Understanding Bankruptcy

Running into financial troubles is never easy - and it is not always our own fault. Events happening within our nation, and even on the global scale, can and do affect us personally. The global financial crisis of 2007-2008 has impacted us all in one way or another. By 2010, unemployment rates here in America had doubled, and they still have not recovered to pre-crisis levels. Many Americans lost their jobs. Even today, not all have made it back to full employment.

Financial turmoil takes its toll on a personal level. For every person who lost their job as a result of the financial crisis, there are many others who took hits to their income: wage cuts, reduced hours, demotion, cancelled bonuses. Even though income is reduced, financial commitments don’t just go away. Once you find yourself struggling to pay mortgages or rent, utility bills, taxes, student loans or other loans, and medical bills, it becomes far too easy to slide into debt. And for many of us, once that spiral of debt sucks us in, it may seem impossible to climb out.

However, there is a solution to escape from seemingly insurmountable debt. It’s called bankruptcy. The very word strikes fear into many - but that is only because they don’t understand what bankruptcy is. Fear of the word may keep you from finding out how bankruptcy can rid you of your debts and give you a chance at a new financial start in life, or even just from learning how bankruptcy works in the first place.

On of the biggest misconceptions about bankruptcy is that people fear that they will “lose everything.” In reality, most people who file for bankruptcy are allowed to keep most or all of their property: from jewels and family heirlooms to their home and their car. The key is in understanding the bankruptcy process and getting quality advice from bankruptcy professionalism, so you make the best decisions and choose the bankruptcy process that works best for you.

There are a few eligibility restrictions for being able to declare bankruptcy, but in general, most individuals who are legitimately struggling to pay their debts will be allowed to file for bankruptcy. If you are worried about your ability to repay your debts, please take time to explore this site and look over the information we have put together. And don’t hesitate to contact us if you have any further questions - we offer free, no-obligation consults with our attorneys. Find out how you can live debt-free by following this completely legal process, to get a fresh financial start and embark on your new life after bankruptcy.

What is bankruptcy?

Bankruptcy is a process defined in the United States Code. It is a completely legal process, and it allows you to reduce your debt or even eliminate it completely.

There are two so-called bankruptcy chapters that individuals can file under. Each chapter resolves their debts in a different way. Which chapter is better to file under depends mainly upon the types of debts you have, as well as a few other factors such as what your income is and what your future plans are, post-bankruptcy.

To declare bankruptcy, a person files a bankruptcy petition, which is a collection of documents that includes a statement of all of their debts and assets, with the bankruptcy court. That person then asks the court to either eliminate their debts completely through a discharge (Chapter 7), or allow them to enter into a repayment plan (Chapter 13).

About 80% of bankruptcy filers can have their debts eliminated in discharge.  For those who enter into a Chapter 13 repayment plan, the plan will last between three to five years. The plan is structured so you only pay what you can afford. Afterward, the court will eliminate your remaining debts through a discharge.

After you have received a discharge, you will no longer be legally obligated to pay your creditors anything else. Your former creditors will no longer be able to contact you about that debt, garnish your wages or try to collect in any way.

A brief history of bankruptcy law

Bankruptcy can be filed both by consumers (in other words, individuals like you and me), or by companies ranging from small businesses to transnationals, and even by governments. The regulation about bankruptcy for each of these entities - individuals, small businesses, transnationals, or governments - is different.

The aim of the process of bankruptcy, and of bankruptcy laws (which are constantly being revised), is to allow debtors - whether they are individuals or organizations - a means to escape from debts that they simply cannot afford to repay, while at the same time protecting their secured creditors as much as possible. Bankruptcy law seeks to allow debtors either a break, and a chance to catch up on payments, or a completely fresh new start, while being as fair as possible to the people or entities that they owe money to.

In Europe, the roots of bankruptcy law go back as far as the 1500s. The bankruptcy laws of England became the base for drafting the American Bankruptcy Act of 1800. These laws were revised multiple times over the following two centuries, with the Bankruptcy Reform Act of 1978 counting for one of the most important revisions. This act is often referred to as the Bankruptcy Code.

In spite of these updates, for decades there remained concern that regulation around individual bankruptcy was not strong enough: that it was too easy for consumers to abuse the system by declaring bankruptcy. “Abuse” in this context is defined as someone declaring bankruptcy to get out of repaying debts that they could actually afford to repay.

After years of debate, and numerous rewrites of controversial language, a new Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) was signed by the President in 2005. One of the significant changes to the Bankruptcy Code as a result of this Act was the addition of the Means Test, which figures out right from the start whether a consumer should be able to afford the debts that they want to have discharged. By doing so, it limits the chance of bankruptcy being abused.

In the United States, bankruptcy is a matter of federal jurisdiction, which means that bankruptcy cases must be filed in United States Bankruptcy Court. However, there are also state laws governing bankruptcy - in particular, what personal exemptions are permitted - so it is important to be aware of the laws in your own particular state.

Bankruptcy “Chapters”

Under U.S. Bankruptcy Code, there are two different types, or “chapters,” of bankruptcy that are appropriate for individuals filing personal bankruptcy: Chapter 7, and Chapter 13. In rare cases, an individual might file under Chapter 11. Which chapter you should file for depends upon the details of your own financial situation.

