Are Chapter 13 Plans Futile?

Individual debts with predominantly non-business debts have several choices when filing for bankruptcy. They can seek a Chapter 7 liquidation, a Chapter 11 reorganization, or a Chapter 13 wage earner's plan. As a result of the means test imposed by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, individual, non-business bankruptcies, individuals who make more than the state median income are frequently ineligible for a Chapter 7 liquidation, under a test that compares their income to certain allowed living expenses.

During calendar year 2007, a total of 822,590 bankruptcy petitions were filed in cases with predominantly nonbusiness debt. Approximately 61 percent of these cases (500,613) were filed under chapter 7, in which a debtor’s assets are liquidated and the non-exempt proceeds are distributed to creditors. About 39 percent (321,359) were filed under chapter 13, in which individuals with regular income and debts below a statutory threshold make installment payments to creditors pursuant to a court-confirmed plan. Fewer than one percent (617) were filed under chapter 11,1 which allows businesses and individuals to continue operating while they formulate plans to reorganize and repay their creditors.2

1 Consumer cases filed under chapter 11 are relatively infrequent (about 10% of chapter 11 cases filed in calendar year 2007 were nonbusiness cases) and are generally believed to be the result of debtors’ exceeding the debt restrictions of 11 U.S.C. § 109(e) that currently restrict chapter 13 to debtors with less than $336,900 in noncontingent, liquidated, unsecured debts and less than $1,010,650 of noncontingent, liquidated, secured debts.
2 The 822,590 bankruptcy petitions filed in 2007 include 1 case with predominantly nonbusiness debt filed under chapter 15. See Table F-2 in Statistical Tables for the Federal Judiciary: December 31, 2007.

From the 2007 Report of the Administrative Offices of the United States Courts.

Historically, the vast majority of individual Chapter 7 cases have been "no asset cases" in which the debtor has no assets avaiable for distribution to unsecured general creditors. Secured debt and priority debts generally exceed the value of the debtor's assets that are subject to creditors claims. Even cases with some assets available for distribution to creditors usually produce payouts of pennies on the dollar. Bankrtupcy reform's impact on this historical trend is hard to gauge. On one hand, heightened paperwork requirements may discourage many of the most destitute debtors from filing for bankrputcy relief at all. On other other hand, the means test removes many of the most financially well off debtors, whose were most likely to have assets, from the Chapter 7 pool.

Debtors in Chapter 13 plans must make a payment designed to consume all available income, after making allowed secured debt payments and an allowance for living expenses to creditors for the life of the plan, which is generally three years for those not required to file under Chapter 13 and five years for those required to file under Chapter 13, based upon the means test.

In 2007, very few of the Chapter 13 cases concluded involved completed payment plans.

A total of 54,958 chapter 13 consumer cases filed on or after October 17, 2006, were closed by dismissal or plan completion during the 12-month period ending December 31, 2007. BAPCPA Table 6 illustrates that 53,007 of these cases were dismissed, and 1,627 cases were discharged after the debtors completed repayment plans. Of the 1,627 chapter 13 consumer cases in which debtors completed repayment plans, 7 cases had plans that were modified at least once prior to plan completion.

This is mostly an artifact of the way the statistics are collected. Normally a Chapter 13 plan filed on or after October 17, 2006, would be completed no sooner than October 17, 2009. Thus, repayment plans would normally be completed only in cases where creditors were fully paid off before the normal plan completion time has run, perhaps because there were few debts to pay (e.g. because the debtor had a liquidity problem rather than an insurmountable debt problem), or perhaps because the debtor received a windfall during the plan period, such as winning the lottery, receiving a big bonus at work, or receiving an inheritance.

Premature dismissals often represent a failure to follow through on paperwork, or an administrative mistake. But 17,134 cases were dismissed in 2007 for a failure to make payments under the plan. Of the cases dismissed, 7,771 cases were refiled, but the rest were abandoned. About 10% of Chapter 13 cases filed since October 17, 2006 have been dismissed and abandoned.

M. Jonathan Hayes at the BankruptcyProf Blog speculates on what is behind these numbers:

1,627 were plans that were completed and 53,007 were not, just cases that were dismissed. That statistic is a little misleading. In California, something like 50% of the chapter 13s filed lately are by pro pers who never file anything but the emergency petition. They are simply buying themselves a few weeks.

Overall, about two-thirds of Chapter 13s are filed without lawyers, and this is not an easy kind of case to file by oneself.

Still, there is reason for concern. Prior to bankruptcy reform, when Chapter 13 plans were typically three years long, payments did not have to include all disposable income, and Chapter 13 was strictly voluntary (although there were some incentives to choose it because it allowed a debtor to retain a home and discharge debts that could not be discharged in Chapter 7) most Chapter 13 plans were ultimately converted to Chapter 7 plans, or dismissed and abandoned. Now that more strict five year plans under Chapter 13 are the only option for many of the debtors who file under Chapter 13, there is a widespread expectation that an even larger percentage of plans will fail.

It is entirely possible that the percentage of Chapter 13 plans that are ultimately completed could stay quite low. If it does, Chapter 13 might become little more than a futile remedy for hard pressed, but high income debtors.

Also notable is a new academic study which "establishes with empirical data that bankruptcy filings are down because of the amendments, credit card profits are up hugely since the amendments, and credit card companies have not passed the savings from fewer bankruptcy case writeoffs onto the consumer."

The easier availablity of credit, lower interest rates and better loan terms that bankruptcy reform was supposed to produce has not materialized, even though the reduced write offs of bad debt that were predicted did materialize.