a bankruptcy case is pending is because – technically – the assets are not yours, but instead they belong to the bankruptcy estate.  And there they will remain while the case is pending, which allows the trustee and the court to review your finances without the interruption of creditors going after assets.
The existence of the estate is also a necessary component to allow the trustee to liquidate assets that may be non-exempt.
In most cases, assets are never seized by the trustee, and so the client remains blissfully unaware that although they retain possession and use of their stuff, that their stuff is technically not theirs.
But fear not!  Like a probate estate, a bankruptcy estate is not permanent.  After the case is no longer pending, the bankruptcy estate is dissolved and ownership interests revest back upon the original owner (you).  Again, it’s very unceremonious, and chances are you’ll never notice that anything actually happened.  In Chapter 7 cases, the revestment typically happens at the same time you receive your discharge.  In Chapter 13, it can happen either at discharge or at confirmation of the plan (and there are strategic reasons to choose one over the other, in terms of legal protections).

Inherited IRAs

Last week, the U.S. Supreme Court issued a decision in Clark v. Rameker (a case from the Western District of Wisconsin), holding that an inherited IRA is not a retirement account for the purpose of the federal retirement funds exemption.
In its ruling, the court distinguished inherited IRAs from traditional IRAs, noting that the heir can never invest additional funds into the account, heirs are required to draw money from the account (even in advance of their own retirement), and heirs can draw the entire amount to be used for any purpose without penalty.
As a result of this decision, holders of inherited IRAs seeking bankruptcy protection will have to claim alternate exemptions (such as the federal wildcard exemption) or use Chapter 13 to protect the funds if there are not enough exemptions to protect the account.

Chapter 7 Exemption Planning & Strategizing

Before I begin this blog post, I just want to assure you that asset cases (what is described below) are relatively rare in the State of Wisconsin due to fairly generous exemption options.  Just based on informal observation, I’d estimate that fewer than 5% of cases have non-exempt assets that could be administered by a trustee, and fewer still are actually administered.  I say this now so as to not induce panic.  Filing for bankruptcy does NOT necessarily mean that you will lose property.  It is certainly possible, but an experienced attorney can estimate with a reasonable degree of certainty whether your case might have an exemption issue during a free initial consult, before you’ve invested a single dime into bankruptcy.  And worst case scenario, you can always file under Chapter 13 and avoid losing assets altogether.  This article below applies to only a very small number of cases.
So, you’re getting ready to file Chapter 7 Bankruptcy.  You’re at your attorney’s office, and he’s punching his keyboard furiously – polishing off the last of the exemption math.  Then he turns to you and says, “You have $10,000″ in non-exempt equity.”
Perhaps you knew this was coming.  Perhaps this news came out of the blue.  Either way, you have non-exempt assets.  So what does this mean?
Well, if we’re going to get technical and grim about it, it means that you either have to cough up $10,000 to give to the Chapter 7 Trustee, or you have to be prepared to lose whatever asset(s) are exposed.
In reality, you’re not in nearly as much trouble as it looks like on paper.  Over the years, I have filed dozens of what appeared – on paper – to be an “asset case” – sometimes with thousands or even tens of thousands of dollars in non-exempt equity.  And in many cases, the trustee still filed an asset report.  Here are just some of the factors weighing on the trustee’s mind when he decides to pursue or abandon a non-exempt asset…
  1. How much is the trustee going to get paid?  The trustee retains a percentage of the assets he recovers for the work he must perform in distributing the assets.  If the only thing he can go after is $100, the costs of administration will far outweigh the mere pittance he will recover.
  2. How much are the creditors going to get paid?  $10,000 is a lot of money if the unsecured claims are only expected to be $25,000.  Even after administrative costs, creditors would still likely get paid over 33% of what is owed them.  But if you owe $200,000, the percentage is a lot less (less than 5%).
  3. How easy will it be to liquidate?  Is the trustee seizing money in a bank account?  If so, that is easy to convert and use to pay creditors.  But what if the exposed money is in household furniture and appliances?  Even if the trustee realized the full market value that you estimated your stuff to be worth, he still has to go through the process of selling the stuff, and that costs money.  And the likelihood of him selling your stuff for even a fraction of what you think it’s worth is still pretty low.
  4. Is the asset contingent?  Sec. 541 of the bankruptcy code describes “property of the estate” and includes contingent assets – or assets that you are entitled to possess, but do not yet possess.  There are tons of contingent assets.  Rights to tax refunds are the most common.  Unresolved lawsuits, inheritances, and residual income are all examples of possible contingent assets (depending on the specific circumstances).  Okay, so you have a lawsuit pending against someone else for $5,000.  Does that mean the trustee wants to hold open your case for months or years, waiting for it to resolve?  Sometimes he will, but often times, he won’t bother.

