Bankruptcy World has two distinctly different “Dis-lands.”
One, “Dis-charged,” is the magnificent, joyful, cherished holy grail of bankruptcy outcomes. Every bankrupt wants to get through the Discharged finish line — where all obligations have been met and eliminated (or discharged) — to embrace the fresh start that lies beyond.
The other – “Dis-missed” – is despair wrapped in tragedy inside disaster. Unlike a criminal proceeding, where a dismissal is a literal get-out-of-jail card for the defendant, a court-ordered bankruptcy dismissal is a train wreck, restoring the financial strife the consumer was attempting to escape in the first place.
For individuals undertaking Chapter 13 bankruptcy (or reorganization bankruptcy), involuntary dismissals happen with a fair amount of frequency, most often when the consumer fails to meet the terms of the agreed-upon plan.
The good news: Dismissal, or the threat of dismissal, is not fatal or final. Restructuring is possible for Chapter 13s at risk of going bad, as well as those that have been dismissed.
Chapter 13 Bankruptcy
Bankruptcy marks the moment when the only hope for surviving financial disaster is through court intervention. Individuals seeking bankruptcy relief typically choose between two types:
- Chapter 7, or liquidation bankruptcy, is the simpler version. Applicants agree to sell, or liquidate, their possessions that don’t qualify for protection. The proceeds go to lenders and the matter is wrapped up in 5-6 months.
- Chapter 13, or “Wage Earners’ Plan,” allows consumers a way out of financial calamity short of having to liquidate precious assets. Chapter 13 bankrupts enter a repayment plan lasting 3-5 years; at the end of the period, all debts that haven’t been repaid are discharged.
Chapter 13 bankruptcies involve a reorganization of the consumer’s debts and a repayment plan extending from three to five years. Much like a consolidation loan or debt management plan (except that a federal judge is watching), debtors make monthly payments to a court-appointed trustee, who distributes the money to creditors.
“Having your wages garnished with a Chapter 13 isn’t easy, and it’ll require some big budgetary sacrifices on your end to make those regular payments,” says David Aylor, Charleston, S.C.-based bankruptcy attorney. “Before you file, you’ll want to cut out all of your extra expenses from your budget and try to minimize your essential bills as much as possible. Sometimes, this simple act can help an out-of-control spender realize they don’t need to file at all. Regardless, you’ll be setting yourself up for better, long-term financial success.”
Early advice: It’s not a good idea to tackle Chapter 13 on your own. It’s a dense, sticky thicket.
“Before you proceed, you should discuss your options with a bankruptcy attorney,” says Cleveland-based lawyer Matthew Alden. “They can clearly share what the pros and cons are for your unique situation. For example, you wouldn’t want to file for Chapter 13 if it’s better for you to file Chapter 7 and vice versa.”
On the upside, application for Chapter 13 bankruptcy provides an automatic stay, which slams the brakes on foreclosures and ends other collections procedures. Indeed, as long as the plan is in good standing, Chapter 13 debtors have no direct contact with their creditors.
Best of all, says Butler, Pa.-based bankruptcy attorney Dai Rosenblum, Chapter 13 means “no negotiating. You dictate to creditors what they’re going to get.”
Why do Chapter 13 Bankruptcy Cases Often Get Dismissed?
Early on, Chapter 13 and Chapter 7 cases may be dismissed for similar reasons, almost all of them procedural: Failure to pay the court filing fee; improper preparation for, or failure to attend, the meeting of creditors; failure to attend the required financial management course; failure to file all required bankruptcy forms.
The complicated nature of Chapter 13 means, along with the benefits, there are more pitfalls. Among the reasons Chapter 13 plans get dismissed:
- Voluntary dismissal. A debtor may quit Chapter 13 at any time.
- Failure to meet court- or code-imposed deadlines.
- Failure to propose a compliant Chapter 13 plan.
- Failure to submit required or acceptable documentation to a Chapter 13 trustee
- Failure to file tax returns or withholding a copy of the return from the trustee.
- Failure to make payments. Beyond the monthly payment to the trustee, the consumer must keep current on mortgage payments, property taxes, income taxes, and domestic support obligations (such as alimony and/or child support).
- Serial filings of Chapter 13 cases. A debtor with two cases pending from the year before will have to provide testimony if (s)he is seeking yet another stay. Testimony will include explaining why the other two cases were dismissed, and why the new plan will succeed.
Because Chapter 13 bankruptcies involve long-term commitments, things can go wrong. Potential setbacks that could prove fatal for a Chapter 13 plan, leading to dismissal, include:
- Lost job: Fired or laid off.
- Injured, or fell ill.
- Demoted.
Loss of income is not always ruinous for a Chapter 13 plan, however. Bankruptcy law provides a certain flexibility that allows for life’s unpleasant turns. If you still have some remaining disposable income after secured debts (including domestic obligations) are paid, you may petition to have payments to unsecured creditors reduced. Ultimately, you may pay back less of the debt than originally scheduled.
“Voluntarily dismissing and then refiling can reset the clock,” says Butler, Pa.’s Rosenblum. “If you are in, say, the 45th month of a 60-month Plan and catching up over 15 months results in an unfeasibly higher new monthly Plan payment, you can get a new 60 months.”
