FROM THE ALABAMA LAWYER - Consumer Bankruptcy for the Non-Bankruptcy Lawyer: The Nuts and Bolts of Chapter 13 and Chapter 7
Published on December 6, 2022
By Eric M. Wilson
That dreaded word – “bankruptcy!” No other area of practice quite strikes fear into the minds of state court practitioners and newbie attorneys than bankruptcy. The federal Bankruptcy Code and the accompanying Federal Rules of Bankruptcy Procedure (that basically mirror their big brother – the Federal Rules of Civil Procedure) govern bankruptcy cases that are filed either on behalf of consumers or companies. This article will try to demystify the basic components of consumer cases filed under chapter 7 or chapter 7. By explaining the basics of each, perhaps the state court practitioner will feel more at ease when one of their clients or cases intersects with a bankruptcy issue.
The General Chapters 1, 3, and 5
Chapters 1, 3, and 5 of the Bankruptcy Code contain provisions that apply generally. Chapter 1 concerns general provisions – the most important provisions being section 105 which gives broad powers to the bankruptcy court and section 109 which outlines who may actually be a debtor. Chapter 3 concerns case administration focuses on the commencement of the case. Perhaps the most important and foundational aspect of any bankruptcy case – the automatic stay – is found at 11 U.S.C. § 362. The automatic stay is the immediate force field of protection that protects the debtor and the assets of the debtor from creditors. The automatic stay stops any and all actions against the debtor or asset of the bankruptcy estate in the collection of a PRE-petition debt. However, the automatic stay does have limits. The automatic stay does not apply to actions: to establish paternity; to establish or modify an order for domestic support; an action concerning child custody or visitation; an action to dissolve a marriage (unless it involves property division of the bankruptcy estate); actions regarding domestic violence; or criminal actions. Chapter 5 deals with creditors, the debtor, and the estate. Important aspects in chapter 5 concern claims and claim status: secured vs. unsecured vs. priority claims.
Consumer Bankruptcy Option 1: Chapter 7 (Straight Bankruptcy)
Generally speaking, chapter 7 is what the layperson considers total bankruptcy or straight bankruptcy and is a liquidation of any non-exempt assets of the individual and a discharge of all debts that are dischargeable. In a chapter 7, the debtor will reaffirm or redeem (redemption is a very unlikely scenario in Alabama due to our limited exemptions) those secured debts that the debtor desires to keep and continue to pay directly to the current lien holder. Business entities cannot receive a discharge under chapter 7 – only individuals can. Under Alabama law, each individual debtor is entitled to claim exemptions of $8,225 for personal property and $16,450 in homestead equity. These amounts are doubled for a joint case where a husband and wife file together.
Reasons to File Chapter 7
What are some factors that determine whether someone should be directed toward filing a chapter 7? A debtor’s amounts of non-exempt personal property and real property; amount of equity in home; amount of unsecured debt; monthly income and expenses; is the debtor current on the secured and exempt obligations that the debtor wishes to retain; the nature of the unsecured obligations (chapter 7 discharge vs. chapter 13 super-discharge); and does the debtor have any priority debts (such as child support or taxes). If the consumer is managing his secured debts (house and car) just fine, but is saddled with extraordinary credit cards, medical bills, or unsecured loans, he or she may want to file a chapter 7.
Attorneys’ Fees for Chapter 7
Attorneys usually charge their attorney fee to be paid up front before the filing of the case. This can be a deterrent for some consumers that need a chapter 7 but are facing imminent garnishment and can’t afford the up-front fee. In this instance, a debtor can file a chapter 13 for minimal up-front costs and then later convert their chapter 13 to chapter 7.
Consumer Bankruptcy Option 2: Chapter 13
Chapter 13, often referred to as debtors’ court, is simply a reorganization for individuals with regular income. A chapter 13 bankruptcy gives the debtor the opportunity to adjust her financial affairs without having to give up or liquidate current assets. Rather than being designed to pay debts from liquidated assets, a chapter 13 case involves payments of debts from future income. The debtor is, for the most part, allowed to keep and use all assets, whether totally exempt or not, and to pay their secured debts and a percentage of unsecured debts over a plan lasting from 36 months to 60 months. After completion of the plan, the debtor receives a discharge similar to that of a chapter 7, yet broader in certain circumstances. A benefit of chapter 13 is often lower payments on secured debts and no interest on unsecured and priority debts. These factors allow for the debtors, in theory, to reorganize their finances and re-group financially.
Chapter 13 is available to individuals (or married couples) with a regular source of income. Regular income can mean wages, alimony, and child support payments; governmental benefits; and, basically, any source of regular income. No creditor can take action against any of the debtor’s property (i.e., repossession or foreclosure) without getting permission from the court to do so via a Motion for Relief from the Automatic Stay.
Attorneys’ Fees in Chapter 13
Attorneys get paid through the plan as a claim in the debtor’s case. The current no-look fee for cases filed in the Northern District of Alabama, Western Division, is $3,500 for below-median-income debtors and $3,750 for above-median-income debtors.
Chapter 13 Current Monthly Income/Means Test
One of the hurdles that may prevent a chapter 7 discharge or a less-than-100-percent chapter 13 discharge is the income of the debtor(s). The snap-shot test is the gross income for the six months preceding the filing of the bankruptcy. If that number is below the state median for a comparably-sized family, then the debtor(s) qualifies. If that number is above the state median, then they must pass the multi-factor Means Test. Certain income does not have to be calculated in this number – such as Social Security disability.
