The goal in Chapter 13 is to use future income to pay all or a portion of one’s debts through a court approved and administered Chapter 13 repayment plan. The judge assigned to the case must confirm the plan. During the confirmation process the creditors are permitted to have some input. However, once the plan is confirmed, the creditors are obligated by its terms. See 11 U.S.C. § 1327(a).
Chapter 13 plans typically last either three or five years, with five years being the statutory maximum. See 11 U.S.C. § 1322(d)(1)(C) and (d)(2)(C). Each month during the pendency of the plan the debtor sends a plan payment to the Chapter 13 Trustee assigned to the case. The Trustee in turn sends payments to the creditors according to the terms of the confirmed plan. At the end of the plan any remaining scheduled unsecured dischargeable debt is discharged.
One attractive feature of Chapter 13 for the debtor wanting to keep collateral securing a debt is the chance to catch up on the payments. For example, the debtor can use the plan to pay off a mortgage arrearage over the life of the plan, rather than having to immediately become current as in a Chapter 7 bankruptcy.
Another benefit is that the debtor does not have to surrender any nonexempt assets: the debtor gets to keep everything. Why? The short answer is because in the plan the debtor makes monthly payments to pay creditors. However, as we shall see, the value of the debtor’s nonexempt assets provides a starting point for the size of the monthly plan payments.
How much are the monthly payments? In order to answer that question we need a little background. In particular, we must observe that a Chapter 13 plan must satisfy three basic criteria. These three criteria contain the essence of 11 U.S.C. § 1322.
I. The Three Basic Requirements Of A Chapter 13 Plan
A. The Chapter 7 Liquidation/Best Efforts Test For Chapter 13
The plan must ultimately pay the general unsecured creditors at least as much as they would have received had the debtor done a Chapter 7. See 11 U.S.C. § 1325(a)(4). Huh? I thought that in a Chapter 7 all dischargeable debts were simply erased. Doesn’t that mean that the creditors get nothing? Not quite. If the debtor has nonexempt assets, the Chapter 7 Trustee will seize and sell them for the benefit of the unsecured creditors. Thus, the bare minimum the Chapter 13 plan must pay out over its lifetime is the lesser of: (a) 100% of the total unsecured debt, and (b) the dollar value of the nonexempt property.
1. Listing Assets
One of the many things included in a set of personal bankruptcy papers is a complete listing of everything the debtor owns – even down to the clothes on the debtor’s body. Schedule A is where real property is listed and Schedule B is where personal property is listed. All of the assets are then divided into exempt and nonexempt categories. In a Chapter 7 bankruptcy the debtor keeps everything that is exempt, while the Chapter 7 Trustee seizes and sells any nonexempt property for the benefit of creditors. This loss of nonexempt property in Chapter 7 is one reason why some debtors decide against seeking Chapter 7 relief.
In contrast to Chapter 7, in a Chapter 13 bankruptcy the debtor keeps all assets – both exempt and nonexempt. However, we still list everything and divide it into exempt and nonexempt categories so we can determine the dollar value of the nonexempt assets. That dollar value is the amount that would have been paid to the general unsecured creditors in a Chapter 7 bankruptcy, and it becomes the starting point for the total Chapter 13 plan payout to those creditors.
2. Exempting Assets
11 U.S.C. § 522 has the Bankruptcy Code’s exemption table. However, § 522(b)(3) permits a debtor to use a given state’s exemption table if the debtor is eligible to use that state’s table. California has two tables: one for homeowners with equity in their primary residence – the homeowner’s equity exemption cannot be used to exempt rental property – and the other for renters and homeowners with no equity.
One benefit of using the renter’s table is the availability of the “wild card” exemption , which gives the debtor an additional $23,250 worth of exempting power over the other categories. This exemption is particularly useful in exempting cash, stocks, bonds, and cars. The car exemption – which can only be used on one vehicle – in the renter’s table is only $3,525, and only $2,725 in the homeowner’s table. Therefore, for most Chapter 7 debtors the wild card is essential in protecting cars.
Note: You cannot mix and match the tables. It’s either the federal table, the homeowner’s table, or the renter’s table, for the entire case.
3. Application To Chapter 13
After exempting as much of the assets as possible, compare the dollar value of what’s left – the nonexempt property – with the value of the general unsecured debts. Whichever is less is the starting point for the Chapter 13 plan – the bare minimum that must be paid out to the general unsecured creditors over the life of the plan.
B. The Fairness/Disposable Income Test For Chapter 13
The plan must be fair. Don’t you just love vague terms in law? Well, it turns out that this is one time we can make the term “fair” very precise.
There are two possibilities: either (1) the plan proposes to pay back 100% of the general unsecured debt over its lifetime, in which case the plan is by definition fair, or (2) the debtor must devote 100% of his or her projected disposable monthly income to the plan. The bankruptcy concept of projected disposable monthly income is a bit complicated. I’ll discuss it in a future post. For now, just think of it as the money left over each month after subtracting taxes and reasonable living expenses from gross income. As a shorthand, I’ll call it DMI.
C. The Feasibility Test For Chapter 13
The plan must be feasible. The basic idea here is that the plan must satisfy the first two requirements (i.e., the Chapter 7 liquidation test and the fairness test), leave enough for the debtor to live on, and treat certain special creditors they way they are entitled to be treated. This “definition” is, admittedly, less than satisfying. The following three simple examples illustrate what can go wrong, and lead to plan infeasibility.
Suppose the debtor’s nonexempt assets are worth $60,000 and the debtor’s general unsecured debt is $100,000. Then according to the Chapter 7 liquidation test the debtor must pay at least $60,000 to the general unsecured creditors over the life of the plan. For simplicity assume the plan will last sixty months. This translates into plan payments of $1,000, plus Trustee fees (usually 11 percent), for a total of say $1,110 per month. Suppose in addition that the debtor’s DMI is $500, meaning that the debtor has a total of $30,000 (= $500 × 60) to pay into the plan over the requisite five years. Then the debtor has insufficient income to support the plan. The plan is infeasible.
As in the previous example, suppose the debtor’s DMI is $500, meaning that in a five-year plan the debtor can pay at most a total of $30,000.
Suppose further that the debtor has a $60,000 income tax liability that is a priority debt . Then the tax liability must be paid in full over the life of the plan, unless the taxing authority agrees to be paid less.
However, since the debtor can only pay $500 per month for a total of $30,000, the plan is infeasible.
Suppose, once again that the debtor’s DMI is $500.
Suppose further that the debtor is behind on his or her mortgage payments by $30,000. The debtor can put the mortgage arrearage into the plan and spread the paying off of it – in full, of course – over the plan’s five years. See 11 U.S.C. § 1322(b)(3). However, the debtor must also pay the contract interest rate. See 11 U.S.C. § 1322(e); cp. Till v. SCS Credit Corp., 541 U.S. 465 (2004). Therefore, even if we ignore Trustee fees – though you can be quite certain that the Trustee will not do so – this means that the debtor must pay more than $30,000 just to cure the arrearage over the life of the plan. Unfortunately, in a five-year plan at $500 per month the debtor would only be able to pay a total of $30,000. Therefore, the plan is infeasible.
This post has just scratched the surface of Chapter 13. And the post has elided over some significant complications in the three factors discussed. The reality is too complicated for a person without an attorney. If you’re interested in Chapter 13 as a way to deal with overwhelming debt, don’t go it alone. Contact a good bankruptcy attorney to take you through the process.