Twice in the last six months, Chapter 13 bankruptcy has saved clients facing catastrophic lawsuits arising out of business.
And because the targets of these lawsuits filed bankruptcy before they’d spent a fortune on lawyers and before the court had a chance to award huge damages, they fit beneath the Chapter 13 debt limits.
We think of Chapter 13 as a consumer tool. It’s designed for those with a regular income. It’s sometimes called a wage earner plan. The amount of debt involved has to be below certain limits.
So, Chapter 13’s application to business litigation isn’t obvious.
But it works like a charm.
Here’s how Chapter 13 rescued one client sued about a business dispute.
Chapter 13 filed before judgment
Chapter 13 is not available to everyone. Only individuals can file. Their debts must fall below certain amounts.
But, critically, the debt limits in Chapter 13 apply to debts that are liquidated. That means that the amount of money owing is fixed.
The lawsuit my client faced asked for “damages according to proof”. The former business associate claimed many measures of harm, all of which was disputed. The claim was unliquidated; you couldn’t see or calculate the claim from the face of the complaint.
The suit could not be ignored. And given the attitude of the plaintiff, the seriousness of the allegations, and the complexity of the case, it was going to be expensive to try. And ruinous if the plaintiff won.
By filing Chapter 13 before trial, the claim was UNliquidated when the bankruptcy was filed.
No matter how much the plaintiff claimed was owed, because no amount of damages had been determined before the bankruptcy was filed, the unliquidated debt didn’t count against the Chapter 13 debt caps. [For context, when the plaintiff later filed a claim, he sought $15,000,000!]
Why Chapter 13 rocks
Chapter 13 offers eyepopping advantages over other forms of bankruptcy that my client could have chosen. The first advantage is that a debtor in Chapter 13 stays in possession and control of his assets during the case.
By contrast, in Chapter 7, a court appointed trustee takes legal control of the debtor’s assets. The trustee is tasked with turning non exempt assets into cash for the benefit of creditors.
My client could have seen his home sold in a Chapter 7, long before it was determined if he really owed the former business associate anything.
In a Chapter 11, which has no debt caps, he could have stayed in possession of his assets. But to confirm a Chapter 11 plan, he would have to get the votes of his creditors in favor of a plan. An angry creditor with a large claim is unlikely to vote for a plan the debtor sees as desireable.
In Chapter 13, the role of creditors in approving a plan is much smaller. A creditor can object only on certain grounds found in the bankruptcy code. Being unhappy with the amount being paid to creditors is not one of the permissible objections.
Not to mention that the legal fees in Chapter 11 are invariably much larger than in Chapter 13.
Plan confirmation limits the damage
When the Chapter 13 plan proposed by my client was confirmed, that plan effectively limited for all time the amount he’d have to pay to put all of his debts behind him.
Where a creditor with a California judgment can collect that judgment for 10 years, and renew it for another 10 years, confirmation of a Chapter 13 plan limits what creditors get. The pot of money the debtor will create through the plan equals the amount that would have been paid to creditors if the bankruptcy case had been Chapter 7 instead of Chapter 13.
Importantly, the amount a Chapter 7 trustee would distribute is what’s left when the trustee’s expenses have been paid, any capital gains taxes have been paid, and any claims with priority over unsecured creditors have been paid.
Instead of his wages and his acquisitions for the next 10 or 20 years being exposed to levy to pay a judgment, now the client has a 5 year payment plan based on the value of his assets on the day he filed bankruptcy.
Appreciation in value and improvement in financial circumstances all remain with the debtor.
What plaintiff gets if he wins
Confirmation of a Chapter 13 plan which fixes the total amount that unsecured creditors get on their claims limits the up-side to the vicious plaintiff.
The dispute about whether my client owes this guy anything is ongoing; since we objected to the $15 M claim, the dispute has to be decided somewhere.
If the debtor wins, his other creditors don’t have to share the pot of money created by the plan with plaintiff.
If plaintiff wins and fixes the amount that the debtor owes him, he gets only a larger slice of the same “pie”. Whether he is owed fifteen dollars or $15, 000,000, plaintiff’s recovery is limited to a share of the money going through the Chapter 13.
At the end of the Chapter 13, any part of the judgment that hasn’t been paid is discharged.
Some pain remains
It’s not going to be a free ride. My client has been forced to file bankruptcy and still has to pay for representation in the bankruptcy case and for his trial lawyers.
The litigation over plaintiff’s claim won’t be pleasant.
He faces five years of plan payments to fund the Chapter 13 plan.
But even an adverse result at trial will not blot his life for the foreseeable future.
That’s why our legal system favors a fresh start through bankruptcy. And why I’m a huge fan of Chapter 13.