Converting from Chapter 13 to Chapter 7: What’s Involved and Why Would You Convert?

Life inevitably changes and things happen that may cause a chapter 13 debtor to no longer need or afford their original chapter 13 plan. A job loss, other reduction of income or unanticipated increase in expenses can all be reasons for a debtor to lose their ability to continue making the chapter 13 plan payments. If the chapter 13 payments become unfeasible and, assuming the debtor qualifies, a chapter 13 case can be converted to chapter 7 for an immediate discharge.

Typically people file chapter 13 bankruptcy for one of two reasons: Either their household income is above the applicable state median income and they do not qualify for chapter 7, or they voluntarily elect to file chapter 13 due to having mortgage arrears, non-dischargeable taxes or other priority debts that can be repaid over the course of a chapter 13 plan. Also debtors may elect to file chapter 13 if they have non-exempt assets that would lose to liquidation by a chapter 7 trustee and instead chose to ‘buy back’ their non-exempt property by making monthly plan payments in chapter 13.

In cases converted to chapter 7 from chapter 13, the debtor must prove that they would qualify for chapter 7 as of the date of conversion (not the original file date) by passing the means test. See What is the “Means Test” and Why Does it Matter in Bankruptcy. The debtor’s bankruptcy attorney will complete a new means test as of the date of conversion to determine if the debtor is chapter 7 eligible. If eligible, the case can be converted by the debtor filing a motion to convert to chapter 7 which gives all creditors and other parties the opportunity to object. (Note that in Minnesota, no motion is required and the debtor can instead file a simple request to convert to chapter 7 along with updated schedules and statements). If the motion/request to convert is granted, the case will proceed as a chapter 7 case and the debtor will attend a chapter 7 Meeting of Creditors before a discharge is ordered.

If your income has gone down or your expenses have increased since your chapter 13 plan was confirmed, you should consult your bankruptcy attorney so she can advise you of what options you have to convert to chapter 7, to have your case dismissed voluntarily or otherwise to modify your chapter 13 plan to reduce the plan payment. Any missed chapter 13 plan payments will result in a quick dismissal of your chapter 13 case so it is important to notify your attorney immediately if you are considering a conversion to chapter 7 from chapter 13. Once a chapter 13 case is dismissed, the debtor will have to pay a significantly larger filing fee to file chapter 7 and also increased attorney fees over the typically smaller attorney fee for just a conversion.

Read more about converting from chapter 7 to chapter 13 bankruptcy here.

Restaurant & Bar Chapter 11s: Top 15 Signs that Your Restaurant May Benefit from Filing a Chapter 11 Bankruptcy

The top 15 common factors that may indicate a chapter 11 bankruptcy filing can help your business stay operational despite debt and other issues:

# 1:  Sales Tax and/or Withholding Tax Owed

In chapter 11, a business can repay all tax obligations including penalties and interest over a five-year payment plan at a low interest rate and sometimes according to a schedule that may adjust with the seasonality of business income. In contrast, state taxing authorities usually only allow tax repayment plans of six months (sometimes longer), resulting in far higher minimum monthly payments than the business can usually achieve in chapter 11. Also, sometimes in chapter 11 penalties and interest on penalties can be reduced. Click here to read more about Sales Tax Obligations and Chapter 11 Business Reorganizations.

#2:  Tax Levies Pending

Filing chapter 11 bankruptcy will automatically stop tax levies from commencing or continuing. Instead, tax obligations can be repaid over a five-year payment plan (see above).

#3:  Pending Tax Audit or other Tax Dispute including an “Indirect Mark-up” Sales Tax Audit

While chapter 11 will not always prevent a tax audit from concluding in an assessment, the forum for disputing the tax audit may be switched from tax court to bankruptcy court and, importantly, filing of bankruptcy opens the door for a settlement outside of continued tax litigation. Additionally, taxes owed can be repaid over a five-year chapter 11 plan versus the usually much shorter repayment periods demanded outside of bankruptcy.

#4:  Posting of Liquor License for Unpaid Tax

Filing chapter 11 will automatically stay most pending actions to enforce an unpaid liability, including an action to post a liquor license for unpaid sales tax. If a license has already been posted, it may take an order of the bankruptcy court to reinstate the liquor license once the chapter 11 has been filed.

