Bankruptcy Law

Updated February 23, 2024
8 min read
Bankruptcy Law: board, book, paper, pen, scales, coins, down arrow

Bankruptcy law is a legal process that helps individuals, businesses, and organizations when they are unable to pay off their debts. Bankruptcy offers a legal framework for debtors to obtain financial relief by either restructuring their debts or discharging them altogether. 

Bankruptcy law provides a fresh start for those facing overwhelming financial difficulties. This legal guide offers the basics of bankruptcy law, including defining key terms and explaining how the process works.

Definition of Bankruptcy Law

What is bankruptcy law? An individual or business that is in unmanageable debt can declare bankruptcy as a way to help manage that debt. Federal law guarantees the right to declare bankruptcy. Only federal courts have jurisdiction over bankruptcy matters. Bankruptcy law is the legal process for dealing with the debt issues. 

Terms To Know

There are several terms for debtors to know in bankruptcy law. Some of the most important indicate the type of bankruptcy a person files, specifically the chapter that the person uses for his or her bankruptcy. Bankruptcies are called chapters because of the associated chapter in the federal Bankruptcy Code. Some of the most common terms to know include: 

  • Chapter 7 — Chapter 7 is liquidating or selling assets to pay as many debts as possible. This method frees the debtor from all unsecured debt and does not include a payment plan.

  • Chapter 13 — Chapter 13 is reorganizing debts or establishing a payment plan for paying all or some debts over three to five years. The court appoints a person to distribute the money to the creditors.

  • Debt — Debt is the amount owed to creditors.

  • Creditors — Creditors are the lenders, those who have provided any type of loan that the debtor owes.

  • Plan — A plan is what the debtor presents to the court outlining the proposed process for repaying the debt. An experienced attorney from a bankruptcy law firm may be able to guide the debtor through developing this plan.

  • Assets — Assets are properties that the debtor owns.

How Bankruptcy Works

There are three categories of claims or debts covered by bankruptcy laws, which are often handled by bankruptcy law firms for businesses that are in debt:

  1. Secured debt — These debts include mortgages, auto loans, and other loans backed by collateral, usually, a house or car or other valuable item. After completing the process according to bankruptcy law, the individual or business can be “discharged” from these debts. 

  2. Priority unsecured debt — These debts have priority payment under governmental policy. They include food stamps and pensions.

  3. Unsecured debt — In chapter 13, creditors of unsecured loans, such as credit cards, are the last to collect. What is left, if anything, is distributed to these creditors. Bankruptcy protects the debtor by “discharging” or removing the remaining debts. 

If you are facing bankruptcy, consider consulting with a bankruptcy law firm to find an attorney experienced in bankruptcy law who can provide legal aid during the process. Be sure to choose one who suits your needs and uses your preferred method of communication.

What Are the Types of Bankruptcy Filings?

Bankruptcy filings are grouped according to which chapter of the federal Bankruptcy laws applies. Chapter 8 relates to asset liquidations. Chapter 10 concerns individual or company reorganizations. Chapter 13 deals with debt repayment under lower debt covenants or specific payment options. Bankruptcy filing costs can vary according to several factors, including the chapter.

Chapter 7: Liquidation

This technique can be used if a company is financially insolvent. Closing a business through a process called “liquidation” lets a project end in an organized way while respecting the rights of its workers and creditors.

The goal is to sell the debtor’s assets quickly and efficiently to pay those the debtor owes (e.g., employees, suppliers, and others). The assets can be liquidated for a maximum of 12 months.

Chapter 13: Repayment Plan

Chapter 13 is a reorganization bankruptcy. It permits debtors to retain ownership of their property by agreeing to make monthly payments against their debt for three to five years.

Chapter 13 of the bankruptcy law offers a lot of benefits besides letting debtors keep their property. An automobile loan, for example, can be restructured to decrease the principal balance to the market value of the collateral and extend the payback period to 60 months, which lowers the monthly payments. Mortgages, some school loans, and tax debts are just a few other debts that can be altered in a chapter 13 bankruptcy. 

