Introduction to Bankruptcy

Bankruptcy Law in Layman’s Terms

Bankruptcy is a form of debt relief through which individuals and businesses can eliminate debt under the protection of the Federal Bankruptcy Court. There are many misconceptions about bankruptcy, many of which we will attempt to dispel in this guide.

Debt Relief

While there are several forms of debt relief available to individuals and businesses, none are as powerful or effective as bankruptcy. There are, nevertheless, downsides to bankruptcy, the primary one being its effect on the petitioner's credit score.

Depending on the level of debt, consolidation of debts or debt settlement may be a more appropriate option. Always talk to a bankruptcy lawyer first about your financial situation before committing to (or deciding against) filing for bankruptcy.

In a nutshell, bankruptcy laws were designed to help debtors who have become insolvent (unable to repay their debts) by either reorganizing their debts or eliminating their debts in return for having certain of their assets liquidated.

Bankruptcy Basics

For individuals or small business owners (the focus of this guide), there are two fundamental types of bankruptcy options offered: liquidation bankruptcy and reorganization bankruptcy.

Liquidation

In a liquidation bankruptcy, a trustee is assigned to the case to determine if the petitioner has any assets of value that can be sold in order to repay some of the creditors involved. In return for the liquidation of assets, the petitioner’s debts are discharged (erased), and he or she is given a fresh start.

The most common type of liquidation bankruptcy is chapter 7, which is available to individuals and families and to small business owners running sole proprietorships, partnerships and certain limited liability companies.

Misconception

In most chapter 7 cases, the petitioner’s significant assets are protected by bankruptcy exemptions. A common misconception is that filing chapter 7 will result in all your property being sold off. In reality, in the great majority of chapter 7 cases, very little, if any, property is sold, primarily because the valuable property is protected and the rest is worth too little or is too difficult for the bankruptcy trustee to sell.

Reorganization

A reorganization bankruptcy offers debtors a way to repay some of their debts over time under a bankruptcy-approved repayment plan. The most common type of reorganization bankruptcy is chapter 13, which is available to individuals, families and certain small business owners.

Under a reorganization bankruptcy, a repayment plan is proposed by the petitioner and approved by the bankruptcy court and trustee. This plan, rather than being based on the petitioner’s debt, is based on his or her monthly disposable income. This means that even in a case in which the amount of debt would require many thousands of dollars per month to pay off, the debtor pays only as much as is affordable, given his or her income. The rest is discharged at the end of the plan.

Misconception

The most common misconception about chapter 13 bankruptcy is that all debts must be repaid. Actually, a monthly payment approved by the bankruptcy court and based on the petitioner's disposable income is what is paid. This means that many petitioners may repay as little as 2 to 10 percent of their debt, depending on their monthly income after bills and housing costs. The amount of debt repaid depends on how much the petitioner can afford to pay after paying regular monthly bills for items such as housing, food, retirement contributions, clothing and other common expenses.

Other Types of Reorganization Bankruptcy

• Chapter 11 – Chapter 11 is very similar to chapter 13 but is for larger limited liability companies and incorporated businesses.
• Chapter 12 – Also similar to chapter 13, chapter 12 is designed for farmers and fishers and gives more leeway in terms of repayment and income calculations.

Different Options for Different Situations

Liquidation or chapter 7 bankruptcy is often termed "fresh start" bankruptcy because, upon completion of the case, usually in 60 to 90 days, the debtor is debt free and given a clean slate. This is usually best for people with little or no income and without significant non-exempt assets (such as several paid-off cars or a large amount of equity in multiple real estate properties).

Reorganization bankruptcy is commonly referred to as “wage earner's” bankruptcy and is best for those with stable regular incomes and significant assets to protect. Chapter 13 also provides those in mortgage default or facing foreclosures a way to keep their homes and pay off mortgage arrears over time.

Next Steps

2. Alternatives to Bankruptcy
3. Deciding to File for Bankruptcy
4. What Bankruptcy Can Do

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