Bankruptcy laws can help individual debtors in two different ways: (1) by liquidating their property to pay creditors and discharging any remaining amounts due, or (2) by letting debtors keep their property and putting them on a repayment plan to make up past due amounts in installments over time. The first way describes a Chapter 7 bankruptcy; the second describes a Chapter 13 bankruptcy.
Chapter 13, classified as a reorganization bankruptcy, is designed for debtors who've been experiencing financial difficulties, and (1) have regular, disposable income, (2) want to keep their homes and personal property (e.g., cars, boats), and (3) want to suffer less damage to their credit than they would under Chapter 7. Chapter 13 is sometimes referred to as wage earners bankruptcy, but the debtor's income doesn't necessarily have to come from wages as long as it's steady.
Tip: Persons who are self-employed or operating an unincorporated business can file under Chapter 13, but not in the business' name (though business debts can be included in the petition). Chapter 11 is a similar form of reorganization bankruptcy tailored to corporations, partnerships, and sole proprietors (Chapter 13 is sometimes referred to a mini Chapter 11). Chapter 12 is a specialized form of reorganization bankruptcy for family farmers and family commercial fishing operations.
Generally, any individual (other than a stockbroker or commodity broker) can file under Chapter 13 as long as the debtor's unsecured debts (such as credit card debt) are less than $419,275 and secured debts (such as mortgages and car loans) are less than $1,257,850 (figures are effective as of April 1, 2019 and are indexed annually for inflation every three years). Chapter 13 relief is denied to debtors who have received a discharge under Chapters 7, 11, or 12 during the preceding four-year period or under Chapter 13 in the preceding two-year period, and debtors must have met with a qualified credit counselor in the 180-day period prior to filing.
Tip: A debtor who does not qualify for relief under Chapter 13 can file under Chapter 11 for reorganization protection.
Pre-Petition Credit Counseling
Debtors are required to obtain a briefing from an accredited credit counselor within the 180-day period (which may be extended for cause) preceding the bankruptcy filing. The briefing can be telephonic or over the Internet, and may be waived under certain circumstances. The requirement does not apply to debtors who are: (1) disabled, (2) incapacitated, or (3) on active military duty in a war zone. Debtors must file a certificate and a copy of the repayment plan, if any, from the counselor with their petitions.
Filing the Petition
A Chapter 13 case typically begins when a debtor files a petition along with several other documents (lists of assets, debts, and creditors) with the bankruptcy court. A Chapter 13 case can also begin when a Chapter 7 case is converted, or by a creditors' petition (but this is very rare). Upon filing, a trustee is appointed to administer the case, and an automatic stay goes into effect.
Debtors must file a number of documents including "pay stubs" for the previous 60 days, an itemized list of monthly income and expenses, and a statement disclosing increases in income and expenses that are anticipated within the next 12 months. If the debtor fails to file all of the required documents within 45 days of the petition filing date, the court is generally required to dismiss the case.
Further, the debtor must provide a copy of his or her most recent tax return to the trustee (and any creditors who request one) within a specified period of time. Again, if the debtor fails to do so, the court is generally required to dismiss the case. Also, upon the request of the court or any interested party, the debtor must file copies of their tax returns for the three years prior to the most recent tax return.
The Automatic Stay
The automatic stay stops further collection efforts by creditors including wage garnishments, foreclosure and other lien enforcements, utility disconnections, dunning letters, and telephone calls demanding payment. The stay, however, does not stop collections of domestic support obligations, bank account freezes, and certain other matters. Additionally, residential landlords are generally able to continue eviction proceedings, the IRS can apply refunds to pre-petition tax debts, and, if the debtor fails to make timely payments to secured creditors under a Chapter 13 reorganization plan, the creditors can collect the collateral. Creditors are also able to petition the court to lift the stay under certain circumstances.
The Reorganization Plan
After filing the petition, the debtor must file a reorganization plan with the court within 14 days of the filing date. The plan must spell out how the debtor will repay his or her debts within a three-year period or, if the court approves, a five-year period. If the debtor's average monthly income (over the previous six months) multiplied by 12 is less than the applicable state's median income, the repayment commitment period is three years; if it's greater, the repayment period must be five years.
Debts are divided into secured (backed by collateral) debts and unsecured (e.g., credit card bills, doctor bills) debts. Unsecured debts are further divided into priority debts and non-priority debts. All secured debt arrearages and unsecured priority debts must be paid in full under the plan. Unsecured non-priority debts are paid to the extent of the debtor's "disposable income." The unpaid portion of the unsecured debt will be discharged (with certain exceptions, discussed further below) at the end of the reorganization plan period as long as the plan is completed successfully.
Caution: Unsecured non-priority debts must be paid at least as much as they would have been under a Chapter 7 bankruptcy. To make this determination, the debtor's property is divided into exempt and non-exempt under Chapter 7 rules.
Secured Debt Cram Down
Debtors who owe more than the current fair market value of the collateral have two choices. They can turn the property over to the creditor who can then sell it and satisfy the debt with the proceeds; any amount remaining due becomes unsecured debt. Or, the debtor can keep the property and reduce the secured debt to the current fair market value of the collateral. This is referred to as a "cram down" or "strip down." The excess debt is converted to unsecured debt.
Debtors, however, cannot cram down debts secured by (1) motor vehicles if the debt was incurred within 910 days of filing, or (2) other personal property if the debt was incurred within one year of filing.
The debtor must use all disposable income to pay creditors under the plan. Generally, disposable income is the amount of income remaining after the debtor has paid reasonable expenses. If the debtor's expenses include luxury items, the debtor may be forced to liquidate them unless the plan provides for full payment of all debts, including unsecured non-priority debts. Disposable income excludes:
- Payments made to repay loans from certain employer-sponsored retirement plans
- Social Security payments
- Charitable contributions not to exceed 15 percent of the debtor's gross income
- Domestic support obligations
- Amounts needed to support the debtor and debtor's dependents
- Amounts needed to operate, continue, or preserve the debtor's business
The Section 341 Meeting of Creditors
Within a specified time period, no later than 60 days after filing, a meeting, referred to as the Section 341 meeting, is held at the court. The debtor must attend, and the creditors can attend but typically only do so if the creditor has questions about the debtor's financial affairs or the proposed plan. The trustee also attends, but judges are prohibited. Unsecured creditors are then generally given 90 days to file claims (governmental units have 180 days). A second meeting, called a confirmation hearing, is held with a judge in attendance, who will confirm the debtor's reorganization plan if it is feasible and meets certain standards.
Creditors have 25 days to object to the confirmation. If the plan is not confirmed, the debtor can modify the plan or convert the case to Chapter 7. Once the plan is confirmed, it is binding on the debtor and all creditors. The debtor must make regular payments to the trustee, who distributes them to the creditors. The first payment is due no later than 30 days after the bankruptcy petition filing date even if the reorganization plan has not yet been confirmed.
The confirmation hearing must take place not less than 20 days or more than 45 days after the Section 341 creditors meeting. Further, the debtor must be current on all domestic support obligations, and all tax returns must be filed before a debtor's reorganization plan can be confirmed.
Discharge of Debts
The debts excepted from discharge in Chapter 13 cases are the same as those debts listed under Chapter 7, except for the following, which are still dischargeable under Chapter 13:
- Debts for willful and malicious injury (intentional torts)
- Debts incurred to pay non-dischargeable tax obligations
- Debts arising from property settlements in divorce or separation proceedings
Discharges will also be conditioned on the debtor's completion of an instructional course concerning personal financial management.
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