October 18, 2017

The Means Test Often Decides Whether You File Chapter 7 or Chapter 13 Bankruptcy

Credit card as a moustrapIn 2005 the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) was signed into law, and continues to be the law applicable to bankruptcies filed on or after October 17, 2005.  

BAPCPA was the result of the credit card industry’s lobbying efforts, and reflects the industry’s goal of forcing more debtors to repay something to creditors by disqualifying them from a Chapter 7 with a “means test.” The “means test” was put into place to determine who was eligible for, and who was disqualified from, a Chapter 7.

If you “fail the means test,” then you are presumed to be ineligible for Chapter 7 bankruptcy, and are generally limited to bankruptcy relief in a Chapter 13 case.

The difference in what you repay unsecured creditors in Chapter 7 and Chapter 13 bankruptcy filings

As we’ve explained before, with Chapter 7, debtors typically make no payments to unsecured creditors whereas with  Chapter 13, they typically make payments equal to either (1) their monthly disposable income, or (2) the value of their non-exempt property—with remaining balances discharged at the end of the payment plan.

Chapter 7 cases are usually discharged within three months while most Chapter 13 cases take five years.

While both Chapter 7 and Chapter 13 offer debtors a fresh start, Chapter 7 obviously feels a bit “fresher” because a discharge order generally comes three months after the filing of a Chapter 7 case (compared with five years after the filing of a Chapter 13 case), and as a general rule, income earned and property received after the filing of a Chapter 7 case cannot be used to repay debts discharged in a Chapter 7.

In contrast, in a Chapter 13 case, income earned and property received during the bankruptcy case are property of the bankruptcy estate, and can lead to an increase in payments to creditors.

The recession guts the means test, reduces bankruptcy’s stigma

BAPCPA went into effect in October 2005 and the recession began in 2007. The recession has largely gutted the effect of the means test, because the majority of personal debtors (at least among our clients) have sufficiently low income – because of job loss, reduction in hours and/or wages, etc.—to qualify for a Chapter 7 bankruptcy.

However, we do still have clients for whom Chapter 13 is their best or only bankruptcy option, sometimes because of their income is too high for Chapter 7 but still not sufficient to pay their debts in full as they become due.

[important]It’s essential to note that the means test is not applicable if the majority of your debt is not “consumer debts.”

Business-related debts, such as guaranteed loans and tax debts, are not consumer debt.[/important]

Personal bankruptcy just doesn’t have the same stigma it used to; the recession has made it all too common. It is important to talk to an experienced bankruptcy attorney about your personal circumstances to determine if and when a bankruptcy filing would be most advantageous for you.

Timing is often one of the most critical bankruptcy issues to be considered.