Demystifying the Law: Bankruptcy

Posted September 2, 2010 in Demystifying the Law by

With the lousy economy, high unemployment and declining real estate prices, many people have been struggling with their finances. When your debt payments exceed your income, it may be time to consider bankruptcy. But what is bankruptcy and what does the process entail? This article will attempt to demystify bankruptcy law.

What Is Bankruptcy Law?

Bankruptcy is a legal process that enables a debtor (or person who owes money) to come to an agreement with creditors (the people or businesses to which money is owed) to pay off and/or forgive many outstanding debts.

In the United States, there are several ways for consumers to file for bankruptcy. These are referred to as chapters. The various types include:

  • Chapter 7, also called straight bankruptcy, which allows individuals or businesses to give up some "non-exempt" assets and clear most debts
  • Chapter 11, also called reorganization, which is mostly used by businesses but also used by individuals who want to continue in business and repay creditors at the same time
  • Chapter 12 provides relief to family farmers and fishermen with regular income
  • Chapter 13 is for individuals with a regular source of income and allows repayment of debts through an approved plan

Chapter 7 Bankruptcy Basics

Chapter 7 bankruptcy is the simplest and fastest type of bankruptcy. To begin Chapter 7 bankruptcy proceedings, you would file a petition with your local bankruptcy court. (There’s at least one in each state.) The petition would include a list of your creditors, a list of your property and assets, a list of your living expenses and income information.

After filing your bankruptcy petition, a bankruptcy trustee takes your non-exempt property (which varies from state-to-state, but might include savings accounts, second homes and collectables), sells those assets and uses the money to pay your creditors.

Certain debts cannot be discharged, or forgiven, in bankruptcy. These include taxes, child support and student loans. Other debts will be forgiven.

Not every debtor is eligible for Chapter 7 bankruptcy. You must qualify through a means test that looks at your income and expenses. If you do not qualify for Chapter 7 bankruptcy, you will have to file for Chapter 11 or Chapter 13 bankruptcy.

Chapter 13 Bankruptcy Basics

Chapter 13 bankruptcy allows a debtor to devise a schedule for partial or full repayment of debts within a three- to five-year period.

To qualify for Chapter 13 bankruptcy, you’ll need a stable income with "disposable income." Disposable income is money left over after you pay for basic life requirements, such as food and utilities. You can’t have more than $1,081,400 in secured debt and $360,475 in unsecured debt. (If you have in excess of this, you’ll have to file for Chapter 11 bankruptcy.)

To file for Chapter 13 bankruptcy, you’ll file a petition with the local bankruptcy court, and provide a list of your creditors, assets and liabilities, and current income and expenses. You’ll also need to provide the court with a proposed repayment plan. A bankruptcy trustee will share your repayment plan with all of your creditors, giving them the chance to voice objections. If they approve, you’ll proceed with the payment plan. Once you have made all payments according to plan, any remaining debt is discharged, or forgiven.

Is Bankruptcy Right for You?

Before filing for bankruptcy, you should probably talk to a couple of people including a credit counselor (which is legally required as part of the Chapter 7 bankruptcy process) and a bankruptcy attorney. They can help you determine whether bankruptcy makes sense in your situation, tell you what type of bankruptcy you qualify for and help you understand the long-term ramifications of a bankruptcy filing.

Among the advantages of filing for bankruptcy:

  • Your debts such as credit card debt will be removed
  • Your home, car and certain other property can’t be taken to pay creditors
  • You can eliminate or modify "secured debt," such as a mortgage or car loan
  • An "automatic stay" will protect you from future collections processes such as repossession, foreclosure and utility shut-off
  • Your attorney has more legal tools to challenge disputed debts with creditors

Among the disadvantages of filing for bankruptcy:

  • Your non-exempt property can be sold to pay off creditors
  • Bankruptcy will become part of your credit history for 10 years and will be part of the public record
  • The costs of filing bankruptcy can be quite steep even if you don’t have an attorney representing you
Related Links: