Deciding Whether to File Chapter 7 or Chapter 13

Once it has been determined that the best answer to a client's financial problems is to file bankruptcy, a determination must be made as to which Chapter to file under.

The following information is taken from The Attorney’s Handbook on Consumer Bankruptcy and Chapter 13 by John H. Williamson and published by Argyle Publishing Company, Lakewood, Colorado. I recommend this book to those of you who think you may be working in the area of bankruptcy some day.

Many factors need to be considered. The following information will give you an idea of the counseling the attorney will provide the client.

1. Dischargeability of the debtor’s debts. There are 14 classes of debts that are not dischargeable under Chapter 7. These include things like taxes; debts incurred under false pretenses; debts that were not listed in the debt list; debts to a spouse, former spouse, or child for alimony, maintenance or support; debts for willful and malicious injury by the debtor; debts for an education benefit overpayment or loan; debts for the payment of restitution in a federal criminal case; debts for embezzlement, larceny, or fraud; debts for fees, costs and expenses imposed by a court in connection with the filing of a case; debts owed to a state or municipality that are in the nature of support and enforceable under 42 U.S.C. 601 et. seq.; etc. Under Chapter 13, debts for alimony, maintenance or support, debts for death or personal injury related to drunk driving, debts for criminal fines and restitution, most debts for student loans, debts not covered by the plan, and installment debts maturing after the close of the plan are not dischargeable. If a debtor has substantial debts that are dischargeable under Chapter 13 and non-dischargeable under Chapter 7, Chapter 13 may be preferable to Chapter 7 for the debtor. The eligibility of the debtor for a discharge may also be a factor to consider. A person who has received a discharge in the last six years is not eligible for a Chapter 7 discharge, but is eligible for a Chapter 13 discharge.

2. Retaining the debtor’s secured property. A debtor who is in default on an important secured obligation, such as a home mortgage or an automobile loan, is usually permitted to cure the default within a reasonable period under Chapter 13 and thereby retain the secured property. The curing of defaults in secured obligations is not usually feasible in a Chapter 7 case. However, under Chapter 7 the debtor is permitted to redeem or set aside liens against certain exempt personal property.

3. Retaining the debtor’s nonexempt assets. Under Chapter 7 a debtor must turn all nonexempt property (or its cash equivalent) over to the trustee. Under Chapter 13 a debtor is usually permitted to retain his or her nonexempt property, provided that meaningful payments are made to unsecured creditors. Thus, if a debtor has a large equity in his or her home or important nonexempt assets, Chapter 13 may be preferable.

4. The debtor’s income. In order to qualify under Chapter 13, the debtor must have "regular income," which is defined as income sufficiently stable and regular to enable a debtor to make payments under a Chapter 13 plan. If a debtor is unemployed or otherwise devoid of regular income, a Chapter 13 case may not be feasible. On the other hand, Chapter 7 may not be feasible for a consumer debtor who has sufficient income with which to repay a significant portion of his or her debts within a reasonable period. The Chapter 7 case of such a debtor may be dismissed by the court as an abuse of Chapter 7.

5. The debtor’s attitude toward his or her debts. If a debtor has a sincere and realistic desire to repay all or most of his or her unsecured debts; Chapter 13 is usually preferable. If a debtor desires to repay only one or two debts, the best practice may be to file under Chapter 7 and later reaffirm the debts that the debtor wishes to repay. Finally, Chapter 7 is preferable for the debtor who simply wishes to obtain a fresh financial start by discharging all debts as quickly and inexpensively as possible.

6. The time and expense factor. Chapter 13 cases normally last from three to five years, with a discharge granted at the close of the case. Chapter 7 cases of typical consumer debtors last about six months, and a discharge is normally granted about four months after the case is filed. In Chapter 13 cases, the attorney’s fees and administration expenses are considerably more than in Chapter 7 cases. If a debtor is unable or unwilling to make meaningful payments and otherwise comply with a Chapter 13 plan during the entire duration of the plan and to bear the additional expenses involved, a Chapter 13 case may not be in the debtor’s best interest.

Summary

Issue	Chapter 7	Chapter 13
Dischargeability of Debts	greater restrictions, e.g., taxes, fines	payment plan created
Retaining secured property	some possible	all possible
Retaining non-exempt assets	not likely	likely, if payments are made on plan
Income of debtor	if have good income, can't file Chapter 7	must have income to file Chapter 13
Debtor's attitude toward debts	relief is preferred -- fresh start	desire to pay as much as possible
Time and expense	approximately 6 months;  discharge in 4 months	discharge in 3-5 years; costs more in administrative and attorney fees

In filing for bankruptcy, timing is also an issue that the attorney will consider. When to file a Chapter 7 bankruptcy depends on the status of the debtor’s dischargeable debts, the nature of nonexempt assets, and actions taken or threatened to be taken. The following "rules" are typical of the advice a debtor might receive.

1. Do not file until all anticipated debts have been incurred, e.g., ongoing medical expenses. Debts incurred after the bankruptcy is started may not be included in the discharge.

2. Do not file until the debtor has received all nonexempt assets to which he/she is entitled, e.g., tax refunds would go to the trustee if received after filing.

3. Do not file if expecting to receive an inheritance, life insurance or divorce property within the next 180 days (6 months). The property would go to the trustee unless it is exempt.

4. If a hostile creditor action threatens exempt assets or future income (e.g., foreclosure or garnishment), file immediately to take advantage of automatic stay. Creditors who intentionally violate the stay may be held in contempt of court and may be liable to debtor for damages. As soon as a petition for bankruptcy is filed, creditors are notified and they may not harass the debtor for payment. Any creditor who knowingly contacts a debtor who has filed for bankruptcy relief should be reported.

Last edited December 29, 2002.