The Ultimate Question: Do I File for Chapter 7 or Chapter 13 Bankruptcy in Colorado?

The two most common types of bankruptcy are chapter 7 and chapter 13. Chapter 7 is common referred to as a “liquidation” bankruptcy as most or all unsecured debts are eliminated. Chapter 13, on the other hand, is referred to as a “wage earner” or involving a “readjustment of debts.”

Most clients in my Denver, Colorado practice initially believe that chapter 7 is preferable because nothing is typically required to be paid back to the bankruptcy trustee and to unsecured creditors. And the chapter 7 bankruptcy process is more simple and quicker. Plus, a debtor will keep most all of his/her assets in chapter 7. (Most chapter 7 cases are “no asset” filings whereby the trustee obtains none of the debtor’s assets or wages.) Overall, chapter 7 filings constitute about 80% of all filings in Colorado.

You will qualify for chapter 7 bankruptcy if you either are not required to take the Means Test or if you pass the Means Test outright. I’ll need information regarding your income, expenses and family size to determine your status under the Means Test. A third way to qualify for chapter 7 is if more than 50% of your debt is business (and not consumer) debt, in which case the Means Test does not apply.

So, why even consider filing for chapter 13 in Colorado? For many clients who actually qualify for chapter 7 under the Means Test, it turns out that a chapter 13 is actually preferable. The following is a list of potential situations in which a debtor would be highly advised to consider chapter 13:

*The debtor is a “higher income” filer in the eyes of the Bankruptcy Code: the debtor simply does not pass the Means Test due to having too high income. This is a situation where chapter 7 is preferable but the next best situation is for the debtor to only be required to pay back “pennies on the dollar” through a chapter 13 payment plan.

• The debtor faces an imminent foreclosure sale date on their home. (In the Denver Metro Area and most areas of Colorado, the foreclosure sale process typically takes months to complete.) Particularly if a debtor is behind on the mortgage payments, only a chapter 13, and not a chapter 7, bankruptcy will prevent against a forced foreclosure sale of the home, to give the debtor an opportunity to catch up on monthly mortgage payments to keep the house. The same principle applies should a debtor instead be looking at an involuntary liquidation of a business by a creditor.
• The overall mortgage balance owed on a first mortgage (by itself) exceeds the fair market value of the debtor’s home, such that a second mortgage is rendered unsecured and, hence, can be stripped off. A second mortgage can only be stripped off in chapter 13. The benefits of stripping off a second mortgage are huge – the debtor’s monthly mortgage payment for the second mortgage and the mortgage balance are wiped out assuming the debtor successfully completes the chapter 13 payment plan. (I’ve had countless numbers of cases whereby the debtor easily qualified for a chapter 7 and would have otherwise eliminated all unsecured debt but, instead, opted to file for chapter 13 to eliminate a second mortgage with a high balance, with the chapter 13 plan payments being lower than what the second mortgage payment was.)
• The debtor owes tax arrears to the IRS and/or Colorado State Department of Revenue. Only in chapter 13 can the tax authorities (as well as unsecured creditors) be forced to accept a court ordered re-payment plan. Regarding clients with high debts owed, stopping the further accumulation of interest and excessive penalties can save a debtor thousands of dollars.
• The debtor is eligible to “Cram Down” the loan balance on a motor vehicle, such that the lender is forced to accept a chapter 13 payment plan that lowers the balance owed on an “upside down” car down to the vehicle’s fair market value, lowers the interest rate down to 4.5% and, if necessary, stretches out the balance of payments due to 60 months (if the car note expires sooner than the chapter 13 plan).
• The debtor owns valuable, non-exempt property (not including a primary residence) subject to the claims to the trustee and unsecured creditors. I’ve had more than a few clients who own equity in an out-of-town property which is co-owned with family. The equity in such property is non-exempt and, unknown to many of my clients, can forcibly be sold by the trustee over the objection of any co-owners (although the trustee would still be required to pay such co-owner the first proceeds of sale). A chapter 13 allows for the gradual payback of the equity in the non-exempt property over the course of 36 to 60 months.
• The debtor filed for chapter 7 within the past 8 years, in which case chapter 13 is the only chapter of bankruptcy available.