Bankruptcy in Chapter 7

The purpose of filing a petition in Chapter 7 Bankruptcy is to give an honest debtor a fresh start. The idea is to eliminate the unsecured debt and keep all the debtor's property or as much as possible by taking the maximum possible exemptions.  Under this Chapter a trustee is required to liquidate the debtor's non-exempt assets.  Exempt assets generally consist of  furniture, furnishings, personal effects, such as clothing, and, with certain monetary limitations, automobiles, jewelry, the residence and other items.  Pre-bankruptcy  exemption analysis is often quite important, and can determine whether Chapter 7 Bankruptcy protection is for you.

An individual debtor will usually receive a discharge within about 3 months from filing.  A discharge relieves the debtor from personal liability on his or her obligations (e.g. credit card debt, deficiency liability on a repossessed car or certain lawsuit damages).  It does not prevent enforcement by a creditor against  property (e.g. seizure, sale)  that is security for its claim or that is leased. The enforcement of a secured claim or right to obtain possession under a lease is, however,  temporarily prevented  by an automatic stay that commences on the filing of the bankruptcy and continues for some period of time while the bankruptcy is pending.  Smart debtors will use this period of time to bring their financial house into order.

Certain debts are excepted from discharge. Debts arising from certain fraud, or willful and malicious injury are excepted from discharge but only (with a couple of exceptions) if the creditor  prevails in a  law suit seeking such determination that is timely filed during the bankruptcy proceedings.   Other debts  are automatically excepted from discharge without the need to file any suit.  These include alimony, child support, certain taxes, drunk driving liability, and student loans. 

A Chapter 7 can be filed by an individual with or without his or her spouse, by a corporation, partnership or other entity.  Only individuals, however, will receive a discharge. For individuals Chapter 13 Bankruptcy is sometimes an alternative and sometimes a compulsory alternative to a Chapter 7.

6. No discharge for a partnership or corporation. 

Bankruptcy in Chapter 13

In a Chapter 13, an individual  pays the creditors through a trustee under a Plan confirmed by the Court over a period of up to five (5) years.  Except for regular long term mortgage payments and sometimes car payments, the debtor pays the creditors by way of the trustee. The payments are made from the debtor's income, and are usually taken out of their paycheck.  The debtor will receive a discharge from the debts upon completion of the Plan.

Certain debts are excepted from the discharge.  These include alimony, child support and government backed student loans.  Priority claims (e.g. recent income tax, alimony and child support) must be paid 100% under the Plan.

Under the Plan, secured debt (described below) must be paid in full plus (not necessarily the contract rate) interest.  On the debtor's residence, however, the regular (contract rate)  payments on any long term note and deed of trust must be maintained with such payments being made directly to the lender. Any pre-bankruptcy default  on the note and deed of trust is cured by payments made via the trustee for a  period of years.  At the end of the Plan, and unlike the other debts, such long term note and deed of trust remains intact (but of course with the balance reduced by the payments made during the Chapter 13 and the default/arrearage reduced to zero).

Under a Chapter 13 Plan, unsecured debt must be paid in an amount that is not less than, at present day value, that which would be paid if the debtor had  instead filed a Chapter 7 (where non-exempt assets, if any, are liquidated for distribution to creditors).  

If the trustee objects, the Plan must provide that the debtor make payments to the trustee equal to the debtor's disposable income  for at least a three year period (but not more than needed to pay the unsecured creditors in full with interest). This requirement can serve to allow unsecured creditors to receive a greater value in the Chapter 13 than if the debtor had instead filed a Chapter 7.

Only individuals may file a Chapter 13 and only if the secured debt is less than about $800,000 and liquidated, non-contingent, unsecured debt less than about  $270,000.

Pros

1. Only the debtor can propose the Chapter 13 Plan.  It is effective when confirmed by the court.

2. Upon completion of the Plan, the debtor is discharged from most types of debt including income tax liability and debts arising from fraud or willful and malicious injury. Recent unsecured income tax must be paid in full under the Plan but usually with no interest. 

3. Except as set forth in the Plan or an order obtained by the debtor, or upon default under the Plan or failure to make regular payments in the case of certain secured debt, all debts are paid only from the debtor's income, not from the sale of any assets. 

4. Any foreclosure process or enforcement of an involuntary lien (e.g. income tax or judgment lien) on real property is generally halted pending Plan confirmation. (see below)

5. The debtor can maintain ownership of real property subject to a long term note secured by a deed of trust if the Plan is complied with and provides for:  1) full payment of any default under the note by way of monthly payments for 3 years and 2) payment of current regular monthly installments as they become due pursuant to the note.

