Bankruptcy: Explained

Bankruptcy is a legal process that occurs when a person or entity cannot repay their outstanding debts. The bankruptcy process begins with a petition filed by the debtor (most common) or on behalf of creditors (less common). All of the debtor’s assets are measured and evaluated, and the assets may be used to repay a portion of outstanding debt.

Bankruptcy offers an individual or business a chance to start fresh by forgiving debts that simply cannot be paid, while offering creditors a chance to obtain some measure of repayment based on the individual’s or business’s assets available for liquidation. In theory, the ability to file for bankruptcy can benefit an overall economy by giving persons and businesses a second chance to gain access to consumer credit and by providing creditors with a measure of debt repayment.

Types of Bankruptcy

Bankruptcy is a complex process, and the typical individual probably isn’t equipped to go through it alone. Working with a bankruptcy lawyer can help ensure your legal rights are protected, and can provide you with the guidance you need throughout the entire process. There are several types of bankruptcy for which individuals or married couples can file, the most common being Chapter 7 and Chapter 13.

Chapter 7 bankruptcy is a liquidation bankruptcy designed to wipe out your general unsecured debts such as credit cards and medical bills. To qualify for Chapter 7 bankruptcy, you must have little or no disposable income. If you make too much money, you may be required to file a Chapter 13 bankruptcy.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy is a reorganization bankruptcy designed for debtors with regular income who can pay back at least a portion of their debts through a repayment plan. If you make too much money to qualify for Chapter 7 bankruptcy, you may have no choice but to file a Chapter 13 case. However, many debtors choose to file for Chapter 13 bankruptcy because it offers many benefits that Chapter 7 bankruptcy does not (such as the ability to catch up on missed mortgage payments or strip wholly unsecured junior liens from your house).

In Chapter 13 bankruptcy, you get to keep all of your property (including nonexempt assets). In exchange, you pay back all or a portion of your debts through a repayment plan (the amount you must pay back depends on your income, expenses, and types of debt). For this reason, Chapter 13 is commonly referred to as a reorganization bankruptcy. Typically, Chapter 13 bankruptcy is for debtors who can afford to pay back a certain amount of their debts (such as mortgage arrears, car loans, or tax debts). If you don’t have enough income to qualify for Chapter 13 bankruptcy, you’ll have Chapter 7 bankruptcy as your only option.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy is a liquidation bankruptcy meaning it can wipe out most of your general unsecured debts such as credit cards and medical bills without the need to pay back balances through a repayment plan. To qualify for Chapter 7 bankruptcy, you must have little or no disposable income. If you have enough income to repay your debts, you’ll have to file a Chapter 13 bankruptcy (discussed next).

When you file for Chapter 7 bankruptcy, a trustee is appointed to administer your case. In addition to reviewing your bankruptcy papers and supporting documents, the Chapter 7 trustee’s job is to sell your nonexempt property to pay back your creditors. If you don’t have any nonexempt assets, your creditors receive nothing. As a result, Chapter 7 bankruptcy is typically for low-income debtors with little or no assets who want to get rid of their unsecured debts.

Bankruptcy Process

The bankruptcy process begins with credit counseling that must be completed within 180 days before you file your case. The purpose of this counseling is to determine whether there are any other means you can handle your debt load besides bankruptcy, such as through a repayment plan. You can find a list of approved credit counseling agencies online.

After you complete your pre-filing credit counseling, if you want to proceed with bankruptcy, you must complete the rest of the forms that detail all of your property, debts, income, expenses, and detailed statements of your financial affairs. These forms, collectively are referred to as the schedules and ask you to describe your current financial status and recent financial transactions (typically within the last two years). If your creditors or the judge feel or find out that you have not been entirely forthcoming in your bankruptcy filing, it could jeopardize the outcome of your petition.

