What it is:
How it works (Example):
Individuals, the self-employed, and those operating unincorporated businesses can file bankruptcy under Chapter 13; corporations and partnerships cannot.
To file Chapter 13, also called a "wage-earner's plan," the debtor files a petition with the local bankruptcy court. The debtor must provide the court with financial and tax information, as well as a list of creditors and outstanding debts. The court also usually requires proof that the individual has obtained credit counseling. Filing a Chapter 13 petition usually stops most collection actions against the debtor, including lawsuits, garnishments, and phone calls.
After the individual files, the court appoints an impartial trustee that meets with the creditors and works with the debtor to develop a repayment plan. If the court approves the plan, the trustee then makes weekly or bimonthly payments to the creditors. For this reason, Chapter 13 is a viable option for people with regular incomes -- it allows debtors to propose installment plans to repay some or all of their debt over three to five years. The debtor makes the plan payments to the trustee, who distributes the payments to creditors.
Alimony, child support, and student loans generally cannot be discharged in a Chapter 13 case, nor can most judgments against the debtor for criminal acts. If the debtor wants to keep his house or other assets that serve as collateral to a particular creditor, then the repayment plan needs to specifically address how that creditor will be paid in full within the five years allowed by the Chapter 13 laws. During this time, the debtor cannot take on any new debt without the trustee's permission.
Not all individuals are eligible for Chapter 13; those who have more than a certain amount of debt don't qualify and must file Chapter 11 or Chapter 7. But debtors often choose Chapter 13 over Chapter 11 or Chapter 7 because it helps them avoid foreclosure on their homes by allowing them to catch up on delinquent mortgage payments, and it helps them avoid direct contact with their creditors. A person can emerge from Chapter 13 (that is, be "discharged") if all of the debt is repaid and if he or she has completed a financial-management course. After discharge, the debtor's creditors can no longer pursue the debtor for payments or try to collect the discharged obligations.
Why it Matters:
Chapter 13 is all about rehabilitation. It gives people the chance to stay in their homes and repay their debts at the same time. However, Chapter 13 can be complex and expensive. Creditors involved with a Chapter 13 borrower bear unusually high risk, and they are usually only able to collect pennies on the dollar (if that). If Chapter 13 proves unsuccessful, the borrower or the judge can convert the case to a Chapter 7 filing. In this scenario, the trustee forecloses on the borrower's assets, liquidates them, and uses the money to pay off the creditors.
Read on to learn why Going Bankrupt Isn't Easy: Startling Facts You Never Knew About Filing Bankruptcy.