When a creditor fails to enforce its lien in a Chapter 7 case, you are left exposed. Not so under Chapter 13.
Non-Enforcement of a Lien in Chapter 7
In a blog post a couple weeks ago we got into what happens when a creditor with a lien on something you own does not enforce that lien in a Chapter 7 “straight bankruptcy” case. This can happen when the collateral depreciates quickly, and may not be worth the cost and effort of repossession. The creditor may not be able to resell it for much, although it may be worth a lot to you.
We used the example of a laptop or tablet computer you bought for $500. It depreciates very quickly because technology moves fast, and people are justifiably afraid of viruses hidden in used computers. But it’s likely worth a lot to you because you’re installed your favorite software. And you constantly put more and more of your data on its hard drive. All your videos, photos, and documents can be stored in the cloud (and probably should be!). But still, for many people their computer is worth to them way beyond what they paid for it.
But because the computer has almost no resale value for the creditor, it may simply not bother contacting you or your bankruptcy lawyer during the few months of a Chapter 7 case. So you may be able to keep it without paying anything more.
Aggressive Enforcement of a Lien in Chapter 7
On the other hand, the creditor may also sensibly figure that the laptop/tablet is worth a lot to you. So it could also use that leverage to make you pay the entire balance on the account. An aggressive creditor could even force you to pay more than the $500 you paid for the computer. If you owe $1,000 on the account because of other minor items you bought, items that the creditor would never pursue, it could make you to pay that full balance to prevent it from repossessing the computer.
This situation could be aggravated if you don’t hear from the creditor during the 3-4 month Chapter 7 case. The lien against your computer survives the bankruptcy case. Right after the case is over the creditor could approach you to repossess the computer. It could try to use its leverage at the time to make you pay the entire debt. You could always surrender the computer (and maybe everything else you bought) and owe nothing. But if you really want to keep what you bought the creditor has you at a disadvantage.
Chapter 13 “Adjustment of Debts” Solves This Problem
Filing a Chapter 13 case elegantly fixes this problem.
First, what if in a Chapter 7 case there really was a lien but the creditor didn’t object to the debt being treated as unsecured? The lien would continue to exist, throughout the life of the case and thereafter. But during the years of the Chapter 13 case the creditor could not repossess the computer or take any other action against it without filing a motion in the bankruptcy court. And then after the end of the case the creditor would almost for sure not pursue the computer. By that time that computer would truly be worthless, if you hadn’t already gotten rid of it.
Second, what if the creditor clearly does have a lien and your Chapter 13 plan acknowledges that fact? Your plan would clearly state what you believe to be the computer’s fair market value. Let’s say you say it’s $100. The creditor would then have a specific amount of time to object to that value. If it does object there would be some dickering about the value. If the creditor doesn’t object—it probably wouldn’t since there’s so little at issue—it’s stuck with that valuation. During the course of your case you would pay that $100, plus probably a bit for interest on $100. The rest of that creditor’s debt would be treated as an unsecured debt, along with your other “general unsecured” debts. That means it would be paid only to the extent that you had spare money to pay them after paying your living expenses and other more important debts. Often you pay only pennies on the dollar on these low-priority debts are paid, and sometimes pay nothing.
The Satisfying Result
Chapter 13 tends to minimize what you have to pay on arguably secured collateral, while minimizing your risks.
You get to propose whether you and your lawyer think the debt is secured in the first place. If you believe the debt is secured, you get to propose what the collateral that you want to keep is worth. The creditor is stuck with that valuation if it doesn’t timely object. And if it does object, the creditor doesn’t have any unfair leverage. The bankruptcy court is a very handy and efficient arbitrator to determine the fair market value.
If you want to keep something like a laptop/tablet that you bought for $500, that’s not likely reason enough to file a Chapter 13 case. But if the collateral is worth a lot more, the same principles apply so filing Chapter 13 may be worthwhile. Or if you need to file Chapter 13 for other reasons, the way it also saves you money and aggravation in dealing with liens is an extra bonus.