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a. To avoid liquidation of assets. In a Chapter 13 proceeding, the bankruptcy trustee assigned to the case does not have the authority to liquidate assets; the debtor may keep all his or her assets. However, as noted above, the debtor must pay creditors the value such assets would have had to creditors had such assets in fact been liquidated by a hypothetical Chapter 7 trustee had the debtor filed Chapter 7. And the debtor is given up to sixty months within which to pay creditors for those assets. For example, say the debtor owns a business as a sole proprietorship and the business has accounts receivable, inventory, and equipment, above and beyond all liens, leases, and available exemptions, worth $30,000. If the debtor files Chapter 7, it is probable that the Chapter 7 trustee will liquidate such assets for the benefit of creditors. Not only would the Chapter 7 trustee be taking the debtor's primary asset, but is interrupting, perhaps irretrievably, the debtor's cashflow, i.e., the debtor's ability to put food on his or her table. In Chapter 13, the debtor is permitted and encouraged to keep the business's accounts receivable, inventory, and equipment and use such assets to continue to make a living. However, the debtor's Chapter 13 plan must propose to pay creditors at least $30,000 over its thirty-six-to-sixty-month duration.

b. Because the debtor may have surplus income, that would make the debtor susceptible to a motion by the United States Trustee to dismiss the case based on 'substantial abuse'. One of the primary changes made by Congress and the President when they enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 is the implementation of a 'means test'. The means test focuses on the combined gross income of all members of the marital community, regardless of whether only one or both members of the marital community file bankruptcy. Income is determined based on an average over the past six months, regardless of whether the average income over the past six months reflects future earning ability. Subtracted from income are various household expenses, some based on objective standards created by the Internal Revenue Service, and some based on the debtor's actual spending history. If the net surplus is greater than the state's median level of income for a family of the debtor's size, the presumption exists that the debtor is not eligible for Chapter 7. If the debtor's net surplus is below the state's median level of income for a family of the debtor's size, but there is still sufficient income to repay a portion of the debtor's debt if forced to do so in a Chapter 13 proceeding, the debtor may nonetheless be ineligible for Chapter 7 relief.

c. To force upon specific types of creditors a payment plan which would otherwise not be acceptable if not forced upon them in a Chapter 13 proceeding. The primary example is mortgage arrearages. Say the debtor owns his or her home. He or she is six months behind, or $15,000, on his or her mortgage payments. Foreclosure is coming up in just a few days. The mortgage company wants all $15,000 else it will proceed to sell the property at foreclosure. The debtor does not have $15,000 saved. Chapter 7 will typically only buy the debtor an additional month or two but will likely nonetheless result in foreclosure and loss of the property. Chapter 13, however, will force the mortgage company into accepting a thirty-six-to-sixty-month cure of the $15,000 of arrearages while the debtor resumes payment of his or her normal monthly mortgage obligation. Another example is taxes. Say the debtor is $20,000 in arrears to the Internal Revenue Service for recent priority nondischargeable taxes. Chapter 7 will prevent the Internal Revenue Service from seizing assets, liening assets, levying against the debtor's bank account, or garnishing wages pursuant to an earnings withholding order, but only temporarily--typically only about four months. Chapter 13, however, will put the debtor on a payment plan to repay the $20,000 to the Internal Revenue Service over the thirty-six to sixty month duration of the plan, and, as long as the debtor is making his payments to the trustee of his court-approved plan payments, the Internal Revenue Service is prohibited from seizing assets, liening assets, levying against the debtor's bank account, garnishing wages pursuant to an earnings withholding order, or making any other attempts to collect.

d. Because the debtor may not be entitled to another Chapter 7 discharge. A debtor may only obtain a Chapter 7 discharge every eight years. If the debtor has already received a Chapter 7 discharge within the past eight years, he or she is nonetheless entitled to a Chapter 13 discharge. Chapter 13 may be a debtor's only viable option if there has been a recent Chapter 7 discharge.

