Brief overview of bankruptcy law and its purpose
Bankruptcy law is a federal law that provides individuals and businesses with a way to eliminate or repay their debts under the protection of the bankruptcy court. The purpose of bankruptcy law is to give debtors a fresh start by discharging most types of debt or by creating a repayment plan for the debt they can afford to pay. Bankruptcy law also serves to protect creditors by providing a process to recover as much of their debts as possible.
Types of Bankruptcy
There are several types of bankruptcy, each designated by a different chapter of the U.S. Bankruptcy Code. The most common types are:
- Chapter 7 bankruptcy - Also known as a "liquidation" bankruptcy, it involves selling off non-exempt assets to pay off creditors and discharging any remaining eligible debts.
- Chapter 13 bankruptcy - This type of bankruptcy allows individuals with a regular income to repay their debts over a period of three to five years under a court-approved repayment plan.
- Chapter 11 bankruptcy - Primarily used by businesses, this type of bankruptcy allows for a reorganization of the debtor's finances and operations in order to repay creditors over time.
- Chapter 12 bankruptcy - A type of bankruptcy specific to family farmers and fishermen, it allows for a reorganization of their finances and operations in order to repay creditors over time.
- Chapter 9 bankruptcy - This type of bankruptcy is specific to municipalities, such as cities and towns, and allows for a reorganization of their finances in order to repay creditors.
Liquidation of assets to pay off creditors
In a Chapter 7 bankruptcy, the debtor's non-exempt assets are sold by a bankruptcy trustee in order to pay off creditors. The funds from the sale of these assets are distributed among the creditors according to a priority set by the Bankruptcy Code. Some assets, such as a primary residence and personal property, may be exempt from sale under state or federal law. After the sale of assets and payment of creditors, any remaining eligible debts are discharged, meaning the debtor is no longer responsible for repaying them. The goal of a Chapter 7 bankruptcy is to provide a fresh start for the debtor by eliminating as much debt as possible.
Repayment plan for individuals with regular income
Chapter 13 bankruptcy is a type of bankruptcy designed for individuals with a regular income. Instead of selling assets to pay off creditors, as in Chapter 7 bankruptcy, the debtor proposes a repayment plan to repay their debts over a period of three to five years. The plan must be approved by the bankruptcy court and must meet certain requirements, such as providing for payment of priority debts in full and a portion of unsecured debts. The debtor must make regular payments to the bankruptcy trustee, who will distribute the funds to creditors according to the terms of the repayment plan. After completion of the plan, any remaining eligible debts are discharged. The goal of Chapter 13 bankruptcy is to allow the debtor to keep their assets and repay their debts over time, with the ultimate goal of a fresh start.
Reorganization for businesses or individuals with high debt
Chapter 11 bankruptcy is a type of bankruptcy that allows for a reorganization of the finances and operations of businesses or individuals with high debt. Unlike Chapter 7 and Chapter 13 bankruptcy, which are designed to either liquidate assets or repay debts over time, Chapter 11 allows the debtor to continue operating while they work out a plan to repay their creditors. The plan must be approved by the bankruptcy court and must meet certain requirements, such as providing for payment of priority debts in full and a fair and equitable treatment of all creditors.
The debtor typically has 120 days to propose a plan and may be given additional time if necessary. After the plan is confirmed, the debtor makes payments to their creditors according to its terms, with the ultimate goal of emerging from bankruptcy as a financially stable entity. Chapter 11 bankruptcy is commonly used by businesses, but can also be used by individuals with high debt.
Eligibility for Bankruptcy
Eligibility for bankruptcy is determined by several factors, including the type of debt, the individual's income, and their recent bankruptcy history. The most common types of bankruptcy, Chapter 7 and Chapter 13, have specific eligibility requirements.
Chapter 7: To be eligible for Chapter 7 bankruptcy, an individual must pass a "means test" which compares their income to the median income in their state. If their income is below the median, they are generally eligible for Chapter 7. If their income is above the median, they must pass additional tests to determine if they can afford to repay some of their debts through a Chapter 13 repayment plan.
Chapter 13: To be eligible for Chapter 13 bankruptcy, an individual must have a regular income and unsecured debt below a certain amount ($419,275 for unsecured debt and $1,257,850 for secured debt as of 2021). In addition, they must not have had a Chapter 7 or 11 bankruptcy case dismissed within the previous 180 days for certain reasons.
It is important to note that eligibility for bankruptcy may change over time, as the Bankruptcy Code is amended and the median income levels are updated. It is always best to consult with a bankruptcy attorney to determine your eligibility for bankruptcy.
