Bankruptcy Article #12
The #1 reason for choosing Chapter 13 bankruptcy over chapter 7 is to save your home from foreclosure.
- Who makes a good candidate for Chapter 13 Bankruptcy?
- Nine Reasons to file for Chapter 13 Bankruptcy
- Are there benefits to Chapter 7 bankruptcy?
Whether an individual uses Chapter 7 or Chapter 13 to address his or her financial problem depends upon the nature of the problem, and the prospective resources of the individual after filing a bankruptcy petition. There are at least ten reasons to choose Chapter 13, and one important reason to choose Chapter 7 when looking for relief under the Bankruptcy Code. Before analyzing each of the reasons to choose Chapter 13 over Chapter 7, it is important to remember the debtor's counsel must first, and foremost, listen carefully to the client to determine the primary goal of the client. There is a perception of the debtor's counsel bar that counsel simply provides cookie cutter solutions to debt problems. Rather than force a solution upon a client because it is convenient for counsel, there may be other solutions that will accomplish the primary goal of the client more effectively. Chapter 13 can often provide the framework for those solutions.
Who makes a good candidate for Chapter 13?
But at the outset, let us acknowledge that Chapter 13 is not for everyone. Individuals who perform best in Chapter 13 frequently have two characteristics.
- stable income
- ability to commit to long term (up to five years) financial plan
Not every debtor has these characteristics. During the initial interview with a debtor, counsel should determine whether the debtor would be a good candidate for Chapter 13 by investigating each of these characteristics. The stability of a debtor's income in the future is crystal ball gazing at its best, but some debtors can demonstrate good work history and/or be persuasive about their future job prospects.
While there can be a concern about a debtor who is on the financial edge of a cliff trying to file a Chapter 13, it is even more important to recognize the debtor who has significant income. When a high earning debtor is considering his or her bankruptcy options, counsel should remember that the last two years of "bankruptcy reform" legislation has been driven by the perception that many high earning debtors are filing Chapter 7 petitions instead of Chapter 13. In Maine and the First Circuit generally, Courts have been carefully considering a debtor's ability to repay some portion of their debts in deciding whether to dismiss ill advised Chapter 7 petitions. In In re Blair, 214 B.R. 257 (Bankr. D. Me. 1997), the Court concluded that ability to repay debt is a primary factor in determining whether to dismiss a case under the "substantial abuse" standard in 11 U.S.C. Section 707(b).
Under this same section of the Code, the First Circuit dismissed a Chapter 7 case where a debtor had $1,350 in monthly income and $580 in monthly expenses (because he was living with his parents). First USA v. Lamanna, 153 F.3d 1 (1st Cir. 1998). Some commentators suggest the Lamanna case was simply poor representation by debtor's counsel for failing to make sure the income and expense schedules (I and J) "zero out". It is unimaginable that anyone can subsist on only $580 of expenses each month. It also raises the question whether Schedule I and J are intended to represent a debtor's income and expenses at the moment of filing, or whether they represent a debtor's projected income in the foreseeable future (such as the next 6 months to one year). In any event, should counsel encounter a high earning doctor, and those earnings are anticipated to continue in the future, Chapter 13 may be the only game in town.
Just as important is a debtor's ability to commit to a long term financial plan. If a debtor has had trouble with self control in the use of credit cards and/or frequently fallen behind in mortgage or car loan payments, that individual may be a poor candidate for a Chapter 13. A Chapter 13 plan requires a debtor to stay on a cash budget for a 3 to 5 year time period. Some debtors can handle that responsibility easily, while others find it impossible to manage. It is important for counsel to have a heart to heart talk with a debtor to determine whether the debtor is up to the task.
Nine Reasons to Choose Chapter 13
Assuming that counsel concludes that the debtor has sufficiently stable income and the tenacity to follow through with a Chapter 13 Plan, what are the top nine reasons to choose a Chapter 13 over a Chapter 7?
