Bankruptcy Law Explained

Bankruptcy law prevents economic enslavement and protects those self-evident, inalienable rights we all hold dear: life, liberty, the pursuit of happiness. It is a Federal Law governed by the United States Courts, which have supremacy over State courts due to the Supremacy Clause of the Constitution.

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A debtor surrenders non-exempt property to a trustee, who liquidates it and distributes the proceeds to creditors. The bankruptcy code provides a priority scheme for paying unsecured claims.

Chapter 7

Chapter 7 is a liquidation process where the trustee sells property that bankruptcy won’t let you keep (nonexempt property) and uses the proceeds to pay your creditors. It might include vehicles, homes, jewelry, collectibles or money in your bank account. Exempt property is a list of things that you can legally keep up to value limits set by state and federal law.

The trustee also pays off the debts that aren’t dischargeable in bankruptcy first–called priority unsecured claims. This includes things like mortgages, child support and spousal support. The rest of your unsecured debt is discharged, which means you don’t have to pay it anymore. You may also be able to remove liens from property through lien stripping or reduce the principal loan balance on secured debts through a loan cramdown.

To qualify for Chapter 7, you must not have filed a chapter 13 or other bankruptcy in the past six years. You must also have completed an approved credit counseling course. A court can dismiss your case if it determines you committed fraud or attempted to conceal assets; lied on the bankruptcy petition; or violated other laws.

If your income is above a certain threshold, the Bankruptcy Code requires the application of a “means test” to determine whether individual consumer debtors should be granted relief under chapter 7. The bankruptcy reform act of 2005 required this change.

Chapter 11

A debtor files Chapter 11 to propose a plan of reorganization, which the court must approve. A Chapter 11 case involves substantial ongoing litigation, which makes it more expensive than Chapter 7 filings. It also includes a trustee who will handle collecting and distributing creditor payments over three to five years.

A chapter 11 bankruptcy allows a business to remain in operation while it tries to come up with a way to pay its creditors. The plan must be approved by the court, and the debtor must prove that it is feasible. A business must also show that it can raise enough money to cover expenses and to pay the unsecured creditors.

The bankruptcy code requires that a business that wants to file under Chapter 11 must complete a disclosure statement, which lists all assets and the estimated value of those assets. It must also set dates for objecting to the reorganization plan and for creditor voting.

A business that does not meet the requirements of Chapter 11 can file a special type of bankruptcy called a subchapter V case. It offers more flexibility for small businesses, but it also requires that the U.S. Trustee appoint a special trustee to oversee and control estate funds and facilitate the development of a consensual plan. It also eliminates the automatic appointment of a committee of unsecured creditors and reduces quarterly fees paid to the U.S. Trustee throughout the case.

Chapter 12

In contrast to Chapter 11 (which is designed to restructure large agribusinesses) and Chapter 13, which can be used by almost any business, Chapter 12 provides relief specifically for family-run farms and fishing operations. This bankruptcy chapter tailors the process to the financial reality of these businesses, and offers benefits that are not available in other chapters.

To qualify for Chapter 12, the debtor must be a “family farmer with regular annual income.” The Bankruptcy Code sets out the requirements, which include an aggregate debt limitation and standards regarding the nature and character of the income. These provisions help to avoid the use of Chapter 12 by investors and speculators, while ensuring that relief is available to true family farmers.

During the course of a Chapter 12 case, the debtor develops a repayment plan and submits it to the bankruptcy court. A judge then confirms (approves) the plan or rejects it. Once the plan is confirmed, it becomes a binding court order that both parties must follow.

Unlike Chapter 7 or Chapter 13, which require that the debtor pay creditors in full, Chapter 12 allows debtors to create plans that repay unsecured creditors at pennies on the dollar. To be approved, the plan must pass a “best interest of the creditors” test, which requires that the amount paid to each creditor through the plan is at least as much as they would receive in a Chapter 7 case.

Chapter 13

Chapter 13 is a bankruptcy option for people who have regular income and want to pay some or all of their debts over three to five years. Unlike Chapter 7, it does not involve liquidation of assets. Instead, you propose a repayment plan and creditors must accept it. In most cases, you can keep your property if it is exempt, which depends on state law and may include all or part of the equity in your home (homestead exemption), tools of your trade that are necessary to perform your job (e.g., auto mechanic tools or dentist tools), and certain family household items.

In a Chapter 13 case, you must propose a payment plan that applies all of your disposable income to paying your creditors. Your payments are made to the trustee, who then distributes them to your creditors. You must begin making your payments within 30 days of filing. Your attorney will help you calculate your disposable income.

Creditors are prohibited from starting or continuing a lawsuit against you, garnishing your wages, or calling you to demand payment while you’re in Chapter 13. The protection of the “automatic stay” also extends to co-debtors on loans and credit cards if they signed them with you. There will be a meeting of creditors between 20-50 days after you file for Chapter 13, which your attorney will attend on your behalf.