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Bankruptcy: Here’s All the Basics You Need to Know

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Every year, thousands of individuals and businesses file for bankruptcy. The United States Administrative Office indicated a decrease in filings, from 773,361 in June 2019 to 682,363 at the end of June 2020. There is a slight drop in the figures, but the number is still relatively high. Bankruptcy remains to be a major problem in the U.S.

What is Bankruptcy? What are Its Most Common Types?

Bankruptcy is a legal procedure that individuals or businesses apply for if they cannot pay their outstanding debts and all financial sources are exhausted. For example, if your business is losing money and plagued with debts, filing for bankruptcy can provide some help and relief. The federal courts handle bankruptcy cases led by a bankruptcy judge.

The bankruptcy judge has two decisions to choose from: debt discharge and debt restructuring. Debtors have the opportunity to pay off their debts according to bankruptcy type specifications. Also, depending on the case’s attributes, the courts may assign a trustee to manage the debt payments and other relevant actions.

There are four types of bankruptcy that individuals and businesses should consider.

Chapter 7 is the most popular and common type as it is suitable for individuals, although it also works best for businesses. To qualify for chapter 7 bankruptcy filing, debtors have to pass a means test, which determines if their income is less than the median and eligible for debt erasure.

Additionally, debtors (whether individuals, businesses, or married couples) who just had a bankruptcy dismissal or discharge are not qualified for a Chapter 7 filing.

Debts that are not covered by Chapter 7 filing include student loans, child or spousal support, and tax.

Chapter 7 is also referred to as liquidation bankruptcy because an appointed trustee sells off the debtors’ non-exempt assets to creditors to pay off debts.

Chapter 11 or Reorganization bankruptcy is ideal for businesses that are in debt but want to continue operating. It involves financial restructuring and rewriting bargaining agreements, among others.

As soon as entities file for Chapter 11 bankruptcy, they automatically receive protection against litigation. The courts assign a trustee to manage the business, and debt repayment is completed via Chapter 7.

Chapter 13 bankruptcy is also popular because it allows debtors to continue their business while paying their debts. It is ideal for individuals, particularly those with sole proprietorship businesses, who do not want to sell off their non-exempt assets and properties. 

However, entities filing for chapter 13 have to prove that they have a steady and regular income. This proof is an assurance that debtors are capable of paying off their debts according to a court-scheduled repayment plan. The collection and distribution of payments are through an appointed trustee.

Certain types of debt are not covered by chapter 13 bankruptcy, including child support, alimony, mortgages, and school loans.

Chapter 12 bankruptcy is intended specifically for family farms, farmers, and fishermen. It is similar to chapter 13 except that it requires debtors to create a repayment plan good for three to five years. Debtors have 90 days after filing to come up with the plan.  

Reasons Why People or Businesses Go Bankrupt

There are five most common reasons for filing bankruptcy: loss of income/reduced income, divorce or separation, medical expenses, unexpected emergencies and expenses, and credit card bills.

When someone loses his source of income, the chances are high that his bills and other expenses will pile up. This situation is particularly common when one is terminated or laid off from work. Although companies typically give severance or separation packages, the amount employees get is often good for only a few months. There are also cases where the laid-off worker does not receive any financial package from the company.

Individuals with reduced income also often find themselves filing for bankruptcy, especially if they do not have an emergency fund and tons of bills to pay.  

A divorce or separation is another reason people file for bankruptcy. Aside from sky-high legal fees, couples also deal with alimony, child support, and the division of their assets.

Medical expenses also cause bankruptcy. In fact, in 2019, health insurance, hospital bills, and other medical issues comprised more or less 66.5% of bankruptcy filings.

Unexpected emergencies and expenses are also major reasons for filing bankruptcy. No one is ever really prepared for earthquakes, tornadoes, floods, and other disasters not covered by home insurance. As such, homeowners often find themselves at a loss when their homes are severely damaged, and they end up spending most of their savings on replacing the properties they lost.

More than the lost personal belongings, however, these emergencies also mean homeowners have to find temporary shelter and ensure that their family and loved ones are fed. For many, situations like this drain their finances, which then leads to bankruptcy.

Credit card bills and unpaid loans can also lead to bankruptcy filings. No matter how many times you remind yourself to control your spending, there are times when you won’t notice that you’ve already gone overboard. Without an emergency or debt consolidation plan, you’ll have no choice but to file for bankruptcy.

