What is Chapter 13 Bankruptcy?

A Chapter 13 Bankruptcy is also known as a “wage earner” or “rehabilitation” Bankruptcy. The key features of a Chapter 13 Bankruptcy are: (1) the debtor gets to keep all or most of their property; and (2) the debtor will use a portion of their future income to pay back creditors over the period of the plan.

The Bankruptcy laws are written to make it easier to file for Chapter 13 rather than Chapter 7. This is most easily shown with the “means test”, which requires to debtor to fall below certain disposable income standards in order to be eligible for Chapter 7.

Chapter 13 is more complex, in part, because it requires the debtor to file a rehabilitation plan with their petition. Once the petition is filed, the debtor begins must begin to make payments within 30 days to the Chapter 13 trustee. The trustee holds this money until the plan is confirmed. The trustee will then transmit this money to creditors in accordance with the plan once the plan is confirmed by the U.S. Bankruptcy Court. Once, the plan is complete the debtor will receive a discharge on the eligible unsecured debt which was not paid. Chapter 13 issues generally relate to details and specifics of the plan.

Details of the Plan

The Chapter 13 rehabilitation plan proposes how the debtor will pay back various creditors throughout the rehabilitation period. It generally contains information such as what income and which assets will be used to fund the repayment of creditors, and how different claims will be treated (secured, priority, unsecured).

What must be included in the Plan

• The plan must commit the debtor to pay future earnings (or give up property) an amount that enables the debtor to successfully execute the plan
• Unlike unsecured claims, the plan must provide for the full payment of priority claims (there is a limited exception for domestic support obligations to government units). Common priority claims in a consumer case are: (1) domestic support obligations; (2) administrative expenses –fees such as trustee fees and fees for professional services; and (3) priority taxes.
• The equitable treatment of claims within a given class. For example, the plan cannot pay certain unsecured creditors more than other unsecured creditors within the plan (paying family member more than a credit card).

Length of Plan

A plan generally is between 36 and 60 months. This figure is dependent on the debtor’s median family income and dependent on the disposable income test discussed below. If the debtor’s median family income is less than standards prescribed by Bureau of the Census for Texas residents then the plan will not be allowed to go beyond 36 months without the court’s approval for cause. Alternatively, if the debtor’s median family income is above the standards for Texas then the plan can extend up the 60 months. This test is the same as the first step of the Chapter 7 “means test.”

Here are the figures for Texas residents as of October 1, 2008 as reported by the U.S. Trustee. * (add $6,900 for each person over family of 4)

Requirements for Plan Confirmation

The Bankruptcy code contains numerous provisions to ensure that unsecured creditors are fairly treated under a Bankruptcy petition. The following tests deal with tools for unsecured creditors to ensure that they are being adequately paid under the debtor’s Chapter 13 rehabilitation plan.

Best Interest Test

The Best Interest Test basic goal is to ensure that unsecured creditors are paid at least the amount under a Chapter 13 plan as they would have received under a Chapter 7 plan. Because of this, there is a hypothetical Chapter 7 liquidation and distribution based on the current value of estate property and the current market rate of interest (to account for the present value for the claim). The creditors under the Chapter 13 plan must receive at least this amount in order for the plan to be confirmed. If under this hypothetical Chapter 7 distribution the unsecured creditors would have received nothing, then it will be proper for them to receive nothing under Chapter 13 so long as the plan is offered in good faith and passes the disposable income test discussed below

• Example 1: Wanda Worker is currently employed and has a home with equity of $100,000, a car with equity of $10,000, and various other personal property with $15,000 of equity. Under Texas exemption law, she would be entitled to keep all of her property under a Chapter 7 plan (unlimited homestead exemption and her personal property is under the $30,000 limit). Thus, in a hypothetical Chapter 7 liquidation her unsecured creditors would not receive anything. Therefore, her plan will pass the best interest test if it pays a minimal amount, such as 10%, to her unsecured creditors so long as she proposes the plan in good faith and it passes the disposable income test.
• Example 2: Same facts as above except her personal property and car equity total $40,000. In this situation her plan must pay her unsecured creditors the present value of $10,000 ($40,000 in personal property minus $30,000 personal property exemption). Her plan will be confirmed so long as the plan is proposed in good faith and it passes the disposable income test.

Disposable Income Test

The disposable income test can be raised by an unsecured creditor and requires that the plan commit all of the debtor’s disposable income for either a 36 month period or 60 month period. The plan will have to commit to 36 months of disposable income if the debtor’s current monthly income is less than the median family income for their state. Alternatively, the plan will have to commit 60 months of disposable income if the debtor’s currently monthly income is greater than the median income for their state (the figures for Texas are given in the chart above). Please note, this DOES NOT MEAN that the plan has to ACTUALLY BE 36 or 60 months. The plan can be shorter, but it must commit the same amount of money over a shorter period of time. Please see the example for further understanding.

Determination the debtor’s current monthly income is also important under the disposable income test because it also determines what method the Bankruptcy Court uses to determine the debtor’s monthly income. If the debtor’s currently monthly income is above the state median, then the debtor will be forced to deduct the pre-set expenses authorized by the Bankruptcy code, not their actual expenses. The format used here is essentially the same as that used in the “means test”.  Alternatively, the debtor will submit their budget and expenses to the Bankruptcy Court for review when their current monthly income is below the state median. It is important to note that in this latter situation the debtor is not required to file for Chapter 13 because they are automatically eligible for Chapter 7. (Review the median income test and means test under the Chapter 7 page for more details).

• Example 1: Wally Worker currently earns pre-tax income of $4,000 per month. Because his current monthly income (48,000) is greater than state median for a 1 earner in Texas ($37,120) his plan will have to commit his disposable income over 60 months. In order to determine the disposable income amount Wally will not get to deduct his actual expenses, but rather have to deduct pre-set expenses. If these expenses are determined to be $3700, Wally will have to commit $18,000 to the plan ($300 monthly disposable income times 60 months). Therefore, the plan must commit this amount. If the plan is 60 months then Wally will have to commit at least $300. However, Wally could shorten his plan period by committing this amount over a shorter period of time (for example 54 months). In this case, Wally would still satisfy the disposable income test by committing at least $333 per month.