Bankruptcy Law Explained

Bankruptcy law is the branch of federal court that deals with matters involving individuals or corporations who are insolvent. The bankruptcy process stops lawsuits, foreclosures and garnishments.

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Individuals who earn wages or have other sources of regular income may file for chapter 13 bankruptcy. Chapter 13 allows debtors to keep most of their property, but they must agree to pay part of their income to creditors through a payment plan.

Chapter 7

Generally, Chapter 7 provides liquidation of the debtor’s nonexempt assets to pay creditors. Exempt assets are those that can be protected by state or federal exemption limits (nolo maintains a list of states and their limits).

A trustee is appointed to convert the debtor’s assets into cash for distribution to creditors. Unsecured priority debts are paid first, followed by secured debt (such as home mortgages) and then nonpriority unsecured debt if funds are available.

Filing for Chapter 7 protection stops all creditor collection actions while the bankruptcy case is pending. The debtor will complete forms describing his or her assets and liabilities, and may hire a petition preparer or attorney.

Debtors who don’t pass the means test must receive credit counseling before filing for Chapter 7. It’s a good idea to check whether you qualify for this requirement. If you do, it’s important to hire a competent lawyer because it’s the only way to make sure that your property is not sold or subject to liens to repay your debts. The success rate for attorney-represented Chapter 7 filers is very high.

Chapter 13

In Chapter 13, debtors propose a plan to repay creditors over three-to-five years. A trustee oversees the payment plan. Chapter 13 allows individuals with regular income to keep their property, if it is exempt, and pay back certain debts over the course of several years.

When the repayment plan is complete, any leftover debt is “discharged.” This means that the debtor no longer has legal liability for the debt. However, it should be noted that discharge only applies to the debts included in the repayment plan or statutorily disallowed from discharge, such as home mortgages, alimony and child support, some taxes and student loans.

In a Chapter 13 repayment plan, any disposable income left after paying priority and secured debts is used to repay unsecured debts, such as credit card balances, utility bills, medical debt and personal loans. Creditors may object to a repayment plan or petition the court for a confirmation hearing if they believe that the proposed payments are not enough. Once a petition is filed, a freeze on collection actions is placed on the debtor’s assets, stopping repossessions, foreclosures, wage garnishments and collection lawsuits immediately.

Discharge of Debts

A debtor’s liability for certain types of unsecured debt can be discharged after a period of time. The timing of the discharge varies according to the chapter under which the case is filed. The discharge releases a debtor from personal liability for the debts and prevents creditors from taking action to collect on those debts. The bankruptcy law excludes from the discharge certain kinds of debt, such as some governmental debts and debts for willful evasion of taxes.

In a Chapter 7 liquidation case, the debtor surrenders nonexempt property to the trustee, which sells the property to pay unsecured creditors. If a creditor objects to the discharge, the debtor must show cause for why the discharge should not be granted. Common reasons include failure to provide requested tax documents; failure to complete a course on personal financial management; and concealment of property with intent to defraud creditors.

If a debtor fails to meet the criteria for a Chapter 7 discharge, or does not complete a Chapter 13 plan, the court will dismiss the case. Once the bankruptcy is dismissed, creditors may resume pursuit of state law remedies to recover unpaid debts.

Reaffirmation of Debts

The Bankruptcy Code divides debts into two general categories: secured and unsecured. A secured debt is one backed by collateral, such as a mortgage or car loan. Unsecured debts are those that are not backed by collateral, such as credit card debt. When the court issues your bankruptcy discharge, you become legally relieved of all your personal liability for any dischargeable unsecured debts, including credit card debt.

If you reaffirm a debt, it becomes your legal obligation to pay and the lender may pursue collection actions against you, including repossessing any property you have that is subject to a lien or mortgage. However, the creditor must comply with federal law concerning disclosures and forms before a reaffirmation can be enforced.

It is important to only reaffirm a debt that you are confident you will be able to keep up with. Reaffirming a debt that you are not able to meet could hurt your credit even more. Likewise, you should never agree to a reaffirmation agreement for an asset that you cannot afford to lose, such as a home or car.

Meeting of Creditors

A meeting of creditors (called a 341 meeting in bankruptcy) is mandatory for most Chapter 7 and 13 cases. It is an opportunity for the trustee to question you under oath about assets, debts and other matters in your case. It is not a chance for creditors to pressure you or embarrass you.

The trustee will ask you questions about any nonexempt assets you own, payments you’ve made to or for your benefit and transfers of property before the filing of your case. The trustee will also ask about your income and expenses. If you own a business, the trustee will ask you about the operation of the business.

You should take to the 341 meeting any documents that verify your financial situation. For example, savings, checking or brokerage account statements, proof of income and expenses, a vehicle title or lease agreement and proof of vehicle insurance. You should also bring your photo ID. The trustee may require additional documents. If the trustee requires further verification of your financial status, he or she will notify you.