What is Bankruptcy?

Bankruptcies are older than the United States.  The Constitution authorizes Congress to pass “uniform laws on the subject of Bankruptcies.”  Congress has established a system of federal courts to administer the bankruptcy law.  Judges have been appointed for 90 bankruptcy districts throughout the country.  Each state is contains at least one district.

The goal of the bankruptcy laws passed by Congress is to give debtors a fresh start.  As the U.S. Supreme Court said,

“It 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.”

There are 6 types of bankruptcy.

Both individuals and business entities such as corporations and limited liability companies may file Chapter 7 and Chapter 11 bankruptcies.  Only individuals with unsecured debts of less than $360,475 and secured debt of less than $1,081,400 can file a Chapter 13 case.  Only family farmers and family fishermen may file a Chapter 12 case.  Only municipalities such as cities, towns, villages, counties and school districts can file Chapter 9.  Chapter 15 is designed to resolve cross border insolvency issues involving claims or assets in both the United States and at least one other country.

Chapter 7 is sometimes called a liquidation bankruptcy.  The debtor is allowed to keep certain “exempt” assets.  Most debtors, but not all, lose no assets as part of their case.  If any assets remain to be distributed from the debtor’s estate, the trustee liquidates the assets (reduces them to cash) and distributes the proceeds to creditors who file a “proof of claim” with the bankruptcy court.  Many debtors prefer a Chapter 7 filing because their case is resolved more quickly and because they often will not have to make any payments to  the trustee.  The trustee may object to filings from debtors with high enough incomes to be able to pay a significant part of their debt in a Chapter 13.

Chapter 13 is designed to ‘adjust’ the debts of a debtor with regular income.  The debtor proposes a plan to repay part or all of the debtor’s debts.  The plan normally consists of 36 to 60 payments over 3 to 5 years and must be “confirmed” by the court.  Many debtors prefer to file a Chapter 13 case because they may be able to keep more property or may want time to repay a creditor for an assortment of reasons.  Also, a Chapter 13 can protect co-signers to some degree and can discharge some debts which can not be discharged in a Chapter 7 case.  In some cases, a debtor may not be permitted to receive a discharge in a Chapter 7 case, because the debtor’s income is considered high enough to permit payment of at least a significant part of the total debt.

Chapter 12 ‘adjusts’ the debts of a family farmer or fisherman with regular income.  This Chapter is designed to keep a farmer or fisherman in business while the plan is carried out.  This Chapter is much like a Chapter 13 in that a plan is proposed to make regular payments to the trustee.  The plan generally does not last longer than 3 years unless the debtor proposes a longer period not to exceed 5 years.  Debtors have some additional powers of a trustee in a Chapter 12.

Chapter 11 was designed to reorganize a commercial enterprise.  However, changes to the Bankruptcy Code in 2005 makes this Chapter useful to many individual debtors.  For individuals, a Chapter 11 functions like an expensive, supercharged Chapter 13.   The object is often to continue to operate a business while repaying creditors through the plan of reorganization.  The debtor has a 120 day exclusivity period in which to propose its plan.  The debtor can use the plan to pay some creditors and to discharge the debts of others.  Chapter 11 cases are often used to free the debtor from burdensome contracts or leases.  The “debtor in possession” has most of the powers of a trustee.  These powers can be used to recover property and pursue claims to aid the reorganization.

Chapter 9 ‘adjusts’ the debts of municipalities.

Chapter 15 provides a mechanism to deal with insolvent debtors with business problems that stretch across international borders.