A GUIDE TO BANKRUPTCY

Bankruptcy

By: Akanksha A. Panicker

A misconception exists that bankruptcy is caused by inescapable debt as a last resort when an individual cannot meet debt obligations and has taken on too much credit. However, bankruptcy can also be filed after suffering a major unexpected financial blow. Bankruptcy does not magically waive all debt, and the debtor is still required to pay. However, the method of payment depends on the type of bankruptcy filed. 

The United States governs bankruptcy via federal law, commonly called the Bankruptcy Code, deriving authority from the US Constitution to enact uniform law. Some laws relevant to bankruptcy are found in other parts of the United States Code; however, with bankruptcy crimes being found in Title 18 of the United States Code (Crimes), tax implications of bankruptcy are found in Title 26 of the United States Code (Internal Revenue Code). The creation and jurisdiction of bankruptcy courts are found in Title 28 of the United States Code (Judiciary and Judicial procedure).

[1.0] INTRODUCTION

Bankruptcy cases are filed in United States Bankruptcy Court (units[1] of the United States District Courts), and federal law governs procedure in bankruptcy cases. However, state laws are often applied to determine how bankruptcy affects the property rights of debtors. For example, laws governing the validity of liens or rules protecting certain property from creditors (known as exemptions) may derive from state law or federal law. Because state law plays a major role in many bankruptcy cases, it is often unwise to generalize some bankruptcy issues across state lines.

What happens when bankruptcy is filed

An automatic stay puts a block on the debt of the individual filing for bankruptcy, which essentially protects them from creditors and collections agencies from pursuing them for what they owe. This means that there is no garnishing of wages and no confiscation of secured assets during the stay.

A debtor is required to file a petition in bankruptcy court to initiate proceedings.  Filing bankruptcy can help a person by discarding debt or making a plan to repay debts.

[2.0] HOW TO FILE FOR BANKRUPTCY

Before filing for bankruptcy, it is necessary to attend a council meeting with a credit counseling organization approved by the Department of Justice’s U.S. Trustee Program. The meeting helps gauge the individual’s financial situation and can educate them as to alternatives to bankruptcy. Furthermore, this can help in the creation of a budget plan. According to the Federal Trade Commission, the counseling session is free for individuals who cannot actually pay for the same, although the standard cost is USD 50.  Obtaining a credit report at this juncture provides insight into the state of the individual’s finances. 

Moreover, every person who files for bankruptcy has to take a credit-counseling course in the 6 months or 180 before their bankruptcy petition is filed with the court in both Chapter 7 and Chapter 13 cases. The course has to be taken through a credit counseling agency approved by the Department of Justice. For discharge of debts, a debtor education course must be taken. Finally, before filing, a creditor’s meeting is required to take place between the individual filing bankruptcy, the bankruptcy trustee, and any attendant creditors. The meeting provides an opportunity for the attendees to question the debtor regarding their decision to file bankruptcy and really comprehend their financial situation. This meeting is termed the 341 meetings. 

The filing fee for the federal racks up a bill of USD 338 for a Chapter 7 bankruptcy., collected at the time of filing the bankruptcy petition with the court. Payment can either be upfront or if the debtor is unable to pay at the time or installments after the case is filed. Up to four monthly payments can be provided. However, if the debtor cannot pay in installments, they can apply for a fee waiver as long as their household income is under 150% of the federal poverty line. However, the denial of the application would require the debtor to pay the sum in installments. 

[2.1] LISTING DEBTS OWED

An inventory of creditors is required to be supplied to the court by the debtor. This is necessary to form a priority list for the repayment of the debts. Debts may be grouped into [A.] secured debts and [B.] unsecured debts. 

In secured debts, the creditor has an actual security interest in property put up as collateral. These include loans like mortgages or car loans, where the collateral is the home or the car. Unsecured debts do not have any property or collateral. They are consequently seen as less pressing by the bankruptcy court since failure to pay an unsecured debt does not have the failsafe collateral to fall back on. 

The bankruptcy court will then issue a discharge, which effectively relieves the individual from liability to pay debts and freezing any collection activity or legal activity by the creditors since the discharge prevents them from enacting further claims. The court is required to send the creditors and the  U.S. Trustee Program at the Department of Justice a notice communicating discharge, since any creditor who attempts to collect a debt after the notice can be penalized. 

Chapter 7 bankruptcy can see discharge issued within six months (typically four) after the bankruptcy petition, contrasting with Chapter 13 bankruptcy, wherein discharge is filed after the payment plan. 

