Consumer Bankruptcy:

Chapter 13

Unlike Chapter 7, which involves a discharge of all debts, Chapter 13 bankruptcy is an interest-free repayment plan for some portion of unsecured debts, over the course of five years. Creditors generally get more of the money they are owed under Chapter 13 than Chapter 7. Because of the new bankruptcy law from October of 2005, more people are being forced to file for Chapter 13 because of a “means test,” which prevents people earning a certain amount of money from filing for Chapter 7. However, not everyone can file for Chapter 13; those with incomes that are irregular or too low may not be allowed because they cannot prove that they have the ability to make the required regular payments.

One of the fundamental benefits of Chapter 13 is that it generally allows the debtor to continue to live in his or her home as usual, provided that he or she agrees and follows the terms of the Chapter 13 arrangement. Failure to do so will result in the court proceeding according to the guidelines of Chapter 7, with liquidation. Furthermore, it gives individuals the opportunity to reschedule debts that are secured (not including the mortgage for a primary residence) and possibly lower payments by extending them over the life of the Chapter 13 repayment plan.

The significant downside of Chapter 13 is that the debtor is not immediately freed from debt and given a fresh start; debts still need to be paid and can thus significantly reduce future income.

Before filing, the debtor must enroll in and take a credit counseling course from a government approved agency. A list of approved agencies and programs can be found on the website of the Department of Justice, here. While a fee will be charged, they are required to offer a reduced rate if the debtor cannot afford to pay. Upon conclusion, the debtor must provide the court with the certificate, proving the requirement was met, along with various forms outlining income, debt, expenses, etc., his or her federal tax return from the previous year, as well as proof of filing for the previous four years. The most important thing to be filed is a Chapter 13 repayment plan, which explains how the debtor intends to pay off debts. There is no official form for this, but many courts have actually designed their own. The filing fee, currently, is $274.

The debtor must begin to follow the Chapter 13 repayment plan within 30 days of filing it. The payments are usually submitted to a bankruptcy trustee (a court representative who oversees the case), who, once the plan is approved, will make sure that the payments reach the proper creditors. In the event that the debtor has a regular job and income, the court may have monthly payments automatically deducted from wages and submitted to the court.

Required Payments

Some debts, under Chapter 13, are required to be paid in full; these “priority debts” take precedence over debts to other creditors. They include domestic support obligations (child support, alimony, etc), wages owed to employees, and tax obligations.

The repayment plan is also required to include regular payments on secured debts (car loan, mortgage, etc) and on arrearages on debts (the amount that the debtor has fallen behind on payments).

Finally, the repayment plan must indicate that any disposable income, after making these required payments, is going toward the repayment of unsecured debts, such as medical bills, credit card debt, etc. These debts do not necessarily need to be repaid in full, or even at all. The debtor is simply required to put remaining income toward the repayment of them.

The length of a debtor’s repayment plan is based upon the amount that is owed and the amount that he or she earns. In the event that his or her average monthly income for the six months preceding the bankruptcy filing is greater than the median income of the state, he or she will have to follow a five year plan. However, if his or her income is lower than the median, the plan only has to be three years. Regardless of the amount earned, if all debts are repaid, then the plan ends.

Failure to Make Payments

In the event that a debtor cannot complete a Chapter 13 repayment plan (for example, because he or she loses a job), the bankruptcy trustee may modify the plan. Possible modifications include:

  • Providing a grace period, if the failure to pay appears to be a temporary problem
  • Reduction of monthly payments
  • Extension of the repayment period

If it is clear that the debtor will not be able to complete the plan, due to circumstances beyond his or her control, the court may allow for a discharge of the debts due to hardship. Potential examples of this include serious illness or the closing of a production facility in a one-factory town.

In the event that the court does not allow a modification or discharge due to hardship, there are still options. The first is to switch to a Chapter 7 plan. This is possible, unless the debtor has received a Chapter 7 discharge within eight years or a Chapter 13 within six years. The second option is to request that the Chapter 13 case be dismissed by the court. The debts will still be owed, though obviously payments made will be deducted. However, creditors will also be able to add on interest that they could not charge will your Chapter 13 case was pending.

After the completion of the repayment plan, all dischargeable debts are eliminated. Before the discharge takes effect, the debtor must prove to the court that he or she has completed a second program in budget counseling at a government approved agency (A list of approved agencies and programs can be found here, on the website of the Department of Justice) as well as proof that he or she is current on all domestic support obligations.