Purposes, Benefits and Costs of Bankruptcy
PURPOSES, BENEFITS AND COSTS OF BANKRUPTCY
Code § 527(a)(1) & § 342(b)(1)
The United States Constitution provides a method whereby individuals, burdened by excessive debt, can obtain a fresh financial start and pursue newly productive lives unimpaired by past financial problems. It is an important alternative for persons mired deep in financial difficulty.
The Federal Bankruptcy Laws were enacted to provide Debtors with a fresh start and to establish a ranking and equity among all the creditors who are clamoring for the Debtor’s limited resources.
Bankruptcy helps people avoid the kind of permanent discouragement that can prevent them from ever reestablishing themselves as hard-working members of society. Also, creditors are ranked so that the Debtor’s non-exempt property can be fairly distributed according to established rules guaranteeing identical treatment to all creditors of the same rank.
This discussion is intended only as a brief overview of the types of bankruptcy filings and of what a bankruptcy filing can and cannot do. Anyone considering this course of action is encouraged to seek the advice and assistance of an attorney specializing in Bankruptcy Law.
Types of Bankruptcy
The Bankruptcy Code is divided into chapters. The chapters which usually apply to consumer Debtors are Chapter 7, known as a Liquidation, and Chapter 13, known as an Adjustment of the Debts of an Individual with Regular Income. An important feature applicable to all types of bankruptcy filings is the automatic stay. The automatic stay means that the mere request for bankruptcy protection automatically “stays” or forces an abrupt halt to repossessions, foreclosures, evictions, garnishments, attachments, utility shut-offs, and debt collection harassment. It offers Debtors a breathing spell by giving the Debtor and the Trustee assigned to the case time to review the situation and develop an appropriate plan.
Creditors cannot take any further action against the Debtor or the property without permission from the Bankruptcy Court.
Chapter 7, entitled Liquidation, contemplates an orderly, court-supervised procedure by which a Trustee takes over the assets of the Debtor’s estate, reduces them to cash, and makes distributions to creditors, subject to the Debtor’s right to retain certain exempt property and the rights of secured creditors. Because there is usually little or no non-exempt property in most Chapter 7 cases, there may not be an actual liquidation of the Debtor’s assets. These cases are called “no-asset cases.” A creditor holding an unsecured claim will get a distribution from the bankruptcy estate only if the case is an asset case and the creditor files a proof of claim with the Bankruptcy Court.
In most Chapter 7 cases, if the Debtor is an individual, he or she receives a discharge that releases him or her from personal liability for certain dischargeable debts. The Debtor normally receives a discharge just a few months after the Petition is filed. Amendments to the Bankruptcy Code enacted in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 require the application of a “means test” to determine whether individual consumer debtors qualify for relief under Chapter 7. If such a Debtor’s income is in excess of certain thresholds, the Debtor may not be eligible for Chapter 7 relief.
Chapter 13, entitled Adjustment of Debts of an Individual with Regular Income, is designed for an individual Debtor who has a regular source of income. Chapter 13 is often preferable to Chapter 7 because it enables the Debtor to keep a valuable asset, such as a house, and because it allows the Debtor to propose a “Plan” to repay creditors over time – usually three to five years.
Chapter 13 is also used by consumer Debtors who do not qualify for Chapter 7 relief under the means test. At a confirmation hearing, the Court either approves or disapproves the Debtor’s repayment plan, depending on whether it meets the Bankruptcy Code’s requirements for confirmation.
Chapter 13 is very different from Chapter 7 since the Chapter 13 Debtor usually remains in possession of the property of the estate and makes payments to creditors, through the Trustee, based on the Debtor’s anticipated income over the life of the Plan. Unlike Chapter 7, the Debtor does not receive an immediate discharge of debts. The Debtor must complete the payments required under the Plan before the discharge is received. The Debtor is protected from lawsuits, garnishments, and other creditor actions while the Plan is in effect. The discharge is also somewhat broader (i.e., more debts are eliminated) under Chapter 13 than the discharge under Chapter 7.
Chapter 11, entitled Reorganization, ordinarily is used by commercial enterprises that desire to continue operating a business and repay creditors concurrently through a Court-approved plan of reorganization. The Chapter 11 Debtor usually has the exclusive right to file a plan of reorganization for the first 120 days after it files the case and must provide creditors with a disclosure statement containing information adequate to enable creditors to evaluate the Plan.
The Court ultimately approves (confirms) or disapproves the plan of reorganization. Under the confirmed Plan, the Debtor can reduce its debts by repaying a portion of its obligations and discharging others. The Debtor can also terminate burdensome contracts and leases, recover assets, and rescale its operations in order to return to profitability. Under Chapter 11, the Debtor normally goes through a period of consolidation and emerges with a reduced debt load and a reorganized business.