#5:  Commercial Eviction Action Pending

Depending on the status of an eviction proceeding under state law, chapter 11 bankruptcy may automatically stay a pending eviction proceeding for unpaid rent or other causes. In Minnesota, this means that filing chapter 11 will prevent the eviction proceeding from moving forward from the moment in time that bankruptcy is filed so long as the county court has not yet entered a judgment for eviction. If a judgment for eviction has been entered, the debtor lessee may still have options to cure the arrears and remain in good standing under the lease so long as the lease has not otherwise terminated as of the date the bankruptcy is filed. Click here to read more about Chapter 11 and Commercial Lease Eviction and the Timelines and Requirements regarding Commercial Leases in Chapter 11.

#6:  Unpaid Rent / Other Lease Obligations Owed

Even if an eviction proceeding has not yet commenced, chapter 11 allows breathing room and time to catch up on unpaid rent while the bankrupt tenant formulates a plan to either stay in the property and assume the lease, or vacate the property while rejecting the lease (see more below).

#7:  Burdensome Rent Obligations and/or Inability to Modify Commercial Lease

In chapter 11, the tenant “lessee” must either assume (i.e., keep) or reject its current commercial property lease no later than 210 days after the bankruptcy is first filed. If a lease is assumed, all pre-petition rent and other lease obligations due through the date of filing bankruptcy must be paid on or before the date that the lease is assumed. Chapter 11 also provides an opportunity to renegotiate lease obligations—including monthly rent or duration of lease, etc.—in exchange for the tenant’s renewed obligation to continue to lease the property. If a lease is rejected, the pre-petition arrears and any rejection damages owed under the lease are treated as a general unsecured debt which is usually paid only a fraction of what is owed under a chapter 11 plan. Additionally, chapter 11 allows several months for a bankrupt tenant to remain in the property while seeking a new location so long as the tenant remains current on rent payments from the time the bankruptcy is filed through the date it rejects the lease. In all cases, post-petition rent due after the date of filing bankruptcy must be paid on time and no later than 60 days after the bankruptcy is filed or the lessee is at risk for eviction even after the bankruptcy is filed.

#8:  Secured Lender Financing is Overly Burdensome to Business 

Chapter 11 provides a business with the opportunity to renegotiate the terms of secured financing agreements or to reject the agreements altogether and surrender the property.

#9: Repossession of Critical Equipment 

Just as with other lease obligations, burdensome lease terms may be renegotiated once chapter 11 is filed and any deficiency or default terms under the lease may be treated as general unsecured debt to be paid a fraction of what is owed.

 #10:  Inability to Fund Monthly Debt Service or other Financial Obligations

Chapter 11 plans typically provide for only partial payment on some debts over the course of time—including credit cards, judgments and other unsecured obligations—while other “priority” debts such as taxes and employee wages are repaid in full over an extended period of time.

#11:  Employee Wage Lawsuit / Class Action

Chapter 11 will automatically stay pending lawsuits and may also have the effect of transferring the forum of the dispute from state court to bankruptcy court. If negotiations have stalled in the state court action, filing bankruptcy will provide for more time and a new platform to negotiate a resolution as an alternative to a trial. If a claim has reached the point of a judgment or award, this amount owed is treated as general unsecured debt which typically only receives a fractional payment under a confirmed chapter 11 plan of reorganization.

# 12:  Other Claims or Lawsuits Pending (particularly if not covered by insurance)

The filing of chapter 11 bankruptcy has the immediate effect of staying all pending litigation against a debtor business. In practice, many plaintiffs will view a chapter 11 filing as effectively diminishing the potential return investment on continuing to litigate their claims since a confirmed plan of reorganization usually provides for only a fractional payment of the claim. Accordingly, many lawsuits are no longer financially worthwhile once bankruptcy is filed and will be dismissed or dropped upon filing of bankruptcy.

#13:  Collection on Judgments / Bank Levies

Chapter 11 immediately stops all collection activity including bank levies. In some cases, it may be possible to have funds levied pre-petition returned to the debtor business if the business acts quickly to file chapter 11 no later than 90 days after the levy was served on the bank.

#14:  Vendor Disputes

As with other debts, a chapter 11 plan will treat most vendor claims as general unsecured debts that receive a fractional repayment only. However, vendors do have certain reclamation rights for certain goods delivered within the 20 days prior to bankruptcy.

#15:  Utility Shutoff

Filing chapter 11 allows utility debts to be treated as general unsecured debts and for the utility account to start again at zero as of the date the bankruptcy is filed and without threat of shutoff for non-payment. Usually utility providers will demand that a deposit be made as “adequate protection” for future payment, usually in the amount equivalent to two or three months of regular service. Located in Edina, Minnesota, Wartchow Law Office is a Chapter 11 law firm providing Chapter 11 consultations to review the business lease and other liabilities affecting a Chapter 11 bankruptcy proceeding.