Seven or Thirteen?
13 or 7?
When you have a choice, how do you decide which chapter of bankruptcy works best?
Usually, the choice is driven by the scope of the discharge and the kind of debts you have.
So why did the client this week choose to walk out of Chapter 7 with fewer debts discharged than if he’d chosen 13?
It’s all about his future. And who will get to share in his growing earning capacity.
Chapter 7 over Chapter 13
On the surface, this client seemed a great candidate for Chapter 13, which is my favorite bankruptcy chapter.
Some of his debts were only dischargeable in Chapter 13; in Chapter 7, he’d emerge still owing some debts from a divorce.
So why choose the smaller discharge?
Because his earnings were likely to double or triple over the life of a Chapter 13 case.
If that happened, we anticipated that a Chapter 13 trustee would move to modify his payment plan to pay more to general unsecured creditors.
Credit card debt, which would get nothing in a Chapter 7, might well get a substantial repayment from his increased earnings.
He’d pay fewer dollars paying directly the non dischargeable debt that survives a Chapter 7 than he would paying in a larger slice of his paycheck to all of his creditors in a Chapter 13 plan.
Chapter 13 after confirmation
Judges approve Chapter 13 plans based on the situation when the bankruptcy case is filed. The means test looks at recent income. The liquidation test looks at non exempt assets at filing.
For this client, each of those numbers was modest and a repayment plan would be relatively cheap.
But Chapter 13 involves committing your future income to the supervision of the Chapter 13 trustee.
Now, that supervision is pretty minimal: it usually means the trustee monitors your tax returns to see in your income has increased.
If there’s a significant increase, the trustee can file a motion with the court proposing increased monthly payments going forward.
The debtor gets to respond with updated expense schedules, and if the parties can’t reach a deal, a judge decides whether payments change.
In the Bay Area, this happens very infrequently. I’ve seen it less than a half dozen times in 20+ years of doing lots of 13’s.
But it can happen, and for this client, it seemed quite likely that a new job in his usual profession would dramatically increase his income.
Chapter 7 looks at today
If Chapter 13 is a years long process, Chapter 7 is a single event.
The rights of the debtor and the creditors are determined by the situation on the day the case is filed.
If the means test says that Chapter 7 is an option, then the creditors get only what the debtor owns at the filing of the case.
And what the creditors share in is only what’s left after the debtor chooses his exempt property. Most Chapter 7 cases make no distribution to creditors.
Future income belongs to the debtor. The Chapter 7 trustee can’t come back a year later and ask for a slice of a larger paycheck.
So, much to my surprise, when we looked at this client’s current situation and his prospects, the more limited discharge was a better deal than Chapter 13.
He’ll get to enjoy a larger share of his future earnings and a fresh start.