Chapter 13 Bankruptcy Rules

The two most common basic types of bankruptcy are chapter 7 and chapter 13. Unlike chapter 7, chapter 13 bankruptcy rules work as a repayment plan (also known as a reorganization) to your creditors over a period of three to five years. You and your creditors agree a schedule of 3 or 5 years to repay, and your assets remain yours – unlike chapter 7  where all your valuable assets, including your home, may have to be sold to pay your creditors.

However, roughly 90% of chapter 7 filings are what are called "no asset" filings, meaning that the debtor has little or no "non exempt" assets, making chapter 7 often more desirable, as you start with the financial slate wiped clean.

Chapter 13 is generally appropriate for those who have got behind in their repayments or missed payments for federal taxes, mortgages, car loans, alimony payments and student loans for example, and are likely to be in a position to repay their debts  over time and with some reorganization, as  opposed to someone who has fallen so far behind and has no means of getting back on  track. In addition, it is also the way to go if you have received a bankruptcy discharge in the past eight years, which prevents a further chapter 7 discharge until those eight years have passed. Chapter 13 affords different forms of protection. This includes protection from creditors and wage garnishments.

Chapter 13 is open only to individuals with regular income. Partnerships and corporations are excluded.

Chapter 7 has the advantage of wiping out all debts and starting with a clean slate without the constraint of a repayment plan. However, under the new bankruptcy laws bought in in 2005, filing for bankruptcy under chapter 7 was made harder. In most cases anyone claiming chapter 7 will be able to do so, but there are more hoops one has to jump through first. A bankruptcy attorney is essential, as they can guide one through all the various bankruptcy forms and ensure that the correct bankruptcy information is provided to the bankruptcy court.

Under the 2005 law, whatever section a debtor decides to file for bankruptcy under, there are a couple of hurdles to jump first:

1. First there is what is called the "Median Test".

If, in the six months prior to filing bankruptcy the debtor's average monthly income is less than the applicable state median income for a family of the same size in the same state, the debtor passes the test and  is automatically eligible for chapter 7 bankruptcy. For filers with higher incomes who fail the median test because their monthly income is greater than the median, the means test is the next step.

The average monthly income for the purposes of the median test also includes the spouse's income, even if the bankruptcy filing is not a joint filing. The exception is if they are legally separated or living apart, where any income provided by the spouse to the debtors household expenses are included.

2. The Bankruptcy Means Test.

The means test only applies to those whose debt is comprised mostly of consumer debt. Consumer debt is defined by the bankruptcy code as "debt incurred by an individual primarily for a personal, family or household purpose." (11 U.S.C. §§101(8)). The idea behind the means test is that anyone who earns more than the median income can afford to pay off at least a portion of their consumer (non secured) debts  and should do so under a chapter 13 plan, rather than simply walk away. The means test was introduced to determine how much an individual can afford to pay.

The means test is complex, and you should seek help from a specialist bankruptcy lawyer.

Whatever the result of the means test, if in the last eight years the debtor was discharged under Chapter 7 they are barred from filing for Chapter 7 again until a full eight years has passed. They may however, have chapter 13 eligibility but there are two exceptions to this rule:

a. If the previous filing did not result in a discharge, in other words the case was dismissed, the eight year rule does not apply. Chapter 7 may be filed.

b. The rule does not apply if your previous bankruptcy filing was a chapter 13 filing, and your creditors received a minimum of 70% of their claims.

Filing a Chapter 13 Bankruptcy.

In order for an individual to qualify for chapter 13 bankruptcy, their debts must fulfil certain criteria. The amount of unsecured debt must not exceed $307,675, and secured debts are less than $922,975.

If a debtor received a discharge in a chapter 7, 11 or 12 case less than four years ago, or a chapter 13 less than two years ago. A debtor cannot eliminate their debts under a chapter 13 filing, however, a chapter 13 filing will keep the creditors at bay, providing the repayment plan is completed on schedule over 3-5 years.

Priority claims, claims such as alimony and back taxes have to be paid in full over 3-5 years. If it is shown that the amounts involved are too great to be paid off in that time, there is no point in filing chapter 13; as such debts MUST be paid within 60 months.

The repayment plan is subject to two tests:

1. Best Interest Test.

This applies to non-exempt property that could be liquidated under chapter 7. Any chapter 13 repayment plan must demonstrate that the creditor will receive at least as much as they would have done under a straight chapter 7 liquidation.

2. Best Efforts Test.

It is usually impossible to repay an individual's creditors in full, and this is generally accepted. However, the plan should demonstrate that you are paying as much as you possibly can. This gets more complicated if the individual's income is more than the state's median. In this case, one's allowable expenses (those deducted from the debtor's current monthly income to arrive at their monthly disposable income) are determined by the IRC's Financial Standards, and any repayment plan must run for a full 5 years.

Chapter 13 - The Process

Before filing bankruptcy, and within 180 days of filing, it is now compulsory to undergo approved credit counselling from an approved credit counsellor and obtain a certificate to certify the fact. Failure to provide the bankruptcy courts with a certificate can result in the case being dismissed.

As soon as bankruptcy is filed, "automatic stay" kicks in. This prevents creditors contacting you for payment and any sort of wage garnishment.

After filing, the individual’s federal income tax returns must be supplied to the trustee and any creditor who requests them seven days before the 341 meeting of creditors. The previous four years federal, state and local tax returns must be filed with the tax authorities.

The court requires that the repayment plan must be submitted within 15 days of the petition, and the first payment is due after 30 days.

There is a requirement to attend the § 341 meeting. The 341 meeting of creditors allows the chapter 13 trustee to examine the repayment plan to make sure that the chapter 13 debtor is likely to be able to maintain the repayments, and that the repayments represent an act of good faith in trying to repay the creditors as much as possible. This is all about making the plan work. After the meeting of creditors, creditors have 30 days to make any objections known.

After the 341 meeting, the court trustee holds a "confirmation hearing", where the repayment plan is approved or rejected. If the trustee is in agreement and there are no objections from creditors, the repayment plan is approved. The debtor only has to attend the meeting if the trustee or a creditor objects.

The debtor's current monthly income details, (pay stubs for example), for the past 60 days before bankruptcy must be filed with the bankruptcy court.

A trustee approved financial management course must be undertaken after filing bankruptcy. This is a condition of the discharge.

The debtor has to file update income and expense accounts every year that the repayment plan is in force.

When the plan is paid, there is a discharge hearing that eliminates any outstanding debt.

The bankruptcy judge may deny a discharge for a number of reasons:

1. The debtor within the previous four years received a discharge under a chapter 7, 11 or 12 filing, or received a discharge under a chapter 13 filing within two years.

2. The debtor failed to make the payments as per the repayment plan.

3. Failed to file the correct tax returns with the bankruptcy court.

4. Failed to attend and complete an approved financial management course.

The bottom line to anyone wanting to file bankruptcy is to employ a bankruptcy attorney and be 100% truthful and accurate with them. This way a debtor is far less likely to have their bankruptcy dismissed. Bankruptcy is right for many individuals in financial difficulties, and should not be treated as a last resort, as any action taken to avoid the inevitable often makes the consequences more difficult. This is another key reason as to why a bankruptcy lawyer should be consulted.

One's credit rating is affected by any type of bankruptcy. After bankruptcy, it is vital that one does all one can with one's fresh start to work towards a better credit rating.

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