Vol. 84, No. 3, March 2011
Bankruptcies in Wisconsin are again on the rise. Even the Archdiocese of Milwaukee has seen fit to file for bankruptcy protection.1 Consumer bankruptcies increased 9 percent nationwide in 2010 from the previous year, according to data from the National Bankruptcy Research Center (NBKRC).2 In the Eastern District of Wisconsin, the number of bankruptcies filed in 2010 increased by 11 percent over those filed in 2009.3 Bankruptcies filed in the Western District of Wisconsin in the first 11 months of 2010 were up 7.5 percent over 2009.4
As a result, more nonbankruptcy attorneys (that is, lawyers who do not focus on bankruptcy law) encounter bankruptcy law in their everyday practices. This article aims to familiarize those lawyers with the basics so they can effectively represent or defend against parties who have filed a bankruptcy proceeding.
Because of the breadth of the topic, the article is in two parts. The first part introduces very basic bankruptcy concepts and practice tips for nonbankruptcy lawyers. The second part will deal with common but specific aspects of bankruptcy practice with additional practice tips. The second part will appear in the April 2011 Wisconsin Lawyer.
The primary sources of bankruptcy law are title 11 of the United States Code, also known as the Bankruptcy Code, and the Federal Rules of Bankruptcy Procedure. Although there are several different chapters under which a debtor may file, most consumer bankruptcy filings in Wisconsin are either Chapter 7 or Chapter 13 proceedings.5 The following discussion focuses on the provisions of those chapters.
A Chapter 7 bankruptcy is sometimes referred to as a straight liquidation, meaning that the debtor’s unsecured, nonexempt assets are sold, the proceeds are used to pay administrative expenses, and the remaining funds are distributed among the unsecured creditors. A Chapter 7 bankruptcy is what typically comes to mind when one thinks of bankruptcy. A Chapter 13 bankruptcy is commonly referred to as a “wage earner’s plan,” because it originally was aimed at benefiting wage earners.6 Generally, a Chapter 13 bankruptcy allows a debtor to keep all his or her assets and pay debts over time. Although a Chapter 7 is the most common consumer bankruptcy, there are situations in which a Chapter 13 is necessary or preferable, for example, if the debtor is in default on a secured debt and wants to force the reinstatement of the obligation, the debtor desires to pay a nondischargeable debt (such as a student loan) over a period of time, or the debtor is not eligible for a Chapter 7 because of high income.
When a Chapter 7 bankruptcy is filed, a trustee is appointed by the U.S. Trustee’s office.7 The trustee performs an investigation, the main purpose of which is to determine whether there are any unsecured, nonexempt assets or any assets recoverable pursuant to the trustee’s numerous avoidance powers.8 Although several avoidance powers are available to the trustee, the most common are the trustee’s abilities to reverse preferential transfers and to reverse fraudulent conveyances. Generally, a preferential transfer is a transfer made to an unsecured creditor within the 90 days before filing a petition or a payment made to a family member within 90 days and one year of filing a petition.9 A fraudulent conveyance may take many forms, but the most common is a transfer of any interest of the debtor, for less than fair market value, in the two years before filing a petition.10 The trustee liquidates (sells) any such assets and distributes the proceeds according to the priority scheme set forth in the Bankruptcy Code.11
In the vast majority of Chapter 7 bankruptcies filed in Wisconsin, no assets are recovered, and debtors retain all their assets.12 These cases, referred to as “no-asset” cases, are common because the debtor has the right to protect certain assets using exemptions, which protect property from being liquidated to pay debts. In addition, the debtor also is able to retain assets subject to secured liens, provided all or the majority of equity in the property is exempt and the debtor pays the secured debt. Therefore, the only event of consequence in most Chapter 7 bankruptcies is the discharge of the debtor’s personal liability on dischargeable debts. Most debts are eligible for discharge with a few exceptions (discussed in greater detail in part two of this article).13 A discharge prevents a creditor to whom a debt is owed from taking any action against the debtor to collect the debt.14 The debtor’s receipt of a discharge does not depend on whether the case is a no-asset case.