Domestic Support and Bankruptcy
Child support and alimony are now considered together as a Domestic Support Obligation (“DSO”). DSO is defined in 11 U.S.C. § 101(14A) and is a debt in the nature of alimony, maintenance, and support. These debts are not dischargeable in either chapter 13 or chapter 7. Property settlements, incident to a divorce decree, are dischargeable in a chapter 13, but are not dischargeable in a chapter 7. Thus, the distinction between a DSO and a non-DSO (i.e., a true property settlement) is an important distinction. The terms used or contained in the divorce decree do not necessarily govern the characterization of DSO versus property settlement. And the bankruptcy court and state courts have concurrent jurisdiction to determine this distinction. Factors include language used, parties’ financial positions, amount of division, whether the obligation ends upon death or remarriage, frequency of payments, whether the agreement can be modified, whether the agreement can be waived, and treatment for tax purposes. Thus, the treatment of the debt can have a huge impact on whether the debtor chooses chapter 13 or chapter 7.
While the automatic stay is the protecting provision, the discharge is the ultimate goal of almost any bankruptcy case – whether chapter 13 or chapter 7. The discharge provisions are § 1328 for chapter 13 and § 727 for chapter 7. The exceptions to discharge are found in § 523 and § 727. Common exceptions to discharge include domestic support obligations, certain tax debts, many student loan debts, and debts procured by fraud. It’s a fascinating laundry list of what a debtor can’t erase, and denying discharge typically takes an affirmative act on behalf of the objecting creditor in filing an adversary proceeding. An adversary proceeding is a trial in front of the judge and operates within the Rules of Bankruptcy Procedure and Federal Rules of Evidence.
A debtor can shield some or all of his unencumbered property by using exemptions available to him. A debtor’s exemption situation is extremely important in advising a client which chapter he should file under. Section 522 of the Bankruptcy Code governs exemptions and gives the choice of state exemptions or federal exemptions. Alabama opted out of federal bankruptcy exemptions so property may only be claimed exempt under state law or federal law other than § 522(d). A brief overview of important exemptions is:
- Homestead exemption of $16,450 per debtor
- Personal property exemption of $8,225 per debtor
- Total exemption for necessary wearing apparel (which has been construed to include a Rolex watch) and family portraits
- Total exemption for burial plots and church seats
- Total exemption for workers’ compensation benefits
- Most all 401(k), IRAs, and ERISA pension funds are totally exempt.
Under Alabama law, a debtor has a constitutional right to claim a homestead exemption. Also, the Alabama Legislature codified the homestead exemption. The property claimed as homestead must be the actual residence of the party claiming the exemption. The statutory homestead exemption establishes that a mobile home or similar dwelling that is the principal place of residence of the individual claiming the exemption may qualify as homestead. A similar dwelling has been construed to encompass house boats.
Summary of Pros and Cons of Chapter 7 Versus Chapter 13
Financial Goals That Are Served by Filing a Chapter 7 Bankruptcy
- Receive discharge quickly (in about three months)
- Remove judgment liens from your home
- Reaffirm and keep good credit with your secured creditors
- Pay zero to unsecured creditors
Risks in a Chapter 7
- May lose to the trustee non-exempt property
- Lose control over lawsuits
- Stays on your credit for 10 years
- Likely can’t get conventional financing on home for two years
- Income may be too high for Chapter 7
- Must be current on secured debts to keep and reaffirm
Financial Goals That Are Served by Filing a Chapter 13 bankruptcy
- Protect non-exempt property
- Lower monthly payments, reduce interest rates, extend repayment on secured debts
- May can remove junior mortgages on homestead
- May can value the vehicle and pay only what it is worth
- Reorganize and repay back child support or back taxes
- Stop foreclosure and allow 60-month plan to catch up
Risks in a Chapter 13 Bankruptcy
- If income changes, it could impact ability to pay the plan
- No discharge received until case is completed
- Stays on credit report for seven to 10 years
Bankruptcy is a unique and intricate legal field. However, bankruptcy should not intimidate state court practitioners. The goal of this short primer was to wash away some of the bankruptcy mystique.
 11 U.S.C. § 101 – § 1532.
 Id. at §§ 101-112.
 Id. at §§ 301-366.
 See 11 U.S.C. § 362(b)(2)(A).
 Id. at §§ 501-562.
 Id. at § 727(a)(1).
 See Ala. Code § 6-10-2 and 6-10-3.
 11 U.S.C. §§ 1301-1330.
 See id. at § 1328.
 Id. at § 1325.
 See id. at § 523(a)(15).
 Ala. Code § 6-10-2.
 Id. at § 6-10-6.
 Id. at § 6-10-6, § 6-10-126.
 Id. at § 6-10-5.
 Id. at § 25-5-86.
 Id. at § 19-3B-508.
 See Ala. Const. of 1901, Art. X, § 205.
 Ala. Code § 6-10-2 (1993).
 In re Scudder, 97 B.R. 617 (Bankr. S.D. Ala. 1989); Travel Trailers (In re Meola, 158 B.R. 881 (Bankr. S.D. Fla. 1993); In re Mangano, 158 B.R. 532 (Bankr. S.D. Fla. 1993).