Bankruptcy Chapter 7, 11, 12, 13

What is Bankruptcy.

Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay their creditors. A declared state of bankruptcy can be requested or initiated by the bankrupt individual or organization, or it can be requested by creditors in an effort to recoup a portion of what they are owed. However, in the overwhelming majority of cases, the bankruptcy is initiated by the "bankrupt" individual or organization.

Purpose of Bankruptcy.

The primary purpose of the laws of bankruptcy are: (1) to give an honest debtor a "fresh start" in life by relieving the debtor of most debts, and (2) to repay creditors in an orderly manner to the extent that the debtor has property available for payment.

Bankruptcy allows the debtor to resolve his debts through the division of his assets among his creditors. Additionally the declaration of bankruptcy allows debtors to be discharged of most of the financial obligations, after their assets are distributed, even if their debts have not been paid in full. During the pendency of a bankruptcy proceeding, the "Debtor" is protected from extra-Bankruptcy action by creditors by a legally imposed "stay."

Bankruptcy Proceedings.

Bankruptcy is federal statutory law (Title 11 of the United States Code) based upon the Constitutional requirement for "uniform laws on the subject of Bankruptcy throughout the United States." (Article I, Section 8). Bankruptcy proceedings are undertaken in the United States Bankruptcy Courts, part of the District Court system.

There are several types of proceedings that fit under the general category bankruptcy. The U S Bankruptcy Code has multiple chapters, each describing a different procedure available for debt resolution. Liquidation under a Chapter 7 filing is the most common form of bankruptcy. Liquidation involves the appointment of a trustee who collects the non-exempt property of the debtor, sells it and distributes the proceeds to the creditors. Bankruptcy under Chapter 11, Chapter 12, or Chapter 13 is more complex and involves allowing the debtor to use future earnings to pay off creditors. In addition, there is Chapter 9 bankruptcy, available only to municipalities; perhaps the most famous example of a municipal bankruptcy was in Orange County, California. Chapter 9 is a form of reorganization, not liquidation. Chapter 12 is somewhat like Chapter 13 but is only available to farmers in certain situations. As recently as mid-2004 Chapter 12 was scheduled to expire but in late 2004 it was given a renewed lease on life.

Bankruptcy can be entered into voluntarily by the debtor. It can also be commenced involuntarily by as few as one creditor if the debt owed is large enough. An involuntary bankruptcy may be used as a collection tool but its use can be very risky and, if wielded improperly, may subject the creditor to large damages.

Some property is exempt from being sold to pay debts in a bankruptcy. The law varies greatly from state to state. In some states, exempt property includes equity in a home or car, tools of the trade, and some amount of personal effects. In other states an asset class such as tools of trade will not be exempt by virtue of its class except to the extent it is claimed under a more general exemption for personal property.

One major purpose of bankruptcy is to ensure orderly and reasonable management of debt. Thus, exemptions for personal effects are thought to prevent punitive seizures of personal items of little or no economic value (diary, toothbrush, ordinary clothing), since this does not promote any desirable economic result. Similarly, tools of the trade may, depending on the available exemptions, be a permitted exemption as their continued possession allows the insolvent debtor to move forward into productive work as soon as possible.

Not every debt may be discharged under every chapter of the Code. Certain taxes owed to Federal, state or local government, government guaranteed student loans, and support obligations are not dischargeable (but nb., guaranteed student loans are potentially dischargeable should the debtor prevail in a difficult-to-win adversary proceeding brought in the nature of a complaint to determine dischargeability that's brought against the lender; also, the debtor can petition the court for a "financial hardship" discharge, but it is very rare that such a discharge is granted). The debtor's liability on a Secured debt, such as a mortgage or mechanics lien on a home, may be discharged, but the effects of the mortgage or mechanics lien cannot be discharged in most cases if it affixed prior to filing, so if the debtor wishes to retain the property, the debt must usually be paid for as agreed. (See also lien avoidance, reaffirmation agreement)(Note: there may be additional flexiblity available in Chapter 13 for debtors dealing with oversecured collateral such as a financed auto, so long as the oversecured property is not the debtor's primary residence.)

Also, any debt tainted by one of a variety of wrongful acts recognized by the Bankruptcy code, including defalcation, or consumer purchases or cash advances above a certain amount incurred a short time before filing, cannot be discharged. However, certain kinds of debt, such as debts incurred by way of fraud, may be dischargeable through the Chapter 13 super discharge. All in all, as of 2005, there are 19 general categories of debt that cannot be discharged in a Chapter 7 bankruptcy, and fewer debts that cannot be discharged under Chapter 13.

Chapter 7 Bankruptcy.