[3.0] TYPES OF BANKRUPTCY

[3.1] CHAPTER 7

Chapter 7 of the Bankruptcy Code is the most common form of bankruptcy in the United States, primarily centers around liquidation. It espoused liquidation, initiating the process by appointing a trustee to collect the assets that are non-exempt of the debtor. This trustee is appointed by the bankruptcy court and is required to sell the assets to accrue the funds to pay the creditors in order of preference. Businesses and individuals in the United States can file for bankruptcy in federal court under Chapter 7.

A company often files for bankruptcy if it is troubled or if advised by the creditors. This means that the business essentially is out of existence when the petition is filed. However, it can still subsist if the court-appointed trustee decides to continue operations. A swathe or even a company division can be sold to retain enough funds to pay creditors, beginning with the secured creditors. The company’s assets already exist as collateral for the credit advanced to the liquidating company. 

Individuals are allowed to keep exempt properties, though they need to adhere to certain specifications to be protected from the exemption.  Some considered subordinate debts are discharged because they are unsecured, and other forms of debt take priority. These are called junior tranche debts since they may be leftover after senior debt paying for the creditors. Due to the high risk associated with the junior tranche, this debt carries a lower credit rating. It pays a higher interest rate than the senior tranche to compensate its holders for the additional risk.

An amendment was made to the bankruptcy law in 2005 with the passing of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005, created to limit consumer debtors from filing bankruptcy in general. 

Chapter 7 debtors do not always have to liquidate their property (unless it’s collateral) because it’s usually exempt or just not worth it. Often, cumbersome property means that the trustee may “abandon” the property, allowing the individual to retain the same even in cases of non-exemption. 

Liquidation can occur only after the creditors who are owed a meeting. The trustee calls for the meeting, and if the vote goes for liquidation, the property is either surrendered or paid for in an equivalent cash value to pay back the debt.

The means test helps in determining whether Chapter 7 or 13 bankruptcy must be filed. The means test compared the average income of the individual filing for bankruptcy over the previous six months alongside the median income for a household of equivalent size in the state. If the individual’s earnings fall below the median, they are eligible for chapter 7 bankruptcy.

However, even if the income is higher than the median, one can still be eligible under chapter 7. This would be done after deducting certain allowable expenses. This will not hold if the individual has enough remaining disposable income to repay their debts.

[3.2] CHAPTER 11

Chapter 11 bankruptcy is the most complex form of bankruptcy and is mostly filed by businesses that require time to restructure their debts. Dubbed reorganization bankruptcy, Chapter 11 involves reorganizing a  debtor’s business affairs, debts, and assets. For that reason, it is known as “reorganization” bankruptcy, allowing the debtor a fresh start dependent on their satisfaction of their liabilities under the plan of reorganization. Higher-income individuals who want to retain their property can also file for a chapter 11 bankruptcy. If they fall outside a chapter 13 bankruptcy chapter, 11 case petition must be filed with the bankruptcy court serving the area where the debtor has a domicile residence. This petition may be voluntary or involuntary, dependent on whether the debtor or the creditor files it.   Dependent on the same, the required forms must be filled. A voluntary petition would require the attachment of Form 1 of the Official Forms prescribed by the Judicial Conference of the United States.

It is necessary to also file [A.] schedules of assets and liabilities; [B.] a schedule of current income and expenditures;  [C.]  a schedule of executory contracts and unexpired leases; and [D.]  a statement of financial affairs. Additional documents need to be filed with the court depending on whether the debtor is a person rather than a company or married. For individuals or people who are married, there are further requirements, including [A.]: a certificate of credit counseling and a copy of any debt repayment plan developed through credit counseling; [B.] evidence of payment from employers, if any, received 60 days before filing;  [C.]a statement of monthly net income and any anticipated increase in income or expenses after filing; and [D.]a record of any interest the debtor has in the federal or state qualified education or tuition accounts. However, married people don’t have to file a joint petition and file for bankruptcy individually. 

A business in the midst of filing Chapter 11 may continue to operate. In most cases, the debtor called a “debtor in possession,” runs the business as usual. However, in cases involving fraud, dishonesty, or gross incompetence, a court-appointed trustee steps in to run the company throughout the entire bankruptcy proceedings. 

[3.3] CHAPTER 13

With chapter 13, a debt plan must be followed. Some debts, called priority debts, need to be paid in full, including alimony, child support, tax obligations, and wages owed to employees. This depends on how much is owed and the income level of the individual declaring bankruptcy. However, it provides detailed instructions on how much should be paid and when it has to be paid.  

