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Bankruptcy
Bankruptcy is a legally declared inability or impairment of ability of an
individual or organization to pay its creditors. In the majority of cases,
however, bankruptcy is initiated by the debtor. There are
six types of bankruptcy under the Bankruptcy Code, located at Title 11
of the United States Code:
• Chapter 7: basic liquidation for individuals and businesses; also known as
straight bankruptcy; it is the simplest and quickest form of bankruptcy
available
• Chapter 9: municipal bankruptcy; a federal mechanism for the resolution of
municipal debts
• Chapter 11: rehabilitation or reorganization, used primarily by business
debtors, but sometimes by individuals with substantial debts and assets; known
as corporate bankruptcy, it is a form of corporate financial reorganization
which typically allows companies to continue to function while they follow debt
repayment plans
• Chapter 12: rehabilitation for family farmers and fishermen;
• Chapter 13: rehabilitation with a payment plan for individuals with a regular
source of income; enables individuals with regular income to develop a plan to
repay all or part of their debts; also known as Wage Earner Bankruptcy
• Chapter 15: ancillary and other international cases; provides a mechanism for
dealing with bankruptcy debtors and helps foreign debtors to clear debts.
The most common types of personal bankruptcy for individuals are Chapter 7 and
Chapter 13. As much as 65% of all U.S. consumer bankruptcy filings are Chapter 7
cases. Corporations and other business forms file under Chapters 7 or 11.
In Chapter 7, a debtor surrenders his or her non-exempt property to a bankruptcy
trustee who then liquidates the property and distributes the proceeds to the
debtor's unsecured creditors. In exchange, the debtor is entitled to a discharge
of some debt; however, the debtor will not be granted a discharge if he or she
is guilty of certain types of inappropriate behavior (e.g. concealing records
relating to financial condition) and certain debts (e.g. spousal and child
support, student loans, some taxes) will not be discharged even though the
debtor is generally discharged from his or her debt. Many individuals in
financial distress own only exempt property (e.g. clothes, household goods, an
older car) and will not have to surrender any property to the trustee. The
amount of property that a debtor may exempt varies from state to state. Chapter
7 relief is available only once in any eight year period. Generally, the rights
of secured creditors to their collateral continues even though their debt is
discharged. For example, absent some arrangement by a debtor to surrender a car
or "reaffirm" a debt, the creditor with a security interest in the debtor's car
may repossess the car even if the debt to the creditor is discharged.
The 2005 amendments to the Bankruptcy Code introduced the "means test" for
eligibility for chapter 7. An individual who fails the means test will have his
or her chapter 7 case dismissed or may have to convert his or her case to a case
under chapter 13. Generally, a trustee will sell most of the debtor’s assets to pay off creditors.
However, certain assets of the debtor are protected to some extent. For example,
Social Security payments, unemployment compensation, and limited values of your
equity in a home, car, or truck, household goods and appliances, trade tools,
and books are protected. However, these exemptions vary from state to state.
Therefore, it is advisable to consult an experienced bankruptcy attorney.
In Chapter 13, the debtor retains ownership and possession of all of his or her
assets, but must devote some portion of his or her future income to repaying
creditors, generally over a period of three to five years. The amount of payment
and the period of the repayment plan depend upon a variety of factors, including
the value of the debtor's property and the amount of a debtor's income and
expenses. Secured creditors may be entitled to greater payment than unsecured
creditors.
Relief under Chapter 13 is available only to individuals with regular income
whose debts do not exceed prescribed limits. If you're an individual or a sole
proprietor, you are allowed to file for a Chapter 13 bankruptcy to repay all or
part of your debts. Under this chapter, you can propose a repayment plan in
which to pay your creditors over three to five years. If your monthly income is
less than the state's median income, your plan will be for three years unless
the court finds "just cause" to extend the plan for a longer period. If your
monthly income is greater than your state's median income, the plan must
generally be for five years. A plan cannot exceed the five-year limitation.
In contrast to Chapter 7, the debtor in Chapter 13 may keep all of his or her
property, whether or not exempt. If the plan appears feasible and if the debtor
complies with all the other requirements, the bankruptcy court will typically
confirm the plan and the debtor and creditors will be bound by its terms.
Creditors have no say in the formulation of the plan other than to object to the
plan, if appropriate, on the grounds that it does not comply with one of the
Code's statutory requirements. Generally, the payments are made to a trustee who
in turn disburses the funds in accordance with the terms of the confirmed plan.
When the debtor completes payments pursuant to the terms of the plan, the court
will formally grant the debtor a discharge of the debts provided for in the
plan. However, if the debtor fails to make the agreed upon payments or fails to
seek or gain court approval of a modified plan, a bankruptcy court will often
dismiss the case on the motion of the trustee. Pursuant to the dismissal,
creditors will typically resume pursuit of state law remedies to the extent a
debt remains unpaid. In Chapter 11, the debtor retains ownership and control of its assets and is
re-termed a debtor in possession ("DIP"). The debtor in possession runs the day
to day operations of the business while creditors and the debtor work with the
Bankruptcy Court in order to negotiate and complete a plan. Upon meeting certain
requirements (e.g. fairness among creditors, priority of certain creditors)
creditors are permitted to vote on the proposed plan. If a plan is confirmed the
debtor will continue to operate and pay its debts under the terms of the
confirmed plan. If a specified majority of creditors do not vote to confirm a
plan, additional requirements may be imposed by the court in order to confirm
the plan.
Chapter 7 and Chapter 13 are the efficient bankruptcy chapters often used by
most individuals. The chapters which almost always apply to consumer debtors are
chapter 7, known as a "straight bankruptcy", and chapter 13, which involves an
affordable plan of repayment. An important feature applicable to all types of
bankruptcy filings is the automatic stay. The automatic stay means that the mere
request for bankruptcy protection automatically stops and brings to a grinding
halt most lawsuits, repossessions, foreclosures, evictions, garnishments,
attachments, utility shut-offs, and debt collection harassment.
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