What is Bankruptcy?

Bankruptcy is a legal proceeding in federal bankruptcy court where certain debts can be adjusted or eliminated depending on the particular facts of each case and the particular chapter under which the case is filed. All bankruptcy cases are governed by uniform federal law known as the “Bankruptcy Code”. The Bankruptcy Code is divided into numbered chapters. Bankruptcy cases can be filed under Chapter 7, 9, 11, 12, or 13. Each of these Chapters has specific requirements and allows for specific forms of relief from debts. The fundamental intent of Congress in passing the Bankruptcy Code was to give “honest but unfortunate” debtors a “fresh start” in situations where debtors are overcome with debt.

It is commonly heard that an individual or business has filed Chapter 7 or Chapter 13. This means a case was filed under the laws of Chapter 7 of the Bankruptcy Code or under the laws of Chapter 13 of the Bankruptcy Code, but for convenience it is simply referred to as filing Chapter 7 or filing Chapter 13.

What is the means test?

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 require a “means test” be applied in situations where a consumer debtor's income is above the state median income to determine whether or not an individual consumer debtor qualifies for debt relief under Chapter 7. The means test is a mathematical calculation that determines whether or not the debtor has the ability to repay a portion of their debt and therefore, filing Chapter 7 is presumed to be abuse of the Bankruptcy Code. In cases where a debtor does not quality for Chapter 7, filing a Chapter 13 case to adjust the amount of debt to be repaid and/or to reorganize the terms of repayment may be a very effective option.

What is Chapter 7?

Chapter 7 is titled Liquidation. It is so named because if the debtor has “non-exempt” property, Chapter 7 allows the assigned Chapter 7 Trustee to take possession of the non-exempt property, subject to the rights of secured creditors, liquidate it to cash, and distribute the cash to creditors on a proportional basis. Non-exempt property is property a debtor cannot legally retain upon filing bankruptcy. The Bankruptcy Code or applicable state law allows a debtor to retain certain property as “exempt” from the bankruptcy estate and from the distribution to creditors. Most Chapter 7 cases are considered “no-asset” cases where there is no non-exempt property to be liquidated and therefore, no actual liquidation.

Chapter 7 is also commonly called “total bankruptcy” because the debtor receives a total “discharge” (release from personal liability) on debts with a few exceptions. Examples of “non-dischargeable” debts include debts for back child support, some federal income taxes, and student loans. An unsecured debt is a debt where the creditor does not hold a security agreement or lien on any property to secure the debt. Secured debt is debt where the creditor does have a lien on the property and has a right to take the property upon default to satisfy the debt. Examples of secured debts are mortgages, vehicle loans, and tax liens. When a Chapter 7 is filed, the secured creditor does not lose their secured status and the debtor must choose whether to keep and continue paying for the property or to surrender the property to the creditor. If the debtor chooses to surrender the property, any deficiency owed to the creditor after the creditor sells the surrendered property and applies the proceeds to the debt balance, would become unsecured debt and would be discharged in the bankruptcy.

What is Chapter 13?

Chapter 13 is titled Adjustment of Debts Of An Individual With Regular Income. Chapter 13 requires an individual to have a steady source of monthly income that can be used to support the debtor and provide for payments to creditors under a chapter 13 plan of reorganization. A debtor makes monthly plan payments to the Chapter 13 Trustee assigned to administer the case. The Trustee makes monthly disbursements to the debtor’s creditors according to the terms of debtor’s plan. Through this plan, a debtor is allowed to repay creditors over a period of three to five years, depending on the facts of the case.

Chapter 13 allows a debtor to adjust the terms of most secured debt included in the plan. The secured creditor retains their lien on property securing the debt throughout the duration of the Chapter 13 case and releases the lien when plan payments are completed and a discharge is granted to the debtor. In some cases, Chapter 13 allows a debtor to file a plan to include direct payments to secured creditors. In this instance, the debtor continues to make regular payments directly to the creditor, the terms of the debt are not adjusted and the lien is released upon final payment, as is customary under state law.

