Bankruptcy Law Explained

Property and Exemptions

[You do not need to study bankruptcy laws or to review this section if you have chosen to have us prepare your bankruptcy for you.]

Index:

Bankruptcy Law Summary
Chapter 7 bankruptcy laws
Chapter 13 bankruptcy laws
Property and Exemptions
Structure of bankruptcy laws
Case administration
Types of bankruptcy
How to file bankruptcy
 

Overview

When a bankruptcy is filed, a legal fiction know as the bankruptcy estates is created and it is comprised of all the property that the debtor owned at the time of the filing of the case. The principal role of the trustee is to act as the custodian of the bankrupt estate. What this means in lay person terms is that when you file bankruptcy, legal control to everything you own at the moment of filing is transferred by law to the trustee. Except for normal daily living or the day to day operation of a business, you cannot sell or transfer ownership of any property of the bankrupt estate until the case is closed. For most cases, you will need the authorization of the trustee in order to sell your house, boat or automobile. Since selling any of these mentioned property is not a regular occurrence for most individuals this power of the trustee will have little or no effect on your freedom during the process.

From a creditor point of view, your bankruptcy is about property. The central concern of creditors is how much property or money they can recover from the debtor. Chapter 11, 12, 13 bankruptcies are concerned with keeping all or most of one's property while repaying the debts under a court approved plan. In Chapter 7, the debtor is concerned with wipe of as much of the debts as possible while retaining title to most if not all of the property. In bankruptcies that do not seek a discharge of debts, (usually, Chapters 11, 12 and 13) the debtor is able to keep whatever property that they wish to, provided that if the property is collateral for a debt, he or she is able to make the payments as prescribed by the repayment plan. Since all Chapter 7 cases seek a discharge of debts, and in the interest of fairness to both the debtor and the creditors, the law imposes limits on what assets a person can keep after bankruptcy. Only real persons are entitled to assets after a Chapter 7 bankruptcy, so the exemption laws discussed here apply only to individual filers. 

On the fairness issue, imagine for a moment that you are a small time contractor and that you have just completed a remodeling job for a homeowner. You were just informed that the homeowner has filed bankruptcy and that you were not going to get any money for your work. You would certainly consider it unfair if the court allowed the homeowner to keep $120,000 in his bank account and a $58,000 Mercedes that was paid for while wiping the $1,700 that you were owed. This fictional scenario obviates the need for laws governing what amount of property a person can keep after filing bankruptcy. Any amounts above the limits could be converted to cash and paid to the creditors. That is what exemption laws are about. Exemption laws specify limits for most categories of assets that you can keep after filing bankruptcy and it is the job of the trustee to liquidate any amounts above those limits for the benefit of the creditors. 

How to Calculate Equity

Exemptions apply to the equity that you have in property, therefore, it is important that you understand how to calculate it. In a nutshell, the equity that you have in an asset is amount that you would normally keep if you sold the asset and paid off any loans secured by the asset.

For example, if your car is valued at $15,000 and your owe $5,000 to the finance company on it, then after selling the car for $15,000 and paying off the $5,000 loan, you would be left with an equity of $10,000.

What if you own the property free and clear? In that case, your equity would simply be the value of the property.

What if you owe more on the property than its value? The equity in that case would be zero since negative equity is not a useful concept when dealing with exemptions.

What does this all mean for you? It means that in trying to protect an asset with an exemption, what you are protecting is not the value per say, but the equity. So, if you own a mansion valued at $1,000,000 and it is over mortgaged so that your equity is zero, it is automatically protected since you only need zero exemption to protect it. On the other hand, you neighbor who owns a house valued at $100,000 that is paid for, needs to find $100,000 in exemption to protect it.

When you hire us to prepare your bankruptcy we will give you access to additional information on how to use the equity principle among others, to help you keep several cars and houses even if there are no apparent exemptions to use.

Exemption Laws

Federal bankruptcy law provides for two types of exemptions, Federal exemptions and state exemptions. The law also leaves it up to each state to decide which exemption laws its residents can use, that is, state or Federal. This flexibility has major consequences for debtors because the amount of equity you can keep varies greatly from one state to the other. For most debtors, the choice between Federal and State exemptions have already been made for you by your state. Some states use Federal exemptions only, some give you the option to use either and some restrict you to the state exemptions. If you live in California, you get to choose between two sets of state exemption laws. It is these exemption laws that enable a person to file bankruptcy and lose nothing, that is, if they properly apply the exemptions to their property. This is the compelling reason why you should have your bankruptcy prepared for you by professionals rather than trying to do it yourself with forms, kits or software.

Exemption laws are broken down according to the classification of the assets. Each law prescribes the exemption limits for each type of property, for example, real estate, motor vehicles, household goods, pension plans, bank accounts, etc. The actual exemption laws are beyond the scope of this site. There are a number of excellent sources for the detailed state by state exemptions laws and they include your state's code.

The Trustee's Powers Over Property

The principal role of the trustee is to act as the custodian of the bankrupt estate. What this means in lay person terms is that when you file bankruptcy, legal control to everything you own at the moment is transferred by law to the trustee. Except for normal daily living or the day to day operation of a business, you cannot sell or transfer ownership of any property of the bankrupt estate until the case is closed.

The trustee has the power to undo any property transfer that you make prior to filing bankruptcy. While this is not common, exercise of this power is usually aimed at discouraging bankruptcy fraud or the preferential treatment of one creditor over another. If you are thinking of hiding your property by transferring ownership to a family member, do not do it. You are better off converting the property to an exempt property before filing. As an example, let us say that your state does not have an exemption laws to protect your bank account and let's say you have $2,000 in your bank account, you can convert it to an exempt property simply by using the money to purchase an item that is exempt, for example, a car.