1.0 What is Bankruptcy?
Bankruptcy is that system of laws, both state and federal, which govern the relationship between debtors (people who owe debts), and creditors (those to whom the debts are owed); and whose ultimate purpose it is to provide relief in at least some measure to those who are overburdened by debt.
2.0 Why Are Their So Many Different Types of Bankruptcy?
Each type of bankruptcy attempts to address a different type of financial need and is named for the chapter within title 11 of the United States Code where they are found.
Chapter 7 is often called a liquidating bankruptcy. It’s intended purpose is to wipe out debt and allow an individual to start over.
Chapter 9's are for cities and municipalities.
Chapter 11 is designed to give an individual or business time to reorganize their financial affairs and repay all or a portion of their debt over time, or to allow the orderly liquidation of assets at a higher value than could be obtained at execution or sheriff sale. The idea is to give creditors more money than they would have received if allowed to pursue their normal collection remedies.
Chapter 12 is for family farmers and fishermen. It is like a cross between chapter 11 and 13.
Chapter 13 is often called a wage earner plan or repayment bankruptcy. In many respects, a chapter 13 is similar to a debt consolidation loan with the payments being made to a bankruptcy trustee who then distributes them according to a set pattern to creditors.
3.0 What Are the Different Types of Debt?
3.1 In General
The court generally divides your debt into different classes, each of which are entitled to different treatment under the law. For simplicity your debts can be divided into four general categories: priority, secured, executory contracts, and unsecured. The chart below lists these four types of debt and gives some common examples of each:
General Types of Debt
and Loans to Pay Taxes
Alimony and Child
Divorce Decree Debt
Debt over $500
Retirement Plan Loans
Houses and Office
Home Equity Lines
and Other Vehicles
Book and Tape Clubs
Furniture or Electronics
Leased Business Equipment.
Most Credit Card
Open Lines of Credit
3.2 What are Priority Debts?
These are debts that are entitled to special treatment under the law. For example, they may have special collection or enforcement rights, or may be non-dischargeable (never go away) in bankruptcy. Examples of this type of debt include: domestic support obligations, unpaid wages, security deposits, taxes, claims for death or personal injury resulting from driving under the influence, student loans, fraudulently incurred debt, debts not listed in a bankruptcy, intentional torts (intentional injuries to individuals or their property), restitution, orders in domestic actions, post-petition association fees, violations of securities laws, or recently incurred consumer debt.
The new law has made a number of changes to the priority debt category. First, recently incurred consumer debt (usually credit card debt) that is non-dischargeable has changed from $1225 or more incurred within 60 days of filing to $500 or more incurred within 90 days of filing. Second, non-dischargeable alimony and support debt appears to have been expanded to include any obligations set forth in a divorce decree. Third, the non-dischargeable student loan provisions have been expanded. Fourth, loans obtained to pay non-dischargeable taxes are now non-dischargeable. Fifth, fines or penalties imposed under Federal Election Laws are non-dischargeable. Sixth, post-petition membership or association fees are non-dischargeable until the debtors ownership interest in the property is terminated. And seventh, loans from a retirement, pension plan, stock bonus, 401k or other plan are non-dischargeable.
3.3 What are Secured Debts?
3.31 In General
The basic concept behind secured debt is that there is some form of collateral which secures payment of the obligation. Then if the appropriate payments are not made, the secured creditor is entitled to take possession of the property to help satisfy the underlying debt. Secured obligations generally fit into one of four categories: title liens, purchase money security interests, consensual liens, and possessory liens.
3.32 What are Title Liens?
A title lien is a debt that is evidenced by a written document such as a trust deed or certificate of title on a motor vehicle. These documents are recorded, and can be examined by any interested third party. The filing puts them on notice that they cannot purchase the item free and clear of the underlying debt. Typical title lien debt includes: cars, boats, trailers, airplanes, houses, office buildings, and mobile homes.
3.33 What is a Purchase Money Security Interest?
A purchase money security interest exists when a creditor either provides financing for a purchase or the cash needed to purchase a specific item. Purchase money security interests can include: cars, obligations to furniture stores, and purchases of “hard ticket items” such as electronics or appliances with credit cards.
3.34 What is a Consensual Lien?
A consensual lien exists when the lender provides cash in return for an interest in property already owned by the person obtaining the loan. In order for a consensual lien to be valid, there must be a written promise to pay and a written security agreement. In addition, a UCC 1 form must be filed with the Secretary of State’s office.
3.35 What is a Possessory Lien?
A possessory lien exists when the lender retains possession of the item until the debt is repaid. For example, a loan with a pawn shop or a mechanic’s lien on a car fits into this category.
3.36 What does it mean if a debt is Perfected?
Associated with secured debt is the concept of perfection. Some secured obligation, such as consensual liens or title liens, are not valid until certain documents are signed and filed with the appropriate state office. Until this filing occurs, the debt is not said to be perfected. In other words it will probably not be entitled to secured status.