e. To force student loan lenders or guarantors into a long-term payment plan, even though the student loan debt will not be discharged at the conclusion of the plan. Say for example, the debtor owes $100,000 of student loan debt. Let's also assume that the student loans are in default and the debtor has already used up all available forbearances and deferments. The student loan lenders and/or guarantors are running out of patience and are perhaps now filing suit or enforcing a judgment against the debtor. If the debtor files a Chapter 13 petition, the debtor can force the student loan lenders and/or guarantors into a payment plan of up to five years in duration at what might be a very small percentage on the dollar, during which time, as long as the debtor is making payments pursuant to the Chapter 13 plan's terms, the student loan lenders and/or guarantors can take no action against the debtor or the debtor's property. At the end of the plan's terms the debtor will receive his or her discharge, but since student loan lenders and/or guarantors are generally not discharged, the debtor will still owe the portion of the student loans that were not paid during the Chapter 13 proceeding, plus the interest which accrued during the plan's duration.

f. To split a secured creditor's lien into a secured portion to be paid in full during the plan, and an under secured portion to be paid the same percentage that other unsecured nonpriority creditors will receive under the Chapter 13 plan. Say for example, the debtor owns a vehicle indisputably worth $10,000, but the debtor owes the bank which holds the vehicle's title $15,000. Let's also assume that the debtor's plan proposes to pay only 05.0% to unsecured nonpriority creditors. With some exceptions, Chapter 13 allows the debtor to pay the secured lender the $10,000 value of the collateral over a period not to exceed the sixty month maximum length of a plan, and to pay the lender only 05.0% on its $5,000 under secured claim.

There are six chapters of bankruptcy that one may file:

a. Chapter 9 is the chapter that municipal entities and railroad companies use when they file bankruptcy. You might recall that Orange County, California filed a bankruptcy in the mid-1990s. Bridgeport, Connecticut also filed a bankruptcy petition. Individuals do not use Chapter 9.

b. Chapter 12 is the chapter that family farmers use. Individuals who do not own agricultural property do not use Chapter 12.

c. Chapter 15 is the chapter used by United States courts to administer assets of companies who have filed for bankruptcy protection in foreign jurisdictions.

d. Chapter 11 is the chapter that you probably hear or read about most often in the news; it is the high-profile chapter used primarily by corporations, limited liability companies and partnerships to reorganize their financial affairs. Individuals are eligible for Chapter 11 relief, but it is a time-consuming and expensive chapter, and therefore only appropriate for individuals whose circumstances make Chapter 7 or Chapter 13 inapplicable or inappropriate.

e. Chapter 7 is a 'straight bankruptcy' or 'liquidation bankruptcy.' It is the most common chapter; approximately two-thirds of all the bankruptcies filed around the country each year are Chapter 7s. In a Chapter 7 proceeding, the debtor is seeking a discharge, which is a document mailed to the debtor by the Clerk of the Bankruptcy Court toward the end of the case. The discharge is the document which essentially states that the debtor is no longer legally responsible for repaying his or her creditors. There are a few 'prices' one pays for the privilege of receiving a Chapter 7 discharge.

There are three primary components to every Chapter 7 bankruptcy proceeding: assets, liabilities, and income:

1. The asset portion of a Chapter 7 bankruptcy proceeding.

In every Chapter 7 proceeding, a judge is assigned, and a trustee is assigned. In most Chapter 7 cases, the debtor never sees his or her judge, but does meet his or her trustee. It is helpful to look at the Chapter 7 trustee as an independent contractor for the federal government; the government wants experienced professionals to help it do its job, but does not want to pay in-house salaries, so it contracts with local attorneys and accountants to provide the needed services. The trustee's primary responsibility is to review the bankruptcy petition, schedules, and statement of financial affairs, examine the debtor by asking some questions at a meeting of creditors approximately five weeks into the case, and determine whether the debtor owns any assets that ought to be liquidated or sold to generate money to pay creditors on their claims, at least in part.

