According to federal bankruptcy law there are six designations under which individuals and companies can file for bankruptcy protection. Each designation takes its name from the chapter within the federal code in which it is addressed. In the case of Chapter 13, this is a bankruptcy proceeding designed for private individuals seeking protection from creditors while they reorganize financially. It is a debt consolidation plan of sorts, in contrast to a complete liquidation under Chapter 7.
The individual circumstances of the debtor play an important role in determining under which chapter he files. Each type of bankruptcy has its own governing rules and regulations which determine if an individual is eligible for Chapter 11, Chapter 13, or Chapter 7 bankruptcy. It is possible for a debtor who filed under one chapter to convert his bankruptcy to another chapter if circumstances warrant. Regardless, the entire proceeding is presided over by a federal bankruptcy court.
Income Qualifications
The two most common bankruptcies among individuals are the Chapter 7 liquidation and the Chapter 13 reorganization. Under Chapter 13 individuals are guaranteed protection from creditors while they develop and implement a debt repayment plan over the course of 3 to 5 years. As long as that plan is approved by the court and followed to the letter, the individual is able to retain ownership of his assets throughout the term. When the bankruptcy is concluded all outstanding debts should be paid and the individual should once again be financially sound.
However, in order for a Chapter 13 bankruptcy plan to be approved by a court the individual must prove he has the financial resources to make good on the plan. In other words, there must be enough income to meet current obligations as well as disposable income to be dedicated to paying off outstanding debt. If a court determines that an individual does not have the financial resources for a reasonable Chapter 13 plan, the petition may be denied and the debtor forced into Chapter 7 liquidation.
The only advantage to Chapter 7 is the fact that once assets have been sold and the proceeds dispersed among creditors, all remaining qualifying debts are dismissed. Where Chapter 7 is a more immediate and permanent relief from creditors, Chapter 13 takes years to resolve and relies on the good faith and commitment of the debtor.
Chapter 13 Bankruptcy Plan
When an individual files for bankruptcy protection under Chapter 13 he will also file a reorganization plan at the same time or shortly thereafter. The plan requires some very specific things which must be documented clearly in order for the petition to proceed. Individuals must document all of their assets and liabilities, all disposable income, and a method by which that disposable income will be dedicated to paying off creditors. The plan is presented to a bankruptcy court which will then determine its viability.
The Chapter 13 bankruptcy plan must also demonstrate that unsecured creditors will receive at least as much compensation as they would under Chapter 7, if not more. This regulation ensures that debtors will not be able to retain assets in lieu of paying creditors what they are owed. Furthermore, creditors must review the plan and approve it without objection, and the debtor must commit all disposable income to debt repayment for a minimum of three years. In some cases the time period can be extended for up to five years.
Long-Term Consequences
Despite what many people believe, filing bankruptcy does not give you a clean slate with which to start over unharmed. Quite the contrary, bankruptcy has many negative effects that need be considered before you embark on this type of financial relief. First and foremost, you need to understand that a bankruptcy proceeding will stay on your credit report for no less than seven years after the completion of the proceeding. If your reorganization plan is completed in three years, that means the bankruptcy is on your credit report for a total of 10 years.
During that time it will be nearly impossible for you to obtain credit. Any credit you do obtain will come with extremely high interest rates and very strict conditions. The bankruptcy could also harm the financial future of your children, especially when it comes to college tuition. For instance, you may make enough money to qualify for certain forms of financial assistance under normal circumstances. But a bankruptcy may prevent your child from receiving such financial assistance, thus causing him to take out expensive and long-term student loans.
Finally, a bankruptcy on your credit report could hinder you from taking a new job or applying for a promotion within the same company. Employers routinely check credit records when hiring or promoting, as they tend to be a good indicator of an individual's personal responsibility. And if the job you are applying for has anything to do with finances, it’s almost certain a bankruptcy will disqualify you from that position.