Fundamentals of Bankruptcy Law

by David Carnes
Bankruptcy won't necessarily leave you penniless.

Bankruptcy won't necessarily leave you penniless.

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The purpose of bankruptcy law is to give an overburdened debtor a fresh start by discharging his debts or allowing him to pay them on more favorable terms. This process is supervised by bankruptcy courts. Because assets and creditors are so often located in different states, bankruptcy law is federal law rather than state law.

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Bankruptcy Basics

Both individuals and businesses may file for bankruptcy. You can file for bankruptcy yourself, or your creditors can force you into bankruptcy. Some of your assets are exempt from seizure by creditors. These assets typically include a personal home up to a certain value, as well as essential personal property such as work tools. Some debts, such as federally guaranteed student loans, alimony and child support, are not eligible for discharge. The bankruptcy process is initiated by filing a bankruptcy petition with a bankruptcy court. After that, the court will issue an order preventing your creditors from pursuing collection activity against you during the bankruptcy process.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy will completely eliminate eligible debts for an individual or business. If your debts are primarily consumer debts rather than business debts, you must pass a "means test" to proceed with Chapter 7. If your income is lower than the state median income, you automatically pass the means test. If it equals or exceeds the state median, you will be allowed to proceed only if your disposable income is insufficient to pay your creditors. If you fail the means test, the court will either deny the petition or convert it into another type of bankruptcy, such as Chapter 13. If the court accepts the petition, it will appoint a receiver to liquidate your non-exempt assets and use the proceeds to partially pay your creditors. If you are an individual, the court will discharge all eligible debts once your creditors are paid. If you represent a company -- a corporation, a partnership or an LLC -- it will be dissolved.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy is available to individuals but not companies. You must develop a payment plan that allows you to pay your creditors over three to five years. To qualify for Chapter 13, you must have a regular income sufficient to make your payments, and your debts must not exceed certain debt ceilings (these ceilings change annually). You will be allowed to keep exempt assets. If the court approves your petition, it will issue an order preventing your creditors from seizing your property until you complete the repayment plan. After you complete repayment, the court will discharge any debt you still owe these creditors.

Chapter 11 Bankruptcy

Chapter 11 bankruptcy is designed to allow companies to repay debts in a manner similar to individuals under Chapter 13. Individuals may apply for Chapter 11 if their debts exceed Chapter 13 debt limits. Like Chapter 13, Chapter 11 allows you to repay your debts over three to five years, and prevents creditors from seizing your property during this time. Unlike Chapter 13, however, your repayment plan must be approved by a majority of your creditors, unless the court issues an order forcing them to accept it. If you represent a company, it will be allowed to remain in business during and after bankruptcy proceedings.