In approximately ninety-five percent of the Chapter 7 cases filed around the United States each year, the trustee comes to the conclusion that there are no such assets worthy of liquidation, because most debtor's assets fall into four basic categories that make those assets relatively unattractive:

a. Liened assets. If the debtor owns a home worth say $200,000, but the property is mortgaged in the amount of $190,000, then there is virtually no equity for the bankruptcy trustee. The trustee is only interested in liened assets if there is substantial equity available for creditors.

b. Leased assets. If the debtor is leasing his or her vehicle or is operating a business and leasing his or her equipment, there is rarely any equity worthy of liquidation.

c. Exempt assets. California law allows California debtors to protect certain assets from judgment creditors and bankruptcy trustees. The California Legislature has determined that if a debtor needs to start over again economically through a bankruptcy proceeding, it would rather see the debtor start over with something rather than nothing, so it allows certain assets to be protected as exempt from trustee administration.

d. Immaterial assets. Not all assets of the debtor may be liened, leased, or exempt, but often those assets which remain are not worthy of liquidation by a bankruptcy trustee because they are simply not worth enough money to warrant the time, expense, and burden to the bankruptcy trustee of liquidating the asset. For example, if the debtor owns a free and clear vehicle worth $7,000, and can only exempt the first $4,800, the likelihood of the bankruptcy trustee liquidating the vehicle just to administer the remaining $2,200 of equity is slim.

If the bankruptcy trustee concludes that all of the debtor's assets are liened, leased, exempt, or immaterial in value, he or she will file a one page document with the Clerk of the Bankruptcy Court called a 'report of no assets,' effectively advising the Clerk of the Bankruptcy Court that he or she reviewed the debtor's bankruptcy petition, schedules, and statement of financial affairs, examined the debtor at the meeting of creditors pursuant to 11 U.S.C. Section 341(a), and concluded that no assets are worthy of liquidation or administration.

For the three or four minutes worth of work on the part of the trustee, he or she is paid $120 from the $338 filing fee paid to the Clerk of the Bankruptcy Court at the commencement of the case.


2. The liability portion of a Chapter 7 bankruptcy proceeding.

The general rule is that a debtor who files a Chapter 7 petition will be discharged of his or her obligations. That is of course the reason why one files Chapter 7 - to receive the piece of paper from the bankruptcy court that states that the debtor is no longer legally obligated to repay his or her creditors.

But there are exceptions, and those exceptions can be separated into two categories:

a. Those obligations which are automatically not dischargeable in a bankruptcy proceeding. Some obligations are not dischargeable regardless of whether the affected creditor takes an active interest in the case; Congress has provided that such obligations are automatically nondischargeable. The examples of obligations which are automatically nondischargeable are probably not altogether surprising: the trust fund portion of an employer's payroll taxes, recent income taxes, student loans (with some exceptions), past and future alimony and child support, liability created in a driving under the influence incident, unpaid fines, penalties, traffic tickets, parking tickets, and criminal restitution awards.

b. Those obligations which are potentially not dischargeable in a bankruptcy proceeding if the affected creditor takes timely action to seek a determination from the court that such an obligation ought not be dischargeable by the debtor, and the creditor ultimately prevails in such action. Examples of obligations which are potentially nondischargeable all share one thing in common: improper conduct on the part of the debtor. Perhaps the most common example of improper conduct in a bankruptcy context is credit card abuse. If a creditor can convince the bankruptcy judge that the debtor incurred or increased a debt, including a credit card, in the weeks and months prior to the filing of the bankruptcy petition knowing that he or she was never going to in fact repay the obligation and therefore lacking the intention to repay the obligation at the time the charges were incurred, the portion of the creditor's balance that was charged in those weeks and months prior to the filing will be deemed nondischargeable. If a creditor can convince the bankruptcy judge that the debtor used a materially false financial statement in order to obtain credit or to increase his or her credit limit, the debtor's obligation to that creditor will be deemed nondischargeable. Other examples of nondischargeable conduct include actual fraud, embezzlement from an employer, breach of a fiduciary obligation, and infliction of willful and malicious injury to another or another's property.

