Personal Bankruptcy Protection: Chapter 7 and Chapter 13 Bankruptcy Filing

Bankruptcy Chapter 7 Liquidation

Most consumer bankruptcies are Chapter 7 bankruptcy filings. You should find a bankruptcy lawyer who is familiar with the process if you are considering filing for personal bankruptcy protection. In most bankruptcy Chapter 7 personal bankruptcy filings, the debtor has no assets. All of the debtor's assets are either exempt property or are subject to the liens of secured creditors. In “no asset” personal bankruptcy cases, there is no distribution to the unsecured creditors.

Certain obligations, generally unsecured debts, may be eliminated entirely while others will need to be repaid, in whole or in part. Debts that are discharged do not need to be repaid. Certain kinds of debt cannot be discharged (generally child support, tax obligations, student loans, personal liability for damages caused by drunk driving and certain other criminal fines and penalties).

There are two main types of personal bankruptcy cases (i) liquidations, in which all non-exempt assets are sold and the proceeds paid to creditors and (ii) reorganizations, in which the debtor retains control of his or her property and repays creditors over time, pursuant to a repayment plan. A Chapter 7 bankruptcy is a liquidation.

Bankruptcy Exempt Property

The bankruptcy code allows each state to designate certain property as excluded from the bankruptcy process. This is called exempt property. Most states allow a debtor to keep certain household necessities such as clothes, furniture, medical devices and a car. Some states will even allow a debtor to keep the equity in his or her home or land up to a certain number of acres. This is known as the homestead exemption. The amount of assets that a debtor may protect with these exemptions will vary from state to state.

Bankruptcy Chapter 13 Reorganization

Chapter 13 bankruptcy is a debt reorganization in which the debtor retains control of his property and repays creditors over time, pursuant to repayment plan approved by the bankruptcy court. In order to qualify for Chapter 13 bankruptcy, a debtor must have a source of regular income, unsecured debt of not more than $336,900 and secured debt of not more than $1,010,650. Under the terms of the repayment plan, the debtor agrees to pay a portion of their income to creditors over a 3 to 5 year period. A bankruptcy trustee is appointed to collect payments from the debtor and make payments to creditors.

A bankruptcy Chapter 13 debtor must complete the Credit Counseling Course before filing a bankruptcy petition and must also complete the Personal Financial Management course after the filing of the bankruptcy petition but before the conclusion of the bankruptcy.

Bankruptcy Repayment Plan

The debtor must submit a payment plan in accordance with the repayment guidelines established by the means test. The payment plan is sent to each creditor and must be approved by the bankruptcy court. The creditors are not allowed to vote on accepting or rejecting the plan. Instead the bankruptcy court determines whether the proposed payment plan satisfies to tests: (i) the Best Interest of Creditors test and (ii) the Best Efforts test.

The Best Interest of Creditors test requires that the plan provide for payments to creditors that are at least as much as the creditors would have received if the debtor had filed a Chapter 7 bankruptcy liquidation. The Best Efforts test requires that the plan must provide for aggregate payments to unsecured creditors in an amount equal to the debtor’s monthly disposable income over a period between 3 and 5 years. For debtors with income below the state median, the period is 36 months while debtors with income above the state median must make payments for 60 months.The terms of the payment plan are extremely flexible. Payments may be the same over the life of the plan or they may increase over time.

Secured Debt

Bankruptcy Chapter 13 filings are frequently used to stop foreclosure proceedings on a house or to stop the repossession of a car. A debtor that has fallen behind in their monthly payments may include the arrearages in the repayment plan so long as the debtor continues to make all regular month payments after the date of the bankruptcy filing.

Bankruptcy Chapter 13 may also be used to modify the terms of certain secured debt. Specifically, when the amount of secured debt exceeds the value of the creditor’s collateral, the debtor may reduce the amount of the secured loan to the current value of the collateral. The balance of the loan will be treated as an unsecured claim. Pursuant to a Bankruptcy Chapter 13 payment play, certain liens can be stripped down to the value of the collateral. This is known as lien stripping and is only available in bankruptcy. Currently, one significant exception to lien stripping is a mortgage secured solely by the debtor’s residence. Lien stripping can be used to reduce the amount of debt secured by automobiles and other personal property such as furniture and appliances where the value of the property is less than the amount of the secured debt.

