Bankruptcy Law: Individual
The bankruptcy laws are designed to help individuals in difficult financial conditions by either helping them reorganize their debts or by allowing them to escape their debts entirely. Those interested in declaring bankruptcy should be aware that there is a price to pay for filing bankruptcy, particularly in terms of damaged credit and attorney's fees. It is usually taken as a last resort, when the debtor has no other place to turn.
The first step for someone interested in filing for bankruptcy is to talk to a bankruptcy attorney. The following discussion provides an overview of the bankruptcy laws and the choices that someone filing for bankruptcy will have to make.
The bankruptcy code is a rather complex federal law. The bankruptcy process has its own system, in the sense that it has a bankruptcy court and bankruptcy judges that are separate from other federal courts and federal judges. The bankruptcy code contains two chapters of importance to the individual: Chapter 7 and Chapter 13. Chapter 7 is for a complete liquidation of assets and elimination of debts, while Chapter 13 is for those who can pay back their debts but need some help from the bankruptcy court to do it.
Chapter 7. A Chapter 7 case is initiated by the filing of a bankruptcy petition with the court. Attached to the petition will be documents that give the court a complete picture of the petitioner's financial condition, including a list of all debts, income sources, assets, etc. Once the petition is filed, all creditors are stayed, which means that they are prohibited from any further collection efforts, including writing letters or making phone calls.
The judge will appoint a trustee who takes control of the debtor's finances. The trustee's role is to sell off the debtor's assets for the highest possible prices in order to pay off as many creditors as possible. The debtor is not required to sell literally everything. State law determines what can be kept, which are called exempt assets, and in Illinois the rule is that debtors can keep up to $7,500 of equity in their personal residence, up to $1,200 equity in their personal vehicle, up to $2,000 in personal property, and up to $750 in professional tools of the trade, plus, without regard to value, clothing, books, family pictures, and professionally prescribed health aids.
Before the trustee sells the assets, he or she will schedule a meeting, at which time the creditors are given the opportunity to question the debtor about his or her finances and assets. In most Chapter 7 cases, the debtor has little or nothing left of value, and the creditors only recourses are to claim that something the debtor is claiming as an exempt asset should not be exempt, that its debt should not be discharged in bankruptcy, or that the debtor should be kicked out of bankruptcy for misconduct.
Any creditor who believes that the debtor will have any equity left after the assets are sold will file a claim. Those who fail to file a claim by the deadline lose their right to seek repayment of their debt. In the typical scenario, if creditors get anything, they will get pennies on the dollar. For example, if all the creditors claims total $50,000, and the sale of assets raises $5,000, each creditor will get 10 cents on the dollar. Thus, a creditor owed $3,000 will get $300 of the debt repaid. Of course, this scenario assumes that all the creditors are in equal standing, which means that they don't have any collateral behind the debt. Those creditors who have collateral - the company, for example, that lent money for the debtor to buy the car - are in better position to collect the debt than those whose debts are unsecured.
Once the assets are sold and the proceeds of the sale are distributed to the creditors, the remaining debts are discharged. Thus, in the example above, the $2,700 that was not paid back is discharged, and the creditor can never seek to have it repaid.
Some debts cannot be discharged. Non-dischargeable debts include alimony and child support responsibilities, tax obligations, student loans, and damages the debtor has been forced to pay for malicious acts. Thus, if the debtor has a judgment against him for injuries he caused in a bar fight, he cannot have that obligation discharged in bankruptcy.
The laws require a debtor whose debts have been discharged in bankruptcy to wait six years before filing a second bankruptcy petition under Chapter 7.
Chapter 13. Chapter 13 is designed for those individuals who need temporary court protection from creditors. Someone who files under Chapter 13 intends to repay the debts in full, but they are unable to because of some temporary financial problem or condition. The advantages of filing under Chapter 13 rather than Chapter 7 are that the debtor is allowed to keep his or her assets during the bankruptcy and the effect on the credit rating is less severe because the debts are ultimately repaid.
To be able to file under Chapter 13, the debtor must have less than $100,000 in unsecured debt and less than $350,000 in secured debt.
The process for filing under Chapter 13 is similar to the process for Chapter 7, in the sense that it begins with the filing of a petition with a list of assets and liabilities, a trustee is appointed, a stay is in effect, and a creditors' meeting is held. It differs in that the debtor is obligated within 15 days of filing the petition to develop a reorganization plan for repaying the debt within five years.
Under Chapter 13, the bankruptcy laws give special priority to certain types of unsecured creditors. These debts will be paid back after secured creditors have been paid off, but before other unsecured creditors are paid off. These include the bankruptcy administration costs, taxes, and employees' wages.
The court will hold a second hearing, this one for the purpose of confirming the reorganization plan. Creditors can raise objections and try to have plan provisions altered.
Debtors who file for Chapter 13 protection are allowed to convert to Chapter 7, where the circumstances indicate that Chapter 7 is appropriate, such as where the debtor's financial condition worsens.
Involuntary bankruptcy. Under certain conditions, creditors can force an individual into Chapter 7 bankruptcy. Thus, the decision to file for bankruptcy protection is not always completely in the debtor's hands.
Spouses. A person may file for bankruptcy without having his or her spouse join the petition. Virtually all bankruptcy petitions include both spouses, but it is not required. If a spouse does not join the petition, the non-joining spouse's debts will not be discharged. Thus, a creditor whose debt was discharged in bankruptcy may try to collect the debt from the non-joining spouse, if the non-joining spouse was also legally liable for the debt.