The core of a Chapter 13 bankruptcy case is a three to five year repayment plan. The ability to stretch out past-due balances across 36-60 months can mean the difference between chaos and financial stability, and Chapter 13 allows many people to regroup and rebuild their finances without surrendering property. But, three to five years is a long time. No matter how committed you are to successfully completing your Chapter 13 plan, you can’t always predict the future. Many people considering Chapter 13 are concerned about what will happen if their circumstances change dramatically in the course of a Chapter 13 case. To a degree, the Chapter 13 process is designed to adapt. When a change like an increase or decrease in income occurs, it is often possible to modify the Chapter 13 plan and keep the case moving forward. Occasionally, however, the debtor’s disposable income disappears completely, or becomes so limited that he or she truly can no longer sustain a Chapter 13 repayment plan. When that happens, the debtor may be entitled to a “hardship discharge” that is, many remaining unsecured debts may be discharged despite the fact that the debtor was unable to successfully complete the Chapter 13 repayment plan. However, not everyone who becomes unable to keep up Chapter 13 plan payments qualifies for a hardship discharge, and a hardship discharge won’t resolve all types of debt.
A Chapter 13 hardship discharge is a special order from the bankruptcy judge, so you and your attorney must file an application for this discharge. To obtain the hardship discharge the debtor must first show an inability to continue making the scheduled Chapter 13 plan payments. In other words, something has happened to you financially that reduced your income or ability to pay your creditors. The change in finances must be beyond the debtor’s control. For instance, if you voluntarily quit your job to go back to school, you are not eligible for a hardship discharge. The change must be serious and on-going. The debtor must also show how the situation is not likely to change, and modification of the repayment plan is not practical or feasible. Finally, the debtor must demonstrate that if the court approves the hardship discharge, creditors will receive at least as much as they would have received during a Chapter 7 case. Hardship discharges are only granted for the most extreme cases. The Bankruptcy Code also limits the scope of the hardship discharge to that of a Chapter 7 discharge, so some debts may not get discharged if the case ends early. If you experience a serious financial setback and cannot no longer afford your Chapter 13 payments, discuss the possibility of a hardship discharge with your bankruptcy attorney. In some cases a hardship discharge is available and preferable to modification, conversion, or dismissal. Your attorney can explain these options and help you decide on the best course of action.
Qualifying for a Chapter 13 Hardship Discharge
Under Section 1328(b) of the U.S. Bankruptcy Code, a discharge may be granted to a Chapter 13 debtor who has not completed the plan if and only if:
• The debtor’s failure to complete payments under the plan is attributable to “circumstances for which the debtor should not justly be held accountable”
So, for example, a debtor who is rendered unable to work by a serious and ongoing medical condition would typically satisfy this requirement. But, if the debtor voluntarily quit his job to start a business that won’t generate significant revenues for a long time (if ever) or was fired for cause, the court would likely determine that the debtor could justly be held accountable for his failure to make plan payments, and so would likely deny a discharge. Each unsecured creditor with an allowed claim has received at least as much as that creditor would have in a Chapter 7 bankruptcy cases. In most cases, Chapter 13 bankruptcy is better for unsecured creditors than Chapter 7. If the debtor has no non-exempt assets, unsecured creditors won’t receive any payment through a Chapter 7 case. But, in a Chapter 13 repayment plan, unsecured creditors may receive a percentage of the funds owed to them through plan payments. In some cases, unsecured creditors receive full payment on the debt through the Chapter 13 case. But when the debtor is unable to continue making payments that can change. This requirement ensures that creditors are not left worse off than if the debtor’s estate had been liquidated. This requirement can present a hurdle for debtors who have not made significant plan payments before the hardship-inducing event occurred and who have non-exempt assets that would have been liquidated for the benefit of creditors in a Chapter 7 case.
Modification of the plan is not practicable
Understandably, the law favours plan modification over total abandonment of the plan. Even if plan payments are reduced, unsecured creditors may still receive some ongoing payments. While some circumstances, such as a permanent disability or a terminal illness, may make it impossible for the debtor to make payments under even a modified plan, modification is preferable when possible. A debtor who meets all three criteria may be granted a discharge without having completed payments under the Chapter 13 plan. But, the discharge won’t necessarily resolve all debts.
