What is bankruptcy – Definition, types, functions, and how to file one

What is bankruptcy?

bankruptcy

Whenever you have confusion in your mind about what bankruptcy is, it will be necessary for you to understand the Bankruptcy definition and its different aspects. Bankruptcy, commonly known as insolvency, is a legal financial status of common people, organizations, and governments of any country. These entities may declare themselves bankrupt when they have more debts than existing funds to repay. Bankruptcy also indicates a financial, legal process initiated by a common man or debtor, who has an unsustainable level of debts, to resolve his/her financial issues, and get protection from creditors, by a bankruptcy court order.

As per the Title 11 of the United States Code, there are several forms of bankruptcy available in the U.S. The bankruptcy process provides options to the debtors to resolve their financial liabilities which they can’t fulfill. To get debt forgiveness, debtors have to submit all of their assets in front of the bankruptcy court and have to surrender most of their wealth to repay their debts. That remaining wealth will be used to pay the creditors so that a part of their loans will be repaid.

As soon as you file for bankruptcy, your creditors can’t take any legal action against you to recover the outstanding debts. Filing bankruptcy will stop multiple debt recovering activities such as repossessions, foreclosures, and wage garnishment. But, along with those benefits filing bankruptcy can negatively affect your credit profile. Apart from that you might find difficulties getting credit cards, loans, home loans, your insurance premiums may increase, your rental application may get rejected, and you may even be denied a job.

In our country, the federal courts handle all bankruptcy cases and all decisions are made by bankruptcy judges. The bankruptcy court will decide whether you, the debtor, are eligible to file bankruptcy, and whether or not your debts will be discharged.

Bankruptcy can allow you a fresh start, but a Chapter 7 bankruptcy will remain on your credit report for 10 years, and a Chapter 13 bankruptcy will stay there for 7 years.

When should you file for bankruptcy?

Bankruptcy law is meant for consumers who are carrying an unaffordable amount of debt, due to credit cards, payday loans, big medical bills, personal loans, civil judgments (except for fraud), past-due rent, past-due utility bills, business debts, old tax debts, or any other unexpected expenses. Filing bankruptcy helps the consumers to make a fresh start, but the associated process may be lengthy and difficult.

Financial experts would suggest you avoid bankruptcy if you have the chance. To get out of your debts you may opt for some other debt relief options and manage your finances, rather than filing bankruptcy. However, you have the legal right to get help from the bankruptcy court if your debts are unmanageable.

You may file for bankruptcy if:
  • 1 Your debts are far greater than your existing assets
  • 2 You’ve failed to manage your finances even after having sessions with a credit counselor
  • 3 The creditor won’t agree to help you with other affordable options
  • 4 You want to get rid of annoying collection calls
  • 5 You have received a foreclosure notice, and you are about to lose your home
  • 6 You are facing a lawsuit, and you want to stop it
  • 7 You have a judgment and facing a wage garnishment

How does bankruptcy work?

As per uscourt.gov, the bankruptcy process is described below:

The procedural aspects of the bankruptcy process are governed by the Federal Rules of Bankruptcy Procedure (often called the “Bankruptcy Rules”) and local rules of each bankruptcy court. The Bankruptcy Rules contain a set of official forms for use in bankruptcy cases. The Bankruptcy Code and Bankruptcy Rules (and local rules) set forth the formal legal procedures for dealing with the debt problems of individuals and businesses.

There is a bankruptcy court for each judicial district in the country. Each state has one or more districts. There are 90 bankruptcy districts across the country. The bankruptcy courts generally have their own clerk’s offices.

The court official with decision-making power over federal bankruptcy cases is the United States bankruptcy judge, a judicial officer of the United States district court. The bankruptcy judge may decide any matter connected with a bankruptcy case, such as eligibility to file or whether a debtor should receive a discharge of debts. Much of the bankruptcy process is administrative, however, and is conducted away from the courthouse. In cases under chapters 7, 12, or 13, and sometimes in chapter 11 cases, this administrative process is carried out by a trustee who is appointed to oversee the case.

