Why Do So Many Chapter 13 Cases Fail?

a frustrated man shakes an empty piggy bank

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In one of our federal judicial districts, our Chapter 13 trustee holds his meetings of creditors one morning a week. All of the debtors who filed during a certain period are scheduled for that time. Before the debtors meet with a hearing officer, they come together in a large classroom. The trustee welcomes them with the following exercise:

Ladies and Gentlemen: Please look to your right. Now, look to your left. Only one of you will complete your Chapter 13 case. Will it be you or one of your neighbors?

The reality is that Chapter 13 cases require a lot of motivation to carry through three to five years of voluntary austerity. 

Emotions, Fortitude, and Motivation

Chapter 13 is hard. There can be no doubt about that. No matter the pains we took to explain to our clients what they were up against, it never seemed to sink in. 

The pre-petition prep process is probably the most emotionally wrenching period of a client's bankruptcy life. Clients are asking themselves:

  • Will this Chapter 13 save my house (or car or sanity)?
  • Can I afford the payments?
  • Why do I have to gather all of this information?
  • Will the court approve my plan?
  • Am I doing the right thing?
  • What if (my boss, my neighbors, the PTA) finds out?

Because emotions are riding high, we would expect that clients only hear about 50% of what we tell them; and of that, they only comprehend about 50%. How do we know this? It's borne out by the number of times a client asks me, "How do I make my Chapter 13 payment?" This, despite the fact that we provide detailed instructions in a form we hand the client and in an email, we send the client with filing information. We hear that question and many others repeatedly, even though we discuss these issues at various times and in various forms from the initial consultation through the meeting of creditors and beyond. 

Chapter 13 is not easy to learn and not easy to carry out. A lot of things happen along the way that could derail a case. And sometimes, cases are filed even when we know they will never reach discharge. Here's why:

Not Enough Resources to Begin With

Many Chapter 13s are filed to stop a foreclosure or some other unwanted event like a car repossession or trial on a lawsuit over a debt. Often, the clients don't come to us until the very last minute when they're out of options. Unfortunately, we don't have as much time as we'd like to give the client's financials a thorough review before the case must be filed. That has to wait until later when we're gathering all of the information needed for the bankruptcy schedules.

Sometimes, it's not until we have access to the particulars on income and expenses that we see that the clients just can't afford to keep the house or the later model car. This was never more true than with the clients who were caught up in the housing crisis, beginning about 2008. Many had been approved for exotic mortgages, adjustable rates and payments that dwarfed the rest of their disposable income. Despite the odds, however, they almost always wanted to go forward. "After all," they'd say, "the bank approved me. I should be able to make these payments. I just need time to catch up." 

Disruption in the Flow of Income

Any disruption in the flow of income, like illness or job loss, will make it very difficult to keep or get back on track. Children are born or their needs change (you can go from pregnancy to school tuition in five years). Marriages begin and end. It's hard to go five years without credit, major car repairs, replacement of an appliance, insurance deductibles, emergency travel or even a vacation. Many of these items can be built into a Chapter 13 budget, but there's really no room for savings. Creditors don't like it when you hold back money that you could be paying to them. 

As a subset, I'd have to add that flavor of a client who just gets tired and wants out. Again, this is a function of time as much as anything else. Five years of fighting even the good fight are exhausting. Many clients decide that it's just not worth it, especially if they filed Chapter 13 to save an asset like a house.

Filing Without an Attorney

According to the Administrative Office of the US Courts, about nine percent (9%) of bankruptcy cases are filed by debtors pro se (meaning on their own, without attorney assistance.) Also, see Pro Se Bankruptcy Filings Growing Faster Than Other Bankruptcy Relief

It is possible to get through a Chapter 7 case without an attorney - possible but not advisable. On the other hand, we have never heard of a successful Chapter 13 case. Most don't get beyond the plan confirmation stage. Chapter 13 plans are subject to such esoteric provisions as the "Best Interest of Creditors Test," and "Good Faith Test" and "Chapter 13 feasibility." Good experienced bankruptcy lawyers, trustees and judges argue over these provisions all the time. That's why we have courts. If a pro se layman makes it past the confirmation stage, I'd have to think it was just dumb luck. (No offense intended). 

This is borne out in a study conducted by the Bankruptcy Court for the Central District of California. The Central District has a particular interest in this issue because it has more pro se filers than any other district in the country. The 2011 study found that approximately 60.9% of pro se Chapter 7 filers obtained a discharge (compared with 94.5% of those represented by an attorney), but less than one-half of one percent (compared with 55% of those represented by an attorney) of pro se Chapter 13 plans were actually confirmed. 

Just Buying Time

In all honesty, perhaps this article should be titled, "Why Do So Many Chapter 13s get dismissed?" Because there are legitimate strategic reasons to leave Chapter 13 before the payments are completed. 

Chapter 13 debtors file for any number of reasons. Many file Chapter 13 just to take advantage of the automatic stay without any intention of actually completing a case. I've filed cases to delay foreclosure, to give the client a chance to sell property, to slow down a lawsuit and negotiate a settlement, to spread out attorneys fees through the plan payments when a client could not pay them upfront, to gain the protection of the bankruptcy court when the debtor had received a Chapter 7 discharge a few years before, to manage student loans. Not all of the debtors in those cases would necessarily benefit from a Chapter 13 discharge. What they needed was time, and filing Chapter 13 provided it. 

Updated by Carron Armstrong.