By: Trev E. Peterson

Congress requires that I disclose that our firm is a “debt relief agency” under the Bankruptcy Code. We help people file for bankruptcy relief under the Bankruptcy Code.  As with all articles on this website, the contents of this article are not intended as legal advice for any specific legal problem. Nothing in this article is intended to create an attorney-client relationship between the author and the reader. The author is licensed to practice law in Nebraska only, if you are considering filing bankruptcy in a state other than Nebraska you are encouraged to consult with an attorney licensed in the state in which the bankruptcy case will be filed.

In this article, which is a companion article to my Chapter 7 article, I will highlight the differences between Chapter 7 cases and Chapter 13 cases, along with some reasons that a debtor might consider filing a Chapter 13 instead of a Chapter 7.

As with a Chapter 7 case, the primary goal of a Chapter 13 case is to complete the Chapter 13 Plan and obtain a discharge order. A discharge order discharges the debtors from any personal liability for the payment of any debts listed in the bankruptcy schedules, except for certain debts that are not subject to being discharged in a bankruptcy case. These nondischargeable debts include most taxes, child support, alimony and student loans. If a creditor’s claim is secured by a lien on an asset, such as a lien on the debtors’ home, the lien is not discharged and in order to keep the asset the debtors have to make monthly payments on the debt. In a Chapter 13 case, unlike a Chapter 7 case, the debtors’ car loans, if any, can be paid in full during the term of the Chapter 13 plan, so when the debtors get discharged their only liability will be for those debts that cannot be discharged (taxes, student loans and domestic support obligations) and any home loan.

Only individuals qualify for Chapter 13 cases. Corporations, partnerships and limited liability companies cannot be debtors in Chapter 13 cases. In addition individuals have to have “regular income” to qualify as debtors in Chapter 13 cases. While that does not mean that debtors have to get paid the exact same amount every month, the debtors have to have an income stream that is sufficiently regular to permit the debtors to make regular monthly payments to the Chapter 13 Trustee. The amount of debt owed by the debtors is also limited in Chapter 13 cases to a total of $383,175 on unsecured debt (this includes any unsecured portion of a secured debt) and $1,149,525 on secured debts. The debt amounts are periodically adjusted to reflect the effects of inflation. If debtors have more unsecured or secured debt than the limits for a Chapter 13, they must file a Chapter 11 if they do not qualify to file a Chapter 7.

The schedules and statement of financial affairs required for a Chapter 13 case are identical to the filings required in a Chapter 7 case. Chapter 13 debtors are required to:

  • Complete the required credit counseling class. This class is required for all individual debtors, whether they are consumer or business debtors. The class, sometimes referred to as the “first class,” is provided by non-profit groups authorized to provide the class by the US Trustee’s office. Classes are available on line, over the phone, or in some cases in person. When the class is completed the class sponsor provides the debtors (or their attorney) with certificates of completion which are filed with the debtors’ other bankruptcy filings when the case is filed. Except in extraordinary cases, and those are few, the certificate has to be filed with the initial bankruptcy filing.
  • Filing of the schedules and statement of financial affairs. The debtors are required to file a complete list of their assets and liabilities. Debtors do not get to pick and choose what creditors may be listed in their case—all creditors, even those that the debtors intend to repay—have to be listed, along with their mailing addresses and account balances. The debtors are also required to list all of their property in connection with the filing of the case. This includes any amounts due to the debtors and any pending lawsuits or claims against third parties. Gifts, payments and transfers of property to family members, friends and other “insiders” made within one year before the filing of the case are also required to be disclosed. The bankruptcy system is based on voluntary disclosure of assets and liabilities. The sanction for a debtor who does not disclose all of his or her assets or liabilities is the denial of a discharge or, in some cases, criminal prosecution for bankruptcy fraud. The schedules and statement of financial affairs should be completed carefully by the debtors to avoid missing any assets or creditors and to avoid any claim that the debtors are secreting assets.
  • After the case is filed the debtors have to complete the financial education class. The debtors should complete the financial education class as soon after the case is filed as possible. The certificate is supposed to be filed within 45 days after the case is filed, but in reality as long as the class is completed before the discharge deadline, the discharge order will be entered. The sanction for failing to complete the class on time is that the case will be closed without a discharge. That means that the debtors do not get the benefit of the filing of the case. If the debtors complete the financial education class later, the case can be reopened (for which the debtors get to pay another filing fee) and the discharge order will be entered. My preference is that the financial education class be completed before the 341 meeting.
  • Attend the section 341 meeting, or first meeting of creditors. This is the only appearance that the debtors make in the bankruptcy case. The 341 meeting is conducted by the trustee, who confirms the debtors’ identity, places the debtors under oath and asks questions about the schedules filed in the case. See my article on the 341 meeting on our website:

Chapter 13 debtors propose a plan to pay some part of the claims of the creditors over 36 to 60 months. The plan cannot be less than 36 months in duration or longer than 60 months in duration. Except for regular home loan payments and payments on domestic support obligations which may be paid by the debtors directly to the creditors, all other plan payments must be made through the Chapter 13 Trustee’s office. The Chapter 13 Trustee collects a percentage fee from the payments made through the Trustee’s office and pays the balance to the creditors as provided under the Chapter 13 plan.

