What Does Bankruptcy Mean?

Bankruptcy is one of those words that everyone’s heard but many don’t really know what it means. Especially with so many high profile bankruptcies in the news these days, it can be hard to figure how bankruptcy can actually help a regular consumer. Let’s take a look at what bankruptcy means and how the different types of bankruptcy enable you to take back charge of your finances. 

What is bankruptcy? 

Bankruptcy is a legal process that resolves debt. Bankruptcy has two goals: to pay creditors as much as possible and to provide a clean slate for the person filing bankruptcy. Scholars have defined bankruptcy as an opportunity for financial rebirth. We like to think of it as a powerful poverty fighting tool.

How are creditors paid in a bankruptcy?

Creditors can be paid through the liquidation of assets, reorganization of debt, and debt repayment plans. If you don’t have money (or assets) to pay creditors, the creditors won’t be paid. Some assets and certain types of debt are exempt from the bankruptcy process, and some are not. In a Chapter 7 bankruptcy, a bankruptcy trustee will review your personal financial situation and sell any nonexempt assets. In a Chapter 13, they’ll administer your payment plan. 

How does a bankruptcy filer get a fresh start

A bankruptcy discharge ends your legal obligation to pay certain debt. The bankruptcy discharge means that you no longer owe the debt — whether it is paid or not. Qualified judgments, garnishments, and collection actions related to the bankruptcy case permanently stop as soon as the case is filed and can never resume once a discharge has been entered. The discharge also protects the filer from employment discrimination. 

Do U.S. bankruptcy laws change the meaning of bankruptcy? 

Politics, economics, and culture influence the definition of bankruptcy. Congress was given the power to create bankruptcy laws through the U.S. Constitution (Article 1, Section 8), and the first bankruptcy law was created in 1800. Big changes to federal bankruptcy laws were passed in the Bankruptcy Acts of 1841, 1898, 1978, 1994, and 2005.

Today, bankruptcy is an economically beneficial and humane solution to financial despair. It helps creditors, people, and corporations resolve debt. The United States Bankruptcy Code (Title 11 U.S.C.) gives us legal direction on how to handle a bankruptcy case in federal court. It also tells us the differences between filing Chapters 7, 9, 11, 12, 13, and 15 bankruptcy actions. The collection of federal laws in the U.S Bankruptcy Code defines what bankruptcy means today. State laws supplement the federal laws as appropriate. 

What does bankruptcy help with? 

Bankruptcy will stop phone calls and letters from bill collectors. When you file your bankruptcy petition, you immediately get an automatic stay.  You’ll be protected from phone calls and collection letters, wage garnishments, repossessions, and lawsuits. At the end of the bankruptcy process, a discharge ends your legal obligation to pay your unsecured debt, such as credit card debts, medical bills, and unsecured personal loans. 

If you have steady income, you may be able to pay secured creditors, like your mortgage company, through a payment plan in a Chapter 13 bankruptcy.

What can’t bankruptcy do? 

Bankruptcy doesn’t make all debt disappear. You’ll still owe child support, alimony, most IRS debt, court fines, and (in some cases) student loan debt. Those are non-dischargeable debts. You’ll also have to pay the debt that you incurred after your petition was filed. Bankruptcy will dismiss old utility bills, but not current bills. Bankruptcy only helps with pre-bankruptcy debt.

If a creditor files an Objection to Discharge, which they might if they think you never planned to pay for the debts you incurred or that you can pay, the judge will decide on the discharge. Bankruptcy is not a way to accumulate assets without paying for them. You can’t hide assets in bankruptcy, everything goes on the table. If you have a car loan, the only way to keep your car is to pay for it. Whether that’s through a reaffirmation agreement that keeps you obligated to pay off the car even after your discharge has been entered, or by paying the fair market value of the vehicle through a redemption. Finally, bankruptcy does not increase your income. 

Now that we have a general idea of what the concept of bankruptcy stands for, let’s take a closer look at the different types of bankruptcy an individual (or married couple) can file. 

Chapter 7 bankruptcy

Chapter 7 is the most popular type of bankruptcy making up approximately 65% of all bankruptcy filings in 2019. Individuals (including married couples) and businesses can file a Chapter 7 petition. 

The Chapter 7 process

A Chapter 7 bankruptcy starts with credit counseling and ends with a discharge of debt. The Chapter 7 bankruptcy process officially starts when you file your bankruptcy petition and that’s when the automatic stay goes into place.You’ll have to get your documents together and fill out bankruptcy forms to share your financial information with the bankruptcy trustee, creditors, and the judge, but it will be worth your time. The creditors will get paid what you can afford to pay, and unsecured debt will be resolved. The whole process can be done in 3-4 months, depending on your personal finances.

What is a Chapter 7 Means Test in bankruptcy?

Chapter 7 has income limits. If you make too much, you’ll have to file for Chapter 13 bankruptcy and use a debt repayment plan to resolve at least some of your debt before getting a discharge. To see if you qualify for a Chapter 7 filing, you’ll need to pass the  Means Test.

The Chapter 7  Means Test is an eligibility test that determines whether your income is too high to qualify for a Chapter 7 bankruptcy. The test was started with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) to help make sure that people who could pay, would pay. Six months of household income will be evaluated. The Means Test does not include social security benefits, veterans’ disability benefits, and certain tax refunds, family gifts, and victim benefits as income.

