How Chapter 13 Bankruptcy Works
Chapter 13 actually works quite differently from Chapter 7. Chapter 7 involves selling any non-exempt assets and using those funds to pay off creditors some portion of what they are owed. Remaining debts are discharged, and the whole thing is over in three to six months.
Chapter 13 bankruptcy is considered “reorganization.” It involves working with creditors to make a repayment plan in order to be able to keep assets such as houses or cars. If it doesn’t make sense to try to keep an asset, Chapter 13 allows you time to come up with a plan to dispose of the asset: for example, allowing six months for the debtor to negotiate a short sale of the home.
Despite the general preference for Chapter 7, there are some benefits to filing Chapter 13. A Chapter 13 bankruptcy on record is usually better for credit score than a Chapter 7, because it involves repayment of the debts.
Also, Chapter 13 allows for lien-stripping. This can be a great advantage to an underwater homeowner with a second or third mortgage: if the home is underwater to the point that the junior mortgage is unsecured, its lien can be “stripped.” This does not mean that the debt itself is wiped out, but it does mean that that mortgage now becomes an unsecured debt: the lien is removed, and only a portion of the debt will have to be repaid. Once other debts are either removed or diminished through Chapter 13, paying a first mortgage and keeping a home may suddenly become more manageable.
Additionally, some people are concerned about the moral implications of filing Chapter 7 and not paying debts they promised to repay. They may wish to pay their creditors in full, but they simply cannot keep up with the interest payments and penalties. Chapter 13 allows them to pay their secured creditors in full through the restructuring plan, but without having to pay extreme interest rates or late penalties.
A typical Chapter 13 repayment plan is for either three or five years. By the end of that period, the debtor must have made up all debts through the repayment plan. If the debtor does not stick to the plan, the creditors may resume any debt-collection proceedings, such as foreclosure.
There are some additional eligibility considerations for filing Chapter 13. Unlike Chapter 7, you do not have to pass the Means Test to file Chapter 13 (in fact, if you do not pass the Means Test, Chapter 13 is probably your only option).
Chapter 13 tends to work best for higher-income individuals, who will be able to afford the payments required by the repayment plan. To be eligible for Chapter 13, you must have no more than $1,149,525 in secured debt, such as mortgages and car loans, and no more than $383,175 in unsecured debt. (Note that these figures are current as of 2015, but they are revised periodically). If your debt levels are too high, your only option is likely to be Chapter 11 - a more complicated process, intended more for people running businesses, and therefore not addressed in any detail in this article series.
How it works
Some steps of the Chapter 13 process are the same as those for Chapter 7, but for completeness we will list all of the steps in order here.
Take a credit counseling course
The credit counseling course must be taken from an approved non-profit credit counseling agency within 180 days before you file bankruptcy. This can be done in person, by phone, or online, and it usually takes around an hour. The course consists of a one-on-one session with a credit counsellor who will ask you a lot of questions, to verify that bankruptcy is actually the best option for you. The course usually costs between $50 and $100, and you will obtain a certificate which you will need in order to file.
File your bankruptcy petition
Your attorney will help you prepare your bankruptcy petition. In most cases, the Schedules (all of the forms listing your financial information) will be filed at the same time - but you do actually have up to 15 days after the petition is filed to submit them, and up to 30 days to submit the Statement of Intention. This is the stage where you determine which property you can exempt from the bankruptcy. It’s very important that you list everything you are permitted to exempt on your Schedule C, because you will have to pay the liquidation value of any asset you did not exempt to your creditors.
Your proposed Chapter 13 repayment plan is submitted with the petition.
The moment the petition is filed, the automatic stay is imposed, which means that your creditors must stop contacting you and that any collection processes such as foreclosure or repossession or utility disconnection must be stopped immediately. The trustee who will oversee your case will also be appointed shortly after you file, and you will receive a Notice of Trustee from the court.
