Last week I tried to answer some of the questions that are commonly asked by clients who are thinking about filing a bankruptcy case. We talked about the impact of bankruptcy on credit scores, the removal of debts discharged in a bankruptcy case from a credit report and the amount of time needed for a client of Kain & Scott to file a chapter 13 bankruptcy case. This week, I will do my best to answer other questions that commonly come up with potential clients. And let’s start with a basic question.
What is the difference between a Chapter 7 and Chapter 13 Bankruptcy?
Most of the clients I meet with at the initial stages of our professional relationship know only that they have a financial problem that is becoming overwhelming, and that filing a bankruptcy case might be in their best interests. But beyond that, the clients may not have a lot of knowledge of the functions of the specific bankruptcy chapters that the lawyers at Kain & Scott practice. So many of them have questions about just what a chapter 7 or a chapter 13 bankruptcy involves, and the clients are looking for information about the different features of the different chapters.
Chapter 7 Bankruptcy Explained
One way to distinguish a chapter 7 and chapter 13 bankruptcy is that a chapter 7 bankruptcy case does not involve making payments to creditors, while chapter 13 does. In a chapter 7 case, the debtor is required to identify all of the debt he/she owes, identify and value the property he/she owns, make an accurate monthly budget of income and expenses, and provide a summary overview of income earned, property sold or transferred and payments made to unsecured creditors and family members or business partners within defined periods of time. That information, put into the chapter 7 petition, schedules and statements compose a chapter 7 filing. The chapter 7 debtor has to disclose her intentions regarding what is going to happen with any secured debt (think car loans and home mortgages) - whether the debtor intends to retain the collateral that secures the loan or whether the debtor intends to surrender the collateral to the lender. In addition, the debtor has to decide whether to assume (continue) or reject (discontinue) payments for leases or unexpired contracts. Once the chapter 7 case is filed, a chapter 7 trustee is appointed to administer the bankruptcy estate. The chapter 7 trustee will collect and liquidate the value of any non-exempt assets. The chapter 7 trustee can also avoid preferential payments made by the debtor to third parties, and avoid transfers of money or property that debtors make without receiving fair value for the property transferred. While a chapter 7 debtor might end up paying the trustee to settle preferential payments or fraudulent transfers, there is nothing in the chapter 7 petition, schedules or statements that proposes that payments be made.
Because of the power of a chapter 7 trustee to collect and liquidate non-exempt assets or avoid payments and transfers in some situations, it is common for debtors filing a chapter 7 case to have confidence that such situations don’t exist - that they don’t own property that cannot be exempted in a bankruptcy case, and that they haven’t been making big payments to creditors or transferring property to friends or relatives without being paid. If a debtor has these types of situations present in the facts of her case, then a chapter 13 bankruptcy might be appropriate.
The Chapter 13 Bankruptcy Difference
The chapter 13 client at Kain & Scott has to assist our firm with preparation of the same types of documents as the chapter 7 client - property, debt, income, expenses, and transactions all have to be disclosed and described. But there’s another, different component to chapter 13: the debtor in a chapter 13 case also proposes a plan for at least a partial repayment of some debt. An important difference between chapter 7 trustees and chapter 13 trustees is that the chapter 7 trustee is a “liquidating” trustee - the chapter 7 trustee can collect the non-exempt asset the debtor owns and sell it, and the chapter 7 trustee can sue the debtor’s creditors who have received preferential payments. The chapter 13 trustee is not a liquidating trustee - the chapter 13 trustee simply receives monthly payments from the chapter 13 debtor and pays the debtor’s creditors according to the terms of a court-confirmed chapter 13 payment plan. So the threat of liquidation or lawsuit that is present with chapter 7 cases is not present in chapter 13 cases, and thus the client with non-exempt assets or preferential payments to relatives often find chapter 13 to be a much less stressful experience than chapter 7.
Another way to distinguish chapter 7 cases and chapter 13 cases is to understand what happens in each chapter with secured debt - and particularly secured debt on which there has been a default in payments. When both a chapter 7 and chapter 13 case is filed, any actions by any creditors - whether secured or unsecured - to collect on a debt are stopped by the institution of the bankruptcy automatic stay. In a chapter 7 case, that stay lasts for approximately three and one-half to four months; in a chapter 13 case, the stay lasts for a minimum of three years up to a maximum of five years. When a chapter 7 case is discharged, the protection of the automatic stay is terminated also. So in a chapter 7 case in which a debtor files the case while in default on a car loan or home mortgage payment, the debtor is protected from repossession or foreclosure while the stay is in effect. But several months after filing, when the chapter 7 debtor receives a discharge, the protection of the automatic stay ends, and the mortgage company or car lender can take whatever legal action they have at their disposal to either foreclose or repossess, provided the chapter 7 debtor has not brought the loans current.
Chapter 13 is different. During the years that the automatic stay protects the chapter 13 debtor, the debtor can pay according to a chapter 13 plan so that mortgage arrears or a defaulted car loan can be brought current, and the chapter 13 debtor has up to 60 months to make up whatever defaults exist on secured debts at the time the chapter 13 case was filed. So chapter 13 is a much bigger help to a client with foreclosure or repossession worries than a chapter 7.
Next week, I’ll continue looking at the differences between chapter 7 and chapter 13.