When discussing various bankruptcy and non-bankruptcy options, an analogy I often use is that each option is like a different tool in a carpenter’s toolbox and serves a different purpose. If one wishes to drive a nail into a piece of wood, a hammer would be the best choice. (My father, who lacked carpentry skills, would often use a pair of pliers for this purpose). Each approach has advantages and disadvantages over other available options and will yield different results. Therefore, it is important to understand the strengths and limitations of each choice.
I. Chapter 13
A Chapter 13 is truly a wonderful tool when used correctly. It is easiest to think of Chapter 13 as a type of debt consolidation. Chapter 13 is also known as a wage-earner plan, which means that the debtor must have a regular income2. The debtor is required to schedule all creditors, including those creditors who are to be paid directly (as opposed to the majority of creditors who are paid through the Chapter 13 trustee), and those creditors paid by a co-signer. The debtor must file a Chapter 13 plan in which the debtor states family income and expenses, disposable income (which is used to fund the Chapter13), mortgages and other secured creditors, priority creditors, special classes, the percentage to be paid to the unsecured creditors, the plan payment and the duration of the plan (the code requires the plan to be completed in three years or less. By request, the plan can run a maximum of five years).3
Plan payments are made to the Chapter 13 trustee, who acts as a dispersing agent. 4 A Section 341 meeting (meeting of creditors) is held, where the Chapter 13 trustee reviews the plan and budget to see if the debtor is making his best effort, and to verify other information. Other requirements for Chapter 13 confirmation include good faith, feasibility and require the debtor to be current in his plan payments to the Chapter 13 Trustee. 5 The debtor is entitled to a Chapter 13 discharge upon the completion of the required Chapter 13 plan payments.6
There are a number of advantages to a Chapter 13.
One of the most important is the automatic stay, 7 which stops creditors from continuing most types of legal proceedings against the debtor. This includes the continuation of a foreclosure, auto repossession, wage garnishment, tax levy, civil litigation, etc. One unique feature of the automatic stay in a Chapter 13 is co-debtor protection. 8 Another advantage is the broad discharge of the Chapter 13 discharge order. The debtor may be able to discharge claims based on fraud, including fraud while acting in a fiduciary capacity, and willful and malicious injury to another, which might not be dischargeable in a Chapter 7.
As an example, the filing of a Chapter 13 will suspend a mortgage foreclosure. This allows the debtor two to three years to cure the mortgage default through the Chapter 13, while continuing to make current monthly mortgage payments.9 This is a right unique through bankruptcy, even after the statutory period to reinstate the mortgage has expired under state law.
Another example of rights found within Chapter 13 is the repayment of past due taxes, even including suspension of an on going tax levy. In fact, most kinds of debt can be repaid through a Chapter 13 and without the agreement of the creditors! In some cases, it is possible to repay unsecured creditors less than 100% and receive a discharge of the balance.10
There are a number of disadvantages of a Chapter 13.
A Chapter 13 is not available to a person who does not have regular income. Chapter 13 is also not available to a corporation, but is available to a person with a business which is not incorporated. Another limitation of a Chapter 13 is the debt limit, currently $871,550.00 for secured creditors and $290,525.00 for unsecured creditors.11 Additionally, because a Chapter 13 is a type of bankruptcy, the filing of a Chapter 13 will have an adverse effect on the debtor’s credit.
II. Chapter 13 v. Chapter 7
New bankruptcy rules require potential debtors to be given information regarding both Chapter 7 bankruptcy and Chapter 13 and the differences between them. Conceptually, a Chapter 7 bankruptcy12 represents the simplest approach. In a Chapter 7, a debtor is trying to get rid of as much debt as possible. First, certain types of debt are not eliminated in a bankruptcy, i.e. student loans, child support, death or injury caused while driving under the influence of alcohol or drugs, recent taxes to the Federal and State governments, criminal fines, etc.13 Some debt may not be eliminated but requires specific action by the creditor. As an example, recent credit card usage may not be eliminated by the bankruptcy if the creditor files an Adversary (a lawsuit filed within the bankruptcy)14 against the debtor and obtains an order declaring it non-dischargeable. A debtor may also elect to reaffirm some debt that would otherwise be discharged by the bankruptcy such as car loans or other secured debt, co-signed debt, etc.
One of the primary considerations in filing a Chapter 7 is what non-exempt asset the debtor may have to forfeit to the Trustee. Non-exempt assets can include equity in real estate or automobiles, personal injury lawsuits, cash on hand, inheritances, etc. Upon the filing of a Chapter 7 bankruptcy, a Chapter 7 Trustee is appointed to oversee the case for the purpose of liquidating non-exempt assets15 and making certain that the debtor has complied with some specific requirements. The equity of assets, which can be exempted, or shielded, from the Chapter 7 Trustee, are listed in 11 USC 522(b). Individual States, including Illinois, have opted out of this section and use their own state exemptions. Illinois’ exemptions are found at 735 ILCS 5/12-1001.
