Answers to Basic Bankruptcy Questions
This pamphlet is intended to answer certain basic questions about the bankruptcy process. A pamphlet of this type cannot address or anticipate every issue that may arise when considering a bankruptcy filing; however, this information will provide an introduction to fundamental concepts. I urge you to discuss these concepts more extensively with me.
- What Is It—And How Does It Work?
Bankruptcy is a legal process governed by federal rules and procedures contained in the Bankruptcy Code and the Bankruptcy Rules. The primary purpose of bankruptcy law is to provide a debtor with a “fresh start” through which some debts can be paid, restructured or discharged. Bankruptcy also provides a way for creditors to be treated fairly and equitably. The debtor is the person who owes money, goods or services, and the creditor is the person to whom the money, goods or services is owed.
On April 20, 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act was enacted, with most provisions becoming effective on October 17, 2005. This new law provided the most substantial changes to bankruptcy law in many years.
A bankruptcy case begins when you (the debtor) pay a filing fee and file a petition with the bankruptcy court. Financial information, including a list of all assets and debts, must be provided. You must certify this information under penalty of perjury. Additionally, all debtors must now participate in consumer credit counseling with an approved nonprofit agency prior to filing a Chapter 7 or Chapter 13 bankruptcy petition. The law also requires that you provide the trustee with copies of your federal tax return for the most recent tax year ending prior to the filing of the petition, along with certain copies of pay stubs. This tax return and the pay stubs must be provided to the trustee seven days prior to the initial meeting of creditors (discussed below). Some trustees will require other financial documentation, as well.
As soon as the bankruptcy petition is filed, an “automatic stay” goes into effect. The “automatic stay” generally stops most debt-collection efforts against you, unless the bankruptcy court grants the creditor permission to pursue collection activities. The bankruptcy court, and in some cases a bankruptcy trustee, oversees the activities of a debtor until the court issues an order discharging the debts and the debtor’s case is concluded.
- Who May File for Bankruptcy?
Almost any person who has a residence, business or property in the United States is eligible to be a debtor under the Bankruptcy Code. Individuals, solo proprietorships, partnerships, corporations and family farmers are eligible for bankruptcy relief. In rare cases, creditors may force someone into bankruptcy by filing an “involuntary petition” against a debtor.
Generally, there are no minimum financial or solvency requirements for the filing of a bankruptcy case by the debtor. However the new law imposes heightened eligibility requirements for filing a petition under Chapter 7. Specifically, a debtor must pass the “means test” provided by the new law, which compares your family’s current monthly income with the statewide median income. As a result, certain individuals may be required to proceed under Chapter 13 (where they must pay at least some portion of their debts) because they are not eligible to file a Chapter 7 petition. Note that certain debt restrictions or financial requirements apply in Chapter 12 or 13 bankruptcy cases.
- Do I Have to Go to Court?
In the early stage of a bankruptcy case, you must attend a meeting of creditors (also called a Section 341 meeting) at which you must provide information and answer questions under oath from the bankruptcy trustee, the United States Trustee or your creditors. The bankruptcy judge does not participate in such meetings. Although the meetings are not formal court hearings, testimony is taken under oath and you are subject to criminal penalties for perjury.
Bankruptcy courts are part of the federal judicial system, and federal bankruptcy judges decide most disputes that arise in bankruptcy cases. If any challenges are raised by creditors in your bankruptcy case, it may be necessary for you to testify in court. Many of the legal issues and procedures that arise in a typical individual case can be handled by an attorney without requiring the debtor’s attendance at bankruptcy court hearings.
- How Long Will It Take?
In a Chapter 7 case, you will typically receive an order discharging most of your debts within 3-4 months. Chapter 13 usually requires payments over a 3-year to 5-year period before you will receive an order discharging your debts.
- What Are the Different Kinds of Bankruptcy Cases?
