Bankruptcy Basics

Bankruptcy provides a Debtor with two primary benefits. The first benefit is the "automatic stay." Once bankruptcy is filed, creditors must cease all collection efforts against the Debtor for debts incurred before the bankruptcy. For example, Creditors may not call and ask for payment, mail billing statements or invoices, commence or continue lawsuits, obtain judgments, garnish wages, obtain liens, repossess cars or foreclose on land or houses. The automatic stay is intended to give Debtors a break from collection efforts during the bankruptcy.

The second benefit is forgiveness of debt, called the "discharge." Most simply stated, the discharge frees Debtors from unsecured debt (e.g., credit cards, hospital bills and other obligations for which there is no collateral). A few types of unsecured debt are not forgiven in bankruptcy without payment. Examples include young taxes, alimony, child support or debts incurred by fraud. Secured debts (e.g., a house against which a lender holds a deed of trust or a car against which the lender holds the pink slip) may also be forgiven. But in most cases, forgiveness of a secured debt requires the Debtor to surrender (give back) the collateral (e.g., house or car).

Each of the three major types of bankruptcy (Chapter 7, Chapter 11, and Chapter 13) provide a Debtor with both of these protections. But the similarities among these different bankruptcies end there.

Chapter 7

Chapter 7 is by far the most common, accounting for 70 percent of all filings. (Administrative Office of the U.S. Courts, Federal Judicial Caseload: Recent Trends 114-115 (2001))

Available to individuals, corporations and other entities, it focuses on the Debtor's assets. The Debtor keeps some assets (called "exempt property") and surrenders other assets (called "non-exempt property") to the trustee, who sells them and uses the proceeds to pay creditors. In the majority of Chapter 7 bankruptcies the Debtor keeps all property. One recent Department of Justice study found that only 4 percent of Chapter 7 Debtors actually surrendered property to the trustee. (U.S. Dept. of Justice, Preliminary Report on Chapter 7 Asset Cases 1994-2000 (2001)) Regardless of whether creditors receive payment from the trustee, when an individual completes his or her bankruptcy most types of debt are forgiven.

Chapter 7 is the bankruptcy of choice for the majority of Debtors because it resolves most debt problems relatively quickly and inexpensively. Generally, the process takes about four months. And though attorneys fees vary from case to case, ordinarily, attorneys fees for a liquidation bankruptcy are less than those of the other bankruptcies.

But for Debtors with more complex financial problems, Chapter 7 does have disadvantages. First, non-exempt property, if any, may be lost to the trustee, who will sell it and use the proceeds to pay creditors. Second, certain types of debt (e.g., young taxes, alimony or child support) are not forgiven in a Chapter 7 bankruptcy. Third, Chapter 7 does not provide a Debtor who is delinquent on mortgage or car payments time to get current, protecting him or her from foreclosure or repossession. Fourth, a consumer Debtor whose income exceeds certain benchmarks is presumed ineligible for relief under Chapter 7. Fifth, ordinarily, the Debtor must pay his or her attorneys fees up front.

Chapter 13

Chapter 13 bankruptcy is the second most common, accounting for 29 percent of all filings. (Administrative Office of the U.S. Courts, Federal Judicial Caseload: Recent Trends 114-115 (2001))

Available only to individuals, not corporations or other entities, Chapter 13 is intended for Debtors who have the ability to repay at least some of their debts. Unlike a Chapter 7 Debtor, a Chapter 13 Debtor retains all land and possessions. The Debtor prepares a "plan," which is a proposal to the court and creditors for repayment of some, or in rare cases all, of the debt. In most cases, a Debtor's plan will propose a regular monthly payment to the trustee. If the plan meets the standards for approval it will be "confirmed." Each month, the Debtor makes a single payment of the amount specified in the plan to the trustee, who in turn disburses it to the creditors. Once the Debtor has performed the plan, almost all types of debts are discharged.

Chapter 13 is ordinarily selected because the Debtor wishes to resolve debt problems but needs one of the five advantages not provided by a Chapter 7. First, unlike Chapter 7, the Debtor keeps all assets, regardless of value or exempt status. Second, Chapter 13 forgives debts that cannot be forgiven in a Chapter 7 (e.g., young taxes, alimony and child support). Third, it stops foreclosure and repossession and gives the Debtor time to become current on a home or car payment. Fourth, unlike Chapter 7, there are no income restrictions; even high income Debtors may obtain relief from creditors. Fifth, it allows a Debtor to pay his or her own lawyer over time. So, the Debtor can file a bankruptcy immediately, obtaining the protection of the Bankruptcy Courts, but pay for it over an extended period of time.

But there are at least three disadvantages to a Chapter 13 bankruptcy. First, it takes longer. Ordinarily, a Chapter 13 bankruptcy lasts at least three, and sometimes as long as five, years. And each month the Debtor must pay the trustee the payment specified in the plan. Second, it is more complex and may cost more. Third, only Debtors with the ability to make a regular monthly payment to the Chapter 13 trustee qualify.

Chapter 11

Chapter 11, also known as a "Reorganization" bankruptcy, is the least common, accounting for only 1 percent of all filings. (Administrative Office of the U.S. Courts, Federal Judicial Caseload: Recent Trends 114-115 (2001))

Available to individuals, corporations and other entities, Chapter 11 is tailored to Debtors with large or complex financial problems. Unlike Chapter 7 or Chapter 13, an independent trustee is not ordinarily appointed. But like a Chapter 13, the Debtor prepares a "plan," which is the Debtor's proposal to the court and creditors for repayment of some, and in some cases all, of the debt. The plan may provide for a liquidation of assets and payment of proceeds to creditors, or it may provide for periodic payments to creditors from future earnings or sales of assets that do not result in cessation of operations. Creditors are allowed to vote, either in favor of or against, the plan. Once confirmed, the Debtor carries out the terms of the plan. Discharge follows plan confirmation; individuals receive a discharge of most types of debts and corporations receive a discharge, provided it continues operations.

Under the right circumstances, Chapter 11 is a powerful tool for debt resolution. And it has two primary advantages over other bankruptcies. First, the Debtor retains greater control over the bankruptcy process. Second, Chapter 11 allows Debtors greater flexibility in the terms of the plan.

The primary disadvantage of a Chapter 11 is cost.