What is Bankruptcy?
This is NOT legal advice.
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What is bankruptcy
Bankruptcy is a legal process used by individuals or companies facing overwhelming debt who can seek protection from creditors in courts. Once filed and approved, federal bankruptcy courts can offer protection, or “grant relief” from debts and any collection activities.
This relief includes what is called “automatic stay”. Once bankruptcy petition is filed, automatic stay immediately stops all collection activities by debtor’s creditors.
Creditors are prohibited from filing a lawsuit against debtor or entering liens against debtor’s property or contacting in an effort to obtain a payment on the debt. It also stops eviction, utility disconnection and wage garnishments.
In turn, creditors may seek relief from this automatic stay by asking courts to “lift” (cancel) it, but those are special cases, and it usually happens only when it is really worth for them to pay bankruptcy attorney to do that.
Because bankruptcy attorneys for creditors can charge $250-$350 an hour, and each such proceeding it makes sense for them to pursue when substantial amounts are involved.
Also, in foreclosure and some other cases, where debt is secured by some asset or real property, creditors may decide to pursue this route and by doing this they start litigation within bankruptcy case – “adversary” litigation/action.
“Adversary proceeding” – is an internal litigation within bankruptcy proceeding itself.
If you are facing foreclosure or have very substantial assets securing debt – you may need to speak to local bankruptcy attorney – let us know.
Hopefully, the above answers basic question of what is bankruptcy.
Who can file bankruptcy?
Anyone, individual or company. For bankruptcy to be approved, debt must be high relative to assets and/or income.
Individual bankruptcy is often called personal bankruptcy. Bankruptcy process where debtor is company is often called business bankruptcy.
How Bankruptcy Case Proceeds
Bankruptcy court will evaluate debtor’s liabilities (debt) and assets, and will decide if there are assets which can be used to repay debt to creditors.
If everything is done right and goes smooth, bankruptcy court may grant debtor a discharge in bankruptcy. Essentially, it means canceling debts.
There are numerous rules as to which debts can or cannot be cancelled, and how it is done, so we will not describe them here. But, most of consumer debt is dischargeable debt.
Dischargeable debt includes most unsecured debts, like credit card debt, medical bills debt. Car loan debt also can be discharged in bankruptcy under many circumstances.
Why filing for bankruptcy? Is filing bankruptcy bad?
There could be different reasons to file for bankruptcy: auto loan, illness, job loss, sudden changes in life, skyrocketing medical bills, foreclosure, and plain bad money management decisions. Other reasons are marital problems, medical bills or unemployment.
All this can happen unexpectedly and when facing constant pressure from creditors and collectors, potential wage garnishment, levy’s, loss of assets, it makes financial sense to file for bankruptcy protection.
Bankruptcy bears bad stigma and is associated with failure. Especially personal bankruptcy. This is not correct point of view.
Bankruptcy is a lawful way to protect assets of individual and his or her family. Large businesses often file for bankruptcy protection and stay in business. Wealthy individuals have absolutely no reservation to file bankruptcy if they see it necessary to protect their assets.
This is legal, meaning allowed by law, and anyone has a right to seek bankruptcy protection if they need it. Bankruptcy gives a fresh start to debtor – bankruptcy filing and discharge allows debtor to start new, from clean slate, without debt, and rebuild credit, get financial situation together, and learn from past mistakes.
Filing for bankruptcy could be a viable option in many instances, including, high credit card debt and constant calls from bill collectors.
Who cannot file for bankruptcy?
Those who already filed within certain number of years. There are special rules regarding tax debt, which often can be discharged in bankruptcy.
Some types of debt cannot be discharged (wiped out) in bankruptcy at all. Those are:
– domestic support obligations, including child support or spousal support, alimony.
– Income tax debt incurred within last three (3) years, and sometimes older tax debt.
– Injury or wrongful debt resulting from accidents, especially one which involved drunk driving.
– Student loan debt (in most cases cannot be discharged).
– Some debts incurred in the six months before filing for bankruptcy.
– Debt obtained using fraud.
– Co-signers for debt are also on the hook, and filing bankruptcy by the debtor generally does not protect co-signers for debt. They may have to file their own bankruptcies.
Types of Bankruptcy
There are several types of bankruptcy. They are called “Chapters,” because they are filed in accordance with different chapters of United States Code.
Which chapter to file depends on circumstances of the case. It is not always up to debtor to decide under which chapter to file. Most common for individuals are:
– Chapter 7.
Chapter 7 bankruptcy is the most common form and is called the liquidation bankruptcy. Chapter 7 can be referred to as a “straight bankruptcy.”
