When a person is determining their options for receiving relief from their debts and getting a fresh financial start, they may pursue one of two possible methods of filing for bankruptcy. While Chapter 7 bankruptcy is often the preferred method, since it will allow for the elimination of many different types of debts within a few months, this option is not always available. If a person does not qualify for Chapter 7, or if they wish to maintain ownership of their home or other assets, they may opt for a Chapter 13 bankruptcy. During the bankruptcy process, there are a variety of situations where a person who had originally planned to pursue a Chapter 13 bankruptcy may decide to convert their case to a Chapter 7 bankruptcy. Understanding when this is possible will help a debtor make the best use of the available options for receiving relief from their debts.

Reasons for Conversion From Chapter 13 to Chapter 7

According to the U.S. Bankruptcy Code (11 U.S.C. § 1307), a Chapter 13 bankruptcy can be converted into a Chapter 7 bankruptcy at any time. A debtor may choose to request this type of conversion for a variety of reasons, including:

• The court declines to confirm a Chapter 13 repayment plan - When a debtor files for Chapter 13 bankruptcy, they will file a proposed repayment plan that will allow them to pay off some of their debts over the next three to five years. If, after reviewing the person’s income and expenses, the court determines that the proposed repayment plan would not be feasible, it may decide not to approve the plan. In these cases, the debtor may decide to request a discharge of their debts through Chapter 7, as long as they meet the eligibility requirements for doing so.

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People who are struggling to repay the debts they owe may be able to receive relief by filing for bankruptcy. While there are different types of bankruptcy that may apply in different situations, Chapter 13 bankruptcy is usually the preferred option for those who wish to avoid losing their homes or other property they own. However, these debtors will be required to make ongoing monthly payments in a repayment plan that will last from three to five years. If they experience financial difficulties that cause them to be unable to make payments, their bankruptcy case may be dismissed. In these situations, debtors may wonder about the money that they already have paid into the repayment plan and whether some of these payments may be refunded to them.

Procedures Followed During the Dismissal of a Chapter 13 Case

If a Chapter 13 bankruptcy is dismissed, bankruptcy protections will no longer apply, and creditors may take action to collect debts owed by the debtor. In some cases, a debtor may choose to convert their case to a Chapter 7 bankruptcy and receive a discharge of their outstanding debts. However, this raises the question of what will happen to funds that were paid to the trustee in the Chapter 13 case but had not yet been distributed to the creditors in the repayment plan. 

Section 349 of the U.S. Bankruptcy Code states that a dismissal of a Chapter 13 bankruptcy “revests the property of the estate in the entity in which such property was vested immediately before the commencement of the case under this title.” This indicates that funds paid to a trustee that were not distributed to creditors before the dismissal of the case should be returned to the debtor. However, the trustee may deduct administrative fees before returning the funds.

If you have large debts that you are struggling to repay, or if you have experienced financial issues that affect your ability to make ongoing payments, bankruptcy may be the best option in your situation. By eliminating debts through Chapter 7 bankruptcy or consolidating debts into a single affordable payment plan through Chapter 13 bankruptcy, you can regain financial stability and take steps to avoid financial problems in the future. However, it is important to understand how certain actions that you may take during the bankruptcy process may affect your case. By avoiding the following, you can make sure you will be able to properly address your debts and move forward successfully:

• Making large purchases or generating new debts - In some cases, people who plan to file for bankruptcy may believe that they should use as much of their debts as possible since those debts will be wiped out once they complete the bankruptcy process. A person may max out their credit cards, take out new loans, or purchase items without the intent of paying the full amount owed. However, these actions may be considered bankruptcy fraud, and they could result in the dismissal of a bankruptcy case because a court believes that a person intended to abuse the bankruptcy process. In some cases, a person may even face criminal charges for these actions. It is best to avoid creating new debts or making significant purchases within 90 days before you file for bankruptcy.

• Increasing your income before filing for bankruptcy - While it may make sense to try to make more money so that you can pay off some debts, such as by finding a new job or working overtime, doing so may affect your bankruptcy case. If your income increases beyond a certain threshold, you may not qualify for Chapter 7 bankruptcy. If you are planning to file for Chapter 13 bankruptcy, your increased income level may affect the amount you will be required to pay each month in a repayment plan. When preparing to file for bankruptcy, it is best to avoid any major career changes.

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At the Law Offices of Chance M. McGhee, we regularly publish blogs addressing a wide variety of topics related to bankruptcy, foreclosure, and debt relief. We work to provide potential clients with helpful information about their options for addressing and eliminating debts while protecting their assets and ensuring that they can maintain financial stability. We wanted to highlight the most-read blogs of 2021, and these articles demonstrate the knowledge and assistance that we offer to people in cases involving bankruptcy.

1. Can I Keep My Car if I File for a Texas Bankruptcy? - In addition to looking at the options for reaffirming or redeeming a car loan during the bankruptcy process, we recently updated this blog with information about when a “cramdown” may be used to reduce the amount owed on these types of loans.

2. What is Considered "Income" for the Chapter 7 "Means Test" - To qualify for Chapter 7 bankruptcy, a debtor will need to demonstrate that their income is below the median amount in their state. This blog looks at the forms of income considered in these cases and the time frames that apply.

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While bankruptcy can provide much-needed relief from debts, it may also affect a person’s ability to maintain ownership of different types of property. While a person can use bankruptcy to discharge multiple different types of debts, the elimination of secured debts will likely result in the repossession of the property used as collateral in these debts. To avoid this, a debtor may be able to reaffirm certain loans. However, it is important to understand the advantages and disadvantages of doing so.

Pros and Cons of Reaffirmation

Property such as vehicles or appliances may be seized by creditors if a debtor fails to make payments on a loan. By entering into a reaffirmation agreement during bankruptcy, a debtor can prevent these types of repossessions. For a reaffirmation agreement to be valid, a person will usually need to catch up on any missed payments, and they will need to submit the agreement in court during the bankruptcy process. Reaffirmation is most commonly used during a Chapter 7 bankruptcy.

In addition to preventing repossession, a reaffirmation may allow a debtor to negotiate more favorable terms, such as a lower interest rate. This may help ensure that they will be able to continue making payments throughout the remainder of the loan. Reaffirmation may also be beneficial if a loan had a co-signer, and it will ensure that the creditor will not seek repayment of the loan from that person if the debt is discharged through bankruptcy. In addition, reaffirmation may help a debtor rebuild their credit after bankruptcy since payments made toward the reaffirmed loan will be reported to credit agencies.