What is bankruptcy?
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Bankruptcy is a legal proceeding that allows a debtor to temporarily or permanently avoid paying some or all of their debts. A debtor is an individual or a company that owes money to creditors; and in most cases, a debtor will file a bankruptcy petition voluntarily. When a debtor files for bankruptcy, they no longer have personal liability for certain unsecured debts, and creditors involved must stop collections on that debt. Unsecured debts are those that do not have property or other collateral attached to them. Secured debts, or debts in which there are liens against property, are generally unaffected by bankruptcy. Other debts that are unaffected by a bankruptcy proceeding include child support or alimony payments, some lawsuit judgments, and certain types of tax claims. Bankruptcy proceedings are done under the exclusive jurisdiction of the federal government, and to initiate the proceeding, the debtor must file their claim within the bankruptcy court in their district. While the claims are always filed in federal bankruptcy courts, state law plays a major role throughout the case. Therefore, bankruptcy rules and regulations can vary from state to state.
Types of Bankruptcy Proceedings
Under the United States Bankruptcy Code, there are six different types of bankruptcy proceedings. Chapter 7 bankruptcy is the most commonly used, and is the simplest and quickest bankruptcy proceeding available to both individuals and businesses. Under Chapter 7, all or some of the debtor’s unsecured debts are wiped out. If an individual does not qualify for Chapter 7, or if they do not need to wipe out their debt, but instead just consolidate it, Chapter 13 is the proceeding for them. Under Chapter 13, debt is restructured over a period of time, so that the debtor is able to continue making payments to their creditors. Chapter 11, known as corporate bankruptcy, is similar to Chapter 13 in that it allows a business to restructure their debts over a period of time, so that they can continue to pay their creditors and stay open for business. The last three bankruptcy proceedings are used the least: Chapter 12 allows family farmers and fisherman to restructure their debt; Chapter 9 allows municipalities to claim bankruptcy in order to restructure their debts; and Chapter 15 deals mainly with foreign debtors.
The Bankruptcy Abuse & Consumer Protection Act
Congress's most recent amendment to the Bankruptcy Code, the Bankruptcy Abuse Prevention & Consumer Protection Act of 2005, placed new restrictions on filing for bankruptcy. The biggest change to bankruptcy that the Act made was to introduce the “means test” to the Chapter 7 proceeding. Because of the “means test” only individuals who make less than the median income of their state, and who have a very high debt to income ratio can file for Chapter 7 bankruptcy. Debtors who do not pass the means test, may file for Chapter 13 instead. As well as the means test, the Act also implemented the requirement that all debtors go through credit counseling from a federally approved agency. There are limited exceptions to this requirement for people who are disabled, on active military duty in a combat zone, or if there are inadequate educational programs available. The Act also prohibits any debtor who recently had a bankruptcy discharge, from filing again until eight years has passed.
Because bankruptcy will stay on your credit report for seven to ten years, it should be considered a last resort. However, bankruptcy can be a useful way to get your head above water if you are drowning in debt. Before filing for bankruptcy, you should consult an experienced bankruptcy attorney to discuss if bankruptcy is right for you, and if so, what type of bankruptcy proceeding best suits your needs.