Bankruptcy Means Test

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 amended the Bankruptcy Code to establish certain eligibility requirements for Chapter 7 and Chapter 13 bankruptcy filings. Pursuant to the amendments, a financial eligibility requirement or ‘means test’ was imposed. The means test has two parts.

Bankruptcy Median Income

First, you must calculate your average monthly income for the prior six (6) month. If your monthly average income (adjusted for number household members) is below your state’s median average monthly income, then you have satisfied the financial test for determining eligibility for Chapter 7. If your average monthly income is above your state’s median, however, you must perform another set of calculations to determine eligibility. The second test requires an analysis of the debtor’s ability to repay some portion of his or her debts over time. Recall that in a Chapter 7 bankruptcy, the debtor’s non-exempt property is liquidated and the proceeds distributed to creditors. The debtor’s remaining obligations are discharged and there are no ongoing repayment obligations. The second test was established to ensure that Chapter 7 debtors were not avoiding responsibility for debts that could be repaid over time. In order to satisfy the second test, the debtor’s net disposable income (after adjusting for normalized expenses using Internal Revenue Service guidelines for the debtor’s state), may not exceed $100 per month. If the debtor’s net disposable income falls between $100 and $167 per month and this amount is sufficient repay not less than 25% of the debtor’s unsecured, non-priority debt over a five year period, the debtor is not eligible to file under Chapter 7. If the debtor can repay $167 per month over a five (5) year period, for a total of $10,000, then Chapter 7 is not available. Chapter 13, pursuant to which a debtor establishes a repayment plan that may extend up to 5 years, is an alternative.

Required Bankruptcy Forms

In order to complete the required Bankruptcy Forms, including the debtor's petition, the statement of financial affairs and the schedules, the debtor must provide:

1. A list of all creditors and the amount and nature of their claims;

2. The source, amount, and frequency of the debtor's income;

3. A list of all of the debtor's property; and

4. A detailed list of the debtor's monthly living expenses (food, clothing, shelter, utilities, taxes, transportation, medicine, etc.)

Married individuals must report this information for their spouse whether or not they are filing a joint petition. Even when only one spouse is filing, the income and expenses of the non-filing spouse must be reported so that the bankruptcy court can properly evaluate the household's financial position.

Bankruptcy Petition and Schedules

When considering a bankruptcy Chapter 7 or bankruptcy Chapter 13 filing, you should review and organize your financial information including pay stubs, bank accounts and bills for at least six (6) months before the filing. Bankruptcy Form B200 sets forth the documents and schedules that will need to be prepared and filed with the bankruptcy petition. As you read through the list, you should consider whether you will prepare the schedules on your own or will need the help of a bankruptcy lawyer.

Installment Payments

Most bankruptcy lawyers will allow you to pay their fees by installment while they are preparing your petition and schedules. In a Chapter 7 bankruptcy case, your bankruptcy lawyers will usually not file your petition until they have been paid in full. If you are paying your bankruptcy lawyers on installment, you can use this time to collect the financial information they will need to prepare the various bankruptcy forms and disclosure schedules to your petition.

With the bankruptcy court's permission, however, individual debtors may pay in installments. The number of installments is limited to four (4) and the debtor must make the final installment no later than 120 days after filing the petition. The bankruptcy court may extend the time of any installment, provided that the last installment is paid not later than 180 days after filing the petition. If you are filing jointly with your spouse, only one filing fee is required. Failure to pay these fees may result in dismissal of the bankruptcy case. If your income is less than 150% of the poverty level and you can establish that your disposable income is insufficient to pay the Chapter 7 filing fees, even in installments, the bankruptcy court may waive the fees. Submit Bankruptcy Form B3B with your Chapter 7 bankruptcy petition in order to request a waiver of the filing fee.

Find a Bankruptcy Lawyer

These calculations are complicated and if the debtor’s record keeping was not careful it may difficult to determine whether Chapter 7 personal bankruptcy protection is available. With some advance planning, the passage of time and meticulous record keeping these deficiencies may be overcome and Chapter 7 eligibility demonstrated. There are several online resources for assisting with these calculations for each state. While these websites may help you calculate the Means Test, you should find a bankruptcy lawyer to assist you in performing the calculations and preparing your filing.