In Chapter 13 bankruptcy, you are usually not required to pay off your nonpriority unsecured debts (such as credit cards or medical bills) in full. Instead you pay off a certain percentage of those debts (in rare instances, the amount is 100%). How much you must pay is determined by:
- the best interest of creditors test -- this is the minimum amount you must pay to nonpriority unsecured creditors in your Chapter 13 plan, and
- your disposable income -- you may have to pay more to your creditors depending on your disposable income.
This article discusses the best interest of creditors test in Chapter 13 bankruptcy. For more information on how to calculate your Chapter 13 plan payment (including a discussion of disposable income), see our topic area on The Chapter 13 Repayment Plan.
What Is the Best Interest of Creditors Test?
The best interest of creditors test states that you must propose a Chapter 13 repayment plan that pays your nonpriority unsecured creditors at least as much as they would have received in a Chapter 7 liquidation bankruptcy. If your plan fails to satisfy the best interest of creditors test, the court will not confirm (approve) it.
But keep in mind that this test is used to calculate the minimum amount of money you must pay your unsecured creditors regardless of your income. If you have a significant amount of disposable income, you may be required to pay a higher dividend.
Purpose of the Best Interest of Creditors Test
The purpose of the best interest of creditors test is to make sure your creditors are treated fairly. Unlike Chapter 7 bankruptcy, Chapter 13 bankruptcy allows you to keep all of your property including your nonexempt assets. In exchange for keeping your property, you agree to pay off a portion of your debts through a repayment plan.
If your unsecured creditors would have been entitled to a distribution in Chapter 7 bankruptcy, it would be unfair if you didn’t pay them as much in your Chapter 13 and still got to keep all of your property.
To learn more about how Chapter 7 bankruptcy works, see our topic area on Chapter 7 Bankruptcy.
Determining How Much You Must Pay
In Chapter 7 bankruptcy, the bankruptcy trustee can sell your nonexempt property to pay back your creditors. Whether your unsecured creditors would receive anything in Chapter 7 bankruptcy depends on:
- how much property you own, and
- the exemption laws of your state.
If all of your property is exempt, a Chapter 7 trustee can’t sell it to pay your creditors. As a result, if you have no nonexempt assets, you technically don’t have to pay anything to unsecured creditors in Chapter 13 bankruptcy to satisfy the best interest of creditors test. If you can’t exempt all of your property, you must pay an amount at least equal to the nonexempt portion of your property’s value.
However, keep in mind that the best interest of creditors test looks at how much creditors would have actually received if your assets were liquidated in a Chapter 7. Depending on the rules in your jurisdiction, the bankruptcy court may allow you to deduct any hypothetical Chapter 7 trustee’s fees and sale costs when determining the amount required to satisfy the best interest of creditors test.
For more information on whether you have nonexempt property, see our topic area on Property and Exemptions in Bankruptcy.