Bankruptcy
How it Could Affect You
Bankruptcy is a legally declared inability or impairment of ability of an
individual or organization to pay their creditors. A declared state of
bankruptcy can be requested by creditors in an effort to recoup a portion of
what they are owed; however, in the overwhelming majority of cases, the
bankruptcy is initiated by the bankrupt individual or organization.
The primary purpose of the laws of bankruptcy are: (1) to give an honest
debtor a "fresh start" in life by relieving the debtor of most debts, and to (2)
repay creditors in an orderly manner to the extent that the debtor has the means
available for payment.
Bankruptcy allows debtors to resolve debts through the division of non-exempt
assets among creditors. Additionally the declaration of bankruptcy allows
debtors to be discharged of most of the financial obligations, after their
non-exempt assets are distributed, even if their debts have not been paid in
full. During the pendency of a bankruptcy proceeding, the debtor is protected
from extra-bankruptcy action by creditors by a legally imposed stay. The
creditor will not be permitted to continue lawsuits, garnish wages, or contact
the debtor by phone to demand payment.
In the Old Testament, Moses's Laws prescribed one "Holy Year" should take place
every half a century, when all debts are eliminated among Jews and all
debt-slaves are freed, due to the heavenly command.
In ancient Greece, bankruptcy did not exist. If a father owed (since only
locally born adult males could be citizens, it was fathers who were legal owners
of property) and he could not pay, his entire family of wife, children and
servants were forced into "debt slavery", until the creditor recouped losses via
their physical labour. Many city-states in ancient Greece limited debt slavery
to a period of five years and debt slaves had protection of life and limb, which
regular slaves (mostly war prisoners and people of color imported from the
marauders) did not enjoy. However, servants of the debtor could be retained
beyond that deadline by the creditor and were often forced to serve their new
lord for a lifetime, usually under significantly harsher conditions.
The word bankruptcy is formed from the ancient Latin bancus (a bench or table),
and ruptus (broken). A "bank" originally referred to a bench, which the first
bankers had in the public places, in markets, fairs, etc. on which they tolled
their money, wrote their bills of exchange, etc. Hence, when a banker failed, he
broke his bank, to advertise to the public that the person to whom the bank
belonged was no longer in a condition to continue his business. As this practice
was very frequent in Italy, it is said the term bankrupt is derived from the
Italian banco rotto, broken bench (see e.g. Ponte Vecchio). Others rather choose
to deduce the word from the French banque, table, and route, vestigium, trace,
by metaphor from the sign left in the ground, of a table once fastened to it and
now gone. On this principle they trace the origin of bankrupts from the ancient
Roman mensarii or argentarii, who had their tabernae or mensae in certain public
places; and who, when they fled, or made off with the money that had been
entrusted to them, left only the sign or shadow of their former station behind
them.
Bankruptcy in the United States is a matter placed under Federal jurisdiction by
the United States Constitution (in Article 1, Section 8), which allows Congress
to enact "uniform laws on the subject of Bankruptcy throughout the United
States." Its implementation, however, is found in statute law. The relevant
statutes are incorporated within the Bankruptcy Code, located at Title 11 of the
United States Code, and amplified by state law in the many places where Federal
law either fails to speak or defers expressly to state law.
While bankruptcy cases are always filed in United States Bankruptcy Court (an
adjunct to the U.S. District Courts), bankruptcy cases, particularly with
respect to the validity of claims and exemptions, are often highly dependent
upon State law. State law therefore plays a major role in many bankruptcy cases,
and it is often quite unwise to generalize bankruptcy issues across state lines.
Upon commencement of a bankruptcy, a bankruptcy estate is created. The
bankruptcy estate (sometimes called "the estate") is a legal entity separate and
distinct from the debtor, the creditors, or the trustee. Because the estate is
not a real person, a trustee is appointed by the office of the U.S. Trustee to
represent the estate and to make decisions on its behalf. It is not strictly
correct to say that the trustee represents the creditors, though the creditors
often benefit from actions by the trustee. With few exceptions, all the assets
of the debtor transfer to the estate when the petition is filed. Exceptions to
this rule include property to which the debtor holds only legal (as opposed to
equitable) title. The estate also owns certain property acquired by the debtor
within 180 days, including property received by inheritance or devise or as the
result of a divorce judgment or a marital settlement agreement. In some
circumstances, the trustee has the right to recover property transferred by the
debtor or money paid by the debtor to a creditor before the case is filed.
