THE BASICS OF CHAPTER 7 AND CHAPTER 13 BANKRUPTCY AND HOW TO CHOOSE THE RIGHT CHAPTER

WHAT IS BANKRUPTCY?

Bankruptcy is the right we all have to be freed of excess debt by having some or all our debts extinguished while at the same time protecting our assets so we can get a fresh start and go on to lead newly productive lives. This is accomplished through a discharge, and the way it is obtained depends on whether it is a Chapter 7 or Chapter 13 bankruptcy that is filed.

Chapter 7: In a Chapter 7 bankruptcy, covered in Chapter 7 of the Bankruptcy Code, all dischargable debts are discharged usually in a period of 3 to 4 months.
Chapter 13: In a Chapter 13 bankruptcy, covered in Chapter 13 of the Bankruptcy Code, a percentage of the debt is repaid through a 3 to 5 year plan depending on the Debtor's income and expenses. After the plan is completed, the remaining dischargable debt is discharged and any non-dischargable debt remains.

There are limits to what kinds of property can be protected in bankruptcy and there are limits to what kinds of debts can be discharged. If the Debtor files a Chapter 7 bankruptcy and has equity in property exceeding in value the amount of the allowed exemptions, the property will be sold to pay their creditors. They can instead file a Chapter 13 and so long as the Debtor's unsecured creditors will receive the equivalent of the unprotected value of the property over the length of the Chapter 13 plan, the property will be protected, but the Debtor has to pay some of the debt back in order for that to be accomplished.

HOW IS PROPERTY PROTECTED IN BANKRUPTCY?

Property is protected in bankruptcy using exemptions. Many states have their own exemption systems, but there is also a federal exemption system that is used in situation where the Debtor's state allows for them to be used instead. Some states allow you to use either the federal system or that state's own exemption system. Other states, like California, have opted out of the federal exemption system. A Debtor must have lived in the state where they are filing bankruptcy for the two years before filing in order to be able to use that state's exemption system. If the Debtor has not lived there for two years, then they must use the exemption system provided for by the state where they lived for the majority of the 6 month period directly proceeding the beginning of the two year period. Some states have residency requirements to use their exemption scheme, so in that case the Debtor would simply use the federal exemptions.

WHAT IS A DISCHARGE AND WHICH DEBTS CAN BE DISCHARGED?

Generally, dischargable debts include:

Credit card debt
Medical bills
Utility bills
Unpaid balances after foreclosure or surrender of secured property like a home or car
Personal loans
Some taxes

A list of which debts are not dischargable in bankruptcy is found in Section 523 of Title 11 of the U.S. Code. They include:

Student loans
Some taxes
Domestic support obligations
Debts incurred while driving under the influence
Debts ordered to be repaid by the court because they were incurred by fraud or deceit
Restitution
Criminal fines and penalties, such as parking tickets

The effect of a discharge is covered in Section 524; the primary effect is for the Debtor to no longer be liable for the debts which are covered by the discharge.

OVERVIEW OF THE PROCESS

Bankruptcy is a good option when a person is at the point where they are significantly in debt and are using their credit cards to pay for basic living necessities, like food and rent. A bankruptcy is comprised of many different documents which include the Petition, Schedules, Statement of Financial Affairs, Statement of Intentions, and Means Test. A typical completed bankruptcy is about 50 pages long. To properly prepare a bankruptcy, the Debtor needs to give their attorney a lot of information, including:

A new credit report (try to get one from each of the 3 credit reporting agencies, they are free at www.annualcreditreport.com)
The names, addresses and account numbers of all debts, plus any collection agencies
A list of personal property items and their current replacement values for their current age and condition
Real property information, including deeds of trust, mortgage agreements, and property tax information, as well as a recent broker's analysis of the market value for the property or recent appraisal
Paystubs and other income information, such as pension and social security payments, and profit and loss statements for self-employed Debtors
Copies of tax returns for the previous 3 tax years
Leases and other contract information, and other necessary information.