- Curing Mortgage Arrears - Foreclosure
If a debtor is behind in his or her mortgage payments and facing a foreclosure, Chapter 13 can permit the debtor to cure the defaults and reinstate the mortgage. See 11 U.S.C. Section 1322. The mortgage arrears are paid as part of the Chapter 13 plan payment to the trustee while the debtor commences regular monthly mortgage payments post petition. This technique creates havoc for the mortgagee's computer system, but is well understood and accepted by mortgagees. Debtors who use Chapter 13 for this purpose will be closely monitored to be certain that they do not fall behind on their mortgages after filing. The Court is less than sympathetic with a debtor who fails a second time in his or her mortgage payment responsibilities.
- Retain Non-Exempt Property.
Chapter 13 enables debtors to retain property which would otherwise be liquidated in a Chapter 7. As long as the debtor can pay the Chapter 13 Trustee, over a 3 to 5 year time period, money that equals or exceeds the value of the property the debtor wishes to retain, the property remains with the debtor. The property in question is usually non-exempt property; accordingly, it is important for debtor's counsel to appreciate the difference between exempt and non-exempt property. Occasionally, a debtor forgets to list an asset on his or her bankruptcy schedules. In a recent case before the Bankruptcy Appellate Panel, In re Kuntz, 233 B.R. 580 (1st Cir. B.A.P. 1999), a debtor in a Chapter 7 case failed to disclose the existence of a certain asset, and upon discovery of the asset, attempted to convert his case to a Chapter 13. The Panel concluded the conversion was not in bad faith, and permitted the debtor to proceed in Chapter 13.
- Co-debtor Stay
11 U.S.C. Section 1301, otherwise known as the "co-debtor stay", prevents a creditor from pursuing a co-debtor on a consumer debt. In order to prevent the creditor from seeking relief from stay, the debtor must propose in his or her Chapter 13 plan to pay the co-signed debt in full. There is no equivalent provision in Chapter 11 or Chapter 7. This provision is said to be the primary reason why there are so many Chapter 13 cases filed in Puerto Rico - most creditors on the island require a debtor's relatives to co-sign obligations of a debtor. Credit unions in Maine also frequently request a co-signer when debts are incurred (perhaps in part because credit unions are willing to extend credit to individuals with few resources). Whenever debtor's counsel encounters a credit union obligation among the list of debts provided by a debtor, inquiry should be made regarding co-debtors.
- Sale of Property
The fourth reason to file a Chapter 13 is where a debtor seeks to control the sale of his or her property in a bankruptcy setting (free from the immediate pursuit of creditors). 11 U.S.C. Section 1303 provides the debtor, exclusive of the trustee, the right to sell property under Section 363 of the Code. This benefit permits a debtor to liquidate property in a manner and at a time which can generate the highest value. Although Chapter 7 Trustees attempt to liquidate property at market value, potential buyers may not be inclined to make their best offer in a setting viewed as liquidation. Where receiving a high price for property is essential for a debtor's financial rehabilitation, Chapter 13 is the best mechanism to achieve the goal.
- Modification of Secured Debt Update: April 10th, 2006
Chapter 13 Vehicle "Cramdown" Now Less Valuable
Brooks v. GMAC. The Maine Bankruptcy Court, on April 10, 2006, held that a car lender is not required to release its lien on a vehicle in a Chapter 13 case, pursuant to payment of the secured portion of the debt on the car, until after the debtor receives his or her chapter 13 discharge for the successful completion of the plan. In the past, debtors have been receiving their lien releases on vehicles after the secured portion of the debt is paid in a Chapter 13. The effect of this decision is to make a vehicle loan “cramdown” in a 13 much less valuable, and removes an incentive that previously existed for debtors to choose Chapter 13 over Chapter 7.
- Classify Unsecured Claims
Chapter 13 permits a debtor to separately classify unsecured claims (to some extent) and allow a debtor to control the payment of priority debt inside the plan instead of being overwhelmed by these types of creditors at the conclusion of the bankruptcy where the debts are nondischargeable. Depending on the inclination of the Judge, a debtor may be able to separately classify student loan creditors and thereby address one of the most troublesome creditors in any bankruptcy case. But see In re Colfer,159 B.R. 602 (Bankr. D. Me. 1993) wherein Judge Haines concluded that student loans may not be separately classified and paid at a different percentage than general unsecured claims simply because the debt was non-dischargeable.
