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Chapter 7 vs. 13–the Easy Choice, and the Not So Easy

Picking the right Chapter to file can be simple, or it can be a very delicate, even difficult choice. And appearances can be deceiving. A situation that seems at first to call out for an obvious choice can turn out to have a twist or two that turns the case upside down.  

That twist can come in the form of an unexpected disadvantage in filing a bankruptcy under the intended Chapter, or instead an unexpected advantage in filing under the other Chapter.

Let me be clear. The majority of my clients walk into their initial consultation meeting with me with a strong idea whether they want to file a Chapter 7 or a 13.  After all, there is a wealth of information available—like this blog that you’re looking at now. So lots of my clients come in having read up on their alternatives. Whether their inclination to file one or the other Chapter comes from their head or from their gut, it’s often correct.

But often it is not correct.

That shouldn’t be a surprise. Although the main differences between Chapter 7 and Chapter 13 can be outlined in a few sentences, there are in fact dozens of more subtle but often crucial differences. Many of them do not matter in most situations, but sometimes one or two of those differences can be decisive in determining what is best in your case. If you did not know about them, you would file the wrong kind of case. And pay the consequences for many years.

So that this doesn’t just sound like just a bunch of hot air, let me show you through one example. Imagine that you have a home that you have been trying to hang onto for years, but by now have pretty much given up on doing so. You’ve fallen behind on both the first and the second mortgage. Besides, with the decline in housing values the last three years or so, the home is now not even worth the amount owed on the first mortgage. And say you owe $80,000 on the second mortgage, so the home is “under water” by that amount. You have no good reason to think that the market value will climb back up enough to give you equity in the home for many years.  Your family would sure like to keep living in their home, so the kids could stay in their schools and close to their friends, but it sure sounds like it makes no sense to keep trying to hang onto something worth $80,000 less than what you owe. Besides, you just can’t don’t have the money to pay both mortgages. So you figure it’s time to give up on the home, and just start fresh with a Chapter 7 “straight bankruptcy.”

But then you learn from your bankruptcy attorney that if your home is worth less than the balance on the first mortgage, through a Chapter 13 case you can “strip” the second mortgage off the title of your home. It becomes an unsecured debt which is lumped in with the rest of your unsecured debt (like credit cards, medical bills). In return for paying into your Chapter 13 Plan a designated amount each month based on your budget, and doing so for the three-to-five year length of your Chapter 13 case, you would be able to keep your home often by paying very little—and sometimes nothing—on that $80,000 balance. At the end of your case, whatever amount is left unpaid on that second mortgages will be “discharged”—legally written-off—so you own the home without that mortgage and having no debt (other than the balance on the first mortgage.  

This “stripping” of the second mortgage is NOT available under the Chapter 7 that you initially thought you should file. Having Saving your home by lowering your payments on it and bringing the debt against it much closer to its value may well swing your choice in the Chapter 13 direction.

This is just one illustration of countless ways that the option you initially think is the better one might not be. So keep an open mind about your options when you first consult with your attorney. Communicate your goals to him or her, and be clear about why you think one Chapter sounds better to you than the other. In the end, after laying out your story and hearing the attorney’s advice, it IS ultimately your choice. But do yourself a favor and be flexible, because you might get a better deal by the end of your meeting than you thought was possible at the beginning of it.

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The Chapter 13 Trustee — A Trustee of Many Hats

Your Chapter 13 trustee plays a huge role in the success or failure of your Chapter 13 case. Except he or she actually has at least a half-dozen different roles. Some of which are contradictory. Let me explain.

1) The trustee serves as the gatekeeper of your case, forcing us to play by the rules before allowing your Chapter 13 Plan to be approved by the bankruptcy judge.

2) As part of that role, the trustee’s job is to make you pay as much as possible to your creditors. Because each individual creditor often doesn’t have all that much to lose or gain compared to the cost of each of them hiring an attorney, the trustee is the creditors’ advocate in your case.

3) The trustee is your disbursal agent, taking in your money and paying it out exactly as your court-approved Plan specifies.

4) During the course of your case, the trustee is your Plan overseer, monitoring your Plan payments and your other obligations, and complaining to the court if you’re not in compliance.

5) The trustee is also your income monitor throughout the course of your case, mostly through annual tax returns that you must file on time and provide to his or her office, and sometimes through additional documentation. If your income rises significantly in a way not provided for in your Plan, the trustee can propose an “Amended Plan” to account for the increase.

6) Through all of this, believe it or not, the trustee is also legally required to be your helper through the Chapter 13 process. The Bankruptcy Code specifically says that the “trustee shall—advise, other than on legal matters, and assist the debtor under the plan.” Different trustees do this quite differently, taking on this helper role more or less seriously. At different points in your case, my staff and I may well suggest that you interact with the trustee’s office in certain specific ways. Always remember that they have a bunch of other roles besides helping you. But also note that on a personal level, the trustee genuinely wants you to have a successful Chapter 13 case, and can sometimes be a good resource to help get you there.

Here’s a good final word on this, from the website of one of the Chapter 13 trustees:

“The role of the chapter 13 trustee is unique. The trustee does not take into his or her possession or control property of the estate. The trustee does not operate the debtor’s business. Rather, the trustee receives payments from the debtor, and disburses those payments to the debtor’s creditors pursuant to the debtor’s plan. The chapter 13 trustee does, however, counsel with and advise the chapter 13 debtor on all matters relating to the plan other than legal matters. In short, the chapter 13 trustee is an amalgam of social worker and disbursing agent.”

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