When you start a Chapter 13 plan, it’s good to have Chapter 7 available as a backup plan.
Converting to Chapter 7 may be a decent result when you can’t meet your Chapter 13 goals, either because of the unexpected circumstances or because your calculated risks simply did not go your way.
The Powerful But Uncertain Chapter 13 Option
Chapter 13 is an amazing tool. It can often do much more than Chapter 7 to save your home or vehicle, and to keep your tax and support collectors at bay. But it also assumes that your income and expenses will stay reasonably steady for at least the next three years, which of course is not always the way life goes.
The power of Chapter 13 gives people the opportunity to make decisions which may make sense but involve more risk. To qualify for Chapter 13 you must be an “individual with regular income,” meaning that your “income is sufficiently stable and regular to enable [you] to make payments under a [Chapter 13] plan.” (Sections 109(e) and 101(30).) That requirement of a “stable and regular” income is a vague one, seemingly asking for a prediction that your income will be “regular and stable” enough into the future. So the bankruptcy courts tend to at least give debtors a chance at fulfilling the terms of their payment plan. So debtors are sometimes attracted by how much Chapter 13 could potentially help them do what they could not otherwise do—such as keep a home or vehicle, or gain some other Chapter 13 advantage—sometimes requiring them to retrench if their income and/or expenses do not play out as originally planned. Knowing that Chapter 7 is there as a fallback option is crucial to making this judgment call a wise one.
The Power and Uncertainty Illustrated
Here’s an example to illustrate this. If you were $15,000 behind in payments on your first mortgage, and the home was worth a lot less than the amounts owed on the two mortgages against it, in a Chapter 7 case you’d likely surrender the home and be out from under those debts.
But the power of Chapter 13 to “strip” the second mortgage off the title of that home means you wouldn’t have to pay that monthly second mortgage payment, significantly lowering the monthly cost to keep the home. This “second mortgage strip” also lowers the debt against the home by the amount of that second mortgage, bringing the debt down closer to the home’s market value. Objectively, keeping the home is now cheaper and more financially sensible. But doing so still may or may not be feasible for a particular person or family, depending on all the amount and reliability of their income and expenses. Some people would understandably stretch their budgets to try to save their home, especially if they have strong intangible reasons to do so, such as to keep their kids in the same schools and neighborhood.
Knowing that Chapter 7 is a fallback option if for whatever reason debtors can’t fulfill the terms of their Chapter 13 plan helps them take appropriate risks when filing Chapter 13.
The Right to Convert to Chapter 7
The Bankruptcy Code explicitly states in subsection 1307(a) that a Chapter 13
debtor may convert a case under this chapter to a case under chapter 7 of this title at any time. Any waiver of the right to convert under this subsection is unenforceable.
Notice that the debtor can switch to a Chapter 7 case “at any time.” And this right cannot be waived.
Applying the Example
Let’s look again at the above hypothetical example. Assume that the debtors are a husband and wife with a 16-year old daughter deeply involved in her public high school’s athletics and other activities. If they surrender their home, let’s assume they would very unlikely be able to rent another within this high school’s boundaries. They are concerned about the stability of their future income, but believe the risk is worth the opportunity for their daughter to complete the next two years at her school.
Why The Conversion Option is Important
The last blog listed some of the potential disadvantages of simply dismissing a Chapter 13 case. Mostly, you immediately lose protection from creditors and your debts are not discharged (legally written off). Conversion to Chapter 7 avoids those disadvantages. The protection from creditors—the “automatic stay”—continues from the prior Chapter 13 case to the new Chapter 7 case. And at the end of the Chapter 7 case, usually about three months after the conversion, most or all of your debts are discharged.
So conversion to Chapter 7 can be a decent result when the goals of Chapter 13 cannot be met, either because of unexpected circumstances or because the debtors took some calculated risks which did not go their way.