We have before us a Mr. John Poor, a man whose troubles may resemble those of a client you will see later today or next week. He may, in fact, remind you of someone you know. For Mr. Poor is nothing more or less than a typical, down-and-out debtor fresh out of good luck as were the 1.6 million Americans who filed for bankruptcy in 2003.
Mr. Poor is poor but hardly alone; the number of consumer filings in 1995 was roughly half the 2003 sum, according to the American Bankruptcy Institute. As personal filings have become increasingly common, any lawyer serving families and individuals should have some familiarity with what people like Mr. Poor can expect to lose and keep in a standard bankruptcy proceeding.
As we have discussed in previous columns, at the heart of the U.S. Bankruptcy Code is the belief that debtors deserve a "fresh start". With that in mind, let's examine the basic particulars of this hypothetical case. Our Mr. Poor is a construction worker recently hit by a drunk driver. His motorcycle survived, but his noggin was fractured. He missed two months of work and lost $5000 in wages before being laid off.
The filing of his bankruptcy petition creates an estate that includes just about all property the debtor has a legal claim to (from bank savings to sofas to diamond rings to real estate). In a Chapter 7 case, these sundry items are to be sold by the court-appointed trustee, who will use the proceeds to pay off creditors. Yet the Bankruptcy Code allows a debtor to "exempt" some property from such action, thus protecting people like Mr. Poor from literally losing their shirts.
Like all debtors, Mr. Poor is required to fill out a series of schedules. Filed under oath, these schedules itemize all assets and include both personal property, such as clothing and cars, and real property, such as houses and land. They demand that the debtor list current market value for each item.
In so filing, Mr. Poor states that his household goods and furniture have a total market value of $1000; his clothes have a total market value of $500; his motorcycle, which he owns free and clear, has a market value of $400; and his construction tools have a market value of $2500.
He also lists his checking account with a $100 balance, a 401(k) plan with total contributions of $100,000, and a lawsuit against the drunk driver in which Mr. Poor seeks $5000 for lost wages and $10,000 for pain and suffering. Finally, Mr. Poor lists a parcel of land that he owns free and clear in Austin, Texas. According to a recent appraisal, the land is worth $10,000. Mr. Poor rents, but does not own, the house in which he lives.
How much of the above-mentioned assets will Mr. Poor be able to keep? This will depend on the state where Mr. Poor lives, as the Bankruptcy Code allows states to dictate the exemption of a domiciliary of that State. For Maryland residents, we apply the Maryland exemption scheme.
The first commonly asserted Maryland exemption, referred to by some practitioners as the Household Exemption, allows a debtor to exempt $1000 worth of household furnishings, goods, clothes, appliances, books, animals kept as pets and other household items. Mr. Poor, who estimated all his household goods and furniture to be worth $1000, can take the full Household Exemption. He will have to rely on other exemptions to keep his remaining assets.
A second commonly asserted Maryland exemption is the Property Exemption, which allows a debtor to shield $5000 in real or personal property. Mr. Poor can apply this exemption towards his clothes ($500), his motorcycle ($400), and his checking account ($100). This leaves Mr. Poor with $4000 remaining of his Property Exemption. He may apply this amount to other assets, provided that those assets are either real or personal property.
That brings us to the Wildcard Exemption, which allows a debtor to protect $6000 in cash or property of any kind. Using this exemption plus the remaining $4000 of his Property Exemption, Mr. Poor can fully protect the $10,000 lot he owns in Austin. (That fact that Mr. Poor's lot is located in Texas does not prevent him from doing this.)
Note that, with the exception of the Wildcard, exemptions are restricted to certain types of assets. Mr. Poor can exempt his clothes under the Household Exemption, but not his motorcycle, which falls under a different category.
That said, debtors are allowed much flexibility in how they use exemptions. A single exemption may be applied to two or more assets, allowing Mr. Poor to rely on the Property Exemption to protect his clothes, motorcycle, and checking account balance. Similarly, two or more exemptions may apply to a single asset. Mr. Poor can use both his Wildcard and Property Exemptions to fully exempt his Texas land. Deciding how to assert the exemptions is a simple question of maximizing protection for the assets on the table, so to speak.
So far so good for Mr. Poor, but what about his tools, nest egg, and the legal claim against the drunk driver?
Fortunately for him, there exists an exemption, conveniently referred to as the Tools Exemption, that allows debtors to protect $5000 in clothes, books, tools, instruments or appliances if they are reasonably necessary for the practice of the debtor's trade. It can be fairly said that Mr. Poor's tools are reasonably necessary for his work as a construction worker, so he can fully exempt them.
As for Mr. Poor's 401(k) plan, there exists an exemption that allows debtors to exempt their interest in a retirement plan qualified under, among other sections, § 401(a) of the U.S. Internal Revenue Code of 1986. There is no dollar limit to this exemption, but it is limited to the tax-deductible portion of the contribution. Here, Mr. Poor will be able to keep his 401(k) plan to the extent that his contributions into it were tax deductible.
Damages resulting from Mr. Poor's lawsuit will be protected in part by an exemption allowing debtors to shield money payable in the event of accident and/or injury. Like the exemption for Mr. Poor's 401(k) plan, this exemption has no dollar limit. However, it does not apply to claims for lost wages. Thus, Mr. Poor would be able to protect his $10,000 claim against the drunk driver, but not the $5000 claim.
In sum, Mr. Poor will be able exempt all of his assets except for this lost wage claim. If and when Mr. Poor recovers it, the trustee may take this $5000 and distribute it among the creditors. Thus, our hapless construction worker will indeed be granted a financial "fresh start".
The scenario is not so rosy for corporate debtors. A business cannot exempt property in a bankruptcy proceeding regardless of whether the debtor filed a Chapter 7 or Chapter 11 petition. In our next article, we will discuss some of the thorny issues involved in corporate Chapter 11 cases.