The Hardship Discharge and How It Can Improve Debtor Success
Abbie Schmadeke
Chapter 13 bankruptcy has long been heralded as a moral alternative to chapter 7 liquidations. Despite this, success among chapter 13 debtors is limited, and debtors who opt for this route face other challenges. The hardship discharge allows chapter 13 debtors to receive a discharge of their debts without plan completion. While the provision has been a piece of the bankruptcy law for nearly a century, little research on its effects on debtors exists. The struggles that chapter 13 debtors face underlies the need for more research on the hardship discharge as a potential solution. This Comment seeks to utilize empirical analysis to broaden the understanding of the hardship discharge and its use in bankruptcy courts. The data behind chapter 13 debtor outcomes and circumstances for which hardship discharges are granted present a compelling argument that expanding the hardship discharge could improve debtor success.
Part I of this Comment will provide an overview of chapter 13 bankruptcy. Part II will summarize some of the documented problems that debtors who go through chapter 13 face. Part III considers the evolution of the hardship discharge provision, leading to its current form today. Part IV consists of two parts of independent research: a quantitative review of 1100 chapter 13 debtor dispositions and a qualitative review of cases in which courts have granted a hardship discharge. Part V reinforces the need for expanding the hardship discharge.
[Page 356]
Introduction.............................................................................................356
I. Chapter 13 Bankruptcy................................................................358
A. Chapter 13 Eligibility Requirements ........................................ 359II. Problems with Chapter 13 Bankruptcies..................................364
B. Chapter 13 Procedures............................................................. 362
III. The Hardship Discharge...............................................................367
A. Summary of Hardship Discharge Changes in the Bankruptcy Reform Act of 1978 ................................................................... 367IV. Empirical Analysis on Hardship Discharges...........................374
B. The Hardship Discharge in Its Current Statutory Form .......... 368
C. When the Hardship Discharge Is Necessary ............................ 371
A. Results of Part I........................................................................ 375V. Expanding the Hardship Discharge Would Lead to More Successful Debtors......................................................................389
B. Results of Part II....................................................................... 383
A. The Connections Between Crashing Out of Bankruptcy and Successful Hardship Discharges .............................................. 389
B. Statutory Expansion of the Hardship Discharge ...................... 391
C. The Necessity of Expanding the Hardship Discharge .............. 393
Conclusion.................................................................................................395
Every year, thousands of American households file for bankruptcy. While many of these debtors have few assets and, therefore, must undergo the chapter 7 liquidation process, others pursue a path of repayment through chapter 13 plans. chapter 13 offers debtors an expanded discharge, along with the opportunity to retain certain assets that they would otherwise have to liquidate under chapter 7. Further, if a debtor fails to make all payments required under their chapter 13 plan, then the hardship discharge provision set forth in section 1328(b) of the United States Bankruptcy Code (the "Code") shall permit a discharge under circumstances where fulfilling outstanding repayment obligations would be difficult—if not impossible—for the debtor to achieve.1
[Page 357]
Among the set of circumstances that may warrant this type of discharge is the COVID-19 pandemic. Beginning in 2020, COVID-19 imposed grave financial hardship upon millions of Americans when measures to mitigate the virus led to lockdowns, layoffs, and widespread unemployment. While jobs that once provided workers with regular, stable income seemingly vanished. In the bankruptcy context, this unforeseen—yet immensely devastating—situation prompts a reconsideration of when courts should grant debtors' requests for a hardship discharge. Boiled down, this reconsideration points toward one central question: what changes in circumstance should debtors be held accountable for?
Consider, for example, a debtor who filed for chapter 13 bankruptcy in late 2016 and has her chapter 13 plan confirmed for five years in early 2017. This debtor's income comes primarily from a serving job at a local restaurant she's held for the past four and a half years. Her hours and income are about as stable as it gets, and her primary goal in filing for bankruptcy is to get rid of some credit card debt without losing her house. This debtor seems like the perfect candidate for a chapter 13, so the bankruptcy judge approves her plan. The first three years of repayment go by without issue.
