Strategic Dismissal: Plan B When Chapter 13 Bankruptcy Conversion Fails

When a conversion from Chapter 13 to Chapter 7 is blocked by the Standing Trustee’s objection or a judge’s denial, many debtors feel trapped in a failing plan. However, there is the nuclear option: Strategic Dismissal.

The goal of the dismissal is to intentionally exit the bankruptcy system, sometimes even by “allowing” the case to be dismissed for missed payments, in order to be able to negotiate directly with creditors.

The premise is simple: without the administrative overhead of a Trustee, you can offer creditors a lump sum that gets them paid faster than a five-year plan, while settling your debt for a fraction of what is owed.

By Alexander Hernandez, J.D., Professor, and Author of Consumer Bankruptcy Law (Routledge).

Key Takeaways: Strategic Dismissal Versus Settlement

• When Conversion Fails: When conversion to Chapter 7 is blocked or the Chapter 13 plan is no longer to the debtor’s benefit, a strategic dismissal allows a debtor to exit the court’s jurisdiction to settle debts privately.
• The Power of Settlement: Creditors are generally willing to settle for 10–30% of the debt if they receive a lump sum payment.
• Leveraging the “Refiling Threat”: A debtor’s strongest negotiation tool outside of bankruptcy is the credible threat of refiling. Creditors often prefer a guaranteed partial payment now over the risk of being halted again by a new automatic stay or a Chapter 7 conversion.
• The Risk of “Prejudice”: Dismissing a case to avoid an unfavorable court ruling can result in a dismissal with prejudice. This can bar you from refiling for 180 days, leaving you vulnerable to aggressive collection tactics like wage garnishment.
• The “1099-C” Tax Trap: Unlike a bankruptcy discharge, forgiven debt in a private settlement is often considered taxable income by the IRS. Debtors must be prepared to file IRS Form 982 to claim the “Insolvency Exception.”
• Loss of Protection: The moment a case is dismissed, the automatic stay vanishes. There is no grace period. Creditors can resume lawsuits and seizures immediately if a settlement isn’t reached quickly.

Voluntary of a Chapter 13 Bankruptcy vs. Passive Dismissal

In a Chapter 13, you generally have an absolute right to dismiss your case under 11 U.S.C. § 1307(b), provided the case wasn’t previously converted.

The Active Approach: Filing a motion to voluntarily dismiss.

The Passive Approach: Intentionally missing payments. While this “triggers” a dismissal, it can sometimes be viewed by the court as “bad faith” if done to evade a specific court order. But personally, I’ve never seen a trustee take action against a debtor for doing so, but it wouldn’t surprise me in other districts.

The Leverage: Settlement or Return to Bankruptcy

If converting from Chapter 13 to 7 isn’t possible, then you can seek to dismiss your case, but the Automatic Stay evaporates. This is where the strategy becomes a high-speed game of legal poker. You are no longer protected from garnishments or repossession, but you have one major advantage: Cash.

Creditors are often more willing to take 10-30 cents on the dollar today rather than wait years for a potential 100% payout that might never materialize if you refile, and that’s assuming they are paid fully under your bankruptcy plan.

For example, if creditors were receiving 20% of the balance through the plan, spread out over 24 months, why wouldn’t they take 20% today? The answer, of course, is they would, but there’s a good chance you can get the creditors to agree to even less, such as 10%.

Creditors know that your leverage is the threat of a new filing if they don’t agree to a settlement, you can simply step back into the bankruptcy, maybe even a Chapter 7 conversion, where you wipe out the remaining unsecured debt.

The Risks vs Rewards

Strategic dismissal isn’t without its risks. Having faced this issue with my bankruptcy clients, here are two issues to consider:

Dismissal With Prejudice: If a judge finds you are “gaming the system,” such as serial filing, they may dismiss your case with prejudice, barring you from refiling for 180 days or more. This leaves you completely exposed to aggressive collections.

The 1099-C Tax Trap: Unlike a bankruptcy discharge, which is tax-free, a private settlement of $600 or more results in “Cancellation of Debt” income. Unless you can prove insolvency via IRS Form 982, you may owe the IRS a portion of what you “saved.”

Summary Comparison: Chapter 13 vs. Strategic Settlement

Feature	Chapter 13 Plan	Strategic Settlement
Duration	3 to 5 Years	3 to 6 Months
Cost	The Liquidation Test Debt + Trustee Fees	10–30% of Debt (Lump Sum)
Protection	Absolute (Automatic Stay)	None (Negotiation only)
Tax Impact	None	Potential Tax on Forgiven Debt

The Professor’s Conclusion

Strategic dismissal is a “power move” for debtors who have access to cash, whether a family gift, an exempt asset sale, or maybe a refinance of their mortgage if they are stuck in a Chapter 13 that no longer serves them, and it’s to their financial advantage to do so.

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