Bankruptcy Filings: Chapter 7 and 13

Although there are other Chapters under which debtors may seek relief, Chapters 7 and 13 are the most frequently encountered.

Chapter 7

Chapter 7 involves a discharge of debt by court order.  While secured debts may be routinely "reaffirmed", unsecured debts normally are not.  Traditionally, debts have been reaffirmed through a Reaffirmation Agreement.  The Courts of the Eastern District of Virginia have held, however, that creditors cannot force debtors to execute reaffirmation agreements if they were not in default at the time of the bankruptcy filing.

Why would a debtor want to pay a debt when he has filed for Chapter 7 relief?  The answer is future credit.  The possibility of future credit can be sufficient incentive to encourage voluntary repayment for at least two (2) reasons:

             1.         Debtors want and need future credit after bankruptcy discharge, and

            2.         Reasonable credit after bankruptcy is very difficult to obtain as bankruptcy carries a stigma.  Absent special circumstances, the only credit card a debtor may obtain after bankruptcy is a "secured" credit card.  These cards are tantamount to a line of credit drawn upon account deposits pledged as security.  There are also user fees and high interest rates.

How do you encourage debtors to voluntarily pay their pre-bankruptcy petition debts?  Consider adopting the following written policies:

             1.         Post-bankruptcy credit may be extended to debtors who voluntarily pay their dischargeable debts ("the carrot").

            2.         No future credit or services, other than those required by law, will be extended to debtors who have caused you a loss by bankruptcy or otherwise, unless the debt is voluntarily repaid (“the stick").

How do creditors inform their debtors of this policy once a petition of bankruptcy is filed?  Consider sending a letter directly to the debtors’ counsel asking that counsel advise their client of the policy.

 Chapter 13

Chapter 13 involves a "reorganization" of the debtor's finances.  The debtor is required to devise a plan for repayment: 100% for secured debts and a court-approved percentage for unsecured debts.  Creditors are paid in the order of priority - preferred (taxes), secured, and finally, unsecured.  Creditors are required to file proofs of claim with the Bankruptcy Court to protect their place in the plan.  Plans can take up to five (5) years to complete.

 Co-Makers

When can you proceed against co-makers?  In Chapter 7 you can proceed immediately.  In Chapter 13, you have to either wait until the plan pays out, or petition the Bankruptcy Court to lift the automatic stay against the co-maker.  Once this is granted you can proceed against the co-maker for the percentage not paid by the plan.  Although you are required to file the motion to lift the stay, the court is required to grant your relief.

Planning Summary

Regardless of the Chapter, the best way to minimize your bankruptcy loss is to be secured.  In Chapter 13 cases, security can mean the difference between payment at 100% rather than at a nominal percentage.  In Chapter 7 cases, security can mean the difference between reaffirmation or no payment at all.  In either Chapter, collateral is the key.

The second best protection from bankruptcy loss is having a solvent co-signer.  The old saying "two heads are better than one" can mean much in bankruptcy, especially when your co-signer is not a spouse.  Generally, spouses do not make good co-signers because they can file a joint petition for bankruptcy and, in fact, often do because family finances are inter-related.  It should be noted, however, that in a case of jointly owned real estate, a spouse's signature is necessary in order to perfect a lien against any real property.