Bankruptcy Basics

At least a few times per week I hear talk – sometimes on the radio, sometimes at the water cooler - of consumer debt-related woes. On many of those occasions I hear the topic deteriorate into a discussion about bankruptcy. Certainly, managing a large debt load can be extremely difficult. It can lead to stress, illness, and even depression. Those who qualify for bankruptcy may find that relief under the law is the only way to dig their way out of a hopeless situation and make a fresh start for themselves or their families. While bankruptcy may be a useful tool to keep creditors under control and deal with certain debts, it also carries with it certain disadvantages. In the ideal bankruptcy situation, the debtor will be in such financial straits concerning his or her creditors that there is no other viable solution available to deal with the debt load. Bankruptcy is a complex area of the law, especially taking into consideration that Texas provides for certain property protections. It can be extremely confusing to those seeking its protections. The goal of this month's article is to cover some of the basics of this legal discipline.
Generally, the most used provisions of the Bankruptcy Code relating to individuals are Chapters 7 and 13, while Chapter 11 is more often utilized by businesses.
Chapter 7
In order to qualify for a Chapter 7 discharge of debt bankruptcy, the debtor must qualify under the Means Test. The means test works to determine how much money one makes after taking out monthly expenses from their current monthly income. The more money one is left over with the less likely one is to qualify for Chapter 7. This figure is then plugged into an average income for other states in the nation to determine how much money would be left over to repay debts. Once qualified for Chapter 7, a bankruptcy trustee takes possession of the debtors nonexempt property (called the debtor's estate) for sale in order to pay the creditors. Since Texas enjoys state laws that protect and exempt many types of property, most of the time the trustee cannot actually take many properties. Chapter 7 provides for a discharge of most consumer debts, or in other words a wiping out of that debt. A debtor does not have to make any payments to creditors out of future income. But not all debt is dischargeable. Examples of some debts that are not dischargeable are those debts not listed in the bankruptcy, student loans (unless repayment would cause undue hardship), most of the federal, state, and local taxes and money borrowed on credit cards to pay such taxes, child support, and debts arising from driving while intoxicated.
Another very important protection under bankruptcy law is the concept of the automatic stay. The automatic stay is like an iron gate that immediately drops upon the filing of a bankruptcy (called a petition) in order to keep the creditors out. Creditors are then prohibited from making any attempt to collect on the debt, including repossession and foreclosure. This is very powerful. Many debtors who get behind in their payments to creditors receive incredibly harassing telephone calls from bill collectors beginning in the morning and continuing into the night. This can truly be a miserable experience. The automatic stay can stop this activity. Finally, a debtor must wait six years before filing another Chapter 7.
Chapter 11
Chapter 11 is generally used by a business to reorganize its debts in a way that allows the debtor to continue its business from within the protection of the bankruptcy code. The debtor pays back the debts over a period of time. This could be a good tool for a business that has a chance to survive if given the opportunity to reorganize, especially in those cases where a creditor may be seeking to sue or file a lien. The business will be required to file various schedules and operating reports showing its ability to operate and repay its debts. Interestingly, the debtor files a repayment plan and the creditors are entitled to vote for or against the plan depending on how comfortable that creditor is with the terms of its repayment plan.
Chapter 13
In the event a debtor cannot pass the Means Test of Chapter 7, that debtor will likely file under Chapter 13. Similar to Chapter 11, the debtor has an opportunity to keep certain property, while entering into a payment plan with creditors to pay back the debt over time. This plan is generally utilized by debtors who want to repay some of their debts because they have steady income, but cannot repay them all at a particular time. Basically, this is best used in a temporary financial crisis. Under this chapter, a debtor may discharge certain debts after successful completion of all the payments of the payment plan. Also, debtors who find that they cannot make their required payments may still act to discharge debts through a Chapter 7. Homeowners may find this relief particularly appealing because the debtor may be allowed to reduce the monthly payments. The homeowner may also be able to make up past due payments on their mortgages. Finally, in most cases the debtor does not have to wait six years to file another Chapter 13, but can file another Chapter 13 bankruptcy at any time. Chapter 13 is probably the most complicated of the chapters.
No bankruptcy discussion would be complete without a mention of a few of the negative consequences of bankruptcy. Although they may seem small compared to the giant burden of living with uncontrollable debt, there is a downside to filing for protection. One such consequence is the stigma of living with a bankruptcy. A debtor will likely find that lenders are reluctant to loan money to them after bankruptcy. However, many times consumer credit card companies will begin sending credit offers immediately after the bankruptcy is finalized. They do this because they know that that consumer will probably not be able to file for bankruptcy protection within the next six years.
Another consequence, or rather observation, about bankruptcy filers is that the filing of a bankruptcy may times does not teach that debtor how to efficiently manage his or her finances after the bankruptcy process. It was not too long ago when people simply did not purchase goods or services unless or until that person had saved enough money to do so. It seems this logic has been replaced by a desire to immediately satisfy our wants and desires. Now we live in a day of record debt loads, bankruptcies, and foreclosures. Somehow the “American Dream” became financed by debt. There may soon be a day when the value of saving will be fashionable again. However, in the meantime, many will need to rely on the legal protections offered by bankruptcy.