Creditors are given a window of opportunity within which to seek a determination that the debtor's obligation to the creditor ought not be discharged as a result of wrongful conduct or that as a result of a pervasive fraud upon the bankruptcy court, such as failure to disclose all assets and/or truthfully respond to all questions posed, the debtor ought not receive a discharge of any of his or her obligations. Accordingly, the opportunity of creditors to seek such a determination is another 'price' the debtor pays for the privilege of receiving a discharge.

3. The income and expense portion of a Chapter 7 bankruptcy proceeding.

One of the primary changes made by Congress and the President when they enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 is the implementation of a 'means test'. The means test focuses on the combined gross income of all members of the marital community, regardless of whether only one or both members of the marital community file bankruptcy. Income is determined based on an average over the past six months, regardless of whether the average income over the past six months reflects future earning ability. Subtracted from income are various household expenses, some based on objective standards created by the Internal Revenue Service, and some based on the debtor's actual spending history. If the net surplus is greater than the state's median level of income for a family of the debtor's size, the presumption exists that the debtor is not eligible for Chapter 7. If the debtor's net surplus is below the state's median level of income for a family of the debtor's size, but there is still sufficient income to repay a portion of the debtor's debt if forced to do so in a Chapter 13 proceeding, the debtor may nonetheless be ineligible for Chapter 7 relief. Approximately five percent of the debtors that could have successfully filed Chapter 7 prior to the 2005 law changes have been forced to either file Chapter 13 instead, or not file bankruptcy at all.

The scrutinization of the debtor's income and expenses in order to determine whether giving the debtor a Chapter 7 discharge constitutes a 'substantial abuse' of the bankruptcy laws is another 'price' one pays for the privilege of receiving a Chapter 7 discharge.

Chapter 13 is often referred to as the individual debt adjustment chapter. It is the chapter selected in approximately one-third of all the bankruptcies filed around the country each year. As in a Chapter 7, the debtor is seeking a discharge, which is the document mailed to the debtor and all creditors by the clerk of the bankruptcy court toward the end of the case advising that the debtor is no longer legally responsible for repaying discharged debts. In a Chapter 13 proceeding, the debtor is essentially saying to his or her creditors that his or her household generates a certain sum, such as $5,000 per month, that it spends a certain sum, say $4,600 per month, on its normal going forward obligations such as rent or mortgage, car payments, utilities, food and groceries, insurance, medical, transportation, etc., and, accordingly, has net funds of say $400 left over at the end of each month to offer to repay to the prebankruptcy creditors, all of whom are put on the proverbial back burner when the bankruptcy petition is first filed.

The Chapter 13 plan states that for a fixed period of time--a minimum of thirty-six months up to a maximum of sixty months--the debtor will forward the net cash surplus, $400 in the example used above, to the Chapter 13 trustee assigned to the case, and the trustee will distribute the funds on a monthly basis to creditors pursuant to the terms of the proposed 'plan', which is an approximately twenty page 'fill in the blanks style' document which divides creditors into certain groups or classes. For example, if the debtor is behind on his or her mortgage payments, the mortgage company will be in a certain class. Other secured creditors, such as car lenders or lessors, may be in their own class. If the debtor owes recent taxes to a governmental tax agency, the tax agency will be in a certain class. All general unsecured nonpriority creditors will be together in another class. If after the specified plan period, whether it be thirty-six months, sixty months, or some period of time in between, the debtor has made all of his or her plan payments, he or she will receive his or her discharge at the conclusion of the case.

Note that once in Chapter 13, the debtor must remain current on his or her going forward obligations, such as mortgage payments, vehicle payments, and current taxes. Failure to remain current on post-petition obligations constitutes grounds to either permit secured lenders to foreclose or repossess their collateral, or to dismiss the case from bankruptcy altogether.

