How does a Chapter 13 “adjustment of debts” protect what you may otherwise lose in a Chapter 7 “straight bankruptcy”?
Chapter 13 is often an excellent way to keep possessions that are not “exempt”—which are worth too much or have too much equity so that their value exceeds the allowed exemption, or that simply don’t fit within any available exemption.
Options Other Than Chapter 13
If you do want to protect possessions which are not exempt, you may have some choices besides Chapter 13.
You could just go ahead and file a Chapter 7 case and surrender the non-exempt asset to the trustee. This may be a sensible choice if that asset is something you don’t really need, such as equipment or inventory from a business that you’ve closed. Surrendering an asset under Chapter 7 may also make sense if you have “priority” debts that you want and need to be paid—such as recent income taxes or back child support—which the Chapter 7 trustee would pay with the proceeds of sale of your surrendered asset(s), ahead of the other debts.
There are also asset protection techniques—such as selling or encumbering those assets before filing the bankruptcy, or negotiating payment terms with the Chapter 7 trustee —which are delicate procedures beyond the scope of this blog post. Suffice to say, however, that you should not try to implement these “sale or encumbrance” strategies without the advice of an experienced bankruptcy attorney.
Chapter 13 Non-Exempt Asset Protection
If you have an asset that is not protected by an exemption which you really need or simply want to keep, by filing under Chapter 13 you can keep that asset by paying over time for the privilege of keeping it. Your attorney simply calculates your Chapter 13 plan so that your creditors receive as much as they would have received if you would have surrendered that asset to a Chapter 7 trustee. (This is called a “liquidation analysis” and it is a lot trickier than it sounds; you will need an experienced bankruptcy attorney to walk you through it.)
For example, if you own a free and clear vehicle worth $3,000 more than the applicable exemption, you would pay that amount into your plan (in addition to amounts being paid to secured creditors such as back payments on your mortgage). You would have 3 to 5 years—the usual span of a Chapter 13 case—throughout which time you’d be protected from your creditors. Your asset-protection payments are spread out over this length of time, making it relatively easy and predictable to pay.
This is in contrast to negotiating with a Chapter 7 trustee to pay to keep an asset, in which you would usually have less time to pay it and less predictability as to how much you’d have to pay.
Chapter 7 vs. Chapter 13 Asset Protection
Whether the asset(s) that you are protecting is worth the additional time and expense of a Chapter 13 case depends on the importance of that asset, and other factors.
First note that people with assets to protect have other reasons to be in a Chapter 13 case, and the asset protection feature is just one more benefit.
Furthermore, in some Chapter 13s you can retain your non-exempt assets without paying anything more to your creditors than if you did not have any assets to protect. If you owe recent income taxes and/or back support payments (or any other special “priority” debts which must be paid in full in a Chapter 13 case), you can use these debts to your advantage. Since in a Chapter 7 case such “priority” debts would be paid in full before other creditors would receive any proceeds of the sale of any surrendered assets, if the amount of such “priority” debts are more than the asset value you are seeking to protect, you may well only need to pay enough into your Chapter 13 case to pay off these “priority” debts.
This way you would get an immediate solution—your assets protected right away and the IRS or other “priority” debt creditor off your back. And you’d have a long-term solution, too—your assets would be protected throughout the Chapter 13 case, and the IRS and/or other “priority” creditor would get paid off. Once your case is completed, you would be debt-free.