Bankruptcy Explained

Bankruptcy Explained

You are here:
  • Main
  • Bankruptcy Explained
< All Topics

Bankruptcy is a system for dealing with debt when it cannot be paid.  It is also known as insolvency.  Bankruptcy courts are outlined in the United States constitution and considered a fundamental part of the court system.  Bankruptcy courts are federal courts. While the bankruptcy code is a federal law it is impacted and altered in each state based on the exemption laws and property laws of that individual state.  Bankruptcy cases rely on a mix of both federal and state law to work.  In addition to the overall federal bankruptcy laws there are federal bankruptcy rules and each court has local rules.

It helps if you try to think of the concepts in bankruptcy like an onion.  We are going to cut the onion into different sections and peel back the layers of the sections we want to look at.  Our offices are in Kansas so we are going to focus on Kansas bankruptcy law.

Bankruptcy cases are either personal bankruptcies or corporate bankruptcies.  This means they are either filed by individual people (including married couples if they want to file together) or some kind of corporate entity.  Our office does not handle corporate cases and they are rarely filed compared to personal cases.  We are going to focus this discussion on personal bankruptcy cases.

Personal bankruptcies are either consumer bankruptcies or non-consumer bankruptcies.  If a case is a consumer bankruptcy then you must take a credit counseling course before filing the case and you must fill out some additional forms when you file the bankruptcy case.  These additional requirements can substantially effect the outcome of a case.

In a consumer bankruptcy at least half the debt you have was used primarily for a personal, family, or a household purpose.  A home loan, car loan, personal credit cards, student loans, personal loans used to improve your home or buy home furnishings, as well as some medical debts can all fall under this category.  If more than half the debt in a personal bankruptcy case falls into this category then the case is a consumer bankruptcy.

If less than half the debt is not consumer debt then the case is considered a non-consumer bankruptcy.  For example, if someone has a small business and they have cosigned or guaranteed the business debts and those debts make up more than half the total debt in the case then the case is not a consumer bankruptcy.  If someone has tax debt that is also not considered a consumer debt.  In some cases medical bills that were incurred in an emergency might not be considered consumer debt.

A bankruptcy attorney should sit down and analyze the dollar amount of the debt and the types of debt to determine whether or not the case is a consumer case.  The vast majority of all bankruptcies filed are personal consumer bankruptcies and this makes up the largest slice of the onion.  In fact if we were to cut the onion up between personal consumer bankruptcy and all other types of bankruptcy then personal consumer bankruptcy would still make up 97% of the onion.

In addition to being broken down as consumer and non-consumer, cases can be divided between liquidation and reorganization cases.  Liquidation cases are known as Chapter 7 bankruptcies.  The majority of reorganization cases are Chapter 13 bankruptcies but on occasion there are Chapter 12 and Chapter 11 cases.  The Chapter 12 is for people whose primary occupations are farming or fishing.  The Chapter 11 is for people that need a reorganization case but do not qualify for a chapter 13 due to the amount of debt they owe.  Although we are not going to discuss the details Chapter 7, Chapter 12, and Chapter 11 are also available to corporate entities but Chapter 13 is not.

A Chapter 7 bankruptcy is a liquidation bankruptcy but also called by numerous nicknames:  fresh start bankruptcy, complete bankruptcy, total bankruptcy, and full bankruptcy are just a few of them.   In a Chapter 7 bankruptcy you are basically going into the court and saying that you do not have the ability to repay your creditors.  You need to wipe them out and start over.  If you have property that is not protected by law it can be liquidated or sold to pay your creditors.

A Chapter 13 bankruptcy is a wage earner’s bankruptcy but it is also called by numerous nicknames:  personal reorganization bankruptcy, payment plan bankruptcy, and long term bankruptcy.  In a Chapter 13 bankruptcy you are basically going into the court and proposing a plan to make a payment into a bankruptcy trustee.  The plan might pay some, all, or none of the money owed to your creditors. Generally property is not liquidated or sold in a Chapter 13 bankruptcy.