A debtor’s involvement with the bankruptcy judge is usually very limited. A typical chapter 7 debtor will not appear in court and will not see the bankruptcy judge unless an objection is raised in the case. A chapter 13 debtor may only have to appear before the bankruptcy judge at a plan confirmation hearing. Usually, the only formal proceeding at which a debtor must appear is the meeting of creditors, which is usually held at the offices of the U.S. trustee. This meeting is informally called a “341 meeting” because section 341 of the Bankruptcy Code requires that the debtor attend this meeting so that creditors can question the debtor about debts and property.

A fundamental goal of the federal bankruptcy laws enacted by Congress is to give debtors a financial “fresh start” from burdensome debts. The Supreme Court made this point about the purpose of the bankruptcy law in a 1934 decision:

[I]t 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.

Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934). This goal is accomplished through the bankruptcy discharge, which releases debtors from personal liability from specific debts and prohibits creditors from ever taking any action against the debtor to collect those debts. This publication describes the bankruptcy discharge in a question and answer format, discussing the timing of the discharge, the scope of the discharge (what debts are discharged and what debts are not discharged), objections to discharge, and revocation of the discharge. It also describes what a debtor can do if a creditor attempts to collect a discharged debt after the bankruptcy case is concluded.


What are the types of bankruptcies?

In the United States, you may file for bankruptcy through multiple chapters of the Bankruptcy Code. These chapters will denote the types of bankruptcies suitable for your different financial situation. Let’s have a look:

  • Chapter 7 – This bankruptcy process involves asset liquidation
  • Chapter 11 – This process helps companies or individual reorganizations to manage debts and finances
  • Chapter 13 – This process may provide debt repayment options through low and easy payment plans.
  • Other Bankruptcy Filings – You may find other chapters of bankruptcy which will meet specific consumer requirements. Chapter 9 bankruptcy is tailored for financially distressed municipalities, such as cities, towns, villages, counties, and school districts.
    Chapter 10 bankruptcy, ended in 1978, was a type of corporate bankruptcy and has few similarities to Chapter 11.
    Chapter 12 bankruptcy is helpful for family owned farms, and fisheries.
    Chapter 15 bankruptcy was included in the law in 2005, for dealing with cross-border cases, involving few parties such as debtors, assets, creditors, and others.

As per uscourts.gov, Total Bankruptcy Filings By Chapter, Years Ending June 30, 2016-2020:

Bankruptcy chapter Year 2020 Year 2019 Year 2018 Year 2017 Year 2016
7 440,593 479,043 479,151 489,011 509,769
11 7,355 7,007 7,141 6,999 7,928
12 580 535 475 482 459
13 233,644 286,635 288,741 299,398 300,858

Normally, common individuals have to deal with two kinds of bankruptcies: Chapter 7 and Chapter 13.

Declaring bankruptcy Chapter 7 or 13

1) Chapter 7 Bankruptcy

According to the American Bankruptcy Institute (ABI), 63% of the 774,940 bankruptcy cases filed in 2019, were Chapter 7. Common people who have huge debts and zero assets to liquidate can typically file Chapter 7 bankruptcy. Through this process, you may remove your unsecured debts by selling nonexempt assets. The non-exempt assets may include second homes, cash, stocks, bonds, cars, real estate, etc. These should be liquidated to repay some or all of the unsecured debts.

You have to pass a “bankruptcy means test’’ to qualify for Chapter 7 bankruptcy. Through the means test, your financial records, such as income, expenses, secured and unsecured debt will be analyzed. This way it will be determined that you have enough disposable income to repay your debts.

As per justice.gov, the bankruptcy means test includes:

Most individual debtors filing for bankruptcy relief are required to complete a version of Bankruptcy Form 122. Official Form 122A-1 (Chapter 7 Statement of Your Current Monthly Income), Official Form 122A-1Supp (Statement of Exemption from Presumption of Abuse Under § 707(b)(2)), and Official Form 122A-2 (Chapter 7 Means Test Calculation) (collectively the “122A Forms”) are designed for use in chapter 7 cases. Official Form 122C-1 (Statement of Your Current Monthly Income and Calculation of Commitment Period) and Official Form 122C-2 (Chapter 13 Calculation of Your Disposable Income) (collectively the “122C Forms”) are designed for use in chapter 13 cases. [The Official Bankruptcy Forms can be found on the Administrative Office of the U.S. Courts Website.]

