What is Chapter 13 Bankruptcy?

Chapter 13 of the Bankruptcy Code is a voluntary bankruptcy used to repay all or some of an individual’s debts. Chapter 13 bankruptcy is only available to individuals (not corporations) who have a regular income.

A Little About Chapter 13 Bankruptcy

Chapter 13 is often called a “wage earner’s plan.” Chapter 13 can stop a foreclosure or repossession and allow the individual time to make payments over three to five years.

Repayment Plan

The main feature of a Chapter 13 bankruptcy is the repayment plan, which must be approved by the bankruptcy court (known as “conformation” of the plan). Within 15 days of the filing of the Chapter 13 bankruptcy petition, the debtor must file a proposed plan to repay creditors over three to five years.

The debtor must make the first payment in accordance with this plan within 30 days of the bankruptcy filing date, regardless whether it is ultimately confirmed by the court. The plan is sent to the U.S. trustee and to all creditors for review and opportunity to object.

The plan must provide for regular fixed payments to the trustee who then distributes the funds to creditors according to the terms of the plan (which may be less than full payment on their claims).

It is common for a Chapter 13 plan to propose to pay secured creditors in full and little or nothing to unsecured creditors, which largely depends on whether there is “extra” money at the end of the month after the debtor’s secured creditors and monthly expenses are paid.

Once the bankruptcy court confirms the Chapter 13 plan, the court will direct the debtor to pay the bankruptcy trustee, who keeps a percentage as a fee and pays out the rest to the creditors in accordance with the plan.

Debt Limits

Eligibility for a Chapter 13 depends on the amount of debt. Currently a debtor may have no more than $383,175.00 in unsecured debts and $1,149,525.00 in secured debts.

Debtors who exceed these limits are not eligible for Chapter 13 relief and should consider filing Chapter 11 reorganization bankruptcy.

Priority of Debts

Chapter 13 differentiates between three types of debts: first, priority debts, including most taxes and child support, must be paid in full. Second, secured debts, debts secured by collateral, must be paid with interest over the life of the plan, or surrendered back to the creditor.

Finally, unsecured debts, like credit cards and medical bills, are paid in relation to financial ability. This may be as much as 100% or as little as 0%.

There are many reasons to consider Chapter 13 bankruptcy, including:

Save Your Home

Many debtors choose to file Chapter 13 to stop a home foreclosure sale. A foreclosure action against the debtor must stop the moment a Chapter 13 case is filed. The debtor is given an opportunity to propose a plan to pay the delinquent mortgage payments over three to five years.

During the Chapter 13 repayment period the debtor must also pay any mortgage payments due after the bankruptcy is filed (called post-petition payments). The debtor’s home is protected from foreclosure as long as the debtor continues to pay the plan amount and the future mortgage payments.

Failure to make plan payments or post-petition payments can result in losing the bankruptcy protection and the bank may resume the foreclosure action.

Cram-Down

A Chapter 13 debtor can ask the bankruptcy court to modify and reduce a secured loan to the value of the security. This process, commonly called a “cram-down,” is done when the amount of the secured loan is significantly more than the value of the property.

The resulting benefit is a lower monthly payment.

For example, say the debtor owes $20,000 on a car loan, but the car is worth only $10,000.

The loan can be “crammed-down” to an allowed secured debt in the amount of $10,000 only. The debtor pays the $10,000 secured during the Chapter 13 bankruptcy and the $10,000 unsecured debt is paid at the same rate as all other unsecured debt in the case (generally pennies on the dollar).

Any unsecured debt that is not paid through the plan is discharged at the end of the case, provided it is not otherwise excluded from the discharge.

Cram-down is available for all secured property other than home loans, and automobile loans incurred within 910 days before filing bankruptcy.

Repayment of Non-Dischargeable Obligations

Sometimes Chapter 13 is used to repay debts that cannot be otherwise discharged. Tax debt and child support debts are two common debts that get paid under the supervision of the bankruptcy courts.

Conversion to Chapter 7 or Hardship Discharge

Unlike Chapter 7, Chapter 13 offers the debtor flexibility to try to work out of debt while protected by the federal bankruptcy court. If circumstances change after confirmation of the Chapter 13 plan that prevents the debtor from completing the repayment plan, the debtor has options.

The debtor may ask the court to allow the debtor to modify the plan, or to convert to a Chapter 7 bankruptcy. A Chapter 13 debtor has an absolute right to convert the Chapter 13 case to a Chapter 7.

If the case is near completion, the debtor may petition the court to grant a “hardship discharge” and end the case early.