Understanding the 'Keep and Pay' Bankruptcy Strategy

“Keep and Pay” refers to a type of bankruptcyBankruptcyBankruptcy is the legal status of a human or a non-human entity (a firm or a government agency) that is unable to repay its outstanding debts strategy that a person can still keep certain assets after filing for bankruptcy, as long as he/she continues to pay for the assets. The rules of keep and pay vary in different states.

Summary

• Keep and pay is a bankruptcy strategy that allows a person to keep certain assets after filing for bankruptcy, as long as he/she continues to make the payments.
• Depending on the existing state or federal laws, people filing for bankruptcy can retain certain properties, known as exemptions, and the rest of their properties – the non-exempts, will be liquidated to pay their creditors.
• Individuals can file a keep-and-pay statement with payment plans to the bankruptcy court to express their intentions to keep certain assets.

Understanding Keep and Pay

An individual can file for bankruptcy when he/she is not able to repay their outstanding debts. The legal proceeding will relieve the individual from their dischargeable debts, but there is still an opportunity for creditors to recover some of their loan value. The assets will be evaluated and liquidated to repay the creditors.

Typically, individuals with limited assets can file for Chapter 7 bankruptcy in the U.S. It allows the individual filing for bankruptcy to retain certain types of assets, such as personal items and clothes, household furniture, essential work tools, and certain farm properties. Such assets are known as exempt assets.

In contrast to exempt assets, non-exempt assets must be liquidated to repay creditors. Stocks and bondsBondsBonds are fixed-income securities that are issued by corporations and governments to raise capital. The bond issuer borrows capital from the bondholder and makes fixed payments to them at a fixed (or variable) interest rate for a specified period., collections with high values, and second homes are some of the examples of non-exempt assets.

If an individual would like to keep certain assets, they can file keep-and-pay statements to show their intention. They usually need to provide plans about paying for the assets in the future. Such assets will also be considered exemptions that can be retained in bankruptcy, and the court will liquidate all the other non-exempts to pay creditors.

For example, an individual filed Chapter 7 bankruptcy while owing $50,000 in his second apartment. As a non-exempt, the apartment should be liquidated to pay back his creditors. However, if the individual would like to retain this apartment, he can file a keep-and-pay statement to the bankruptcy court to express his intention. As long as he can meet the scheduled repayments for the $50,000 outstanding debt going forward, he will be able to keep this apartment.

Rules of Keep and Pay

The rules of keep and pay – and other bankruptcy exemptions – vary between different states. Some states, such as California, implement both the state rules and federal rules. Typically, individuals filing for bankruptcy need to comply with the rules set by the states that they live in.

The bankruptcy rules usually set limits for the category and value of exemptions. The federal law allows exemptions that sum up to $13,400 in household furniture and personal items, such as clothes and books. Additionally, there is also a limit of $625 for each item.

Thus, in the example above, if the individual filing for bankruptcy is subject to the federal rules, his second apartment is neither within the exemption category nor within the value limit. The property is not automatically exempt from bankruptcy liquidation, so the keep-and-pay strategy needs to be adopted for the individual to keep it.

Benefits of Keep and Pay

Through keep and pay, people filing for bankruptcy can prevent certain assets from liquidationNet Asset LiquidationNet asset liquidation or net asset dissolution is the process by which a business sells off its assets and ceases operations thereafter. Net assets are the excess value of a firm’s assets over its liabilities. However, the revenue generated by the sale of the net assets in the market might be different from their recorded book value.. Besides the debtors, the strategy also benefits creditors. If creditors think that they will still be able to receive repayments from their bankrupt debtors, they are usually open to keep and pay.

One of the reasons is that it takes time and effort to evaluate and liquidate the assets. Also, this type of illiquid asset, and under time constraints can only be sold at a discount.

In the same example above, if the bankrupted person does not file a keep-and-pay statement for his apartment, the bank will need to resell this apartment for repayments. Since the apartment is an illiquid asset, it costs time and money for the bank to sell it.

The selling price might be even lower than the $50,000 amount outstanding. Thus, it can be favorable to creditors if debtors take the keep-and-pay strategy and continue to make the payments.

Related Readings

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To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

• Chapter 11 BankruptcyChapter 11 BankruptcyChapter 11 is a legal process that involves reorganization of a debtor’s debts and assets. It is available to individuals, partnerships, corporations
• Debtor in Possession (DIP)Debtor in Possession (DIP)Debtor in Possession (DIP) is a form of financing that is provided to companies that have filed for Chapter 11 bankruptcy.
• Personal FinancePersonal FinancePersonal finance is the process of planning and managing personal financial activities such as income generation, spending, saving, investing, and protection. The process of managing one’s personal finances can be summarized in a budget or financial plan.
• US Bankruptcy CodeUS Bankruptcy CodeThe US Bankruptcy Code is also referred to as Title 11 of the United States Code, and it governs the procedure that businesses and individuals follow