Why Convert a Chapter 7 Case to a Chapter 13 Plan?

You cannot waive your right to conversion. Even a court cannot prevent you from converting so long as you qualify under the provisions of the new chapter. This powerful right opens a new world of opportunities. The key to understanding why someone may prefer to convert is the type of debts included within a plan. You can bring past due payments current without payment.

By design, Chapter 7 charges off liability quickly. Debts subject to discharge include general unsecured debts, secured debts, and in limited circumstances, student loans. You may retain collateral if you make all regular payments. Therein lays the rub, because you must keep your payments current to prevent creditors from lifting the automatic stay. If your payments slip past due, expect the court to lift the stay and allow creditors to foreclose or repossess your exempt property.

Chapter 13 operates differently. A plan must provide at least partial repayment toward all debts. The percentage is not critical, so long as each creditor receives more than a complete charge off. In exchange for these payments, Chapter 13 debtors may include a wide assortment of debts and past due payments in a plan. This absolute right includes past due payments on secured debts, including your home, cars, and other exempt property. Creditor objections are irrelevant.

Consider an example. A debtor files Chapter 7 and intends to keep his home and maintain all payments current. Unexpectedly, his employer downsizes, cuts salaries, and he slips past due while his case is pending. As long as he earns a salary—any salary—he satisfies the Chapter 13 requirement of earning a regular income. At this point, the debtor could convert to Chapter 13 and roll all past due payments into the plan. His payments are now current by operation of law. Further, the plan may provide for only an extremely low percentage payment on all other debts, depending on the results from the means test. This debtor’s options now expand. The debtor may also convert from Chapter 7 to Chapter 13 bankruptcy.

Assume the debtor made payments for six months and then finds a workout lender willing to approve a buyout loan. Buyout loans are rather easy to obtain if owning substantial equity and proving a record of timely trustee payments. The debtor may now buyout the remaining Chapter 13 plan payments with loan proceeds. The result? All home payments are current, and rather than receiving a 100% discharge of all remaining debt, the debtor’s discharge is limited to 98% of remaining debt. In this example, the conversion could easily save the debtors home equity worth 10 times the total cost of conversion and percentage debt payments combined. The discharge could take eight rather than four months, to eliminate all remaining debt.

Few people realize that the IRS can ignore homestead exemptions. If you have home equity, the IRS can seize your exempt property for past due income taxes. For most people, Chapter 13 provides the only realistic exception to the super-priority status enjoyed by the IRS. You may also include past due taxes of all types in your plan, plus child support payments, fines, and past due student loan payments.

The right of conversion potentially helps all debtors. It is but one of hundreds of unique rights and available strategies under the U.S. Code. Used creatively, you are free to receive the advantages of all chapters.

The best result in all cases requires thorough evaluation, thoughtful preparation, and flawless execution. Once you file, maximum benefits should follow as easy as dominoes rolling past dismayed creditors.

Dave Clark is an attorney who enjoys writing consumer articles about bankruptcy strategies and answering questions: why convert chapter 7 to chapter 13?