The Chapter 13 Marathon: Why You Need Permission Before Taking on New Debt

In a prior article, I discussed that a Chapter 7 filing should sometimes be delayed if a debtor is likely to incur more debt, especially because of medical bills. While post-filing debt isn’t dischargeable, with Chapter 13 bankruptcy, incurring new debt without court approval could have serious consequences for a debtor.

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

Key Takeaways: Navigating New Debt in Chapter 13

• Court Approval: Unlike Chapter 7 bankruptcy, Chapter 13 requires court approval under 11 U.S.C. §1305 and §364 before you incur new debt.
• The Necessity Requirement: To successfully file a Motion to Incur Debt, you must prove the expense is essential, such as a reliable vehicle for work, rather than an upgrade.
• The Feasibility Test: Under 11 U.S.C. §1325(a)(6), the court will only approve new debt if you can prove it won’t jeopardize your existing plan payments or violate the Liquidation Test requirements for unsecured creditors.
• Risk of Case Dismissal: Incurring debt without authorization is a violation of your bankruptcy terms that allows the Standing Trustee to move for dismissal, instantly stripping away the protection of the automatic stay.

The Requirement: The Motion to Incur Debt

In a Chapter 13 case, you are generally prohibited from taking on significant new debt without the permission of the Bankruptcy Trustee or a formal court order under 11 U.S.C. §1305 and 11 U.S.C. §364.

To obtain approval to incur more debt, whether refinancing a mortgage, purchasing a vehicle, or obtaining a new credit card, the debtor must demonstrate that the new debt is necessary and financially feasible under 11 U.S.C. § 1325(a)(6).

A replacement vehicle needed to maintain employment is typically viewed as a necessity, especially if the current car is inoperable, but an upgrade is not. Courts also consider whether the new debt would reduce the funds available to unsecured creditors under §1325(a)(4) and the Liquidation Test.

Under the Liquidation Test, unsecured creditors must receive at least as much in Chapter 13 as they would have received in a hypothetical Chapter 7 liquidation. For example, suppose the non-exempt equity in the debtor’s vehicle was $5,000. Then that is the minimum that unsecured creditors would receive in a Chapter 13 plan.

Any new debt that increases monthly expenses or reduces disposable income can jeopardize this requirement, forcing the bankruptcy judge to deny the motion.

The Consequences of Unauthorized Debt: What Happens if Court Approval Isn’t Obtained?

Taking on debt behind the court’s back is a violation of your bankruptcy terms and can lead to severe consequences:

Case Dismissal: If the Trustee discovers unauthorized debt, they can move to dismiss your case. You lose the protection of the bankruptcy court and the automatic stay, and all your original creditors can immediately resume collection efforts, including lawsuits and wage garnishments.

Denial of Discharge: Even if your case isn’t dismissed immediately, the court may refuse to grant your final discharge at the end of your plan because you failed to follow the court’s rules.

Non-Dischargeable New Debt: Just like in Chapter 7, debt incurred after your filing date is not part of your current bankruptcy. If you run up a secret credit card and then can’t pay it, that debt is permanent and follows you even after your bankruptcy is over.

The Professor’s Conclusion

Chapter 13 bankruptcy is a long process, and because of that, it’s common that plan modifications have to be made. However, before a mortgage is refinanced, or you apply for a new car loan, or even a credit card, note that court approval is necessary, and it must be proven that you can afford it, that it is necessary, and that unsecured creditors won’t be shortchanged under the Liquidation Test.

If an emergency forces you to incur more debt, consult first with your bankruptcy attorney.  Filing a Motion to Incur Debt protects you from dismissal, protects your discharge, and ensures your plan meets the requirements under the Bankruptcy Code.

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