Bankruptcy Glossary of Terms

There are many bankruptcy terms that might sound new to you, but these four are the most common ones. Understanding each one is essential.

Creditor The creditor is the person or entity that the debtor owes money to. Creditors also need to understand the bankruptcy process as their claims depend on the chapter filed and the details of the case.

Debtor – The debtor is the person or entity that files the bankruptcy case. A debtor owes money to an individual or a business or organization.

Exemptions – Also known as exempt property, exemptions are the assets or properties that the debtor can keep from creditors as mandated by the Bankruptcy Code and specific state laws. The amount or cost of assets that are exempted varies per state.

Liquidation – Liquidation is a process that involves the selling of the debtor’s assets at discounted amounts and using the proceeds to pay creditors. It is a chapter 7 bankruptcy procedure applied to both individuals and insolvent businesses. However, liquidation is not a requirement for all bankruptcies.

Trustee – A trustee is usually appointed by the courts to represent the bankruptcy estate and execute statutory powers. Supervised by the bankruptcy administrator and the courts, the trustee performs several tasks, including liquidating estate property and distributing payments to creditors in chapter 7 cases, receiving debtor’s payments, handing out payments to creditors, and managing debtor’s plans.

Bankruptcy Facts

Aside from understanding bankruptcy terms, it is also vital for individuals and other entities filing for bankruptcy to know the following facts:

Bankruptcy processes take years to finish.

The bankruptcy process is not a tomorrow-it’s-all-over thing. Chapter 7 cases usually last from a minimum of four to a maximum of six months. A chapter 11 bankruptcy can go on for two years, more or less, while a chapter 13 bankruptcy takes longer to finish – anywhere between three and five years.

Bankruptcy processes require the filling up of complicated forms.

If it is your first time to file for bankruptcy, you might find yourself overwhelmed by the forms you have to complete. These are not fill-in-the-blanks or check-the-box forms, but ones that require you to answer vital financial questions. You’ll need the help of a bankruptcy lawyer to understand and complete the forms.

Bankruptcy processes publicly scrutinize your finances.

One of the bankruptcy protection requirements is a schedule or list of assets, expenses, income or salary, financial transactions, and debts. These details are made open to the public as creditors’ meetings are only done privately in special or extreme cases and circumstances.

You’ll also be asked some probing, private, and sensitive questions during the meeting.

As such, before proceeding with the bankruptcy filing, you have to prepare yourself (and your family) for public scrutiny.

Bankruptcy requires complete honesty, or you can be arrested.

When you submit a list of your properties or assets, creditors, and debts, you must not leave out or hide any information. Lying or committing a dishonest act during the process can lead to loss of bankruptcy discharge. The Federal Bureau of Investigation may also step in and charge you with the federal crime of bankruptcy fraud.

Bankruptcy cases cost a lot.

Apart from the filing fees, you also have to consider spending for your bankruptcy lawyer’s retainer fee. Even if you decide not to hire an attorney, though, you’ll still be spending a significant amount of money.

If you’re confident that your income is not 150% above the federal poverty level, you can apply for a fee waiver from the bankruptcy court.

Bankruptcy discharges do not erase shared debt.

A bankruptcy discharge protects debtors from creditors who want to collect payments from you. However, it acts as a shield only for you, not for other entities or shared debt. So, if you shared a home loan and co-signed with a family member or partner, the lending company cannot collect from you but can do so from your co-signer. The debt remains active.

Bankruptcy can significantly affect your credit.

You have to make sure you’re ready to file for bankruptcy and that you won’t regret doing so. One of the biggest consequences of a bankruptcy filing is its impact on your credit, which can last many years after your case is wrapped up. Creditors will think twice about lending or giving you credit.

Although some lenders do offer former debtors credit, they almost always charge increased premiums. Applying for credit will help improve your credit score, but you have to guarantee that you will pay the fees on time.

If you want a smooth and efficient process for the bankruptcy filing, be determined and committed to your financial recovery. Also, find a good and experienced bankruptcy lawyer.


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Sam Mazella is the Marketing Director of The Peterson Law Firm, the go-to practice in Arizona when facing divorce, child custody, child support, and financial crisis. In his spare time, he enjoys cooking and going on camping trips with his family and friends.

1 Comment

  1. Never knew this about bankruptcy, until now. Thanks for the read.

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