Friday, August 30, 2013

Should I File a Chapter 7 or a Chapter 13 Bankruptcy

While some of my clients know what bankruptcy chapter they should file under, most look to me to advise them whether to file for Chapter 7 or Chapter 13 (or Chapter 11 or Chapter 12, the topics of a later blog). What do I look at in deciding which chapter to recommend?

My “default” setting is Chapter 7. This is the least expensive, fastest and simplest chapter of the Bankruptcy Code. Unless there is a significant reason to file under a different chapter, I will normally recommend that the client file for Chapter 7.

What happens in a Chapter 7? The answer depends on the type of debt. Generally, there are three kinds of debt: priority, secured and general unsecured. Priority debt consists of recent tax debt and domestic support obligations such as alimony and child support. Priority debt is not dischargeable in a Chapter 7. Unless it’s paid in full during the case, you still owe it after you get a discharge. Most secured debt, that is, debt where you pledge something as collateral, such as mortgages and car loans, are changed from “recourse debt” to “non-recourse debt.” What does this legalese mean? It means that if the lender could sue you for a deficiency or shortfall after a foreclosure or repossession if the sale of the collateral doesn’t bring in enough to pay the debt in full, the bankruptcy discharge stops them from going after you. All they can go after is the collateral, and if it doesn’t bring in enough to pay the debt in full, tough. You’re off the hook. This means that you can walk away from the house or car if you want to. If you don’t want to, just keep the payment current and you’ll be fine. Upon the entry of a discharge, most general unsecured debt–credit cards, medical debt, personal loans, old taxes, tax penalties, foreclosure and repossession deficiencies, unpaid rent, unpaid HOA and condo fees, unpaid utility bills, etc. (but not student loans)–are wiped out. You don’t need to pay these debts at all.

A typical Chapter 7 lasts about 4 months from filing to discharge.

Why would you want to file a Chapter 13? Several main reasons:
1. You aren’t eligible for a Chapter 7. You fail the means test, or have too much disposable income to qualify for a Chapter 7. Or you might have filed a Chapter 7 case in which you received a discharge within the last eight years. None of these are problems in a Chapter 13
2. You are behind on your mortgage and need time to catch up. A Chapter 13 gives you up to five years to spread these payments out to bring the mortgage current, without interest.
3. You owe more on the first mortgage on your home than it’s worth, and have a second or third mortgage. A Chapter 13 lets you “strip off,” or wipe out, wholly unsecured second and third mortgages.
4. You’re behind on your tax or domestic support payments and need time to catch up. A Chapter 13 gives you up to five years to spread these payments out to bring them current.
5. You owe a domestic support property distribution and want to discharge it. A Chapter 13 “super discharge” allows you to do this.
In these circumstances, I would normally advise my clients to consider a Chapter 13.
This decision is not always easy or straightforward. It requires a detailed analysis of your assets, debt, income and expenses, and an in-depth knowledge of the Bankruptcy Code. An experienced bankruptcy attorney is the best person to advise you.