There are a number of advantages to a Chapter 7 as compared to a Chapter 13.
Chapter 7 bankruptcy eliminates debt, giving the debtor a fresh start. There are an extremely high percentage of debtors who receive a discharge in a Chapter 7 bankruptcy. Additionally, there is no debt limit within a Chapter 7 bankruptcy. And a Chapter 7 is completed within a short time taking approximately 4-5 months from filing to discharge.
There are a number of disadvantages to a Chapter 7 as compared to a Chapter13. First, the Chapter 7 discharge is not as broad as the Chapter13 discharge. Additionally, a Chapter 7 can be filed only once every six years from the date of filing the previous Chapter 7. 16 There is also no cure provision for loans that are currently in default. This means that you cannot use a Chapter 7 to reinstate a mortgage or a default on an automobile loan. There is also no co-debtor protection as there is in a Chapter 13.
III. Chapter 13 v. Chapter 11
Kids, don’t try this at home. A Chapter 1117 is reorganization for corporations, or for those individuals with a large amount of debt. Like diamonds, remember the four "C‘s" when reviewing Chapter 11 options:
1 Cost - As an example, the filing fee for a Chapter 11 is four times that of either a Chapter 7 or a Chapter13. It is not uncommon for law firms to ask for a $5,000.00-$15,000.00 retainer to begin a relatively simple Chapter 11.
2 Complexity - Unlike a Chapter 13 plan, the Chapter 11 disclosure statement and plan18 requires a lot of work and is not for the faint of heart.
3 Creditors - Unlike a Chapter 13, there may be an unsecured creditor’s committee in a Chapter11. 19 This committee has the right to accept or reject the Chapter 11 debtor’s proposed plan of reorganization or propose their own plan of reorganization.
4 Confirmation - Unlike a Chapter13, the Chapter 11 confirmation concludes the creditors voting and accepting their treatment under the plan20
After confirmation, claims must be reviewed for possible objections. The debtor is required to file quarterly reports. By its very nature, a Chapter 11 is not the type of a bankruptcy case that an attorney with limited bankruptcy experience should attempt.
IV. Chapter 13 v. debt consolidation
Debt consolidation, either through a debt consolidation company such as Consumer Credit Counseling Service or some form of self-help, should be considered as a viable alternative to any type of bankruptcy approach.
There are a number of advantages to debt consolidation as compared to a Chapter 13.
Most important, debt consolidation is not a type of bankruptcy and therefore has a less adverse effect on one’s credit. In debt consolidation, one does not have to list all creditors. One can pick and chose creditors to be paid through debt consolidation. Often, creditors are willing to work with a debt consolidation company because the creditors know the alternative could be a Chapter 7 notice. Finally, debt consolidation is purely voluntary.
There are a number of disadvantages to debt consolidation as compared to a Chapter 13.
One of the most significant disadvantages to debt consolidation is the absence of an automatic stay. This means that if a house is in foreclosure, debt consolidation will likely not stop the foreclosure. If one is behind on an automobile loan, the debt consolidation will not stop an automobile repossession. There is also no protection for any co-debtors. It up to an individual creditor whether they are willing to work with the person entering debt consolidation. Nothing prevents creditors from continuing to call, allowing interest to continue to accrue, continuing with litigation, etc.
In summary, a conscientious attorney will explore both bankruptcy and non-bankruptcy approaches with a potential client. However, not every solution will result in a client for the attorney.
1 11 U.S.C. 1301-1330
2 11 U.S.C 109(e)
3 11 U.S.C. 1322
4 11 U.S.C. 1302
5 11 U.S.C. 1325 (a)
6 11 U.S.C. 1328 (a)
7 11 U.S.C. 362 (a)
8 11 U.S.C. 1301 (a)
9 11 U.S.C. 1322 (c)
10 11 U.S.C. 1325 (b)
11 11 U.S.C. 109 (e)
12 11 U.S.C. 701-784
13 11 U.S.C. 523 (a)
14 Bankruptcy Rules 7001-7087
15 11 U.S.C. 704
16 11 U.S.C. 727 (a)(9)
17 11 U.S.C. 1101-1174
18 11 U.S.C. 1121-1127
19 11 U.S.C. 1102-1103
20 11 U.S.C. 1128-1142
Marc C. Scheinbaum is a Principal,Kofkin, Springer,Scheinbaum & Davis, P.C. Our firm concentrates in Bankruptcy Law, consumer debtor and creditor representation, commercial bankruptcy representation, bankruptcy litigation, bankruptcy appeals, work-outs and Bankruptcy Trustee representation. Marc C. Scheinbaum has been a practicing bankruptcy attorney for more than 20 years in the Chicago area, having represented both debtors and creditors. Education: Illinois Institute of Technology, B.S., 1971; DePaul University College of Law, J.D., 1981.