It is important to note that all of the above are pragmatic considerations for the Trustee.  That doesn’t mean that you will always get off the hook.  The trustees are also under considerable pressure from the U.S. Trustee to pursue worthwhile assets, and of course, they have a fiduciary duty to unsecured creditors.
Trustees are also human beings.  Understand that sometimes, the trustee’s decision to pursue or abandon an asset could be influenced by what kind of a day he is having and what kind of mood he is in.  For example, if he just landed a million dollar asset case earlier in the day, he probably doesn’t care too much about your thousand dollar case.  On the other hand, if you (believing that the trustee is going to screw you over and take things from you) treat the trustee with hostility and contempt – he might just exercise his full rights just to be vindictive.  Fortunately, trustees in our district are pretty good people and easy to get along with.
Younger trustees tend to scrutinize cases more to look for assets.  With age and experience, apathy tends to follow.  They know an asset case when they see one, and they don’t bother with the tiny cases.
So, what are some strategies you can use to retain as many of your assets as you can?
  1. Don’t try to hide any assets.  Anything not disclosed, if discovered later, cannot be taken as exempt – even if you had plenty of exemption to use.  And trustees WILL go after non-exempt assets, if for no other reason than to make an example of you and deter other people from lying to the bankruptcy court.  Learn from the mistakes of others.
  2. Believe it or not, I have learned that it’s actually better to over-estimate the value of your assets.  Trustees can usually tell if you’ve perhaps been a little too generous about their personal belongings.  They can also tell if you’re short-changing your schedules.  If they believe that is the case, they will scrutinize your schedules moreso, and perhaps hire their own appraiser.  If you thought you had problems with $1k in non-exempt equity, wait until the trustee gets real values and finds out that you actually have $10k exposed.  (It’s worth dispelling a common myth at this point.  Trustees do not actually come out to your home to look at your stuff.  But they can, and they will, if they have good reason to believe you have not been truthful on your schedules.)
  3. Check your exemption options.  For example, Wisconsin residents who have resided in Wisconsin for at least two years may choose between federal exemptions and Wisconsin state exemptions.  Each set has its own benefits and drawbacks, so debtors may select whichever set is most beneficial to them (though they may not mix-and-match).  Which exemptions you are entitled to depends on which state you currently reside in, and which state you have resided in during the past 730 days.  (We’ll discuss residency requirements and exemptions a different day.)
  4. You will have access to a variety of exemptions, which can only be applied toward certain types of property, and most of which have dollar limits to them.  To the extent the exemptions allow you to do so, leave exposed things that are hard for the trustee to sell, like furniture and appliances.  Cover up cash and cash-like items (aka liquid assets, such as bank accounts, whole life insurance policies, retirement accounts, tax refunds, stocks, and bonds).  Then cover up real estate and motor vehicles – yes, the trustee has to sell them, but they’re easier to sell.  Whatever is left – that is what you want to leave exposed.
  5. If there are assets secured by liens that you intend to surrender back to the bank, leave those items exposed, too.  The trustee can try to intervene in a repossession or foreclosure action if he chooses to.  But since you’re already resigned to losing the property, it’s no skin off your nose.  If you have a piece-of-junk snowmobile sitting in your backyard collecting rust that you could care less about – don’t waste exemptions on it if they can be better utilized elsewhere.
  6. Expose contingent assets.  These are things you don’t have yet, and it’s harder to miss things that you never had possession of in the first place.
  7. If the trustee is not willing to abandon assets completely, he is still likely going to be open to a settlement – particularly if you have left exposed contingent or hard-to-sell assets.  He doesn’t want to go through the hassle of administration, or leave a case open for months or years to collect a contingent asset.  He would much rather get a cash payment from you, in exchange for which, he will settle for less than what is exposed.  So, for example, let’s say you have $5k exposed in a car.  The trustee may settle for $3k and you get to keep the car.  Now, this isn’t Chapter 13, so you would be able to stretch payments out for 3-5 years.  In Chapter 7, if the trustee settles, he is going to expect payment pretty promptly.  Sometimes he may give you a month.  Sometimes 3-4 months.  The longest I’ve ever seen a payment plan for was 12 months, and that was for an extremely large asset (as I recall, $60-70k).