Liquidation under Chapter 7 of the Bankruptcy Code is the most common form of bankruptcy in the United States.

Bankruptcy filings by individuals:

* Chapter 7 filings: 1,156,284

* Chapter 11 filings: 959

* Chapter 13 filings: 468,562

Bankruptcy filings by businesses:

* Chapter 7 filings: 21,008

* Chapter 11 filings: 9,185

* Chapter 12 filings: 698

* Chapter 13 filings: 5,201

The total number of bankruptcies rose 7.4 percent over the previous twelve months. These totals were for the 12-month period ending September 30, 2003.

Chapter 7 Bankruptcy for Business.

When a troubled business is badly in debt and unable to service that debt or pay its creditors, it may file (or be forced by its creditors to file) for bankruptcy in a federal court under Chapter 7 (liquidation) or Chapter 11 (reorganization). A Chapter 7 filing means that the business intends to sell all its assets, distribute the proceeds to its creditors, and then cease operations.

This may or may not mean that all employees will lose their jobs; when a very large company enters Chapter 7 bankruptcy, it may be that entire divisions of the company are sold intact to other companies during the liquidation.

Secured creditors, such as bondholders, have a higher-priority claim on the proceeds than unsecured creditors, such as vendors who have not yet been paid for products they previously delivered to the company.

A corporation or other legal entity that is a debtor under Chapter 7 is not entitled to a discharge of its debts: once all assets of the company have been fully administered, the case is closed and the debts of the entity, theoretically, continue to exist.

Chapter 7 Bankruptcy for Individuals.

Individuals can file for bankruptcy in a federal court under Chapter 7 ("straight bankruptcy", formally liquidation) or Chapter 13 (a "reorganization", formally debt adjustment case). In a Chapter 7 bankruptcy, the individual is allowed to keep certain exempt property, and most liens, such as real estate mortgages, survive. Other assets, if any, are sold (liquidated) by the interim trustee to repay creditors. Many types of unsecured debt are cancelled. There are 19 (as of 2005) general classes of debt not discharged in a Chapter 7. Common exceptions to discharge include child support, most taxes, most student loans (unless the debtor prevails in a difficult-to-win adversary proceeding brought to determinate the dischargeability of the student loan), and fines and restitution imposed by a court for any crimes committed by the debtor.

A disadvantage of filing for personal bankruptcy is that a record of it stays on the individual's credit report for 10 years. This may make credit less available and/or terms less favorable. That must be balanced against the removal of actual debt from the filer's record by the bankruptcy, which tends to improve creditworthiness. Consumer credit and creditworthiness is a complex subject, however. Future ability to obtain credit is dependent on multiple factors and difficult to predict.

Another aspect to consider is whether or not the debtor can avoid a challenge by the United States Trustee to his or her Chapter 7 filing as abusive. One aspect of whether the U.S. Trustee can prevail in a challenge to the debtor's Chapter 7 filing is whether or not he can otherwise afford to repay some or all of his debts out of disposable income in the three year time frame provided by Chapter 13. If so, then the U.S. Trustee may succeed in preventing the debtor from receiving a discharge under Chapter 7, effectively forcing the debtor into Chapter 13.

It's widely held amongst bankruptcy practioners that the U.S. Trustee has become much more aggressive in recent times in pursuing (what the U.S. Trustee believes to be) abusive Chapter 7 filings. Through these activities it is achieving what the Congress and most creditor-friendly commentors have consistently espoused, i.e., a formal means test for Chapter 7. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has clarified this area of concern by proposing changes to the U.S. Code that include, along with many other reforms, language that acts as an explicit means test for Chapter 7.

Creditworthiness and the likelihood of receiving a Chapter 7 discharge are only a few many issues to be considered in determining whether to file bankruptcy. The importance of the effects of bankruptcy on creditworthiness is sometimes overemphasized because by the time most debtors are ready to file for bankruptcy their credit score is already ruined.

Chapter 11 Bankruptcy.

Chapter 11 of the Bankruptcy Code governs the process of reorganization under the bankruptcy laws of the United States.

When a troubled business decides that it is unable to service its debt or pay its creditors, it can file (or be forced by its creditors to file) with a federal bankruptcy court for bankruptcy protection under either Chapter 7 (liquidation) or Chapter 11. A Chapter 7 filing means that the business intends to sell all its assets, distribute the proceeds to its creditors, and then cease operations. A Chapter 11 filing, on the other hand, is an attempt to stay in business while a bankruptcy court supervises the "reorganization" of the company's contractual and debt obligations. The court can grant complete or partial relief from most of the company's debts and its contracts, so that the company can make a fresh start. Often, if the company's debts exceed its assets, then at the completion of bankruptcy the company's owners (stockholders) all end up with nothing -- all their rights and interests are terminated -- and the company's creditors end up with ownership of the newly reorganized company, in the hopes that it will eventually succeed financially as compensation for their losses.

