Bankruptcy law

What Is Bankruptcy?

Basic information on Chapter 7 and Chapter 13 bankruptcy.

Bankruptcy is a federal court process designed to help consumers and businesses eliminate their debts or repay them under the protection of the bankruptcy court. Bankruptcies can generally be described as "liquidations" or "reorganizations."

Chapter 7 bankruptcy is the liquidation variety -- property is sold (liquidated) to pay off as much of your debt as possible, while leaving you with enough property to make a fresh start. Chapter 13 is the most common type of "reorganization" bankruptcy for consumers -- you repay your debts over three to five years.

Both kinds of bankruptcy have numerous rules -- and exceptions to those rules -- about what kinds of debts are covered, who can file, and what property you can and cannot keep.

 

• 1Liquidation -- Chapter 7
• 2Reorganization -- Chapter 13
  • 2.1Who Can File for Chapter 7 Bankruptcy?
  • 2.2Other Types of Reorganization Bankruptcy
  • 2.3NOLO - Bankruptcy Books
  • 2.4Consumer Bankruptcy Discussion Forum
  • 2.5Orher Links

[top]Liquidation -- Chapter 7

Liquidation bankruptcy is called Chapter 7, and it can be filed by individuals (a "consumer" Chapter 7 bankruptcy) or businesses (a "business" Chapter 7 bankruptcy). A Chapter 7 bankruptcy typically lasts three to six months.

In a liquidation bankruptcy, some of your property may be sold to pay down your debt. In return, most or all of your unsecured debts (that is, debts for which collateral has not been pledged) will be erased. You get to keep any property that is classified as "exempt" under the state or federal laws available to you (such as your clothes, car, and household furnishings). If you don't own much, chances are that all of your property is exempt and you have what is known as a "no asset" case.

If you owe money on a secured debt (for example, a car loan, where the car is pledged as a guarantee of payment), you have a choice of allowing the creditor to repossess the property; continuing your payments on the property under the contract (if the lender agrees); or paying the creditor a lump sum amount equal to the current replacement value of the property. Some types of secured debts can be eliminated in Chapter 7 bankruptcy.

Not everyone can file for Chapter 7 bankruptcy. For example, if your disposable income is sufficient, after subtracting certain allowed expenses and monthly payments for certain debts (including child support and debts that secure property), to fund a Chapter 13 repayment plan, you won't be allowed to use Chapter 7. For more on this and other requirements, see Who Can File for Chapter 7 Bankruptcy? below. For more information on Chapter 7 bankruptcy generally, see An Overview of Chapter 7 Bankruptcy.

Bankruptcy doesn't work on some kinds of debts. Though bankruptcy can eliminate many kinds of debts, such as credit card debt, medical bills, and unsecured loans, there are many types of debts, including child support and spousal support obligations and most tax debts, that cannot be wiped out in bankruptcy. For more information, see What Bankruptcy Can and Cannot Do.

[top]Reorganization -- Chapter 13

Chapter 13 bankruptcy is also known as "wage earner" bankruptcy because, in order to file for Chapter 13, you must have a reliable source of income that you can use to repay some portion of your debt. And to qualify for Chapter 13, your secured debts must be less than $922,975 and your unsecured debts less than $307,675.

When you file for Chapter 13 bankruptcy you propose a repayment plan that details how you are going to pay back your debts over the next three to five years. The minimum amount you'll have to repay depends on how much you earn, how much you owe, and how much your unsecured creditors would have received if you'd filed for Chapter 7.

If you have secured debts, Chapter 13 gives you an option to make up missed payments to avoid repossession or foreclosure. You can include these past due amounts in your repayment plan and make them up over time.

[top]Who Can File for Chapter 7 Bankruptcy?

Learn about eligibility rules for Chapter 7 -- including the new "means test."

Filing for Chapter 7 bankruptcy can be a powerful tool for dealing with overwhelming debt. But it isn't available to everyone. Here are some situations in which you will not be allowed to file for Chapter 7.

You Can Afford a Chapter 13 Plan

Under the old bankruptcy rules, the bankruptcy judge had the power to dismiss a Chapter 7 case if he or she thought the debtor had sufficient disposable income to fund a Chapter 13 repayment plan. There were no hard and fast rules dictating when a judge should dismiss a case on these grounds -- it depended on the facts of the case and the attitude of the judge.

Now that the new bankruptcy law has gone into effect, however, there are clear criteria that dictate who will be allowed to stay in Chapter 7 -- and who will be forced to use Chapter 13, if they choose to file for bankruptcy. Disabled veterans whose debts were incurred during active duty and people whose debts come primarily from the operation of a business get a fast pass to Chapter 7. All others must meet the requirements set out below.

How High is Your Income?

Under the new rules, the first step in figuring out whether you can file for Chapter 7 is to measure your "current monthly income" against the median income for a family of your size in your state. Your "current monthly income" is not your income at the time you file, however: It is your average income over the last six months before you file. (You don't have to include Social Security retirement and disability payments.) For many people, particularly those who are filing for bankruptcy because they recently lost a job, their "current monthly income" according to these rules will be much more than they take in each month by the time they file for bankruptcy.

Once you've calculated your income, compare it to the median income for your state. (You can find median income tables, by state and family size, at the website of the United States Trustee, U.S. Trustee Program/Dept. of Justice; click "Means Testing Information.")

If your income is less than or equal to the median, you can file for Chapter 7. If it is more than the median, however, you must pass "the means test" -- another requirement of the new law -- in order to file for Chapter 7.

Can You Pass the Means Test?

The purpose of the means test is to figure out whether you have enough disposable income, after subtracting certain allowed expenses and required debt payments, to repay at least a portion of your unsecured debts over a five-year repayment period.

