One of the more common questions potential bankruptcy filers have regards the difference between Chapter 7 and Chapter 13. For those who have never filed for bankruptcy protection, or known someone close to them involved in a bankruptcy filing, it may come as a surprise that there are options. The answer to, “What type of bankruptcy would you like to file?” is often, “Excuse me?”
If you are feeling the need to excuse yourself from the conversation because you don’t know enough about bankruptcy to feel comfortable discussing the different types, stick around. We’ll point out the principal differences between the two most common types of bankruptcy: Chapter 7 and Chapter 13.
Chapter 7 is sometimes called liquidation or “straight” bankruptcy. Petitioners who file for Chapter 7 bankruptcy protection must surrender “nonexempt” (any assets not protected from forced liquidation by statute) assets to the Chapter 7 trustee, who liquidates the assets and distributes the proceeds to unsecured creditors. Examples of exempt assets include: domestic support benefits, state or federal benefits, specific amounts for a primary residence and vehicles.
All income earned by a Chapter 7 debtor after the start of the case is for the debtor to keep. The overwhelming majority of consumer Chapter 7 cases are so-called “no-asset” cases because the debtor does not have any nonexempt and unencumbered property that might be used to pay creditors.
Debt that is otherwise not paid in a Chapter 7 case is discharged (with a few exceptions). That means the debtor is no longer liable for debt that is discharged through Chapter 7 bankruptcy and creditors are forever more prohibited from trying to collect the debt discharged. To file for Chapter 7, petitioners generally must pass an income eligibility test.
Petitioners who do not pass the income eligibility test can still file for bankruptcy protection. They simply move on to Chapter 13 bankruptcy in order to obtain the necessary debt relief. This bankruptcy is often referred to as the “wage-earner’s plan.” In contrast to Chapter 7, in a Chapter 13 case the debtor keeps all nonexempt property but commits for a specified time period to pay a portion of his or her income for distribution among unsecured creditors.
The time period is designated by the court and is either three or five years. The percentage of unsecured debt repaid during the designated time period must be equal to or more than what the creditors would have received if the debtor had instead filed for Chapter 7 bankruptcy. When petitioners successfully complete the payment program as designated by the court, any remaining unsecured debt is discharged (again, with a few exceptions).
One of the major differences between these two common types of bankruptcy is the effect that they have on foreclosure. Filing a Chapter 7 bankruptcy petition will delay foreclosure, but it will not prevent it from happening unless the property is liquidated to satisfy the mortgage debt or the debtor reaffirms his obligation to repay. Filing for Chapter 13 bankruptcy provides petitioners with the opportunity to catch up on their mortgage arrearage in full as part of the court approved repayment plan.
If petitioners successfully catch up on their mortgage arrearage, the foreclosure is prevented and the petitioner ends up “up to date” on their mortgage. For these reasons, persons with substantial nonexempt equity in their residence are ill-advised to file for Chapter 7 protection.
If you know someone who may be contemplating bankruptcy Code, please have them call or email me so that we can discuss the details of their situation and determine which type of bankruptcy protection would suit their needs.
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