Once an individual or couple realize that bankruptcy is the only option to deal with their financial situation, they must then decide whether to choose Chapter 7 or Chapter 13. For most people, Chapter 7 is the preferred alternative. A Chapter 7 can generally be completed in roughly 4 months. By contrast a Chapter 13 normally will run a minimum of 36 months and could extend to 60 months. A Chapter 7 does not involve a payment plan and generally does not require the individual to surrender assets to trustee. By contrast, a Chapter 13 requires a regular payment to a trustee for the full term of the plan.
Given the burdens of a Chapter 13, why would anybody choose that over a Chapter 7? I have found that there are generally about seven reasons to consider Chapter 13.
1. Prior bankruptcy: Chapter 13 is available if a prior Chapter 7 was filed within the last 8 years. The issue is whether a discharge is needed. If so, the prior Chapter 7 must have been filed more than 4 years ago or Chapter 13 must have been filed more than 2 years prior to the present case.
Why would you file if you are not seeking a discharge? A Chapter 13 can do two things even if the debtor is not entitled to a discharge. First, it can force the creditor into a payment plan that might either reduce or eliminate interest and penalties going forward. Second, it will allow the debtor to strip off a wholly unsecured junior mortgage that was personally discharged in a prior Chapter 7.
2. Non-dischargeable debts: certain debts are not dischargeable in Chapter 7, but are dischargeable in Chapter 13. Those debts include noncriminal court fines, willful and malicious injury claims to property, and divorce related debts, other than child-support or alimony. In addition, a Chapter 13 can bind the IRS to a payment plan over a period of up to five years, which will stop the running of interest and penalties. Chapter 13 is an effective way to deal with past due domestic support obligations. The Support Enforcement agency will generally abide by a Plan if the debt is paid in full. Criminal fines can also be paid through a Chapter 13 Plan. In Washington, this becomes effective way of reinstating a drivers license.
3. At risk assets: One of the most common reasons people file Chapter 13 is to prevent foreclosure. A Plan should provide for a cure of the arrears over the life of the Plan. In addition, Junior mortgages can be eliminated if there is no equity to support them.
Car loans can be modified in a Chapter 13, but the extent of the modification will depend upon when the car was purchased. .
Although the rules protecting or exempting assets are quite generous, occasionally a client will have assets that cannot be exempted. The debtor is generally entitled to retain those assets in a Chapter 13 so long as the unsecured creditors receive equivalent value over the life of the Plan.
4 Means Test: If the debtor has a positive disposable monthly income the debtor may be required to file chapter 13. One of the quirks of the Code is that the Means Test is different in several areas between Chapter 7 and 13. For instance, voluntary contributions to retirement plans and retirement loan payments are deductible on the Chapter 13 Test, but not on the Chapter 7 Test. See my discussion of the Means Test in my other blog. There is a qualifier regarding retirement plans that I will discuss in a future blog.
5. Security clearance: Some employers are very touchy about bankruptcy. This is especially true with the military. If a debtor has a secret or top secret clearance, his clearance may be revoked if he files Chapter 7. However, generally the military will not revoke the security clearance if the debtor files Chapter 13.
6. Co-signor protection: The automatic stay of debt enforcement applies only to the debtor in Chapter 7. However, that stay may extend to individual no-filing co-debtors in Chapter 13.
7. Moral choice: Some people have a problem walking away from their debts and feel a moral obligation to pay their creditors. I never discount this as a reason to file Chapter 13. The advantage of a Chapter 13 for them is that they can pay their creditors in a manner they can afford and bind the creditors to the Plan.
In summary, Chapter 13 is a good debt solution in the appropriate case. Your attorney can help you weigh the advantages and disadvantages of this option and contrast it with Chapter 7.