Bankruptcy - An Overview
For individuals, there are two primary forms of
bankruptcy protection in the Bankruptcy Code (called simply, the “Code”). By
far the most common is what is referred to as a “Chapter 7” bankruptcy,
otherwise known as a “liquidation” or “zero-asset” case.
The second most utilized type of bankruptcy is a
“Chapter 13”, called “Reorganization”. Most people are at least somewhat
aware of the corporate version of this form of bankruptcy because the media
reports many high-profile cases such as Enron or K-Mart extensively.
Chapter 7 bankruptcy is most appropriate in situations
where the debtor either does not have a home mortgage, or if they do, they
are current on the mortgage, but their unsecured debt such as credit cards
bills are causing them financial problems. A Chapter 13, on the other hand, is most
useful when a homeowner or small business is so far behind on payments on
secured assets they want to keep (for example, a mortgage loan on their
residence) that the lender is about to start or has already started
foreclosure proceedings in court.
Either type of bankruptcy starts with the filing of a
petition by the debtor with the court. Western Pennsylvania falls under the
jurisdiction of the United States Bankruptcy Court for the Western District
of Pennsylvania, located in the USX Tower on Grant Street in Pittsburgh.
United States Trustees, who oversee the administration of bankruptcy
matters, are appointed by the U.S. Attorney General’s Office.
The bankruptcy petition is an exhaustive document which
outlines what the debtor: (a) owns (his assets), (b) owes to creditors (the
liabilities), (c) is claiming are, by law, out-of-reach of the creditors
(called “exemptions”), (d) makes as income (or household income if the
petition is filed with a spouse), and various other information pertaining
to the financial affairs of the debtor. In a Chapter 13 bankruptcy only, the
debtor must also file with the court a plan as to how the debtor intends to
pay secured creditors for money past due (arrears). The plan, depending on
various factors beyond the scope of this summary, can last from three (3)
years up to five (5) years.
Once the Court receives the debtor's petition for
protection, it sends a notice to all the debtor’s creditors informing them
about the petition, and warning them that all collection activities,
including sending bills, telephone calls to the debtor, and law suits
against the debtor, must cease immediately, and cannot resume unless another
court order either says those activities can resume, or the case is
dismissed. This is referred to in legalese as the
“automatic stay”. The stay is an extremely powerful tool for debtors and is
one of the primary advantages of filing bankruptcy. It provides the debtor
with the breathing room to step back, plan appropriately, and start making
sense of the financial chaos that lead them to file.
In a Chapter 7 case, the court selects a trustee
(usually an attorney who has extensive bankruptcy practice experience) to
oversee the business that needs to be performed on the case during the
process. In a Chapter 13 matter, the United States Trustee for the district
oversees the case. About 30 days after the petition is filed, a meeting is
held with the trustee, the debtor and the debtor’s attorney. This meeting is
referred to as the “First Meeting of the Creditors”, or sometimes the “341
Meeting” (341 being the applicable Code section).
The purpose of the meeting of creditors is to allow the
trustee to ask the debtor and the debtor’s attorney any questions about the
petition that may need clarified. The trustee may request that the attorney
later provide additional or updated information in the form of an amendment
to the petition. The Trustee does not "cross examine" the debtor
or ask "trick question", and most
trustees are sensitive to the fact that many people feel embarrassed and
humiliated to be there, so they act appropriately.
Creditors are also permitted to attend the first meeting
of creditors (either personally or by legal counsel) and ask relevant questions
regarding facts asserted in the debtor’s petition. As a practical matter
however, few creditors ever show up to question or contest the bankruptcy,
because their rights are normally very clear according to the Code.
Critical in all bankruptcies is the notion of
“exemptions”. The Code has set up various categories of federal law
exemptions that act to shield a debtor’s property from reach of the
creditors. The most important example of this is the primary residence
exemption. With this exemption, a debtor can exempt $21,625 equity in a home
(double this amount if the debtor and spouse file bankruptcy jointly)
without being forced by the court or the creditors to sell the home. For
example, if a single debtor home owner has a house worth $80,000 and a
mortgage lien on the home of $65,000, then all of the $15,000 excess value
(equity) in the home is shielded from the reach of the creditors since it is
under the $21.625 allowable limit. That is, the value
in the home is exempt from the reach of any creditor. The debtor still must
pay the lender the monthly mortgage payment however, since this is a secured debt as
opposed to an unsecured one.
After the meeting of creditors in a Chapter 7, the court
is required by the Code to let a certain number of days to elapse before
granting a discharge of the debtor’s unsecured debts that where listed on the petition. In a
Chapter 13 case, the court must consider any objections that any creditor
may have to the plan the debtor filed. Objections can be complex and
sometimes numerous, but the plan starts immediately upon its filing and
continues through any objections unless changed by the court as a result of
an objection the court believes has merit. After objections have been
considered and decided the court determines if it will confirm the plan or
not. Confirmation of the plan effectively finalizes the terms of the plan
unless unforeseen circumstances of the debtor occur during the plan’s life
that dictates a change be made.
A Chapter 7 bankruptcy effectively gets rid of 100% of
most unsecured debt of the debtor, including such debt as credit card
balances and medical bills. Chapter 13 gives the debtor time to clear up
arrears on secured debt, but the debtor's unsecured creditors sometimes end
up getting paid something on the dollar over three to five years.
Financial Crisis: Warning Signs