Patrick O'Malley

Chapter 20 Bankruptcy

Combining Chapter 7 & 13 cases. 

A Chapter “20” is a classic example of creative lawyering. It benefits filers who have very specific facts and goals.

Chapter 20 bankruptcy doesn’t actually exist. Rather, it’s called a chapter 20 when a filer has two bankruptcy cases. The first filing is a Chapter 7 case. Chapter 7 will get rid of certain debts. Once that is accomplished, they file a Chapter 13 case to get rid of the debts that Chapter 7 could not discharge. Lawyers, a profession not known for their math skills, still know that 7 + 13 = 20. As you might guess, a highly-specific set of facts and goals must exist before it makes sense to invest the extra time and expense in doing a Chapter “20”.

Here’s a simplified—but definitely not simple—example of how a Chapter 20 plays out.

Fred the filer has many unsecured debts. His debt is both priority debt (which must be repaid no matter what) and non-priority debt (can be discharged even if not fully repaid.) These unsecured debts are: credit cards, civil judgments from a failed business, property settlement from divorce, child support, taxes, and student loans. He also has significant debt that is secured by his assets, his home and car. He is behind on the payments for his home mortgage and car. The home has a first mortgage, a second mortgage, and there are other liens that are secured by the home. The first mortgage is less than the current market value of the home. After subtracting the amount of the first mortgage and his homestead dollar exemption, the home’s market price is too little to support the second mortgage and the other liens. Similarly, his car is currently worth less than the amount he owes on it.

First, Fred files for Chapter 7. Very importantly, all the assets he wants to keep after Chapter 7 must be exempt assets, otherwise none of this will work. Once the non-exempt assets, if any, are sold, the proceeds are used to pay some portion of the priority debts: the property settlement, child support, taxes, student loans. Note that Chapter 7 does not eliminate these priority debts. Eventually they must be fully paid. The unsecured credit card debt and the civil judgments from a failed business are fully eliminated by Chapter 7 even if they only receive pennies on the dollar. By first eliminating the unsecured debts and some portion of the priority debt, this allows Fred to qualify for Chapter 13. He will also have more disposable income available to repay the remaining non-dischargeable debts.

After Chapter 7, Fred files for Chapter 13. In Chapter 13 he is allowed to “lien strip” away all the liens on his home, except the first mortgage. A home mortgage usually cannot be reduced (“crammed-down”). The junior liens on the home now become unsecured debt. Similarly, he can also cramdown the difference between his car loan and the market value of the car. The difference becomes unsecured debt, along with the junior liens that were stripped off the home. These unsecured debts will be the lowest priority, and as such, these creditors very often receive little or nothing. The priority debts-the child support, taxes, and student loans-will be paid through the repayment plan. They will not be discharged until they are paid in full, either during the Chapter 13 payment plan period, or after. But, the divorce property settlement is not a priority debt, so it will be discharged in Chapter 13, even though it could not be discharged in Chapter 7.

And there you have it. Chapter 20, a complex legal maneuver to solve complex problems.

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