Differences Between Chapter 7 and Chapter 13 Bankruptcy

The bankruptcy laws offer two primary options for consumer bankruptcies: Chapter 7 or Chapter 13. This blog post describes the basics of each of these chapters. In addition, the costs, benefits, and eligibility requirements of each chapter are described.

A Chapter 7 consumer bankruptcy is commonly referred to as a “liquidation” bankruptcy. Basically, consumers who file for Chapter 7 must give up all of their non-exempt property[1] in exchange for a discharge of a portion of their debt. The ability to discharge (which means to completely get rid of) outstanding debt is a very attractive feature of Chapter 7. However, lawmakers thought that consumers were abusing the system. So, in the last 10 years, the laws were changed to make it more difficult for consumers to be eligible for Chapter 7 “relief.” If the court determines that a consumer has the means and financial ability to make consistent payments to the consumer’s creditors over time, then the court can either convert the case into a Chapter 13 consumer bankruptcy (discussed below) or the court can dismiss the case entirely.

A Chapter 13 consumer bankruptcy is “repayment” bankruptcy. Consumers who file for Chapter 13 are allowed to keep all of their property. In exchange, consumers must promise to pay a portion of their future income over to the court for a period 3 to 5 years. This is called a repayment plan. The consumer submits her own repayment plan, and both the court and the consumer’s creditors are required to approve the plan. In deciding whether to approve the repayment plan, the court will look at whether the consumer’s income is stable and consistent, among other factors. If the court approves the plan, the consumer must not miss payments or default in any way, because the court can convert the case to a Chapter 7 or dismiss the case entirely.

As discussed above, Chapter 7 and Chapter 13 consumer bankruptcies contain different legal consequences and eligibility requirements. Each chapter is suited for different consumer financial profiles, and there are important advantages and disadvantages of each chapter. Here are some important requirements and features of Chapter 7 and Chapter 13 bankruptcies:

• Chapter 7 “Liquidation”
  • Main Benefit:
    • Ability to make a fresh start by discharging a large portion of outstanding debt
  • Downside:
    • Must give up all non-exempt property
  • Eligibility
    • Not all consumers are eligible
      • **But, those with “below-median” incomes are usually eligible
    • The court will compare the amount of debt with the amount of the consumer’s disposable income
    • A consumer may only receive a Chapter 7 discharge once very 8 years
    • A consumer may convert a Chapter 13 to a Chapter 7 case at any time

• Chapter 13 “Repayment”
  • Benefits:
    • The consumer is able to keep all of her property
    • Discharge of some debt is potentially available at the end of the repayment plan
  • Downside:
    • Often, a consumer cannot discharge any debt
    • The consumer must endure a fixed budget and pay portion of her income to the court for 3 to 5 years
    • If consumer misses payments or otherwise defaults, the case is converted to a Chapter 7
  • Eligibility
    • Only available to individuals (not corporations or other organizations)
      • **But, individuals with business debts are eligible
    • The consumer must have stable and consistent income
    • The consumer may only have up to a limited amount of outstanding debt
    • The court must approve conversion from a Chapter 7 to a Chapter 13

The bankruptcy laws can be complicated, and Chapter 7 and Chapter 13 are different in many ways. For this reason, it is always recommended to consult with an experienced consumer bankruptcy attorney to discuss your options before filing for bankruptcy.

[1] For a discussion of exempt property in bankruptcy, please visit the blog post titled “Bankruptcy Basics – Exempt Property.”