Chapter 13 Bankruptcy

Bankruptcy laws in the United States allow individuals and corporations to get out of debt, either by selling off a debtor's assets and repaying creditors (i.e., liquidation) or by undergoing a court-supervised reorganization of the debtor's finances. Filing for bankruptcy allows many unsecured debts to be extinguished.

The Bankruptcy Code sets forth several paths for individuals and businesses to emerge from debt. Each route is contained within a chapter of the law. Chapter 13 provides a process of court-supervised reorganization of an individual's finances so that the individual may pay back his or her creditors.

Who may file for Chapter 13 bankruptcy?

An individual with a large amount of debt that he or she can no longer make payments on can file for federal bankruptcy protection under Chapter 13. That individual may be self-employed, or operating an unincorporated business, but he or she must have enough disposable income to be able to repay creditors over a three to five year period. If the individual won't be able to make regular payments, Chapter 7 bankruptcy will allow an immediate solution to the individual's debt, but the debtor's assets will be sold to pay creditors in a Chapter 7 liquidation bankruptcy.

An individual cannot file for a Chapter 13 reorganization bankruptcy if he or she already did so in the previous 180 days and either the bankruptcy petition was dismissed or that individual failed to appear or comply with the court's orders. An individual also must complete credit counseling with an approved agency in the 180 days prior to filing for Chapter 13 bankruptcy, unless the court grants a waiver, as well as an "instructional course concerning personal financial management." A record of the individual's bankruptcy filing stays on his or her credit report for 10 years. A husband and wife may file together for Chapter 13 bankruptcy.

How it works

An individual seeking bankruptcy protection under Chapter 13 must a petition with the bankruptcy court that includes his or her income and expenditures, assets and liabilities, contracts and leases in effect, and other documents evidencing his or her financial affairs, including tax returns. Individuals filing for Chapter 13 bankruptcy must pay applicable fees unless the court waives them.

Once an individual or business has filed for Chapter 13 bankruptcy, the law provides for an automatic stay of outstanding debts, which means that creditors generally cannot carry out collection attempts, lawsuits, or wage garnishments. Some actions are excluded from the automatic stay, but a debtor will be able to protect his or her home from foreclosure by filing a Chapter 13 petition before the mortgage company completes a foreclosure sale. The debtor must make mortgage payments again after filing to prevent foreclosure.

A special automatic stay provision within Chapter 13 also protects co-debtors: A creditor can't try to collect a consumer debt, which is a debt incurred by an individual primarily for a family, household, or personal reason, from any individual who is liable along with the debtor who has filed for bankruptcy, such as a co-signer on a loan.

Upon filing, the court appoints a trustee to oversee a Chapter 13 petition. The trustee will hold a meeting with the debtor and creditors between 20 and 50 days after the petition is filed and evaluate the case. At the meeting, the debtor will have to answer questions under oath about his or her debt and finances. The trustee will manage the reorganization, collecting money from the debtor and distributing it to creditors after the court has approved a plan for repayment.

Plan of repayment

Debtors must file a plan for repayment with the court within 15 days (unless the court extends this deadline) of their Chapter 13 filing. The repayment plan encompasses payments of fixed amounts on a regular schedule over a three to five year period. Some debts can be discharged completely by the court, while other creditors will receive partial or full payment, depending on the nature of the debt. There are three kinds of debts: secured, unsecured, and priority, and the plan must meet specific rules for each kind of debt. Priority debts, for example, must be paid in full.

A plan of repayment must satisfy many requirements for a court to confirm it. Several are fundamental: The plan must commit all of the debtor's income after taxes to paying off the debts for at least three years—unless all unsecured debt can be paid off in fewer than three years—and up to five years. The plan also must establish that unsecured creditors will be repaid as much money under a Chapter 13 repayment plan as they would if the debtor instead had his or her assets liquidated through a Chapter 7 filing.