James W. McNeilly Jr., U.W. 1981, has been a Chapter 7 Bankruptcy Panel trustee since 1987 and has occasionally served as an operating Chapter 11 trustee. A substantial portion of his practice is bankruptcy and insolvency matters. He is chair-elect of the State Bar’s Bankruptcy, Insolvency and Creditors’ Rights Section.
Joan K. Mueller, Marquette 2007, concentrates her practice on bankruptcy and insolvency matters. Contact either attorney at www.mcneillylawoffices.com.
Although many Chapter 7 rules and procedures also are applicable to Chapter 13 bankruptcies, there are significant differences. The most important difference is that in Chapter 13 cases, the debtor must file a plan, which governs the full or partial payment of the debts. Generally, the plan must last at least three years and may last as long as five years. A debtor who files a Chapter 13 must devote his or her disposable income over the life of the plan to the payment of unsecured debts. Disposable income is a term of art and is generally determined by objective standards, not the debtor’s actual monthly expenses. Additionally, the debtor must pay certain secured debts through the plan. Many other rules govern the allowable and required terms of a Chapter 13 plan, all of which are beyond the scope of this article.15
Nonbankruptcy lawyers need to be able to identify situations in which it is appropriate to consult with a bankruptcy attorney on the lawyer’s own behalf or on behalf of prospective or current clients. For example, if a debtor has substantial credit card debt relative to his or her annual income, significant medical debt, or a job loss, bankruptcy may be an option. In addition, if a married client is considering divorce and there is significant marital debt, it may be advisable for the client to meet with a bankruptcy attorney to see if bankruptcy is necessary, and if so, if there is a benefit to filing bankruptcy before obtaining a divorce. Even if bankruptcy is not necessary, it may benefit the divorcing client to have a bankruptcy attorney assist in drafting the marital settlement agreement and judgment, in anticipation of a potential future bankruptcy of either party.
A lawyer drafting estate planning documents for individuals who have children with financial troubles may find it beneficial to consult with a bankruptcy attorney to determine if there are ways to protect the client’s assets from the child’s creditors. These examples are not inclusive, but they are some of the most common situations for which bankruptcy knowledge may be beneficial.
Several factors determine whether a debtor is eligible to file for relief under a particular chapter. Basically, almost all debtors (except for railroads and certain financial institutions and insurance companies16) with mostly nonconsumer debts are eligible to file a Chapter 7. Debtors with mostly consumer debts are eligible to file a Chapter 7, provided that the debtor’s household income is not excessive according to the Code.
Whether a debtor’s income is too high for a Chapter 7 is determined by two tests, the “means test”17 and the “totality of the circumstances” test.18 The means test is the more controversial of the two. The means test focuses on the debtor’s gross household income for the six months immediately preceding filing. Essentially, it annualizes a debtor’s income to determine if the debtor is eligible for relief under a Chapter 7. If a debtor’s household income exceeds the median income for Wisconsin based on family size, more analysis is required. That analysis consists of subtracting amounts for allowable expenses, most of which are predetermined based on Internal Revenue Service standards, to determine how much disposable income the debtor has available to pay debts. If the means test is applicable and the debtor has disposable income, the debtor is not eligible to file a Chapter 7. Even if the debtor passes the means test, the debtor may be found ineligible for a Chapter 7 based on the totality of the circumstances test.
The totality of the circumstances test exists because payments on secured debts, even those secured by second homes and “luxuries” such as motorcycles, boats, and additional vehicles, are allowed expense deductions on the means test. As a result, some very-high-income debtors may pass the means test. The policy behind the totality of the circumstances test is that those debtors have or should have sufficient income to pay some or all of their unsecured debts. The test allows the bankruptcy court to deny the debtor relief under Chapter 7 if it would be unfair to creditors to grant the debtor that relief based on the totality of the circumstances, which can be a nebulous concept.
