Intro to Bankruptcy

Bankruptcy is a legal process by which individuals or entities (like a corporation) can eliminate or repay some or all of their debts under the protection of the federal Bankruptcy Court.  There are several sections of the bankruptcy code, or "Chapters", under which a debtor can file.  Most consumers file bankruptcy under either Chapter 7 or Chapter 13.

Chapter 7 is liquidation bankruptcy.  It's called liquidation because the bankruptcy trustee will sell (or "liquidate") some of your assets in order to pay back some or all of your debt.  However, the trustee can't just take whatever he or she wants.  Much, if not all, of what you own will be protected from seizure (called "exempt") under state or federal law.  Whether or not the trustee can seize and liquidate your assets, at the end of the process all of your dischargeable debt will be eliminated.

Chapter 13 is reorganization, or repayment, bankruptcy.  In a Chapter 13, you keep all of your property, but you must make payments over the course of 3 or 5 years.  After the payment period, whatever amount remains of your dischargeable debt will be discharged.

Chapter 7 Bankruptcy

A Chapter 7 bankruptcy can be filed by individuals or businesses.  It typically lasts 3 to 6 months.  But  not everyone can qualify for a Chapter 7 bankruptcy.  If your disposable income is sufficient to fund a Chapter 13 bankruptcy payment plan, you will be required to file under Chapter 13.  The way this is determined is through what is called the Means Test.  In most cases, if your average income is equal to or less than the median income for your state, you will qualify for a Chapter 7.

In a Chapter 7 bankruptcy, some of your property will be sold (liquidated) to pay off some of your debt.  In return, all of your dischargeable unsecured debts will be erased.  Only property that is designated as "non-exempt" can be taken and sold off by the trustee.  You will keep all of your property that is designated "exempt" under the laws of your state.  Exempt property includes things like clothes, household furnishings, and your car.  Your house may also be exempt.

For money you owe on secured debt (for example, a car loan for which the car is pledged as collateral), you may do one of three things.  You can decide to let the lender repossess the property, or you can pledge to keep making payments, or you can pay off the amount of the loan.  If you decide to keep on making payments, you will need to sign a "reaffirmation agreement", and your creditor will have to agree to the new agreement.

Not all debts can be discharged in a bankruptcy.  Debts due to unpaid child support, unpaid spousal support, and unpaid taxes will not be discharged in a bankruptcy.  Criminal penalties and restitution will not be discharged in a bankruptcy.  And in most cases, student loans will not be discharged in a bankruptcy.  However, other debts such as credit card debt, medical bills, payday loans, and other unsecured loans will be discharged.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy allows you to repay some or all of your debt.  In order to file for bankruptcy under Chapter 13, you must have a reliable source of income that you can use to make monthly payments.  How much you pay depends on your repayment plan.

When you file under Chapter 13, you propose a repayment plan that details how you are going to pay back your debts over the next 3 or 5 years.  The minimum amount you will be required to pay back depends on several factors: your income, your total debt, and how much your unsecured debtors would have received if you had filed under Chapter 7.  Your monthly payment must also be approved by the Bankruptcy Court.

Secured debts can be included in the payment plan, to give you an opportunity to make up missed payments and get current.  Whether you include secured debts in the payment plan is optional, depending on your situation.

Other Chapters

There are other types of bankruptcy under which people can file: Chapter 11 and Chapter 12.

A Chapter 11 bankruptcy is generally used by businesses.  Like Chapter 13, this form of bankruptcy allows the debtor to reorganize their affairs and create a payment plan.  It is also available to individuals, but is more expensive and time-consuming than a Chapter 13.  If your debts exceed the debt limits for a Chapter 13, or if you own substantial non-exempt assets (like real estate), a Chapter 11 may be a viable option for you.

A Chapter 12 bankruptcy is almost identical to Chapter 13, but is available only to farmers.  If at least 80% of your debts arise from the operation of a family farm, you will qualify for a Chapter 12.  The debt ceilings are higher than in a Chapter 13 to accommodate the large debts that may arise from operating a farm.  It also allows the debtor to eliminate ccertain types of liens not allowed under a Chapter 13.