Notice of Chapter 13 Case sent to all creditors
Within a few days from when you file, the court will send out a “Notice of Chapter 13 Case” to all of your creditors. This notice will provide a summary of your Chapter 13 plan, specify the dates of your Meeting with Creditors and your confirmation hearing, and notify the creditors to state what their claims are against you and the deadlines if they wish to object to your case.
Creditors may file objections
If your creditors have any objections to your repayment plan, they may file their objections with the court, in the hopes of modifying that plan before your Meeting with Creditors.
Start making your repayments according to the plan
Yes, that’s right! You must start making your repayments according to your plan right away - even though your plan has not been approved yet. If your plan is never approved, those payments will be refunded, less any administrative costs.
Submit 4002 documents
As debtor, you will be required by Rule 4002 of the Bankruptcy Code to provide certain documents. You must provide your trustee with a copy of your most recent tax return at least seven days before your Meeting with Creditors. In addition, if any of your creditors have requested a copy of your tax return by 14 days before that meeting, you must provide them with it at least seven days before the meeting. You must also bring to the meeting:
- a government-issued photo ID
- documentation or evidence of your social security number
- evidence regarding current income such as recent pay stubs
- statements for all bank accounts, investment accounts, brokerage accounts, etc.
- proof that you have filed tax returns for the last four years.
If you cannot provide any of the documents listed above, you must provide a written statement that the documentation either is not in your possession or does not exist.
Attend your Meeting with Creditors
The Meeting with Creditors, also known as the “341 hearing” or “341 meeting,” usually takes place within 40 days after you file. Your creditors may or may not attend - depending upon whether they have any questions about your plan, or any objections to it. Often, they will simply file their objections with your attorney rather than attend the meeting. You, however, are required to attend and to bring the documents listed above. If you do not attend, your case will be dismissed.
File a modified plan
Depending upon whether any of your creditors objected to your repayment plan, you may choose to file a modified plan before your confirmation hearing. If you are going to file a modified plan, it must be sent to all of your creditors a minimum of 20 days before your confirmation hearing.
The confirmation hearing is normally held between 20 and 45 days after your Meeting with Creditors. If you failed to give your creditors 20 days notice after modifying your repayment plan, you will have to postpone and reschedule your confirmation hearing.
In most states, either you or your attorney must attend the confirmation hearing. Some states require that that the debtor attend.
At the hearing, the court will address any objections your creditors may have to your repayment plan. Even if there are no objections, the judge may have questions for you regarding your plan. The judge may approve your plan first time around. If there were objections and further issues to work out, the judge may allow more time to modify the plan and a second hearing will be scheduled.
Creditors file Proofs of Claim
Your creditors must file Proofs of Claim documents, which specify how much they are owed, within 90 days following your Meeting with Creditors. If you have any objections to what they claim they are owed, you or your trustee should file those as soon as possible. Any objections you have must be filed at least 30 days in advance of any hearing regarding those objections.
On-going documentation of the plan
Your repayment plan will last for either three or five years. Throughout that period, your trustee will send you documentation updating you on which creditors have filed claims and the value of those claims, how much has been paid to each creditor, and the balance still owing to each creditor. You may also have to provide annual income and expense statements to your trustee, if they are requested by your trustee, the court, the United States trustee, or any creditor.
Attend your Debtor Education Briefing
The “Debtor Education Briefing” or “Financial Management Briefing” must be taken before you make your final payment on your repayment plan. You will not be granted your discharge until you have filed a certificate verifying that you have completed this course.
This course is often confused with the credit counseling course that you started the bankruptcy process with, but it is actually very different. It is more instructional in nature, and it teaches you how to manage your personal finances after bankruptcy. The course takes around two hours to complete, and it can be taken in person, by phone, or online.
Receive your discharge
You will receive your discharge once the the three- or five-year repayment plan has been completed, and once you have completed your Debtor Education Briefing. You may be required to attend a final “discharge hearing,” or the court may simply send you your discharge papers. This means that the debts that you had are now permanently discharged, and your former creditors may never contact you about collecting on them. The final article in this series is dedicated to this final stage: Life After Bankruptcy.
Read on for our next article in this series: Your Chapter 13 Bankruptcy Repayment Plan