There are several different types of bankruptcy cases:
- Chapter 7—Liquidation
- Chapter 11—Reorganization (or liquidation)
- Chapter 12—Family Farmer and Fisherman Reorganization
- Chapter 13—Adjustments of Debts of Individual Regular Income
In a Chapter 7 liquidation case, sometimes referred to as “straight bankruptcy,” a trustee is appointed to collect and liquidate the debtor’s nonexempt assets (see below for an explanation of “nonexempt assets”) and to pay the proceeds to creditors in the order set forth in the Bankruptcy Code. Most Chapter 7 cases are “no asset” cases. This means that the debtor does not have sufficient nonexempt assets or sufficient income to make any distribution to unsecured creditors. Unsecured creditors are those who do not have a valid lien on collateral.
Chapter 11 is available to individuals and businesses that seek to reorganize their affairs or to liquidate in an orderly manner. In Chapter 11, the debtor remains in control of his or her property and operates as a “debtor in possession” subject to bankruptcy court supervision. In Chapter 11, the debtor is allowed a certain period of time within which to propose a plan of reorganization. The plan of reorganization sets the terms for payment of the debts. The terms of Chapter 11 plans vary, depending on the nature of the debt or the type of business the debtor operates, and creditors usually get to vote on the plan.
Chapter 12 allows family farmers and family fishermen with regular annual income to adjust their debts. Generally, the family farmer must have less than $3,544,525 in debts (50 percent of which must arise out of the farming operation) and at least 50 percent of the individual’s gross income must come from the farming operation. The aggregate debts of a family fisherman must not exceed $1,642,500 (80 percent of which must arise out of the commercial fishing operation) and at least 50 percent of the individual’s gross income must come from the fishing operation. A debtor under Chapter 12 must have regular and stable income that enables him or her to repay creditors under a long-term plan.
Chapter 13 is available to individuals with regular income who owe unsecured debts of less than $336,900 (unsecured debts are debts owed to creditors who do not have liens on any collateral) and secured debts of less than $1,010,650 (secured debts are debts subject to valid liens such as mortgages and car loans). By choosing Chapter 13, an individual debtor may avoid a Chapter 7 liquidation, stop home mortgage foreclosures, reinstate defaulted home mortgages and obtain a broader discharge of debts than is available in a Chapter 7 liquidation. In exchange, the debtor in a Chapter 13 case must repay unsecured creditors a portion of their claims from the debtor’s future income over a 3-year to 5-year period. Ordinarily, payments to unsecured creditors will be made by the Chapter 13 trustee according to the plan filed by the debtor and approved by the bankruptcy judge.
- How Does Bankruptcy Help?
Bankruptcy can help a debtor in a number of ways. The filing of a bankruptcy case automatically stops most collection actions against you, such as garnishments, foreclosures and lawsuits, at least temporarily. This allows you to have a “breathing spell” during which you have the opportunity to put your finances in order and chart your financial future. While the bankruptcy case is pending, creditors cannot pursue most actions against debtors without bankruptcy court approval.
The ultimate goal of a bankruptcy filing is to obtain a discharge from certain debts that arose prior to the bankruptcy filing. Once the discharge is obtained, creditors cannot pursue collection efforts against the debtor, and those claims are permanently forgiven unless a lien remains in place or you “reaffirm” your obligation to the creditor (see below for a description of reaffirmation of debts). If a lien remains in place, the creditor can pursue the collateral securing the lien even after bankruptcy. If you reaffirm a debt, then the creditor can pursue you personally even after bankruptcy.
Bankruptcy also affords a debtor an opportunity to reject ongoing obligations under certain types of contracts, recover property or assets that were transferred or seized prior to the bankruptcy case, and remove certain kinds of liens.
- What Property Can a Debtor Keep?
The Bankruptcy Code allows the individual debtor to retain certain property as “exempt.” Exempt property is free of the claims of creditors and cannot be taken by the trustee to be liquidated. Virginia law determines the types and amount of exempt property. The debtor is entitled to a “homestead exemption” which allows each debtor to claim a one-time exemption of up to $5,000 (plus $500 for each dependent) in any kind of property. The debtor is also entitled to a specific exemption, sometimes referred to as the “poor debtor’s exemption,” in different types of property (for example, clothes up to $1,000; household furnishings up to $5,000; tools of a person’s trade or business up to $10,000). Other types of property (such as proceeds from a personal injury settlement or award and certain contributions to qualified pension plans or IRAs) may also be exempt under Virginia law. You must claim the property as exempt in your bankruptcy schedules and to claim the homestead exemption, you or your lawyer must also properly prepare and file a “homestead deed” within a certain time limit. Creditors or the bankruptcy trustee can challenge the type or amount of the exemptions claimed by the debtor.
