Bankruptcy is a legal process which allows a person who owes more money than he or she can currently repay, to either (1) repay a portion of the money over time under Chapter 11, 12, or 13, or (2) have the entire debt forgiven under chapter 7. Under chapter 7, a Debtor may be required to surrender assets to a trustee. Bankruptcy is also available to businesses, corporations, and partnerships. Even municipal governments can file bankruptcy (under Chapter 9).
A Debtor is a person, a married couple, or a business who files for bankruptcy.
Article I, Section 8, of the United States Constitution authorizes Congress to enact “uniform Laws on the subject of Bankruptcies.” Because of the Constitution, Congress created the “Bankruptcy Code” in 1978. The Bankruptcy Code has been changed and updated since then and most significantly in 2005. The Bankruptcy Code is the set of federal laws that governs all bankruptcy cases. The major goal of the federal bankruptcy laws is to give debtors a “fresh start” from their debts. The Supreme Court said “[Bankruptcy] gives to the honest but unfortunate debtor…a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt”. Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934). This goal is accomplished through the bankruptcy discharge, which releases debtors from their liability from specific debts and prevents creditors from ever taking any action against the debtor to collect those debts.
There are two common types of bankruptcies for individuals. There is a Chapter 7 bankruptcy case and a Chapter 13 bankruptcy case. A chapter 7 case is often referred to as a fresh start and lasts approximately four to six months. A Chapter 13 case is often referred to as a reorganization. In the reorganization, the debtor files a bankruptcy plan to catch up, reorganize, and discharge some of their debt. Chapter 13 cases often last three to five years.
A Chapter 7 case is formally called a “liquidation”. This is because a trustee will review your assets and exemptions. If you try to keep more stuff than you have exemptions for, the trustee will either give you the option to buy that stuff back or liquidate/sell the stuff. If you buy your stuff back, the trustee uses the money to pay off your creditors. If you cannot buy your stuff back or agree that the trustee can liquidate the stuff, the trustee will sell the stuff and pay off your creditors.
Most chapter 7 cases have little or no nonexempt property. This could be because you do not have a lot of stuff or your stuff is covered by your allowed exemptions. These types of Chapter 7 cases are called “no-asset cases” and the trustee will not sell or liquidate anything.
After 2005 when the bankruptcy laws changed, debtors must now complete a “means test” to see if they qualify for relief under chapter 7. The means test will compare your gross income (before taxes), based on the number of people in your household, against a national average (the “mean”). If your household gross income is larger than the national average, you may not be able to file a Chapter 7 case. You may, however, be able to file a Chapter 13 case.
In a Chapter 13 case, any individual who earns an income (whether self-employed, operating a business, or working a W2 job) can file a case. Currently, your secured debts (mortgage, car loan, boat loan, etc.) must be less than $1,184,200 and your unsecured debts (credit cards, medical bills, etc.) must be less than $394,725. These numbers change periodically. You can find the most up to date numbers here. A business cannot be a chapter 13 debtor. Businesses can only file a Chapter 7 (Liquidation) or a Chapter 11 (Reorganization).
A Chapter 13 case is formally called “Adjustment of Debts of an Individual With Regular Income”. Chapter 13 is often used by debtors who are behind on payments but want to keep an asset, such as a house. Through a Chapter 13 reorganization, the debtor proposes a “plan” to repay creditors over time – usually three to five years. Another reason people file Chapter 13 because they did not qualify for chapter 7 relief under the means test because their household income is too high.
After the filing of a Chapter 13 case, a trustee will review your proposed Chapter 13 Plan to see if it meets the Bankruptcy Code’s requirements for confirmation. In a Chapter 13, the debtor makes payments to the trustee who then disburses those payments out to creditors based on the payments you make through the plan. In order to receive a discharge in Chapter 13, a debtor must complete all payments required under the plan. While you are in a Chapter 13 and making the required payments, a debtor is protected from lawsuits, garnishments, and other creditor actions.
Going to Court
Our position is – you only have to attend one administrative meeting for your case. Anything other than that in a Chapter 7 or a Chapter 13 case is usually a problem. The only required administrative meeting (not a hearing, not in the courthouse) is the 341 Meeting of Creditors. A meeting of creditors is called a “341 Meeting” because that is the section of the Bankruptcy Code that requires the meeting to be held. A Meeting is where a Debtor appears before the Trustee to answer questions about their petition, schedules, and statements, under oath. The meeting is also an opportunity for the Trustee to review the information you provided, confirm the information is correct, and ask any additional questions they may have.
What is “usually a problem” for a bankruptcy case? A chapter 7 or a Chapter 13 debtor will not appear in court unless there is an objection in the case. An objection could be because you took too many exemptions, you fraudulently completed your paperwork, or you are trying to discharge a non-dischargeable debt.
The Bankruptcy Discharge
A Discharge of Debtor is a Court decree/finding that you no longer owe money for the debts that you listed in your bankruptcy petition and schedules. This Court order prohibits creditors from coming after you for those discharged debts. Prohibited actions include filing lawsuits, calling or writing to the debtor, and contacting any family, friends, or employers of the debtor. Even though a debtor gets a discharge, there are sometimes liens that are still in place. A lien is placed against specific property to secure payment of a debt. Often, we see liens from the IRS, a contractor, or even a mechanic. If that lien has not been dealt with in the bankruptcy case, it will remain in place. This means that the creditor with the lien may still come after the property to enforce the lien. This means you could lose the property secured by the lien if it is not dealt with in the bankruptcy case.
It is also important to understand that not all debts are discharged. There are specific debts that you cannot discharge under Section 523(a) of the Bankruptcy Code. Congress determined that these types of debts are not dischargeable for public policy reasons. Non-dischargeable debts include student loans*, IRS debt*, drunk driving damage, restitution, alimony, and child support, to name a few. This means the debtor must still repay those debts after bankruptcy and they are not discharged in bankruptcy.
*As with many rules/regulations, there are exceptions. In some rare cases, your student loans and/or IRS debt may be dischargeable. You should speak with an experienced bankruptcy attorney to see if your debt qualifies for a discharge.