Chapter 11 is oriented more towards companies that are filing for bankruptcy, but it may also be filed by individuals whose debt exceeds the amounts allowable for Chapter 13, or by consumers with extremely complex finances. The case of individuals filing Chapter 11 is very rare, and in fact most bankruptcy attorneys refuse to do Chapter 11 filings because of how difficult they are.

So Chapter 7 and Chapter 13 are the two bankruptcy types that most individuals would look at filing. They are both very different: Chapter 7 is a quick discharge of debt, whereas Chapter 13 is more of a reorganization of debt that involves a repayment plan of three to five years. Here is a brief overview of the differences between Chapter 7 and Chapter 13 bankruptcy. Other articles on this site go into more detail explaining how Chapter 7 bankruptcy works, and how Chapter 13 bankruptcy works, as well as explaining the Chapter 13 repayment plan.

Chapter 7

Chapter 7 bankruptcy is also known as “liquidation.” It is is the most common type of bankruptcy that individuals file for, and it is much quicker and cheaper than Chapter 13.

Filing Chapter 7 involves appointment of a trustee, and liquidation (sale) of non-exempt property in order to pay off creditors. Since most property that is considered “essential” is actually exempted, debtors usually get to keep most or all of their property, for example: their home and furnishings, their car, their tools, and any family jewels and heirlooms. However, it is important to understand that losing some possessions is a possibility when declaring Chapter 7 bankruptcy.

Chapter 13

Chapter 13 bankruptcy is considered “reorganization.” Rather than liquidating assets (in other words, selling them), it involves coming up with repayment plans in order to keep secured assets such as houses or cars, or allowing time to come up with an alternative plan to dispose of an asset: for example, allowing six months for the debtor to negotiate a short sale of the home.

A typical Chapter 13 repayment plan is for either three or five years. The repayment must be reasonable and affordable to the debtor - otherwise the court will not approve it. By the end of that period, the debtor must have made up all debts through the repayment plan. If the debtor does not stick to the plan, the creditor may resume any debt-collection proceedings, such as foreclosure.

Choosing which chapter to file under

For most individuals, Chapter 7 is preferable, but there are also certain benefits to filing Chapter 13. The eligibility requirements for each are different, so you may not have any choice about which one you are allowed to file for. But, if you find you are eligible for both, it’s really important to understand the finer points of each, because one or the other may be much more beneficial to you on the long run. Your current financial situation, your expected future financial situation (for example, whether or not you anticipate returning to high-paying work soon), and your own personal values and long-term goals will all play a part in determining which bankruptcy chapter will provide you with the greatest benefits.

There is also what is known as “Chapter 20 bankruptcy.” This is not a true bankruptcy chapter. Rather, its name comes from combining both chapters: filing Chapter 7 and then quickly following by filing Chapter 13. This combination may, in some cases, provide benefits that one or the other chapter cannot provide on its own. Information on how “Chapter 20” works is included in our article on bankruptcy strategies.

A primer on how bankruptcy works

The many articles on this site will give you a complete picture of how bankruptcy works. However, to put that information into context, it helps to have an idea of how the whole process works, so here is a quick overview. Refer to our glossary of terms used in bankruptcy if you encounter any words you are not familiar with.

Once you file bankruptcy, the Bankruptcy Code defines your “estate,” which is everything you own: all of your property and assets, not including any assets which have been exempted. In many cases, most or even everything that you own is exempted: you get to keep it, and little or nothing goes to the estate.

It then imposes what is called an automatic stay, which immediately stops any collections against the estate (including foreclosure). How long that automatic stay is in place depends upon which type of bankruptcy you filed for. Under Chapter 7, a lender may file for relief from the automatic stay. If the court grants that relief, the stop to actions such as foreclosure may only be temporary - but even that short stop to collection actions still may be very valuable, because it has bought you some breathing time, to come up with a financial plan.

Under Chapter 13, that relief is usually much longer: giving you time to come up with a plan for selling assets or negotiating a repayment plan with your creditors. As long as you stick with your plan, that relief becomes permanent.

Regardless of whether you file for Chapter 7 or Chapter 13, the bankruptcy process will involve the appointment of a trustee. Under Chapter 7, the trustee works to sell unexempted assets (if there are any) to pay off creditors. The whole process is usually completed within around three months. Under Chapter 13 the trustee assists in coming up with a payment plan to pay back creditors, usually structured over a period of three or five years.

Filing bankruptcy may have implications on your future financial situation. A bankruptcy on record will affect your credit score, and may make it more difficult for you to obtain financing for a few years. If you receive a discharge through bankruptcy, you may not be permitted to receive another bankruptcy discharge again for two to eight years (depending upon the details of your case). However, you may still be permitted to file bankruptcy again to receive protection from your creditors; you just won’t be eligible to receive the discharge.

Other articles on this site go through how the bankruptcy process works in more detail, including information on the parties involved and the fees for filing, as well as how to determine whether you are eligible to file bankruptcy, the paperwork required to file bankruptcy and an explanation of the voluntary petition, and how the automatic stay protects you from your creditors the moment you file.

Read on for our next article in this series: Understanding the Different Types of Debt