The Bankruptcy Process
The bankruptcy process typically involves the following steps:
- Consultation with a bankruptcy attorney - Before filing for bankruptcy, it is recommended to consult with a bankruptcy attorney to discuss your options and determine eligibility.
- Preparation of bankruptcy petition and schedules - The debtor prepares and files a bankruptcy petition with the bankruptcy court, along with schedules listing their assets, liabilities, income, and expenses.
- Credit counseling - Before a case can be filed, the debtor must complete a credit counseling course.
- Filing of bankruptcy petition - The bankruptcy petition, schedules, and any required fees are filed with the bankruptcy court.
- Appointment of a trustee - The bankruptcy court appoints a trustee to oversee the case and manage any assets that may be sold.
- Automatic stay - Once the bankruptcy petition is filed, an automatic stay goes into effect, prohibiting creditors from taking any collection action against the debtor.
- Meeting of creditors - A meeting of creditors is held, during which the debtor is questioned under oath by the trustee and creditors about their financial affairs and the information in the bankruptcy petition.
- Confirmation of repayment plan (Chapter 13 only) - In a Chapter 13 case, the bankruptcy court will review the debtor's proposed repayment plan and confirm it if it meets the requirements of the Bankruptcy Code.
- Discharge of eligible debts - After completing the necessary steps, such as the meeting of creditors or confirmation of a repayment plan, the bankruptcy court will issue a discharge of eligible debts, releasing the debtor from personal liability for those debts.
The length of the bankruptcy process can vary depending on the type of bankruptcy, the complexity of the case, and other factors, but typically lasts three to six months for a Chapter 7 case and three to five years for a Chapter 13 case.
Effects of Bankruptcy
Bankruptcy can have both short-term and long-term effects on an individual's financial situation. Some of the most common effects of bankruptcy include:
- Discharge of eligible debts - One of the main benefits of bankruptcy is the discharge of eligible debts, releasing the individual from personal liability for those debts.
- Damage to credit score - Filing for bankruptcy can have a significant impact on an individual's credit score, typically lowering it by 200 to 300 points.
- Difficulty obtaining credit - After bankruptcy, it can be difficult for an individual to obtain credit, such as loans or credit cards, for several years.
- Public record - Bankruptcy cases are public record and can be viewed by anyone, including future employers, landlords, and creditors.
- Limitations on future bankruptcy filings - There are limits on the frequency with which an individual can file for bankruptcy, with the most common types of bankruptcy requiring a waiting period of eight years between filings.
While bankruptcy can have negative effects, it can also provide a fresh start for individuals who are struggling with debt and unable to repay their creditors. The ultimate goal of bankruptcy is to allow the individual to get back on their feet and move forward with their financial lives.
Alternatives to Bankruptcy
There are several alternatives to bankruptcy for individuals struggling with debt, including:
- Debt settlement - Debt settlement involves negotiating with creditors to reduce the amount owed and repay the debt in a lump sum or through a payment plan.
- Debt consolidation - Debt consolidation involves combining multiple debts into a single loan with a lower interest rate, making it easier to manage and repay the debt.
- Credit counseling - Credit counseling involves working with a credit counseling agency to develop a budget and repay debt through a debt management plan.
- Loan modification - Loan modification involves negotiating with a lender to change the terms of a loan, such as reducing the interest rate or extending the repayment term, to make the payments more affordable.
- Informal debt repayment - Informal debt repayment involves negotiating directly with creditors to repay the debt in a more affordable manner, such as through a payment plan or debt settlement.
It is important to note that these alternatives may not be available to everyone and may have their own pros and cons. In some cases, bankruptcy may still be the best option for individuals struggling with debt. It is always best to consult with a financial advisor or bankruptcy attorney to determine the best course of action.
What are the three things that lead to bankruptcy?
The three most common factors that lead to bankruptcy are:
- Medical expenses - High medical bills and medical debt are one of the leading causes of bankruptcy, particularly for individuals without health insurance or with inadequate coverage.
- Job loss or reduced income - A sudden loss of income, such as from job loss, can make it difficult to keep up with debt obligations and lead to bankruptcy.
- Overwhelming credit card debt - High levels of credit card debt, often due to living beyond one's means or using credit cards to cover basic living expenses, can quickly become unmanageable and lead to bankruptcy.
Other factors that can contribute to bankruptcy include divorce, loss of property, business failure, and other unexpected expenses or events. In many cases, it is a combination of these factors that leads to the financial difficulties that ultimately result in bankruptcy.
