Chapter 13 is a repayment bankruptcy. It is most useful when consumer debtors have enough income to meet their basic needs and a little bit more, but have fallen behind in their regular mortgage or car payments. It is also useful for people who have significant tax debt which can be paid over time without interest or further penalties. If house values fall below the amount owed on the first mortgage, Chapter 13 can be used to remove (strip off) a second mortgage (such as a HELOC). The Chapter 13 plan governs how payments are made by the debtor and how that money is paid out to the creditors. Chapter 13 is a powerful tool in the bankruptcy attorneys' toolboxes and, with new laws pending to help struggling homeowners, Chapter 13 may become even more important.
Here are the basic rules for a personal Chapter 13 Bankruptcy:
- Debtor(s) make payments of their projected disposable income for three to five years;
- Debtor(s) generally keep all of their property; and
- When the payments are done, all of their debt (except mortgages) is eliminated and/or paid. Chapter 13 is generally called the wage earner plan, but it is also available to anyone who has a “regular” source of money such as government support, gifts from a family member, business, or any other source.
Chapter 13 cases are frequently used by debtors to “refinance automobiles”, bring mortgages current, remove or “strip” junior liens, and keep property that would be lost in Chapter 7. The 2005 changes in bankruptcy law were intended to force some debtors to use Chapter 13 instead of Chapter 7.
Chapter 13 has eligibility rules. First, only people can file Chapter 13. Corporations, partnerships, and other business entities are not eligible. Someone who works as a sole proprietor, however, is eligible to file. Second, you can't have too much debt. The limit of non-contingent, liquidated debt is $2,750,000. That would include, secured loans, credit cards, medical bills, legal bills, and called guarantees of business debt or other types of loans. If a claim against you for a contested debt has been decided by a judgment, it would be included.
Like all bankruptcies now, individual debtors must complete credit counseling before they file the case. There are exceptions for military personnel, those who are disabled, and those who only speak unusual languages. A person can not eliminate their debts in Chapter 13 if they filed a Chapter 7, 11, or 12 within the last 4 years or a Chapter 13 within the last 2 years.
Rule No. 1: Payment of Projected Disposable Income for Three to Five Years.
Chapter 13 is a repayment bankruptcy where debtors use their best efforts to repay debt. Debtors propose, and the Court must approve a Chapter 13 Plan. Payments are made according to the Plan to the Chapter 13 Trustee who then sends the funds to the creditors based upon the Plan. The Chapter 13 Trustee holds the First Meeting of Creditors where the Trustee obtains information used to evaluate whether or not the Trustee will object to the plan. If the Trustee objects to the plan the the Court decides if the Plan meets the criteria of a confirmable plan.
Plans typically last between 3 and 5 years. Several factors determine the length of a plan. In Chapter 13, just as in Chapter 7, a means test is performed, if a debtor would not be allowed to file a Chapter 7, then the Chapter 13 Plan must last for 5 years (or until all of the debt can be repaid if that would take less time). The means test was designed to determine if debtor(s) can afford to make significant repayments of their debt. A Chapter 13 debtor must pay to their unsecured creditors at least as much as those creditors would have received if a Chapter 7 had been filed. This can require a plan to last longer than 3 years. Finally, depending on the budget of the debtors and the type of debt that is being paid in Chapter 13, debtors may need more than 3 years to meet their goal of keeping their home or paying taxes or other priority debt.
Unless the Chapter 13 Plan pays all debt in full, the monthly Plan payment amount is generally determined by the “projected disposable income” of the debtors. “Disposable income” is income (other than child support payments received by the debtor) less amounts reasonably necessary for the maintenance or support of the debtor or dependents and less charitable contributions up to 15% of the debtor's gross income. If the debtor operates a business, the definition of disposable income excludes those amounts that are necessary for ordinary operating expenses. Usually, disposable income is based upon income for the six months just before filing, but this is not always the case if the debtors can show that their prior income is not what they can reasonably expect over the term of the Plan. (Examples may include bonuses, loss of a job, divorce, or death of a breadwinner). Expenses are usually determined using IRS standards with some deviations if debtors can prove excess necessary expenses.
The Chapter 13 Plan is proposed by debtors. It is reviewed by the Chapter 13 Trustee and must ultimately be approved by the Bankruptcy Judge. Chapter 13 Plans divide debts into 3 categories: priority debts such as taxes, secured debts such as car loans or home mortgages, and unsecured debts. Priority debts must be paid in full over the life of the Plan. Unsecured debts must be paid at least as much as they would have received in Chapter 7.
Rule No. 2: Keeping the property.
Chapter 13 debtors usually keep all of their property. This is because that property is either exempt or because debtors are essentially buying it back by making their Plan payments. Sometimes it makes sense to sell property in a Chapter 13 Plan so that property can be sold at a fair price, rather than a fire sale or foreclosure. The proceeds are then used to pay creditors.
What makes Chapter 13 powerful is how debtors can deal with secured debt. Most secured debt (except debts secured by the debtor's residence) can be reduced to the value of the property securing the debt and then paid back with interest over the length of the Chapter 13 plan. (If new proposed laws are passed, this same rule will even apply to home mortgages and distressed homeowners will be able to reduce their mortgages to the value of the property and then make payments over 30 or even 40 years). If a home value has dropped below the amount of the first lien or mortgage, then any junior liens (such as HELOCs) can be removed, or “stripped” from the property. Debtors can make regular payments on their home directly and make up delinquent payments over the length of the Chapter 13 plan using the Plan payments. Debtors who want to return cars, furniture, jewelry, or other property that act as loan collateral can do so and treat any remaining balance due as an unsecured debt. Sometimes Plans provide for the sale of property with the equity going into the Plan. Experienced bankruptcy attorneys, such as those in the Law Offices of Patrick M. Hunter can propose creative affordable Chapter 13 plans to fit most debtors that qualify to file a Chapter 13.
Rule No. 3: Elimination of the Debt.
Many, but not all debts are eliminated or paid in a Chapter 13 bankruptcy. This problem was made worse by the 2005 changes to the Bankruptcy Law. One of the biggest problems with Chapter 13 cases are non-dischargeable debts which have the same priority as regular unsecured debts. Under the law, these debts cannot be treated differently from other unsecured debts and may remain partially unpaid after the Chapter 13 case is over. While the Chapter 13 case is still going on, debtors are protected from collection efforts, but once the Plan is completed and the case is over, these non-dischargeable debts can be a problem again Here are some of the debts that fall into this category: (1) student loans; (2) debts related to divorce or separation which are NOT for support; (3) debts related to death or personal injury caused by drunk driving; (4) criminal fines or restitution payments; and (5) debts caused by intentional injuries.
Just like a Chapter 7, before obtaining a Chapter 13 discharge, the debtors must complete an approved course in financial management. There must also be a finding that the debtor is current in any child or spousal support payments and that there is no pending litigation that might impair a homestead exemption.