In Chapter 7, Bankruptcy court agrees to liquidate (sell) assets and discharge (completely wipe out) most of debtor’s personal debt in exchange for Bankruptcy Trustee, appointed by the court in bankruptcy proceeding, distributing cash from selling of some of the debtor’s assets to pay creditors.
Debtor can keep property “exempted” by the state law. It means that such property is allowed to avoid being included in assets for purpose of being sold for cash to pay creditors.
Often it includes clothing, some money, vehicles, furniture, household items, work tools, and more. Each state has own laws concerning what property can be exempted and kept in bankruptcy.
Non-exempt property, which can be sold by trustee, may include cash, bank accounts, stocks, coins, investments, collectibles, artwork, a second car, a second home, etc.
Most unsecured debt (debts that are not guaranteed by collateral) can be wiped out.
Some of the secured debt can be dealed with as follows: a debtor has an option of either giving property securing debt back to creditor – a car, for example, and any remaining balance is discharged. Or, he or she can keep the car and renegotiate payments.
Businesses can also file for chapter 7 bankruptcy protection, but business bankruptcy is a topic beyond the scope of this article.
Generally, Chapter 7 bankruptcy can wipe out many of the debts in a three to six month’s period.
Who can file Chapter 7 Bankruptcy?
Debtor must qualify for Chapter 7 bankruptcy by passing means test – a calculation, which can be initially performed by bankruptcy attorneys or bankruptcy prepares helping debtors to fill out petition.
To be eligible for Chapter 7, you must be not making enough money (minus certain expenses and monthly debt payments) to be able to fund a Chapter 13 bankruptcy repayment plan.
If most of the debt is consumer debt (credit cards, shopping, etc.), and debtor’s disposable income is higher in ration to expenses, then debtor may not qualify for Chapter 7 Bankruptcy discharge, but may qualify for Chapter 13 bankruptcy (see below).
The bankruptcy court takes into consideration ability of debtor to repay debt. Those assets considered include not only physical assets like real property, or items like vehicle, or money, but also things like retirement funds, stocks, investments, bonds, savings.
Perks like stock options or money payable to (owed to) debtor under contract or other arrangement are also reviewed. The court will look at all bills, statements, and all liabilities of debtor to determine if assets can cover those.
Chapter 7 bankruptcy can be filed only once every 8 years, so this must be a calculated decision.
Also, please note, that Chapter 7 bankruptcy results in assets being sold to repay debtors, except for exempt property. So, if debtor owns a home, business, or some personal assets which he or she desires to retain, Chapter 7 may not be the best option.
Sometimes individual can successfully prepare and file bankruptcy petition without lawyer. Often in small cases chapter 7 can be filed pro se (without lawyer) by personally filling out and filing bankruptcy petition package with the court, or with the help of bankruptcy petition preparer.
Or debtor can hire an attorney, if cost v. debt &circumstances makes sense.
The American Bankruptcy Institute (ABI) did a study and found that about 95% of the Chapter 7 bankruptcy cases get discharged, meaning, get approved by the bankruptcy court, debts are eliminated and debtor was no longer required to repay the debt.
Bankruptcy and foreclosure.
Yes, sometimes debt owed to bank for home loan can be discharged in bankruptcy. Also, each state may exempt certain amount of home equity, and, in rare circumstances debtor’s amount owed to bank is less than that, homeowner may potentially go debt free.
But such proceeding is usually complicated requiring services of experienced bankruptcy attorney or foreclosure attorney.
– Chapter 13 Bankruptcy.
Chapter 13 bankruptcy is called “restructuring” bankruptcy. Bankruptcy courts use this chapter in cases where debtor has more substantial assets and/or income, is able to repay creditors, and does not qualify for Chapter 7 bankruptcy.
To qualify for chapter 13 bankruptcy a debtor usually must have sufficient income to cover expenses. Debtor will propose a repayment plan to repay debts within three to five years. Debtor cannot have more than $1,257,850 in secured debt and $419,275 in unsecured debt.
Chapter 13 bankruptcy is usually more complicated than chapter 7, and usually it is recommended to obtain bankruptcy attorney to represent debtor’s interests if filing under Chapter 13.
Bankruptcy attorney is an attorney who specializes in bankruptcy law. Such specialist usually has sufficient knowledge in bankruptcy and in other areas of law, including litigation in bankruptcy court (adversary proceedings), and can manage complex cases.
Surely, services of bankruptcy attorney cost substantially more than those of bankruptcy preparer, but the cost is justified in complex cases involving substantial size of debt, number of creditors and important assets.
It is also highly recommended to use attorney when filing for bankruptcy in the instances where debtor is also homeowner facing foreclosure, as such cases usually involve adversary proceedings where banks are trying to prevent debtor from filing bankruptcy.
Only bankruptcy attorney can advise you on laws and regulations, and devise bankruptcy strategy, if you have complex case. Neither judges, no bankruptcy preparers are allowed to give legal advice.
