Chapter 7 Bankruptcy
Chapter 7 bankruptcy is known as the liquidation bankruptcy because non-exempt assets are sold before the debtor receives a discharge. However, despite the liquidation label, most chapter 7 cases do not involve a liquidation sale because most the debtor's property can be exempted under state exemption law. Once all of the property is exempt under state exemption law the property is not sold by the Trustee in bankruptcy. However, liens on real and personal property ride-through the bankruptcy absent permissible modifications or redemption of personal property.
Not everyone qualifies for chapter 7 bankruptcy. To qualify for chapter 7 bankruptcy the individual must pass what is known as the "means test;" an income qualifying test which favors individuals with low income or high secured debt. The specifics of the means test are complex, but some features can be quickly explained. You can bypass the means test and qualify for chapter 7 bankruptcy if your household's current monthly income is below the median income for a household of your size in your state. This safe harbor allows many lower income individuals to automatically bypass the means test and qualify for chapter 7 bankruptcy. However, if current monthly income exceeds this benchmark then the means test must be applied. One characteristic of the means test is that secured debt payments (car payments, mortgage payments) can be deducted in the test, thereby allowing individuals with high secured debt payments to pass.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is the retain-and-pay form of bankruptcy. In chapter 13 bankruptcy the individual may retain his or her property (including non-exempt property to the extent permitted by the best interests test) but must repay all or a portion of their debts over a period of 3 to 5 years. Whether repayment must be 3 or 5 years in chapter 13 bankruptcy is determined by reference to the debtor's annualized current monthly income and the state median income for a household of the debtor's size. If the debtor's annualized current monthly income exceeds the state median annual income of a household of the debtor's size, the debtor must propose a 5 year repayment plan. However, if the debtor's annualized income falls below the state median the debtor can propose a 3 year repayment plan.
The debtor may not get to retain all of their non-exempt property in chapter 13 bankruptcy. For a chapter 13 plan to be confirmed it must pass the "best interests of creditors test" which requires general unsecured creditors to receive as much in chapter 13 bankruptcy as they would in chapter 7. If that second house would get sold in chapter 7 bankruptcy and unsecured creditors would get $50,000, the chapter 13 plan must propose to pay general unsecured creditors at least $50,000. Hence, not all property may be retained in chapter 13 bankruptcy.
In addition to the best interests test in chapter 13 bankruptcy, the chapter 13 plan must satisfy a few other conditions to be confirmed. First, the chapter 13 plan must be feasible. For a chapter 13 plan to be feasible it must have a reasonable possibility of success. For instance, if the debtor's schedules show expenses exceeding income, then it may appear that the debtor cannot afford chapter 13 plan payments and the plan may not be feasible. Second, the debtor's chapter 13 plan must be proposed in good faith. Good faith is not defined and really means the absence of bad faith. If the debtor proposes a chapter 13 plan that does not conflict with bankruptcy law or try to "sneak" something past the court the debtor's plan should meet this requirement. Evidence of bad faith may include dishonestly in reporting income and expenses.
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