Bankruptcy Chapter 7 and Chapter 13

Bankruptcy in the United States is a matter placed under Federal jurisdiction by the United States Constitution (in Article 1, Section 8, Clause 4), which allows Congress to enact "uniform laws on the subject of bankruptcies throughout the United States." Its implementation, however, is found in statute law. The relevant statutes are incorporated within the Bankruptcy Code, located at Title 11 of the United States Code, and amplified by state law in the many places where Federal law either fails to speak or expressly defers to state law.

While bankruptcy cases are always filed in United States Bankruptcy Court (an adjunct to the U.S. District Courts), bankruptcy cases, particularly with respect to the validity of claims and exemptions, are often highly dependent upon State law. State law therefore plays a major role in many bankruptcy cases, and it is often not possible to generalize bankruptcy law across state lines. The Hathaway Law Center deal with two types of Bankruptcy in the State of Michigan as listed below. The main cities we practice law are in Detroit, Lansing, East Lansing, Battle Creek, Grand Rapids, Kalamazoo, Owosso, Jackson and St John's Michigan.


Chapter 7 of the Title 11 of the United States Code (Bankruptcy Code) governs the process of liquidation under the bankruptcy laws of the United States. (In contrast, Chapter 11 governs the process of reorganization of a debtor in bankruptcy). Chapter 7 is the most common form of bankruptcy in the United States.

Businesses filing Chapter 7

When a troubled business is badly in debt and unable to service that debt or pay its creditors, it may file (or be forced by its creditors to file) for bankruptcy in a federal court under Chapter 7. A Chapter 7 filing means that the business ceases operations unless continued by the Chapter 7 Trustee. A Chapter 7 Trustee is appointed almost immediately. The Trustee generally sells all the assets and distributes the proceeds to the creditors.

This may or may not mean that all employees will lose their jobs. When a very large company enters Chapter 7 bankruptcy, entire divisions of the company may be sold intact to other companies during the liquidation.

Fully-secured creditors, such as bondholders or mortgage lenders, have a legally-enforceable right to the collateral securing their loans or to the equivalent value, which right cannot be defeated by bankruptcy. A creditor is fully secured if the value of the collateral for its loan to the debtor equals or exceeds the amount of the debt. For this reason, however, fully-secured creditors are not entitled to participate in any distribution of liquidated assets which the bankruptcy trustee might make.

In a Chapter 7 case, a corporation or partnership does not receive a bankruptcy discharge. Only an individual can receive a Chapter 7 discharge (see 11 U.S.C. § 727. Once all assets of the corporate or partnership debtor have been fully administered, the case is closed. The debts of the corporation or partnership theoretically continue to exist until applicable statutory periods of limitations expire.

Individuals filing Chapter 7

Individuals can file for bankruptcy in a federal court under Chapter 7 ("straight bankruptcy", or liquidation) or Chapter 13 (a "reorganization", or debt adjustment case). (Although individuals can technically file Chapter 11 bankruptcies, those filings are rare.) In a Chapter 7 bankruptcy, the individual is allowed to keep certain exempt property. Some liens, however (such as real estate mortgages and car loans), survive. The value of property which can be claimed as exempt varies from state-to-state. Other assets, if any, are sold (liquidated) by the interim trustee to repay creditors. Many types of unsecured debt are legally discharged by the bankruptcy proceeding, but there are various types of debt that are not discharged in a Chapter 7. Common exceptions to discharge include child support, income taxes less than 3 years old and property taxes, most student loans (unless the debtor prevails in a difficult-to-win adversary proceeding brought to determine the dischargeability of the student loan), and fines and restitution imposed by a court for any crimes committed by the debtor.

Bankruptcy discharge stays on the individual's credit report for up to 10 years for most purposes. This may make credit less available and/or terms less favorable, although high debt can have the same effect. That must be balanced against the removal of actual debt from the filer's record by the bankruptcy, which tends to improve creditworthiness. Consumer credit and creditworthiness is a complex subject, however. Future ability to obtain credit is dependent on multiple factors and difficult to predict.

