Why file Chapter 13? Keeping the Stuff You Would Lose in Chapter 7

I’ve found over the years that if folks know they need to file bankruptcy, and have learned a little about their options, they usually want or hope to file a chapter 7, or “straight bankruptcy.” After all, chapter 7 means you don’t have to make any more payments on your dischargeable debts. Why would you choose to make payments on your debt for 3 – 5 years if you could avoid it?

In truth, there are several reasons to choose chapter 13. Let’s start by looking at “reconciliation”, or the benefit of not giving up your stuff in your bankruptcy case.

Awhile back, I had the opportunity to work with a husband and wife who were falling behind on their bills while working to build their new business and raise a son. The $100,000+ in unsecured debt was not getting paid any time soon, especially considering their tax and child support debts, which were not dischargeable in a bankruptcy.

It was clear they needed to file for bankruptcy protection. The big question was how to deal with their rental property, which had over $35,000 in equity. If they filed a chapter 7, their trustee would simply sell the property and use all the proceeds to pay their creditors (after keeping a commission, of course) because rental properties are not exempt, or protected from your creditors, under Colorado law. They could have sold the property, but they had no interest in losing an appreciating asset and leaving their renters out in the cold.

So what to do? In short – file chapter 13, and show how their payments passed the “best interests of the creditors” test through “reconciliation.”

In chapter 13, you have to pay at least your last three years of tax debt, and it requires you to pay on your child support arrears. After that, you have to ensure you’re paying everyone else at least as much as they would get had you filed a chapter 7. This is called the “best interests of the creditors test.” Colorado’s chapter 13 plan contains a reconciliation section to show how you pass this test.

In reconciling the value of your property, you have to account for its fair market value. You can then subtract a reasonable hypothetical cost of sale, trustee’s fees, and the total of priority debts such as recent tax debt and child support arrears, to arrive at a minimum amount which must be paid to the rest of your creditors. It’s quite complicated, and not something a lay person would want to deal with, but a competent chapter 13 attorney can complete this section in a way that minimizes what you must pay to pass the test.

In this case, chapter 13 worked beautifully for my clients. We designed a chapter 13 repayment plan, which was confirmed (i.e. made a binding contract between the debtors and their creditors, which replaced all previous agreements). The confirmed plan paid less than 2% of their dischargeable debts and allowed them to keep the rental property – success!