A chapter 13 bankruptcy is a very helpful tool for many people who are encountering overwhelming financial problems. For individuals dealing with a potential mortgage foreclosure, chapter 13 offers a structured, affordable way to keep families in their homes. For a person who has a car payment that has unexpectedly become too expensive, chapter 13 offers a way to restructure the car loan to make the payment more affordable. For the person who is dealing with child support arrears, or back income taxes, chapter 13 provides a structure to pay these important obligations.
So chapter 13 is a powerful help for people facing these vexing problems. The theory of chapter 13 is simple: debtors propose a monthly payment plan, based on the debtor’s budget of income and expenses, to pay back creditors according to the creditors’ classifications. Priority creditors, such as taxes and child support get paid in full. Secured creditors, such as home mortgage companies and car lenders, get paid - in some cases, the secured lender is paid only the amount necessary to catch up on arrears; sometimes, the entire secured loan is paid through the chapter 13 plan. General unsecured creditors, such as medical bills or credit cards, get paid what the debtor can afford after priority and secured claims are paid - these general unsecured creditors need not be paid in full in order to get a debtor’s chapter 13 plan confirmed and to ultimately receive a discharge. Chapter 13 plans last for a minimum of three years and a maximum of five years. After the payment plan is completed, the debtor receives a discharge; the discharge eliminates the debtor’s liability on any remaining debt and the debtor will have cured any mortgage arrears, paid off the vehicle loan and is no longer on the hook for any unsecured debt.
Chapter 13 plans are funded based on the debtor’s monthly income and expense budget. The bankruptcy code requires debtors to commit all of their disposable income into the repayment plan unless a debtor is proposing to pay 100% of all unsecured debt (that doesn’t happen very often).
And Chapter 13 offers a way - through plan modification - for a debtor to change the terms of the chapter 13 plan to reflect changes in income and expenses. Again, the law requires a commitment of disposable income - so when a debtor’s disposable income changes, the debtor’s chapter 13 payment plan can change.
The requirement of paying all disposable income into the chapter 13 plan isn’t new - it’s been required as a feature of chapter 13 since the Bankruptcy Reform Act of 1978. Modification of chapter 13 payment plans in situations where a debtor’s household income has decreased has always been a feature of chapter 13. A person in that situation contacts his attorney and together, the attorney and client figure out a new plan payment. Debtor’s with decreased resources have been able to modify their plans based on their new financial reality for the 40 years since the 1978 law passed.
But the ability of the chapter 13 trustee to monitor a debtor’s disposable income has changed - due to the provisions of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005.
Under the 1978 law, the determination of disposable income was completed when the debtor’s chapter 13 plan was confirmed by the bankruptcy court. Further inquiries into the debtor’s income and expenses only took place when a debtor sought to modify the chapter 13 plan. But the 2005 law requires the chapter 13 debtor to send complete copies of state and federal income tax returns to the chapter 13 trustee for every year that the debtor is “in” the chapter 13 case. Further, the debtor is required to report increases in income (more than 5% annual raises) and/or the receipt of employment-related bonuses to the chapter 13 trustee. And when income tax refunds are received, the debtor can keep the first $1200 ($2000 if the debtor is married) of the refund, but has to send the “surplus” of the refund to the trustee as an additional plan payment. And if the trustee sees that debtors are making more money than the debtors were at the time of the filing of the chapter 13 case, the bankruptcy trustee can request the debtor to re-do the budget of income and expenses. If the debtor declines to revise the budget, the trustee can ask the court to dismiss the debtor’s chapter 13 case.
So what’s a debtor to do in these situations? That’s what I’ll write about in my next post.