Chapter 13 is often called a wage earner’s reorganization since debtors must submit and follow through with the plan within three to five years.  The plan must be consistent and substantial payback to the creditors be assured, even if it takes up the entirety of the debtors’ disposable income. The payback must be at least equal to what creditors would receive under other forms of bankruptcy. An exhaustive list of creditors must consequently be compiled with inventory regarding the amount owed to each property owned, with a record of the individual’s income sources and monthly expenses. Furthermore, credit counseling should have been completed.

Upon determining the plan’s financial situation and conduct, the debtor is required to pay the monthly amount to an appointed, impartial bankruptcy trustee, who is responsible for distributing money to the creditors equitably. However, debtors have no direct contact with creditors under Chapter 13 protection.

There is an eligibility criterion to avail of Chapter 13 bankruptcy. If the individuals have [A.] unsecured debt under USD 419 274 or [B.] secured debt of under USD 1,257,850, they are eligible for Chapter 13 bankruptcy. However, increases to the same are likely and come in three-year intervals.

[4.0] IMPACT OF BANKRUPTCY 

The main impact of bankruptcy can be seen on one’s credit score.  There is a steep plummet in one’s credit score after any bankruptcy filing. With more accounts involved, the graver the impact on the score. This can make it more difficult to obtain a credit card, car loan, or mortgage, impacting the individual’s insurance rates or rent acquisition.  In general, a chapter 7 bankruptcy will remain on your credit report for 10 years, and chapter 13 stays on for seven.

Most debts in bankruptcy are discharged. However, some debts are more difficult to get rid of than others, including tax debts, alimony, and divorce-related debts. Furthermore, student loans can be discharged only after a federal test for hard-ship has been passed. 

A bankruptcy alternative is negotiating with creditors to work out a payment plan or another arrangement to pay off debts. Even though bankruptcy is not as dire as it is made out to be, alternatives can be worth exploring before declaring bankruptcy.  This is a good way to avoid a negative credit score marring the report. Negotiations with creditors is often a route to pursue, wherein creditors are more comfortable with a reduced period over a longer period of time rather than waiting for a bankruptcy settlement.  Since there is prioritization in repayment, creditors run the risk of getting nothing and, consequently, are more likely to accept a side-payment plant.

For outstanding loans and engagements like a mortgage, interacting with loan servicers is important to understand the options available. Some lenders are accommodating enough to postpone payments for a period of time, enacting forbearance, but others can help devise a loan repayment or modification program. This would allow for smaller payments over a period or a change in Sloan’s loan’s interest rate to make it easier to repay. 

Sometimes, negotiations may even be done with the Internal Revenue Service, wherein an offer in compromise can also be included. Payment plans are also in function in the IRS, which would allow eligible taxpayers to pay taxes over a period of time.

[4.1] HOW TO RECOVER AFTER BANKRUPTCY

As mentioned above, bankruptcy will remain on a credit report for either seven years (in the case of Chapter 13) or 10 years (Chapter 7). The first step to recovering after bankruptcy is simple: the credit report should show a $0 balance for any accounts that have been discharged through bankruptcy. This can also prevent continual reportage of negative account information by creditors even after discharged bankruptcy. Engaging with credit repair companies is not advisable if the bankruptcy report is accurate; however, there is nothing these companies can legally do for an individual. 

A tool to reinstate good credit for individuals is a secured credit card, where a deposit is made with the issuing bank to develop into a credit line. Responsible usage of that card can establish a better credit history, and regular payments on time can even allow for a regular, non-secured credit card.

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Sources

1.2005—Pub. L. 109–8, title VIII, § 801(b), title X, § 1007(d), Apr.

2. (Article 1, Section 8, Clause 4) authorizes Congress to enact “uniform Laws on the subject of Bankruptcies throughout the United States.”

3.U.S. Trustee Program. (2020, October 16). Retrieved December 04, 2020, from https://www.justice.gov/ust

4.2005—Pub. L. 109–8, title I, § 102(k), title VII

5.122A-2 Form.

6.United States Courts. “Chapter 11 – Bankruptcy Basics.” Accessed December 4, 2020.

7.11 U.S.C. §§ 301, 303.

8.Fed. R. Bankr. P. 1007(b)

9.11 U.S.C. § 521.

10.11 U.S.C. § 302(a)

11.Federal Register. “Revision of Certain Dollar Amounts in the Bankruptcy Code Prescribed Under Section 104(a) of the Code.” Accessed December 4th, 2020.

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