By Walter Metzen
It may be counter-intuitive to think that having more debt is better for a Chapter 7 or Chapter 13 bankruptcy proceeding.
However, in the case of an automobile lien, this is actually true—within reason.
Owning a vehicle free and clear is a righteous path to responsible financial management in that ideal area outside of the bankruptcy process known as “real life.”
So long as said vehicle is not nickel-and-diming you to death with constantly needed repairs and maintenance, there is no better way to save several hundred dollars per month than avoiding a car payment.
Why is that, in some cases, different within a Chapter 7 or Chapter 13 bankruptcy process?
This article will discuss a few of the reasons why below.
Bear in mind that you should never purchase or refinance a vehicle prior to the filing of a bankruptcy case within consulting a highly experienced bankruptcy attorney first!
No portion of this article is intended as legal advice, and the provision of this information is for general educational and legal advertising purposes only.
Asset Protection in Chapter 7 and Lower Plan Payments in Chapter 13
The value of your assets plays a significant role in both Chapter 7 and Chapter 13 bankruptcy.
Chapter 7 Bankruptcy
In Chapter 7, known as a “liquidation” bankruptcy, assets that are worth more than can be “exempted,” or removed, from the legal Bankruptcy Estate created upon filing of the case, are seized and liquidated for the benefit of your creditors by the Chapter 7 Trustee assigned to the case.
Assets in Chapter 7 are exempted by applying to each and every item of property you own or to which you have a claim an “exemption,” which is an allowance provided by statute, either in the US Bankruptcy Code or in a list codified under Michigan state law.
There are different exemptions for different types of property, with dollar-value caps that vary from property type to property type.
In particular, there is a specific automobile exemption for your vehicle. If your vehicle has more equity in it than the exemption allows for, it will be seized and sold off in a Chapter 7 bankruptcy.
Thus, unless your vehicle carries a very low value, it is not useful to own a vehicle free and clear in Chapter 7 bankruptcy.
Chapter 13 Bankruptcy
In Chapter 13 bankruptcy, no property is ever seized and liquidated.
However, the same exercise of listing all of your assets and applying the available exemptions to their value must still be undertaken.
In Chapter 13 bankruptcy, otherwise known as a “reorganization” bankruptcy, you spend 3-5 years repaying as much debt as your household income will allow through a Bankruptcy Court-enforced and supervised “Chapter 13 Payment Plan.”
You pay nothing to your creditors directly (with exceptions). Instead, in Chapter 13, you send a monthly payment equivalent to your “net” monthly household average income (what’s left over from your take-home pay after all necessary monthly household expenses are deducted) to a Chapter 13 Trustee.
The Chapter 13 Trustee does not seize property. Instead, she takes your monthly Plan payment and disburses it out to your creditors in a priority order dependent upon the types of debt involved.
Unsecured debt such as credit cards, medical debt, state court money judgments, back rent, and others are paid last, after all higher priority creditors are paid.
Unsecured creditors only receive whatever is left over after all other creditors (including your bankruptcy lawyer) paid. Anything they are still owed “on paper” after that is then totally discharged at the end of the Chapter 13 process.
There is generally no minimum amount that unsecured creditors must receive.
However, if you have property is that non-exempt as discussed above, that dollar-value of the non-exempt portion does constitute a minimum amount that your pool of unsecured creditors must receive.
For example, if you own a car worth $15,000 free and clear and, between the automobile exemption and some available “wildcard” exemption, you are able to exempt only $10,000 of its value, you will need make a monthly Plan payment high to engineer that result that, after high priority creditors are paid, there is still $5,000 remaining from your Chapter 3 Plan payments for the Trustee to disburse to unsecured creditors.
This is known as the “Best Interest of Creditors Rule,” or “the Liquidation Analysis.”
In other words, your Plan payment will be higher because you own that car free and clear than it might have needed to be otherwise.
Further, given that, in Chapter 13, your Plan payment is equivalent to your net, monthly, after-expense income, it doesn’t make a ton of sense to overly reduce expenses to the point of senselessness.
Eliminating a $300/month car payment prior to filing Chapter 13 simply means that you will have to send $300 more per month to the Chapter 13 Trustee.
Car Liens and the Chapter 7 and Chapter 13 Means Test
It is well known that the bankruptcy process requires completion of a form entitled “the Means Test” which determines whether or not a person is income-eligible for Chapter 7 Bankruptcy.
This Means Test also, however, must completed in a Chapter 13 Bankruptcy, for different reasons.
First, briefly, what is it?
The Means Test is essentially a mathematical formula that calculates your gross (pre-deduction) household income for the 6-month period of time prior to the filing of the bankruptcy case.
The income of every wage earner in the household—regardless of whether they are jointly filing the bankruptcy or not—is included.
That 6 months’ worth of income is averaged by the Means Test and, then, that average amount is multiplied by 12 (months) to calculate what the Means Test thinks is your total annual household income.
