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Choosing the Best Approach for You: Chapters of the Bankruptcy Code

The first thing you should expect of us is to review your financial situation and advise you of the best strategy for your particular profile of debts, assets, and income.

To meet the needs of various kinds of debtors with different debt problems, the Bankruptcy Code makes available several alternative approaches.  Because the rules for each approach are collected in a different chapter of the Code, we refer to each approach by its chapter number.

Chapter 7 exists primarily to discharge unsecured debts like credit cards, personal loans, and medical bills – to make those debts legally unenforceable.  Often you can also discharge certain special kinds of secured debt, including judgments and finance company loans.  But with most secured debts, such as mortgages and auto loans, the creditor continues to retain its lien on the property (collateral) pledged to secure the debt.  Filing Chapter 7 usually has very little effect on these debts.  The debtor can surrender the collateral and not have to pay the debt, but keeping the collateral usually requires paying the debt with no change in its terms.

As a trade-off for having unsecured debts discharged, a Chapter 7 trustee is appointed to determine whether the debtor owns anything that could be sold for the benefit of the creditors whose debts are being wiped out.  Usually the answer is no.  This is because

  • the trustee takes subject to any existing liens on the debtor’s property, and
  • debtors can protect certain kinds of property – most limited to a certain maximum dollar value – through exemptions established by law.  State law determines the property debtors can protect.  South Carolina exemptions are relatively debtor-friendly

Once the liens and exemptions are taken into consideration, there is usually insufficient value remaining to justify a trustee selling the debtor’s property.  For this reason, well over 90% of all Chapter 7 cases result in no loss of assets for the debtor and no distribution to unsecured creditors.

Chapter 13 is a very different approach.  The debtor files a plan committing to pay a set dollar amount each month for three to five years toward the debts.  That payment is calculated based on the treatment required for each type of debt:

  • If the debtor is behind on a mortgage, the plan must pay the entire arrearage while the debtor makes all future payments directly to the mortgage holder.
  • Auto loans and other short-term secured debts are paid with interest, but the balance can sometimes be reduced if it exceeds the value of the collateral.
  • Priority debts such as past-due taxes, alimony, or child support are paid in full, usually without interest.
  • Unsecured debts are generally paid only a few cents on the dollar, depending on the debtor’s assets and disposable income.

Chapter 13 offers a chance to catch up with a past due mortgage by paying the amount behind over several years while the debtor is protected from foreclosure.  For this reason, most people who file Chapter 13 choose that approach to save their homes from a pending or threatened foreclosure.  But Chapter 13 can also help solve other specific debt problems such delinquent taxes, child support, or alimony.

The Code includes several other approaches that are rarely attractive to consumers:

  • Chapter 9 is a form of reorganization for cities and other local governments.
  • Chapter 12 allows family farmers to reorganize their debt.
  • Chapter 11 is a reorganization approach primarily intended for corporations and other business entities.  While individuals can file Chapter 11, the benefits rarely justify the complexity and costs of this approach.

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