Why would any debtor chose to file a Chapter 13 instead of a Chapter 7? There are several reasons:

  1. The debtors fail the means test. If the income of the debtors is exceeds the median income in Nebraska for the debtors’ family size, the debtors may be required to file a Chapter 13 case. If the debtors’ disposable net income (gross income less taxes, insurance, and other living expenses) exceeds $400.00 per month, the debtors are required to file a Chapter 13.
  2. The debtors have non-exempt equity in their assets. If the debtors have too much equity in their home or in their vehicles (or other assets) and it is anticipated that the Chapter 7 trustee will claim and sell those assets to generate funds to pay to the creditors, the debtors may opt for Chapter 13 to protect any nonexempt equity in their assets. This factor can, to an extent, be reduced by pre-bankruptcy planning if there is enough time for the debtors to consult with their bankruptcy attorney before the filing of a bankruptcy case becomes a necessity. Gifting property is ALMOST NEVER good bankruptcy planning. Gifts can be set aside by a bankruptcy trustee for up to four years after the gift is made, so unless the debtors have the luxury of waiting four years for the statute of limitations on the fraudulent transfer to expire, gifting property is a bad idea. However, it may be possible to sell some non-exempt assets and convert the proceeds into exempt assets for the purpose of maximizing the exemptions available to the debtors. Any pre-bankruptcy planning should be done with the advice of a bankruptcy attorney so that any transactions are properly documented and with the advice debtors’ accountant or tax advisor because the sale of assets could create nondischargeable tax liability.
  3. The debtors want to avoid foreclosure of their home. If the debtors are behind in their house payments, they may have to file a Chapter 13 to stop the foreclosure sale of their home. If the debtors can make the pre-petition monthly payments required under their loan documents on the mortgage loan after the filing of the bankruptcy case, the debtors can pay the arrearage to the mortgage lender through the plan over the three to five year term of the plan. At the end of the plan, and assuming that all of the plan payments are made, the debtors will be current on their home mortgage.
  4. The debtors have a second lien on their home and no equity over the first lien. This situation was fairly common between 2007 and 2012. If the debtors obtained a second lien on their home and the value of the home is less than the amount of the first lien, the debtors can strip off the second lien. This requires the filing of a lawsuit against the second lien holder and the lien is only voided upon completion of the payments under the plan, but if there is a second lien on the home that is unsecured there is an opportunity for the debtors to discharge the second without having to pay the second lien in full.
  5. The debtors want to avoid repossession of their vehicles. If the debtors are behind on their vehicle loans, the arrearage can be paid over the term of the Chapter 13 plan. The arrearage is treated as part of the lender’s claim and is paid in monthly payment through the Chapter 13 Trustee’s office during the term of the plan. If all plan payments are made, the debtors will generally have paid off their vehicle loans through the bankruptcy plan.
  6. The debtors have tax liabilities and cannot resolve the dispute with the IRS or Nebraska Department of Revenue. This is a fairly uncommon situation, but if the IRS or the NDOR are not willing to accept payments that the debtors can afford, as long as the entire claim will be paid through the Chapter 13 plan, including interest and penalties, the debtors can file a Chapter 13 to force the taxing authorities to accept payments. A Chapter 13 could also be used in a case where an investor bought the tax sale certificates for real estate taxes on the debtors’ real estate and the holder of the certificates is not willing to negotiate a payment plan.
  7. The debtors want to file a 13. Some debtors do not feel right about discharging their debts and want to make some kind of payments on the debt.

Chapter 13’s have some advantages over Chapter 11 cases. Only the debtor can propose a plan in a 13 and the creditors do not get to vote on whether to accept the debtor’s plan in a Chapter 13. Creditors can, however, object to confirmation if the plan does not pay them at least as much as they would have received in a liquidation and if the creditor is a secured creditor, the plan must pay the secured creditor the amount of the value of the secured creditor’s secured claim and that the secured creditor retain its lien until plan payments are completed.

The Chapter 13 plan can change some of the terms of the debtors’ obligations to their creditors. Loans secured only by the debtors’ principal residence cannot be modified in a Chapter 13 plan, but loans secured by the debtors’ vehicles or other personal property may be modified. If the vehicle loan is more than 910[1] days old, or if the loan proceeds were not used to buy the vehicle, the debtors can cram down or reduce the creditor’s claim to the value of the car on the date of the fling of the case.[2] The debtors have the same cram down rights on loans secured by personal property. In addition to the potential for a cram down, the debtors can stretch payments on loans secured by personal property to five years from the date of filing and can reduce interest rates from the contract rate to the 5.25% rate currently provided under the local bankruptcy rules. These advantages may make a Chapter 13 an attractive alternative to those debtors who are having some trouble making payments on their consumer debt but still earn enough to make almost all of the monthly payments.

The decision about whether a person qualifies for a Chapter 7 or Chapter 13 depends on the facts and circumstances of each debtors’ case, and anyone interested in considering bankruptcy should consult with a knowledgeable bankruptcy attorney.

[1] Yes, 910 days. Only Congress—or Solomon—would pick such an odd number.

[2] If the debtors bought a car three years before the fling of the case and the balance owed on the car at the time of filing is $15,000 and the value of the car is $10,000, the plan payment based on a 60 month plan at 5.25% interest would be $189.86 on a $10,000 value instead of $284.79 on a $15,000 claim.