Good Faith
The conduct of Debtors in Bankruptcy Court is judged by the standard of "good faith". A Chapter 7 case may be dismissed by the Court if it is not filed in good faith or a substantial abuse of the bankruptcy system. Any Plan proposed under Chapter 13 must be proposed in good faith. [Bankruptcy Code Section 1325(a)(3).] Therefore, Debtors and Debtors' attorneys must consider good faith in determining under which chapter to file.
Chapter 7
Chapter 7 is a liquidation bankruptcy. All Debtor's non-exempt assets (described below) are sold or otherwise liquidated to create a fund to pay creditor's claims. In exchange, a Debtor's debts are discharged. That is, the legal duty to pay those debts is extinguished. However, a Chapter 7 Debtor may voluntarily pay a discharged debt. [Bankruptcy Code Section 524(f).] Although a Chapter 7 Bankruptcy discharges debts, it generally does not discharge liens. Thus, while the obligation to pay a mortgage note may be discharged - the mortgage lien is not. Therefore, in order to keep a mortgage company from foreclosing on its lien, a Chapter 7 Debtor may agree to pay or reaffirm the mortgage note. If the Debtor has no equity in his home over and above his exemptions, the Debtor "keeps" the house even though he has been through a Chapter 7 Bankruptcy.
Exemptions refer to those items which may not be executed upon, or seized and sold, to satisfy a court judgment. In certain states, though, a lien can impair an exemption. Therefore, if a Bankruptcy Debtor has given a lien on his household goods to secure a loan, he must reaffirm on the loan or redeem (pay for) the value of the furniture in order to keep it.
Chapter 13
Chapter 13 is a wage-earner's reorganization. The idea behind a Chapter 13 Bankruptcy is that a Debtor pays all or some of his debt over a three to five year time period. This is accomplished by the Debtor making payments pursuant to a Court-approved Plan through the Chapter 13 Trustee. If debt remains after a Debtor has completed his Court-approved Plan, that debt is discharged. In order for a Plan to be Court-approved (or confirmed), the Plan must:
Provide for the Chapter 13 Trustee's receipt of so much of the Debtor's wages as are necessary to make the Plan payments.
Provide for the full payment of priority claims. For example, a tax claim may be a priority claim.
Be proposed in good faith.
Propose to pay sufficient payments under the Plan so that those payments exceed the amount creditors would get if the Debtor's assets were liquidated under a Chapter 7 Bankruptcy filing.
Propose to pay secured creditors the fair value of their collateral or obtain the acceptance of the secured creditors.
Be "feasible", that is, show that the Debtor can afford to make the required payments.
Show that Debtor is applying all of his "disposable income" to the Plan.
Pay the Debtor's home mortgage payments and pay any arrearages owed to the mortgage holder.
It is expected that those who can afford to proceed under Chapter 13 do so, rather than Chapter 7.