The Basics of Bankruptcy Explained
Bankruptcy is a complicated process, whether personal or commercial. There are some common questions between them, such as: Are debts erased? Or, are assets protected from liquidation? An experienced debt relief attorney can help clients decide which form of bankruptcy is right for their particular situation.
It starts with deciding which type of bankruptcy is needed. Is the party declaring bankruptcy as an individual or business? Different statutes apply to each circumstance.
There are two types of personal bankruptcy and determining which one is right for a particular situation should be guided by a bankruptcy attorney.
- Chapter 7 – This is the most common form of bankruptcy and usually addresses people in financial distress.
Filing for Chapter 7 will discharge most forms of unsecured debt (such as medical debt or credit card debt), so they do not have to be paid back. Secured debts, like a mortgage or car loan must be paid back, but if the debtor chooses to return the property, the debt may be discharged. In general, though, people keep most of their property if opting for Chapter 7, but if the debtor does not remain current on their secured debt payments, they may face foreclosure or have their secured property confiscated, if it is nonexempt.
Under Chapter 7, the debtor’s assets are liquidated. This can take between four and six months to complete and, during this process, all nonexempt property is placed in a bankruptcy estate. This property is controlled by a trustee who determines how to sell it and pay back creditors
Student loan debt is not discharged by Chapter 7 bankruptcy. Account holders must continue making payments on those loans even after the proceedings are finished.
- Chapter 13 – Individuals must choose Chapter 13 if they are above a certain salary threshold, with thresholds varying by state. Standard practice is to take the debtor’s income six months prior to filing for bankruptcy and compare it to the state’s median income. If the debtor’s income is higher than the median, Chapter 7 will usually be unavailable.
With Chapter 13, property is not liquidated. Instead, the debtor must produce a repayment plan that satisfies creditors. The repayment plan is the key to Chapter 13 bankruptcy and explains how the debtor will resolve their accounts over the next three to five years. Payments are made to a bankruptcy trustee, and secured property will be taken back if payments are not kept current.
Every repayment plan must address priority, secured and unsecured debts. Priority debts include domestic support, like child support and alimony. It also includes wages for any employees and some taxes. Priority debts have to be paid in full.
If property can be taken from the debtor in response to nonpayment, it’s a secured debt, and in a Chapter 13 repayment plan, secured debts usually have to be paid back in full. Chapter 13, though, often extends payment schedules, which can reduce month to month expenses.
Some unsecured debt, like credit cards and medical debts may be wiped out, but usually not in their entirety. How much the debtor is responsible for depends on their income, but it’s usually a small fraction of what is owed. If the debtor’s median income is below the state’s average, they may not have to pay any unsecured debt back at all.
What is exempt and nonexempt property?
Exempt and nonexempt property is a primary consideration with bankruptcy and should be explained.
With Chapter 7, some property can be sold by the trustee, without the debtor’s permission, to generate funds, and some property is protected from this process. Protected property is considered “exempt.”
This is where states differ the most on the bankruptcy process. Bankruptcy laws from state to state are similar, with only a couple exceptions. Exempt property provisions are one of those exceptions.
Texas, for example, is lenient with debtors, and this is true of bankruptcy as well. Texas allows people to choose between the state and federal government’s list of exemptions. Debtors must choose one and cannot mix and match state and federal exemptions together. Here are some of its defining features:
- The homestead exception is generous – Some states only allow people to protect a few thousand dollars’ worth of equity. The federal exemption allows for up to $23,675 of equity protection. Texas goes much further, with an unlimited homestead exception, effectively making it impossible for a trustee to liquidate a home when paying off creditors.
- The motor vehicle exception is also generous – Texas also provides an unlimited motor vehicle exception, while the federal government provides a $3,775 exception. Further, for every licensed person in the household, an additional vehicle can be exempted.
- Property exemptions are also considerable – Texas allows debtors to exempt up to $50,000 of personal property and $100,000 of personal property if the household contains a family. This is more than what most other states allow for.
Like most states, Texas considers most tax-exempt retirement accounts and pensions to be exempt from Chapter 7, even if the debtor opts for the federal exemptions instead.
