Being able to convert to a Chapter 13 case can be crucial if the unexpected happens soon after filing a Chapter 7 case.
Here’s the sentence that we’re explaining today:
If you file a Chapter 7 ‘straight bankruptcy” case you can “convert” it into a Chapter 13 “adjustment of debts” one, either voluntarily because of changed circumstances or as a better alternative to your case being dismissed.
Filing under Chapter 7
When most consumers hear “bankruptcy” they are likely thinking of the Chapter 7 version. It is often the quickest and easiest way to get relief from either all or most of your creditors. So it tends to be what most consumers think they need.
Filing a Chapter 7 case immediately stops the repossession of a vehicle, foreclosure of a home, almost all wage and bank account garnishments, and virtually all other debt collection activity against you, your income, and your assets. And then usually within a few months most or all of your debts are permanently discharged—legally written off.
Under Chapter 7 you are often allowed to keep paying and remain liable on those debts that you want to, if you want to, such as your home mortgage and vehicle loan. Some debts, such as recent income tax debts and child/spousal support obligations, are not discharged and must be paid just as if you had not filed bankruptcy.
If the majority of your debts are consumer ones, you have to qualify for Chapter 7 through the “means test.” That’s a mostly income-based test, although if your income is relatively high the test can involve your expenses and other factors.
Most people can keep everything they own because usually it’s all “exempt”—protected from their creditors and from the Chapter 7 trustee. But in the unusual situation in which something is not exempt, the Chapter 7 trustee can take that asset, sell it, and distribute the proceeds to the creditors, which are paid according to a prioritization schedule, meaning that often only one or a few creditors are paid something and the rest receive nothing.
Filing under Chapter 13
The primary focus of a Chapter 13 case is to have a protected legal procedure to pay some of your debts, especially special ones that you want to or need to pay, like a home mortgage or vehicle loan arrearage, income taxes, or child/spousal support. It takes much, much longer—usually 3 to 5 years from beginning to end. But the length is often a benefit, giving you more time to catch up on or pay your special debts.
How much creditors other than the special ones are paid depend on many factors but mostly on how much you can afford to pay them within the period of time you are in the case. The amount they are paid can range from 100% to 0%, with lower percentages being more common. At the end of the case all or most of the debt amounts still remaining are written off.
“Conversion” from Chapter 7 to 13
“Conversion” is switching from one bankruptcy Chapter to another before the bankruptcy case is completed. Focusing today on “converting” from Chapter 7 to 13, there are two basic reasons why you would you want to make this switch between these very different options:
1) changed circumstances make Chapter 13 the better option for you after all, or
2) you are induced to convert to Chapter 13 even if you would have preferred to stay in the Chapter 7 case, often because of not passing the “means test.”
Converting because Chapter 13 Becomes Better than Chapter 7
Chapter 7 cases seldom convert to a Chapter 13 one on a purely voluntary basis, because of changed circumstances or because Chapter 13 simply comes to be the better alternative. That’s because a Chapter 7 case is usually active for such a short period of time—usually between 3 and 4 months—that there’s not much time for circumstances to change.
But conversion CAN be a valuable tool for dealing with unexpected financial changes within that short window. For example, you might sensibly decide to file a Chapter 7 case because you are just too far behind on your home mortgage payments and you don’t have high enough income to be able to catch up and do whatever else would be required to justify filing a Chapter 13 case. But if just a month or two after filing the Chapter 7 case you unexpectedly get a much better paying job, or a relative dies and leaves you a little money, making a Chapter 13 payment plan feasible after all, you could convert from your Chapter 7 case into a Chapter 13 one.
Or if you filed your Chapter 7 case without an attorney, you may learn during the case that Chapter 13 is better because of how well it deals with certain important creditors. Even if you did file with the help of an attorney, you may change your mind for a myriad of reasons—an asset needs the extra protection that Chapter 13 provides, you want to protect a co-signer better, or to protect yourself from a creditor while paying its special debt, for instance.
In all of these situations, if you otherwise qualify under Chapter 13 you would likely be able to convert your Chapter 7 case into a Chapter 13 one.
Converting Because Chapter 13 is Better than No Bankruptcy
The vast majority of Chapter 7 cases are completed successfully, especially if you are represented by an attorney. But there are some situations in which a case can be “dismissed,” or thrown out by the bankruptcy court. Usually before that would happen you’d be given an opportunity to convert your case into a Chapter 13 one instead of being without any bankruptcy protection altogether.
Putting aside situations involving a debtor’s outright fraud on the bankruptcy system (for example, hiding assets), the most likely way you could be induced to convert your case into a Chapter 13 one is if you fail the “means test.” The point of that test in to require you—if you can afford to do so—to pay a meaningful amount of your debts within a reasonable time, instead of discharging the debts altogether. That’s loosely the definition of a Chapter 13 case.
So if you file a Chapter 7 case knowing that passing the “means test” is not a sure thing, and the U. S. Trustee (who deals with these matters) threatens to have your case dismissed, you can instead convert the case into a Chapter 13 one. That may not be a huge disadvantage—you might even have some benefits there that were not available under Chapter 7.
But even if Chapter 13 would require you to pay money to your creditors that you would not have to under Chapter 7, most of the time Chapter 13 is significantly better than not being in bankruptcy at all. You are virtually never directly forced to file a Chapter 13 case; you can simply allow your Chapter 7 case to be dismissed. But at the moment of such a dismissal, creditors are allowed to resume all their collection activity. None of your debts would have been discharged (written off), and so you’d have the same debt problems as before, except perhaps worse because you’d be even further behind than when you filed the case. Being able to convert to Chapter 13 is often a very helpful back-up option.