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Will You Lose Your Assets If You File Bankruptcy?

As a general proposition it is a myth that the mere act of filing bankruptcy will cause the debtor to lose his/her assets. This post explains why that is typically not the case and generally, debtors will not lose assets due to bankruptcy filing.


Creditors

The bankruptcy does not cause debtors to lose their assets to a creditor (only failure to make payments to the creditor will cause this). To the contrary, and regardless of which chapter a debtor files, bankruptcy can only increase a debtor’s chances of keeping his/her assets. In a chapter 7, although a debtor cannot “cram down” a lien, a debtor will discharge his/her unsecured debts. This will free up cash to pay secured creditors holding liens against the debtor’s assets.


In addition, a chapter 7 allows a debtor to redeem personal property such as a vehicle. Under a redemption, the debtor pays the secured creditor a cash lump sum equal to the value of the vehicle. In return, the secured creditor’s lien is extinguished and the debtor owns the vehicle free and clear of such creditors lien. For example, if a debtor owes $10,000 on a used car worth $5,000, the debtor can own the car free and clear by paying the car lender $5,000. Certain lenders specialize in redemption loans that may be a source if a debtor is short on cash.


In a reorganization chapter, such as chapter 11 or 13, the debtor can modify liens securing his/her debtor by reducing the balance of the loan to the value of the collateral (except for home mortgage securing the debtor’s principal residence). Example: the debtor owns vehicle worth $10,000 that is subject to a lien securing a loan balance of $20,000 payable at 15% interest. A cram down allows the debtor to reduce the loan balance (and lien) to $10,000, as well as the interest rate to a market rate (currently approximately 5% for used car loans). Instead of paying this $10,000 up front in a cash lump sum, the debtor can continue to make payments over the remaining life of the financing agreement (thereby reducing monthly payments and substantially reducing the amount of loan repayments the debtor will ultimately pay the lender).


Also like a chapter 7, the chapter 13 debtor will likely pay a fraction of nonpriority unsecured creditors, thus also freeing up disposable income towards secured creditors.


Trustee

The other way to lose assets due to is to a bankruptcy trustee. Generally, this only happens in a chapter 7. In a reorganization chapter, the trustee does not take title to the debtor’s assets to liquidate and distribute to creditors. In a chapter 13, the trustee is not a liquidator but instead a disbursing agent for plan payments. In a chapter 11, the debtor is actually 2 things for bankruptcy purposes: 1) the debtor and 2) the “debtor in possession” (DIP). The DIP has all the powers of the chapter 7 trustee. I have never heard of a case where the DIP repossessed an asset from itself to pay unsecured creditors; it doesn’t happen.


A debtor can lose assets to the trustee as to an asset in which there is non-exempt equity beyond a secured creditor’s lien in the asset. To understand what that means you need to know the chapter 7 trustee’s role. The trustee’s job is to find non-exempt equity so that he/she can realize that equity and distribute to unsecured creditors. The trustee can’t take assets to the extent covered by a lien to distribute to unsecured creditors because the secured creditor holds the lien.


“Non-exempt” equity means just that. A debtor is entitled to exemptions in certain assets. If equity in an asset is exempt, then the trustee does not hold legal title to such equity and cannot liquidate the same.


When a debtor files in Washington state, the debtor can choose between: (1) exemptions provided by state law plus exemptions provided by federal, nonbankruptcy law; or (2) only the bankruptcy exemptions. The exemptions amounts are not the same. A debtor cannot pick some Washington state exemptions and some bankruptcy exemptions; it’s one or the other. Therefore, it is imperative that the debtor assess his/her financial scenario and choose the set of exemptions that make sense.


The bankruptcy exemptions are listed and set forth at §522(d)(1) of the Bankruptcy Code. Some include:

  • $25,150 for equity in homestead;

  • $4,000 for vehicle;

  • $1,700 for jewelry;

  • $13,400 aggregate value for household goods (clothes, appliances, etc.,);

  • $13,900 unused homestead exemption.


The Washington state bankruptcy exemptions include:

  • $125,000 for equity in homestead;

  • $3,000 wildcard exemption;

  • $3,250 vehicle exemption;

  • $6,500 household goods exemption per individual.


So in sum, only assets in which the debtor has sufficient equity i.e., equity beyond the value of the lien and the value of an applicable exemption, will the trustee be entitled to take that asset to realize the excess equity. But, if that is the case, the debtor can avoid such scenario by filing a chapter 13.


With careful planning, a debtor should not lose assets because of bankruptcy.


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