Chapter 7 or Chapter 13 Bankruptcy.... What's the Difference?

Dear Readers:

As you know there are two types of bankruptcy which are relevant to most consumer debtors.  Those are Chapter 7 which is considered a financial mulligan, start over, start fresh (Yes David you can still keep your House, your Car, your Boat and the Helicopter!).  A Chapter 13 is a reorganization.... essentially, you need some time due to get caught up without being penalized.    This information is not intended to constitute legal advice, it is purely for entertainment purposes. Always consult with a lawyer who is in your community to know how much of this applies to you!

With that being said, there are advantages and disadvantages of both Chapter 7 and Chapter 13.  Under Chapter 13 the Debtor will make regular payments on a plan to pay all or part of the debts.  Under Chapter 7 there is no plan to repay creditors and all debts that are “dischargeable” are simply liquidated.  The absence of regular payments is a powerful inducement for many Debtors, which may explain why there are more Chapter 7 cases than Chapter 13 cases.  Under Chapter 7 a Debtor will generally lose “non-exempt” property, while under Chapter 13 Debtors are normally able to keep both “exempt” and “non-exempt” property.  Of course, this is of no concern if a Debtor has little or no property or only property which is “exempt” - moreover, the exemptions have been liberalized over the years and many Debtors keep property of significant value.

A Chapter 13 discharge is also broader than a Chapter 7 discharge in that it covers certain types of debts not “dischargeable” under a Chapter 7.  However, the 2005 Bankruptcy Law did add several categories of debts that are no longer dischargeable in a Chapter 13.  The debts dischargeable in a Chapter 7 are discussed below.  All Debts dischargeable under Chapter 7 are also dischargeable under Chapter 13, but several categories of debts can be discharged in a Chapter 13 but not under a Chapter 7 such as debts for willful and malicious injury to property, debts incurred to pay non-dischargeable tax bills and certain debts arising from property settlements in divorce of marital separation cases.

Secured debts, even when the Debtor is behind on payments, can be handled in a Chapter 13, giving the Debtor additional time to come up with money to save the secured property.  Chapter 13 can also be used to protect co-signers, who cannot be protected through a Chapter 7.

Is it more difficult for someone to file bankruptcy?  Under the new law Chapter 7 or Chapter 13 will make it easier for some people to file and harder for others.  We discuss many of the advantages and disadvantages below.  The new law was a major revision and space does not permit a discussion of all the changes.  However, there are some new requirements for credit counseling and debtor education which
will affect almost everybody.  The Debtor must file a certificate of completion of credit counseling.  Average pre filing counseling typically requires about 90 minutes (actual time may vary).  This requirement may be waived in only a limited number of circumstances.  A list of the agencies offering such briefing can be found in the Appendix at the end of this document.  The Debtor must also prove completion of a financial management course before a discharge is granted.  It may be possible to take this course over the telephone and will last at least 2 hours.  The new law also requires the filing of the Debtor’s tax return or transcript and some of the Debtor’s pay stubs may have to be filed as well.  The Debtor will have to provide proof of identity and certain financial records, if requested.

CHAPTER 7 - DO NOT USE THIS CHAPTER TO STOP A FORECLOSURE SALE!

What is Chapter 7?  Chapter 7 is the most popular type of bankruptcy.  It is a legal proceeding in a special federal court, the United States Bankruptcy Court.  At the end of this proceeding, certain debts are said to be discharged.  [11 U.S.C. §727].  “Discharged” means, among other things, that the Debtor no longer has to pay the debt.  However, not all debts are dischargeable under Chapter 7.  Most Chapter 7 cases are “no assets” cases.  In a no assets case, none of the assets of the Debtor are used to pay creditors.  Assets are unavailable to pay creditors if they are already encumbered by liens at least equal to the value of the asset.  An asset is unavailable if it does not become part of the bankruptcy case — many, but not all, pensions may
fall into this category.   Also, an asset is unavailable if the Debtor is able to claim it is “exempt”.

How does Chapter 7 protect Debtors?  As soon as a bankruptcy is filed a Debtor is protected by a part of the Bankruptcy Code called the “Automatic Stay”.  [11 U.S.C. §362].   YES David, this means that the foreclosure sale cannot go forward provided that you file your bankruptcy BEFORE the sale with enough time to GIVE CREDITOR NOTICE that you have filed.  In California this means well before 8:00 a.m. the day of a sale.  If you want to make sure your house doesn't go to sale PLEASE FILE THE DAY BEFORE!!!!  However, if you use this Chapter 7 to stop the sale, you put yourself at risk of losing your home if you cannot pay back everything you are behind immediately or if you do not get a loan modification!

This stay functions as an Order or injunction from the Bankruptcy Court and can be enforced by  proceedings in the Bankruptcy Court.  The stay stops most legal proceedings against the Debtor.  The Automatic Stay prohibits almost all attempts to collect debts owed by the Debtor while the bankruptcy is pending.   Most Chapter 7 cases will remain pending for three to four months.  