What Bankruptcy Can and Cannot Do
Bankruptcy may make it possible for financially distressed individuals to:
1. Discharge liability for most or all of their debts and get a fresh start. When the debt is discharged, the Debtor has no further legal obligation to pay the debt.
2. Stop foreclosure actions on their home and allow them an opportunity to catch up on missed payments.
3. Prevent repossession of a car or other property, or force the creditor to return property even after it has been repossessed.
4. Stop wage garnishment and other debt collection harassment, and give the individual some breathing room.
5. Restore or prevent termination of utility service.
6. Lower the monthly payments on debts, including secured debts such as car loans.
7. Allow Debtors an opportunity to challenge the claims of certain creditors who have committed fraud or who are otherwise seeking to collect more than they are legally entitled to.
Bankruptcy, however, cannot cure every financial problem. It is usually not possible to:
a. Eliminate certain rights of secured creditors. Although a Debtor can force secured creditors to take payments over time in the bankruptcy process, a Debtor generally cannot keep the collateral unless the Debtor continues to pay the debt.
b. Discharge types of debts singled out by the Federal Bankruptcy Statutes for special treatment, such as child support, alimony, some student loans, certain Court ordered payments, criminal fines, and some taxes.
c. Protect all co-signers on their debts. If a relative or friend co-signed a loan which the Debtor discharged in bankruptcy, the co-signer may still be obligated to repay the loan.
d. Discharge debts that are incurred after bankruptcy has been filed.
Bankruptcy’s Effect on Your Credit
By Federal law, a bankruptcy can remain part of a Debtor’s credit history for 10 years. Whether or not the Debtor will be granted credit in the future is unpredictable. In some cases it may actually be easier to obtain future credit, because new creditors may feel that since the old obligations have been discharged, they will be first in line. They also recognize that the Debtor cannot again file bankruptcy for at least the next 6 years. Debtors have the option after bankruptcy of voluntarily paying some creditors, such as a doctor or hospital, with whom they wish to maintain credit. The payments are voluntary and do not reaffirm the past obligation.
About Credit Counseling Agencies
11 U.S.C § 342(b)(1)(B)
The following information is taken verbatim from the web site of the Federal Trade Commission.
Living paycheck to paycheck? Worried about debt collectors? Can’t seem to develop a workable budget, let alone save money for retirement? If this sounds familiar, you may want to consider the services of a credit counselor. Many credit counseling organizations are non-profit and work with you to solve your financial problems. But beware — just because an organization says it is “non-profit” doesn’t guarantee that its services are free or affordable, or that its services are legitimate. In fact, some credit counseling organizations charge high fees, some of which may be hidden, or urge consumers to make “voluntary” contributions that cause them to fall deeper into debt. Most credit counselors offer services through local offices, the Internet, or on the telephone. If possible, find an organization that offers in-person counseling. Many universities, military bases, credit unions, housing authorities, and branches of the U.S. Cooperative Extension Service operate non-profit credit counseling programs. Your financial institution, local consumer protection agency, and friends and family also may be good sources of information and referrals.
Reputable credit counseling organizations advise you on managing your money and debts, help you develop a budget, and usually offer free educational materials and workshops. Their counselors are certified and trained in the areas of consumer credit, money and debt management and budgeting. Counselors discuss your entire financial situation with you, and help you develop a personalized plan to solve your money problems. An initial counseling session typically lasts an hour, with an offer of follow-up sessions.
Debt Management Plans
If your financial problems stem from too much debt or your inability to repay your debts, a credit counseling agency may recommend that you enroll in a Debt Management Plan. A DMP alone is not credit counseling, and DMPs are not for everyone. Consider signing on for one of these plans only after a certified credit counselor has spent time thoroughly reviewing your financial situation, and has offered you customized advice on managing your money. Even if a DMP is appropriate for you, a reputable credit counseling organization still will help you create a budget and teach you money management skills.
How a DMP Works
You deposit money each month with the credit counseling organization. The organization uses your deposits to pay your unsecured debts, like credit card bills, student loans, and medical bills, according to a payment schedule the counselor develops with you and your creditors. Your creditors may agree to lower your interest rates and waive certain fees, but check with all your creditors to be sure that they offer the concessions that a credit counseling organization describes to you. A successful DMP requires you to make regular, timely payments, and could take 48 months or longer to complete. Ask the credit counselor to estimate how long it will take for you to complete the plan. You also may have to agree not to apply for — or use — any additional credit while you’re participating in the plan.