Chapter 13 Bankruptcy

A chapter 13 bankruptcy is also known as a debt repayment plan. While a chapter 7 bankruptcy wipes out debt, the debtor who files a chapter 13 bankruptcy makes payments to a bankruptcy trustee over a period of three to five years. During that time, the debtor catches up on payment of the debtor’s secured debt and pays as much of the debtor’s unsecured debt as the debtor can afford.

When the plan is completed successfully, all unsecured debts are discharged.

Eligibility for a Chapter 13 Bankruptcy

You cannot file any bankruptcy, including a chapter 13 bankruptcy, until you have received credit counseling that is provided by an approved agency. Your bankruptcy attorney can help you choose a credit counseling agency that will not pressure you into purchasing their debt negotiation services or other services that you do not need.

Because a chapter 13 bankruptcy requires a debtor to make regular plan payments, the debtor must have a regular source of income to qualify for a chapter 13 bankruptcy. After monthly expenses (including mortgage payments and other monthly payments on secured loans) are subtracted from monthly income, there must be enough left over to permit the debtor to make payments required by the chapter 13 plan. Chapter 13 payments are generally paid by means of a payroll deduction.

Reasons for Choosing a Chapter 13 Bankruptcy

Some people are not eligible to file a chapter 7 (debt liquidation) bankruptcy. If their income relative to their expenses is large enough to permit them to make monthly payments to their creditors (as determined by a “means test”), the only bankruptcy option available to those debtors is a chapter 13 repayment plan.

Even debtors who are eligible to file a chapter 7 bankruptcy might want to choose a chapter 13 repayment plan. The benefits of a chapter 13 plan include:

  • Repayment of nondischargeable debts. Some kinds of debt (including student loans, child support arrearages, and most taxes) generally cannot be discharged in a chapter 7 bankruptcy. Chapter 13 allow you to repay those debts over a period of years.
  • Avoiding foreclosure or repossession. If you fall behind on your mortgage payments or car loan and are facing foreclosure or repossession, a chapter 7 bankruptcy might not help you keep your house or car. A chapter 13 plan can put collection efforts on hold to give you a chance to make up missing payments and keep your house or vehicle.
  • Protecting co-borrowers. If someone co-signed a loan that you discharge under chapter 7, your co-debtor can usually be held responsible for the balance of the loan. Including the debt in a chapter 13 plan can prevent the creditor from pursuing your cosigner for repayment of the loan.
  • Repaying debts that are important to you. Sometimes debtors don’t want to wipe out their debt. They like to know that they have made their best effort to pay their debts, particularly if they owe money to friends, family members, or businesses with which they want to maintain a good relationship.

Payment of Debts in a Chapter 13 Plan

Some debts must be paid in full during the life of your chapter 13 plan. These include:

  • Arrearages in child support and alimony.
  • Most tax debts.
  • Wages owed to employees.
  • Delinquent mortgage payments. As long as any mortgage payments you missed are paid in full through your chapter 13 plan, and you are able to make all of your current mortgage payments when they come due, you avoid mortgage foreclosure and can keep your house.
  • Delinquent payments on car loans and other secured loans. If you are behind on payments on a car loan, you can catch up on those payments during the life of your chapter 13 plan. If you pay the delinquency in full and continue to make your current loan payments, you avoid repossession of your car. The same is true for any other property you purchased with a loan if you gave the lender a lien on that property.
  • Certain administrative expenses of the chapter 13 plan.

Unsecured creditors (and secured creditors if you don’t want to keep the property that secures the debt) do not need to be paid in full. Most credit card debt is unsecured. The amount you pay your unsecured creditors depends on the amount of your plan payment and the length of the plan. Sometimes unsecured creditors are paid nothing and sometimes they are paid in full. Usually they are paid a percentage of the amount you owe them. The percentage depends upon on the plan you propose.

Proposing a Chapter 13 Plan

When you propose a chapter 13 plan, you determine your monthly income after payroll taxes are deducted (i.e., your take-home pay). Then you prepare a budget that takes into account your rent or mortgage payment, your car payment and other payments on secured debt, and the amount you will spend on food, transportation, clothing, and other necessary expenses. The difference between your monthly income and your monthly budget is the payment you will make in your chapter 13 plan.

The trustee will review your budget and will not recommend approval of your plan unless the budget appears to be reasonable. The plan must reflect your “best effort” to repay as much of your debt as you can afford.

If the average income you earned over the six months prior to filing your chapter 13 petition was greater than the median income for your family size in your state, your chapter 13 plan must last for five years. If your average income was less than the median, you can propose a shorter plan, but no shorter than three years. The plan must last long enough for you to pay the debts listed above that must be paid in full, so even if your income allows you to have a three year plan, you might need to propose a longer plan.

Court Proceedings in a Chapter 13 Bankruptcy

Your attorney will help you prepare your chapter 13 petition. The petition will consist of several forms that disclose your income and assets, itemize your debts, and identify the names and addresses of your creditors and any collection agencies or attorneys working to collect your debts on behalf of your creditors. The petition also proposes your chapter 13 plan. When it is complete, you sign the petition and swear that its contents are true.

After you file your petition in court, several things happen:

  • Entry of automatic stay. As soon as the petition is accepted for filing, an automatic stay goes into effect. The Bankruptcy Court mails notice of the stay to each creditor you listed in your petition. The stay prevents your creditors from making further efforts to collect the debt from you unless they can persuade the court to lift the stay.
  • Debtor education course. Before you make your first plan payment, you must attend a debtor education class. The class teaches you how to live within a budget and how to manage debt responsibly.
  • First meeting of creditors. A few weeks after you file the petition, you and your attorney will attend a meeting with the bankruptcy trustee appointed to your case. The trustee will ask you some questions about your petition to verify that it is accurate and complete. Your creditors are entitled to attend the meeting and to question you, although they rarely do so unless they suspect that you are hiding assets or committing some other form of fraud. Typically, your participation in a First Meeting of Creditors will last only a few minutes.
  • Review claims of creditors. Your creditors must file a claim with the court if they want to get paid. If you object to the amount of the claim or dispute the debt, you can file an objection that the trustee or the Bankruptcy Judge will resolve.
  • Confirmation hearing. Some Bankruptcy Judges hold a confirmation hearing in every chapter 13 case and require the debtor to attend. Assuming the trustee has recommended approval of your plan, the hearing is a formality. Some judges require only the debtor’s attorney to attend, and some judges do not hold the hearing unless an objection to confirmation has been filed.
  • Adversary hearings. Although they are rare, an adversary hearing can be held in some circumstances, particularly if the trustee or a creditor thinks you have committed fraud or violated a court order. An adversary hearing can also be held if you propose to “strip the liens” on your house. In a chapter 13 bankruptcy, if you owe a second mortgage or have additional liens on your house other than your primary mortgage, and if the value of your house is less than the balance due on your primary mortgage, you may be able to have all the liens other than your primary mortgage treated as unsecured debts.
  • Complete your plan. Make your required plan payments every month. At the end of your plan, you will receive a discharge of all unsecured debts that were not paid in full. You will then be able to enjoy your fresh start, free from the burden of unmanageable debt.