It used to be that filing for bankruptcy carried with it a large measure of opprobrium. People and companies with burdensome debt felt that filing for bankruptcy would socially ostracize them or destroy their credibility, and thus was not a viable option. Today that has changed.
The global recession of the last decade has revealed that many forces outside the debtor’s control, and not caused by the debtor, are the culprit. Financial hardship resulting from these forces, and not reckless spending, are often the primary culprit.
As a result, bankruptcy today is often considered a smart financial tool for managing debt.
Myths of Bankruptcy
Many people have a huge misunderstanding of how bankruptcy works — the product of confusion, apprehension and lack of research on their part. On the one side, there are those who fear they will lose everything. On the other side, there are those who think they can discharge all of their debts in one fell swoop and keep everything they own. Neither is true. Every bankruptcy is unique to the individual or company, and the form of bankruptcy protection that fits your situation will determine how your debts and assets are treated.
Jurisdiction for Bankruptcy
Bankruptcy is a tool governed exclusive by the federal bankruptcy laws. It is not a state court matter and a petition for bankruptcy cannot be filed in state court. All bankruptcy petitions are filed in your local federal bankruptcy court, usually located in the federal courthouse. These are specialty courts created and designed specifically to handle all bankruptcy matters that arise in the United States.
Purpose of Bankruptcy
The purpose of bankruptcy is to provide the debtor a “fresh start" by discharging your debts or enabling you to manage them while carrying on. But it’s not just there to benefit the debtor. It is also designed to treat all creditors fairly. Fairness is determined in part by the type of debt involved. Some super-priority debts such as back child support, back taxes and unpaid student loans cannot even be discharged. These debts must eventually be paid, within certain conditions. Secured debts, such as real estate loans secured by the residence in question, have priority over unsecured debts. As between unsecured creditors, everyone is treated equally.
Can the Debtor Determine the Priority of Repayment?
The debtor does not have the right to determine who gets paid first; nor does the debtor have the right to pay one creditor he likes more than another creditor he does not. This applies not only to debts owed after the debtor files for bankruptcy, but also to any debts paid within 90 days prior to filing your petition. Any debts paid off during that precedent 90 days will be considered improper preferences and will be set aside by the bankruptcy trustee.
This means the trustee will contact the preferred creditor and require it to repay that amount to the trustee. The trustee, who works as a fiduciary on behalf of all creditors, then manages the bankruptcy from filing to conclusion, ensuring all legally-mandated priorities and fairness are carried out to the letter. As part of the bankruptcy proceeding, you will be required to meet with the trustee at least once during the proceedings to provide him any information or assistance he requires to do his job.
Different Forms of Bankruptcy Protection
Most individuals will file for Chapter 7 Bankruptcy or Chapter 13 Bankruptcy. These Chapters are simply Chapters from the federal Bankruptcy Code. Chapter 7’s are commonly referred to as “Straight Bankruptcy," since most all debts are discharged after the trustee liquidates or sells all non-exempt assets. Chapter 13’s are often referred to as “Reorganizations" since the debts are merely consolidated by the trustee and paid off for a set time frame and in a manner affordable by the debtor. Your total income and debts, and the kind of debts involved, will determine which route is available – or preferable – to you.
“Straight Bankruptcy" / Chapter 7:
Straight Bankruptcy means all of the debtor’s non-exempt assets are liquidated or sold by the trustee to pay off your creditors. You get to keep most of your important assets, which are considered exempt, such as your house, car, tools of trade, and all of your personal property up to a certain total monetary value. Any debts remaining after liquidation are fully discharged and no longer owed, unless the debts are among a short list of debts that cannot be discharged in bankruptcy, such as child support, alimony, unpaid student loans and taxes. These must still be paid off.
“Reorganization" / Chapters 13:
Chapter 13 bankruptcy is the process by which the debtor establishes a repayment plan which he can reliably meet over the next three to five years. As long as the debtor honors his repayment plan, at the end of that time most remaining debts will be extinguished. This option is not available to everyone. Individuals or small business owners must have no more than $383,175 in unsecured debt and $1,149,525 in secured debt in order to qualify.
Bankruptcy Stays Litigation and Garnishment
One of the primary reasons for filing a bankruptcy is to stop pending or threatened litigation, and to terminate wage garnishments. In bankruptcy jargon, the bankruptcy is said to impose an “automatic stay" on all such litigation or any garnishment resulting from litigation or judgement.
More precisely, section 362 of the Bankruptcy Code states that any legal actions (including enforcement of judgements through garnishment or otherwise) which may negatively affect the bankruptcy estate are stayed during the course of the bankruptcy. Sounds simple, but determining which actions may have a negative affect can be complicated. For example, if the petitioning debtor is one of several defendants, the lawsuit may proceed as to the other defendants unless it would negatively impact the bankruptcy estate.
Debts Commonly Non-Dischargeable (or Exempt from Discharge)
Public policy protects certain debts from being discharged. The list of non-dischargeable debts includes:
- Unscheduled Debts – debts not listed on your debt schedule.
- Taxes and Tax Liens
- Spousal Support, Alimony and Child Support
- Fines and Penalties Due Government Agencies
- Student Loans
- Personal Injury Debts caused by Driving Under the Influence
- Certain Retirement Plans
The Bankruptcy Code contains other exemptions as well, so be sure to do your research.
Debts Dischargeable UNLESS the Creditor Timely Objects to Discharge
Some debts are dischargeable only if the creditor makes a timely objection and proves the grounds for that objection to the satisfaction of the bankruptcy court. These include:
- Luxury goods purchased by credit card in the preceding 90 days and adding up to $650 or more.
- Cash advances obtained within 70 days of the debtor’s petition that add up to more than $925.
- Debts incurred by fraud.
- Debts resulting from willful and malicious damage to person or property.
Thus, though most debts are dischargeable, or subject to reorganization, some debts will follow you to the grave unless and until resolved by settlement or payment in full.
11 U.S. Code §523 – Exceptions to discharge
U.S. Courts Official Website (bankruptcy and alternatives): http://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics.
11 U.S.C.S. § 362(a)(1) (stays)
Online Articles of General Interest
http://www.americanbar.org/newsletter/publications/gp_solo_magazine_home/gp_solo_magazine_index/debts.html (debts that follow you to the grave)