Questions and Answers About Chapter 13
By Eric C. Rajala, Attorney at Law

"The Law Office of Eric C. Rajala is a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code."

1. What is Chapter 13 bankruptcy?

Chapter 13 bankruptcy is similar to Chapter 7, in that the same basic information must be presented in the petition, schedules and statement of financial affairs. Also, the automatic stay in Chapter 13 operates the same way, preventing creditors from taking action to collect debts while the case is pending.

However, unlike Chapter 7, cases filed under Chapter 13 require the debtor to submit a plan of repayment for approval by the Court. The amount of the payment depends upon the debtor's "Monthly Disposable Income, " which is determined by a calculation using a formula for income and expenses set forth in the Bankruptcy Abuse Prevention and Consumer Protection Act, which became effective on October 17, 2005. The payment is made to the Chapter 13 trustee, who disburses the funds to the creditors, pursuant to the terms of the plan.

Most Chapter 13 plans do not propose to pay all unsecured debts in full. However, the trustee monitors your disposable income throughout the life of the plan. If your disposable income goes up, he can ask the Court to increase your plan payments accordingly. If the increase is approved, the extra money goes toward paying a larger dividend to your unsecured creditors. On the other hand, if your disposable income goes down, you have the right to seek a modification of the plan to reduce the amount of the payment.

Once you have made all of the required payments under the plan, you become eligible for a discharge, even if you haven't paid all of the debts in full.

2. How long does the repayment plan have to run?

The plan must be in effect for three to five years, during which time the debtor is required to pay in an amount equivalent to all of his Monthly Disposable Income. This amount can include other funds you receive while the case is pending, in addition to the regular monthly payment. For instance, if you receive a bonus or a tax refund during the term of the plan, you may be required to pay in most, if not all, of the amount you receive.

A plan may last longer than three years, if necessary. In some cases, plans are scheduled to operate for up to five years, because the debtor cannot afford to pay what needs to be paid within the normal three year term. If the debtor's Current Monthly Income exceeds the median income for the same size household in the State of his residence, then the plan must run for a full five year term.

3. Is the plan automatically approved?

The plan of repayment must meet certain requirements for approval, or confirmation. Among other things, the plan must be proposed in good faith; it must pay secured creditors the value of the collateral securing the debt; and it must pay unsecured creditors at least as much as they would receive if the debtor's property was liquidated under Chapter 7.

The Chapter 13 trustee and the creditors may object to the confirmation of the plan, if they believe that it doesn't comply with the rules. In that event, the Court would have to decide whether to confirm the plan, after hearing evidence at a trial.

4. Why would anyone want to file a Chapter 13 case?

There are a number of reasons for choosing Chapter 13 instead of Chapter 7.