Only individual debtors (not limited liability entities, partnerships, and the like) are eligible to file a Chapter 13. However, a debtor who owes more than $336,900 in noncontingent, liquidated unsecured debts or more than $1,010,650 in noncontingent, liquidated secured debts is not eligible for relief under Chapter 13. In addition, an individual who is a stockbroker or commodity broker cannot file a Chapter 13 even if he or she meets the debt limitations.19
Petition, Schedules, and Statement of Financial Affairs
A bankruptcy proceeding is commenced by the filing of a petition.20 The debtor also is required to file Schedules A to J21 and a statement of financial affairs (often called SOFA)22 and must provide other documents to the trustee and creditors. These documents are often collectively referred to as “the schedules.” Schedules A to J list all the debtor’s real and personal property, debts, leases, and executory contracts, along with the debtor’s income and expenses. The debts are categorized as secured, unsecured priority, or unsecured nonpriority. Secured debts are obligations, such as motor vehicle loans or real estate mortgages, secured by liens on property.23 Unsecured priority claims are those debts given priority by the Code, such as past-due child support or outstanding tax liabilities, and are paid before unsecured nonpriority claims.24 All other debts (for example, credit cards, student loans, or medical bills) are unsecured nonpriority claims.
The statement of financial affairs is based on a series of questions that assist the trustee, creditors, and the court in administering the case. For example, the debtor must disclose any funds received by gift, wages, or windfall or any assets transferred, surrendered, repossessed, or foreclosed on in the two years before filing. The debtor also must disclose any ownership interest in a business the debtor owned within the six years before filing and any transfers the debtor made in the ordinary course of business in the two years before filing.25
Practice Tip: If you represent a creditor you should always carefully review the debtor’s schedules, because debtors do not always accurately complete these documents. If the information contained in the schedules is not accurate, notify the trustee. If you uncover an undisclosed, nonexempt asset, your creditor client may be entitled to a pro rata share of funds recovered by the trustee, or the debtor’s ability to discharge the client’s debt may be in jeopardy. In addition, if you can show a Chapter 13 trustee that the debtor has undisclosed income, the client may be entitled to higher payments than those proposed in the plan, or the case may even be dismissed.
Property of the Estate
In a bankruptcy proceeding, virtually all the assets owned by the debtor on the filing date immediately become the property of the bankruptcy estate.26 Upon the filing, those assets are legally within the trustee’s control in a Chapter 7 bankruptcy until the assets are properly exempted or the trustee either liquidates or abandons them. The trustee may abandon an asset either formally or by failing to administer the asset before the case is closed.
In a Chapter 13 bankruptcy, property of the estate also includes virtually any property acquired after filing but before the case is closed, including, most importantly, the debtors’ income.27 However, once a plan is confirmed (that is, approved by the court), all the interest in the property of the estate is vested in the debtor unless the plan or order states otherwise.28
Practice Tip: Because the debtor’s property is property of the estate, attorneys should always verify that neither party involved in a real estate transaction has filed a bankruptcy. If you are an estate planning attorney, ask your client if any of his or her children are financially unstable, and if so, counsel the client that any property interest given to a child may be subject to creditors’ claims if the child needs to file a bankruptcy. Additionally, your client needs to understand that inheritances, bequests, and life insurance and death benefit plan proceeds that a debtor is entitled to receive within 180 days of filing are property of the estate.29 Many estate planning attorneys, on advice of bankruptcy counsel, alter their clients’ estate plans to provide that the financially unstable child’s share of the parents’ estate be placed into a spendthrift trust, because such trusts are not subject to creditors’ claims.30
The Automatic Stay
An automatic stay is effective immediately upon the filing of a bankruptcy petition without any other action, even against creditors who have no knowledge of the bankruptcy filing, and is applicable in both Chapter 7 and Chapter 13 bankruptcies. The stay enjoins most actions against the debtor and the debtor’s property, including collection actions.
Because there are severe penalties for violating the stay, such as fines and the award of attorney fees and damages,31 and also because bankruptcy courts usually are amenable to granting emergency motions to lift the stay,32 it often is advisable to refrain from taking action that may violate the stay.
Generally, if a debtor files more than one bankruptcy within a year, the automatic stay terminates 30 days from the second filing date, and if a third filing is commenced, the stay does not apply. However, if the refiling follows a dismissal under 11
U.S. C. § 707(b), the stay may remain in place.33
Practice Tip: The automatic stay does not apply to certain family law proceedings, such as ones concerning paternity, establishing or modifying a support order, or determining child custody or visitation schedules. Nor does the stay apply to criminal prosecutions, contempt matters, and certain eviction actions. For example, if a landlord client obtained an eviction judgment for a debtor tenant before the bankruptcy was filed, the automatic stay does not apply, and the client may continue with the eviction despite the bankruptcy filing.34
A Typical Chapter 7 Bankruptcy Scenario
Facts: A husband and wife (the debtors) had a gross household income last year of $70,000, but the wife just lost her job. In addition to their household goods and furniture valued at approximately $4,000, the debtors own a home valued at $120,000, two vehicles each valued at $3,500, and a flat-bottom fishing boat worth approximately $750. Their savings account contains $2,000, which they would like to retain for emergencies. The couple have $45,000 in credit card debt, $3,600 in medical bills, $3,000 in student loans, a $3,000 car loan, a $1,500 car loan, and a $90,000 mortgage.