Chapter 11: Large Reorganization

Chapter 11 of the bankruptcy law is a type of bankruptcy available to large businesses and corporations and to individuals who have significant debts. Chapter 11 allows debtors to reorganize their finances, restructure their debts, and continue operating their businesses while they repay their creditors. 

Businesses that have gone bankrupt but wish to continue operating may file for chapter 11 bankruptcy protection. Like a personal reorganization, chapter 11 shelters corporations from creditors while they work out a repayment plan. The properties of the business can be reorganized to provide the company with a second opportunity at profitability.

Chapter 12: Family Farmers

Chapter 12 is for “family farmers” or “family fishermen” with a “regular annual income.” This type of bankruptcy enables financially challenged family farmers to create and implement a repayment plan for all or part of their obligations. Under chapter 12, debtors propose a repayment plan to make installments to creditors over three to five years. Payments must be spread over three years unless the court grants an extended period “for cause.” However, unless the plan seeks to pay 100 percent of domestic support claims (i.e., child support and alimony), it must last five years and contain all the debtor’s disposable income. In no circumstance may a plan provide for payments over five years. 

Chapter 15: Foreign Cases

Chapter 15 allows foreign creditors to participate in U.S. bankruptcy proceedings and bans discrimination against foreign creditors (save for some foreign government and tax rights).

Chapter 9: Municipalities

The protection from a municipality’s creditors provided by chapter 9 is meant to be only temporary. This is provided so the municipality can plan and negotiate a strategy for reorganizing its debts when it receives protection from its creditors under chapter 9.

Being Discharged From Bankruptcy

If everything proceeds according to plan with a bankruptcy, the court’s final action is to grant a discharge, which absolves the debtor of all eligible debts. The discharge order forbids creditors from taking any further action to pursue a discharged obligation.

The court may refuse a discharge in extremely limited circumstances. These include when a debtor attempts to deceive a creditor by concealing property, providing false information to the court, failing to comply with an order from the court, and others.

Bankruptcy Pros and Cons

Bankruptcy has both pros and cons for the debtor. The pros of bankruptcy can include the following:

  • Debt relief — Bankruptcy can relieve debtors from their financial obligations and allow them to start fresh.
  • Protection of assets — Bankruptcy can protect debtors’ assets from seizure by creditors.
  • Automatic stay — Bankruptcy imposes an automatic stay on creditors, which stops collection efforts and legal actions against the debtor.
  • Time to catch up on payments — Chapter 13 bankruptcy allows individuals to restructure their debts and pay them off over time, which can provide a more manageable payment plan.

Some of the drawbacks to filing for bankruptcy include the following:

  • Negative impact on credit — Bankruptcy stays on a credit report for up to 10 years and can make it difficult to obtain credit in the future.
  • Potential loss of assets — In chapter 7 bankruptcy, assets may be liquidated to pay off debts, including homes, cars, and other property.
  • Emotional toll — Filing for bankruptcy can be stressful and emotionally draining, as individuals or business owners struggle through feelings of financial failure.

Alternatives to Bankruptcy

Before deciding to file for bankruptcy, a debtor may want to consider one or more of the following alternatives:

  • Avoid bankruptcy by paying off or settling debts.

  • Reduce regular expenses, earn more money, negotiate a better loan rate, or sell property to make debt payments.

  • Contact a bankruptcy law firm to discuss additional legal options. A bankruptcy lawyer can provide more information on other options that may be available.

  • Take advantage of credit counseling services. These can aid debtors in creating a budget, negotiating a repayment schedule with low or even no interest, and ending aggressive collection tactics from creditors.

What Is the Downside of Filing for Bankruptcy?

While bankruptcy can provide financial relief, the process has several downsides. One of the biggest is the impact on the debtor’s credit.

Warning

Bankruptcy stays on a person’s credit report for up to 10 years, making it difficult to obtain credit in the future. Some employers and landlords may view a bankruptcy filing as a negative mark on a person’s financial history and be less inclined to hire or rent to the person.

