Our good friend and colleague out here in Clarkston, David Shook, provides another bankruptcy-related guest blog post.

Many debtors imagine repo men descending on their homes to loot and pillage their estate seconds after the bankruptcy papers are filed in federal bankruptcy court.

While this makes for great television, the facts could not be further from the truth.  While there are cases where assets need to be sold for the benefit of creditors, there is a process to be followed, and the opportunity for hearing before a judge, prior to the sale of anything in a case.

Debtors are allowed to retain up to fixed amount of value in assets through a process of exemptions, which are written into the Bankruptcy Code.  Exemptions allow for the first dollars of any asset to remain in the debtors possession throughout the bankruptcy process.  If for some reason the Chapter 7 Trustee should choose to sell an asset for the benefit of the creditors (which is very rare) the Debtor would receive the exemption amount from the sale proceeds, prior to creditors seeing a dime.

Keep in mind the system focuses on the debtor’s value in the property, not the value of the asset.  I receive many a creditor phone call to inform me that “Bob” filed bankruptcy, but got to keep his Corvette, ski boat, etc.   If the Corvette is worth $25,000 but subject to a creditor lien of $23,000, Bob has only $2,000 in equity in the car.  Given The Code, allows the debtor an exemption of up to $3,450 in an automobile, there is no benefit to creditors in selling the car.  Thus the bankruptcy Trustee has no interest in the selling the Corvette, if “Bob” continues to pay the creditor on his car loan, he may retain it after bankruptcy.

On the other hand if the Corvette does not have a creditor lien, or the lien is small enough to warrant the sale of the asset, the exemption must be paid to the debtor from the sale proceeds.  In our example the Corvette is worth $25,000, but the creditor lien is only $5,000.   Here the Trustee might very well sell the car, pay off the creditor lien, and all expenses of sale, and retain $18,000.   The Trustee must give the Debtor the exempt amount from the sale proceeds.

While $3,450 might not sound like a good deal, depending on the amount of debt this may be a great deal.  In effect the debtor has traded the Corvette for $3,400 in cash and wiping clean all creditor claims.

If upon review, it is determined a debtor may have assets that cannot normally be retained in bankruptcy, Chapter 13 of the Bankruptcy Code may very well help.  One of the benefits of Chapter 13, which focuses on the repayment of debts over a 3 to 5 year period, is a debtor is allowed to “buy back” assets from the estate. 

In this example the Debtor is allowed to pay creditors the value of the Corvette ($25,000), less the lien and exemption ($5000 + $3,400 = $8,400) over the life of the plan.  Again depending on the amount of debt involved, paying $16,400 over a 36 to 60 month period may very well be a great deal.

So what can you keep in a bankruptcy?  One of the few clear benefits for the debtor in the 2005 bankruptcy reforms relates to retirement accounts. 

The vast majority of tax deferred retirement accounts, IRA’s, 401(k), 403(b), etc., are exempt from the bankruptcy estate.  While the probations against transfers discuss in my last post apply, and it is not advisable to move a $10,000 CD into a IRA on the eve of bankruptcy, normal contributions are exempt regardless of the balance in the account.  A debtor, who puts 6% of his gross pay into a 401(k) or contributes the maximum deductible amount to his IRA each year, has an unlimited exemption in the account.  As I tell clients, the difference between your case, and a case with $100,000 in an IRA, is the money you have after bankruptcy.

I have seen several cases over the years where the Debtor has hundreds of thousands of dollars in an IRA or 401(k).  In one example the Debtor had close to two million dollars in his IRA’s.  All of these funds where retained free of claims by creditors or the Trustee.

For all of the energy invested in wealth retention, the best protection is also the simplest.  Everyone with a paycheck should have some type of retirement account, and deposit as much as possible into the account, up to the deposit limit’s set by the IRS.

Great advice Dave.  Any of our readers with questions are encouraged to contact Mr. Shook for answers.

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