Bankruptcy is the legal process through which individuals and businesses can eliminate their debts or repay them under the protection of the bankruptcy court. It allows people or businesses to make a fresh start after experiencing financial difficulties.
There is more than one type of bankruptcy. The most common types of bankruptcies are (1) Chapter 7 proceedings (a liquidation of debt, eliminating most debt but exposing the debtor to loss of property) and (2) Chapter 13 proceedings (a court-supervised reorganization of debt, reducing a debtor’s monthly payment and allowing repayment to creditors over a specified period of time). Chapter 11 proceedings are available for debtors who are not eligible to file either a Chapter 7 or Chapter 13 bankruptcies.
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Chapter 7 proceedings in Florida are discussed in a separate article.
A Chapter 13 proceeding is a reorganization of debt in bankruptcy. In a Chapter 13 proceeding, the debtor will be allowed to propose a plan that will decrease the amount of debt and allow for debt payment at levels that the debtor can afford by extending the debt over a period of three to five years.
Debtors must take a credit-counseling course within 180 days of filing bankruptcy as a condition to filing.
Availability of Chapter 13 Bankruptcy
Chapter 13 bankruptcy is unavailable if the debtor’s secured or unsecured debt is excessive; in that case, only Chapter 11 relief is available; currently to be eligible to file under Chapter 13 unsecured debt must be less than $360,475.00 and secured debts less than $1,081,400.00. These debt limits are subject to annual cost of living increases. Chapter 13 reorganization bankruptcies are more expensive and complicated than a Chapter 7 bankruptcy.
Limitations of Filing
Only individuals can seek protection under a Chapter 13 bankruptcy, although small businesses can use a Chapter 13 to reorganize if they are sole proprietorships and are owned either by an individual or a married couple. Corporations and partnerships, (other than a partnership between a husband and wife) do not qualify for Chapter 13 reorganizations.
Chapter 13 Petition
A Chapter 13 bankruptcy begins with the filing of a petition and a proposed payment plan with the United States Bankruptcy Court. The law requires that the payments that will ultimately be made to creditors will have a value that is at least equal to what would have been distributed in a Chapter 7 liquidation case. During the Chapter 13 proceeding, debtors are permitted to keep all of their assets while the plan is in effect and to ultimately retain those assets after the debtor has complied with the Chapter 13 plan.
As of the date the petition is filed, all of the debtor’s assets come under the protection of the bankruptcy court. This means that creditors may not take any collection efforts against the debtor unless an order is obtained from the bankruptcy court; this is referred to as an ‘automatic stay’. The automatic stay will afford the debtor immediate relief from collection efforts by creditors. When the bankruptcy petition is filed, creditors are notified of the filing and with some exceptions, all lawsuits against the debtor are stopped and creditors cannot enforce any judgments that were not collected before the bankruptcy filing. The automatic stay also prevents creditors, except for taxing authorities, from putting a lien on the debtor’s property.
Advantages of Chapter 13 Filing
There are several advantages to filing a Chapter 13 proceeding as opposed to a Chapter 7 liquidating bankruptcy.
Retention of Assets
A debtor will be able to retain and use all of his/her assets as long as payments are made to the trustee as agreed.
‘Cram Down’ of Secured Debt
A debtor may own an asset that he/she wishes to retain, but the value of the asset may be less than the amount owed on it. This situation can be dealt with in a Chapter 13 proceeding. Certain types of secured debts may be ‘crammed down’ by the Bankruptcy Court. For example, if the outstanding balance on an automobile loan is $12,000 but the value of the car is only $6,000, the court will approve a cram down of the loan to $6,000 and monthly payments will be reduced to reflect the lower loan balance.
A debtor cannot modify the rights of a creditor who has a lien on the debtor’s home. This means that the debtor will have to make the same payments each month as were originally contracted for. While non-residential mortgages may be ‘crammed down’, the court will, however, allow three to five years to make up payments that may have been missed on a mortgage. Inferior mortgages (second and third liens, HELOCS, etc.) may be ‘stripped out’ or ‘crammed down’ if the value of the property is equal to or less than the first mortgage. A qualified attorney or other professional should be consulted to determine whether inferior mortgages can be stripped out, crammed down, or eliminated.
