BANKRUPTCY-BASIC INFORMATION
FOR CONSUMERS

by BRUCE R. EPSTEIN, J.D.

INTRODUCTION

Bankruptcy is a judicial process for businesses and individuals to address financial difficulties through reorganization, liquidation and discharge. The United States Bankruptcy Court is a part of the Federal judicial system and applies the provisions of the Federal Bankruptcy Code to the cases filed in that Court.

Roots of the Bankruptcy concept are noted as long ago as in Leviticus of the Old Testament. While American Bankruptcy law dates back to 1800, the current statutes governing Bankruptcy are the Bankruptcy Code found at Title 1]. of the United States Code, as enacted by Congress. These statutes are periodically revised and constantly undergo interpretation by the Courts. This results in an aver changing and adapting body of law.

BANKRUPTCY CODE:

Title 11 of the United States Code is a book divided into chapters, hence the designation of different types of Bankruptcy by chapter number, e.g. “Chapter 7” or “Chapter 11”. Chapters 1, 3, and 5 contain provisions applicable in the various types of Bankruptcy actions which can be pursued. Chapter 1 consists of general provisions and includes definitions. Chapter 3 covers administrative concepts such as commencing cases, hiring professionals, appointment of Trustees, and administrative powers. Chapter 5 deals with the creditors and their claims, duties of the debtors, and determining the scope and nature of the bankruptcy estate. Chapter 7 governs the liquidation provisions. Chapter 9 governs municipality bankruptcies. Chapter 11 is reorganization, primarily designed for businesses. Chapter 12 is for family owned farms. Chapter 13 governs adjustment of debts for individuals with regular income.

PARTIES:

The main “players” in Bankruptcy are the “Debtor”, “Creditors”, “Trustee”, "Clerk of Court” and "Bankruptcy Judge”. The Debtor is the person or entity which owes debts it is unable to repay as they come due. The Creditors are those to whom the debts are owed and are categorized according to the nature of the debt. The Trustee serves different purposes in the different Chapters, ranging from the person who administers the collection and liquidation of assets for distribution, to the person who runs a business in reorganization. The Clark of Court operates a staff which maintains the documents and records of the proceedings as an administrative function. The Bankruptcy Judge fulfills the judicial function which includes presiding over trials on issues germane to the Bankruptcy process and confirming plans of reorganization.

TYPES OF BANKRUPTCIES:

On a basic level, Bankruptcy can be divided into liquidation cases and reorganization cases. In liquidation a person’s or entities assets are converted into cash and are applied to the obligations to the extent such funds are available. Reorganization involves a restructuring of the debts and may be done in a variety of ways such as payments over time, or exchanging ownership in the Debtor business to offset the debts.

Bankruptcy may also be divided into the classifications of consumer cases or business cases. This classification depends on whether the majority debts arise from the operation of a business by the Debtor.

For consumers, Bankruptcy consists of two principal options, Chapter 7 Liquidations and Chapter 13 Repayment Plans. Many basic concepts of Bankruptcy and procedures apply to both Chapters.

PROCEDURE:

Bankruptcy is initiated by the filing of a Voluntary Petition with the Clerk of the United States Bankruptcy Court in the District where the Debtor resides. The documents to be filed include a Schedule of Debts, classified as secured (where there is a lien or security interest of the creditor in some asset belonging to the Debtor); priority (such as certain tax obligations); and unsecured. The sets of the debtor are listed and valued, and any allowable exemptions are claimed. A budget is filed showing all sources of income on a monthly basis and projected living expenses. A statement of financial affairs provides general information of current and recent financial activity. The Statement of Intentions indicates how the Debtor plans to address secured debts.

Immediately upon filing the Debtor is protected by what is termed the “Automat!; Stay”. This stay prohibits any action by creditors to collect a debt from the Debtor or his assets. Creditors are thus required to stop making demands for payment, cannot proceed with pending law suits, cannot continue with wage garnishments, foreclosures, or repossessions. Under proper circumstances the creditors may obtain approval of the Bankruptcy Court to terminate the “stay” to pursue specific property.

Notice of the Bankruptcy filing is sent to all creditors, generally done by the Court or Trustee. There is some variance in the local rules on service of notice. A Hearing known as the Meeting of Creditors, or 341 Hearing is scheduled between 20 and 40 days after the filing. This is conducted by the Trustee and affords an opportunity for creditors and the Trustee to examine the Debtor under oath. In many cases this is the Debtor’s only formal contact with the Court.

CHAPTER 7:

CHAPTER 7: The goal of Chapter 7 is to discharge or eliminate the obligation to pay on debts and thus obtain a “fresh start”. One cost of wiping the slate clean is the risk that the Debtor may have to relinquish some of his or her assets. The equity in Debtor’s assets, i.e. the amount by which the value exceeds any lien or exemption is subject to liquidation (sale) by the Trustee to produce cash for disbursement to the creditors. Disbursements are made according to a statutory order of priority with all creditors in one class receiving pro-rata payment before there is distribution to the next class of priority.