The American Bankruptcy Institute (ABI) found that only about half of Chapter 13 bankruptcy cases were discharged.
How to File for Bankruptcy – filing Bankruptcy. Filing bankruptcy tips.
Bankruptcy is filed using document called “bankruptcy petition”, and it must be filled with local bankruptcy court. Bankruptcy is usually filed by the debtor (“voluntary bankruptcy”). In more rare cases it can be filed by one or a group of creditors.
Most common way to file for voluntary bankruptcy is when debtor voluntarily files bankruptcy petition seeking protection from creditors attempts to collect debt.
Before that, debtor must gather all financial records listing debts, assets, income, expenses, because he or she will be required to list them.
Usually, bankruptcy filing must be done in bankruptcy court in district where debtor established residence.
Chapter 7 Bankruptcy petition preparation is usually easier than preparing and filing Chapter 13.
The United States Bankruptcy Court will also require debtor to obtain credit counseling within 180 days before filing bankruptcy petition. Sometimes counseling can be done online or over the phone and is quite easy to go through.
Debtor will be required to obtain credit counseling from provider approved by local bankruptcy court.
After receiving certificate, that certificate must be attached to bankruptcy petition filed with the bankruptcy court.
After filing, debtor will be required to undergo debtor education courses and obtain certificate, before bankruptcy can be discharged.
So, lets summarize the bankruptcy process – how to file bankruptcy.
- Debtor undergoes credit counseling.
- Then prepares bankruptcy petition with the help of bankruptcy preparer or bankruptcy attorney.
- Files bankruptcy petition. This stops all collection efforts by creditors, and they are not allowed to bother debtor with calls or letters, and cannot take any measures to collect on debt. They can be punished if they violate this rule.
- Petition includes whole number of different forms and attachments. It is better to use professional to prepare your petition.
- Court appoints independent Trustee, usually an experienced bankruptcy attorney, who will review the cases, assets, liabilities, and will give recommendations.
- Then meeting with creditors occurs.
- Then judges will review the case and make their determination whether to discharge debts.
- If bankruptcy is approved, then within four months debtor usually receives notice of discharge.
Notes. Bankruptcy life after. Bankruptcy tips.
Bankruptcy costs include attorney fees and filing fees. If you file on your own, you will still be responsible for court filing fees.
Please note that filing for bankruptcy affects credit and future ability to use money. On the other hand, it may prevent or delay foreclosure on a home and repossession of a car and it can also stop wage garnishment and other legal actions creditors use to collect debts.
Bankruptcy will remain on your credit report for 7-10 years. In fact, Chapter 7 bankruptcy remains on credit report for 10 years, and Chapter 13 for 7 years.
During that time, bankruptcy record may prevent debtor from obtaining new credit, or from obtain some jobs. However, if you debtor’s credit is already severely damaged, this may not be such serious trade off.
Declaring bankruptcy may also impact personal ego and self-image. Again, there is nothing wrong with using legal protection, as long as it is justified.
Debtor also may have to scale down lifestyle expenses after bankruptcy, and it may be challenging to rebuild credit. But if debt is initially unsustainable, then all these things do not matter even compare to starting from clean slate.
Please note, that debts which arise after filing for bankruptcy, cannot be discharged for 7-10 years, until next bankruptcy. On the other hand, person is not prohibited from trying to file another chapter within limitation period.
Option to avoid bankruptcy may be to attempting to reach settlement with creditors, or debt consolidation.
You should review your situation before filing. You may not need to file bankruptcy because you are judgment proof (assets are not reachable even with court judgment against you, etc). Or, it does not make sense to file if you can easily fix your financial situation without bankruptcy.
Also, bankruptcy may protect against repossessions and delinquency judgments which may occur after repossessions. Repossessions also look bad on credit report.
Note, that debtor will lose all credit cards in bankruptcy.
Most pension plans and life insurance policies will be protected by state laws in a bankruptcy. But if you have substantial (401(k), IRA) and/or life insurance policy, it makes sense to check before filing if those will be protected.
Taxes
The Bankruptcy Code, specifically a provision found at 11 U.S.C. § 362 (b)(9), allows IRS audits, notices of tax deficiencies, and demands for tax returns during bankruptcy.
To learn more about bankruptcy read the Federal Trade Commission’s informational pages. Bankruptcy forms can be obtained from local Bankruptcy Court’s web-site.
Max Feofanov, JD, MBA, Tax LLM
Max Feofanov has extensive law work experience starting in 2005 as legal assistant at small law firm in Los Angeles, and eventually moving to working on selected multinational arbitration cases. Currently, Max is blogging and training paralegals, legal translators and is building and managing teams for various outsourcing projects.
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