The Limitations of a Chapter 13 Hardship Discharge
For a debtor, there are two significant differences between receiving a discharge after successful completion of a Chapter 13 plan and receiving a hardship discharge in a Chapter 13 case.
The first and most obvious difference is that while the hardship discharge may relieve the debtor of many remaining unsecured debts, a bankruptcy discharge does not eliminate liens. In a successful Chapter 13 plan, the debtor catches up payments on or entirely pays off secured debt, eliminating or significantly forestalling the risk of foreclosure or repossession. However, when the debtor is unable to complete the plan, some or all of the property serving as collateral for secured debts may be at risk once again.
Not all unsecured debts are dischargeable in Chapter 7 bankruptcy. In Chapter 13 bankruptcy, some debts–or a portion thereof–that would not be eligible for discharge in Chapter 7 may be eliminated. For example, in a Chapter 13 case the debtor may be able to discharge some or all debt arising from:
• Willful or malicious damage to property (but not to a person)
• Debt incurred to pay non-dischargeable tax debt
• Property settlements in divorce or separation proceedings
Ultimately, a hardship discharge in a Chapter 13 case won’t provide all of the benefits that successful plan completion followed by discharge could. However, for those who qualify, a hardship discharge can provide some relief to debtors whose changing circumstances have made successful plan completion impossible. If you can’t complete your Chapter 13 repayment plan because of an unexpected event, such as a job loss, you might be able to ask the bankruptcy court to discharge your debt early. In this article, you’ll learn what you’ll need to show to qualify for a hardship discharge in Chapter 13 bankruptcy.
The court will grant your request for a hardship discharge if you can prove three conditions:
• Circumstances beyond your control. You failed to complete your plan payments due to circumstances “for which you should not justly be held accountable.” Your burden is to show more than just a temporary job loss or physical disability. The key to proving the permanence of your condition will likely be medical evidence.
• Unsecured creditors received adequate payment. Based on what you have already paid into the plan, your unsecured creditors have received at least what they would have received if you had filed for Chapter 7.
• Modification of your plan is not practical. To meet this requirement, you don’t have to file and lose a motion for modification. You just need to show the bankruptcy court that you don’t have enough money to pay into a modified plan.
If you don’t qualify for a hardship discharge, it’s likely because you need to pay money to your unsecured creditors. If that’s the case, you can convert from a Chapter 13 to a Chapter 7 bankruptcy. The Chapter 7 trustee will sell your non-exempt property (assets you can’t protect with a bankruptcy exemption) and distribute the funds to your creditors.
Debts a Hardship Discharge Won’t Eliminate
If the court grants your motion for a hardship discharge, only unsecured non-priority debts get discharged. The following debts typically aren’t wiped out in a hardship discharge:
• priority debts (such as domestic support obligations and recent taxes)
• secured debts if you kept the property (for instance, a house or car payment)
• arrears on secured obligations
• debts not listed in your bankruptcy papers
• student loans
• most federal, state, and local taxes, as well as any amounts you borrowed or charged on a credit card to pay those taxes
• child support, alimony, and debts resulting from a divorce or separation decree
• fines or restitution imposed in a criminal-type proceeding
• liabilities for death or personal injury resulting from your intoxicated driving
• debts for dues or special assessments you owe to a condominium or cooperative association
• obligations you couldn’t discharge in a previous bankruptcy due to fraud or misfeasance, and
• debts owed to a pension, profit-sharing, stock bonus, or other plan established under various sections of the Internal Revenue Code.
Some debts will be wiped out in a hardship discharge unless the creditor objects to the debt by filing and winning a lawsuit called an adversary proceeding. These debts include:
• debts incurred through fraudulent acts, including using a credit card when you knew you would be unable to pay the bill
• debts from willful and malicious injury you caused to another person or property, and
• debts from embezzlement, larceny, or breach of trust (fiduciary duty).