They are consulting with an attorney because although they are current on all their obligations, they do not have the income going forward to keep making the payments on all their debts as a result of the wife losing her job. They don’t know what to do and need some advice. They believe that if they did not have to pay the credit card debts, they could meet all their other financial obligations. They are considering filing for bankruptcy, but they are afraid that they could lose their house or vehicles in the process.
Analysis: The debtors are eligible to file a Chapter 7 bankruptcy because the median income for a household of four in Wisconsin is $76,188. The debtors are up to date on all their secured debt and should be able to retain their home and vehicles by reaffirming those debts so long as they can make their current payments going forward. If the debtors file for bankruptcy, using either state or federal exemptions, they will be able to retain all their assets. When they receive a discharge, the debtors will no longer be obligated to pay the $45,000 of credit card debt and $3,600 of medical bills. They will have to continue to make payments on their student loans, which are nondischargeable, and on loans for any of the secured assets they choose to retain.
The Meeting of Creditors
The meeting of creditors, also known as the “section 341 meeting,” is held not less than 20 and not more than 60 days after the bankruptcy is filed.35 The time, date, and place of the meeting can be found on the notice of meeting of creditors, which the court mails to all interested parties shortly after the petition is filed. The trustee presides at this meeting and questions the debtor about the schedules and the debtor’s financial dealings.36 This is not a formal court proceeding – the trustee cannot rule on objections nor can pleadings be filed or motions made – but creditors may appear and question the debtor. However, time is limited, and so the questioning must be brief. If extensive questioning is deemed necessary, the creditor or any interested party may move for a “2004 exam,” so called after the Bankruptcy Rule governing the examination. This allows any interested party to question any entity relative to the debtor’s financial situation, administration of the debtor’s estate, or the debtor’s right to a discharge.37
Practice Tip: Whether creditor’s counsel should attend the meeting depends on the circumstances of the creditor’s claim. Typically it is unnecessary to attend, but occasionally the lawyer should. For example, if the creditor has a lien on collateral, the lawyer may wish to question the debtor about its condition and location and whether it is insured or perhaps make arrangements for its surrender, if that is the debtor’s intention.
PACER Access and Electronic Filing
Because the filing of a bankruptcy can affect virtually any nonbankruptcy matter, all attorneys should sign up for PACER, the Public Access to Court Electronic Records, “an electronic public access service that allows users to obtain case and docket information from federal appellate, district and bankruptcy courts”38 PACER allows attorneys to search for bankruptcy filings, view dockets, and download pleadings from anywhere Internet access is available.
Electronic filing allows attorneys to file documents at any time of day or night. In the Eastern District of Wisconsin, an attorney must be registered for electronic filing to file any document with the court unless a waiver of the requirement is obtained.39 Paper filing is still allowed in the Western District.
Differences between the Eastern District and the Western District
Bankruptcy is a creation of and is governed by federal law. Thus, there should be no difference in filing any type of bankruptcy case in one federal district or another. However, there are sometimes significant differences, even between the two Wisconsin districts. For example, the local rules of the Western District of Wisconsin differ greatly from those of the Eastern District. There are far fewer rules in the Western District than in the Eastern District. Moreover, each judge in the Eastern District also has a set of published procedures.40 A crucial difference between the districts is the time within which to object to a plan in a Chapter 13. In the Western District, the deadline is “prior to the conclusion of the Meeting of Creditors,” while in the Eastern District, it is “no later than ten days after the completion of the Meeting of Creditors.”41 There are even some differences between the judges on substantive legal issues. Additionally, each Chapter 7 and Chapter 13 trustee has his or her own set of documents required of parties. Furthermore, there are variations in how trustees handle similar matters such as an acceptable amount for settlement of a preference claim. It is important to be aware of these differences and keep them in mind when practicing in both districts.