Chapter 7 liquidation

A Chapter 7 bankruptcy is also known as a “liquidation bankruptcy.”  Through the trustee, your non-exempt assets (personal property and real estate) will be sold to pay creditors. Some assets are exempt and can be kept, but not luxury items. Have a boat? It’s most likely nonexempt property. Many bankruptcies under Chapter 7 are “no asset” cases and move faster since nothing can be sold and creditors take no action. A Chapter 7 is faster than a Chapter 13 bankruptcy because Chapter 7 doesn’t have the payment plan requirement. A Chapter 7 may take a few months, but Chapter 13 payment plan has to be at least 3 years in length, unless 100% of all allowed claims are paid off in full before then. That’s not very common, however. In the end, your unsecured debt will be discharged and you’ll get a fresh start.

Chapter 13 bankruptcy

Chapter 13 bankruptcy is for individuals and sole proprietors that have a regular source of income. If you don’t qualify for Chapter 7, you can file for a Chapter 13 bankruptcy and create a repayment plan for your debts. A Chapter 13 may take 3-5 years to complete. Payments are based on your income and expenses, your assets, and your goals —not creditor demands. You get to suggest the payment plan, but the trustee reviews and the court approves the plan.

The tough part about a Chapter 13 is sticking with the plan. Many people can’t. The bright side of a Chapter 13 bankruptcy is that you have a chance to retain possession of your property even if it’s not covered by any exemptions, as long as you pay for its value. Your credit report rebound may be faster with a Chapter 13 bankruptcy as it shows an ability to make payments. 

Creditor payments must be paid at least as much as they would receive under a Chapter 7 filing. A bankruptcy attorney can help you with a Chapter 13 bankruptcy repayment plan; it’s best not to attempt a Chapter 13 without one, as they are much more complicated than Chapter 7 bankruptcy. You’ll also have to attend a credit counseling agency session before you file your petition, just as you would with a Chapter 7 bankruptcy and Chapter 11 bankruptcy.

Chapter 11 bankruptcy

Chapter 11 bankruptcies were created to help businesses survive, but individuals can also file a Chapter 11 bankruptcy. The bankruptcy filing fees for Chapter 7 and Chapter 13 are both in the $300 range, but the filing fee for a Chapter 11 is over $1,000 and it’s generally not refundable. A court can dismiss a Chapter 11 if the judge thinks reorganization isn’t possible. 

Businesses in Chapter 11 can reorganize debt, keep or liquidate assets, and get new payment plans all with the protection of the courts and with an order for creditors to stop collecting. A reorganization plan is created by the filer, but it goes up for a vote and requires court approval. A creditor’s committee may be formed, and creditors can object and suggest their own plans. The plan can go on for years, be modified, or converted to a Chapter 7 case. 

Chapter 11 bankruptcies are lengthy and complex. Business operations continue during the bankruptcy proceedings, and unnecessary transactions must be approved with the courts. If you’re considering a Chapter 11 bankruptcy,consult a bankruptcy attorney. 

Alternatives to bankruptcy

Bankruptcy isn’t the only possible solution to your debt issues. One downside of bankruptcy is that it stays on your record for 7-10 years. Maybe you don’t want that heavy dent in your credit record. You have options. 

Debt consolidation

One way to use debt consolidation to pay off debt is to take out a new loan to pay off your debt. You’ll still have new debt and a new loan to pay, so you’re not debt-free. To consolidate debt, you can take out a new credit card loan or personal loan with a lower interest rate. Look closely at the fees, timelines, and terms. Your credit report will show the debt is paid, but it’s also going to show your new loan and new debt.

Debt management plan (DMP)

 A debt management plan is a form of debt consolidation. It consolidates your many monthly payments into one big monthly payment. It might sound too big to handle, but if you arrange the plan through a debt management program, you can get help lowering interest rates and making payments manageable. You’ll make payments to the DMP administrator, and they will pay creditors. While your credit score will initially take a hit, your credit report will eventually show you paid your debt in full. 

Debt settlement 

Debt relief through debt settlement is another way to clear up debt. Debt settlement in debt relief terms means you settle your debt for less than you originally owed. Negotiations are held with creditors and a percentage of the debt is forgiven. You pay the rest. You might pay it all at once or make monthly payments to a debt settlement company. Your credit score will suffer and bill collectors can still be aggressive. Bankruptcy is safer in that regard because it protects you from collection activity. The IRS considers the forgiven debt income and you’ll be stuck paying taxes on any forgiven amount over $600 using the debt settlement method. Debt discharged in bankruptcy is considered taxable income by the IRS.

Bankruptcy has the advantage of resolving all your debt at once, whereas debt settlement, debt consolidation, and debt management plans require you or a representative to call and negotiate with each creditor individually and there are no guarantees that all of them will agree to work with you. 

Do I need a lawyer to file bankruptcy?

The bankruptcy process can feel like a mangled maze. A bankruptcy lawyer will help if you have valuable assets, a difficult case, or if you want to file bankruptcy under Chapter 11 or 13. A bankruptcy case can get kicked for a technicality. When you hire a bankruptcy attorney, you invest in your future. An attorney will save you time in bankruptcy court, fight objections, help you with assets and secured debt, and make sure technical details aren’t missed. If you can’t afford a lawyer, you can contact a local Legal Aid office and ask them if they offer bankruptcy assistance. You can also ask for a referral. 

If you don’t want to hire a lawyer and you’re not afraid of diving into forms and documents, then try Upsolve’s free web app and let Upsolve be your personal tour guide through the bankruptcy maze.