What are 3 things you can do to avoid bankruptcy?
Here are three steps individuals can take to avoid bankruptcy:
- Create and stick to a budget - Creating a budget and tracking expenses can help individuals avoid overspending and build a safety cushion to deal with unexpected expenses.
- Avoid accumulating high-interest debt - Using credit cards responsibly and avoiding high-interest debt, such as payday loans, can help individuals avoid falling into debt traps.
- Seek help early - If financial difficulties arise, seeking help early from a financial advisor, credit counselor, or bankruptcy attorney can help individuals find a solution before the situation becomes critical.
Additionally, having a solid emergency fund, maintaining adequate health insurance coverage, and avoiding overextending oneself financially can also help individuals avoid bankruptcy. The key to avoiding bankruptcy is being proactive, seeking help early, and taking steps to manage finances responsibly.
What Cannot be wiped out by bankruptcy?
While bankruptcy can provide relief from many types of debt, there are certain debts that cannot be wiped out through bankruptcy. These include:
- Most taxes - Most taxes, including income taxes, are not dischargeable in bankruptcy, although certain taxes may be dischargeable under specific circumstances.
- Student loans - Student loans are generally not dischargeable in bankruptcy, although there are limited exceptions for individuals with exceptional circumstances, such as a permanent disability.
- Child support and alimony - Child support and alimony obligations are considered to be priority debts and are not dischargeable in bankruptcy.
- Criminal fines and penalties - Criminal fines and penalties, such as those for DUI or other driving offenses, cannot be discharged in bankruptcy.
- Personal injury judgments - Personal injury judgments, such as those resulting from a car accident, are not dischargeable in bankruptcy.
- Certain debts incurred while committing fraud - Debts incurred while committing fraud, such as those incurred while using a credit card obtained through fraudulent means, cannot be discharged in bankruptcy.
It is important to note that the specific types of debt that are not dischargeable in bankruptcy can vary depending on the type of bankruptcy being filed and the laws of the jurisdiction in which the bankruptcy is being filed. It is always best to consult with a bankruptcy attorney for specific information on what debts may be dischargeable in a particular case.
What is the first step to avoid bankruptcies?
The first step to avoiding bankruptcy is to assess one's current financial situation and identify any areas of financial stress or difficulty. This can include reviewing one's income and expenses, debts, and assets, and seeking help from a financial advisor, credit counselor, or bankruptcy attorney if necessary.
Once an individual has a clear understanding of their financial situation, they can take steps to manage their finances more responsibly, such as:
- Creating a budget and tracking expenses
- Paying down high-interest debt
- Building an emergency fund
- Avoiding overspending and living within one's means
- Seeking help early if financial difficulties arise
The key to avoiding bankruptcy is being proactive and taking steps to manage finances responsibly, before debt levels become overwhelming and lead to financial difficulty. By taking control of one's finances and seeking help early, individuals can reduce their risk of bankruptcy and achieve financial stability.
What does bankruptcies do to your credit
Filing for bankruptcy can have a significant impact on an individual's credit score and credit history. Bankruptcy is considered a negative event by credit reporting agencies and can stay on an individual's credit report for up to 10 years. This can make it difficult for an individual to obtain credit, such as loans or credit cards, and can result in higher interest rates and fees when credit is obtained.
The specific impact of bankruptcy on an individual's credit score and credit history can vary depending on several factors, including the type of bankruptcy filed, the individual's credit history before filing, and how they manage their finances after filing.
In general, filing for Chapter 7 bankruptcy (liquidation) can have a more significant impact on credit than filing for Chapter 13 bankruptcy (repayment plan). In some cases, filing for Chapter 13 bankruptcy can even result in a higher credit score after the bankruptcy is completed, as individuals who successfully complete a repayment plan are seen as having made an effort to repay their debts.
It is important to understand that bankruptcy is not the end of the road for an individual's credit and that it is possible to rebuild credit and achieve financial stability after a bankruptcy. This may involve steps such as obtaining a secured credit card, paying bills on time, and maintaining a responsible use of credit. However, the process of rebuilding credit after bankruptcy can take time and effort.
Bankruptcy law provides individuals and businesses with a legal process to eliminate or repay their debts under the protection of the bankruptcy court. It is a complex area of law with many rules and requirements, and it is important to understand the different types of bankruptcy, eligibility criteria, the bankruptcy process, and its effects. While bankruptcy can offer a fresh start for those struggling with debt, it is not the only option and there are alternatives to consider.