Chapter 13 bankruptcies also allow the debtor up to five years to pay money that may be owed to IRS.
Chapter 13 Plans
Under the rules for a Chapter 13 filing, the debtor must prepare a plan providing for payment in whole or in part to creditors. The plan is submitted to the court and to a Chapter 13 trustee, who is appointed to handle Chapter 13 cases. The trustee verifies the accuracy and reasonableness of the plan and is in charge of distributing the proposal to the creditors. Creditors will have an opportunity to challenge the plan if they believe it is unreasonable. The ultimate issue is whether the debtor is making a “good faith” effort to repay debt. Once the court approves the payment plan, the debtor will make regular monthly payments to the trustee who distributes the payments among the creditors according to the plan.
If payments are not made as agreed, the creditors may seek to have the case converted to a Chapter 7 bankruptcy or simply to have the Chapter 13 case dismissed. If the case is dismissed, collection efforts by the creditors will again begin.
Thirty days after the bankruptcy plan is filed the debtor is expected to start making payments to the trustee. Some districts require payments to be deducted from the debtor’s paycheck. Creditors must be notified that the plan has been filed so that they will be able to oversee their collection activities.
After the plan is filed, the first meeting with the trustee will take place to determine whether the debtor’s budget allows for reasonable repayments. After the creditors meeting, the trustee will recommend or oppose confirmation (approval) of the plan. If the trustee believes that the proposed plan is impractical or not made in good faith, the trustee will oppose confirmation. The judge ultimately decides whether to grant a Chapter 13 reorganization, however, the recommendations of the trustee are given great weight. The trustees are paid up to ten percent of what is paid towards debt, i.e., ten dollars of every one hundred dollars that is paid to creditors.
Creditors are treated differently in a Chapter 13 proceeding than in a liquidating bankruptcy (Chapter 7). Debts are divided into three major categories: priority, secured and unsecured claims.
Priority claims must be paid in full over the term of the plan. Taxes, alimony and child support are examples of priority claims.
Secured debt, that is debt that has a specific asset such as a car or shanghai houses pledged to insure payment, also receives special treatment. For secured debt other than a home mortgage, the debtor is allowed to pay the value of the collateral over the term of the plan as opposed to paying the principle amount of the debt (see ‘cram down’, above).
Meeting of Creditors
After the plan is filed and after the first meeting with the trustee, a creditors meeting will take place to discuss how the creditors’ claims are being treated. The tone of this meeting is usually informal, however the creditors’ attorneys may ask questions.
Proof of Claim
For creditors’ claims to be considered, the creditor must file a ‘proof of claim’ with the court within certain specified times. If the creditor fails to file a claim, the claim may be considered forfeited. Creditors generally have ninety days after the first meeting of creditors to file their proof of claim.
After meetings with the trustee and creditors, a confirmation hearing is scheduled before the judge who will determine whether the reorganization plan complies with the bankruptcy code. Specifically, the court will determine whether the plan is proposed in good faith, whether the unsecured creditors are receiving as much as they would have received in a Chapter 7 bankruptcy and whether the secured creditors have either received their collateral or will be paid the value of the collateral over the term of the plan. The court will also determine whether the debtor has the ability to make payments under the plan.
If an unexpected emergency or event takes place which makes it impossible for the debtor to continue making payments in accordance with the plan, a modification may be applied for requesting that the court extend the time over which the debtor is required to make payments and/or for a reduction in the amount that the unsecured creditors are to receive.
If the Chapter 13 petitioner is unable to make payments in accordance with the plan, the debtor may convert the case to a straight liquidating Chapter 7 bankruptcy.
Occasionally, and rarely, if the debtor’s failure to comply with the Chapter 13 reorganization plan is due to circumstances that were not the debtor’s fault or were beyond the debtor’s control, and if the unsecured creditors have received as much as they would have received under a straight liquidating bankruptcy, the court may discharge all remaining debt.
Hoffman, Larin & Agnetti, PA offers a free consultation for your bankruptcy issues and questions. Let us evaluate the specific facts of your case and make recommendations that address you individual issues. Convenient payment plans to meet your budget are available.