Many individuals in financial trouble wish to take action to protect assets from creditors, such as conveying assets to relatives before filing bankruptcy. Although a certain amount of pre-bankruptcy planning is allowed, a debtor’s bankruptcy can be dismissed42 or a debtor can be denied a discharge43 or even convicted of a crime44 if planning is not done correctly.
Practice Tip: If you represent a financially stressed debtor, do not be tempted by your client to engage in pre-bankruptcy planning, unless you are schooled in the art.
This concludes the introduction to bankruptcy concepts. Next month the discussion will continue with specific aspects of bankruptcy law that will be of interest to attorneys from a variety of practice areas. The discussion will focus on topics such as how domestic-support obligations are handled in a bankruptcy, how attorney fees arising from nonbankruptcy matters can be paid from the bankruptcy estate, and how to identify and handle nondischargeable debts.
1In re Catholic Archdiocese of Milwaukee, 11-20059, U.S. Bankruptcy Court, Eastern District of Wisconsin (Milwaukee).
2Ronald Mann, Columbia Law School, National Bankruptcy Research Center 2010 Year-End Bankruptcy Filings Report, available at www.nbkrc.com/Premium/NBKRC_Report_January_2011.pdf.
3U.S. Bankruptcy Court Eastern District of Wisconsin, Office of the Clerk, Bankruptcy Filings Comparisons Year to Date, available at www.wieb.uscourts.gov/index.php/court-info/stats.
4United States Bankruptcy Court Western District of Wisconsin, Statistics by Month, available at www.wiwb.uscourts.gov/stats_month.htm.
5United States Bankruptcy Court Eastern District of Wisconsin, Office of the Clerk, Bankruptcy Filings Comparisons Year to Date, available at www.wieb.uscourts.gov/index.php/court-info/stats; Western District of Wisconsin Bankruptcy Statistics by Chapter, available at www.wiwb.uscourts.gov/stats_chapter.htm.
6Available at http://legal-dictionary.thefreedictionary.com/Wage+Earner’s+Plan.
711 U.S.C. § 701.
811 U.S.C. § 704.
911 U.S.C. § 547.
1011 U.S.C. § 548.
1111 U.S.C. § 507.
12United States Trustee Program Annual Report of Significant Accomplishments Fiscal Year 2009, available at www.justice.gov/ust/eo/
13See generally 11 U.S.C. §§ 523, 727.
1411 U.S.C. § 524(a)(2).
15See generally 11 U.S.C. § 1322.
1611 U.S.C. § 109(b).
17See Official Bankruptcy Forms 22A, 22C.
1811 U.S.C. § 722(b).
1911 U.S.C. § 109(e).
20See Official Bankruptcy Form 1.
21See Official Bankruptcy Forms 6A-6J.
22See Official Bankruptcy Form 7.
2311 U.S.C. § 506.
2411 U.S.C. § 507.
25See Official Bankruptcy Form 7.
2611 U.S.C. § 541.
2711 U.S.C. § 1306.
2811 U.S.C. § 1327.
2911 U.S.C. § 541(a)(5).
3011 U.S.C. § 541(c)(2).
3111 U.S.C. § 362(k)(1).
32In re Strumpf, 516 U.S. 16 (1995).
3311 U.S.C. § 362(c)(3), (4).
3411 U.S.C. § 362.
35See Fed. R. Bankr. Proc. 2003.
3611 U.S.C. § 341.
37See Fed. R. Bankr. Proc. 2004.
38Available at www.pacer.gov/.
39See Local Rule 5005, E.D. Wisconsin Bankruptcy Court.
40Available at www.wieb.uscourts.gov/index.php/orders-rules.
41For the U.S. Bankruptcy Court for the Western District of Wisconsin, see Official Bankruptcy Form 9I; for the U.S. Bankruptcy Court for the Eastern District of Wisconsin, see Form B9I (Chapter 13 Case) (1/10).
4211 U.S.C. §§ 707(b), 1330.
43See generally 11 U.S.C. §§ 727, 523, 1328.
4418 U.S.C. § 157.