3.37 Why is Priority of debt important?
Another concept you need to be aware of in connection with secured debt is priority. It is possible for more than one creditor to claim an interest in the same collateral. If the value of the collateral is not sufficient to cover all of the debt pledged against it, it can become necessary to determine who is entitled to what share of the proceeds. In other words, who is entitled to be satisfied first if the property were to be sold. Priority is based upon the date of perfection of the obligation. In other words, whoever perfects first is in first place, whoever perfects second has second priority and so on.
3.4 What are Executory Contracts?
An executory contract is simply an agreement under which both sides have continuing obligations to each other. This is where you pay a monthly fee for a service or the use of the other persons property. Typical obligations in this category include: apartment rentals, utilities, book and tape clubs, spa memberships, cell phones, leased cars, rent to own furniture, or leased business equipment.
3.5 What is Unsecured debt?
Unsecured debt includes all of the obligations that do not fit into one of the three categories previously discussed as well as the unsecured portion of any secured obligation. For example, if you owe $5000.00 on a car which is worth $3000.00, $3000.00 of the debt is secured and $2000.00 of the debt is unsecured. Typical unsecured debts include medical and dental bills, credit card debt, open accounts with vendors, and promissory notes.
4.0 What Happens to My Debt in a Bankruptcy?
The answer to this question depends upon the type of debt you have the type of bankruptcy you file. Chapter 5 of this text discusses in detail debt treatment in chapter 7, while Chapter 6 of this text discusses in detail debt treatment in chapter 13.
5.0 What Happens to My Property in a Bankruptcy?
The answer to this question depends upon the type of assets you have, any debt that may be pledged against it, and the type of bankruptcy you file. Chapter 7 of this text discusses in detail debt treatment in chapter 7 Chap 7
6.0 What Will Happen to My Credit If I File Bankruptcy?
The filing of a bankruptcy will typically end up on your credit report for a period of at least 10 years. However, the actual impact of a bankruptcy on your future credit will depend upon a number of factors. The first is the type of bankruptcy you file. It typically takes 1-2 years to re-establish credit after the filing of a chapter 7. On the other hand it may take as long as 6-7 years to establish credit after a chapter 13 (five years of making plan payments and then an additional 1-2 years to re-establish credit). In addition, during the term of your chapter 13 plan, you may not incur any new credit without a judges written permission. A mortgage foreclosure will generally impact your credit for three years and a voluntary debt repayment plan for up to three years after you make the final payment.
The second factor is whether you would qualify for the loan if you had not filed bankruptcy. Most creditors look to a number of things in extending credit. These include your age, your income, your debt/equity ratio (meaning how much money you have left over at the end of each month after the payment of debt), if you own a home, if you have been married for at least 6 months and if you have held the same job for at least 6 months. Many individuals find that the filing of a chapter 7 bankruptcy immediately improves their credit to the point where they begin receiving solicitations for un-secured debt. This is because their debt equity ratio has improved as a result of discharging debt and they may not file a new chapter 7 bankruptcy for at least 8 years.
Assuming you otherwise qualify for the loan, most creditors will ignore your bankruptcy filing after the appropriate length of time. This means you may be able to purchase a new home or car at regular interest rates. Many creditors will actually offer you new credit card and motor vehicle credit as soon as the court issues your discharge notice concluding your case. However, you will pay higher interest rates during that first year or two.
Many individuals wonder why a chapter 13 is harder on your credit than a chapter 7, when the individual is attempting to repay the debt. The answer is quite simple. In a chapter 7, the moment an individual receives their discharge, creditors know that the debts have been wiped out and the clients debt-to-equity ratio has improved. In a chapter 13, the debtor typically repays 5 to 20% of the debt over a three to five year period. This means that 80 to 95% of the debt is never paid. This debt only goes away if the debtor completes their chapter 13 plan. If the debtor fails to make payments and the 13 is dismissed, all of this debt plus accumulated late charges and interest fall back onto the debtor and is still owed. Thus, a chapter 13 debtor is not a good credit risk until the plan is completed.
7.0 How Often Can I File bankruptcy?
Under the old law you could file a chapter 7 every 6 years. You could file a chapter 13 in a little as one year after filing a chapter 7. And you could file a chapter 7 immediately after completing a chapter 13 plan that returned 70% to unsecured creditors. The new law has dramatically changed the rules on multiple filings. This will be discussed in detail in Chapter 3 and 4.
8.0 How Does the Filing of a Bankruptcy Effect My Creditors?
The filing of a bankruptcy creates something called an “automatic stay”. This means that your creditors are not allowed to take any action to collect their debt or improve their financial position in relation to your other creditors. This means that they cannot file legal action against you, continue a foreclosure, continue any legal action that has already been filed, garnish wages, perfect a lien or security interest, or call you on the phone. However, bankruptcy does not stop criminal prosecutions, or actions to collect alimony, maintenance, or support, or an action by a government unit to enforce a police or regulatory power.
The new bankruptcy law has dramatically changed this section of the code, giving creditors many new rights. As a result, this matter will be treated in greater detail in Chapter 4 of this text.