- "Super Discharge"
The discharge a debtor can receive at the successful conclusion of a Chapter 13 case is broader than a Chapter 7 discharge. Compare 11 U.S.C. Sections 1328 and 523. Chapter 13's "super discharge" enables a debtor with certain tort debt or a debt incurred by fraud to obtain a discharge of the obligation. Counsel should study the differences between the two discharge sections of the Code to be prepared for a debtor with unusual debt which could easily be addressed by Chapter 13 but still pose a nightmare for the debtor in Chapter 7.
- Operation of Business
For a debtor operating a sole proprietorship, Chapter 13 permits that debtor to continue to do business. Whether or not the business can thrive, or even survive, in Chapter 13 is another issue. A debtor using Chapter 13 to save his or her business must first understand why the business performed poorly outside the bankruptcy system. Once inside Chapter 13, the business will be expected to be managed properly, with adequate cash flow reporting systems and up to date tax reporting. Nonetheless, if a debtor can address the bookkeeping associated with Chapter 13, many businesses can recover and operate at a profit once free from old unsecured debt.
- Freezing Amount of Debt
Some debtors wish to make a percentage payment to their creditors without every dollar being attributed to interest and late charges. Through a Chapter 13 payment plan, any money provided to creditors will pay down the balance of the debt that existed at the date of filing, since all unsecured claims are frozen as of the filing date (even priority debt such as tax obligation to the Internal Revenue Service and Maine Revenue Service). While making payments under a plan to benefit credit card creditors may not make much sense to some people, this author has had debtors insist on trying Chapter 13 in order to pay at least some of their debt because they believed it was the honorable way to deal with the debt.
- Refinancing Home and Future Credit
It may be easier and quicker to finance a home purchased while in Chapter 13 than if that same debtor filed Chapter 7. The secondary market, where many debtors seek financing, is willing to provide home purchase money at competitive rates if a debtor has been in Chapter 13 for 12 months and has made every payment under the plan to the trustee in full and on time. If a debtor instead files Chapter 7, the debtor must wait two years after his or her Chapter 7 discharge before he or she can qualify for the same financing. While the above information should cause debtors to flock to Chapter 13, some debtors are finding that new financiers are more willing to provide almost any other type of financing (such as motor vehicle) much more quickly after a Chapter 7 discharge and be completely unwilling to consider such financing while a debtor is in Chapter 13. These financiers focus their attention on when a debtor receives his or her discharge (which is usually three months after filing a Chapter 7 versus three to five years after filing a Chapter 13).
The mortgage cure provision can be effective in a Chapter 13 plan up to the date of the foreclosure sale. 11 U.S.C. Section 1322 (c) (1). This author recently filed a Chapter 13 case to save a debtor's home at 12:00 noon on Friday when the foreclosure sale was scheduled for 2:00 p.m. that same day. However, whether a Chapter 13 can save a home can depend upon the nature of foreclosure. Maine's Bankruptcy Court recently held that a debtor's cure rights under Section 1322 do not permit a debtor to reinstate a mortgage where the foreclosure was pursuant to Maine's strict foreclosure statute, instead of by the usual foreclosure sale. In re Stephens, 221 B.R. 290 (Bankr. D. Me. 1998). The Court concluded that where, pursuant to statute, a debtor's interest in property terminated prepetition; the debtor could not recreate rights in the property under Section 1322.
Benefits of Chapter 7
This brings us to the principal reason not to file a Chapter 13. Three to five years is a long time! Some debtors, in their initial visit with bankruptcy counsel are depressed and distressed by the pressures associated with significant debt. They have been criticized and harassed by their creditors and generally feel humiliated when considering bankruptcy as an option to free them from debt. Chapter 13 can offer them significant relief, but they may instead simply need to move past the debt as quickly as possible and restart their financial lives. For these individuals, Chapter 7, with its relatively prompt discharge, offers greater relief. It is incumbent upon counsel to distinguish between those individuals who can benefit from Chapter 13 and those who must use Chapter 7 to get past this difficult time in their lives.