Can I Have Too Much Debt to File Chapter 13 Bankruptcy?

By John M. Hilla, a Michigan Bankruptcy Attorney

Unlike in Chapter 7 bankruptcy, in which there are no limits to the amount of debt that may be discharged, in a Chapter 13 reorganization bankruptcy, it is possible to have “too much debt” to file a Chapter 13.

Under Section 109(e) of the US Bankruptcy Code, a debtor is, by definition, an individual with less than $360,475 in unsecured debt and less than $1,081,400 in secured debt in Chapter 13 bankruptcy. This means that, if you owe more than either of these limits (or both), you may not be eligible to file a Chapter 13 bankruptcy and would be required to file either a Chapter 7 bankruptcy, provided that you are eligible for that Chapter under the Means Test eligibility standard, or an individual Chapter 11 bankruptcy, which is the form of “reorganization” bankruptcy that is usually reserved for corporations and which, for individuals, is a complex and expensive process.

In other words, the question of whether a debt is “secured” or “unsecured” is vitally important in analyzing what form of bankruptcy is most appropriate for you.

“Secured” debt is just that: debt that is secured by collateral of some sort. An auto loan is a “secured” loan, for example, because the automobile that is being purchased also serves as collateral for the loan that is extended by the lender. If you default on your payments, the lender has the right to reclaim the collateral, or to repossess the car, in this case. A mortgage note is a personal loan secured by the collateral that is the house that is being purchased under the terms of the mortgage agreement. Some credit unions extend what would otherwise be unsecured personal loans by “cross-collateralizing” the loan, making the collateral for some other loan (a car loan, say) that they have extended to a customer also serve as collateral for the personal loan.

“Unsecured” debt is everything else: medical bills, credit card debt, personal loans from family members or friends, lines of credit (other than Home Equity Lines of Credit and other secured forms), and so on. These are debts that have no collateral: they were just loans extended, with the consequence of default being the collection lawsuit and other remedies for breach of contract as provided by your state’s law.

The trick in Chapter 13 for determining some finer points here lies in the classification of debt done by you and your attorney in preparing your petition and your Chapter 13 repayment plan. In a Chapter 13, a second mortgage or HELOC on a primary residence that is worth less than is owed on a first mortgage can usually be “stripped off” and treated, upon completion of the Plan, as unsecured debt—even though it is, by the terms of the contractual note providing the guidelines of the original loan, secured by collateral: the home in question.

So is that debt, upon the initial filing of the petition and Plan, an unsecured debt or a secured debt?

The answer is that it depends on the rulings made by the Bankruptcy Court in your local area. In the Eastern District of Michigan, where I practice, although I am regularly able to have such second mortgages stripped off and declared to be “unsecured” debt by my local Bankruptcy Court, such debts are classified as secured debt for initial filing purposes. The actual stripping of the lien (conversion to “unsecured” classification) does not occur until the end of the 3-5-year Chapter 13 payment Plan. If I, as a filing debtor’s attorney, were able to pick and choose which classification to give a debt upon filing. it would certainly make a difference from time to time as to the eligibility of a client for Chapter 13.

This practice and and these rules vary significantly from jurisdiction to jurisdiction around the country.

The bottom-line is that it is vitally important to seek out and retain an experienced bankruptcy attorney who is familiar with the analysis that is appropriate for your geographic area. In a Chapter 13 bankruptcy, especially, going it alone or with a non-specialist attorney, you can easily trip on such nuances.