Chapter 13 Bankruptcy as an Alternative to Chapter 7
| Publication year | 1989 |
| Pages | 2089 |
1989, November, Pg. 2089. Chapter 13 Bankruptcy as an Alternative to Chapter 7
When a potential individual client is unable to pay his or her debts as they become due, it is the responsibility of the attorney to advise the client on the alternatives available under the federal bankruptcy laws.(fn1) While individuals are eligible to reorganize their financial affairs under Chapter 11,(fn2) because of the expense involved, the only options for most debtors are a straight liquidation under Chapter 7 of Title 11, United States Code, or a debt adjustment plan under Chapter 13.
As a result of certain amendments to Chapter 13 that were adopted by Congress in 1984, a debtor under Chapter 13 is now required to pay all of his or her monthly disposable income to the bankruptcy trustee for three years unless the debts can be paid in full prior to that time. Because of this requirement, most consumer debtors in Colorado who need a discharge in bankruptcy simply file for straight liquidation under Chapter 7. For example, in 1988, of the 17,584 non-Chapter 11 bankruptcy petitions that were filed in Colorado, 13,749 were Chapter 7 filings and only 3,780 were Chapter 13 filings.
Despite the fact that a Chapter 13 debtor now must make a serious financial commitment in order to obtain a discharge of his or her debts, Chapter 13 often offers a far more effective solution to a debtor's problems than a straight liquidation under Chapter 7. This article discusses what can be accomplished under Chapter 13 that cannot be achieved under Chapter 7.
When the Bankruptcy Reform Act of 1978 (the "Code")(fn3) was passed, it was clear that significant changes had been made to the old Chapter XIII wage earner plan as it existed under the Bankruptcy Act of 1898. Under the provisions of Chapter 13 as enacted in 1978, a debtor did not necessarily have to have regular income in the form of wages or salary. As long as the debtor's income, regardless of its source, was regular enough to permit payments under a plan, the debtor was eligible to file for Chapter 13. For example, even disability payments could potentially provide a source of income regular enough to permit confirmation of a Chapter 13 plan.(fn4) Under new Chapter 13, the structure of the plan was flexible. The plan could provide for payments that would increase periodically or provide for fluctuating payments to accommodate seasonal workers.(fn5)
Contrary to the provisions of old Chapter XIII, after 1978 unsecured creditors did not have the right to vote on the debtor's proposed Chapter 13 plan. Significantly, a debtor could "cram down" secured creditors by paying them the value of their collateral over the life of the plan at a "capitalization" rate that was invariably less than the rate specified under the loan contract. For example, a debtor could buy a car for $12,000 under a retail installment loan contract with interest at 14 percent. If subsequently forced to file for bankruptcy, the debtor could elect to proceed under Chapter 13 and establish that the car's fair value on the date of filing was $9,000. By so doing, the debtor could force the lender to accept $9,000 over three years capitalized at a reasonable rate, which could be less than the contract rate. The difference between the value of the car and the amount owed to the creditor was treated as a general unsecured claim under the debtor's plan.(fn6)
Most interesting of all, the Code did not expressly require the Chapter 13 debtor to make meaningful payments to his or her unsecured creditors. The Code provided that the Chapter 13 plan must be proposed in good faith, and
C. William ("Chuck") Schlosser, Jr., is a shareholder in the Denver firm of Milwid & Schlosser, P.C., which limits its practice to bankruptcy.
With the advent of the so-called "dollar" or minimum payment plan, Chapter 13 became more popular. In 1978, the last year prior to the effective date of the Code, 472 old Chapter XIII cases were filed in Colorado. In 1980, the number of new Chapter 13 cases filed was 2,499.
In response to the minimum payment Chapter 13 plan, a number of courts in the early 1980s ruled that the "good faith" requirement of Chapter 13 mandated meaningful payments to unsecured creditors.(fn9) Other courts took a middle ground and held that the amount of payments to creditors under the plan was only one factor in determining whether the plan was proposed in good faith.(fn10)
In In re Flygare (Flygare v. Bolden),(fn11) the U.S. Court of Appeals for the Tenth Circuit examined the meaning of the "good faith" requirement of § 1325 of the Code and adopted the "middle" approach. In other words, the amount of the proposed payments to unsecured creditors was one of the factors to be considered by the court in determining whether the plan had been proposed in good faith, but not the only factor.
Subsequent to Flygare, Congress passed the Bankruptcy Amendments and Federal Judgeship Act of 1984 (the "BAFJA" Amendments).(fn12) The BAFJA Amendments changed the requirements of Chapter 13 so that the debtor had to either (1) pay all of his or her debts in full over the term of the plan; or (2) pay all of his or her "disposable income" each month into the plan for distribution to the creditors. "Disposable income" was defined as income that is received by the debtor and which is not necessary to the maintenance or support of the debtor and his or her dependents. If the debtor is engaged in business, "disposable income" means income not reasonably necessary for the debtor's business.(fn13)
Even though a debtor is now required to pay all of his or her disposable monthly income into the plan under Chapter 13, there are numerous significant advantages to filing for Chapter 13 rather than Chapter 7 in appropriate cases.
The main reason for filing under Chapter 13 after the BAFJA Amendments is that the Chapter 13 debtor can discharge debts that are non-dischargeable in a Chapter 7.(fn14) Examples of non-dischargeable debts that can be discharged under Chapter 13 are as follows.
Under Chapter 7, most types of taxes are non-dischargeable.(fn15) For example, income taxes that are less than three years old and liabilities for payroll taxes regardless of age are non-dischargeable.(fn16) The IRS can proceed to collect the tax from the debtor as soon as the order of discharge is entered.(fn17) Often an installment payment agreement can be negotiated with the IRS outside of bankruptcy whereby the delinquent taxes are paid over a period of time with interest. However, for a debtor who has not been successful in working out an installment payment with the IRS, Chapter 13 may be very helpful.
Under Chapter 13, the debtor still has to pay the IRS's priority tax claims in full,(fn18) but can do so over the three-year life of the plan. Significantly, the filing of a petition under Chapter 13 tolls the accrual of interest and penalties on the delinquent taxes.(fn19) This can represent a substantial savings to a debtor who might otherwise be in a situation where most of the monthly installment payments are devoted to interest that is accruing on the taxes. If the taxes are the only debt being paid under the plan, counsel to the debtor may be able to extend the time for payment of the delinquent taxes for as long as five years.(fn20) So long as the debtor is current in his or her plan payments, the IRS may not take any collection steps. Upon completion...
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