Bankruptcy Law: An Overview

By: LawInfo

Bankruptcy is one of the nation’s oldest and longest-standing federal protections. The first bankruptcy law was established in 1800, and although the process has evolved tremendously over the past two centuries, it remains essential to our economy.

Bankruptcy law provides a lifeline or second chance for individuals and businesses unable to meet their financial obligations. Depending on the type of bankruptcy, it can set debtors on the path to financial freedom by either liquidating existing assets or establishing a reasonable repayment plan. Doing so allows a debtor to gradually pay off a portion of the debt without suffering additional financial hardship.

Why Bankruptcy Matters

A robust economy depends on its citizens’ ability to establish credit, secure loans, start businesses and purchase real estate. For someone buried in debt, these abilities are hindered if not barred altogether. One person’s inability to buy a car can have greater societal repercussions, so bankruptcy provides a way to bring the debtor back into the fold while at the same time securing payment for creditors.

Determining When to File for Bankruptcy

Bankruptcy is not always the best choice for debt relief. Certain debts, such as child support, student loans, and criminal restitution, are considered nondischargeable debts. This means they cannot be eliminated through bankruptcy. In addition, certain creditors are known to work out negotiable payment plans, which can preclude the need for bankruptcy filing. Each form of bankruptcy contains its own eligibility requirements, and potential filers must determine whether they meet those requirements.

In a typical scenario, a debtor will file for bankruptcy after all options have been exhausted. In some instances, the debtor will file when faced with a potential lawsuit, foreclosure, or wage garnishment from a creditor. Bankruptcy can provide certain protections from these activities, effectively stopping all collection activity and delaying the repossession process.

Personal Bankruptcy Options

Chapter 7 and Chapter 13 are the two most common types of bankruptcies undertaken by individuals. Chapter 7 is a liquidation bankruptcy while Chapter 13 is a reorganization bankruptcy. In other words, Chapter 7 requires the liquidation of some personal nonexempt assets while Chapter 13 allows debtors to keep their assets but repay a sizable portion of their debt over a period of 3 to 5 years.

Chapter 7

Chapter 7 bankruptcy is the most common form of bankruptcy. Eligibility is typically determined based on income, with the state median income serving as a benchmark. Debtors who earn below the state median are commonly eligible for Chapter 7 filing because their limited income might prevent them from honoring the type of repayment plan typical of Chapter 13. Debtors who earn in excess of the state median may be ineligible for Chapter 7 filing, especially if they have the means to meet their financial obligations.

Those filing for Chapter 7 bankruptcy must provide detailed financial information, including income information, tax returns, records of outstanding debts, and detailed living expenses. They must also undergo credit counseling and provide the court with evidence of completion. Eligible debtors will then have their nonexempt assets sold off, with the proceeds distributed among all applicable creditors. When that process is complete, the debtor will receive a Chapter 7 discharge, relinquishing any further responsibility in those debts.

Chapter 13

Filing for a Chapter 13 bankruptcy is very similar to the process for Chapter 7. The debtor must undergo credit counseling and provide the court with detailed financial and debt records, and they must meet certain eligibility requirements.

Under Chapter 13 the debtor must have the income required to make the monthly payments, typically divided over 3 to 5 years. Additionally, Chapter 13 is subject to maximum debt limits that render some debtors ineligible.

Though the payments typically continue for 3 to 5 years, most collection activity stops immediately when Chapter 13 bankruptcy is filed. This includes collections notices, wage garnishments, bank levies, and even some foreclosure activity.

Chapter 11

Chapter 11 bankruptcy is the most common form of bankruptcy for businesses. While it is possible for certain individuals to file Chapter 11, most individual debtors do not meet the eligibility requirements. Chapter 11 bankruptcy gives businesses the opportunity to reorganize their debts, usually in an effort to keep the business alive. This is one of the most complex forms of bankruptcy as the business must propose a detailed reorganization plan and negotiate the plan with its creditors. If both parties cannot agree on a reorganization plan, the bankruptcy may be altered to a Chapter 7 filing, or the case may be discharged altogether.

Chapter 11 bankruptcy can provide businesses with a fresh start, but it can also result in at least partial ownership being relinquished to creditors, so business owners must weigh the costs with the benefits when consider whether or not to file.

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