Too Broke for Bankruptcy: I Actually Don’t Qualify For Chapter 13?

01 Jun Too Broke for Bankruptcy: I Actually Don’t Qualify For Chapter 13?

When people look into filing for bankruptcy, some people consider Chapter 13 reorganization. Reorganization holds many advantages, but many people are under the mistaken impression that they qualify for Chapter 13 bankruptcy, when in fact, they don’t. You have to owe less than a certain amount of money to qualify for Chapter 13, but there are also different kinds of debts that make up the formula. Some people simply add up what they owe, without digging a little deeper to really ascertain how much is actually secured or unsecured. If you owe too much of a certain kind of debt, you may have to consider Chapter 11 bankruptcy, a more complicated and expensive type of bankruptcy.

Chapter 13 eligibility under the Bankruptcy Code is determined by 11 USC 109(e), which presently allows a debtor to file for chapter 13 protection, provided:

1) Secured Debt is under $1,010,650.00, and

2) Unsecured Debt is under $336,900.00.

Until recently, these limits were quite simple to determine whether one was eligible for Chapter 13 relief. Now, however, with the recent drop in real estate values, the determination is not so easy. This is because some bankruptcy courts now look to the substance of the secured claim and not merely to the label.

When getting a loan or equity line, the home that is collateral is supposed to be worth more than the mortgage loan(s) balance. For example, if there is a second mortgage on real estate that used to be totally secured, but now due to the drop in real estate values, is now partially or totally unsecured, this new unsecured amount may get added to the other unsecured debt amount and could trigger disqualification.

Consider the following example as expressed in years 2006 and 2008:

2006: Home Value $1,000,000. First mortgage $800,000. Second Mortgage $200,000. Other unsecured debt $150,000. Totals: $1,000,000 secured and $200,000 unsecured. CLEARLY QUALIFIES FOR CHAPTER 13.

2011: Home Value now $800,000. First mortgage $800,000. Second Mortgage $200,000. Other unsecured debt $150,000. Total $800,000 secured and $350,000 unsecured. FAILS TO QUALIFY SINCE UNSECURED EXCEEDS $336,900.

The debtor in 2011 no longer qualifies for Chapter 13 in Courts that follow this line of cases, since these Courts do not view the second mortgage as secured anymore due to the decline in real estate value. So now the debtor is stuck with filing a costly Chapter 11 case.

Out here in the 9th Circuit (California), the Scovis Case follows this logic and governs us:

Scovis v. Henrichsen (In re Scovis), 249 F.3d 975, 2001 U.S. App. LEXIS 8875, 2001 Cal. Daily Op. Service 3769, 2001 D.A.R. 4653, 46 Collier Bankr. Cas. 2d (MB) 489 (9th Cir. Cal. 2001) 05/11/2001.
Through the inclusion of a 506(a) analysis to define “secured” and “unsecured” in the 109(e) context, a vast majority of courts, and all circuit courts that have considered the issue, have held that the unsecured portion of undersecured debt is counted as unsecured for 109(e) eligibility purposes. See, e. g., In re Balbus, 933 F.2d 246, 247 (4th Cir. 1991); Miller v. United States, 907 F.2d 80, 81-82 (8th Cir. 1990); In the Matter of Day, 747 F.2d 405, 407 (7th Cir. 1984); Soderlund v. Cohen, 236 B.R. 271, 273-74 (BAP 9th Cir. 1999). HN7Go to the description of this Headnote.Section 506(a) provides in pertinent part:

An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under section 553 of this title, . . . is an unsecured claim to the extent that the value of such creditor’s interest or the amount so subject to setoff is less than the amount of such allowed claim.

HN8Go to the description of this Headnote.It is true that although 506(a) speaks in terms of an “allowed claim,” applying 506(a) to 109(e) is necessary to prevent “raising form over substance and manipulation of the debt limits” to achieve Chapter 13 eligibility. Soderlund, 236 B.R. at 274. By merely looking at the value of Debtors’ residence, the first deed trust, and the judgment lien, it is clear that Henrichsen’s judgment lien is undersecured to a significant extent. The listed value of Debtors’ residence is $ 325,000.

So what is the solution other than paying $20,000 for a Chapter 11? Well, one remedy around this might be to file a Chapter 7 first, discharge the $150k in unsecured debt, and then file a Chapter 13 bankruptcy when you can qualify for it. Your situation should first be reviewed by an experienced attorney to determine if this makes sense for you.

It just goes to show, that pre-bankruptcy planning and making sure you are with the right attorney, can make the difference between discharge of debts versus dismissal of case.

Written by Michael G. Doan

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