The amount of repayment required to general unsecured creditors in a Chapter 13 is determined by the amount of “disposable income” a debtor has each month. Disposable income is calculated from the debtor’s income minus allowed reasonable and necessary expenses. Chapter 13 plans can range from zero percent repayment (as in a no-asset Chapter 7 case) to one hundred percent repayment to general unsecured creditors. Any unsecured, dischargeable debt that the debtor was not required to repay under the plan will be discharged at that time. As with Chapter 7, some debts remain non-dischargeable, such as student loans.

What is Chapter 9, 11, 12?

Chapter 9, entitled Adjustment of Debts of a Municipality, is only available to municipalities that wish to reorganize. Chapter 11, entitled Reorganization, is most often filed by businesses and individuals whose debt limits exceeds those of Chapter 13. Chapter 12, entitled Adjustment of Debts of a Family Farmer or Fisherman With Regular Annual Income, is similar to Chapter 13 but is available only to family farmers or fishermen. For a full discussion of these Chapters, please see Bankruptcy Basics, an article by the Director of the Administrative Office of the United States Courts.

Is pre-bankruptcy credit counseling required?

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 requires all consumer debtors, with very limited exceptions, to receive pre-bankruptcy credit counseling from an approved nonprofit budget and credit counseling agency within 180 days prior to filing a bankruptcy case. Upon completion of this briefing, which can be by telephone, internet, or in person, the debtor will be issued a certificate of completion of the pre-bankruptcy credit counseling that will be filed in the court along with the debtor’s bankruptcy petition.

Is a personal financial management course required?

Prior to receiving a discharge, the debtor must also complete an instructional course in personal financial management from an approved nonprofit budget and credit counseling agency. Once this course is completed, the debtor receives a certificate that will be filed with the court.

How is a bankruptcy case filed (started)?

The bankruptcy case is started by filing a document called a petition in federal bankruptcy court. Once a case is opened, the debtor is required to file a set of official forms that includes schedules of assets, liabilities, income and expenses, a statement of financial affairs, and a mailing list of creditors. The court mails a notice of the bankruptcy case to each party on the mailing list filed by the debtor. This notice contains vital information about the case including the date the case was filed, the date of the 341 Meeting of Creditors, and important deadlines.

What is a 341 Meeting of Creditors?

The 341 Meeting of Creditors is a meeting required by bankruptcy law. The meeting is a formal meeting that is held shortly after the case is filed. The meeting is usually presided over by the bankruptcy trustee that has been assigned to administer the bankruptcy case. The purpose of this meeting is for the debtor to appear, represented by an attorney, and be questioned by the Trustee and any creditor present about the debtor’s debts, property, and information provided by the debtor in the schedules and statements filed with the court. In normal cases, this meeting will last approximately 15 to 20 minutes.

What is the bankruptcy automatic stay?

The automatic stay operates as an injunction that automatically stops all lawsuits, repossessions, foreclosures, garnishments, and collection efforts, including harassing telephone calls. In most cases, the automatic stay goes into effect immediately upon filing a bankruptcy petition to protect the "bankruptcy estate". A bankruptcy estate (similar to a probate estate created upon a person’s death) is created by law when a bankruptcy case is filed. The bankruptcy estate includes all legal or equitable interests in any property or assets the debtor owns.

How does filing bankruptcy effect your credit?

Filing bankruptcy will negatively affect a person’s credit rating. However, most debtors’ credit scores are already negatively impacted by debt overload, late payments, or account defaults. Filing bankruptcy often leads to a debtor being able to more quickly re-establish good credit.

How do you rebuild your credit after completing a bankruptcy?

When a bankruptcy case is successfully completed, the individual debtor receives a discharge and the case is officially closed. The debtor can then begin the process of re-building their credit. Individuals should always be weary of the avalanche of credit card applications they will inevitably receive after they receive their discharge. However, responsibly entering into a new credit agreement for a very small debt and making on-time payments may be a way to begin rebuilding credit. Debtors can also monitor their credit reports and correct any reporting mistakes by creditors to the credit reporting agencies that is reflecting negatively on their credit rating.