Anecdotes – nondisclosure of assets, perjury, and bankruptcy fraud

From a press release last week from the Madison division of the FBI.
Bonnie Block of Lancaster was sentenced to two years probation and a $1,000 fine for failing to disclose $10,750 she held in a bank account on the date her bankruptcy case was filed and for lying about how she spent the money when questioned about it.
Two years probation and a $1,000 fine, by the way, was hardly the maximum that she could have faced for her crime.  She could have been imprisoned for up to 5 years, and the fine could have been a lot more.
The bankruptcy court denied her discharge.  Additionally (the press release doesn’t detail this, but I have it on good authority from a former trustee in that district), she ended up having to turn over the hidden funds.
Now, I can’t speak as to the totality of the exemption math in her case.  But it is likely that she would have been able to protect almost half of that money if she had disclosed it and used state exemptions.  (Federal exemptions may well have protected even more.)  Or she could have gone the Chapter 13 route.  Instead, she lost the entire amount, attorney fees for representation in the bankruptcy, attorney fees for representation in the criminal proceedings, her discharge, the fine, plus the criminal mark on her record.
Lesson of the story: no matter how bad you think something might be in bankruptcy, lying and getting caught is going to be MUCH WORSE.  Always be honest with your attorney and disclose all of your income and assets.

Residency Requirements for Exemptions

In a Chapter 7 or Chapter 13 bankruptcy case, debtors must make a full disclosure of all of their assets.  Assets range from the tangible (furniture and appliances) to the intangible (stocks and intellectual property), from the valuable (real estate and vehicles) to the invaluable (clothing and timeshares), from the known to the contingent (tax refunds and personal injury claims), and include future, partial, and equitable interests.
Assets, particularly in Chapter 7, can be seized by a trustee and sold for the benefit of unsecured creditors unless the asset’s full value can be taken as exempt.  Each state has its own respective property exemption laws (and the federal bankruptcy code also provides for its own exemptions).  But you can only select one exemption set.  Which one should you choose?  Which ones can you choose?
It probably won’t come as much of a surprise that you can’t use California exemptions if you do not currently reside in California, nor have you resided there at any time in the past.
What might surprise you is that you can be a legal resident of California and not be eligible to claim its exemptions.
Let’s take a look at and parse the controlling rule, 11 U.S.C. § 522(b)(3)(A).

Property listed in this paragraph is […] any property that is exempt under Federal law, other than subsection (d) of this section, or State or local law that is applicable on the date of the filing of the petition to the place in which the debtor’s domicile has been located for the 730 days immediately preceding the date of the filing of the petition or if the debtor’s domicile has not been located in a single State for such 730-day period, the place in which the debtor’s domicile was located for 180 days immediately preceding the 730-day period or for a longer portion of such 180-day period than in any other place;

