Introduction to Bankruptcy Law

The mere idea of filing for bankruptcy is enough to fill the hearts of many debtors with terror. After all, to most, bankruptcy seems less a tool of managing one's finances than a public admission of failure. However, despite common belief, certain types of bankruptcy can be the method through which individuals and businesses actually protect their financial standing.

What is Bankruptcy?

In common language, bankruptcy is a process by which individuals and businesses eliminate their debt entirely or pay back their debt over time under the protection of the United States Bankruptcy Courts. While debtors usually file for bankruptcy, under certain situations, creditors can force a debtor into bankruptcy.

Types of Bankruptcy

There are six different types of bankruptcy, including several set out for very specific situations, such as bankruptcies created specifically for municipalities or for farmers. However, the most common types of bankruptcies are as follows:

Chapter 7

Chapter 7 liquidation requires that the debtor turn over the majority of his assets, with the exception of exempt property such as clothes, furniture, and household items, to a bankruptcy trustee. The bankruptcy trustee then sells the property in order to pay off the existing debt. Once a debtor's assets have been sold off by the trustee, the debtor begins with a clean slate, having been able to discharge (or cancel) most debts, with the exception of certain debts, such as child support, alimony, and school loans.

Chapter 11

In Chapter 11 bankruptcy, the debtor (usually a business but sometimes a debtor with significant assets) maintains control over the day-to-day operations of the business or estate. The bankruptcy trustee, the debtor, and the creditors work together to negotiate a plan for the debtor to repay part of all of the existing debt.

Chapter 13

Chapter 13 bankruptcy allows the debtor to retain his assets. However, the debtor must devote a significant portion of their future income, usually determined by the bankruptcy court, to the repayment of the existing debt.

Changes In Bankruptcy Law

In October of 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 went into effect. This Act modified the U.S. Bankruptcy Code and made it much more difficult for debtors to file for Chapter 7 bankruptcy, forcing more debtors to file for bankruptcy under Chapter 13. As a result, far fewer debtors will be able to have their debts discharged and more will have to engage in some type of payment plan to pay off at least part of their debt.

How Does Filing for Bankruptcy Affect Credit?

No matter whether the debtor is an individual or a business, filing bankruptcy has a significant impact on the debtor's ability to obtain lines of credit. However, while a bankruptcy will stay on an individual's credit report for up to ten years, many debtors are able to rebuild their credit in a much shorter period of time. Though obtaining unsecured credit may be difficult shortly following the closing of a bankruptcy, with careful financial planning and responsible management of one's income and assets, good credit may be reestablished in as little as a few years.

Who Should File for Bankruptcy?

Because of the long-term effects bankruptcy can have on a debtor's credit, estate, and self-esteem, there are several things that should be considered before filing for bankruptcy:

Are the creditors willing to negotiate?

Because new federal laws limit who can file for Chapter 7 liquidation bankruptcy, more and more individuals are filing for Chapter 13 bankruptcy. Needless to say, a large part of the bankruptcy trustee's job in Chapter 13 is to arrange a payment plan with the existing creditors. If a debtor is able to negotiate a plan to repay his creditors over time, it is wise to try this tact first before filing for bankruptcy.

Do the debtor's liabilities exceed his assets?

If the debtor is in possession of assets that can be liquidated in order to satisfy the outstanding debt, such as bank accounts, real property that is not exempt under the state's homestead laws, or stocks and bonds, it is wise to attempt to pay off creditors rather than filing for bankruptcy.

How will the emotional impact of filing for bankruptcy affect the debtor?

Even in today's society, declaring oneself or one's business to be bankrupt is seen as a failure by many. Before deciding to file for bankruptcy, the debtor should consider how filing for bankruptcy will affect his self-esteem and his self-worth in the company of others.

Will the debtor need to obtain credit in the near future?

Because it can take several years for a debtor who has filed for bankruptcy to rehabilitate his credit, he should consider whether he will need to obtain significant credit in the near future. While bankruptcy should always be a last resort, a debtor should seriously consider the effect bankruptcy will have on their ability to obtain unsecured credit over the next few years.

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