Another aspect to consider is whether the debtor can avoid a challenge by the United States Trustee to his or her Chapter 7 filing as abusive. One factor in considering whether the U.S. Trustee can prevail in a challenge to the debtor's Chapter 7 filing is whether the debtor can otherwise afford to repay some or all of his debts out of disposable income in the five year time frame provided by Chapter 13. If so, then the U.S. Trustee may succeed in preventing the debtor from receiving a discharge under Chapter 7, effectively forcing the debtor into Chapter 13.

It is widely held amongst bankruptcy practitioners that the U.S. Trustee has become much more aggressive in recent times in pursuing (what the U.S. Trustee believes to be) abusive Chapter 7 filings. Through these activities the U.S. Trustee has achieved a regulatory system that Congress and most creditor-friendly commentors have consistently espoused, i.e., a formal means test for Chapter 7. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has clarified this area of concern by making changes to the U.S. Bankruptcy Code that include, along with many other reforms, language imposing a means test for Chapter 7 cases.

Creditworthiness and the likelihood of receiving a Chapter 7 discharge are only a few of many issues to be considered in determining whether to file bankruptcy. The importance of the effects of bankruptcy on creditworthiness is sometimes overemphasized because by the time most debtors are ready to file for bankruptcy their credit score is already ruined.

Chapter 7 bankruptcy since 2005 bankruptcy law revision

On October 17, 2005 the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) went into effect. This legislation was the biggest reform to the bankruptcy laws since 1978. The legislation was enacted after years of lobbying efforts by banks and lending institutions and was intended to prevent perceived abuses of the bankruptcy laws. The changes to Chapter 7 were extensive.

Means testing

The most noteworthy change occurred within 11 U.S.C. § 707(b). Congress amended this section of the Bankruptcy Code to provide for dismissal (or conversion) of a Chapter 7 case upon a finding of "abuse" by an individual debtor (or married couple) with "primarily consumer debt." Old §707(b) provided for dismissal of a chapter 7 case upon a finding of "substantial abuse."

New §707(b) defines "abuse" in two ways. "Abuse" can be found when there is an unrebutted "presumption of abuse" arising under a newly created "means test," [§707(b)(2)]. The second way to find "abuse" is through general grounds, including bad faith, determined under a totality of the circumstances [§707(b)(3)].

To determine whether a presumption of abuse arises under the means test under §707(b)(2), it is necessary to look at the debtor's income compared with the median income in the debtor's state. Income for purposes of this bankruptcy code section is defined as "current monthly income." "Current monthly income" is defined in 11 U.S.C. § 101(10A) as a monthly average of all the income received by the debtor (and the debtor's spouse in a joint case) including regular contributions to household expenses made by other persons, but excluding Social Security benefits and certain victim's payments during a defined six-month time period prior to the filing of the bankruptcy case. Note that this average income may or may not be the debtor's actual income at the time of filing. This has led some commentators to refer to the bankruptcy code's "current monthly income" as "presumed income."

The applicable median income will vary by family size. Generally, the larger the family, the greater the state's median income and the more money the debtor must earn before a presumption of abuse arises

This code section then requires a comparison between the debtor's "current monthly income" and the median income for the debtor's state. If the debtor's income exceeds the median income, then the debtor must apply a "means test" designed to objectively determine the extent of a debtor's ability to repay unsecured creditors. The "means test" requires the debtor to take the "current monthly income" and reduce it by a list of allowed deductions. Note that just as the "current monthly income" defined in the bankruptcy code is not necessarily "current," "monthly," or "income", these deductions are not necessarily the actual expenses the debtor incurs on a monthly basis. Similarly, some commentators have referred to these deductions as "presumed expenses." The deductions applicable in the "means test" are defined in §707(b)(2)(A)(ii)-(iv) and include: 1) living expenses specified under the ''collection standards of the Internal Revenue Service,'' (2) actual expenses not provided by the Internal Revenue Standards including "reasonably necessary health insurance, disability insurance, and health savings account expenses," (3) expenses for protection from family violence, (4) continued contributions to care of nondependent family members, (5) actual expenses of administering a chapter 13 plan, (6) expenses for grade and high school, up to $1,500 annually per minor child provided that the expenses are reasonable and necessary, (7) additional home energy costs in addition to those laid out in the IRS guidelines that are reasonable and necessary, (8) 1/60th of all secured debt that will become due in the five years after the filing of the bankruptcy case, (9) 1/60th of all priority debt, and (10) continued contributions to tax-exempt charities.

