Before you can file for bankruptcy, you must choose which bankruptcy chapter to file under. Of the five bankruptcy chapters, three are available to individuals (Chapters 7, 11 and 13) and two of those are commonly used by individuals (Chapters 7 and 13).
Considerations favoring Chapter 7
For many consumer debtors, straight bankruptcy, now provided for in Chapter 7 of the Bankruptcy Code, has traditionally been the remedy chosen. There are a number of reasons why Chapter 7 usually meets the needs of the low-income debtor in particular.
One of the main factors leading to a Chapter 13 case–the desire to protect nonexempt property–is rarely present. In most states, a low-income debtor or a debtor who does not own a home rarely has any nonexempt property. Nor is the debtor likely to have any excess income with which to pay unsecured creditors through a Chapter 13 plan.
Thus, unless a Chapter 13 petition is necessary for some specific reason, such as those discussed below, many consumer debtors will not desire it. They can obtain a quick and easy fresh start through a Chapter 7 case that will discharge most of their debts. Even if the debtor has one or two secured creditors to deal with, a Chapter 13 plan may not be necessary. Debtors can handle some secured creditors as well, or better, in a Chapter 7 case by reducing or eliminating their liens, by paying them outside of bankruptcy, or by defending against their claims outside the bankruptcy court.
A small number of consumer debtors have a different problem. Their debts exceed the limitations for eligibility to file a Chapter 13 case. If a debtor’s secured debts exceed $871,550 or unsecured debts exceed $290,525, the Code denies the debtor access to Chapter 13. These limits are not doubled for a husband and wife filing together. The debt limits may dictate that only one spouse file a Chapter 13 case if that spouse’s debts alone are within the statutory limits.
Moreover, a Chapter 13 case may be filed at any time after a Chapter 7 case. Thus, if a Chapter 13 case is not necessary when the debtor wants to file, it may still be filed later if circumstances change. There is no Chapter 13 counterpart to the rule barring a new Chapter 7 discharge after a prior bankruptcy case.
Considerations favoring Chapter 13
Probably the most common reason for filing a Chapter 13 case is the presence of one or more secured creditors who cannot be satisfactorily handled any other way. One frequent example is a bank or finance company that is about to repossess the debtor’s car. Few legal steps prevent repossession as quickly and effectively as a Chapter 13 petition and plan. A Chapter 13 case can usually lower the monthly payments and perhaps the balance due. Similarly, Chapter 13 can be used to halt a mortgage foreclosure, giving the client time to cure a default and perhaps a chance to lower the payments or principal due.
As mentioned above, other reasons to file a Chapter 13 case spring from deficiencies in the relief available under Chapter 7. If the debtor has nonexempt property, it is protected in Chapter 13, though its present value must usually be paid to unsecured creditors over the course of the plan. If the debtor has obtained a Chapter 7 discharge in a case filed within the previous six years, the only real option in bankruptcy is Chapter 13.
Another feature of Chapter 13 that may sometimes be important is the broader discharge that it provides. Many debts that are not dischargeable in Chapter 7 may be discharged in Chapter 13. These include some taxes; debts incurred by use of false financial statements, false pretenses or fraud; willful and malicious torts; fraud in a fiduciary capacity; certain restitution obligations; and debts that could not be discharged in a previous bankruptcy case.
Even though some nondischargeable debts, such as taxes, must be paid in a Chapter 13 case because they are priority debts, a Chapter 13 plan may still benefit the debtor by allowing him or her to stretch out the payments over a longer period than would otherwise be possible and perhaps avoid interest and penalties. In addition, most of the possible objections to a Chapter 7 discharge–such as fraudulent transfer, concealment of property or inability to explain loss of assets–may not be raised in a Chapter 13 case; however, the issue of the debtor’s good faith may be raised as an objection to Chapter 13 plan confirmation.
A decision to file under Chapter 13 sometimes depends on how likely it is that these questions will arise. Some debts are dischargeable in Chapter 7 unless a creditor files a complaint seeking a declaration of their nondischargeability. When an objection to discharge or dischargeability is not predictable, it may be preferable to commence a Chapter 7 case and later convert to Chapter 13, if necessary.
Another reason to file a Chapter 13 case is to help debtors who want to pay their debts but need the protection of the bankruptcy court and, perhaps, the discipline of a Chapter 13 plan. In addition, Chapter 13 usually offers an end to finance charges and late charges on unsecured claims and possibly less detriment (where there is any) to the debtor’s credit rating and reputation. However, debtors should remember that most of these advantages are available without a Chapter 13 case. They may pay all or part of any debt voluntarily after a Chapter 7 case, without the deadlines and extra costs of a Chapter 13 plan.
Finally, if the debtor is uncertain as to whether any bankruptcy is the right solution but for some reason must file a petition before that doubt can be resolved, Chapter 13 usually offers a safer course than Chapter 7. The debtor may voluntarily dismiss a case commenced under Chapter 13 at any time without obtaining court permission. The same is not true of a case commenced under Chapter 7 or later converted to Chapter 7. In a Chapter 7 case, the dismissal may occur only with permission from the court and may be refused if it appears to prejudice the rights of creditors.
Use of Chapter 11 by consumer debtors
For the great majority of consumer debtors, Chapter 11 is not the right choice. Most of the relief available in Chapter 11 is available for individuals in Chapter 13 at a much lower cost in time and money. However, a limited number of debtors might prefer Chapter 11 over Chapter 13 in the following situations:
- The debtor is ineligible to file under Chapter 13 because of noncontingent, liquidated, secured debt in excess of $871,550 or noncontingent, liquidated, unsecured debt in excess of $290,525.
- The debtor cannot pay priority tax claims within the five-year period permitted under Chapter 13 but could do so within the six-year period permitted under Chapter 11.
- The debtor has a high income and yet hopes to avoid the ability-to-pay test of Chapter 13.
Chapter 11 cases tend to be expensive and complicated. Unlike Chapter 13, a Chapter 11 case:
- may not be dismissed without court permission;
- a plan may be proposed by creditors, rather than the debtor, over the debtor’s objection;
- creditors generally must vote on the plan;
- there is no codebtor stay; and
- the same exceptions to discharge found in Chapter 7 apply.
For this reason, it is advisable to make certain that Chapter 11 is necessary before filing under that Chapter.