Once the bankruptcy is prepared, it's reviewed, signed and then filed. Once filed, the Debtor is assigned a case number, a case trustee, and a hearing date for the Meeting of Creditors. An automatic stay goes into effect which prohibits creditors from contacting the Debtor, and any pending foreclosures, wage garnishments and lawsuits must be placed on hold. There are some exceptions to the automatic stay for persons who have previously filed 1 or more bankruptcies in the year before the present case. Another important factor of filing bankruptcy is that once the case is filed all of Debtor's property becomes part of the bankruptcy estate, which is administered by the bankruptcy trustee. This means the Debtor cannot transfer or sell property without the trustee's permission until the estate closes. In a Chapter 7, the Debtor can normally do what they wish with their property so long as 30 days have passed since the conclusion of the Meeting of Creditors, but in some cases it is necessary to file a motion asking the trustee and the creditors to abandon certain assets. About a month to 6 weeks after the case is filed, the Debtor will have a hearing with a bankruptcy trustee who's job it is to administer their bankrupcy case.

In a Chapter 7, the trustee spends usually less than 5 minutes asking the Debtor a few basic questions about the information in their bankruptcy paperwork under oath and before a live tape recorder. Some typical questions include: did you list all of your assets and all of your debts? Are you expecting anyone to die and leave you money or property in the next six months? Do you have a reason to sue anyone? The goal of the trustee is to determine whether the Debtor really cannot afford to pay their debts back and whether there are any unprotected assets that can be liquidated to pay creditors. Creditors can also show up at the hearing and question the Debtor for a limit of 5 minutes, but they rarely do. If the Chapter 7 Trustee is satisfied that there are no assets to be administered and there is no income available for creditors, they will close their investigation and in approximately 2 to 3 months after the hearing the Debtor will receive their discharge.
In a Chapter 13, the trustee at the hearing will want to make sure the Debtor can afford the Chapter 13 Plan filed with the court and that the plan represents the Debtor's best efforts to repay their debt. If the Chapter 13 Trustee is satisfied that the plan represents the Debtor's best efforts to pay the creditors, and the plan is feasible, meaning it is something they can afford to do, they will confirm the plan. The Debtor then continues to send the trustee a money order every month until the end of the plan, with the first payment due within 30 days of the case being filed. Once the plan is completed, the Debtor will receive their discharge.

WHICH CHAPTER SHOULD THE DEBTOR FILE?

The first question to ask when deciding which chapter under the bankruptcy code the Debtor should file is: does the Debtor have a choice? If a Chapter 7 is over and done with in usually less than 4 months and doesn't involve paying creditors, why wouldn't everyone simply choose to file Chapter 7 over Chapter 13? The reason is because there are limits as to who can file and what can be accomplished in a Chapter 7. Deciding which chapter to file requires a thorough examination of the Debtor's complete financial situation to determine whether they are excluded from filing a Chapter 7 for any of the various reasons. If they are not, they may still choose to file a Chapter 13 because there are some things that can be accomplished in a Chapter 13 that cannot be accomplished in a Chapter 7 that may be extremely valuable to the Debtor depending on their particular circumstances. Persons wishing to file bankruptcy should first meet with a qualified attorney to discuss the issues involved in their particular situation and to learn which type of bankruptcy will best meet their needs.

Why not Chapter 7?

ELIGIBILITY LIMITATIONS Debtor may not be eligible if they have filed a Chapter 7 within the previous 8 years, or if their debts are primarily consumer in nature and their budget (or the Chapter 7 Means Test) show they have disposable income and can afford to pay at least part of their debt back in a Chapter 13.
LIMITATIONS ON PROTECTION OF ASSETS If the Debtor has assets that exceed the exemption limits; these assets can be sold in a Chapter 7 with the proceeds going to pay their creditors, but can be protected in a Chapter 13, so long as a certain amount is paid to their creditors through the Chapter 13 Plan. If the Debtor is behind on their mortgage, they could catch up on the behind payments in Chapter 13, but not Chapter 7.
LIMITATIONS ON DISCHARGE OF DEBTS Some debts are not dischargable in a Chapter 7, which would be dischargeable in a Chapter 13, including debts owed as part of a Marital Settlement Agreement. If a Debtor has used a credit card to pay a non-dischargable tax or student loans, that would not be dischargable in a Chapter 7 but could be discharged in Chapter 13.

Limits on Chapter 13