Introduction to Chapter 13 Bankruptcy

This illustration shows how chapter 13 bankruptcy works including that the debtor files a bankruptcy case, makes monthly payments to a chapter 13 trustee, makes payments for a period of 36 to 60 months, and then the trustee distributes the money to the debtor's creditors.

Image by Kelly Miller © The Balance 2020

Bankruptcy doesn't mean that you get stripped to your shorts and thrown out on the street. Far from it. In fact, there are several different types of bankruptcy, all with their own procedures and rules, that are designed to accomplish different goals.

Federal law provides for five types of bankruptcy. Individuals can file four different types. Of these, most people file under Chapter 7,* a process that allows for forgiveness of debt—also called discharge of debt—in exchange for the filer's nonexempt assets. Nonexempt assets are deemed under state or federal law to be nonessential to a fresh start,

The second most common type of bankruptcy for individuals is a Chapter 13* case. Chapter 13 is less about the elimination of debt and more about the reorganization of an individual’s finances. The Chapter 13 process requires that the debtor (that’s what we call the person who files the bankruptcy case) make a monthly payment to a Chapter 13 Trustee for a period of 36 to 60 months. The Trustee then distributes that money to the debtor’s creditors who have filed proper claims.

*The Bankruptcy Code is the federal law that governs our bankruptcy court system. The Code is divided into numbered chapters and sections. Hence we refer to each type of bankruptcy by the number of the Bankruptcy Code chapter that covers it.

Chapter 7 Discharge of debt in exchange for nonexempt (nonessential) property.
Chapter 11 Reorganization of debt, usually more effective for high debt/high asset individuals and business interests
Chapter 12 Reorganization reserved for family farmers, small farming concerns, and fishermen, that draws elements from Chapter 11 and Chapter 13
Chapter 13 A monthly payment plan for managing debt that lasts three to five years and usually results in a discharge.
Types of Bankruptcy Available to Individuals

Discharging Debt in Bankruptcy

In both a Chapter 13 and a Chapter 7 case the debtor ends up with a discharge of debt. That is, the debtor is relieved from the obligation to pay certain debts like credit cards and medical bills. The difference is in how a debtor gets to the discharge.

In a Chapter 7 case, he is required to turn over any nonexempt property. Exempt property is defined under federal or state law and is usually property deemed necessary for the debtor to achieve a fresh start after the bankruptcy is over. In a Chapter 7 case, the debtor would turn over all nonexempt property to a trustee, who will sell it for the benefit of the debtor's creditors.

In a Chapter 13 case, instead of turning over the property for a trustee to sell, the debtor makes payments for 36 to 60 months to a Chapter 13 trustee who distributes the funds to creditors who have filed claims that the court agrees are proper.

So, why would someone file a Chapter 13 case that can last as long as five years when a Chapter 7 case usually lasts about six (6) months? There are a number of factors that go into that decision. Let’s explore some of the considerations in deciding when a Chapter 13 is better than a Chapter 7 case. 

A Word About the Means Test

The Means Test is a calculation applied to almost every consumer Chapter 7 bankruptcy case and is purportedly designed to determine whether the debtor has enough disposable income to fund a meaningful Chapter 13 plan. If so, the debtor is said to be filing the Chapter 7 case under a "presumption of abuse." That is, the bankruptcy laws would rather have that debtor making payments for a period and paying back at least a portion of the debt, rather than get an outright discharge of the debt.

Although it is possible to overcome the "presumption of abuse" by showing special circumstances, most debtors who "fail" the Means Test choose to file a Chapter 13 case rather than suffer through the scrutiny necessary to overcome the presumption.

There are many reasons why a debtor would choose to file Chapter 13 despite the Means Test. 

What a Chapter 13 Can Do That a Chapter 7 Cannot Do

Chapter 13 may provide a debtor with bankruptcy protection even if they make too much money to qualify for a Chapter 7 case or if he received a discharge in a prior Chapter 7 case. It allows a debtor the length of the plan to pay back past due amounts owed on houses, cars and other loans that have collateral. Chapter 13 may allow a debtor to set new terms for the payment of a car loan that is older than 2.5 years.

Chapter 13 allows a debtor to pay past-due income taxes and domestic support obligations like child support and alimony over the three to five year Chapter 13 payment plan. This form of bankruptcy protects the debtor's co-signer on a personal loan from having to pay. Also, it may allow the debtor to better manage high student loan payments.

Further, Chapter 13 allows the debtor to protect property that he might have to give up in a Chapter 7 case. A Chapter 13 filing may even allow the debtor to pay his bankruptcy attorney’s fee as a part of the Chapter 13 plan payment instead of all upfront.

Chapter 13 is not an easy process. It requires commitment, perseverance, stability, and sacrifice. We go into this more in-depth in Living With Chapter 13, Part 1 and Living With Chapter 13, Part 2.

The Chapter 13 Payment Plan

The hallmark of a Chapter 13 case is its payment plan. The payments last from 36 to 60 months and may include an amount that will go to unsecured creditors, past-due taxes, child support, and past-due home mortgage amounts. It may even include car or house payments and some portion of a debtor's attorney fees. It is designed to 

  • Help make payment of unsecured debts like medical bills and credit cards more affordable and manageable.
  • Provide a way to pay past-due house, car, income tax, child support and alimony payments over time.
  • Substitute for the need to sell or turn over the nonexempt property.

The amount of the payment is determined by the amount and types of debt owed, the debtor's income and the debtor's reasonable and necessary expenses. 

You can find out more about the important events in a Chapter 13 case in Timeline of a "Typical" Chapter 13 Case

Updated by Carron Nicks