Bankruptcy

Don't Assume You Can File Chapter 7 and "Start Over"

By Jonathan

Over the past few days, I have received several calls and emails from potential clients who comprise a very different profile from my traditional client base.  These folks are solidly middle class to upper middle class families, often earning $100,000+ and living in $400,000 houses.   Here is an example of the type of correspondence I have been getting and my response thereto:

Jonathan:  I desperately need your advice.  I work in sales at XYZ company and last year I earned more than $200,000.  I am married with 2 kids.  This year I'm on track to earn about $120,000.  My house is worth $425,000, but the first and second mortgage combined equal to about $435,000.  I am also financing a Mercedes - the monthly payment is $725 per month and the payoff is $37,500.  I also have $35,000 in credit card debt.  I am not behind on anything and I have borrowed twice against my 401(k) to keep afloat.  My wife and I have made the decision that we are prepared to give up the house and the car and move into an apartment.  I would like to file Chapter 7 and walk away from everything - when can I schedule an appointment? –Fred

Here is my response: Dear Fred - unfortunately I don't think you can file a Chapter 7.  Under the bankruptcy law, you cannot qualify to file a Chapter 7 unless your income falls below a certain threshhold called the "median income."   As part of my analysis, I will compare your household income with the median household income for a family of 4 in Georgia (currently $68,908.00).  As your household income exceeds the median by over $50,000, a median income evaluation in your case would create something called a "presumption of abuse."  This presumption is rebuttable in theory, but as a practical matter, I think is unlikely that you would be able to squeeze into a Chapter 7.

Instead, the "means test" of personal bankruptcy would dictate that you would have to file a Chapter 13 repayment plan.  Assuming that you did give up your house and your expensive vehicle, the bankruptcy trustee would expect you to downsize your lifestyle substantially in a Chapter 13 - at least to the point where you would have sufficient disposable income to pay back all of your creditors in full in a Chapter 13 case that will last 3 to 5 years.

Given that you are in sales, you also run the risk of committing to a Chapter 13 that provides for a payment based on current income.  Chapter 13 is not a flexible vehicle so you should not go into a Chapter 13 expecting that your plan payment would change if your commission income goes down.

So, for folks like Fred, the alternatives are - maintain your lifestyle and struggle to keep your head above water until you find a way to earn more money, or walk away from the expensive big ticket items, reduce your lifestyle, and commit every penny of disposable income to a 3 to 5 year payment plan.

Full post as published by The BK Blawg on October 11, 2008 (boomark / email).