Kentucky Bankruptcy Law

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Not as scary as it seems: Chapter 13 plan

Many people in debt feel overwhelmed when looking a filing a chapter 13. As much as five years of plan payments seem daunting and having to seek approval of incurring new debt seems intrusive. However, a Chapter 13 bankruptcy can often accomplish goals for people that a Chapter 7 cannot. One of the most frequent of these goals is for the debtor to keep their home even though they are behind on payments. To take some of the mystery and fear out of Chapter 13 plans, let’s look at what it takes for a Chapter 13 plan to be confirmed (approved) by the court.

There are three tests that a Chapter 13 plan have to pass in order to be confirmed. First, since debtors often turn to a 13 to save a house with an arrearage on the payments, the Chapter 13 plan has to account for full repayment on any secured debts. In the Eastern District of Kentucky, past due amounts of any secured debt, such as house payment arrearages, must be paid through the plan. Your ongoing house payment can usually continue to be paid directly (outside the plan) to the creditor so that you are not also paying the trustee commission on that debt. This can be done on any secured debt that is scheduled to be paid off in more than sixty (60) months (or 36 months if you qualify for a 3 year plan). So, if your regular house payment is $1000.00 per month and your loan won’t be paid off for five (5) plus years, you keep paying the creditor directly. But, if you owe $12,000.00 in arrearages on that same house, you will have to pay $12,000.00 into the plan over the course of those sixty (60) months (or $200.00 per month). Now, lets say you own a car and only have twenty-four (24) months left on the debt. Since this will be paid in full during the duration of the plan, it has to be paid through the plan. So, the first test is that all secured debt is accounted for in the plan. I am calling this the “first” test not because there is any particular order, but because most people’s highest priority is keeping their house. So, if you can make a high enough plan payment to take care of the secured debt for any property you hope to keep, then the plan may be confirmable.

The second test is the “disposable income” (a.k.a. “projected disposable income”) test. Basically, the debtor accounts for their average income (current monthly income) each month and subtracts out their reasonable living expenses. This takes the debtor looking back in time and seeing what they spend on food, clothing, recreation, and various other items (expenses are a topic I’ll cover in a later post). Determining reasonable expenses is probably the place where there are the most challenges by trustees to the plan. If you report expenses that are substantially over the norm for most people in similar situations, then your plan will draw challenges. However, if your expenses are in the realm of reasonableness, whatever is left over after you subtract these expenses from your income is the disposable income. The debtor is expected to pay their disposable income into the plan. If your proposed plan payment is substantially less than your disposable income, your plan will not get confirmed. If it is higher than your income minus expenses, then it will also be challenged because the plan has to be feasible (I consider feasibility a sub-test of the disposable income test though most treat it as a standalone test – six of one; 1/2 dozen of another).

Lastly, your payment plan has to pass the “liquidation test”. In essence, the unsecured creditors in the Chapter 13 must get paid at least as much through the plan as they would have gotten had you filed a Chapter 7. If, in a hypothetical Chapter 7, all of your assets were covered by exemptions creating a “no asset” bankruptcy, then your Chapter 13 does not have to pay anything to unsecured creditors (some districts expect at least a small percentage of unsecured debt to be paid, but zero (0%) percent plans have been approved in Kentucky). Alternatively, if your home (or other asset) that you are wanting to keep has equity that could not be covered by exemptions, then the amount of equity left “exposed” has to be paid to unsecured creditors over the life of the plan. Let’s use the same example as above where a $12,000.00 arrearage existed and add that $6,000.00 of equity in the home was left exposed (not covered by exemptions). In this scenario the debtor would have to pay $100.00 more than the $200.00 per month. The $200.00 covers the arrearage and the $100.00 takes care of the “liquidation test” and pays the exposed equity.

Now, we have a $300.00 per month payment at least (in practice, it is best to build in some cushion too and, remember, we are oversimplifying by leaving out the trustee’s commission and attorney fees). This is where one has to look at all three tests in concert because if the disposable income is only $150.00 per month, the plan is not feasible and the debtor either has to cut expenses or surrender the house (or other asset). If, though, the disposable income is actually $400.00 per month, then that will be the plan payment and the other tests are easily passed. One of the good things about Chapter 13 is that through looking at these tests, the debtor is often faced with making decisions about what expenses can be reduced in order to come up with a confirmable plan. The result of that process is that they sometimes realize there is no way to hang on to an asset, such as a home, with their income. Sometimes, though, they learn how to live within a budget which is feasible and which lets them keep important assets. Either way, Chapter 13 pushes debtors to live within their means far better than a Chapter 7.

With the assistance of an attorney versed in bankruptcy law, a Chapter 13 bankruptcy does not need to be overwhelming. It can bring relief that a Chapter 7 may not afford and set the debtor on a lifelong course of living within their means. So long as the Chapter 13 plan accounts for secured debt, pays unsecured creditors the value of any non-exempt assets, and can be funded with the disposable income available, then the plan will likely be approved. Then, the debtor just has to make the payment each month, which they would have had to do anyway outside of bankruptcy.


September 11, 2010 - Posted by | Bankruptcy, Chapter 13, Plan, Plan payments | , , , , , ,

1 Comment »

  1. […] you go back to the “Not as scary as it seems: Chapter 13 plan” post, you can see that there are certain tests applied to a Chapter 13 plan to see if it will get […]

    Pingback by Troutman & Napier, PLLC | Attorney fees in a Chapter 13 | December 8, 2014 | Reply

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