Another downside to filing for bankruptcy is the potential loss of assets. In chapter 7 bankruptcy, certain assets — homes, cars, and other property — may be liquidated to pay off debts. While chapter 13 bankruptcy allows individuals to restructure their debts and pay them off over time, it may still require the sale of some assets to pay off creditors.

Is Bankruptcy a Good Choice?

Bankruptcy may be a good choice if a person has excess debt and has no other options. Filing for bankruptcy can eliminate or reduce debts, stop creditor harassment, and give the debtor a fresh financial start. 

However, bankruptcy is not a decision to be taken lightly because it has serious long-term consequences. Bankruptcy can negatively impact a person’s credit score, making it difficult to obtain credit in the future and affecting the person’s ability to get certain jobs or rent an apartment. It’s important to consider all options before deciding if bankruptcy is the best choice. Consulting with bankruptcy law firms may also help.

Are All Debts Forgiven if You File for Bankruptcy?

Unsecured debts — credit cards and personal loans — are sometimes dischargeable in bankruptcy. However, bankruptcy laws won’t wipe out certain other debts, including student loans.

Will I Lose My Car if I Declare Bankruptcy?

When you declare bankruptcy, you may not necessarily lose your car. If part of your debt is a car loan, you generally may choose to surrender the car to the lender or continue making payments. 

If you choose to keep the car, you can reaffirm the debt. Reaffirming means agreeing to continue making payments on the loan. Another option is to redeem the car by paying the vehicle’s current value to the lender. If a debtor owns a car outright, he or she can keep the car if it is within the state’s allowed exemption limit.

How Does One File for Bankruptcy?

Typically, a bankruptcy proceeding begins when the debtor submits a petition to the bankruptcy court. An individual, a married couple, a corporation, or another legal entity can file a petition for bankruptcy. 

Is Bankruptcy a State Law or Federal Law?

Federal bankruptcy law governs all bankruptcy proceedings. Bankruptcy rules, known as the federal rules of bankruptcy procedure, and the local laws of the bankruptcy court in each state govern the bankruptcy process.

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Frequently Asked Questions

Can I file for bankruptcy at my local court?

Yes, you can file for bankruptcy in your local bankruptcy court. There are bankruptcy courts in all states. Locate the court in your state and file your petition for bankruptcy. For more information, visit your state’s bankruptcy website or contact bankruptcy law firms.

What is the first step to filing for bankruptcy?

The first step to filing for bankruptcy for some may be to consult with lawyers from bankruptcy law firms. The attorney can offer guidance in determining if bankruptcy is the best option. Individuals and businesses can generally file under two types of bankruptcy: chapter 7 and chapter 13. After determining the chapter to file under, the debtor will file a petition with the court, often with the help of an attorney.

Who can file a petition for bankruptcy?

A debtor petitions the bankruptcy court. This can often be done with the help of a lawyer from a bankruptcy law firm who specializes in these types of cases.

To file for chapter 13 bankruptcy, an individual must have a regular income and have debts that fall within the eligibility limits. As of 2023, individuals cannot have more than $419,275 in unsecured debt or $1,257,850 in secured debt to be eligible for chapter 13 bankruptcy.

Businesses that wish to file for bankruptcy must also meet specific eligibility requirements. These requirements vary depending on the type of bankruptcy being filed.

What do I need to put on my petition?

When filing for bankruptcy, you’ll need to submit a petition to the court. The petition is a legal document that provides information about a debtor’s financial situation, assets, liabilities, and income. The petition must be completed accurately and truthfully. Providing false information can result in serious consequences.

Attorneys from bankruptcy law firms must include the following information in a bankruptcy petition:

  • A list of all creditors and the amount owed to each creditor;
  • A list of all assets and their values;
  • A list of all income and expenses;
  • A statement of financial affairs;
  • A copy of the debtor’s most recent tax return; and
  • Proof of completion of a credit counseling course.
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