Chapter 7 personal bankruptcy is also known as straight bankruptcy or
liquidation bankruptcy. Under Chapter 7, debtors are sometimes required to turn
certain property that they owned when they filed their bankruptcy petition, over
to the trustee. This property is sold, and the proceeds are used to pay the
creditors. This process is called "administration" of the estate. However, in
the vast majority of cases the debtor is allowed to keep most, if not all of his
or her property. Debtors are required to file a schedule of exemptions in which
they may elect to apply certain statutes, known as exemptions, to protect from
the trustee and creditors, the equity they have in their property. Exemption
statutes typically allow debtors to retain a portion or all of the equity they
have in a given type of property like the homestead, a vehicle, household goods,
and tools-of-trade. In most cases debtors have few if any assets with equity
they cannot protect in this manner (non-exempt assets), and thus in most cases
they do not lose anything to the trustee. The list of possible exempt assets
differs slightly in each state. It is important to consult a personal bankruptcy
attorney to determine what you can and cannot keep.
In most Chapter 7 cases the discharge is entered about 90 days after filing. The
discharge is an order by the bankruptcy court that permanently forbids creditors
from attempting almost any act to collect a debt owed by the debtor that existed
at the time the case was filed. One example of an act not forbidden by the
discharge is the sending of a home mortgage statement to the debtor even though
the personal obligation to pay the mortgage has been discharged (see discussion
of secured debts below).
The general rule is that all debts are discharged upon the entry of an order of
discharge by the court. Unless a debt falls within one of very few exceptions to
the general rule, it will be discharged. The court does not normally endeavor to
determine which debts are discharged unless the debtor or a creditor files a law
suit, known as an adversary proceeding, to determine dischargeability. This it
is typically left to the debtor and creditor to figure out whether a given debt
has been discharged.
Some of the more common debts to be discharged in bankruptcy include credit
cards, medical bills, personal loans, liability for negligence, and liability
for breach of contract. In Chapter 7, exceptions to the general rule include
most student loans, certain taxes, domestic support obligations (like child
support and spousal support), fines and penalties owing to the government, and
liability for personal injury arising from the operation of a motor vehicle by
the debtor while intoxicated. Student loans can be discharged through bankruptcy
by filing an adversary proceeding. Some debts will be discharged unless the
creditor objects. These include debts arising from fraud, malicious injury to a
person or property, and debts (other than support) arising from a judgment of
divorce or a marital settlement agreement. Unscheduled debts (debts that are not
listed by the debtor in the bankruptcy) are also sometimes not discharged.
However, unscheduled debts are discharged as long as the creditor receives
notice of the bankruptcy in time to file a proof of claim and in most Chapter 7
cases, it is never too late to file a proof of claim.
To understand how secured debts are treated differently in bankruptcy than
unsecured debts, it is important to understand that there are two aspects to a
secured debt. A secured debt includes the personal obligations (usually the
obligation to pay and to keep the collateral insured) and the security interest.
The security interest is a what allows the creditor to take the collateral from
the debtor if the debtor does not satisfy his or her personal obligations
associated with the particular debt. The personal obligations are dischargeable
according to the same rules that apply to unsecured debts. However, the security
interest survives the discharge in most cases. This means that, while most car
loans, home loans, and other secured debts are discharged, the creditor retains
the right to take the collateral if the debtor doesn't pay. This may seem like a
fine distinction upon first glance, but it becomes critical when the debtor
decides after the discharge that the personal obligations are more burdensome
than the collateral is worth. For instance, a debtor will be glad for his or her
discharge if the car that is collateral for a secured debt gets stolen or
wrecked and insurance will not pay off the amount due on the contract.
Under the new rules implemented as a result of the 2005 Bankruptcy Reform, it is
now more difficult for people with an income exceeding the state median to
qualify for Chapter 7 bankruptcy. These debtors are subject to a means test, and
if their disposable income (income left over after paying their expenses)
exceeds limits set by the government, the debtor is not entitled to a discharge
in Chapter 7 and may elect to convert the case to a Chapter 13.
Chapter 13 bankruptcy is a reorganization plan for individuals. To qualify for
Chapter 13, an individual must have secured debts under $807,750 and unsecured
debts under $269,750. Under Chapter 13 the debtor keeps all of their property,
but in return they make regular payments to a trustee, who distributes the
payments to the creditors. Most Chapter 13 plans last for three to five years,
and then the remaining unpaid and eligible debts are discharged. The types of
debt that can be discharged under Chapter 13 was substantially scaled back by
the 2005 reform amendments. Creditors may challenge a Chapter 13 plan but a plan
can still be confirmed over their objection if the criteria for confirmation is
otherwise met. A requirement for confirmation of a Chapter 13 plan is that
unsecured creditors would receive at least as much as they would receive in a
Chapter 7 liquidation.
Chapter 15 incorporates the Model Law on Cross Border Insolvency drafted by the
United Nations Commission on International Trade and Law. The law provides
solutions to problems which arise in connection with cross-border bankuptcy,
allowing US courts to issue subpoeanas, orders to turn over assets, stays on
pending actions, and orders of other types as circumstances dictate. The
ancillary proceeding permitted under Chapter 15 is often a more efficient and
less costly alternative to initiating an independent bankruptcy proceeding in
the United States. It also avoids the conflicts which could arise between the
jurisdictions involved in two independent bankruptcy proceedings initiated in
connection with the same debtor..