A debtor may “reaffirm” his or her obligations to a secured creditor who holds a lien on a house, car or other significant item. A reaffirmation agreement must be in writing, signed by both the debtor and the debtor’s attorney, and must be filed with the bankruptcy court. A debtor may rescind a reaffirmation agreement within 60 days after signing the agreement. A debtor may also free or “redeem” property from a lien by paying the secured creditor the fair market value of the property in a lump sum. The bankruptcy judge can set the value if the parties do not agree.
- What Kinds of Claims Survive Bankruptcy?
The liens of secured creditors survive bankruptcy unless the underlying debt is paid off or the lien is removed during the bankruptcy case. This means the creditor can pursue the collateral (i.e., repossess the vehicle) but the creditor cannot collect against the debtor unless the debt has been reaffirmed. Debts that are reaffirmed during the bankruptcy case will survive.
Some debts cannot be discharged in a bankruptcy case. These nondischargeable debts include recent taxes, alimony or child support obligations, student loans and DUI claims. If a debt is nondischargeable, you are legally obligated to pay the debt even after the bankruptcy. Other types of generally nondischargeable debt may be discharged in a Chapter 13 case but not in a Chapter 7 case.
- What Effect Does Bankruptcy Have on Credit Ratings or Employment?
A bankruptcy filing can be reflected on your credit record for up to ten years, regardless of the type or outcome of the bankruptcy case. A bankruptcy filing may also affect your ability to borrow money, although the effects of such a filing vary significantly depending on the creditor and the nature of the debt. For example, a person’s ability to obtain refinancing on a home mortgage may not be adversely affected by a prior bankruptcy filing as long as payments on similar obligations have remained current. The ability to obtain postbankruptcy credit or to incur additional debt after a bankruptcy filing may be limited in a Chapter 12 or 13 case because all of the debtor’s disposable income must already be committed to repayment of prior creditors’ claims under a plan. Otherwise, there are no legal prohibitions or restrictions against borrowing money, owning property or transacting business after a bankruptcy filing other than the restrictions set forth in the Bankruptcy Code or by local bankruptcy courts.
Private employers are prohibited from terminating or otherwise discriminating against an individual solely because of a bankruptcy filing. A governmental employer may not terminate or refuse to hire a person solely as a result of a bankruptcy filing. Similarly, a governmental unit may not deny, suspend or refuse to renew a license, permit or similar grant to a debtor as the result of a bankruptcy filing.
- How Much Does a Bankruptcy Case Cost?
Each bankruptcy case requires a filing fee. Typically, the filing fee is paid in full with the filing, although an individual debtor may apply to pay the filing fee in installments. There may be other costs and administrative fees associated with a bankruptcy filing. The legal fees and costs charged by attorneys to handle a bankruptcy case vary significantly depending on the type and complexity of the case. The bankruptcy court has authority to approve or disapprove fees paid to a bankruptcy lawyer.
- What Are the Alternatives to Bankruptcy?
Bankruptcy is typically thought of as a “last resort” for individuals and entities that have serious financial problems. Prior to a bankruptcy filing, it is common for financially troubled individuals or entities to consider alternatives such as consumer credit counseling or an out-of-court workout or debt restructuring in which obligations to some or all creditors are modified to provide the individual or entity with some financial relief. Virginia law also provides for an “assignment for the benefit of creditors” under which another individual handles the disposition of assets and proceeds for the benefit of creditors.
The nature and extent of a debtor’s financial problems will dictate the course of action, or the legal procedure, that should be followed in a particular case. Individuals or entities who are experiencing such problems should consult with knowledgeable and competent professionals, including attorneys, before making such a decision.
lf you need assistance in selecting an attorney to assist you with resolving your financial problems, the Virginia State Bar offers a Lawyer Referral Service through which you can obtain the names, addresses and phone numbers of attorneys in your area who practice bankruptcy law.