That income amount is then compared to the average income for a household of your size in the state in which you reside.
If your household Means Test income is over that average, you may not be eligible for Chapter 7 Bankruptcy.
In Chapter 13, if you are over that average, it means that you must file a 5-year rather than 3-year Chapter 13 Plan—and it also means that your unsecured creditors may, again, be required to receive a certain minimum amount of money (see below).
Before either of these things is determined, however, the Means Test allows the application of a variety of income deductions.
Listing them all is beyond the scope of this Article, but one of them is the averaged amount of vehicle payments you will make pursuant to a car loan over the 60 months following the filing of the bankruptcy case.
Owning a vehicle free and clear means that you lose this deduction entirely and will be able to apply only a modest “vehicle operating expense” deduction.
As to Chapter 13 and unsecured creditors, the Chapter 13 version of the Means Test will, after application of all available deductions, compute a further number called “Disposable Monthly Income,” or “DMI.”
The Bankruptcy Code requires that unsecured creditors in Chapter 13 receive no less than DMI multiplied by the number of months in the Plan.
Thus, if you have a DMI of $100.00 and are in a 60-month Plan, your unsecured creditors must receive (as a pool) at least $6,000.
This will require that your Plan payment is, again, high enough to pay all higher priority creditors first and to then leave at least $6,000 available for distribution to your unsecured creditors.
Having no car payment and no related Means Test deduction does you no favors in Chapter 13 bankruptcy.
It simply means that your DMI is going to be higher and your Plan more expensive.
Chapter 13 Survivability and Post-Chapter 7 Filing Transportation Needs
The US Supreme Court has ruled that, while “pre-bankruptcy planning” between a bankruptcy lawyer and a prospective bankruptcy debtor is acceptable, it also ruled that none of the above reasons for having a car lien in bankruptcy are, alone, acceptable “pre-bankruptcy planning.”
What is, then?
The legitimate need for reliable and safe transportation is a basis for such discussion between a bankruptcy lawyer and a client.
It is a fact that public transportation in the Metro Detroit area is sorely lacking in every conceivable way.
Although many do rely on DTA for daily transportation, Detroit and its surrounding areas simply do not provide for practical public transportation in the way that other cities like New York City and Chicago and Washington, DC, do.
Further, nothing in the US Bankruptcy Code requires that, simply because someone files for Chapter 7 or Chapter 13 bankruptcy, they must be reduced to utilizing public transportation exclusively.
It is also a fact that, after you file for bankruptcy, it is very difficult to obtain a vehicle loan at any reasonable interest rate (or, sometimes, at all, at least in the short-term).
Thus, if you are driving a nickel-and-diming clunker that is likely to die a bad death at any moment, the question of whether you ought to buy a new car prior to filing is a very legitimate and very common conversation to have with a bankruptcy attorney at an initial consultation.
You need a car after you file, period.
In a Chapter 13 Bankruptcy, further, you may be in the bankruptcy process for up to 5 years. While in Chapter 13, you cannot borrow or take on new debt without prior permission of the Bankruptcy Court.
Filing the required motion to obtain that permission will cost you in terms of your attorney’s fees, which, in turn, increase the cost of your Chapter 13 process as they nearly always paid through the Chapter 13 Plan.
Further, your Plan payment is premised upon your average monthly expenses at the time that you file. Adding a new car payment in later will require the entire Plan to be modified, even if the new car loan is approved.
Thus, it makes all the sense in the world to ensure that you have reliable transportation that will last you throughout your entire Chapter 13 process—if you have the luxury of that level of pre-filing planning (if facing foreclosure or other action, you may not).
What Not to Do If Considering A New Car Lien Prior to Bankruptcy
This is an easy sub-topic … What not to do?
The answer: don’t do anything at all without retaining an experienced bankruptcy attorney to guide your potential new vehicle purchase first.
It’s that simple.
What will seem like a reasonable vehicle purchase to you, a layperson, will be highly objectionable to a Chapter 13 Trustee or, worse, the US Trustee’s Office.
The US Trustee is the division of the Department of Justice tasked with rooting out fraud in the bankruptcy process.
Whether or not you have engaged in fraud or whether or not your case was filed “in bad faith” is not a conversation you want to be having when you all you wanted was relief from overwhelming financial hardship.
Car Liens in Bankruptcy: The Bottom Line
The bottom line with regard to car liens in bankruptcy is that they are legally useful and practically necessary.
However, engaging in “self-help” and taking action without the proper legal guidance will not only complicate your Chapter 7 or Chapter 13 process, it will also potentially land you in hot water.
Attorney Walter Metzen is a Board Certified Bankruptcy Expert who has represented thousands of Metro Detroit Chapter 7 and Chapter 13 clients for over 25 years.
Contact us now to schedule your free initial consultation.