Chapter 13 Individual Wage Earners Bankruptcy

Chapter 13 cases are “pay out” rather than “sell out” cases. As a general matter, the trustee does not sell the debtor’s nonexempt assets. Instead the debtor is allowed to keep them as long as the debtor is paying at least the value of these nonexempt assets to creditors over time under the plan. In a sense, the debtor is buying back these assets from creditors over the course of the plan. Chapter 13 bankruptcies allows a debtor to keep all of his assets but in return for that benefit, the debtor agrees to a plan in which he agrees to turn over a portion of future income to pay creditors over a 3-5 year period. Over that period, the debtor will pay all allowed secured claims in full, all priority claims in full, and will pay a distribution to unsecured creditors as well, assuming the debtor has sufficient disposable income to do so. In Chapter 13, post petition income, and other assets become part of the estate. In order to qualify for a Chapter 13, a debtor must have future disposable income over and above his current living expenses, to pay the obligations in the plan.

In Chapter 13 cases, commonly litigated issues are: (1) the value of allowed secured claims, or really, the value of the underlying collateral; (2) priority treatment of certain claims; (3) whether the debtor has contributed all of his disposable income to the plan, which is required under Chapter 13; and (4) the value of exempt property, since it bears on the minimum distributions the debtor must pay under the plan. The Chapter 13 trustee plays a substantial role in the success of Chapter 13 cases and is often the one to object to the plan and otherwise ensure that it is in compliance with the Code. If all the rules contained within the Code are met, the court approves the plan and the debtor begins making the scheduled payments.

Elements of an Acceptable Plan

Secured creditors must be given payments that satisfy the statutory requirements for present value of the allowed secured claim. Secured debt is secured only to the extent of the value of such creditor’s interest in the property. The process of reducing the loan to the value of the collateral is called “cramdown”. One of the biggest benefits of Chapter 13 is the ability to cramdown the secured debt to the value of the collateral.

There are a few secured creditors who are entitled to payment in full (home mortgage on primary residence, security interest created within 1 year, and purchase money security interests in vehicles purchased within 2 ½ years).

Priority unsecured claimants are entitled to full payment, while general unsecured creditors are pooled together and do not get any special protection. There are four tests that are imposed by the Code to ensure protection of unsecured creditors; (1) the best interests test; (2) the disposable income test; (3) the good faith test; (4) the feasibility test. The “Best Interests” test protects holders of unsecured claims by guaranteeing a minimum level of payment in Chapter 13. The present value of proposed payments to a holder of an unsecured claim must be at least equal to the amount the creditor would have received in liquidation. In a typical consumer Chapter 7 case, the unsecured creditor gets nothing, so in most cases the test is easily satisfied. The disposable income test also requires the debtor to contribute all of his projected disposable income to the plan. The good faith test provides that a plan be proposed in good faith and not by any means forbidden by law. The feasibility test requires the court to find that the debtor will be able to make all payments under the plan and to comply with the plan.

Eligibility Issues

Chapter 13 bankruptcy is available to individuals with regular income and non-contingent and liquidated liability. Individual means a debtor must be an individual with regular income, Chapter 13 is not available to corporations. The regular income requirement is not strictly enforced. Regularity and stability are more important than the type or source of income. Noncontingent and liquidated liability means that a claim is subject to ready determination and precision in computation of the amount due.

The means test of the code has been amended to provide for dismissal of a Chapter 7 case or conversion to a Chapter 13 upon finding of abuse by an individual debtor. Abuse can be found in 1 of 2 ways: (1) Through an unrebuttable presumptions of abuse arising under the means test; (2) on general grounds of bad faith. The means test says every debtor who files for Chapter 7 and is an above median debtor in that state and has at least $166.67 ($10K for 5 yrs) in current monthly income available after allowed deductions then abuse is presumed regardless of the amount of the debtors unsecured debt. If the debtor has at least $100 a month of such income (6000 for 5 years) abuse is presumed if the income is sufficient to pay at least 25% of the debtors unsecured debt over 5 yrs.

Dismissal

The Code provides that a Chapter 13 debtor will be denied a discharge if he or she received a discharge in a case under Chapter 7, 11, or 12 during the 4 year period preceding the date for the order for relief. This means no so called “Chapter 20’s” (a Chapter 7 followed soon by a Chapter 13 bankruptcy).