A debtor must enter income and expense information onto the appropriate form (i.e., the 122A Forms or the 122C Forms) and then make calculations using the information entered. Some of the information needed to complete these forms, such as a debtor’s current monthly income, comes from the debtor’s own personal records. However, other information needed to complete the forms comes from the Census Bureau and the Internal Revenue Service (IRS). This Web site reproduces the Census Bureau and IRS Data necessary to complete the 122A Forms and the 122C Forms. The source data reproduced here is also available directly from the IRS and Census Bureau using the links at the bottom of this page.

For questions related to this data, e-mail: ust.mt.help@usdoj.gov. For general assistance in filing for bankruptcy relief, the clerk of your local bankruptcy court or your local state Bar Association may have information regarding individuals or organizations offering bankruptcy related services, including on a reduced fee or pro bono basis. However, we and the clerk of your local bankruptcy court are prohibited from providing any legal advice.

Normally, the Chapter 7 process gets completed within four to six months, so you will be out of your misery within that period. Do not forget to consult a bankruptcy attorney before filing bankruptcy chapter 7.

Eligibility criteria:
  • Your debts are far greater than yYou must be a resident of the USA.
  • Your monthly income should be less than the average disposable income in your state.
  • You aren’t granted discharge by Chapter 7 within the last 8 years.
  • Your bankruptcy filing hasn’t been dismissed for any reason within the last 180 days.
  • You aren’t trying to hide, transfer, or destroy your properties, and aren’t trying to manipulate your creditors or the court trustee in your case.

Discharged/un-discharged debts in Chapter 7 bankruptcy:

  • Chapter 7 dischargeable debts
  • Credit card debt
  • Medical bills
  • Auto accident claims
  • Business debts
  • Personal loan
  • Judgments
  • Leases
  • Mortgage or automobile loans that you can no longer pay (Repossession deficiencies)
  • Any other form of unsecured debt
  • Chapter 7 non-dischargeable debts
  • Student loans
  • Child or family support
  • Alimony
  • Back taxes
  • Trust fund taxes
  • Court fees and penalties
  • Homeowner Association fees
  • Any unfiled unsecured debts
  • Criminal fine or restitution
  • Debts due to personal injury or accident claims that involve intoxication
  • Debts listed in previous bankruptcy where you were denied a discharge
  • Affect on credit score:

    Affect on credit score

    A Chapter 7 bankruptcy will stay on your credit report for long 10 years. All debts added in the Chapter 7 bankruptcy are discharged within 4 to 6 months of filing. Normally discharged debt drops off a credit report after 7 years.

    Chapter 7 has a severe negative impact on your credit score, and it can drop your credit score by almost 200 points. Due to the low credit score, most lenders and financial institutions would consider you as a high credit risk individual.

    With time, debts and negative items associated with the chapter 7 bankruptcy will have less effect on your credit score.

    2) Chapter 13 Bankruptcy

    Your credit score will get a moderate hit with this bankruptcy. Chapter 13 bankruptcy is focused on people who can pay off their debts within 3-5 years. That’s why it is called a “Wage earner’s bankruptcy.”

    You may keep your non-exempt properties and pay back your creditors via an easy repayment plan. For this, you need to discuss this with your bankruptcy attorney and the creditor. This legal process is governed by the bankruptcy court. Under Chapter 13 bankruptcy, if you have a regular source of income, you may pay off the debts of 3-5 years.

    Eligibility criteria:

    • You should have a regular source of income and submit the information to the court within 14 days of filing a petition.
    • You shouldn’t have more than $250,000 in unsecured debt and more than $750,000 in secured debt.
    • You need to be current in your tax filings. You must submit proof to your filed state and federal tax returns for the past four years.
    • Your debts and income statements will be reviewed and a hearing will be scheduled to decide whether or not your proposed repayment plan is acceptable.

