The bankruptcy process exists for the purpose of giving individuals and in some circumstances businesses the opportunity for a “fresh start” free and clear of antecedent debt where other options have failed or are not available. As the U.S. Supreme Court stated in Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934), Bankruptcy “gives to the honest but unfortunate debtor a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt. The fresh start provided by Bankruptcy is ultimately accomplished by the bankruptcy discharge at the conclusion of the case.
Bankruptcy relief is commonly divided into three distinct chapters: 7, 11, and 13. While all chapters are governed by the Bankruptcy Code and the Bankruptcy Rules of Procedure, each chapter is distinct in its processes and procedures.
1. Chapter 7 Bankruptcy – Liquidation
Possibly the most commonly known of the chapters is Chapter 7, which is referred to as “Liquidation” in the Bankruptcy Code. Through the process of Chapter 7, a debtor’s assets and debts are accounted for and, through administration by a Trustee, the debtor’s assets are liquidated and the proceeds used to satisfy the debts to the extent possible. Upon completion of the administration, any remaining debts which are unsatisfied (or all debts as the case may be) are discharged.
Although the purpose of Chapter 7 is to liquidate the assets of the debtor to pay creditors, there are several exemptions which protect certain property of the debtor from liquidation. As such it is frequently the case where no property is available to be liquidated and therefore debts are wholly discharged.
Another important consideration is the treatment of (1) unsecured debts and (2) secured debts. Unsecured debts lack any collateral and therefore are discharged summarily. Secured debts, such as an automobile loan or home loan, are secured by the underlying collateral. In this circumstance a debtor must make the choice of whether to surrender the collateral to the secured party or continue making the obligated loan payments. In addition to the aforementioned there are certain limitations to which debts may be discharged. Some common types of debt which may be non-dischargeable include debts for federal taxes, federal student loans, and domestic support obligations (such as child support or spousal maintenance.)
While Chapter 7 provides for a complete discharge of debts upon the completion of administration, the Bankruptcy Code requires that an individual seeking to file a Chapter 7 qualify pursuant the requirements of a “means test.” The purpose of the “means test” is to determine whether an individual’s income is too high, in comparison to established territorial standards, to permit a Chapter 7 filing. The result of the “means test” is the initial determination for eligibility to file a Chapter 7. If an individual is ineligible for a Chapter 7, a filing under another chapter, such as Chapter 13, may be required in order for an individual to seek relief under the Bankruptcy Code.
2. Chapter 11 – Reorganization
Chapter 11 is most commonly filed by businesses with the ultimate goal of restructuring debts while continuing their operations. As a result, a Chapter 11 seeks to modify the debts of a company through a combination of repayment of certain amounts and discharge of the remainder.
In order to be successful in a Chapter 11, a business must be able to propose a sustainable plan for profitability following the bankruptcy petition which is subject to the approval of creditors of the business. Often times, creditors have an incentive to work with the debtor company in establishing this plan as the alternative is that the business fails and the creditor will most likely receive far less, if anything, under those circumstances.
Although a Chapter 11 may provide for a business to stay in operation and restructure its debt to promote future success, it is much more lengthy and expensive than other bankruptcy chapters.
3. Chapter 13 – Adjustment of Debts of an Individual with Regular Income
A Chapter 13 bankruptcy is geared towards individuals with a regular income who are seeking to resolve their debt through a payment plan over a fixed period of time, typically three to five years. In a Chapter 13 a debtor must propose and have confirmed a “plan” for the payment of debts. The purpose of the “plan” is to allow for the repayment of a portion of the debts over the plan period. In order for the “plan” to be successful, it must first be approved by the court based on criteria set out in the Bankruptcy Code.
The “plan” is carried out by the debtor making periodic payments, usually monthly, to the bankruptcy trustee in a fixed amount for the life of the plan. The payment amount is typically determined by the debtor’s projected income over the period. The debtor must complete all payments required under the “plan” in order to receive a discharge. In addition, as a Chapter 13 bankruptcy provides for a repayment of some debts, a debtor may be able to eliminate more types of debt under a Chapter 13 than under other bankruptcy Chapters.
The Automatic Stay
One commonality between all of the aforementioned bankruptcy chapters is the initiation of the “automatic stay” upon the filing of a bankruptcy petition. The “automatic stay” is activated immediately upon the filing of a bankruptcy petition by a debtor. The purpose of the “automatic stay” is to immediately require the cessation of all collection activity and subject it to the oversight of the bankruptcy court. Creditors are prohibited from collection calls, initiating or continuing collection law suits, foreclosures, repossessions, garnishments and a variety of other collection activity while a debtor is under the protection of the “automatic stay.”
The “automatic stay” can be modified or lifted upon a creditor’s application to the court pursuant to an applicable section of the Bankruptcy Code. The automatic stay remains in effect until the debtor is discharged at the culmination of their bankruptcy. The “automatic stay” offers a significant and substantial protection to a debtor who is proceeding under bankruptcy and is strictly enforced. Creditors who are found to have willfully violated the automatic stay can be subjected to harsh penalties, and in some cases may even result in punitive damages. As a result, the “automatic stay” often provides the much needed relief from aggressive collection activity.
The bankruptcy discharge is the ultimate goal of a petition filed by an individual under any of the above Chapters. The effect of the discharge is to terminate all debts which were included in the bankruptcy. As mentioned above, upon the discharge, the protections afforded by the “automatic stay” terminate, however these protections are replaced by the permanent status of the discharge which prohibits those same creditors from commencing or continuing any collection activity with respect to discharged debt.
Although if used properly bankruptcy can provide substantial relief, it is not always the best option for an individual. At Leighton & Abdo, PLLC we strive to provide all of our clients with a comprehensive analysis tailored to their individual needs enabling our clients to make well-informed decisions that are right for their individual circumstances. All of our consultations are handled by a licensed attorney experienced in bankruptcy and debtor and creditor rights. If you have any questions regarding bankruptcy or would like to set up an appointment to discuss whether bankruptcy is right for you, please contact our office at (480) 947-1403.