What Are Bankruptcy Exemptions?
Exemptions play an enormously important role in all chapters of bankruptcy. But think of exemptions as rooted in Chapter 7 bankruptcy because the concept of exemptions has everything to do with liquidation. The basic bargain in Chapter 7 bankruptcy goes like this. The debtor proves to the Bankruptcy Court that he or she cannot afford to make payments on existing debts while still meeting certain necessary monthly living expenses. Provided that is true Chapter 7 will discharge, or permanently forgive, most types of the debtor’s unsecured debts.
But if the debtor has assets and possessions with values greater than what state law arbitrarily considers necessary, then in Chapter 7, the debtor loses those assets to a trustee who can liquidate (seize and sell) them to distribute whatever money the trustee can get (after paying himself of course) to the debtor’s creditors. The Chapter 7 trustee is not the debtor’s friend.
Chapter 7 offers a bargain to the debtor that says something like this: “Since you can’t afford to make any monthly payments on your debts and still maintain a reasonable living standard, those debts will be discharged … however … if you have stuff you could sell worth more than the law lets you keep, then the trustee is going to take that stuff and sell it for you to pay something toward your debt.”
Bankruptcy Exemptions Are All About Liquidation
Back to exemptions. Exemptions are the values of assets a Chapter 7 debtor can claim as exempt from liquidation by a Chapter 7 trustee. They fall into categories to protect some value in a home, a car, retirement savings, personal belongings, and so forth. In California we have a “wildcard” exemption for miscellaneous personal property. These values are left for state law to set, so they vary from state to state. If a debtor’s assets exceed the exemptions available to protect those assets, then the debtor in Chapter 7 will suffer the indignity of having some of her assets seized and liquidated by a Chapter 7 trustee. Chapter 7 bankruptcy offers powerful debt relief—potentially wiping out all of one’s unsecured debts—but if you own assets, you should consider Chapter 13.
Neither Chapter 13 bankruptcy or Chapter 11 bankruptcy pose the risk of liquidation (unless they are converted to a Chapter 7!). I often describe Chapter 13 to my clients as the safer, saner, more civilized bankruptcy. Chapter 13 offers a different bargain: since the debtor is going to commit to paying some portion of his debts, there will be no liquidation of any of his assets. The Chapter 13 trustee’s role is entirely different from that of the Chapter 7 trustee. In Chapter 13, the trustee administers the debtor’s payment plan, collects monthly payments and distributes the debtor’s payments to creditors pursuant to a confirmed Chapter 13 plan. She is not out to take the debtor’s possessions. As I said, the whole thing is more civilized if you have assets.
Why Are Bankruptcy Exemptions Important in Chapter 13?
Bankruptcy exemptions are all about liquidation of assets, right? And I said there is no liquidation of a debtor’s assets in Chapter 13 or 11? So, what gives?
In all chapters of bankruptcy, the concept that if a debtor could pay her debts by selling off her stuff, then she ought to at least pay whatever amount she could get doing so to her creditors. This is called the “liquidation analysis.” Or alternatively in Chapter 13, the “best interest of the creditors test”—a term I never use.
For a Chapter 13 plan (ditto Chapter 11) to be confirmed by the Court, the Plan must propose to pay to the unsecured creditors at least as much as the debtor could have gotten by voluntarily liquidating her non-exempt assets. In other words, the excess value of her assets, or the amount by which the value of her assets exceeds the applicable state exemptions. Some Chapter 13 plans call for payment to unsecured creditors based on the liquidation value of non-exempt assets. Other Chapter 13 plans are driven not by assets, but by disposable income. Either way, the greater of these two values: liquidation of non-exempt assets or projected disposable monthly income determine how much the unsecured creditors must be paid in a Chapter 13 bankruptcy. Often this amounts to very little. Sometimes, the unsecured creditors don’t have to be paid anything at all in a Chapter 13 plan, and those debts will be discharged entirely at the completion of the Plan.
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