What is Bankruptcy?

Financial StormBankruptcy may well be the shelter from the financial storm you are looking for. Bankruptcy is a federal legal proceeding that affords relief to the honest debtor (person or business enterprise) facing serious financial obstacles. A person or business files bankruptcy in order to obtain some form of financial relief – either by way of discharge (debt forgiveness) or financial restructuring.

What are the Different Types of Bankruptcy?

The Bankruptcy Code is comprised of several chapters. Each chapter of the Bankruptcy Code after chapter 5, addresses a different type of bankruptcy. As such there are presently 6 different types of bankruptcy: Chapter 7(liquidation or straight bankruptcy), Chapter 9 (municipality bankruptcy), Chapter 11 (business reorganization), Chapter 12 (family farmer reorganization), Chapter 13 (wage earner reorganization), and Chapter 15 (cross-border bankruptcy). As you can likely guess, the most common bankruptcies are Chapter 7, Chapter 11, and Chapter 13.

Chapter 7

Chapter 7 bankruptcy is commonly known as a liquidating bankruptcy or straight bankruptcy and usually lasts about 120 days. The filing of a Chapter 7 bankruptcy petition creates an estate comprised of all assets owned by the Debtor. Nonetheless, the Debtor retains the right to exempt certain assets from the bankruptcy estate and shield them from the bankruptcy process and possible sale by a trustee. In most cases the Chapter 7 Debtor will be able to exempt all of his/her assets under applicable Texas or Federal law. However, if there remain certain assets that do not qualify for an exemption, the Chapter 7 bankruptcy trustee will sell those non-exempt assets. The proceeds from the sale of those non-exempt assets are then distributed amongst the Debtor’s creditors.

The objective or goal of a Chapter 7 bankruptcy is to provide the honest Debtor with a fresh start. This objective, under Chapter 7 of the Bankruptcy Code, is accomplished by granting the Debtor a discharge in exchange for the sale of all non-exempt assets as discussed above. This bankruptcy discharge relieves the Debtor from any obligations due and owing his/her unsecured creditors (exceptions are noted below). In other words, upon successful completion of a Chapter 7 bankruptcy case, the Debtor will no longer be legally obligated to pay any: (1) credit card debts; (2) medical bills; (3) any monies due and owing any secured creditor resulting from the repossession or surrender of the secured creditor’s collateral (i.e. a car, boat, or real property); and (4) personal loans to friends and/or family members. While technically, a Chapter 7 Debtor is also discharged from having to repay any secured obligations (a car loan and home mortgage being the most common), the secured creditor retains the right to repossess or foreclose upon those assets in the event of non-payment. As such, if there are certain assets which a Debtor wishes to retain and which are the subject of a secured loan, the Debtor must continue to make payments to that creditor even after the discharge.

A bankruptcy discharge under Chapter 7 is not, however, without limitations. For example, a Chapter 7 bankruptcy discharge does not eliminate debts for most taxes, student loans, domestic support obligations or debts from fraud, intentional injuries or damages for driving under the influence of drugs or alcohol. Click here for more information on Chapter 7.

Chapter 13

A Chapter 13 bankruptcy petition requires the Debtor to formulate a plan of reorganization under which the Debtor proposes to re-pay his/her Creditors all or a portion of the debt owed to them over a period of three to five years. In so doing, the honest Debtor is entitled to retain all assets, exempt or otherwise (unlike a chapter 7 bankruptcy). The Chapter 13 Bankruptcy Plan requires the Debtor to make monthly plan payments to a bankruptcy trustee for the duration of the plan. The bankruptcy trustee, in turn, distributes those plan payments amongst all of the Debtor’s creditors pursuant to the terms of the Chapter 13 Bankruptcy Plan. The Chapter 13 plan payment is intended to address the obligations of the Debtor’s: (1) unsecured creditors, (2) tax obligations; (3) arrearage on secured assets the Debtor wishes to retain; and (4) vehicle loans or other forms of short term secured debt. Note that in most cases long-term secured liabilities like a mortgage, will be paid outside of the plan.

There are many options available to a Chapter 13 Debtor that are not available to a Chapter 7 Debtor. For example if a Debtor is behind on his/her mortgage payment, those arrears can be cured within the Chapter 13 Plan thereby permitting the Debtor to keep the home. In addition, many secured claims need only be paid to the extent of the value of the property securing the claim (exclusive of home mortgages which have special rules in this regard). Lastly, Chapter 13 is an ideal vehicle for paying off back taxes and preventing any further IRS levies or garnishments. Click here for more information on Chapter 13.

Chapter 11

While a vast majority of Chapter 11 bankruptcy cases are filed by business enterprises (sole proprietorships, partnerships, limited liability companies and corporations) an individual wage earner may also file for relief under Chapter 11 (individual wage earners will usually file Chapter 11 where they do not qualify for Chapter 13). The primary objective of Chapter 11 is to allow the Debtor to continue operating a business while reorganizing its finances. The basic rule is that the debtor may continue to operate the business enterprise and manage its property in the ordinary course of business as a “debtor in possession.” The Debtor in Possession, in the ordinary course of events, retains management control and has certain additional powers not otherwise available. For example, a Debtor in Possession is able to reject executor contracts (leases) and recover certain pre-petition transfers.

A Chapter 11 Debtor has the exclusive right  to propose a reorganization plan for four months. The court can  shorten or extend the exclusivity period depending on the circumstances.  The Chapter 11 plan allows the Debtor to restructure its financial affairs.  At least one class of “impaired” claims must vote in favor of the plan for it to be confirmed. A confirmed Chapter 11 plan is essentially a contract between the Debtor and its creditors.  The plan dictates how the reorganized Debtor will operate and the manner and amount of any dividends paid out to the creditors.  The Chapter 11 plan process is very flexible.  Plans range from the traditional reorganization to a total liquidation.  Click here for more information on Chapter 11.