Filing the Petition

The process of bankruptcy begins with the debtor who files a petition with the bankruptcy court. The petition can be filed by an individual, by spouses together, or by a corporation or other entity. The debtor is also required to file statements listing assets, income, liabilities, and the names and addresses of all creditors and how much they are owed. The filing of the petition automatically prevents, or “stays,” debt collection actions against the debtor and the debtor’s property. As long as the stay is in effect, creditors cannot bring or continue lawsuits, make wage garnishments, or even make telephone calls demanding payment.

Creditors receive notice from the clerk of court that the debtor has filed a bankruptcy petition. Some bankruptcy cases are complex, but most are relatively simple. The main aspects of a bankruptcy case are the filing of the petition, the meeting of creditors, the debtor’s discharge, and the role of the trustee.

Meeting of Creditors

A meeting of creditors is a usually short meeting where the trustee and the debtor’s attorney ask the debtor questions about his or her financial condition and give creditors the chance to do the same. This meeting is also known as a 341 meeting, named after the section of the bankruptcy code that requires it. The meeting is required under Section 341(a) of the U.S. Bankruptcy Code and requires the debtor to attend and answer questions about his or her financial affairs and property.

This meeting is presided over by the trustee and is held about a month after you file for bankruptcy. Creditors may attend, although they rarely do. The trustee – not a judge – runs the meeting and asks you questions about your bankruptcy and the documents you filed. For example, the trustee might ask about your income, expenses, debts, assets, and other financial matters. If you filed for Chapter 7 bankruptcy, the trustee will ask you about your property and whether any of your property is secured by a loan.

Discharge in Bankruptcy

A bankruptcy discharge releases the debtor from personal liability for certain specified types of debts. In other words, the debtor is no longer legally required to pay any debts that are discharged. The discharge is a permanent order prohibiting the creditors of the debtor from taking any form of collection action on discharged debts, including legal action and communications with the debtor, such as telephone calls, letters, and personal contacts.

Although a debtor is relieved of personal liability for all debts that are discharged, a valid lien (i.e., a charge upon specific property to secure payment of a debt) that has not been avoided (i.e., made unenforceable) in the bankruptcy case will remain after the bankruptcy case. Therefore, a secured creditor may enforce the lien to recover the property secured by the lien.

When does the discharge occur?

The timing of the discharge varies, depending on the chapter under which the case is filed. In a chapter 7 (liquidation) case, for example, the court usually grants the discharge promptly on expiration of the time fixed for filing a complaint objecting to discharge and the time fixed for filing a motion to dismiss the case for substantial abuse (60 days following the first date set for the 341 meeting).

Generally, the debtor will receive a discharge within four months after the date of filing the petition. In a Chapter 13 (adjustment of debts of an individual with regular income) case, the court grants the discharge as soon as practicable after the debtor completes all payments under the plan.

Can the discharge be revoked?

The court may revoke a discharge under certain circumstances. For example, a trustee, creditor, or the U.S. trustee may request that the court revoke the debtor’s discharge in a chapter 7 case based on allegations that the debtor: obtained the discharge fraudulently; failed to disclose the fact that he or she acquired or became entitled to acquire property that constitutes property of the bankruptcy estate; committed one of several acts of impropriety described in section 727(a)(6) of the Bankruptcy Code; or failed to explain any misstatements discovered in an audit of the case or fails to provide documents or information requested in an audit of the case.

Typically, a request to revoke the debtor’s discharge must be filed within one year of the discharge or, in some cases, before the date that the case is closed. The court will decide whether such allegations are true and, if so, whether to revoke the discharge.

Conclusion

Bankruptcy is a serious business, so you need to understand it clearly. Bankruptcy laws are in place to help people who can no longer pay their creditors get a fresh start – by liquidating assets to pay their debts or by creating a repayment plan. Bankruptcy laws also protect troubled businesses and provide for orderly distributions to business creditors through reorganization or liquidation.

Most cases are voluntary, but some are involuntary when creditors file against a debtor. Bankruptcy cases almost exclusively fall under federal law, though states may pass laws governing issues that federal law doesn’t address. Special bankruptcy courts nationwide handle only debtor-creditor cases. Generally, any bankruptcy-related claim must be filed with the U.S. Bankruptcy Court.

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