A Brief Explanation of the Bankruptcy System
The following is educational and is intended to serve only as an overview of the various chapters of the Federal Bankruptcy Code, and is not intended as a substitute for counsel or the bankruptcy notices required by the Code and located on this site. See Federal Debt Relief Notices.
Bankruptcy is a series of Federal laws that deal with the relationships of debtors and creditors. The right time to file for bankruptcy protection is when you are in financial trouble, but still have assets to protect
. Generally, a person or business may file for bankruptcy when financial obligations cannot be met as they come due. The three most common bankruptcy chapters are: Chapter 7 (liquidation); Chapter 13 (wage earner’s plan); and Chapter 11 (business re-organization).
CHAPTER 7. This Chapter allows an individual, single or married, to file a petition in federal bankruptcy court to liquidate certain assets in exchange for a discharge of the person’s debts. The following are some of the most frequent concerns with Chapter 7:
Automatic Stay. Once the bankruptcy petition is filed, an automatic stay goes into effect which stops all collection proceedings and attempts to collect on outstanding debts. This is often only a temporary stay for mortgages and other secured debts.
The Family Home. If a house is worth less than the mortgage plus your
home-equity exemption you can file for Chapter 7 bankruptcy and retain your home if your mortgage is current. This will result in the discharge of most consumer debts and the retention of your home. If your house is worth more than the mortgage plus your home-equity exemption or you are not current on your payments, then it will be liquidated. Liquidation and/or the sale of the home as well as other assets are done through an appointed trustee.
IRAs and 401(k)s. These are generally protected in bankruptcy. Therefore, it may make sense to avoid using these sources to pay credit cards and other unsecured debts if you are considering bankruptcy or see it coming.
529 College-Savings Accounts. The majority of a child's 529 college-savings account is protected during bankruptcy. Again, it may be advisable that these funds should not be used to pay unsecured debts if bankruptcy is inevitable.
Health Care Bills. Most health care bills will be discharged in the bankruptcy.
Credit Card Bills. Most credit card bills will be dishcarged in bankruptcy.
Time Between Bankruptcies. There must be at least 8 years between bankruptcies to qualify for protection.
The Family Car(s). If your vehicle is paid for and is valued at less than the state exemption you will keep the vehicle. Generally, most filers will pay the value of the vehicle as of the date a petition is filed. This is often done through “redemption financing..” However, most states have an exemption for automobiles so you should be aware that the exemption will be an offset in your favor should you file.
Re-affirming a Debt. Creditors usually seek to re-affirm a debt (to re-commit the debtor to that obligation). You should seek legal advice in deciding whether re-affirming a debt makes sense in your situation. A creditor may not coerce or force you into reaffirming any debt. Avoiding reaffirming debts is often the best option for a person seeking to file for bankruptcy.
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CHAPTER 13. Chapter 13 is a bankruptcy plan for people with regular income that often allows a person to keep his or her assets and change payment terms to creditors. Essentially, an individual is allowed to reorganize its debts and payments.
The Plan. A Plan is submitted to the court, usually with the filing of the petition or shortly thereafter, that accounts for income and expenses, and attempts to adjust debts to fit income over a period of 3 or 5 years.
Mortgage Foreclosure. Any mortgage foreclosure action is immediately stopped by the automatic stay. The court will usually allow a person filing for bankruptcy who has regular income to develop a plan to correct the mortgage arrears over a 3 or 5 year plan. Note: Congress is currently considering a “Cram Down” provision to this section of the Code that would allow a bankruptcy court to adjust the value of a mortgage to the current value of a home if the principle amount owed according to the mortgage is greater.
Median Income Table. Whether your plan is 3 or 5 years is determined by a median income table. If your income is below the median income you will be assigned a 3 year plan and if it is above the median income then you will be assigned a 5 year plan.
Co-Signer Protection. Chapter 13 provides co-signer protection.
Priority. Chapter 13 pays creditors according to priority generally favoring certain taxes, then mortgage holders/secured lenders, and lastly unsecured creditors (e.g., credit cards, heath care bills, etc.).
Trustee. A Trustee is appointed to aid in administration of the case.
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CHAPTER 11. In a Chapter 11 proceeding, a reorganization/re-structuring of an established business is proposed when the business can no longer pay its obligations as they come due. The reorganization adjusts the repayments to creditors according to priorities established by the Bankruptcy Code. These proceedings generally concern themselves with establishing new terms with old lenders, creditors, including suppliers, equipment lease holders, landlords, subcontractors, etc. Chapter 11 is often the best option for established small business owners who are facing new or unexpected money problems. This Chapter requires a well negotiated plan to be confirmed by a bankruptcy judge.
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CHAPTER 12. Chapter 12 concerns family farmers and fishermen and, in most respects, operates much like a Chapter 13 filing.
CHAPTER 9. This Chapter is used by municipalities.
CHAPTERS 1, 3, and 5. These Chapters are not operating sections of the Code.
