Chapter 13 Bankruptcy
Understanding Chapter 13 of the U.S. Bankruptcy Code
Chapter 13 of the United States Bankruptcy Code is titled "Adjustment of debts of an individual with regular income." Therefore, under Chapter 13 of the bankruptcy code, relief is available only to individuals or families. This relief is not available to corporations, LLCs, or other legal entities. A bankruptcy petition filed under Chapter 13 of the bankruptcy code must include a plan to repay some or all of the debtor's debts. Generally, the plan duration cannot be less than three years and it cannot be more than five years. Usually, whatever debts are not paid off in the bankruptcy plan are "wiped out" or "discharged" at the end of the plan.
Common Uses of Chapter 13 Process
Debtors typically use the Chapter 13 process for one or more of the following reasons:
Repayment of Mortgage Delinquencies
Debtors who have fallen behind on their home mortgage can use the chapter process to "catch up" or "cure" their mortgage delinquency. In most cases, the mortgage delinquency is paid off over three to five years at zero percent interest. The debtors make their regular mortgage payment within 30 days of filing a Chapter 13 petition. They also make a monthly payment to the bankruptcy trustee. The trustee will use the funds to "cure" the mortgage delinquency.
Typically, the monthly payment to the trustee will have to be at least enough to pay off the entire mortgage delinquency, plus trustee fees and the balance of attorney fees in five years. This amount is paid in equal monthly payments, but sometimes, the payments start at a lower amount and are "stepped up" during the life of the plan.
For example, if the Debtors have $10,000 in mortgage delinquency, an attorney fees balance of $2,000, and estimated trustee fees of $1,000, their monthly payment to the trustee will have to be at least $217. The payments, however, may be more if they are "high-income" individuals or if certain other criteria are triggered. In some instances, debtors use the Chapter 13 process in conjunction with the mortgage modification process.
Repayment of Income Taxes
Certain taxes are not discharged in bankruptcy. In many cases, debtors use the Chapter 13 process to pay these taxes in an organized, manageable manner over five years. Typically, the taxes are paid off at zero percent or very low interest.
Repayment of Back-Due Child Support
Child support delinquencies are not discharged in bankruptcy. Debtors can use the Chapter 13 process to pay their back-due child support.
Eliminating Second (or Third) Mortgage Liens
Mortgage liens are not "wiped out" in a Chapter 7 bankruptcy. However, debtors can remove the second or third mortgage lien from their home through the Chapter 13 process if certain requirements are met.
Generally, to qualify for removal of a second or third mortgage lien, the debtors must have no equity in their house available for the second or third mortgage. For example, if debtors own a house with a first mortgage of $130,000 and a fair market value of $120,000, they can remove any second or third mortgage liens. Likewise, if debtors own a house with a first mortgage of $130,000 and a property tax lien, they can remove any second or third mortgage liens if the home value is less than $130,000.
Please note that the lien removal is not finalized until the debtors complete their Chapter 13 plan. This generally means that the debtors must remain in bankruptcy for three to five years. After completing the plan, the unpaid debt balance on the second or third mortgage debt is discharged.
Repayment of Vehicle Loans
Debtors can use the Chapter 13 process to pay off vehicle loans. For example, debtors can use the Chapter 13 process to stretch their car payments over five years to obtain lower monthly payments. Often, debtors have car loan balances that exceed the car's retail value. In some circumstances, these debtors can use the Chapter 13 process to reduce the principal on their car loan to the car's retail value. When a debtor uses the Chapter 13 plan to reduce the principal on a car loan, the unpaid debt balance on the car loan is discharged at the end.
Protecting Assets from Liquidation
In a Chapter 7 bankruptcy, the bankruptcy trustee can sell the debtor's assets if they are not "exempt." Most bankruptcy debtors have little or no assets and are not worried about liquidation. Other debtors have modest assets that are protected by exemptions. For example, equity in a vehicle or qualified retirement accounts is generally exempt from liquidation up to a specific limit. Likewise, equity in a primary residence is protected by the "homestead exemption" up to a certain limit. Other legal exemptions can protect debtors' tools of the trade, personal jewelry, household furnishings, personal injury awards, and many other assets. Even cash, bank accounts, and stocks can be protected up to a certain limit!