A debtor must satisfy all five of the following criteria to be eligible for Chapter 13 relief:

a. The debtor must be an individual, or the debtors must be husband and wife. Corporations, limited liability companies, partnerships, and business trusts are ineligible for Chapter 13 relief.

b. The debtor must be generating income, whether it be employment income, proceeds generated from operation of a business, rental income, government assistance, or assistance from friends or family.

c. The debtor must be generating more income each month than he or she is spending on going forward expenses (i.e., rent or mortgage, car payments, utilities, food and groceries, insurance, medical, transportation, etc.), putting all the prebankruptcy creditors on the back burner. In other words, the debtor must offer something to his or her creditors on a monthly basis. A plan cannot indicate that the debtor is generating $2,000 per month income but incurring $2,300 per month in expenses. The debtor must have positive cashflow so that he or she can offer something to creditors.

d. The debtor’s debts, secured and unsecured together, must total less than $2,750,000.

What if the debtor is being sued by someone based upon a tort theory, such as negligence or fraud, and the plaintiff seeks $1 million? Does the plaintiff's lawsuit make the debtor ineligible for Chapter 13 relief? No. Tort-based claims are generally not capable of readily being determined as to liability and as to amount, and therefore are deemed 'unliquidated'. Only liquidated obligations are included in the calculation of eligibility. Creditors holding unliquidated claims are entitled to claims against the bankruptcy estate just like creditors with liquidated claims, but for purposes of determining whether the debtor is eligible for Chapter 13 relief, only liquidated claims are considered.

What tests determine whether the debtor's plan will be approved by the bankruptcy court, and, if approved, how much the debtor will have to pay his or her creditors in that plan?

The debtor's plan must satisfy all five of the following tests to be confirmed by the court:

a. The debtor's plan must be proposed in good faith. In most cases, good faith is not in question, but it might be if the debtor's primary creditor asserts that because of improper conduct, the debt ought to be deemed nondischargeable.

b. The debtor's plan must satisfy the 'best interests of creditors/liquidation test', i.e., the plan must propose to pay creditors at least as much as they would have received had the debtor in fact filed a Chapter 7 proceeding and administrable assets were liquidated by a bankruptcy trustee to pay the claims of creditors.

c. The debtor's plan must be feasible. The debtor is required to demonstrate that he or she is actually generating the income he or she claims in his or her bankruptcy schedules to be generating. The debtor is required to provide income tax returns, paystubs, bank statements, proof of rental income, proof of government assistance, etc.

d. The debtor's plan must devote all available disposable income to creditors. The Chapter 13 trustee will scrutinize closely the debtor's budget, in which the debtor has represented how much he or she is spending each month for rent or mortgage, utilities, food and groceries, insurance, medical, transportation, etc. If the debtor's budget includes expenses which appear to be unreasonably high, such as food and groceries of $2,000 per month for a family of three, or appear to be inappropriate, such as leasing a new Mercedes Benz vehicle for $1,200 per month rather than a Toyota Tercel for $250 per month, the trustee will likely object and urge the bankruptcy judge to either dismiss the case, or confirm the plan only if the offending expense is reduced or removed from the budget.

e. The debtor's plan must provide specific treatment for specific creditors. If the debtor is behind on his or her mortgage and wishes to keep the property, the debtor's plan must fully amortize the mortgage arrearages. For example, if a debtor is $20,000 in arrears to his or her mortgage company, and his or her plan provides that only $12,000 will be paid to the mortgage company in partial cure of the arrearages, the bankruptcy judge cannot confirm the plan. If the debtor is behind on recent and therefore priority tax obligations, the plan must fully amortize such tax obligations. For example, if a debtor is $20,000 in arrears to the Internal Revenue Service for recent priority nondischargeable taxes, and his or her plan provides that only $12,000 will be paid to the Service in partial cure of the tax obligations, the plan cannot be confirmed by the bankruptcy judge.