The 2005 Bankruptcy law created some new exceptions to the Automatic Stay, for the most part dealing with serial filers of repeat bankruptcies, and some actions against tenants involved in eviction actions.  The law also changed to permit certain actions such as setoffs of tax refunds and withholding of wages to repay loans from retirement funds.  Therefore you MUST CONSULT an Attorney, if you are filing another bankruptcy there may be no automatic stay in place.  So protect yourself by knowing your rights.

The Automatic Stay provision is a very important part of the Bankruptcy Code.  It can be even more important than the discharge of debts.  It will stop harassment by creditors over the phone or by letter.  And it can be used to stop, at least temporarily, a foreclosure and give a Debtor more time to come up with a mortgage arrearage.  However, this protection is not absolute.  For instance, a secured creditor who is found to by the Bankruptcy Court to be inadequately protected can be granted permission to repossess or foreclose on secured property. In most cases the Automatic Stay expires when the debts of the Debtor are discharged.  The discharge provisions of the Bankruptcy Code will then generally prohibit almost all attempts to collect debts which have been discharged.  However, after the discharge, creditors will be free to pursue debts which have not been discharged and debts which have been reaffirmed.

Who qualifies for Chapter 7?  Any person who resides in the United States, or is domiciled here or who has business or property in the United States can be a Debtor under Chapter 7.  [11 U.S.C. §109].  NOTE you DO NOT NEED TO BE A US CITIZEN! A special exception to this rule prohibits some people whose bankruptcy case was involuntarily dismissed in the previous 180 days from refiling.  A person who has received a discharge in another Chapter 7 (or Chapter 11) case filed within the preceding 8 years cannot be granted a Chapter 7 discharge.  [11 U.S.C. §727(a)(8)].  Also, a Chapter 7 discharge cannot be granted to someone until 6 years after a Chapter 13 discharge.
The 2005 Bankruptcy Law created an additional barrier for some who seek Chapter 7 protection.  A presumption of abuse is created unless a Debtor can meet a new means test.  This change will not affect most people who wish to file a Chapter 7 case.  A “safe harbor” is created if a Debtor’s income is below the statewide median income for the Debtor’s family size.  Please check with an attorney to see what your limits may be.  

However, do not despair, even a Debtor with income over the median may still qualify by demonstrating an
inability to repay creditors.  In this case, IRS standards for various normal expenses such as food, clothing, personal care, etc. are compared to the Debtor’s income.  Deductions of standard amounts from IRS tables are permitted for transportation.  Other necessary expenses from the IRS list of necessary expenses may also be deducted.  These expenses include costs as child care, alimony, medical/dental care, expenses to avoid being a victim of domestic violence, taxes, or support of elderly and disable family members and various other expenses.  Obviously, if your income is over the statewide median, your attorney may have to help you determine if a Chapter 7 filing is feasible.

Being able to file does not mean it is advisable to file under Chapter 7.  A person who has substantial bills that are not dischargeable often will not benefit from Chapter 7.  A person who owns substantial assets that would not be exempt may not benefit unless the debt that could be discharged would be substantially in excess of the assets that would be lost.  Also, the Court may dismiss the case of someone who could repay  a substantial portion of his or her debt within a reasonable time it found the case amounted to an abuse of Chapter 7.  There are other instances in which the filing of a Chapter 7 case would not benefit a Debtor.  It is important for people to seek competent legal advice before filing a bankruptcy petition.

How much does it cost to file a Chapter 7 Bankruptcy?  The filing fee for a Chapter 7 case is $299.  While it is possible for a Debtor to file without the help of an attorney or professional preparer, unassisted “pro se” filings are unusual.  Since added requirements of the new Bankruptcy Law mean much more work and responsibility for the lawyer, attorney fees have gone up recently.  The amount charged for attorney fees normally reflects the difficulty of the case.  Such factors as a large number of creditors, a debtor engaged in business or a unique legal situation requiring additional legal research will normally increase the attorney fee.

What property will a Debtor lose in a Chapter 7 case?  In most Chapter 7 cases, the Debtor does not lose any property.  The Debtor is allowed to keep all property that does not become part of the bankruptcy estate or that is exempt.  The Debtor’s attorney first divides the property into various classifications such as the Debtor’s homestead, household goods or tools of the Debtor’s trade.  The value of property in each classification is then determined.  It is sometimes difficult to figure the exemptions a Debtor is entitled to.

In California there are two sets of exemption codes which basically break down to whether the Debtor has a home with equity or without equity.  There are many factors which go into determining which set of California exemptions will apply.  Additionally, in some instances California Debtors qualify for using some Federal exemptions.  You practically need an attorney to really figure out what can be exempted.  If you don't own much, more than likely you won't need an attorney to do a Chapter 7 bankruptcy.  If you are contemplating a Chapter 13, I strongly suggest you hire a bankruptcy attorney.  All these exemptions all have various limitations and are broad categories often requiring more exact definitions.  Ask your lawyer about any property you are concerned about.

