Bankruptcy

By Katie Martens

If you think you can declare bankruptcy like Michael Scott, you’re probably in the right place. This article is going to break down what bankruptcy can look like for individuals, and discuss the following topics:

1. A general overview of what bankruptcy is;

2. Life cycle of a bankruptcy;

3. Types of bankruptcies;

4. When to file;

5. Pros and cons of bankruptcy; and

6. Life after bankruptcy

General Overview of Bankruptcy

Bankruptcy is a process designed to help individuals and businesses get protection from their creditors. The right to a bankruptcy is provided by federal law, which means that all bankruptcy cases are handled in federal bankruptcy court. Here are some general guidelines on what bankruptcy can and cannot do:

Bankruptcy can:

• Stop home foreclosure and allow a homeowner an opportunity to catch up on missed payments (note: bankruptcy does not automatically eliminate mortgages)

• Prevent repossession of car and other property

• Stop wage garnishments, debt collections, and similar creditor actions

• Lower monthly payments on some debts

Bankruptcy can not:

• Eliminate certain rights of secured creditors

• Discharge some types of debts, such as child support, most student loans, criminal fines, and most taxes

• Discharge debts that arise after the bankruptcy is filed

Life Cycle of a Bankruptcy

When a bankruptcy is filed, the filing instantly creates an “automatic stay.” This means that it temporarily stops creditors from taking actions to collect debts. The automatic stay also halts collection proceedings in state courts, stops replevin cases, and stops trustee sale proceedings.

After the filing, the next big event in the life cycle of a bankruptcy is the 341 Meeting, or the Meeting of the Creditors. The debtor must appear at this meeting, and any creditor of the debtor can appear and may sometimes ask questions. At this meeting, the Trustee will require the debtor’s photo ID, the debtor’s social security number, and the debtor’s most recent tax returns. Often, the debtor will also provide the Trustee bank statements showing any bank balances the debtor had at the time of filing for the bankruptcy. The Trustee will ask general questions and sometimes more specific questions about the debtor’s bankruptcy petition (which is the filing that gets the bankruptcy started). The point of the meeting is for the Trustee to make sure unsecured creditors are receiving anything possible out of the debtor’s assets.

Once the meeting is complete, the Trustee will issue an order that does two things: (1) releases the debtor from liability for certain debts, and (2) prohibits creditors from trying to collect discharged debts.

As you’ll see below, a bankruptcy’s ending depends on the type of bankruptcy an individual files for. While there are four ways an individual can file for bankruptcy, the two most common are Chapter 7 and Chapter 13. The most discussion you’ll find in this article will be on Chapter 7 and Chapter 13 bankruptcies.

Types of Bankruptcies

There are four types of bankruptcy cases an individual can file, and the name of each one refers to the chapter in the Bankruptcy Code that it can be found:

1. Chapter 7

   1. This is sometimes known as a “straight” or “liquidation” bankruptcy because it is fairly straightforward - the debtor lists all assets and creditors, and the Chapter 7 Trustee determines if there are any assets available to pay unsecured creditors.

   2. Most debtors are able to retain all of their property except property which is very valuable or property subject to a lien that they cannot afford to pay

   3. Timeline: usually only takes about 3 months from start to finish of the case, and debtors receive a discharge relatively quickly

   4. Who can qualify? There is now a “means test” that’s applied to debtors seeking a Chapter 6 bankruptcy in order to make it more difficult for wealthy consumers to file for a Chapter 7. If a debtor has a household income below the state median family income, then the debtor is not subject to the means test, and can file for a Chapter 7 bankruptcy. If a debtor has income above the median, then the debtor must fill out a form that compares monthly income with actual and assumed expenses in a variety of categories.

   5. Basic notes on Chapter 7 bankruptcies:

      1. Liens are not canceled by Chapter 7

      2. The debtor must continue to pay on secured debt if the debtor wants to keep the property

      3. Secured debt may be reaffirmed, surrendered, paid off, or sometimes the debtor may retain the property and pay it off

      4. Most Chapter 7 cases are no asset cases - the purpose of a Chapter 7 (usually) is to discharge all unsecured debt in a short time period

2. Chapter 13

   1. Chapter 13 bankruptcies are considered a “reorganization” used by individuals. The debtor must submit a Chapter 13 Plan to provide a payment plan for all or a portion of debts over a period of 3 - 5 years using the debtor’s current income

   2. Who is eligible: debtors typically file a Chapter 13 bankruptcy because their income is too high for a Chapter 7 or because there are assets that can’t be protected from the Trustee in a Chapter 7 case.

   3. Timeline:

      1. The debtor must make a Plan of Reorganization;

      2. After the Plan is submitted and accepted by the bankruptcy Trustee, the debtor must make monthly payments to the Chapter 13 Trustee;

      3. The monthly payments are a consolidation of all of the debtor’s debts;

      4. Once the Plan is in place, it allows the debtor to stop any foreclosures on the debtor’s property and the debtor can catch up on any arrears (anything the debtor owes money on);

   4. What is not dischargeable under Chapter 13:

      1. Student loans

      2. Alimony

      3. Child support

      4. Certain other debts

   5. When does a Chapter 13 bankruptcy end?

      1. The debtor has a voluntary right to dismiss the case at any time (the debtor probably wouldn’t want to do this, as it allows creditors to reinstate any proceedings they had to collect what’s owed to them)

      2. The debtor may convert the Chapter 13 to a Chapter 7 in certain circumstances (the debtor will still be subject to the “means test” to qualify for a Chapter 7);

      3. The Chapter 13 Trustee may move to convert or dismiss if Plan payments are not made; or

      4. When Plan payments are completed (which includes debtor’s completion of a financial management course by an approved provider).

3. Chapter 11

   1. This is a “reorganization” used by businesses, and a few individuals whose debts are very large

4. Chapter 12

   1. This is used only for family farmers and fishermen

When to file Bankruptcy

The timing of your bankruptcy will depend on the type of bankruptcy you file for, as well as what kind of debts you have. Debts that you incurred prior to filing for bankruptcy will be included in the bankruptcy discharge that the Trustee grants you. However, if you have debts that occur after your bankruptcy filing date, the Trustee will not include those debts in your discharge. So it’s critically important for you to disclose all debts that you have to your bankruptcy lawyer so that the lawyer can make a strategic decision on when he or she files your bankruptcy petition.

Pros & Cons of Bankruptcy

While the stigma of filing for bankruptcy may be difficult for some people, the benefits can be a breath of fresh air:

• Relief from creditors

• Fresh start on their financial strategies and how to manage their money

• Automatic stay prevents creditors from taking legal action against the debtor

• The debtor can come up with an affordable repayment plan

• The debtor can raise claims and defenses against creditors that may not be available in the overwhelm before a bankruptcy

The drawbacks of filing for a bankruptcy include:

• Loss of certain property

• Loss of privacy

• Impact on credit rating

• Discrimination for having a bankruptcy on your credit rating

What does life look like after a bankruptcy?

A Chapter 7 bankruptcy will remain on your credit report for 10 years. If you completed a Chapter 13 bankruptcy, it will remain on your credit report for 7 years. Bankruptcies can be quite a red flag on a credit report - it shows creditors that you are unreliable. The best way to fix that is to maintain employment, maintain a place to live, and pay your bills on time.