A bankruptcy trustee would pay your “priority” debts ahead of other debts in an “asset case.” But what happens in a “no asset case”?
Our last blog post showed how a Chapter 7 trustee favors “priority” debts when paying any of your debts. The trustee pays priority debts in full before paying anything to your other debts. It gets the money to pay any of your debts by liquidating assets that you might own which are not protected, or “exempt.”
But the reality is that most of the time the trustee doesn’t pay ANY of your debts. That’s because most Chapter 7 cases are “no asset cases.” This means that the trustee has no assets to distribute to your creditors, since everything you own is protected from them.
So what happens to your priority debts then?
Priority Debts and Debts that Can’t Be Discharged
There’s a list of ten different kinds of priority debts in the U.S. Bankruptcy Code. (See Section 507(a)(1-10).) Many of them only apply to businesses filing bankruptcy, and of those quite a few to rather obscure businesses. (For example, one applies only to businesses that own a grain storage facility!) Only a few kinds of priority debts apply to consumer and small business bankruptcies. In our last blog post we mentioned two of them—child/spousal support and certain taxes—but there are a couple others you may encounter.
If all the assets that you own are not protected, so that the trustee is not going to take anything from you, and not going to pay any of your debts, the priority debt distinction doesn’t make any difference.
But many kinds of priority debts have a characteristic that does make a difference in every Chapter 7 case where they are found: they can’t be discharged—legally written off—in bankruptcy.
Not every priority debt is nondischargeable. We must look at each kind of priority debt one at a time to see if it can be discharged. One of your biggest concerns when considering bankruptcy is whether you have any debts that bankruptcy would not discharge and that you’d have to pay anyway.
There’s a separate list of debts that a bankruptcy does not discharge, or legally write off. Actually there’s one list that applies to Chapter 7 and another to Chapter 13. (See Section 523(a)(1-19) and Section 1328(a & b).
In the next few blog posts we go through the most important kinds of the priority debts, and see which of them can’t be discharged in bankruptcy.
Child and Spousal Support
We start today with child and spousal support. It is the priority debt of the highest priority. It is also never discharged in bankruptcy. Let’s look at how this works in practice.
“Domestic Support Obligation”
The Bankruptcy Code succinctly states that you can’t discharge a debt “for a domestic support obligation.” Section 523(a)(5). The definition of “domestic support obligation” is anything but succinct. (See the 220-word definition at Section 101(14A)!) But to keep it simple, a “domestic support obligation” is essentially a debt owed for child or spousal support.
Here’s an example how this works in a straightforward “no asset” Chapter 7 case.
A Practical Example
Assume that at the time you file bankruptcy you owe $85,000 in medical bills, personal loans, and credit cards. You’re also behind $2,700 on your $500 monthly child support payments because of a period of prior unemployment. You decide to file a Chapter 7 case because:
- Everything you own is covered by property exemptions, meaning the bankruptcy trustee can’t take anything from you.
- The $85,000 of debts would very likely all be discharged, and that would happen within about 4 months of filing.
- Assume that you qualify for Chapter 7 because your income is less than the “median family income” for your family size for your state.
- You know that you can’t discharge the $2,700 that you’re behind on in child support. But you already have made or expect to make arrangements to catch up with your ex-spouse or support enforcement.
You and your bankruptcy lawyer prepare the documents and file your Chapter 7 bankruptcy case. The trustee assigned to your case verifies that everything you own is exempt—that you have a “no asset case.” So, even though your $2,700 support debt is a priority debt, the trustee has nothing to pay it with. Instead you agree to pay an extra $150 per month in catch-up payments directly to your ex-spouse or support enforcement agency, bringing you current in 18 months. You are confident about being able to afford this after discharging all your other debts.
Your Fresh Start
Three or four months after filing your case the bankruptcy court enters an order discharging all of your debts except the child support. You have gotten a fast financial fresh start, except for the support arrearage. But you have reasonable way to catch up on that, giving you a completely fresh start 18 months later. That’s much faster than a Chapter 13 case, which can give you more protection and flexibility on the back child support but would likely take 3 to 5 years to complete.