Finally, valuation of property is sometimes a problem.  The current value of the property is used, not the value of the time of purchase or at some future date when the Debtor might sell.  Also, only the Debtor’s interest in property is valued.  If the Debtor owns property along with someone else, only the Debtor’s part is valued.  Also, if there is a lien on property the Debtor’s interest in the property is reduced by the amount of the lien.  For instance, the Debtor’s interest in a home with a market value of $100,000 and a mortgage of $90,000 is $10,000.  If the amount of the lien is greater than the property the Debtor may elect to keep the property but it may be in the Debtor’s interest to give up the property (see the next section).

Liens and Secured Debts.  Secured creditors are those protected by a lien or mortgage against the Debtor’s property (often referred to as the “collateral”).  Secured creditors have an interest in a specified item of property in the amount of their lien.  A secured creditor will generally be permitted to  repossess or foreclose on the secured property unless the Debtor elects to retain the property and reaffirm the debt.  If the Debtor reaffirms the debt, the secured creditor will be allowed to retain its rights to the collateral but the Debtor will be permitted to retain the property subject to the terms and conditions of the security agreement.  In some cases the amount of the lien will exceed the value of the collateral.  In many of these cases the Debtor will want to return the property to the secured creditor and discharge the debt.  In some cases a Debtor may
wish to retain collateral even though the amount of the lien exceeds its value.  This situation may be somewhat more complicated and Debtors are advised to seek their lawyer’s advice.

What debts can be discharged in a Chapter 7 case?  All debts are discharged unless they are excepted from discharge by a section of the Bankruptcy Code.  [11 U.S.C. §523]  The major EXCEPTIONS TO DISCHARGE are these:
1.  Some Income Taxes.  See your attorney to figure out which ones.  Old Income taxes may be dischargeable!
2.  Debts for money, property or related to the extension, renewal or refinancing if procured through false pretenses, false representations or fraudulent financial statement; included are certain debts for luxury goods or services within 90 days before the bankruptcy was filed or certain cash advances within 70 days before filing;  Note that some lenders will go back up to one year asking for you to pay them.
3.  Unlisted debts, if the failure to notify the creditor prevented the creditor from filing a claim or objecting to the discharge of the debt.
4.  Debts for fraud or embezzlement by a Debtor in a position of trust;
5.  Most domestic support obligations (including alimony, spousal maintenance or child support);
6.  Debts for willful and malicious injury by the Debtor;
7.  Fines, penalties or forfeitures owed to a government;
8.  Student loans and educational benefits, unless the debt poses an undue hardship on the Debtor and Debtor’s dependents;  This requires a lawsuit to get ride of this debt.  IT CAN BE DONE.
9.  Debts for death or personal injury caused by the Debtor’s use of a motor vehicle while intoxicated by alcohol, a drug or other intoxicant;
10.  Debts which were or could have been listed in a previous bankruptcy and which were not discharged;
11.  Certain debts owed to a spouse or ex-spouse arising in a divorce or separation - in these cases the Bankruptcy Court weighs various equities to determine whether the benefits of discharge to the Debtor outweigh the detrimental consequences to the spouse or ex-spouse;
12.  Certain fees or assessment connected to membership associations related to the Debtor’s interest in his or her dwelling;
13.  Debts incurred to pay non-dischargeable state or local taxes;
14.  Federal election law fines and penalties;
15.  Property settlements owed to a former spouse or to a child;16.  Condo or homeowner’s association fees;
17.  Certain fees imposed on prisoners by a court.
18.  Loans on pensions; and
19.  Certain debts arising from securities violations or wrongful acts of a fiduciary.

Objections to discharge.  In addition to objecting to discharge of a given debt, a creditor may also object to the grant of a discharge to the Debtor.  These cases are fairly rare.  The most common grounds for objecting to discharge are [11 U.S.C. §727]:

1.  Intentional concealment, transfer or destruction of property by the Debtor;
2.  Failure to keep books or financial records;
3.  Dishonesty in connection with the bankruptcy;
4.  Unexplained loss of assets of the Debtor;
5.  Refusal to cooperate, obey court orders or to testify in a bankruptcy proceeding;
6.  The Debtor has been involved in prohibited transactions with insiders (persons closely related to the Debtor);
7.  A prior discharge was granted to the Debtor in another Chapter 7 case within eight years; and
8.  A prior discharge was granted to the Debtor in a Chapter 13 case within six years - but a discharge may be granted if more than 70% of the unsecured claims were paid and the Debtor made a good faith best effort to pay creditors in the Chapter 13 case.

Moreover, once granted a discharge may be revoked if the Debtor obtained his or her
discharge through fraud and the party requesting revocation was unaware of the fraud prior to the
discharge or if the Debtor fraudulently failed to report the acquisition of property that may have
been part of the bankruptcy estate.

In Part II of this series of articles, I will tell you more about Chapter 13.  Stay tuned!!!