There are several different types of commercial bankruptcy. These are more specific and have special designations or groups that some entities may fall under.
Chapter 11 – Chapter 11 is only for commercial entities and is the best option when a business owner wants to keep their company operating. For this reason, most Chapter 11 cases are submitted voluntarily by the business owner. Chapter 11 is like the commercial version of Chapter 13, and during Chapter 11 proceedings, the business owner submits a reorganization plan to the court. If the plan is approved, the business remains in operation, and the business owner becomes the “debtor in possession.” The debtor in possession remains in control of the company, though if the business has been affected by fraud, incompetence or serious mismanagement, the court may appoint a trustee to handle the company’s affairs instead.
The debtor in possession gives up some control of the company in exchange for going through Chapter 11. The bankruptcy court assumes this final decision-making in several areas, including:
- Entering into or modifying a property lease
- Selling any assets, excluding inventory
- Expanding or shutting down operations
- Entering into a mortgage or any other financial agreement that allows the debtor or company to borrow money after the bankruptcy case is filed
- Retaining or paying fees to an attorney or other professional
- Entering into or modifying most agreements or contracts
The business owner has four months after filing for bankruptcy to provide a reorganization plan, though this period can be extended if the business owner can provide a good cause for doing so. If a plan is not submitted by this deadline, the company’s creditors may submit their own plan, though this is rare. In most cases the business owner’s plan is approved.
In the reorganization plan, the business owner must show how it intends on paying back creditors, how long it will take and what steps the company will take to free up funds for repayment. Most reorganization plans address the last point by including downsizing or liquidation measures.
Chapter 7 – Business owners can also opt for Chapter 7, and it is the commercial version of liquidation. When a business owner files for Chapter 7, they are turning over the business to a trustee for prompt asset selling. The company’s operations come to a halt and everything is sold off to pay creditors, but unlike with personal Chapter 7, there are no property exemptions available to business owners, so everything the business owns can be sold.
As assets are liquidated, creditors are paid off and obligations like contracts, loans, credit cards and utility bills are paid down as much as possible. If, following liquidation, there remains outstanding debts, they are wiped out, unless the business owner is personally liable for the debts. If they are, the debtor will need to file personal Chapter 7 to protect their personal assets.
Chapter 9 – Chapter 9 only concerns municipalities, including cities, counties, school districts, taxing districts and other municipalities. It is similar to Chapter 11, in that it requires the filing party to develop a reorganization plan that is resolved after several years.
Chapter 12 – Chapter 12 is similar to Chapter 13 bankruptcy, though it is only reserved for family farmers that rely on annual income. Like Chapter 13, Chapter 12 requires the property owner to submit a repayment plan that resolves over three or five years. A bankruptcy trustee is also assigned to the case and oversees payments to creditors, which is another similarity with Chapter 13. With Chapter 12, the property owner may continue to operate the farm as normal.
What debt relief attorneys can do outside of bankruptcy
Although an attorney can assist during every stage of the bankruptcy process, they are not limited to bankruptcy. An attorney can help with other debt relief options, including:
Stopping collection calls – A debt relief attorney, upon representing a new client, will notify creditors of this fact. Once a creditor receives this notification, they must contact the attorney to attempt further collections. It’s also common for a debt relief attorney to dispute most, or all, outstanding debts. Once a debt is disputed, the collector must validate it with the information they have on the account. This is often difficult for third-party debt buyers to manage and can reveal weaknesses in the collector’s case. It will also provide time for the attorney to organize further defenses.
Defend against any debt collection lawsuit – If their client is sued, a debt relief attorney will ensure the collector doesn’t win a default judgment outright, as this grants the collector with additional power to pursue assets.
Experienced attorneys have several methods in pushing back against a debt collection lawsuit. The collector will be required to provide comprehensive information on the account in question (something they often cannot do) and verify that they aren’t violating the statute of limitations. In short, collectors will have to fight much harder when they are up against a debt relief attorney.
There is a lot to consider with bankruptcy, and it’s easy to make a mistake if you don’t have a knowledgeable expert on your side. A debt relief attorney knows bankruptcy, can explain it to their clients and ensure they enter the process informed and prepared. If additional debt relief measures are required, an attorney can provide those, too.