All creditors who register with the court can be heard by the court, which is responsible for determining whether the plan of reorganization complies with the purposes of the bankruptcy law and provides for fair and equitable treatment of all parties in interest. Priority of claims is determined by Section 507 of the Bankruptcy Code, but as a general rule secured creditors, such as some banks and bondholders, have a higher-priority claim on the proceeds of the sale of corporate assets than unsecured creditors, such as vendors who have not been paid for products they previously delivered to the company (and who don't have any collateral for their claim). Once a business files for Chapter 11 bankruptcy, its creditors are not allowed to attempt to collect previously incurred debts except through the bankruptcy court. Under some circumstances, the creditors or the United States Trustee can ask the court either to convert the case to a liquidation under Chapter 7, or to appoint a trustee to manage the debtor's business. The court will grant a motion to convert to Chapter 7 or appoint a trustee if either of these actions is in the best interest of all creditors (appointment of a trustee also requires some wrongdoing or gross mismanagement on the part of existing management, and is relatively rare).

Typical debts and contracts cancelled in a Chapter 11 bankruptcy include unsecured loans and, if cancelling them would be financially favorable to the company, union contracts, supply or operating contracts (with both vendors and customers) and long-term real estate leases.

Once Chapter 11 is filed, the company may "emerge" from bankruptcy within a few months or within several years, depending on the size and complexity of the bankruptcy. All debtors filing Chapter 11 cases are required to propose a plan of reorganization: if the debtor fails to make a proposal, the court may consider proposals from creditors. If no plan of reorganization is approved by the court (this process is called confirmation) then the court may either convert the case to a liquidation under Chapter 7 or, if in the best interests of the creditors and the estate, the case may be dismissed resulting into a return to the status quo ante bankruptcy.

If the company's stock is publicly traded, a Chapter 11 filing causes trading on it to be transferred to the NASDAQ if primary trading on it had been previously conducted at either the New York Stock Exchange or the American Stock Exchange, and the identifying letter "Q" is added to the end of its stock symbol, which is also lengthened to four letters, not including the "Q," if such a transfer is necessary (formerly, the site at which such a stock was traded was not moved and the "Q" was placed in front of the pre-existing stock symbol; a celebrated example was Penn Central, whose symbol was originally "PC" and became "QPC" after the company filed Chapter 11 in 1970).

The largest bankruptcy in history was of the US telecommunications corporation Worldcom, Inc., which listed over 103 billion dollars in assets as of its Chapter 11 filing in 2002; the bankruptcy was triggered by the discovery that in the previous several years, the company had fraudulently overreported its assets by an estimated 12 billion dollars.

Individuals may also file Chapter 11, but due to the complexity and expense of the proceeding, this option is rarely chosen by debtors who are eligible for Chapter 7 or Chapter 13 relief.

Chapter 12 Bankruptcy.

Chapter 12 is somewhat like Chapter 13 but is only available to farmers in certain situations. As recently as mid-2004 Chapter 12 was scheduled to expire but in late 2004 it was given a renewed lease on life.

Chapter 13 Bankruptcy.

Chapter 13 bankruptcy filing is a way for individuals in the United States to undergo a financial reorganization supervised by a federal bankruptcy court. The Bankruptcy Code anticipates the goal of Chapter 13 as enabling income-receiving debtors a debtor rehabilitation provided they fulfill a court-approved plan.pla Compare the goal of Chapter 13 with the relief contemplated in Chapter 7 that offers immediate, complete relief of many oppressive debt(s).

An individual who is badly in debt can file for bankruptcy either under Chapter 7 (liquidation, or straight bankruptcy) or under Chapter 13 (reorganization). The choice is not a coin flip. The appropriate chapter depends on the situation. The debtor's disposable income and the type of relief sought plays a tremendous role in the choice of chapters. In some cases the debtor simply cannot file under Chapter 13, as he or she cannot, if he or she simply lacks the disposable income necessary to fund a viable Chapter 13 plan (see below).

Under Chapter 13, the debtor proposes a plan to pay his creditors over a 3 to 5 year period. During this period, his creditors cannot attempt to collect on the individual's previously incurred debt except through the bankruptcy court. In general, the individual gets to keep his property, and his creditors end up with less money than they are owed.

The disadvantage of filing for personal bankruptcy is that a record of this stays on the individual's credit report for 10 years. During the pendancy of a Chapter 13 case the debtor is not permitted to obtain additional credit without the Chapter 13 Trustee's permission. Moreover, creditors may not be willing to risk lending money to such an individual. However, this disadvantage is not unique to Chapter 13; it may also apply to individuals currently in a Chapter 11 case or those who are in or have recently been in a Chapter 7 case.

