IS CHAPTER 7 OR 13 MORE SUITABLE FOR DEBTOR WITH $50K CREDIT CARDS AND ONE COLLECTION LAWSUIT FOR $10K

Client is 48 and has just been sued for $10K by American Express. He just received the summons and complaint yesterday. He is single with one teenager dependent. He used to have a business but that has failed. He now works as a manager and earns $4K/mo. He doesn’t own a house now, but did own a house as joint tenant, which was sold about 3 years ago.  Net proceeds from sale of house were $100K. Being a joint tenant, half or $50K of the net proceeds went to him. 

At first glance, this should be a Chapter 7 where he gets a fresh start where the court wipes out the $10K lawsuit and the rest of the $40K credit cards. There is really no problem qualifying for the means test for Chapter 7 because his income for a family of 2 is below the median for California. This looks like a slam-dunk case for Chapter 7. However, there is a circumstance during the sale of the house that puts a crinkle in this otherwise clear cut Chapter 7 case. For some reason that I don’t really understand, client transferred his 50% share of the net proceeds from sale of the house to the other joint tenant. Upon close of escrow, the entire 100% of net proceeds went to the other joint tenant.

At this point of the analysis, this circumstance becomes a “transfer of asset” that occurred in the last four years. However, as client explains it, he did make the transfer to the joint tenant, but the joint tenant gave him back the $50K, which he has since used up completely for living expenses.

There could be some issue that a Chapter 7 trustee may raise because of the $50K transfer that occurred 3 years ago. Trustee might say that the $50K was a preferential transfer, which is within his powers to avoid or cancel. In other words, trustee may try to get back the $50K from the transferee joint tenant even if the $50K was actually returned to client who then used it all up for living expenses in the last 3 years.

Well, let’s just put it this way. There is a 10% chance that a Chapter 7 trustee may raise this issue but there is a 90% chance that no such issue will be raised in Chapter 7. The defense of the transferee would be that the transfer was nominal and the transferee merely held the $50K in trust for the client, the true owner of the $50K, and the transferee actually returned the $50K to client immediately. This is a pretty good defense since it’s the truth that the actual owner of the $50K was still client. It was property held in trust by the transferee for client and under bankruptcy law, property held in trust by third parties for the debtor are still considered property of the debtor. 

The problem is that it’s an issue that can be litigated by the Chapter 7 trustee. Once the adversary proceeding is filed, the transferee needs to defend himself. In this situation, the legal expenses go up because it costs money to defend against an adversary complaint.

To avoid this problem completely, a low plan payment Chapter 13 is more suitable for client. Since client’s income is below median, he will qualify for a low plan payment under Chapter 13. In Chapter 13, the $50K transfer is not a big issue because typically Chapter 13 trustee do not litigate this kind of issue. They may try to increase the plan payment to compensate for the transfer, but in this case, the fact is the $50K actually belonged to client and the money has been used up. That’s the truth. The transfer was nominal only. The transferee held the $50K in trust for client and immediately gave it back to him and he has used it all up for living expenses for the last 3 years. 

How low can the plan payment be? I estimate that client may pay $200 a month for 36 months. After paying $7K, the balance of $43K will be discharged. 

Without Chapter 13 protection, the $10K lawsuit of American Express will eventually become a wage garnishment. In this instance, American Express will garnish 25% of client’s gross income every month. That’s $1K a month. The amount is too big. Client will not be able to pay his rent. Of course, client can apply for exemption from garnishment based on the ground that he has no disposable income every month but the exemption is only good for 90 days. He has to show up in court every 90 days to show the judge that he has no money to pay. So this is very inconvenient. 

For peace of mind, the best alternative for client is Chapter 13 with low plan payment. I had one client who pays only $150 a month for $60K of credit cards. Same situation. She sold her house to her brother in law for below market, in exchange, brother in law allows her to stay in the house rent-free until she dies. In chapter 7, the trustee would try to get the property back because it was sold below market price by $100K within the last 4 years.

“AND EVERYONE WHO LIVES AND BELIEVES IN ME SHALL NEVER DIE. DO YOU BELIEVE THIS?” JOHN 11:26

Lawrence B. Yang is a graduate of Georgetown University with a Master’s Degree in Law and specializes in Bankruptcy, Business, Real Estate and Civil Litigation.  He speaks English, Mandarin and Fujian and has successfully represented thousands of clients in California, including companies overseas. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S. Fremont Ave., MAILSTOP 58 BUILDING A-1 SUITE 1125, Alhambra, CA OR at 20274 Carrey Road, Walnut, CA 91789.