Chapter 13 Bankruptcy – A Lender of Last Resort

By Donald A. Hayes, Attorney at Law


Normally an individual is interested in filing a Chapter 7 Bankruptcy in order to discharge all of their unsecured debts, i.e. credit cards, personal loans, lawsuits etc. However sometimes an individual has become delinquent in mortgage payments, car payments, or taxes and the creditor is threatening to foreclose, repossess, or levy on bank accounts. Filing a Chapter 7 case will temporarily stop the creditor from foreclosing on the mortgage or repossessing the car, but once the bankruptcy case is closed, or if relief from the automatic stay is obtained even sooner, the secured creditor will be allowed to continue with all of its collection remedies and the debtor will lose the property if the default is not cured. By filing a Chapter 13 Bankruptcy, the debtor will be granted protection from the foreclosing secured creditor and will be permitted to file a plan for individual reorganization.

The debtors plan must propose full repayment of arrearages over a period of time, usually no more than 5 years, in most cases without interest. If there are any unsecured debts, i.e. credit card debts, they will be included in debtors plan. However, the general unsecured creditors need not be paid back in full. Instead, the debtor will offer to pay only as much to the unsecured creditors as the debtors budget will permit. That is, the debtor is requried to make his Abest efforts@, in good faith, to pay whatever amount is left over in his personal budget at the end of the month. The plan can range from a 0% to a 100% plan, and the creditor will be forced to accept it. The budget is the difference between the debtors monthly net income and debts.

Here is an example, a debtor owes $20,000 in arrearages on his residential mortgage. He also owes $50,000 in credit cards and other personal unsecured loans. Assume the monthly budget surplus is $500. The mortgagee is foreclosing or threatening to foreclose on the property. The debtor files a Chapter 13 case and proposes the following plan: a 100% pay back of the $10,000 arrearages over 36 months. The balance of attorneys fees may be paid through the plan of $1,500. The 10% trustee fee to administer the case is mandatory so add on $2,150. So this debtor will need to submit his Abest efforts plan@ of $500 per month over 60 months. At the end of 47 months the debtor will have paid $23,650 over the course of the plan including all of the arrearages,, attorneys fees, trustee fees, and this is important, only $6,500 or 13% of the unsecured credit card debt!!

The debtor will be forever discharged from the balance of credit card debt and at the same time has rescued his house from foreclosure. In this instance a Chapter 13 has proven the best course of action for this debtor. It is important to note that the debtor must have enough money left over in his monthly budget to make at least the minimum required plan payment of $500 in this example. Since the debtor had $500 surplus each month, most of the payment went toward the mortgage arrearage and only a portion of it went to pay a fraction of unsecured debt, in this case only 13%. If the debtor had only the required minimum payment to pay the mortgage arrears and no more, then the unsecured creditors would get nothing and the plan would be approved nonetheless. If the debtor did not have enough income to make the required minimum payment then the plan would not be confirmed. You can begin to see that a chapter 13 is really just a short term loan and the Bankruptcy Court is really just a lender of last resort!