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Bankruptcy

Learn more about the bankruptcy process and the laws that guide it.

Bankruptcy can be a sound last resort for individuals struggling with debt. [©Jupiter Images, 2008]
©Jupiter Images, 2008
Bankruptcy can be a sound last resort for individuals struggling with debt.

Bankruptcy is a legal mechanism that allows debtors to declare their inability to pay off their debt.

The U.S. Constitution placed bankruptcy under federal jurisdiction and gave Congress the authority to enact uniform bankruptcy laws, resulting in the Bankruptcy Code (Title 11 of the U.S. Code). Congress amended the code in 2005 with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). The new code, among other things, exempts certain properties from seizure by creditors and allows individual states to adopt their own exemption laws.

The U. S. Courts outline basic principles and procedures involved in filing bankruptcy, which are governed by the Federal Rules of Bankruptcy Procedure. Both individuals and businesses can file, and the case is presided over by a bankruptcy judge in one of the 90 established districts. In most states, cases filed under the most frequently used Chapters 7, 11, 12 and 13 are also assigned to a Department of Justice trustee who oversees the administration of the bankruptcy. Two states, North Carolina and Alabama, rely on bankruptcy administrators with the U.S. Courts.

The Bankruptcy Process

The bankruptcy code allows debtors to discharge certain debts, preventing creditors from future attempts to collect. The specific debts a debtor can discharge and what property can be protected from creditors depend on state law and under which chapter of the code the case is filed. Debtors are still responsible for any debts not covered under the discharge. Non-dischargeable debts may include tax claims, family support or alimony ordered during divorce, legal settlements and fines, student loans and other debts owed the government. Creditors have the right to object to the discharge, but once debt is discharged they can be legally sanctioned for attempting to collect.

Individuals and corporations can file for discharge under one of four chapters in the bankruptcy code:

  • Chapter 7 allows individuals to discharge unsecured debts, but they may have to surrender any property (including houses) used as collateral for loans. For businesses, this means liquidation.
  • Chapter 13, also called the "wage-earners plan" allows individuals to repay some or all of their debts over a period of time (up to five years) determined by their income.
  • Chapter 11 is similar to Chapter 13 but provides for repayment though the reorganization of debt. Whether or not personal assets are protected depends on whether the bankruptcy is filed by a corporation or a sole proprietor.
  • Chapter 12 specifically applies to family farmers or fishermen with regular incomes to streamline difficulties they would face if they filed as corporations or as wage earners.

Two additional chapters, 9 and 15, are designed for municipalities and for debts involving international transactions.

Eligibility for Bankruptcy

People file for bankruptcy for a number of reasons, but primarily because their income is no longer sufficient to maintain scheduled payment on their debts. Some assets are legally protected from collection under any circumstances. Other assets can be seized for default of payments. If an individual does not own any property that can be seized in collection for debts, he or she may not need to file for bankruptcy even if he or she has fallen behind on payments. Others file because of financial stress or to free themselves of current debt in order to secure future income and assets. The American Bankruptcy Institute lists several possible situations that might qualify an individual for bankruptcy, including:

  • A high number of unsecured debts that cannot be paid over a five-year period
  • Garnished wages, repossession or pending lawsuits
  • Costly, uninsured medical bills
  • Few assets and/or limited savings

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005

Congress implemented BAPCPA to strengthen the integrity of the system and to combat what was perceived to be fraud and abuse. The act implemented new standards to determine whether an individual was eligible for Chapter 7 or Chapter 13, allowed the trustees to target and supervise audits to determine the accuracy of a debtor's Chapter 7 documents, provided for certification of credit counselors and financial educators, and enhanced the oversight of small business Chapter 11 reorganization.

BAPCPA requires anyone filing for bankruptcy to seek professional credit counseling six months before filing, and debtor education after filing. The Federal Trade Commission provides a review of issues to consider before signing with a counseling or education service. Primarily, the counseling and debtor education agency must be approved by the Department of Justice Trustees program. Fee waivers can be requested, and debtors must acquire a certificate of completion for both courses.

Alternatives to Bankruptcy

Although debtors can pursue credit counseling as an alternative to filing for bankruptcy, they should be careful about which debt counseling provider they select. Important questions to consider are whether or not the counselor will help develop a plan to avoid future debt, whether or not fees are reasonable, accreditation, willingness to protect client confidentially and whether or not the agency provides employees with financial incentives to solicit additional services.

It may be possible for individual debtors to work out alternative repayment plans with creditors on their own. If the creditor believes the debtor is acting in good faith and offers a reasonable payment plan, the creditor may re-negotiate. They may also adjust the balance, reduce rates or offer extended terms.

Advantages and Drawbacks of Bankruptcy

As soon as a debtor files for bankruptcy, the court issues a stay against collection efforts. The stay includes foreclosure, the repossession or sale of property and prohibits collection letters, phone calls and any collection lawsuits. In addition, any wage garnishes will be stopped, and some of the previously garnished wages could be returned. The stay against secured debts is only temporary. Secured creditors can still approach the court to seek payment or permission to seize the property if the loan still cannot be repaid. However, filing under Chapter 13 will allow the debtor to repay secured loans over time and will also protect co-debtors and anyone who may have guaranteed the debt.

Under Chapter 7 bankruptcy, individuals have their entire debt erased but could potentially lose property, such as automobiles and real estate. Under Chapter 13, debtors cannot incur any new debt without permission of the trustee appointed to administer the bankruptcy, and they must commit all disposable income to repay creditors. In addition, the trustee and creditors can petition the court to have the bankruptcy dismissed if they are unwilling to compromise over debt obligation. Filing for bankruptcy, does not ensure an individual can successfully repay scheduled debts and in some cases, individuals fail out of bankruptcy. This is why it is important to consult a bankruptcy attorney to make sure all possible options have been explored.

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