6. Any pending repossession, sale, or lease termination resulting from monies due and owing on a debt or a lease, secured by or pertaining to personal property, is generally halted pending Plan confirmation (see below) (also applies also to a real property lease).

7. The debtor can retain a lease of real or personal property (at least as to one not  yet terminated) if the Plan is complied with and provides for the lease to be 'assumed' and for full payment, within a few months, of any default thereunder. Payment of current rental payments would resume. 

8. The debtor can keep personal property that secures a loan, or any real property subject to a short term note and deed of trust, irrespective of a default, or any real property subject to an involuntary lien (e.g. an income tax or judicial lien) if the Plan is complied with and provides for payment of the entire balance of such obligation or of the value of the property securing the debt, whichever is less, by way of monthly payments during the Plan period, with interest at a rate generally less than the contract rate.    

9. The debtor can also hold on to real property, that is not the debtor's residence and that is subject to a long term note and deed of trust, under the circumstances described in 5 or 9. 

10. A Chapter 13 can be dismissed or converted to a Chapter 7 by the debtor at any time.

Cons

1. Only an individual can file (i.e. not a corporation or a partnership).

2. The debtor has to pay unsecured claims to the extent he/she has sufficient income to do so for at least a 3 year period.

3. The Plan period cannot go beyond 5 years.

4. There are debt limits.

5. There is a rather short timetable given to file a Plan.

6. Delays credit repair by the time period of the Plan.

Bankruptcy in Chapter 11

This is the most complex and expensive type of bankruptcy.  It allows a debtor tremendous flexibility to reorganize.  In most instances the debtor is left in possession of his assets (which includes his business).

In order to succeed in a Chapter 11 Bankruptcy, the court must confirm a Plan of Reorganization.  The Plan sets forth the amount and manner of payments on the debtor's  obligations.   Upon  confirmation, the debtor is discharged from liability on the original obligations but becomes liable, instead, for payments on such liability to the extent  as set forth in the Plan. 

The Plan allows the debtor to fund payments to creditors from the income generated from the debtor's business. Liquidation of some or all assets can also be provided for under the Plan.

Any person or entity can file a Chapter 11.  An individual will receive a discharge in a Chapter 11 upon the confirmation of a  Plan. An entity (i.e. corporation or partnership) will also receive a discharge upon confirmation of a non-liquidating Plan.

There are many requirements placed on the debtor in a Chapter  11, and a Bankruptcy under this section is more difficult for all parties. The Court will rely on your attorney for provide it information at every stage of the process, and it is in the debtor's interest to provide this information on request. 

Generally a Chapter 11 Plan cannot be confirmed unless creditors are paid under its terms at least what they would receive if the debtor's assets (to the extent not exempt) are liquidated.  Furthermore there can be no confirmation unless at least one class of  'impaired' creditors 'accepts' the Plan. 

Certain debts are excepted from discharge where the debtor is an individual.  These are the same as in a Chapter 7.  No debts are excepted from discharge where the  debtor is a corporation or partnership. 

If possible, it is more economical for an individual to reorganize under a Chapter 13 .

Pros

1. Any individual or entity can file.

2. No debt limits.

3. Corporations and partnerships can receive a discharge unless the Chapter 11 Plan calls for liquidation.

4. No statutory limitation on the Plan period.

5. Great flexibility in devising a Plan.

6. Usually there is no trustee in charge of the case, just the debtor in the role of a 'debtor in possession'.

7. No exceptions to discharge for partnerships and corporations.

8. The bankruptcy of choice for corporate and partnership entities that wish to remain in business, and individuals that cannot file a Chapter 13 because of the debt limits.

9. Except as set forth in the Plan or an order obtained by the debtor in possession, or  upon default under the Plan or failure to make regular payments in the case of certain secured debt, debts are paid only from the debtor's income and not from the sale of any assets. 

Cons

1. A creditor as well as the debtor in possession can file a Plan.

2. Continuous reporting requirements prior to confirmation of Plan.

3. No discharge from recent income tax liability, or income tax liability where returns are not filed or not filed recently or fraud is involved in the return. 

4. It is possible, in a partnership or corporate case, that the Plan might only be confirmed if current stock holders give up their stock.

5. The most complex and expensive of the bankruptcies.