In severe cases, debtors confronting extreme challenges may apply for a hardship discharge. Rarely granted, a hardship discharge requires debtors to clear a variety of hurdles — shifting circ*mstances were beyond their control; creditors have been paid at least what they’d receive in a Chapter 7 filing — but is at least worth exploring.
What Happens Next?
When a Chapter 13 case is dismissed, it is, in the view of the court, as though the bankruptcy filing never existed. The automatic stay that had protected the debtor is lifted; creditors may pounce immediately, with results that include:
- Collections letters
- Calls from collections departments or agencies
- Debt-collection lawsuits that could result in wage garnishment
- Repossessions
- Foreclosures
Worse, penalties and/or interest that would have been discharged with a successful conclusion to the bankruptcy may be reimposed, with the time those charges were held in abeyance applied to the debt.
All is not lost, however. Consumers can forestall creditors by making full and timely payments (perhaps with a consolidation loan or through a debt management program), or by refiling for bankruptcy.
Refiling Chapter 13 Bankruptcy
In keeping with its founding principal — provide debtors the best possible chance at a second chance — bankruptcy law allows failed Chapter 13 petitioners a second bite at the apple. Debtors whose wage-earner plans didn’t work out, may refile immediately.
This does not mean there are not caveats. The automatic stay that accompanies a refiled Chapter 13 petition usually lasts only 30 days. Debtors must file a motion to extend the automatic stay, which most likely will involve a hearing before the judge in which the debtor must lay out his situation and explain why the proposed plan will succeed this time.
As demonstrated above, Chapter 13 bankruptcies are complex legal undertakings with lots of precise moving pieces. The failure of any single link can cause the entire structure to collapse. What’s the key to failure? Facing the court without professional legal representation.
“Unless you’re intimately familiar with bankruptcy law yourself, you need legal counsel,” says Jake Hill, CEO of DebtHammer.com, a personal finance advice publication. “There are a lot of ways to get a case dismissed based on technicalities and a legal team can help mitigate this.”
A key study from the American Bankruptcy Institute examining Chapter 13 bankruptcies from 2010-2016 shows the self-represented debtors filing first-time petitions fail to reach the discharge finish line nearly 98% of the time. Refilers representing themselves result in a washout rate approaching 99%.
“If all you know about a Chapter 13 case is that it was filed pro se (self-represented),” writes Ed Flynn, coordinating editor for the American Bankruptcy Institute, “it is a pretty safe bet that the case will not result in a completed repayment plan and a discharge of the debtor.”
Filing a Chapter 7 Case
If a Chapter 13 plan goes south — and they very often do — there are options beyond getting pummeled by creditors and refiling under Chapter 13. Chapter 7 bankruptcy — the simple liquidation plan mentioned at the top — is a possibility.
Debtors who have not received a Chapter 7 bankruptcy discharge within the last eight years are eligible to convert from Chapter 13 to Chapter 7 at any time.
Conversion requires filing a motion with the court. The motion to begin the conversion happens automatically; no court hearing is necessary. Consult your trustee for additional information about making the switch, including who should notify your creditors.
Customarily, forms filed for a Chapter 13 petition transfer neatly into a Chapter 7 case. But not always. Your court may mandate a fresh batch of forms, as well as a Statement of Intention (required by Chapter 7). Additionally, the court imposes a small conversion fee (up to $25).
Applying for a conversion is not always the same thing as qualifying. Depending on the bankruptcy court, petitioners may be required to pass a means test before qualifying for a Chapter 7 conversion. (Courts lack unity on this topic; consult your attorney or trustee.)
Most likely, petitioners must explain why they’re seeking a conversion. Oftentimes, it’s the result of a significant change in the debtor’s financial status (job loss, income reduction, sickness, injury) that makes the agreed-upon Chapter 13 repayment plan impossible to meet.
Bankrupts enduring a prickly Chapter 13 program do not have to wait for dismissal to seek a conversion to Chapter 7. While it’s an excellent idea to have professional legal counsel prior to deciding, debtors have the right to apply for conversion at any time — before, during, or after dismissal. Or even if dismissal isn’t on the horizon. Again, successful conversion may (depending on the jurisdiction) hinge on income restrictions.
However, a conversion should not be undertaken lightly or hastily. Property the petitioner sought to protect under Chapter 13 may be subject to liquidation under Chapter 7. Borrowers who are behind on their mortgage may, under Chapter 7, lose their property.
Because Chapter 7 bankruptcies are significantly less complex than Chapter 13 filings, petitioners are better able to represent themselves. However, the courts (per uscourts.gov) advise against it:
Filing personal bankruptcy under Chapter 7 or Chapter 13 takes careful preparation and understanding of legal issues. Misunderstandings of the law or making mistakes in the process can affect your rights. Court employees and bankruptcy judges are prohibited by law from offering legal advice.
As Butler, Pa., attorney Rosenblum says, “It is possible to successfully file a simple Chapter 7 without a lawyer, and it is possible to be your own dentist, but it’s going to hurt.”
The bankruptcy path is tricky and errors can be punishing, debtors should strongly consider retaining legal counsel before tackling bankruptcy.
“Seek legal counsel and listen to what they say,” says DebtHammer’s Hill. “You don’t want to get dismissed because you aren’t following the rules.”
