Articles Posted in Chapter 13 Bankruptcy

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As followers of this Blog know, Chapter 7 is the most common type of bankruptcy. This is the bankruptcy that discharges your debts. In exchange for that, a trustee is appointed who liquidates certain assets to pay your debts. However, you get to keep other items, i.e. the trustee cannot take them. These include your home with equity of up to $150,000, your car with equity of up to $6000, most household goods and appliances, a computer, and retirement plans.

A Chapter 13, on the other hand, is a reorganization bankruptcy where you pay your disposable income to the trustee for 3-5 years in order to obtain your discharge. Debts do not necessarily have to be paid in full. Disposable income means the income you have left over after paying your reasonable living expenses such as house payment, food, utilities etc. Paying $1000 per month to play golf would not be a reasonable expense.

When looking at these 2 types of bankruptcies, many clients ask me why someone would ever file a Chapter 13? After all, who would want to make payments for 5 years in a Chapter 13, when there are no payments in a Chapter 7 and you get your discharge in 4-5 months? The answer is that you can accomplish things in a Chapter 13 that you cannot do in a Chapter 7. Here are some of the reasons someone would file a Chapter 13 rather than a Chapter 7.

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When the real estate market crashed, starting in 2007, we had many homeowners stuck in a situation where their homes plummeted in value so much that there was no equity at all. Thousands of homeowners walked from their homes, allowing the properties to be foreclosed upon.

A lien strip is where the lien of a lienholder, other than the first mortgage, is stripped and ultimately changes the status of the obligation owed to the lienholder from “secured” to “unsecured”.

The legal authority for lien stripping in Chapter 13 is 11 U.S.C. § 1322(b)(2). and 11 U.S.C. § 1328(a). § 1322(b)(2) allows a wholly unsecured lien on a debtor’s principal residence to be modified. § 1328(a) allows any unpaid portion of the claim to be discharged as an unsecured debt.

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If tax debt is a substantial portion of your liability and you can qualify, you may want to consider filing a Chapter 13 bankruptcy. Even if the taxes are secured, the majority of courts have held that tax penalties are not secured and are never a priority. The reasoning is that the courts are not willing to penalize the unsecured creditors by giving priority to the penalties. This also applies to interest that has accrued on the penalties. Therefore, the superdischarge remains in effect for tax penalties and the interest that accrues thereon no matter when assessed or when the triggering event happened. (Section 523 (a)(7)(A) and (B); and Section 1328(a). Contrast this with chapter 7 where penalties are dischargeable only if the triggering event causing the penalty is over 3 years old.

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These are the types of debts that are discharged in a chapter 13 bankruptcy that are NOT dischargeable in a chapter 7 bankruptcy:

1. Debts that weren’t or couldn’t be discharged in a previous case.

2. Court Fees

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Many assume that all debts are paid back in a chapter 13 bankruptcy. The reality is that most chapter 13 bankruptcy filers don’t pay very much of the dischargeable debt back. Most of it is wiped away at the end of the case.

The common follow up question is then…what type of debt is not dischargeable in a chapter 13 plan. Here is the list:

1. Criminal Penalties – Fines or Restitution resulting from a criminal conviction can’t be discharged.

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Amounts paid on certain debts secured by assets can be reduced in a chapter 13 bankruptcy. The most common are:

1. Car loans entered into more than 910 days prior to the filing of a chapter 13 bankruptcy.

2. Second mortgages on homes where the home value is less then the debt owed on the first mortgage.

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When a chapter 13 case is filed, a “plan” must be proposed that tells the court and creditors how each debt is going to be treated i.e. paid or not, how much and when.

How each type of debt is treated, depends on the bankruptcy code and case law. Generally, a chapter 13 filer must have enough income to pay the following in full:

1. Living Expenses
The law assumes that you need a certain amount of money to pay for your “reasonable” living expenses. What is considered to be reasonable is litigated around the country each week. In Arizona, your reasonable living expenses typically includes: mortgage, food, utilities, insurances, out of pocket medical care costs, upkeep on home, hoa dues, property tax, child care, spousal maintenance, daycare, costs related to maintaining your small business, or related to your employment, gas and upkeep on car, laundry, mandatory withholdings at work, car lease and a few other items. These items are paid outside the plan of course.

2. Car Loan
Car payments are paid through the chapter 13 plan as part of the plan payment. The plan will often change the treatment of the car loan creditor. The law often allows for the debtor to pay less in principal and or interest and the length of the loan payout is either shortened or lengthened.

3. “Priority” Debt
Certain taxes, child support, spousal maintenance are the most common debts that must be paid in full through the plan.

4. Tax Lien
If a taxing entity has properly recorded a tax lien and the debtor has assets with value, the tax lien will have to be paid through the plan with interest.

5. Mortgage Arrears
If behind on a home loan, the amount that is owed will be paid as part of the plan payment and any foreclosure will be stopped while the payments are made.

6. Value of Non Exempt Assets
If the debtor has a asset that is not considered “protected” under state law, in order to create a viable chapter 13 plan, unsecured creditors must be paid it’s value during the plan. If the debtor has an antique jukebox worth 10000.00, these creditors will need to be paid 10000.00 during the plan or give the jukebox up to the chapter 13 trustee for sale and distribution as in a chapter 7 bankruptcy.
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If a car was purchased more than 910 days prior to the date a chapter 13 bankruptcy case is filed and the car is worth less then what the bank is owed, the debtor should be able to change the amount it pays the creditor on the car in the chapter 13 case as follows:

1. Instead of paying the full loan amount, the debtor can pay the bank the value of the car over the length of the chapter 13 plan.

2. Instead of paying the original interest rate, the debtor can pay the bank the “prime plus rate” or the national prime rate plus a specific rate adjustment for risk of non payment. (hovers at around 4.5 to 5.0% now) See Till v. SCS Credit Corp 541 U.S. 465, 124 S. Ct. 1951, 158 L.Ed.2d 787 (2004). (Can the debtor cram down the interest rate on a car purchased within 910 days? topic for another entry)

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A chapter 13 bankruptcy requires that an “above median” debtor take a “means test” in order to determine how much that debtor must pay to unsecured creditors during the plan. This amount is called “disposable monthly income”

A key to obtaining a favorable i.e. low number is to be able to show the highest “budget” possible when taking this test.

In an attempt to do so, many bankruptcy filers throughout the U.S. have been showing as part of their budget the debt owed on cars they know will be surrendered, with some mixed results.

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If you file for bankruptcy, all collection activity by creditors must stop with a few exceptions. The part of the law governs this is called the “automatic stay”.

So if a creditor is trying to collect from your or sue you based on a credit card, medical, breach of contract or other debt, they must stop all activity against you once you file.

They can’t file a lawsuit, continue in a lawsuit, record a lien, report the debt to the credit reporting agency or seize property without permission from the court.