In furtherance of the goal of a “fresh start” the Bankruptcy Code does not require that the Debtor give up all worldly possessions and start over with nothing. The Debtor is allowed to exempt or protect from liquidation, certain dollar values of equity in various categories of assets. For example, if the Debtor’s residence is worth $75,000.00 and has a mortgage of $65,000.00, then there is equity of $10,000.00 which may be claimed by the Trustee for the benefit of the creditors. If the allowed exemption for residential property is $10,000.00 or more, then the Trustee will not sell the residence since the exempt amount belongs to the Debtor. Caveat: Congress permitted each State to elect to apply the Federal exemptions set forth in the Bankruptcy Code or to opt-out and apply the State’s own exemptions. Accordingly, you must determine what exemption amount your State allows for each class of assets you own.

The Debtor’s treatment of secured debts in Chapter 7 generally follows one of three options. First, collateral may be surrendered, in which case the Debtor no longer has any debt to that creditor, even if the collateral is subsequently sold for less than the amount owed. Second, the Debtor may redeem the asset by paying the fair market value to the creditor, up to the amount of the debt. If the redemption amount is less than the amount owed, the balance is discharged by the Bankruptcy. Third, the Debtor may reaffirm the debt whereby a negotiated rewriting of the loan takes place. Note that this requires agreement by both Debtor and Creditor as to the terms of payment. Note that there are circumstances in which a separate action can be taken in the Bankruptcy Court to avoid or eliminate certain types of liens. If successful, then the creditor becomes treated as unsecured and is not entitled to any of the three previously listed options.

The Bankruptcy Code lists a variety of exceptions to discharge. For consumers the more common issues include the following: certain tax liabilities; fraudulently obtained money or services; willful or malicious injury to another or another’s property; luxury goods or services, or cash advances obtained within a short time prior to the filing; alimony and spousal or child support; certain student loans; death or personal injury caused by a driver under the influence of alcohol, drugs or other substance. Some of the exceptions to discharge are automatic, while others require the affected creditor to file an Adversary action in the Bankruptcy Court within strict time limits.

CHAPTER 13 :

CHAPTER 13: This section of the Bankruptcy Code is known as the reorganization provision for individuals (although it may be used by some unincorporated small businesses). The automatic stay affords relief from collection pressures while the repayment plan is formulated and implemented. Repayment may span a period of time up to five years. Depending on factors such as the value of equity in assets, the Debtor’s budget, and classification of the debts, the treatment of the creditors may range from 100% repayment to a very minimal percentage paid over time. Unmatured interest is not paid on unsecured debts and contracts may be modified as to most secured debts. Formulation of a Chapter 13 repayment plan, even where paying 100%, generally results in a significant reduction in the monthly cash outlay while retaining all assets.

There are various reasons for employing Chapter 13. First, if the Debtor has the ability to pay the debts, though at an adjusted monthly rate, the Debtor may choose this option. If the Debtor has this ability to pay, the Court may refuse to allow discharge in Chapter 7 as an option. Second, where the Debtor has unprotected equity in assets, rather than have the asset liquidated and the proceeds paid to creditors in administration of the Chapter 7 estate, the Chapter 13 Debtor can provide for the payment of that amount, over time, and retain the asset. Third, the Debtor may have debts that are nondischargeable in a Chapter 7, such as taxes or student loans. In the Chapter 13 Plan, the obligation may be paid in full at a monthly payment which fits the Debtor’s budget rather than the Creditor’s demanded rate of payment. Fourth, co­signed consumer debts can be paid in full over the life of the repayment plan with the cosigner protected from collection. Fifth, where the Debtor is in default on a residential mortgage, the arrearage can be cured over time in order to avoid, or stop, foreclosure. Likewise, a vehicle or other secured loan which is in default may be addressed over the term of the Chapter 13 Plan, rather than face immediate repossession if unable to bring the account current. Thus, Chapter 13 can allow the Debtor to retain collateral.

In Chapter 13, periodic payments are made by the Debtor to the Court appointed Trustee who then administers the funds and makes monthly disbursements to the creditors. Payroll deduction orders are often used for funding of the Plan. Eligibility for Chapter 13 does not require ”wages” but may include income from self-employment, social security or workers compensation benefits and other means.

TO FILE, OR NOT TO FILE:

Who should file Bankruptcy The first inquiry to be made is whether the potential filer has need to file. Is there an inability to meet the current debts as they become due? It is beneficial to carefully review the budget to see if there are sufficient funds to pay basic living expenses and to service the existing credit obligations through austerity and discipline. Are there alternatives such as refinancing existing debts, informal negotiation of accommodations with Creditors, supplementing income? Filing a Bankruptcy is a significant event and may have long range implications as to obtaining credit in the future. If the current credit is bad, or is headed toward repossession or foreclosure, it must be recognized that these too have long range implications to obtaining credit in the future. There is also a non empirical consideration, that being the benefit of relief from the stress which accompanies the debt and dealing with creditors who cannot be satisfied.

LEGAL REPRESENTATION?

Is an attorney necessary? There is no requirement in the Bankruptcy Code that an individual filing Bankruptcy be represented by an attorney. The Bankruptcy Petition involves completing forms, which are for the most part, straight forward. However, there are enumerable exceptions in the Code and areas for potential errors which can risk the Debtor’s obtaining a discharge of an individual debt or of any debts. Determining the correct Chapter for the specific circumstances may call for expertise in the field. In most areas of the country, Bankruptcy is a competitive field and that has generally kept costs down. Seeking professional assistance may be worthwhile and affordable.