If you have a debt that falls into one of these categories, your best strategy is to do nothing and hope the creditor does the same. If the creditor files the lawsuit, you’ll need to respond if you want the debt to remain dischargeable. If you’re in the middle of a Chapter 13 bankruptcy, and your financial picture starts looking rosy, it’s understandable that you’d want to pay off your repayment plan early but don’t count on being let out of your plan. In fact, it’s more likely that your monthly payment will increase because your creditors are entitled to all of your discretionary income for the duration of your three- to five-year repayment period. In Chapter 13 bankruptcy, you’re allowed to keep all of your property and repay your debt over a period of three to five years through a court-approved repayment plan. You fund your plan with your disposable income or the amount remaining after paying allowed monthly expenses. Because bankruptcy law assumes a reasonable lifestyle, not the filer’s actual lifestyle, you won’t be able to use all of your actual expenses. For instance, reasonable rent, food, and utility payments are predetermined according to your area. Also, your disposable income is not static. The amount you’re expected to pay can change throughout your repayment period. For instance, if your income increases but your expenses stay the same, your disposable income and your plan payment will increase.
You Must Complete Your Repayment Plan
In Chapter 13 bankruptcy, you agree to pay your disposable income to the bankruptcy trustee appointed to administer your case for three to five years. On successful completion of the plan, any remaining balance on non-priority unsecured debt (credit card balances, personal loans, medical bills, and the like, but not student loans), gets discharged. Your income determines the minimum length of time you must make payments, called the applicable commitment period. Here’s how it works.
• Below your state’s median income. If your income is less than the median income in your state and you want to file Chapter 13 bankruptcy instead of Chapter 7 bankruptcy, you must pay all of your disposable income into the plan for at least three years. However, your disposable income is figured differently. The court will consider your actual expenses.
• Above your state’s median income. If your income is above the median in your state, the applicable commitment period is five years. Throughout this period, you must pay either your disposable income or the value of the property the Chapter 7 trustee would have sold for the benefit your creditors (your non-exempt property), whichever amount is greater.
Why You Usually Can’t Pay Off Your Plan Early
It’s unlikely that the court will grant you a discharge wiping out a debt balance if you don’t pay your disposable income for your entire commitment period. Much like a contract, you must do certain things before you’re entitled to the discharge. Here are the terms you agreed to:
• to pay all of your disposable income to your creditors (or the value of your non-exempt property, whichever is greater)
• for three to five years, and
• in exchange, at the completion of the three- to five-year period, your non-priority, unsecured debt balances would be wiped out.
Your Creditors (and Trustee) Will Likely Object to an Early Payoff
If you want to pay off your plan early, you must notify your creditors and get court approval. Creditors and the bankruptcy trustee will have the opportunity to object to your early payoff and you should expect them to do so. Because it’s no secret that a Chapter 13 bankruptcy filer must live frugally, your creditors will suspect that you’re trying to avoid paying more into the plan due to an income increase. Your creditors will argue that the funds you intend to use to pay off the plan (employment bonus, inheritance) should be used to increase your payment to creditors, not to shorten the duration of your Chapter 13 bankruptcy. They’ll further argue that if you’re allowed to pay off your debt early, they’ll lose the benefit of any future increase in your disposable income from a pay raise, bonus, inheritance, and the like, or a decrease in expenses over the life of your Chapter 13 plan. If the court agrees, the court will deny the early payoff and likely require you to increase your payments to reflect your additional income.
Requesting an Early Discharge Due to Hardship
If you suffer a financial setback, and your plan pays less than 100% of what you owe, the court might end your plan early if your situation doesn’t look like it will improve. Here are the requirements for a hardship discharge:
• You’ve paid your creditors at least as much as they would have received in a Chapter 7 bankruptcy.
• You’ve suffered a change of circumstances due to no fault of your own.
• There’s no reason to believe your financial condition will improve.
• A payment modification isn’t practical because you don’t have enough discretionary income to support a plan.
If you successfully prove these criteria, the court will end your plan early, grant you a hardship discharge, and wipe out your non-priority, unsecured debt (except student loans).
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