To find out whether you pass the means test, you start with your "current monthly income," calculated as described above. From that amount, you subtract both of the following:

• certain allowed expenses, in amounts set by the IRS. Generally, you cannot subtract what you actually spend for things like transportation, food, clothing, and so on; instead, you have to use the limits the IRS imposes, which may be lower than the cost of living in your area.
  
• monthly payments you will have to make on secured and priority debts. Secured debts are those for which the creditor is entitled to seize property if you don't pay (such as a mortgage or car loan); priority debts are obligations that the law deems to be so important that they are entitled to jump to the head of the repayment line. Typical priority debts include child support, alimony, tax debts, and wages owed to employees.

If your total monthly disposable income after subtracting these amounts is less than $100, you pass the means test, and will be allowed to file for Chapter 7. If your total remaining monthly disposable income is more than $166.66, you have flunked the means test, and will be prohibited from using Chapter 7, with one exception: If you can prove to the court that you're facing special circumstances that aren't reflected in the calculations above, and that effectively decrease your income or increase your expenses to bring your disposable income below the $166.66 figure, you will be allowed to use Chapter 7.

So what about those in the middle? They have to do some more math. If your remaining monthly disposable income is between $100 and $166.66, you must figure out whether what you have left over is enough to pay more than 25% of your unsecured, nonpriority debts (such as credit card bills, student loans, medical bills, and so on) over a five-year period. If so, you flunk the means test, and Chapter 7 won't be available to you. (Again, if you are facing special circumstances that alter these figures, you may be able to convince the court to allow you to use Chapter 7.) If not, you pass the means test, and Chapter 7 remains an option.

For much more information on these new requirements, including detailed worksheets that will help you figure out whether you can use Chapter 7, see The New Bankruptcy: Will It Work for You?, by Stephen Elias (available in December 2005 from Nolo).

You Previously Received a Bankruptcy Discharge

You cannot file for Chapter 7 bankruptcy if you obtained a discharge of your debts in a Chapter 7 case within the last eight years, or a Chapter 13 case within the last six years.

A Previous Bankruptcy Was Dismissed Within the Previous 180 Days
You cannot file for Chapter 7 bankruptcy if a previous Chapter 7 or Chapter 13 case was dismissed within the past 180 days because:

• you violated a court order
• the court ruled that your filing was fraudulent or constituted an abuse of the bankruptcy system, or
• you requested the dismissal after a creditor asked for relief from the automatic stay.

You Defrauded Your Creditors

A bankruptcy court may dismiss your case if it thinks you have tried to cheat your creditors or concealed assets so you can keep them for yourself.

Certain activities are red flags to the courts and trustees. If you have engaged in any of them during the past year, your bankruptcy case may be dismissed. These no-nos include:

• unloading assets to your friends or relatives to hide them from creditors or from the bankruptcy court
• running up debts for luxury items when you were clearly broke and had no way to pay them off
• concealing property or money from your spouse during a divorce proceeding, or
• lying about your income or debts on a credit application.

In addition, you must sign your bankruptcy papers under "penalty of perjury" swearing that everything in them is true. If you deliberately fail to disclose property, omit material information about your financial affairs, or use a false Social Security number (to hide your identity as a prior filer), and the court discovers your action, your case will be dismissed and you may be prosecuted for fraud.

[top]Other Types of Reorganization Bankruptcy

In addition to Chapter 13, there are two other types of reorganization bankruptcy you may have heard of: Chapter 11 and Chapter 12.

Chapter 11 bankruptcy is the type of bankruptcy used by financially struggling businesses -- such as Macy's -- to reorganize their affairs. It is also available to individuals, but because Chapter 11 bankruptcy is expensive and time-consuming, it is typically used only by those who have debts that exceed the Chapter 13 bankruptcy limits or who own substantial nonexempt assets (such as several pieces of real estate). To learn more about this kind of bankruptcy, see A Feast for Lawyers, by Sol Stein (M. Evans & Co., Inc.).

Chapter 12 bankruptcy is almost identical to Chapter 13 bankruptcy. But to be eligible for Chapter 12 bankruptcy, at least 80% of your debts must arise from the operation of a family farm. Chapter 12 has higher debt ceilings to accommodate the large debts that may come with operating a farm, and it offers the debtor more power to eliminate certain types of liens. Only a few hundred people file for Chapter 12 each year, while hundreds of thousands file for Chapter 13. You need a lawyer to file for Chapter 12.

[top]NOLO - Bankruptcy Books

The New Bankruptcy: Will It Work for You?
Everything you need to understand your options and pick the best strategies for eliminating overwhelming debts.

Credit Repair
Polish up your credit and avoid overspending with this bestseller.

Solve Your Money Troubles: Get Debt Collectors Off Your Back & Regain Financial Freedom
The all-in-one guide to tackling your money issues.

Chapter 13 Bankruptcy: Repay Your Debts
Chapter 13 bankruptcy laws have changed, and it's harder than ever to file. This book show you how to get it done.

How to File for Chapter 7 Bankruptcy
Bankruptcy laws have changed -- now it's even more complicated to file. This book guides you through the process, step by step.

Other Nolo books: Bankruptcy: Deciding Whether to File

[top]Consumer Bankruptcy Discussion Forum

Latest threads from the forum Consumer Bankruptcy

 

[top]Orher Links

Legal Information Institute: Law About Bankruptcy - An overview of bankruptcy law with links to key primary and secondary sources.

California Bankruptcy Law - California information pertaining to personal and corporate bankruptcy law. Includes Chapters 7, 11 and 13 bankruptcy law.




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