Chapter 13 Bankruptcy Overview
A Chapter 13 bankruptcy (aka wage-earner's plan) is one of the so-called rehabilitative bankruptcies that allows the individual debtor—but not a business—with regular income to repay either all or some of his debts over a 3 or 5 year period, with the period of repayment depending on whether the debtor's income is less or greater than the median for the debtor's state.
Chapter 13 Advantages and Disadvantages
The advantage of Chapter 13 over Chapter 7 is that you can keep all of your property, including secured property, and the listing in your credit report lasts only 7 years from its commencement rather than the 10 years that a Chapter 7 is listed. Also, the automatic stay prevents creditors from taking any action against co-debtors who have not filed for bankruptcy.
The disadvantage is that it takes much longer than the 4 – 6 months from filing to discharge of a Chapter 7 bankruptcy, thus delaying the debtor's fresh start, which is 1 of the 2 main goals of bankruptcy (the other goal is the equal treatment of creditors), by several years. Since Chapter 13 takes at least 3 years to complete its payment plan, you cannot reestablish credit until after your discharge, since few creditors are going to lend to you while you are obliged to pay off your former creditors with your disposable income.
It has oft been said that a Chapter 13 is better for your credit history than a Chapter 7, since you are making at least some attempt to pay your unsecured creditors. However, understanding how credit ratings work plainly shows that a Chapter 7 would be better. Credit scores, which are most often used to assess the creditworthiness of borrowers, depends mostly on the past 2 years of your credit history, with greater weighting given to more recent transactions. So if you received a Chapter 7 discharge, you could get credit within 6 months, and have a high credit rating within 2 ½ years of your bankruptcy filing, whereas with a Chapter 13 plan, you would not even be done with your payment plan. Although a Chapter 7 stays on your credit report for 10 years after filing, it is given less and less weight as the time passes. If you demonstrate your creditworthiness after receiving your discharge, your credit score will quickly increase in spite of the Chapter 7 discharge on your record. In fact, your creditworthiness improves because most of your unsecured debt is wiped out.
However, if you have a lot of equity in your home or have other valuables, especially non-exempt property, then Chapter 13 may be the only way to keep this property. Furthermore, a few debts can be discharged in Chapter 13 that can't be discharged in Chapter 7, although the number of debts that can be discharged with this so-called super-discharge has been reduced by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).
Chapter 13 Eligibility
Only individuals can file for Chapter 13, not corporations or partnerships. A husband and wife can file jointly. Furthermore, petitioners must have taken a credit counseling course approved by the U.S. Trustee within 180 days of filing.
A debtor who wants to file under Chapter 13 must have noncontingent, liquidated, unsecured debts of less than $394,725 and noncontingent, liquidated secured debts of less than $1,184,200 as of April 1, 2016. These amounts are adjusted for inflation every 3 years. (Noncontingent simply means that the debt does not depend on a future event and liquidated means that the debt is fixed in value.)
A debtor is also prevented from filing for bankruptcy under any chapter if a prior case was dismissed because the debtor failed to attend a court hearing or failed to obey court orders, or because the debtor dismissed his own case because lienholders were petitioning the court to lift the automatic stay for their collateral.
Because Chapter 13 involves the petitioner paying his unsecured creditors over 3 or 5 years, he must have regular and sufficient income to make such payments. If his income is insufficient or erratic, then he will be unable to use Chapter 13, and will, instead, have to file for Chapter 7. A means test is used to determine Chapter 13 eligibility. Only if the petitioner passes the means test will he be able to file for Chapter 13. The means test determines if the petitioner will be able to pay his unsecured creditors at least the present value of what they would have received in Chapter 7 liquidation. If so, then he can file under Chapter 13.
How Chapter 13 Works
A Chapter 13 bankruptcy begins with the filing of the petition and paying the court a $239 case filing fee and a $39 administrative fee. The fees can be paid in up to 4 installments within 120 days of the filing date.
The bankruptcy petitioner must file the bankruptcy forms that detail his assets and liabilities, income and expenditures, and a statement of his financial affairs, among other required items. He must also provide supporting documents, such as tax returns and pay stubs, if he has them. As soon as the petition is filed and stamped, the order for relief is granted, and the automatic stay is invoked. A notice is sent to each creditor listed on the creditors' matrix that is part of the bankruptcy filing.
A standing trustee administers the bankruptcy case, and receives payments from the petitioners to pay unsecured creditors.
After 20 to 50 days, but not later than 60 days, petitioners must attend a creditors meeting, where they must swear under oath that the statements in their petition are true and that any testimony provided at the creditors meeting will also be true. Creditors or the trustee may ask questions of the petitioners.
Creditors have 90 days after the creditors meeting to file a proof of claim to participate in the trustee's disbursements of the petitioner's payments; governmental units have 180 days.
