Bankruptcy: What Are The Three Main Types?

What is Bankruptcy?

Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order. 

What is a Bankruptcy Court Proceeding?

During a bankruptcy court proceeding, a judge and court trustee will examine the assets and liabilities of individuals and businesses who are functionally insolvent and determine whether to discharge debts. If the judge and trustee decide to discharge debts, the individual or business who filed for bankruptcy becomes relieved of the requirement to pay them off.

Before Filing for Bankruptcy

Before filing for bankruptcy, a debtor should make a list of all debts, assets, income and expenses. This helps the individual and anyone else involved in a potential bankruptcy filing to gain a clear understanding of the financial landscape involved.

Bankruptcy courts require all petitioners to undergo credit counseling from a Federally approved counseling agency within 180 days prior to filing for bankruptcy. This typically takes fewer than two hours over the telephone or online, and is done to ensure that all possible alternatives to bankruptcy have been explored. When the session is completed, a certificate is issued that must be included within a bankruptcy filing.

The Three Primary Forms of Bankruptcy

Chapter 7 bankruptcy is filed by individual debtors who do not usually have a high amount of income. Chapter 7 bankruptcy involves the paying off unsecured creditors through a liquidation of the debtor’s assets that are non-exempt from liquidation by either state or federal law. Assets that are generally considered exempt include your home, a car utilized for work, retirement savings, welfare entitlements and Social Security checks. These assets are all essential to living and are protected from liquidation to repay debt. Non-exempt assets include cash, funds held in bank accounts, funds held in the stock market, jewelry, collectibles, and any second homes or cars. These types of non-exempt assets will be subject to liquidation under a Chapter 7 proceeding, with the resultant funds raised utilized to pay off creditors.

 Chapter 13 bankruptcy is filed by individual debtors who possess an income higher than the median level of the state in which they live and is an option for people whose income may be too high to file for Chapter 7 relief. Chapter 13 bankruptcy involves designing a three- to five-year repayment plan that prioritizes paying off some creditors in order to have other debts forgiven. When the repayment plan is completed, remaining debts are discharged.

Chapter 11 bankruptcy is most often utilized by businesses, though some individuals use it when their debts exceed the limits granted in Chapter 13. Chapter 11 bankruptcy is considered a “reorganization” bankruptcy proceeding, as it provides businesses the opportunity to continue operating while restructuring debts. The size of these businesses can range. Chapter 11 allows the debtor to pay off debts over time without having to sell assets or go out of business.

The Mechanics of Filing Bankruptcy

In filing any bankruptcy petition, the debtor provides information related to:

• income,
• expenses,
• names of creditors,
• amounts owed,
• and assets.

This information is given to a court appointed trustee, who oversees and manages the entire process while maintaining contact with the petitioner and requesting additional information as needed.

When filing, the petitioner provides specifics as to his average income over the past six months. If this income is below the median income for his or her state, then he can file under Chapter 7 bankruptcy protection. If this income is above the median, then the filer must fill out a form detailing monthly income and expenses to determine whether he has the means to pay off some of the debt within three to five years. If the means test indicates that the debtor can do so, then he files under Chapter 13 bankruptcy protection.

Do I Need an Attorney to File Bankruptcy?

Consulting an attorney is not a requirement for filing bankruptcy, but it may be in the debtor’s best interest to do so. A clear understanding of which federal and state laws apply to your situation can lead to the best possible outcome as to which debts are eventually discharged. Judges and employees of the court, including the petitioner, are not permitted to dispense legal advice regarding your filing. There are important differences between filing bankruptcy under Chapter 7 and Chapter 13.

There are a number of forms to complete, and if you lack a full understanding of the rules and procedures associated with your particular case, the outcome may not go as well as it otherwise could with an experienced attorney by your side. 

What Happens Once I’ve Filed for Bankruptcy?

The debtor must attend a creditors meeting within three to six months of filing for Chapter 7 bankruptcy. The meeting usually takes place in the debtor’s county. This meeting provides creditors the opportunity to ask questions of the debtor in person, though credit card companies and large banks rarely show up. The trustee asks questions related to the forms filed by the petitioner in an interview that is generally only a matter of minutes. Though any creditors in attendance are allowed to ask questions, they can do little to stop the likely discharge of debts that results within a few months of the creditor’s meeting.

Chapter 7 Discharge

Prior to being granted discharge under Chapter 7, the debtor will undergo a brief budget counseling session through a Federally approved credit counseling agency. Once this counseling session is completed, the discharge will erase credit card debts, loans, medical expenses, legal expenses and court judgments. However, obligations including but not limited to Federal student loans, taxes, alimony and child support, debts that arose following the bankruptcy filing and debts resulting from driving under the influence of alcohol are not eliminated through bankruptcy. Bankruptcy may not relieve any co-signers from financial responsibility on all or part of any loans that they agreed to pay off if the debtor could not.

Chapter 13 Discharge

The debtor must attend a creditor’s meeting after formulating a three- to five-year repayment plan. At the meeting any creditors present will have the opportunity to voice their objection to the plan. Any issues that arise out of this meeting can be raised at an ensuing confirmation hearing, where the debtor will present the repayment plan before the judge. If the plan is approved, the debtor must make payments to the trustee, who then distributes the funds to creditors according to the terms laid out in the repayment plan. If the plan is not approved, the debtor can amend the plan and present it in front of the judge again at another confirmation hearing. Once approved, the debtor becomes eligible for debts to be discharged, but only after the repayment plan is fulfilled.

What are the Consequences of Declaring Bankruptcy?

The main reason that anyone would declare bankruptcy is that it provides the benefit of a fresh start and a second chance at financial well-being. A number of things can lead to bankruptcy, such as: a series of poor financial decisions, improper long-term planning, bad luck, or an enormous debt balance. 

Bankruptcy should not be entered lightly without an understanding of the long-term consequences. For example, a Chapter 7 bankruptcy will remain on a credit report for ten years from the filing date, and a Chapter 13 bankruptcy will remain on a credit report for seven years from the filing date. Both can hinder your ability to obtain new lines of credit and potential employers may frown upon this aspect of your financial history. Your credit score is also affected. It is likely that a bankruptcy discharge will lower your FICO credit score toward the low 500s. 

Before deciding whether to file bankruptcy and dealing with the long-term stain of a bankruptcy discharge on your credit report, be certain to investigate other alternatives such as debt settlement.

Debt settlement is an agreement made between a creditor and a consumer in which the total debt balance owed is reduced and/or fees are waived, and the reduced debt amount is paid in a lump sum instead of revolving monthly. CuraDebt is a debt settlement company that is able to help you with all of your debt related needs. If you are looking for an alternative to bankruptcy, contact us today for your free consultation. 1-877-850-3328