After the debtor's "current monthly income" is reduced by the allowed deductions as described in the previous paragraph, it can be determined whether there will be a "presumption of abuse." The "presumption of abuse" will arise if: (1) the debtor has at least $166.67 in current monthly income available after the allowed deductions (this equals $10,000 over five years) regardless of the amount of debt, or (2) the debtor has at least $100 of such income ($6,000 over five years) and this sum would be enough to pay general unsecured creditors more than 25% over five years. For example, if a debtor had exactly $100 of "current monthly income" left after deductions and owed less than $24,000 in general unsecured debt, then the presumption of abuse would arise, [§707(b)(2)(A)(i)].

Of course, presumptions could be rebutted and §707(b)(2)(B) requires the debtor swear to and document "special circumstances" that would decrease income or increase expenses such that the debtor's remaining "current monthly income" would fall below the above two presumption of abuse trigger points discussed in the prior paragraph.

Even in cases where there is no presumption of abuse because the debtor's "current monthly income" was below the median, or because the application of the "means test" did not trigger the presumption, it is still possible for a Chapter 7 case to be dismissed or converted. Only a judge or the United States Trustee (or bankruptcy administrator) can seek dismissal or conversion of the debtor's case if the debtor's "current monthly income" is below the median. Any party in interest can seek dismissal or conversion if the debtor's "current monthly income" is above the median, even if no presumption of abuse was triggered. The grounds for dismissal under §707(b)(3) are "bad faith" or when "the totality of the circumstances (including whether the debtor seeks to reject a personal services contract and the financial need for such rejection as sought by the debtor) of the debtor's financial situation demonstrates abuse."

Longer waiting period between filings: Another change that resulted from the BAPCPA was an extension of the time between multiple bankruptcy filings. §727(a)(8) was amended to provide that the debtor would be denied a discharge if a debtor had received a discharge in a prior Chapter 7 case filed within eight (8) years of the filing of the present case. Prior to BAPCPA, the rule was six (6) years between chapter 7 filings. BAPCPA did not change the rule for the waiting period if the debtor filed a chapter 13 previously.

Credit counseling and debtor education requirements: Another major change to the law enacted by BAPCPA deals with eligibility. §109(h) provides that a debtor will no longer be eligible to file under either chapter 7 or chapter 13 unless within 180 days prior to filing the debtor received an "individual or group briefing" from a nonprofit budget and credit counseling agency approved by the United States trustee or bankruptcy administrator.

The new legislation also requires that all individual debtors in either chapter 7 or chapter 13 complete an "instructional course concerning personal financial management." If a chapter 7 debtor does not complete the course, this constitutes grounds for denial of discharge pursuant to new §727(a)(11). The financial management program is experimental and the effectiveness of the program is to be studied for 18 months. Theoretically, if the educational courses prove to be ineffective, the requirement may disappear.

Applicability of Automatic Stay:

The automatic stay in bankruptcy is the court order that requires all collection proceedings to stop. There are exceptions, of course, but generally this is the term for the "relief" from collection proceedings a debtor receives by filing the bankruptcy with the bankruptcy clerk's office. BAPCPA limited the protections the stay provides in some re-filed cases. New §362(c)(3) provides that if the debtor files a chapter 7, 11 or 13 case within one year of the dismissal of an earlier case, the automatic stay in the present case terminates 30 days after the filing, unless the debtor or some other party in interest files a motion and demonstrates that the present case was filed in good faith with respect to the creditor, or creditors, being stayed. If the present case is a third filing within one (1) year, the automatic stay does not go into effect at all, unless the debtor or any other party in interest files a motion to impose the stay that demonstrates that the third filing is in good faith with respect to the creditor, or creditors, being stayed.

The provision presumes that the repeat filings are not in good faith and requires the party seeking to impose the stay (usually the debtor) to rebut the presumption by clear and convincing evidence.