For many consumers, these exemptions are enough to protect their assets in a Chapter 7 liquidation fully. But some consumers have assets that exceed the available exemptions. If these consumers choose to file Chapter 7, the bankruptcy trustee will likely liquidate assets that are not protected by an exemption. These consumers can choose to file Chapter 13 instead. In Chapter 13, the consumer keeps these assets but must make monthly payments to the bankruptcy trustee. In this circumstance, the consumer must propose a Chapter 13 plan that pays their unsecured creditors at least as much as the creditors would have received if the consumer's assets were liquidated in bankruptcy.
Continuing a Small Business Operation
In a Chapter 7 bankruptcy, continuing a small business operation can be difficult. The bankruptcy trustee may liquidate the business inventory, sell the business lease, or sell the business receivables. If the business has liability exposure, the trustee may order the business to shut down during the Chapter 7 bankruptcy. Debtors operating a small business often find that Chapter 7 is not a good option. Debtors who own a small business can use the Chapter 13 process to continue operating their business. If the business has a lease (for example, on an office, factory, or equipment), the debtor can ask the court to allow them to keep the lease. Alternatively, if the lease is not economically feasible, the debtors can reject it and walk away from their obligation.
Obtaining Bankruptcy Relief for High-Income Individuals
Certain high-income individuals cannot qualify for bankruptcy relief under Chapter 7. Under certain circumstances, these debtors can obtain bankruptcy relief under Chapter 13. If they satisfy the other requirements of qualifying for Chapter 13, these debtors can obtain bankruptcy relief under Chapter 13. Under the requirements of Chapter 13, they will have to pay their "disposable income" for five years to the bankruptcy trustee. The trustee uses these funds to pay creditors according to the Chapter 13 plan. Generally, the unpaid balances on the debts are wiped out at the end of the Chapter 13 plan.
Qualifying for Chapter 13 bankruptcy
Not every debtor qualifies for Chapter 13.
The list below is a partial list of requirements for qualifying for Chapter 13 relief:
- The debtor must be an individual. As discussed above, Chapter 13 relief is unavailable to corporations, LLCs, partnerships, or other entities.
- The debtor must have a regular income. Because a Chapter 13 plan requires monthly payments to the trustee, debtors must show that they have a regular income source and can afford their monthly payments. Fortunately, the courts tend to be generous and routinely allow creative income sources. For example, debtors can usually use unemployment benefits, disability benefits, and even anticipated family assistance as a source of income to pay for their Chapter 13 plan payments.
- The debtor must not recently have had a bankruptcy petition dismissed. An individual cannot file under Chapter 13 or any other chapter if, during the preceding 180 days, a prior bankruptcy petition was dismissed due to the debtor's willful failure to appear before the court or comply with orders of the court or was voluntarily dismissed after creditors sought relief from the bankruptcy court to recover property upon which they hold liens. 11 U.S.C. §§ 109(g), 362(d) and (e).
- The debtor must have received credit counseling. No individual may be a debtor under Chapter 13 or any chapter of the Bankruptcy Code unless they have, within 180 days before filing, received credit counseling from an approved credit counseling agency in an individual or group briefing. (11 U.S.C. §§ 109, 111) There are exceptions in emergencies or where the U.S. trustee (or bankruptcy administrator) has determined that there are insufficient approved agencies to provide the required counseling. If a debt management plan is developed during required credit counseling, it must be filed with the court.
- The debtor's debts must not exceed the legal limits. The bankruptcy code limits the debts an individual may have to qualify for Chapter 13. Specifically, the code requires that debtors or their attorneys break down debtors' debts into two categories.
For the last point, the first category, known as "secured debts," are those debts that are secured by an asset. Generally, if the debtors do not pay their obligations on these debts, the lender can recover the assets. The most typical secured debts are real estate loans and car loans. If the debtor does not pay these loans, the lender can foreclose the real estate or take away the car. Other secured debts include debts that are extended against assets such as jewelry, furniture, and other personal goods. Currently, the bankruptcy code places a limit of $1,010,650 on secured debts for debtors seeking Chapter 13 relief. This number is subject to periodic change. Furthermore, calculating this number requires some legal analysis. You should contact an attorney to help you determine whether your secured debts exceed the legal requirements.
The second category of debts, known as "unsecured debts," are all debts not secured by an asset. This includes most credit card debt, personal lines of credit, and even most taxes and child support obligations. Currently, the bankruptcy code places a limit of $336,900 on unsecured debts for debtors seeking Chapter 13 relief. This number is also subject to frequent change, and calculating the number also requires legal analysis. You should contact an attorney to help you determine whether your unsecured debts exceed the legal requirements.
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