Converting from Chapter 13 to Chapter 7 Bankruptcy

A misconception that many of my clients have is that they are stuck with the particular chapter of bankruptcy filed without the opportunity to re-file to account for changed circumstances. Fortunately, the Bankruptcy Code allows an eligible debtor to convert from chapter 13 to chapter 7.

Conversion from chapter 13 to chapter 7 under Bankruptcy Code section 1307(a) most commonly occurs when an above median income debtor either loses a job or has reduced pay if the Means Test so allows.

Another common scenario occurs when a debtor decides to no longer cure mortgage arrears and surrender the house. Section 1307(a) operates to allow for an automatic (e.g. not subject to court or creditor scrutiny) conversion to chapter 7 if the debtor passes the Means Test.

Initially, the chapter 13 plan payment will account for past due arrears owed to a mortgage lender. (The overall plan payment may also include priority tax payments to the IRS and/or payments based upon monthly disposable income to unsecured creditors depending upon the circumstances.) Even when mortgage arrears are cured over 36 to 60 months in the plan, the debtor remains on the hook for the normal monthly mortgage payment which continues to be paid to the lender outside the bankruptcy. The mortgage lender will likely request Relief from Automatic Stay (and ultimately pursue foreclosure) if the regular mortgage payments are not made. The often onerous burden of simultaneously making plan payments and the regular monthly mortgage payment causes many debtors to reverse course and surrender the house. For debtors who pass the Means Test, converting to chapter 7 to eliminate all unsecured debt – particularly a deficiency on the mortgage loan(s) – is typically the best option.

Some of my clients (again who pass the Means Test) who unsuccessfully attempt to strip off a second mortgage in chapter 13 opt to convert to chapter 7. This most commonly occurs when a lender successfully challenges the valuation and establishes that the second mortgage is not wholly unsecured. For instance, the Court may find in favor of the lender’s expert witness who will invariably testify in favor of a higher value for the debtor’s home than the debtor’s expert.

Other clients who file for chapter 13 to protect equity in a small business (as evidenced by the balance sheet showing assets exceeding liabilities) and to keep a chapter 7 trustee from liquidating the business later decide to voluntarily shut down the business, obtain a W-2 job and convert to chapter 7. Unless the business owns valuable inventory or equipment that can be easily and profitably sold, the chapter 7 trustee likely will not care about any computers, desks or books owned by the business. Additionally, the tool of trade exemption can be used to protect $20,000 (or $40,000 for joint bankruptcy filers) of tools or equipment used in a business if the property is owned individually by the debtor (and not by the business).

Yet other clients in bankruptcy simply are not able to make chapter 13 plan payments for 3 to 5 years or, even if able to pay the trustee monthly, want to be done with the case and move forward quicker particularly to avoid the stress of having an ongoing case in bankruptcy.

Converting to chapter 13 is relatively easy. Any new debts incurred since the case was originally filed can be included in the schedules. Our office will file a Notice of the conversion to all creditors and the trustee. A new 341 hearing (before a chapter 7 trustee) is required and we will charge you a reasonable fee for the work involved but this is typically a small price to pay for the benefit of not having to make any further plan payments. As an experienced Denver bankruptcy lawyer, attorney David M. Serafin will ensure that the process of converting your case goes as smoothly as possible.