The Basics of Bankruptcy


             Declaring bankruptcy can be a daunting process. It is a complex area of law, weaving contract law, real estate law, tax law, property law, and corporate law. For people who are already stressed by finances, the cure to your credit problems may seem worse than the disease. But, here are a few basic terms and ideas to help you understand the process of bankruptcy.


            The main parties are involved in bankruptcy filings are the debtor and the creditor. The debtor is the party who owes money and cannot pay it back. The creditor is the party who has previously loaned money. A debtor can be a company or an individual person. Many bankruptcy cases involve several creditors.


            There are two types of debt: secured and unsecured. Secured debts are ones which creditors have the legal right to take something of yours if you fail to make the proper payments. Most mortgages, for example, are secured debts, which are secured by the house. If you cannot pay your mortgage, the bank will foreclose on the house.  The technical term for what the bank gets, is a lien. Unsecured debt is a debt that is not tied to any piece of property. Credit card debt is an example of an unsecured debt.


            Congress passed the Bankruptcy Code in 1978, and has amended it several times since. This code outlines, among other things, the different types of bankruptcy filings, the most popular of which are Chapter 7, Chapter 11, and Chapter 13.


            Chapter 7 is known as liquidation. It is the simplest, and quickest, bankruptcy option.  When you file for bankruptcy, a trustee is assigned by the court to your case. In Chapter 7, the trustee sells off all non-exempt assets held by the debtor so that the debts can be repaid to the fullest extent possible. Individuals, corporations and partnerships are all eligible for Chapter 7 bankruptcies. If the debt owed is greater than the value of the assets, the remaining debt is discharged and no longer owed. Businesses generally try to avoid Chapter 7. Generally, this option is designed to quickly free you from unsecured debt, including: credit cards, department store cards, medical bills, payday loans, some personal loans, utility bills, and other such debts. One advantage to Chapter 7 is that income generated after the bankruptcy filing is kept by the debtor. The creditors cannot take future earnings.


            Chapter 11 is the more complex bankruptcy filing. This is generally used by businesses. In Chapter 11, the debtor continues to function as a business, maintains ownership of all assets, and tries to work out a reorganization plan to pay off creditors. This is useful for businesses, since under Chapter 7, they cannot operate effectively while in bankruptcy. Chapter 11 is appropriate for companies who believe that their long term revenues will be higher than their current valuation of assets.


            The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 created two very important restrictions on Chapter 11. First, it forces the debtor to submit a reorganization plan within a 120-day time limit. After that limit expires, creditors can submit their own plans. Second, it forces any business wishing to file bankruptcy to have lived in the state in which they are filing for two years. Previously, it was very advantageous for business to find the states with the most lax bankruptcy laws and file there.


            Chapter 13 is like Chapter 11, but for individuals. This is used to create a new repayment plan. The debtor retains control and ownership of their assets. This is important for debtors who own a house and/or car which they wish to keep. The debtor and creditor will work out out a three to five-year repayment plan in Chapter 13. A portion of the debt may be discharged, and the debtor would not need to repay. The extent to how much debt is discharged will depend on the income of the debtor. There are also limits on the amount of debt involved, as one cannot use Chapter 13 if they owe more than $1,010,650 in secured debt and $336,900 in unsecured debt. Also, the debtor must have a stable income.


            While the basics of these three types of filings may now seem easier to grasp, they still can get very complex. Choosing the right type for you or your business is a very important decision. It is imperative that you speak with a qualified bankruptcy attorney before making these decisions.