Will I Have To Pay Back Some Of My Debt In A Chapter 13 Bankruptcy? How Is The Payback Amount Calculated Then?

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1. Chapter 7 Disguised As Chapter 13 Is Not Allowed

Suppose you’re filing Chapter 13 and expecting that your debts are just going to be discharged without paying anything at all. You’re not going to get very far because Judges are loathe to allow somebody to do a Chapter 13 that is a Chapter 7 in disguise. The two chapters are not interchangeable.

This creates a problem for a debtor who received a discharge in a prior Chapter 7 that was filed during the previous eight years. Chapter 7 is not available. However, if the debtor filed the previous Chapter 7 more than four years ago, then there is no chronological limitation for Chapter 13. But the debtor must enter a real Chapter 13, rather than a Chapter 7 disguised as a Chapter 13. The Chapter 13 must include a genuine repayment plan.

Having said that, I have had clients who are way behind on the mortgage, and have enough income to cure the arrearage, but not enough to pay the general unsecured creditors anything. I have put those clients into zero percent Chapter 13 plans. This means that the debtor will cure the mortgage arrearage through the chapter 13 plan, but won’t pay anything to the general unsecured creditors. Notice the difference: Since the debtor is paying debt through the plan — just not unsecured debt — so it’s not a Chapter 7 disguised as a Chapter 13.

2. The Three Key Requirements Of A Chapter 13 Plan

To understand how creditors get paid, it helps to know the three key requirements of a Chapter 13 plan. There are other requirements, but these are the make-or-break requirements of a Chapter 13 plan.

A. The Chapter 7 Liquidation Requirement For Chapter 13

The first requirement of a Chapter 13 plan is sometimes referred to as the Chapter 7 liquidation requirement, or the best interest of creditors requirement. It says that over the life of the Chapter 13 plan, you must pay back your general unsecured creditors at least as much as they would have gotten if you had done a Chapter 7.

When I tell this requirement to a prospective client, the natural response is, “I thought in Chapter 7, my creditors wouldn’t get anything at all.” Indeed that’s the way it is in most Chapter 7s. However, if you have nonexempt assets, then the Chapter 7 Trustee will seize and liquidate them, to have money to pay the creditors. Therefore, if you have nonexempt assets, the creditors will get paid something in a Chapter 7 liquidation.

In chapter 13, you keep all of your possessions. No Trustee will seize and liquidate them. However, in Chapter 13 we still go through the exercise of listing everything you own, and dividing it into exempt and nonexempt categories. This is because the dollar value of the nonexempt assets is the amount the general unsecured creditors would have gotten in a Chapter 7.

B. The Fairness Requirement

The second requirement is the plan has to be fair. Fair means one of two possibilities:

Possibility number 1: You propose a 100% plan, meaning that over the life of the plan you’re going to pay back 100% of your debts to the general unsecured creditors. If you propose the 100% plan, that, by definition, is fair. You never have to pay back more than a 100%. Moreover, the interest on unsecured debt stops accruing. But 100% plans are not the norm. I’ve certainly put people in 100% plans, but most of the time, when I file a chapter 13 for somebody, the plan proposes to pay back less than 100% to the general unsecured creditors.

Possibility number 2: You propose a plan that pays back less than 100% to your general unsecured creditors. Then for the plan to be fair, you must devote all of your disposable income to the Chapter 13 plan payments each month.

The Bankruptcy Code has a technical definition of disposable income. However, if we strip away the technicalities and get to the core idea, the gist is: To get disposable monthly income we subtract taxes, social security, and reasonable living expenses from your monthly gross income. Most of the reasonable living expenses are the IRS standard living expenses for a family of your size.

C. The Feasibility Requirement

The third requirement — feasibility — is a little bit harder to define. To be feasible, the plan must satisfy the chapter 7 liquidation requirement and the fairness requirement, and in addition must pay back certain special creditors 100% of what they are owed. Since this definition is a bit vague, an example will help to illustrate what’s going on:

Suppose you owe $35,000 in what is called priority tax debt. That type of debt is not only nondischargeable, according to the statute it must be paid in full over the 60-month plan. Suppose further that we determine that you’ve got $500 a month in disposable monthly income to devote to the plan payments, so we propose a plan with monthly payments of $500. Will that work? No. Why not?

Even ignoring trustee fees and all the other creditors, these numbers mean that you will repay $30,000 (= $500 per month × 60 months) on the $35,000 tax debt. Since the plan will not pay the entire priority tax debt in full, it is infeasible because you have insufficient income to fund a plan that satisfies the statutory requirement.

3. Calculating The Plan Payment

Based on the three key requirements we calculate plan payments by first:

1. Determining the dollar value of the nonexempt assets,
2. Determining the disposable monthly income,
3. Determining the amounts that must be paid on priority debts and secured debt arrearages, and
4. Trustee fees.

Using the results we determine how much must be paid over the life of the plan, and divide by the number of months the pan must last. My goal is always to minimize the amount my client must pay within the limits of the law.

For more information on Chapter 13 Bankruptcy In California, an initial consultation is your best next step. Get the information and legal answers you are seeking by calling (562) 777-9159 today.