I represent a wide range of people in New Jersey and New York. Most want to file for Chapter 7 relief because they think that this is the best and most complete way out of debt. For many, that is true but there are exceptions.
The question that gets often asked is what debts are discharged in a Chapter 7 case. A general answer is that most unsecured debts get cleared out. The better question would be, however, what is not discharged?
At the close of an ordinary individual Chapter 7 case, the Court will issue an Order of Discharge which says that every debt that can be discharged is discharged and that there is a permanent injunction against collection, enforcement, liens, etc arising from that debt. The Discharge Order is the goal of every bankruptcy case and is an incredibly potent tool. It is NOT, however, absolute. Some debts are not discharged in a Chapter 7 and certain secured debts can still be partially enforced:
Non – Dischargeable Debts – Unsecured Debts
There are several categories of debt that are automatically not discharged. These are the ones that I see the most in my practice, because the others will relate more to business cases:
- Income taxes that were incurred less than 3 years prior to filing, or were assessed less than 240 days ago or debts incurred to pay these taxes or debts resulting from a fraudulent return or tax evasion.
- Sales taxes or other “trust fund taxes” or debts to pay these taxes.
- Alimony or child support.
- Other debts resulting from a matrimonial court’s order in a family matter.
- Student loans without a showing of undue hardship.
- Criminal fines/restitution.
- Fines or penalties that are payable to and for the benefit of a governmental entity – for example EZ-Pass fines for failure to pay a toll.
- Creditors who are not listed in the event of an asset case (meaning there is money to go to creditors).
- Retirement (401K/Pension) loans.
Some other kinds of debts may not be discharged if a creditor raises a successful challenge to them:
- Debts incurred because of fraud or misrepresentation in writing or orally.
- Debts for fraud, embezzlement, larceny or “defalcation while in a fiduciary duty.” (like stealing from someone over whom you have power of attorney)
- Debts incurred because of the debtor’s willful and malicious injury to another.
- Debts arising from a claim for personal injury or wrongful death due to the Debtor driving, boating or flying while under the influence of alcohol, drugs or other substances.
- Debts for luxury goods purchased in the 90 days pre-filing
- Debts for cash advances taken within 70 days pre-filing.
If a creditor wants to challenge the dischargeability of a debt, OR if a debtor wants to say that a debt is dischargeable and a creditor disagrees, it is resolved via an adversary proceeding (a lawsuit), where the plaintiff seeks the Court’s determination of a debt’s dischargeability. You cannot determine a debt’s dischargeability by a motion. You have to file the lawsuit (Fed. R. Bankr. P. 7001(4)).
Secured Debts – What Happens to These in Chapter 7?
A secured debt has two elements to it: (1) the actual debt and (2) the security interest. The debt is the personal responsibility of the debtor to pay the creditor a certain amount of money. For instance, if John borrows $30 from Jim and promises to pay Jim back. The security interest is the right of a creditor to take a piece of collateral if the debtor does not pay the debt, such as foreclosure on a house or repossession of a car. Security interests come in three main varieties: (1) contractual, such as mortgages, car loans, and other agreements like merchant cash advances, (2) judgments, and (3) statutory liens such as condominium dues for a certain period or tax liens. Chapter 7 cases can have different effects on these liens.
Contractual Secured Debts (Cars, Mortgages, Secured Lending for Furniture, etc)
In a Chapter 7 case, when dealing with most agreements for security, the lender may repossess the collateral in the event of a default even if the debtor files for bankruptcy after either (1) the issuance of a discharge or (2) the granting of a motion for relief from stay. The most common situation is if the debtor has not paid for either a car or a mortgage. In the event of the car, the lender can still repossess, but cannot chase the debtor for the deficiency after the car is repossessed and sold at auction unless the debtor has previously agreed to “reaffirm” the car.
With respect to mortgages lenders can still foreclose, but they cannot sue for a deficiency on the mortgage if the foreclosure sale does not generate enough money to pay off the mortgages. Another annoying factor is that all the mortgages stay as of record and must be paid off when the real property is sold if the debtor sells the property. That means that if the balances of the mortgages plus closing costs are more than the sales price, then the debtor will have to either do a short sale, bring cash to close or walk away from the property. The debtor is not personally liable, but the mortgages have to get paid in order to give the buyer clear title.
The important thing to remember is that a discharge in bankruptcy is NOT the same as a discharge of mortgage. The former is a court injunction that prevents collections on a debt, the latter is a filing with the county land record office (or clerk) that states that the mortgage has been satisfied and paid off or that the lender is releasing the mortgage.
Lien Stripping or Cram Down in Chapter 7
Lien stripping refers to the legal principle applicable in Chapter 13 and Chapter 11 cases whereby a lien (usually a mortgage) that has no equity to underlie it can have the security be stripped away and be treated as a general unsecured claim. This is a common remedy in a Chapter 13 case where the debtor will strip the lien from, for example, a second mortgage where the value of the property at the time of filing is less than the balance on the first mortgage. Unfortunately, there is no lien stripping in Chapter 7. There used to be an exception for this in the 11th Circuit, but in 2015, the Supreme Court, in the matter of Bank of America, NA v. Caulkett, 135 S. Ct. 1995, 192 L.Ed. 2d 52, 83 U.S. 4379 (2015), decided that 11 U.S.C. §506 precluded a lien strip in Chapter 7 cases. The option to lien strip remains available in Chapter 13 and 11 cases.
Judgments create a lien on all assets of the debtor and are not automatically wiped clean. This usually creates an issue ONLY when the debtor has real property and the judgment creditor does not vacate the judgment voluntarily. In my districts, liens are generally ineffective after the discharge is entered if there is no real property. If there is real property, sometimes the seller’s title agency when they try to sell the house will require that a motion to avoid the judgment lien be filed in order to remove same as of record. For most bankruptcy attorneys where I practice this is an “extra” and is not part of a standard case. You can either do this when in the bankruptcy under 11 U.S.C. §522(f) or your state may have a supplemental procedure to do this in state court after a certain period from when the discharge was entered (for example, a motion under NJSA 2A:16-49.1). These usually pop up as a concern when a person filed for bankruptcy years ago and was unconcerned because they were current on the mortgage and may not have even realized that there was a judgment. The bankruptcy gets discharged and then when they go to sell the house 5 or 10 years later, the judgment pops up on title and has to get cleaned up.
Statutory Liens and Tax Liens
These are liens that exist solely because of state law, such as Homeowners Association liens, tax liens and mechanics liens. These cannot be avoided and remain on the property after a Chapter 7 case.
What do You do with Non-Dischargeable debt?
If your debt is not dischargeable in Chapter 7, it might be dischargeable in Chapter 13. If the debt is still non-dischargeable a Chapter 13 case could still allow you to create a payment plan to take care of the non dischargeable debt in an affordable manner. Sometimes a Chapter 11 case might be the best way to move forward.
For more information about what might be a good solution for your personal financial situation, contact the Law Offices of Scott J. Goldstein, LLC at 973-453-2838 or make an appointment to discuss your financial issues and what can be done to alleviate them!