Chapter 13 Filings

April 13, 2006

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Among the types of bankruptcy filings, in a Chapter 13 proceeding, an individual debtor with regular wages or income agrees to pay back a portion of his or her debts over a period of three to five years. This chapter is available only to individuals.

The debtor proposes a plan that usually involves paying secured creditors the value of their liens, and paying unsecured creditors a fraction of their claims (e.g., 20 percent) or nothing at all. The plan must treat each creditor within a class (e.g., secured creditors) the same, but it may treat creditors in separate classes differently.

Why would a debtor choose Chapter 13? Traditionally, most do not. But a new bankruptcy reform law went into effect on October 17, 2005. Debtors inclined to choose Chapter 7 liquidation now must submit to a means test to determine their eligibility. If their income is above a certain threshold, debtors must go into a Chapter 13 repayment plan.

In some cases, Chapter 13 may be the better alternative when the debtor has defaulted on secured loans (e.g., a home mortgage, or car loan) and is unable to make up the default, or pay off the lien, in one lump sum payment (as would be required in Chapter 7), but is also unwilling to surrender the property to the secured creditor. In Chapter 13, the debtor can make up the default or pay off the lien over three to five years, rather than immediately in one lump sum.

Absent this one particular circumstance, Chapter 7 will almost always be the superior alternative. But according to new laws, many debtors will not be eligible for it. A major disadvantage of Chapter 13 is the fact that the debtor must account for all of the income or assets received during this three- to five-year period.