There are exceptions. Notably, §362(i) provides that the presumption that the repeat filing was not in good faith would not arise in a "subsequent" case if a debtor's prior case was dismissed "due to the creation of a debt repayment plan."

BAPCPA also limited the applicability of the automatic stay in eviction proceedings. The stay does not stop an eviction proceeding if the landlord has already obtained a judgment of possession prior to the bankruptcy case being filed, §362(b)(22). The stay also would not apply in a situation where the eviction is based on "endangerment" of the rented property or "illegal use of controlled substances" on the property, §362(b)(23). In either situation the landlord must file with the court and serve on the debtor a certificate of non-applicability of the stay spelling out the facts giving rise to one of the exceptions. There is a process for the debtor to contest the assertions in the landlord's certificate or if state law gives the debtor an additional right to cure the default even after an order for possession is entered, §362(l) & (m).

Chapter 13

Chapter 13 bankruptcy filing is a way for individuals in the United States to undergo a financial reorganization supervised by a federal bankruptcy court. The Bankruptcy Code anticipates the goal of Chapter 13 as enabling income-receiving debtors a debtor rehabilitation provided they fulfill a court-approved plan. Compare the goal of Chapter 13 with the relief contemplated in Chapter 7 that offers immediate, complete relief of many oppressive debt(s)

An individual who is badly in debt can file for bankruptcy either under Chapter 7 (liquidation, or straight bankruptcy), under Chapter 13 (reorganization) or Chapter 11, Title 11, United States Code.

Debtors may also be forced into bankruptcy by creditors in the case of an involuntary bankruptcy, but only under Chapters 7 or 11. However, in most instances the debtor may choose under which chapter to file.

The debtor's financial characteristics and the type of relief sought plays a tremendous role in the choice of chapters. In some cases the debtor simply cannot file under Chapter 13, as he or she lacks the disposable income necessary to fund a viable Chapter 13 plan (see below). Furthermore, Section 109(e) of Title 11, United States Code sets forth debt limits for individuals to be eligible to file under Chapter 13 the debt limits for filing Chapter 13 of unsecured debts of less than $336,900.00 and secured debts of less than $1,010,650.00. These debt limits are subject to annual cost of living increases and represent values updated through April 1, 2007.

Under Chapter 13, the debtor proposes a plan to pay his creditors over a 3 to 5 year period. During this period, his creditors cannot attempt to collect on the individual's previously incurred debt except through the bankruptcy court. In general, the individual gets to keep his property, and his creditors end up with less money than they are owed.

Disadvantages of Chapter 13

The disadvantage of filing for personal bankruptcy is that a record of this stays on the individual's credit report for 10 years. During the pendency of a Chapter 13 case the debtor is not permitted to obtain additional credit without the permission of the bankruptcy court. Moreover, creditors may not be willing to risk lending money to such an individual. However, this disadvantage is not unique to Chapter 13; it may also apply to individuals currently in a Chapter 11 case or those who are in or have recently been in a Chapter 7 case.

Advantages of Chapter 13

The advantages of Chapter 13 over Chapter 7 include: the ability to stop foreclosures and to have a mortgage that has been accelerated declared reinstated upon bankruptcy plan completion; to achieve a super discharge of debts of kinds not dischargeable under Chapter 7; to value collateral; to bifurcate the security interest of creditors in certain property that creditors are either charging too much interest for, or are over-secured, or both, and in some cases; to prevent collection activities against non-filing co-signers (co-debtors) during the life of the case.

The Chapter 13 Plan

A Chapter 13 plan is a document filed with or shortly after a debtor's Chapter 13 bankruptcy petition.

The plan details the treatment of debts, liens, and the secured status of assets and liabilities owned or owed by the debtor in regard to his bankruptcy petition. In order for plans to take effect, it must meet a number of requirements. These are specified in § 1325 and include:

* providing that unsecured creditors will receive at least as much through the chapter 13 plan as they would in a chapter 7 liquidation

* either not be objected to, repay all creditors in full, or commit all of the debtor's disposable income to the Chapter 13 plan for at least three years (or five years for a debtor who makes an above median income)