By early 2020, she has yet to miss a single payment and seems well-positioned to fall within the one-third of chapter 13 debtors who actually receive a standard discharge. However, when the COVID-19 pandemic causes all non-essential businesses to temporarily close that April, the restaurant furloughs her. Fortunately, she is ultimately able to return to work by the end of May when the restaurant reopens under reduced capacity conditions. To balance out the decline in business, the restaurant cuts her hours to half of what they were three months prior, causing her income to fall below the amount she needs to afford a minimal standard of living—let alone make her bankruptcy payments.
Due to this unforeseen change in financial circumstances, she files for a modification, but the payments she can afford are $0, so the court declines. This debtor is left with the option of dropping out of the bankruptcy without any of the discharge she has been working towards for three years or requesting a hardship discharge. The hardship discharge—if granted—would absolve her of all outstanding payment obligations.
[Page 358]
While the hardship discharge may be an effective option here, little data exists to indicate how often courts grant such discharges, or on what grounds.2 The general wisdom is that hardship discharges are rarely filed for by debtors, and even more rarely approved by courts.3 However, the effects of the COVID-19 pandemic prompt a reconsideration of what types of debtors chapter 13 is and is not working for; and what, if anything, can courts do about these discrepancies. This Comment explores these questions in hopes of understanding potential effects of an expanded hardship discharge.
Section I of this Comment will review the fundamentals of the chapter 13 bankruptcy process, followed by Section II's summary of the various problems chapter 13 debtors tend to face. After introducing these broader issues for context, Section III contains an examination the hardship discharge provision, as set forth in Section 1328 of the Code. Then, Section IV reviews the debtor's disposition in various chapter 13 cases to assess whether the debtor could have been an ideal hardship discharge candidate. Finally, section V argues that expanding the scope of the hardship discharge could lead to improved chapter 13 outcomes.
Chapter 13 is also called "the wage earner's plan."4 When first created, Congress saw this chapter as a "cornerstone" for improving relief for consumer debtors.5 Chapter 13's primary difference from chapter 7 is that the debtor must complete a repayment plan to obtain a discharge, while the chapter 7 debtor receives a discharge through liquidation.6 More specifically, over the course of three to five years, the chapter 13 debtor makes payments using all their disposable income, as calculated by a formula created by the Code.7 Under this system, debtors are subjected to modest budgets, while "as much income as possible goes to creditors."8 These repayment plans give debtors a chance to directly repay their debts, in part or in full.9
[Page 359]
The formula used to calculate a debtor's payment obligations under a chapter 13 plan depends on the debtor having regular income.10 In exchange for payments made on the basis of that income, the debtors may keep their assets.11 Because of this benefit, many debtors opt for chapter 13 over chapter 7 to save their homes.12 In fact, "[c]hapter 13 is still probably the most widespread home-saving device in American Law."13 Specifically, the Code gives chapter 13 debtors the option of stopping foreclosure proceedings during the bankruptcy process, as well as the possibility of curing delinquent mortgage payments through chapter 13 discharge.14 These provisions allow a chapter 13 debtor who fell behind on mortgage payments to stay in their home, settle their mortgage debts, and, ultimately, avoid foreclosure.
A. Chapter 13 Eligibility Requirements
Generally, chapter 13 eligibility is limited to a specific class of debtors who satisfy three key requirements. First, a chapter 13 debtor must have regular income.15 The Code defines regular income as an income that is "sufficiently stable and regular to enable [a debtor] to make payments" under a chapter 13 plan."16 Some debtors depend on receiving regular financial assistance from friends or family. Courts typically discourage this practice in most cases—with some exceptions.17
When evaluating these situations, courts evaluate a variety of factors surrounding both the non-debtor's ability and likelihood of continued payments.18...