A bankruptcy provides you with certain protections.  The first and most important is the Automatic Stay.  It is also commonly called the Order for Relief, the Stay, or the Stay Order.  When you file bankruptcy the court issues an order that stops your creditors from taking any further or additional action against you or your property.  Once the case is filed they cannot seize your wages, your vehicle, your personal property or your home.  The Automatic Stay is the law that allows this order to be issued.  When the case is filed you include a list of all your creditors and the order is mailed out to them.  The Automatic Stay normally lasts until the case is completed.

Not only does the Automatic Stay stop garnishments from taking effect it also forces garnishments in place to be lifted.  It stops lawsuits, seizures, foreclosures, harassment, repossessions, and all manner of collections activity.  Out of tens of thousands of creditors our office has dealt with only a few have tried to ignore the Automatic Stay and the court will sanction them if they are found to have violated the order.  Bankruptcy judges take their court orders very seriously.

The Discharge is the next important protection in bankruptcy.  The Discharge replaces the Automatic Stay when the case is completed. This is the order that says certain debts have been wiped out.  The creditors that are discharged can never attempt to collect their debt.  Creditors that are generally discharged include credit cards, personal loans, medical bills, lines of personal credit, and utilities.  Creditors that are generally not discharged include child support, some student loans, and some taxes.

The discharge order is called an injunction because it tells your creditors that they cannot take certain actions. The Discharge injunction is normally permanent so once it is issued your creditors are bound by it.

There are some other common themes in all bankruptcy cases.  The first is that relief is available to the honest but unfortunate person.  This is a very important idea because the most important thing you must do when you file a bankruptcy is disclose to the bankruptcy court and the bankruptcy trustee all of your assets and you must fill out the paperwork truthfully.

If you are not honest with the court then you may not be able to get a discharge in bankruptcy.  There are cases where the court makes the debts in the case impossible to discharge even if you refile later.  There are also cases where people are banned from refiling for a period of time.

The second theme in consumer bankruptcy is that if you can pay your creditors some of the money owed to them then you should probably be in a Chapter 13 case.  This idea only applies in consumer bankruptcy cases so if you can show the court that at least half of your debt is not consumer debt you can avoid this rule. Congress has decided that in a consumer bankruptcy it would be unfair for you to wipe out your creditors in a Chapter 7 case if you can pay them.  There are many ways this idea is measured, but the first is simply by looking at your current income and subtracting out the expenses you would have after you filed a Chapter 7 bankruptcy.

If there is money left over and it is enough to make a meaningful repayment to your creditors then you cannot get discharge in a Chapter 7 bankruptcy.  You can of course still do a Chapter 13 bankruptcy and make a payment but there are different hoops to jump through.

When you file a bankruptcy case it creates an entity known as your bankruptcy estate.  In that estate resides all your property and all your debts. This new estate is given a case number to identify it as it goes through the bankruptcy process.  If your name is Wilson, then your bankruptcy case will be known as In re Wilson, case no. xx-xxxxx.  The case numbers have a different format in every bankruptcy courthouse so they can be differentiated around the country.  The way that cases are named and tracked is similar in bankruptcy courts throughout the country.

There are several people that are involved whenever a bankruptcy is filed.  You have a bankruptcy attorney that represents you.  There are your creditors.  There is a bankruptcy clerk that processes the paperwork and makes sure the automatic stay is mailed out to your creditors.  When the clerk is processing your case a bankruptcy trustee is assigned to manage the case.  In addition to the bankruptcy trustee that manages your case directly there is also a United States Bankruptcy Trustee for Kansas and they have several Assistant United States Trustees that help manage the bankruptcy system in Kansas.  A bankruptcy judge is assigned to make all the rulings in the case.  At a minimum these are the people that you will be involved in your case.

Your bankruptcy attorney represents you personally.  Your attorney does not decide everything for you but they help you decide a course of action.  They are required to give you advice and help you understand the options.  Your bankruptcy attorney will have obligations not just to you but also to the court.  One of those obligations is to make sure everything is disclosed and nothing is left out.  Your bankruptcy attorney is an officer of the court and bound to be truthful and to make sure that you are being truthful as well.

In most personal consumer bankruptcy cases your creditors do not take much of a direct role in the case.  They often have an idea of what is going to happen because they experience bankruptcy on a professional basis daily.  If they have an issue with a case they normally hire an attorney that will represent them in the case.

