Crucial Question: How Can I Use an Unprotected “Non-Exempt” Asset to My Benefit Even Under Chapter 7 “Straight Bankruptcy”?
Give your asset to the Chapter 7 trustee to pay a very special creditor. Either because you don’t need that asset or it’s your best option.
In our last blog post we discussed two ways that you can keep something you own in a Chapter 7 “straight bankruptcy” case that is not protected by a property exemption: 1) by paying off your trustee or, 2) by letting the trustee abandon the asset either because it is worth too little to bother with it, or because it is too costly or too risky to liquidate.
Today we’ll cover a third way such assets could be handled, by surrendering them to the trustee so the proceeds can be used to pay a debt that you would have to pay on your own anyway.
Why Surrender What You Own to the Chapter 7 Trustee?
A lot of effort is often put into—including in this immediate series of blog posts—keeping the bankruptcy trustee’s mitts off everything you own. So why would you sometimes give up something to the trustee?
You may be willing to just surrender assets for two logical reasons.
First, you may simply not need or want the asset any more. For example, if you’ve closed down a failed business you may have some remaining business equipment, tools, or inventory from that business that you simply no longer have any use for. Or you may own a boat that you used to enjoy but now can’t any more for health reasons, or you’ve accepted the fact that you just can’t afford the costs of operating it.
Second, you may prefer to keep the unprotected asset(s), but among all the alternatives surrendering it to the Chapter 7 trustee could be by far your best option. It just may not be worthwhile to pay the Chapter 7 trustee either a lump sum or a year or so of monthly payments for the privilege of keeping the asset. You simply may not have the money or paying it may just be too much of a sacrifice. Or you may sensibly decide it not worth going through the substantial extra time, expense, and risk of a Chapter 13 case just to be able to keep the asset.(See our next blog post for more about this option.)
So for either of these reasons, or a combination of both, you could understandably decide that it would be best to give the asset to the trustee for liquidation.
Surrendering with a Bonus
Giving an asset to the trustee becomes much more attractive if you can get a debt that you want paid anyway to be paid in full or in part when the Chapter 7 trustee liquidates your surrendered asset and pays much of the proceeds towards that debt.
How can you make the trustee pay the money from his or her sale of your asset to the debt you want to be paid? You don’t make the trustee do this; the law does.
The law does not treat all debts the same in a Chapter 7 trustee distribution. So because the debts that the law greatly favors for payment often happen to be the ones that you have to pay anyway out of your own pocket after the bankruptcy is finished, you may well be able to get a debt or two like this paid in part or in full.
And besides, the debts favored in the law may even be ones that you would want to be paid anyway.
What Are the Favored Debts that Would Be Paid First by the Chapter 7 Trustee?
Putting aside secured debts—those with collateral—unsecured debts come in two categories: “general unsecured” and “priority.” Priority debts are paid IN FULL before any “general unsecured” debts are paid anything. In addition, among the various categories of priority debts, they are all paid in a prescribed order, again with the higher priority debts being paid IN FULL before the next lower priority ones receive anything.
The priority debts include, most importantly in the individual consumer context, past due child and spousal support as the highest priority, and then further down the list, relatively recent income tax debts. These are both the kinds of debts that would not be “discharged”—legally written off—in a Chapter 7 case. So you would directly benefit if they were paid—in part or in full—by the Chapter 7 trustee out of the proceeds of whatever item(s) you are surrendering.
The Downsides—the Trustee’s Commission
The trustee is paid a commission out of the proceeds of any liquidation before paying any creditors anything. So some of the money is “wasted” on the trustee instead of going to the creditor you want to be paid.
The trustee’s commission is calculated by applying a tiered percentage formula on the total amount of dollars being administered: 25% of the first $5,000 being administered, plus 10% of any amount over $5,000 but less than $50,000, plus 5% of any amount over $50,000 and under $1,000,000, and 3% of any amount above $1,000,000. So for example, if the trustee sells your assets for $9,000, that would mean a trustee commission of $1,650—$1,250 being 25% of $5,000 + $400 being 10% of the remaining $4,000. A bankruptcy judge also has to approve the amount of trustee commission, but generally does so at least in straightforward cases.
The Downsides—the Trustee’s Discretion
The trustee will not always act the way we anticipate that he or she will.
First, he or she is an independent actor and may simply see things differently than we expect. For example, he or she may sell your asset for less than you think it’s really worth, and practically speaking you wouldn’t have much say about it.
Second, your attorney usually does not know who your assigned trustee will be. In virtually all jurisdictions there’s a “panel” of trustees, without any way to know who will be assigned to your case.
Also, you or your attorney have to take some precautions to make sure that the debt you want paid is set up to be paid—such as to monitor that its creditor files a timely “proof of claim” at the bankruptcy court.
There are clearly risks in surrendering assets to a Chapter 7 trustee with the expectation that much of the proceeds of their sale will be going to the child/spousal support obligation or income tax debt that you want to be paid. So talk to your attorney in detail about the risks and the possibilities. But if the stars align appropriately, giving up something you own to the Chapter 7 trustee would certainly feel better if its proceeds did in fact largely go towards a debt that you would want to or have to pay anyway.