The advantages of Chapter 13 over Chapter 7 include the ability to stop foreclosure, to achieve a super discharge of debts of kinds not dischargeable under Chapter 7, to value collateral, to bifurcate the security interest of creditors in certain property that creditors are either charging too much interest for, or are over-secured, or both, and in some cases, to prevent collection activities against non-filing co-signers (co-debtors) during the life of the case.

A Chapter 13 plan is a document filed with or shortly after a debtor's Chapter 13 bankruptcy petition. The plan details the treatment of debts, liens, and the secured status of assets and liabilities owned or owed by the debtor in regard to his bankruptcy petition filed in United States Bankruptcy Court. For the plan to be confirmable, it must, at a minimum (actually there are more requirements and these vary from state to state), meet all of the following tests:

- Commit every penny of the debtor's household's disposable income to the Chapter 13 Plan for at least three years (unless a 100% repayment of all unsecured debt will occur in less than three years), or up to five years, but longer than three years only if the debtor elects it.

- Provide that unsecured creditors will receive at least as much through the Chapter 13 Plan as they would in a Chapter 7 liquidation.

- Provide a meaningful payback to the unsecured creditors. In some districts and divisions this means as little as a one cent on the dollar payback. In others it may be as much as twenty cents on the dollar.

Bankruptcy Abuse and Fraud.

Bankruptcy Abuse Prevention & Consumer Protection Act of 2005

(In 2005), the United States Congress enacted and President George W. Bush signed into law legislation that vastly changes the laws of bankruptcy as they pertain to individuals. This law will go into effect on October 17, 2005 and drastically change the historical American version of bankruptcy in that creditors will be treated much more favorably than debtors. Some of the more significant (and controversial) changes include:

* Making it more difficult for individuals to receive a Chapter 7 discharge. A means test is to be imposed on would-be filers, one that is linked to whether the debtor's earnings in the six-month period prior to filing were above or below the median income for the debtor's state of residence.

* Making Chapter 13 far less attractive by, amongst other things, eliminating its "super discharge," eliminating the ability of debtors to "cram down" non-residential secured property (i.e., to disallow them from paying off the real value of the secured property as secured while treating the excess value as unsecured, by disallowing the reduction of interest charged on the debt to reasonable values), by removing the credit for payments on retained secured property from the calculation of disposable income, and by requiring that debtors undergo counselling in order to file under Chapter 13.

* Requiring that debtor counsel conducts an investigation of their clients' filings and be personally liable for them, a duty apparently unprecedented under U.S. law. A similar requirement will likely force debtors desiring to reaffirm to attend a court hearing and prove to the court that they can meet obligations they wish to reaffirm (because few debtor's attorneys will wish to certify their belief of their client's prospective ability to pay on a reaffirmed debt). Those who cannot thus prove will be compelled to surrender the property.

* Limiting the homestead protection to $125,000 in equity and establishing a 40 month residency period before such protections are recognized in Bankruptcy.

The legislation, sponsored (introduced) by the chairman of the Finance Committee, Republican Senator Chuck Grassley of Iowa, was supported by President George W. Bush and opposed by many Democrats and the Green Party. Although the original legislation was introduced during the Clinton Administration, and had more bi-partisan Congressional support at the time, the president vetoed it nonetheless. The bill languished for years due to disagreements in Congress as to the level of the means test, and whether anti-abortion groups could use bankruptcy to discharge fines levied against them by courts for actions that resulted in property damage or injury such as bombing abortion clinics.

Bankruptcy fraud

Bankruptcy fraud is the a business crime of filing for bankruptcy with criminal intent, that is with the intention of evading payment for goods even though the buyer has funds that could be used to pay for them, or accepting payment for goods or services but not supplying them. Common types of bankruptcy fraud include petition mills, false oath, concealment of assets, and fraudulent conveyance. Multiple filings are not per se fraudulent; as with all things in the law, it depends on the circumstances. Bankruptcy fraud should be distinguished from strategic bankruptcy, which is not a criminal act (but may prejudice a judge against the filer if there is evidence that bankruptcy is being used strategically). In the United States, bankruptcy fraud is a federal crime. Its provisions are found at Title 18 of the United States Code. It is prosecuted by the United States Attorney, typically after a reference from the United States Trustee, the Interim Trustee, or a bankruptcy judge. Bankruptcy fraud can also sometimes lead to criminal prosecution in state courts, under the charge of theft of the goods or services obtained by the debtor for which payment, in whole or in part, was evaded by the fraudulent bankruptcy filing.

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