Quite a mouthful, eh?
Scenario #1.  For simplicity’s sake, 730 days is two [non-leap] years.  So, what this statute is saying is that – the state whose exemptions control is the state that the debtor has resided in for two years.  So, let’s start with a simple example.  John Doe is a resident of Wisconsin.  Today’s date is May 29, 2013.  John moved to Wisconsin from Rhode Island in 2006.  Therefore, John Doe has been a resident of Wisconsin for more than two years.  Therefore, John is entitled to use Wisconsin’s exemptions.
Before we continue any further, I should mention that Wisconsin is one of a few states that allows its qualifying residents to elect to choose Wisconsin’s state exemptions or the federal exemptions.  As a practical matter, most attorneys use federal exemptions because the federal wildcard exemption protects certain assets like tax refunds that Wisconsin’s state exemptions do not.  Wisconsin exemptions are favored when there is a lot of equity in a particular asset (such as a homestead) where the state exemptions are much more favorable than the federal exemptions.
Scenario #2.  So, let’s change the facts around a little bit.  Let’s say John Doe moved to Wisconsin from Rhode Island on June 12, 2012.  Let’s further assume that John Doe began living in Rhode Island since 2003.  John has had two residences in the past 730 days – Wisconsin and Rhode Island.  Now, we have to look past the 2 year mark and look at the timeframe of 2.5 years ago to 2 years ago.  During that time, John Doe was a resident of Rhode Island, which means Rhode Island exemption laws still control in John Doe’s case.  In order to be eligible to use Wisconsin exemptions, John must wait to file his case until June 13, 2014.
Scenario #3.  Now, let’s make it REALLY confusing.  John Doe moved from Rhode Island to Wisconsin on June 12, 2012, and today is May 29, 2013.  Prior to Rhode Island, John lived in Nebraska from 1999 to May 1, 2011.  In the last 2 years, John lived in Wisconsin and Rhode Island.  So, we shift our focus from the past 2 years, to the range of 2.5 years to 2 years ago.  During that time, he lived in Nebraska and Rhode Island.  Also during that time, he spent the majority of his time in Nebraska.  Therefore, Nebraska exemptions control in this case.
In scenario #2, we are stuck with Rhode Island exemptions.  Rhode Island allows nonresidents to claim its exemptions.  Like Wisconsin, Rhode Island residents may also use federal exemptions.  So, in this scenario, John Doe can choose between federal exemptions and Rhode Island state exemptions.
In scenario #3, we are stuck with Nebraska exemptions.  Nebraska also allows nonresidents to claim its exemptions, but does not allow federal exemptions.  Therefore, in this scenario, John would be limited to claiming Nebraska exemptions.
Other states, such as Arizona, do not allow nonresidents to claim its exemptions, but allow the use of federal exemptions.  If Arizona was the controlling state, John Doe would have to use federal exemptions.
What about a state like Idaho, which does not allow nonresidents to use its state exemptions, but also forbids federal exemptions?  In that case, the hanging paragraph in 11 U.S.C. § 522(b)(3) (just below subsection ‘C’) kicks in, and federal exemptions are available.  This is also true if there is no controlling state (the debtor resided outside of the 50 states and D.C. in the qualifying time period).

If the effect of the domiciliary requirement under subparagraph (A) is to render the debtor ineligible for any exemption, the debtor may elect to exempt property that is specified under subsection (d).

A side-by-side comparison of Chapter 7 and Chapter 13 Bankruptcy.

Chapter 7
Chapter 13
Liquidation of non-exempt assets, discharge of general unsecured debts.
Reorganization and repayment plan.  Debts split into categories. Some paid in full, others paid a percentage based on income and other factors.
Time between filing and discharge is approximately 4 months.
Time between filing and discharge is approximately 3-5 years.
More Expensive
Must be below median or be able to “beat” the Means Test.
Surplus disposable income on either the Means Test or the budget.
Prior Bankruptcy
Ineligible to file if filed a prior Chapter 7 in the last 8 years or a prior Chapter 13 in the last 6 years.
Eligible to file even if not eligible for a discharge. Eligible for discharge 4 years after prior Chapter 7 or 2 years after prior Chapter 13.
If equity exceeds allowable exemptions, trustee can sell for benefit of unsecured creditors.
Assets are not liquidated, but repayment plan may require a minimum threshold paid to unsecured creditors to make them as whole as they would have been under Chapter 7.
Stay Protections
Both chapters stop collection efforts, lawsuits, wage garnishments, and utility disconnection.
Repossession & Foreclosure
Automatic stay suspends pending actions temporarily, but no adequate protection for arrears.
Arrears are cured. Foreclosure and repossession fully stayed pending successful completion of repayment plan.
Codebtor Stay
Other Issues
Preference payments, insider payments, transfers of assets, excessive gambling losses, and fraudulently incurred debt all pose the risk of adversary proceedings or denials of discharge.
Chapter 13 is sort of a fix-all remedy to anything that might be a problem in Chapter 7. Many issues become non-issues, or are mitigated with a floor amount paid to unsecured creditors spread out over the life of the repayment plan.
Non-dischargeable debts simply survive the bankruptcy.
Certain non-dischargeable debts (priority debts, such as taxes and child support) are paid in full.  Other non-dischargeable debts (such as student loans) can be paid down concurrently with unsecured creditors.
Most people have improved credit scores about 12 months after bankruptcy is filed, assuming they have made payments on surviving debts (e.g. mortgages, car loans, or student loans).
Credit rebuilds a little faster in Chapter 13 than in Chapter 7.