Payment Plan and Confirmation Hearing
There are 3 types of claims in bankruptcy: priority claims, secured claims, and unsecured claims.
- Priority claims, such as domestic support obligations, current taxes, and bankruptcy administrative fees, must be paid in full before all other claims.
- Secured claims are for property which can be repossessed if the debt is not paid. If the debtor wants to keep secured property, then he must continue making payments and make up for any arrearages according to his payment plan. Mortgages, auto loans for vehicles purchased within 910 days of the filing, and loans acquired within 1 year of filing must be paid in full. However, for all other collateral for secured loans, only the current value of the collateral needs to be paid.
- Unsecured claims have the least protection under bankruptcy, since the debtor only has to pay a fraction of these claims, and, in some cases, these claims can be discharged without paying any portion of the claim.
A payment plan must be submitted to the court for approval within 15 days of the filing of the petition. The payments must be of fixed amounts that are paid to the trustee either biweekly or monthly, who then disburses the payments to the creditors according to the payment plan. Although the total payments to creditors can be for less than what they are owed, it must at least be equal to the present value of what they would have received under Chapter 7 liquidation and the debtor must apply all of his disposable income to the payment plan. Disposable income is what is left over after paying priority claims and what is necessary for living expenses. It also includes reasonable operating expenses if the debtor runs a business.
If the debtor's income is below the median for the state under which he is filing, then the applicable commitment period must be for 3 years over which he will pay his unsecured creditors. The payment plan can only be less than 3 years if all unsecured creditors are paid in full. If income is greater than the state median, then the applicable commitment period is 5 years.
Within 45 days of the creditors meeting, the bankruptcy judge must hold a hearing to confirm the payment plan. If there are no objections from the trustee or the creditors and the payment plan meets statutory requirements, then the plan will be approved. The most common causes for objections is that the creditors are not receiving what they would have gotten in a Chapter 7 liquidation or that the debtor is not applying the full amount of his disposable income. However, once the payment plan is confirmed, then the debtor and his creditors are bound by its terms. Furthermore, the debtor cannot obtain new loans or credit during the bankruptcy without the permission of the trustee.
If the court rejects the payment plan, the petitioner can amend the plan and re-submit it for approval. The trustee or an unsecured creditor can also submit an amended payment plan for the debtor. If the court still rejects the plan, then the debtor can move to dismiss his case, or convert to Chapter 7 for a small fee.
Payment plans can also be modified even after its confirmation. If circumstances change, if new creditors who were not listed file an objection, or if the debtor is failing to maintain payments, then the payment plan can be modified after confirmation, not only by the debtor, but even the trustee or a creditor can file an amended plan.
If the debtor fails to carry out the plan, which includes domestic support obligations and taxes that become due during the bankruptcy, then his case may be dismissed or converted to Chapter 7.
Chapter 13 Discharge
After the debtor has successfully completed the payment plan, then he will receive a discharge of all debts included in the payment plan, even if the creditors did not receive the full amount of their loan. To receive a discharge the debtor must certify that:
- all domestic support obligations that became due during the bankruptcy were paid;
- petitioner has not received a prior discharge under Chapter 13 within 2 years, or under Chapter 7, 11, or 12 within 4 years;
- and has taken a financial management course approved by the U.S. Trustee.
After this certification and if the judge has no reason to believe that there are pending proceedings that may limit the homestead exemption under 11 U.S.C. § 1328(h), a specialized section that limits the homestead exemption to $160,375 (adjusted periodically for inflation: valid until April 2019) if:
- the debtor was convicted of a felony that indicates that the present filing is abusive;
- the debtor has a debt that has arisen from some types of security violations or from willful or reckless conduct that resulted in injury or death in the preceding 5 years.
Debts that are discharged in Chapter 13 but not Chapter 7 include:
- debts incurred because of willful and malicious damage to property, but not persons;
- debts that were not dischargeable because they were incurred to pay nondischargeable taxes;
- and debts that arose from property settlements because of a divorce or separation proceeding.
Chapter 13 Hardship Discharge
If the debtor is unable to complete the payment plan as originally proposed, he may request a hardship discharge, which will only be granted if:
- circumstances beyond the debtor's control changed and prevented the debtor from completing the payment plan;
- his creditors were paid at least as much as they would have gotten in a Chapter 7 discharge; and
- no modification of the payment plan can be completed by the debtor that would make up for the changed circumstances. For instance, illness or injury may prevent the debtor from consummating his payment plan or a modification of it.
The Chapter 13 hardship discharge is more limited in scope, being equivalent to the Chapter 7 discharge. Hence, debts dischargeable under Chapter 13 but not under Chapter 7 will not be included in the hardship discharge.