The bankruptcy clerk will make sure all the documents in the case are properly stored and available for everyone in the case.  They will make sure the basic rules for filing documents are followed and that all the dates in the case are tracked correctly.  Many of the documents in a bankruptcy case are prepared by the clerk’s office.  There is an online document library for every bankruptcy case that can be reached through the Public Access to Court Electronic Records also known as PACER.  Your attorney as well as anyone familiar with the bankruptcy system can access PACER for a fee and there is free PACER access at the courthouse.

The bankruptcy trustee manages your bankruptcy estate.  The first job a bankruptcy trustee has is to make sure that you are disclosing everything and obeying the basic bankruptcy rules.  The bankruptcy trustee conducts the basic hearing in your case. The bankruptcy trustee is an attorney and they are supervised by the United States Trustee's office.

As a general rule the bankruptcy trustee does not come out and seize all the property of a bankruptcy estate.  Most of the property in a personal bankruptcy will be protected by law.  In Kansas this includes household goods and furnishings, retirement accounts, clothing, your homestead, your vehicles.  In some cases if you have extra vehicles or high value items there can be issues with the bankruptcy trustee but your attorney should go over those things with you before the case is filed.

In a Chapter 7 case the bankruptcy trustee’s next job is to look and see if you have any property that can be seized for the benefit of your bankruptcy estate.  They also might try to collect money you are owed and unwind or reverse payments you have made or property you have transferred within the last 90 days up to the last 4 years in extreme cases.  Now most property is protected by law or exempt from seizure by the bankruptcy trustee and most transactions cannot be unwound but your attorney will cover all of that with you.  This last job of the bankruptcy trustee is known as marshaling the estate.   If they find assets or property they will liquidate or sell them and then have your creditors file claims in the case and pay them out pro rata. 

In a Chapter 13 case the bankruptcy trustee’s job is to make sure the plan you are proposing meets all the requirements of the bankruptcy code.  Although they do not directly represent your creditors they are in a way making sure your creditors are treated fairly under the bankruptcy system.  The trustee in a chapter 13 case is also responsible for managing all the money that is paid through their office and making sure all the payments go out to the appropriate people.

The United States Bankruptcy Trustee’s office is a branch of the Department of Justice.  They are there to make sure the system is running correctly, that the local chapter 7 and chapter 13 trustees are doing their jobs and staying on top of their cases.  They are also looking for people that they think are abusing the system.  In some case those people have filed bankruptcy, in other cases they are protecting people who have filed bankruptcy from predatory attorneys and companies that have taken advantage of people in financial distress.

The bankruptcy Judge is there to make sure everyone, including you, your attorney, your creditors and the bankruptcy trustees are following the law.  The bankruptcy clerks work with the bankruptcy judge to make sure the court is efficient and that the cases flow smoothly.  When the people involved in the case cannot agree upon a course of action or how to do something then the bankruptcy Judge will make the decision as to what will happen.  The bankruptcy Judge is an impartial person and decides what will happen based on the law.  In most consumer cases you never see the bankruptcy Judge.

Most Bankruptcy Judges publish their opinions for people to read on the Bankruptcy District Court website so the local bankruptcy attorneys can be familiar with how the court interprets the law.  In addition to the local cases there are cases that have been appealed to higher courts that also impact how the law is interpreted at the trial court level where bankruptcy cases are filed.

Most decisions in bankruptcy cases are made by the Bankruptcy Judge in an individual case and not appealed.  Most people do not have the funds to appeal those rulings.  There are over 300 bankruptcy judges in the United States and everyone of them sees the law slightly differently.

Because of all the various federal laws, federal rules, local rules, different state laws, and how the Bankruptcy Judges interpret things you can have two similar cases filed and get very different results depending on what state the case is filed in.  These differences often only make sense to bankruptcy practitioners.

Bankruptcy can be challenging to understand.  There are rules and regulations that help define things and you can apply them to the individual facts of a case.  However, there are so many rules and so many regulations as well as things that can only be known by understanding the case law that it is very easy to get lost in all the information.  The amount of material becomes overwhelming.  The outline above is just a very basic overview of bankruptcy.  Please make sure you read the other materials we have on the website if you want a better grasp of bankruptcy concepts and practice.  If you have specific questions please don't hesitate to contact us.