    Discharged/undischarged debts in Chapter 13 bankruptcy:

  • Chapter 13 dischargeable debts
  • Certain income tax debts
  • Credit card debts
  • Personal loans
  • Mortgage
  • Debts due to fraud, false representations, embezzlement, or larceny
  • Debts incurred by willful and malicious injury to another person or their property
    • Chapter 13 non-dischargeable debts
    • Maintenance and support obligations
    • Long term debts such as a home mortgage
    • Debts for alimony
    • Government-funded or guaranteed educational loans
    • Debts incurred due to death or personal injury caused by driving as a result of intoxication or under the influence of drugs
    • Payments imposed on the debtor due to criminal convictions

    Affect on credit score

    A completed Chapter 13 bankruptcy will remain on your report for up to 7 years, and discharged debts will also stick on the report up to 7 years after they are discharged. Many debts will be active in a Chapter 13 bankruptcy until the end of a three to five-year repayment plan.

    With Chapter 13, you’re making payments on some or all of your debts. So, it won’t damage your credit as much as chapter 7 does. Your payment history will be good, so future lenders won’t neglect you as a high-risk consumer.

    How do you file for bankruptcy?

    Filing for bankruptcy is a legal process that helps you to reduce your debts, restructures your financial status, and eliminates all the interaction with creditors. But the bankruptcy court will decide whether or not you are eligible to get that opportunity. You may file for bankruptcy on your own, or you may take help from a professional bankruptcy attorney, which most experts will suggest you do.

    How much does it cost to file bankruptcy?

    Bankruptcy costs may include attorney fees and filing fees to the court. If you file on your own, then also you have to bear filing fees

    As per the national bankruptcy forum, bankruptcy costs may include:

    Bankruptcy Services Cost
    Chapter 7 filing fee $335
    Chapter 13 filing fee $310
    Conversion from Chapter 7 to Chapter 13 Free
    Conversion from Chapter 13 to Chapter 7 $25
    Credit counseling/financial management course $20-$100
    Total cost pro se (filing on your own), with a low success rate $350-$450
    Total cost Chapter 7 with attorney $1,500-$3,000
    Total cost Chapter 13 with attorney $3,000-$4,000

    Updated as on – Apr, 2020

    Things to do before filing bankruptcy:

    • Analyze your financial situation and opt for a suitable budget
    • Choose a suitable debt relief program and try to get out of debt faster
    • Categorize your debts as per the priority and set up alternative payment plans by negotiating with creditors
    • Select a credit counseling agency and opt for a pre-bankruptcy counseling
    • Consult a bankruptcy attorney before declaring bankruptcy

    The steps to filing bankruptcy:

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    Gather and analyze financial records

    List your debts, assets, income, expenses, and other financial records. You may also provide that information to the court for a better understanding of your situation.

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    Opt for credit counseling within 180 days before filing

    You can’t file for bankruptcy until you’ve opted for pre-bankruptcy counseling. The counselor should be from an approved one listed on the U.S. Courts website. After the counseling, you will receive a certificate of completion. The certificate must be included within the documents you submit for filing bankruptcy. If you skip this step, your filing will be rejected.

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    File the petition

    It is better to hire a bankruptcy attorney as it would reduce the risk of representing yourself if you have limited knowledge about federal and state bankruptcy laws. Judges will not give you advice in your case, so you need professional support from your end. If you don’t know and follow the proper procedures and rules in court, it might destroy your case and your finances totally.

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    Communicate with creditors

    As soon as your petition is accepted, your case will be assigned to a court trustee, who will arrange a meeting with your creditors. You must attend that meeting. There, the court will ask you questions about your case.

    Conclusion

    In this piece of content, bankruptcy and its different factors are explained. But, apart from this information, there are multiple more characteristics and aspects of bankruptcy that you have to know.
    While filing bankruptcy, you might have to face different scenarios and legal challenges, which you might not be able to answer at all. Therefore, it is always suggested that before filing bankruptcy, you should consult a bankruptcy attorney for proper bankruptcy information. The process will include a lot of paperwork and legal formalities, which a professional attorney can handle efficiently.