Don’t let fear or misinformation deter you from seeking relief.

From time to time, I hear an anecdote from a client that reminds me that everywhere across the country, there are thousands of people who are not getting the fresh start they need because of misconceptions about bankruptcy.
The other day, I met with a fellow who was terrified that if he filed for bankruptcy, that he would lose his car, because a friend of his filed for bankruptcy, and she lost her car.
I explained to him that bankruptcy does not necessarily mean you will lose a car.  In fact, losing a car because of bankruptcy is incredibly rare.  Losing a car during bankruptcy (but not because of bankruptcy) is a little more common.  There are still others who choose to voluntarily give up their vehicle in the course of a bankruptcy, though there is no mandate that anyone do so.
There are only two ways that someone can lose a vehicle in bankruptcy.  And one of those ways doesn’t really have to do with the bankruptcy at all.
First, you could lose a car if there is a secured loan on the vehicle and you have defaulted on the loan, resulting a repossession.  This often occurs while someone is preparing to file for bankruptcy, but it certainly doesn’t happen because of it.  If you default on a secured loan payment, creditors have a right to repossess, whether you file for bankruptcy or not.  Thinking that bankruptcy has anything to do with repossession is the classic post hoc, ergo, propter hoc logic fallacy.  After this, therefore, because of this.  In fact, the repossession had absolutely nothing to do with the bankruptcy, the timing just happened to coincide because the bankrupt debtor was struggling on all bills, car loans included.
The second way to lose a vehicle in bankruptcy is if the equity in the vehicle exceeds the allowable exemptions.  Again, this is pretty rare.  Most vehicles don’t have equity to begin with.  Most vehicles depreciate rapidly the moment you drive them off of the lot.  Additionally, most people pay the minimum amounts on their vehicle loan.  This ensures that throughout much of the life of the vehicle, the amount owed on the car exceeds the value of the car, creating no equity.  By the time the debt is paid down enough to create equity, the car is several years old, has tens of thousands of miles on it, and is worth maybe a couple thousand dollars.  At that point, Wisconsin residents enjoy pretty healthy motor vehicle exemptions whether they elect federal exemptions: $3,450, plus any remaining wildcard exemption (up to $11,975) using federal exemptions, and $4,000, plus any remaining household goods exemptions (up to $12,000) using state exemptions – and both numbers are doubled for joint filers.
Still, there are times where there are vehicles in excess of exemptions, such as people who have purchased a new vehicle recently with cash and have no loan against it, people with expensive large vehicles, or people who have a collection of cars of high or antique value.  In these scenarios, it is possible that your exemptions will fall short of the equity you own.  But even then, the trustee has to want to sell the car.  In my experience, trustees don’t like to sell stuff, particularly in today’s economy.  They prefer to liquidate non-exempt assets that are easier to move, such as real estate, cash, and cash-like items such as tax refunds.
And by the way – both of these problems (non-exempt equity or a default on a secured loan payment) can both be fixed by filing a Chapter 13 Bankruptcy instead of Chapter 7.
The moral of the story is that no two bankruptcy cases are exactly alike.  How your bankruptcy case will unfold, how you will benefit, the extent of your relief, and the negative consequences you experience are highly contextual and dependent on the specific circumstances of your case.
It is important not to rely on the anecdotal evidence you hear from friends and family, who may not fully understand how or why certain things may have happened to them.  Consult with an experienced attorney to find out exactly what bankruptcy will mean for you, so that you can make an informed decision and weigh the risks and benefits for yourself.