• You can avoid the liquidation of non-exempt property. In Chapter 13, the debtor may stay in possession of all of his property, as long as the plan proposes to pay the creditors at least as much as they would have received in a Chapter 7 liquidation. If you have non-exempt property which you wish to keep, which would be taken from you in a Chapter 7 case, and you have enough disposable income to pay your creditors the same dividend they would have received if the property were liquidated, Chapter 13 allows you to keep it.
  For example, the Kansas exemption law allows each debtor to claim one vehicle as the debtor's exempt means of transportation. Under Chapter 7, if you have an extra vehicle which is worth more than is owed against it, the trustee could sell the extra vehicle, use part of the proceeds to pay the off the loan against it (if any), and use the rest to pay a dividend to your unsecured creditors.
  However, under Chapter 13, you would be allowed to keep the extra vehicle, as long as your plan proposes to pay the same dividend to the unsecured creditors as they would have received in a Chapter 7 liquidation.
• You can pay taxes and other nondischargeable debts at a rate you can afford. For instance, if you have a tax debt which cannot be discharged under Chapter 7, you would still owe the tax (plus additional interest and penalties) after the Chapter 7 discharge is final. In some cases, the tax debt continues to grow faster than the debtor can pay it down. You could end up after your Chapter 7 discharge with a tax bill that just keeps getting bigger, regardless of your attempts to pay it.
  In a Chapter 13 case, the same tax debt can be set up in a special class for full payment, without incurring additional penalties, and often without incurring interest while you are paying it off. If you would be stuck paying the tax anyway, it might make sense to use Chapter 13 to pay it down dollar-for-dollar, instead of losing ground each month due to high interest and penalty charges.
• You can re-amortize secured debt. If you file under Chapter 7 at a time when you are behind in payments on a debt secured by property (for instance, a car loan), and you are not able to catch up the late payments as quickly as the lender demands, the lender can ask the Court to "lift the automatic stay" so that it can repossess the collateral. When this request is made, it's almost automatically granted. Although the lender could agree to a reaffirmation of the debt, it may chose not to do so. Therefore, going into a Chapter 7 when you are delinquent in paying a secured debt puts the collateral at risk of repossession or foreclosure.
  Under Chapter 13, you can set up the secured debt for payment in a special category; then, the lateness of your pre-bankruptcy payments would not matter.
• You can prevent your home from being foreclosed. If you fall behind in paying the mortgage on your home, the lender can call the loan, foreclose the mortgage, and sell the house on the courthouse steps. A Chapter 7 filing will slow this process down, but won't stop it. But if you file a Chapter 13 case anytime before the sale, your plan can provide for the "de-acceleration" of the loan. This means that the foreclosure sale cannot take place. However, you must then begin making normal monthly payments to the lender, starting with the next payment due after the filing of the case.
  The past due payments are put into a separate category under the plan, and will be paid in full out of the money you pay to the trustee over the term of the plan. By the time you make the last payment under the plan, your monthly payments under the mortgage loan will be fully caught up. After discharge, the lender cannot use the pre-bankruptcy default to accelerate the loan again. This procedure works for second mortgages, too.
• You can avoid complaints about whether certain debts should be discharged. Under Chapter 7, if a creditor believes that you have taken unfair advantage (for instance, abuse of a credit card just before the bankruptcy is filed), he can file a complaint alleging that you have committed a fraud. If the creditor proves that a fraud was committed, you would be held liable to pay the debt after the bankruptcy case is over.
  Under Chapter 13, the fact that a particular debt may have been incurred through fraud may raise a question of good faith. But if the Court finds that the plan was filed in good faith, your Chapter 13 plan may be confirmed, and the debt would be discharged upon completion of the payments required under the plan.
• You may not have any choice. Section 707(b) of the Bankruptcy Code provides that a Chapter 7 case filed by a consumer is subject to dismissal if allowing the case to proceed would constitute an abuse of Chapter 7. Abuse may be found where the debtor has (in theory) enough disposable income to make a meaningful payment to his unsecured creditors in a Chapter 13 case.

Under procedures mandated by BAPCPA, if you have enough disposable income such that you could pay a meaningful dividend to your unsecured creditors over a five year period, the U.S. Trustee will file a motion to dismiss your case. If the Court agrees, your case will be dismissed, unless you convert it to a Chapter 13 case.

The determination of abuse must be made by your attorney prior to the filing of the case, so that you will know up front whether to even try to file under Chapter 7.

5. What are the disadvantages of Chapter 13?

• It could be a three to five year process. You won't get a discharge until all of the required payments are made. Any new credit you wish to acquire during the process must be approved by the Court. Also, since your discharge is delayed, it takes that much longer to start rebuilding your credit.
• Your income and expenses will be monitored, and you may be required to increase your plan payment. The trustee will try to verify that you are paying in all of your disposable income during the term of the plan. He does this by periodically reviewing your tax returns, paycheck stubs and bank statements. If he believes that you aren't paying in all of your disposable income, he can file a motion to dismiss your case. This can be a real problem, especially if you've received an increase in your income, but have already spent it.
  This probably generates the most complaints from Chapter 13 debtors. Just when your hard work and overtime starts to pay off, the trustee can attempt to force an increase in your plan payments. The only way to get relief is to prove that you also had legitimate increases in your business or living expenses.
  For example, using the extra income to purchase a replacement for your worn-out vehicle may or may not be allowed, depending on the situation. In general, you won't be permitted to use any increase in income for savings, or to upgrade your lifestyle during the term of the plan.
• Most Chapter 13 cases fail. In fact, only about 30% of Chapter 13 cases make it all the way to discharge. The primary reasons for this are -

1. changes in the debtor's employment, health, or family situation during the case make it impossible to continue;
2. the car (or house) which the debtor has been trying to hang on to finally becomes more trouble than it's worth, and he would rather surrender the collateral, convert to Chapter 7 and start over, instead of continuing to throw good money after bad; or
3. the debtor keeps getting into deeper financial trouble, by not making his ongoing mortgage payments, not paying his taxes, or by incurring more debt during the case.

6. Who should consider filing under Chapter 13?

• First, there should be a good reason to do so - see section 4 above.
• Second, you should have confidence that you can maintain your income and control your expenses for at least the next three to five years. Loss of income and out of control expenses are probably the most common factors which cause Chapter 13 cases to fail before all of the plan payments are made.
• Finally, you should resign yourself to the fact that any extra money you make during the three to five years of the plan could be taken from you to pay a bigger dividend to your creditors.

The bottom line: Chapter 13 is a useful tool, but it's not for everyone.