Sunday, March 27, 2011

Choosing between Chapter 7 and 13 Bankruptcies

Consumer bankruptcy cases are generally governed under chapters 7 and 13 of the Bankruptcy Code (while individuals can also file under chapter 11, this is more  rare and expensive).   A natural question consumers ask is – what is the difference between chapters 7 and 13 and which is the best one to file under?

Chapter 7 cases are typically known as “liquidation bankruptcies.”  That means that the Court, through a Trustee appointed by the United States Department of Justice, will look at a debtor's assets and liabilities and decide which of those assets can be liquidated in order to satisfy those liabilities.  Certain assets will be deemed to be “exempt,” meaning that they cannot be liquidated in a chapter 7 case.  Each state has its own set of exemptions and some of them allow to debtors to use a set of federal exemptions.  After the Chapter 7 Trustee looks at the assets, she will deem the case a “no asset” case if there are no assets to liquidate.  The majority of cases are “no asset” cases.  If the Trustee finds assets to liquidate, she will liquidate those assets to distribute to creditors.  After the Trustee administers the case and either deems it to be “no asset” or liquidates the assets, the debtor will generally receive a discharge and the case will be closed.

In contrast to chapter 7 cases, which generally last 3-4 months, chapter 13 cases will last between 3-5 years.  Chapter 13 cases are known as “wage earner” cases and involve monthly payments to a Chapter 13 Trustee to pay back debts.  In order to determine the monthly payment amount, the Chapter 13 Trustee will first look at the debtor's monthly income and then subtract the necessary monthly expenses, such as mortgage, food costs, etc.  The resulting number is the debtor's monthly “disposable income” and is generally what the monthly payment will be.

The next logical questions is – should a debtor file under chapter 7 or 13?  Lots of times, chapter 7 is preferable to individuals because it is quicker, less costly, and involves less Court supervision.  However, in order to file under chapter 7, an individual must qualify to do so.  There are 2 ways to do this:
  1. If an individual or married couple’s annual household income is less than the median income for a same-sized household in the same area, they can file under chapter 7.
  2. If an individual or married couple cannot qualify under the first option above, their incomes and expenses are plugged into a complicated mathematical formula known as the Mean Test to see whether they qualify.  Any bankruptcy attorney should be able to quickly do this computation for you.
There are certain reasons an individual may choose to file under chapter 13, however.  For instance, chapter 13 allows an individual to pay back mortgage arrears as part of her plan payments and, in certain situations, even wipe away a second mortgage on a home.   Also, if an asset, such as a valuable automobile owned free and clear, would be subject to liquidation under chapter 7, an individual may want to file under chapter 13 to protect such assets.

This is only a brief overview of chapters 7 and 13 and some of the considerations to take into account when deciding under which chapter to file.  However, it should provide a basic foundation when discussing which bankrputchy chapter may be right for you with an attorney.