Divorce and Bankruptcy

Divorce and bankruptcy tend to go hand in hand.  Either the financial stresses that led to bankruptcy also break down the marriage, or ex-spouses use bankruptcy as a way to clean-up and get a fresh start after divorce.
However, the issue of divorce can weak havoc on bankruptcy, and vice-versa.  So it’s good to revisit some of these themes.  Particularly when you’re trying to decide which to do first: file for divorce or file for bankruptcy, and whether to file joint or individual.  Many of these themes have circular reasoning, so there really was no linear way to present these, other than randomly…
  • Filing a joint bankruptcy before a divorce is finalized is almost always the preferred route.  It’s cheaper to file one joint petition rather than two separate individual petitions.  Both debtors benefit equally from the discharge, neither one has to rely on the “phantom discharge”, and it renders most “hold harmless” clauses in divorce papers moot.
  • On the other hand, some debtors don’t want to file joint because of impact on credit scores, because bankruptcy causes the revelation of certain financial information that could give one of the spouses leverage in divorce proceedings, or because the income potential of one debtor disqualifies both debtors – as a married couple – from Chapter 7.
  • For reasons beyond my comprehension, creditors are not required to abide by the terms of divorce orders.  Which means that a bankruptcy filed after divorce may not be as effective as a bankruptcy filed before divorce.  Divorce orders usually contain “hold harmless” clauses.  Which means if one spouse gets a debt discharged in bankruptcy that was assigned to him or her in the divorce, and the creditor then pursues the other spouse for payment, the second spouse can go into family court and get a non-dischargeable support order from the first spouse for damages resulting from their failure to pay the debt assigned to them in divorce.  So, if you do file divorce before bankruptcy, make sure that your attorney knows of your intent to file for bankruptcy and that your divorce papers do not include “hold harmless” clauses.  (DO NOT FILE FOR DIVORCE WITHOUT AN ATTORNEY!  Most divorcees who have done so will tell you that it was a mistake.)
  • Get rid of the mentality that you and your spouse split everything 50-50, or that credit cards in one spouse’s name are not the responsibility of the other spouse.  Wisconsin is a community property state, which means that married spouses are deemed a single legal entity, and each spouse is presumed to own a whole and undivided interest in all assets (and share a whole and undivided liability in all debts).
  • Consequently, a bankruptcy petition must disclose the assets of both spouses (if the divorce is not yet finalized), even if one spouse is filing without the other spouse.  Assets of the non-filing spouse that are not disclosed (even if it is due to the non-filing spouse’s lack of cooperation) cannot be taken as exempt, which means the trustee can seize and liquidate unreported and non-exempt assets of the non-filing spouse.  While the filing spouse might not care, this adverse impact on the non-filing spouse could hurt the filing spouse when it comes time to settle the divorce.
  • Additionally, in a non-filing spouse scenario, only the filing spouse can claim exemptions (which are generally half of the exemptions available to joint filers), often creating non-exempt assets where there would be none of both spouses filed.
  • Bankruptcy filed after divorce also must contend with a potential fraudulent conveyance issue.  Were the assets in divorce split roughly 50-50?  If not, why?  If the non-filing spouse got the house, both cars, and all the jewelry, and the filing spouse got stuck with nothing, there could be a fraud issue.  It is not unheard of for a married couple to get divorced just to protect assets from unsecured creditors (in fact, I had a client once myself who tried to pull this stunt, and I fired her as a client).
  • In the event that a single filer has enough exemptions on his own to cover the assets of both spouses, then the question becomes whether the filing spouse can exempt the non-filing spouse’s interest.  If that seems strange to you in light of what I said earlier about community property, you’re not alone.  It seems that this is where the “whole and undivided interest” standard breaks down into a 50-50 theory, again for reasons beyond my comprehension.  At any rate, the court then looks at the non-exempt asset.  Is it readily divisible – like a bank account?  If yes, the debtor can only exempt their half share.  If it is not readily divisible (like a house or single vehicle), then the debtor can exempt both spouse’s share in the asset, provided enough exemptions exist to cover the asset.
  • Once a divorce is final, former spouses can no longer file a joint petition.  A joint bankruptcy petition must be filed before the divorce is finalized.
  • As you may have gathered, it is quite simple for one spouse to adversely impact the spouse by filing for bankruptcy.  Some people would say this is unfair.  I agree.  But it is also part of the cost of marriage that too few people understand and appreciate before they get married.
  • I get a number of clients who cannot provide me with the information of their non-filing spouse because they have been estranged for so long.  They may not be on speaking terms, or they may not even know how to contact the spouse anymore.  Does that mean the filing spouse is off the hook for disclosing the information of the non-filing spouse?  Unfortunately, no.  As stated earlier, unreported assets could potentially be liquidated by the trustee, and even if the filing spouse doesn’t care, it would impact the divorce proceedings when they come.  The solution – if you are unable or unwilling to work with your spouse in a joint filing is to file for divorce first.  Newspaper publication resolves any problems with being unable to locate/contact the other spouse.  Just remember that in filing divorce before filing bankruptcy, to be on the lookout for “hold harmless” clauses that can affect your discharge.