California Bankruptcy: Chapter 7 Basics
There are two primary foreclosure-related benefits to Chapter 7: the “discharge” that wipes out your personal liability to pay debts which occurs at the end of the 4 to 5 month case, and the “automatic stay” which may freeze or postpone a foreclosure sale until the case is over or sooner, if the judge so orders.
Chapter 7 is a “liquidation” chapter that typically ends when you receive a “discharge” of your personal liability to pay debts. Not all debts are wiped out and exceptions include student loans, alimony and some income taxes. Eligibility for Chapter 7 is often driven by your last 6 months’ income. If your income is below the median in your state or if your debts are mostly from business, you are generally eligible for Chapter 7. Even if your income is higher than the median, you may still qualify for Chapter 7 if you can pass the new “means test”. The means test is a statutory maze of income and expense calculations, composed of real and IRS created standards, used to determine if you have the ability to pay back some of your unsecured debt over 5 year repayment plan. If you fail the means test, you typically have to use Chapter 11 or 13 to get any bankruptcy relief.
In addition to the means test, a liquidation test has to be satisfied unless you want to risk losing unprotected assets. In Chapter 7, a trustee serves as liquidator of unencumbered and “non-exempt” assets. In theory, the trustee can sell assets for the benefit of the creditors. In practice, however liquidation is rare. Chapter 7 Trustees do not sell properties that have no equity, such as a house that is worth less than the sum of the loan balances. Most assets are encumbered by liens or are legally “exempt” from sale, preventing the trustee from liquidating. If there is a pending foreclosure, most matters are considered to be “no asset” cases.
Assuming you receive a “discharge” before your foreclosure sale, you remain the owner of the home even after the Chapter 7. You are still free to sell it, save it or let it go to auction. Whether you keep the home or let it go to foreclosure sale, your personal liability to pay the mortgage debt and any income taxes related to that debt is legally wiped out. After the Chapter 7, the lender still has the right to foreclose and try to get paid out of the proceeds of any sale of the property, but they cannot come after you or your future earnings or assets.
Under the best case scenario, filing a Chapter 7 freezes a foreclosure sale until the case ends and a “discharge” is ordered, typically in 4 or 5 months. However, there are exceptions. If you had another bankruptcy dismissed within the last year, the automatic stay only lasts for 30 days. If you had two cases dismissed, there is no automatic stay in the third case. If your case is “dismissed”, the automatic stay is terminated and the lender is free to resume the foreclosure process where they left off.
Most lenders will attempt to have the automatic stay “lifted” before the end of a Chapter 7. They will ask the judge for permission to proceed with the foreclosure sale before the end of the case and claim that they are not being “adequately protected” (i.e. they are not receiving monthly payments during the case). Generally, the judge will not lift the automatic stay or allow the foreclosure if the borrower agrees to resume the regular mortgage payment for the remainder of the Chapter 7. If the lender has violated the Truth In Lending Act (TILA), the borrower and his or her attorney can raise this as a defense to the motion. Most importantly, a hearing on a lender’s motion for relief of stay is a great opportunity to discuss Loan Modification directly with the lender’s attorney.
It is important to know on what date a postponed foreclosure sale is re-scheduled. A Chapter 7 filing generally postpones a scheduled foreclosure sale for about a month. After that month, if the automatic stay is still in place, the lender continues to subsequently postpone the sale into the future. Whether it lasts one or five months, eventually, the automatic stay will terminate. There are special rules if the foreclosure sale date is postponed by bankruptcy; no further written notice is required to sell the property. On the original day of the foreclosure sale, the lender is only required to orally announce the new sale date. If you are out of bankruptcy on that new date, your house can be sold without further notice.
Unless a settlement or loan modification has been reached, completing a Chapter 7 case does not end the foreclosure process. However, the Chapter 7 does buy additional time to continue to pursue a loan modification, to increase your income or find a short sale buyer. Furthermore, a Chapter 7 “discharge” reduces your unsecured debt burden and improves your negotiating position with your second mortgage company. Credit card companies, auto finances and mortgage lenders can no longer sue you. Whether the property is sold at auction or short sale, you will no longer have any personal obligation to pay back your debts or any resulting income tax to the IRS.