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Bankruptcy by Chapter

The vast majority of bankruptcy cases are filed under the three main chapters of the Bankruptcy Code, which are Chapter 7, Chapter 11, and Chapter 13.

  • Chapter 7
  • Chapter 11
  • Chapter 13

Under Chapter 7, sometimes known as a liquidation, a bankruptcy trustee gathers and sells the debtor's nonexempt assets, and uses the proceeds to pay holders of claims (creditors). In general, however, the majority of Chapter 7 cases are no-asset cases, in which the debtor has no available property for the trustee to sell. Part of the debtor's property may be subject to liens and mortgages in favor of specific creditors. In addition, under Chapter 7, the individual debtor is permitted to retain certain exempt property. The debtor's remaining assets are liquidated by a trustee. Accordingly, potential debtors should realize that the filing of a petition under Chapter 7 may result in the loss of property.

To qualify for relief under Chapter 7 of the Bankruptcy Code, the debtor must be an individual, a partnership, or a corporation.

One of the primary purposes of bankruptcy is to discharge certain debts to give an honest individual debtor a fresh start. The discharge has the effect of extinguishing the debtor's personal liability on discharge able debts. In a Chapter 7 case, however, a discharge is available to individual debtors only, not to partnerships or corporations. Although the filing of an individual Chapter 7 petition usually results in a discharge of debts, an individual's right to a discharge is not absolute, and some types of debts are not discharged. Moreover, a bankruptcy discharge does not extinguish a lien on property. In other words, a creditor will retain its rights to collateral securing a debtor's obligation.

  • How Chapter 7 Works

A Chapter 7 case begins with the debtor filing a petition with the bankruptcy court. In addition to the petition, the debtor is also required to file with the court several schedules (lists) of assets and liabilities, a schedule of current income and expenditures, a statement of financial affairs, and a schedule of executory contracts and unexpired leases. The schedules and statements include the following information:

1. A list of all creditors and the amount and nature of their claims;
2. The source, amount, and frequency of the debtor's income;
3. A list of all of the debtor's property; and
4. A detailed list of the debtor's monthly living expenses (food, clothing, shelter, utilities, taxes, transportation, medicine, etc.).

The filing of a petition under Chapter 7 automatically stays most actions against the debtor or the debtor's property. This stay arises by operation of law and requires no judicial action. As long as the stay is in effect, creditors generally cannot initiate or continue any lawsuits, garnish wages, or make telephone calls demanding payments. Creditors normally receive notice of the filing of the petition from the bankruptcy court clerk. One of the schedules that will be filed by the individual debtor is a schedule of exempt property. Federal bankruptcy law provides that an individual debtor can protect some property from the claims of creditors for two reasons: (1) it is exempt under federal bankruptcy law or (2) it is exempt under the laws of the debtor's home state. The following are a few examples of exemptions available under federal bankruptcy law: (1) the debtor's interest, not to exceed $15,000, in real property; (2) the debtor's interest, not to exceed $2,400, in one motor vehicle; (3) the debtor's interest, not to exceed $1,000, in jewelry; and (4) the debtor's right to receive Social Security benefits, unemployment compensation, veterans' benefits, and alimony (to the extent necessary for the support of the debtor and any dependent of the debtor).

Many states have taken advantage of a provision in the bankruptcy law that permits each state to adopt its own exemption law in place of the federal exemptions. In other jurisdictions, the individual debtor has the option of choosing between a federal package of exemptions or exemptions available under state law. Thus, whether certain property is exempt and may be kept by the debtor is often a question of state law.

A meeting of creditors is usually held 20 to 40 days after the petition is filed. The debtor must attend this meeting, at which creditors may appear and ask questions regarding the debtor''s financial affairs and property. If a husband and wife have filed a joint petition, they both must attend the creditors' meeting. The trustee also will attend this meeting. It is important for the debtor to cooperate with the trustee and to provide any financial records or documents that the trustee requests. The trustee is required to examine the debtor orally at the meeting of creditors to ensure that the debtor is aware of the potential consequences of seeking a discharge in bankruptcy, including the effect on credit history, the ability to file a petition under a different chapter, the effect of receiving a discharge, and the effect of reaffirming a debt. In some courts, trustees may provide written information on these topics at or in advance of the meeting to ensure that the debtor is aware of this information. To preserve their independent judgment, bankruptcy judges are prohibited from attending the meeting of creditors.

  • Role of the Case Trustee

Upon the filing of the Chapter 7 petition, an impartial case trustee is appointed by the U.S. trustee to administer the case and liquidate the debtor's nonexempt assets. If, as is often the case, all of the debtor's assets are exempt or subject to valid liens, there will be no distribution to unsecured creditors. Typically, most Chapter 7 cases involving individual debtors are no-asset cases. If the case appears to be an asset case at the outset, however, unsecured creditors who have claims against the debtor must file their claims with the clerk of court within 90 days of the first date set for the meeting of creditors. In the typical no-asset Chapter 7 case, there is no need for creditors to file proofs of claim. If the trustee later recovers assets for distribution to unsecured creditors, creditors will be given notice of that fact and additional time to file proofs of claim. The commencement of a bankruptcy case creates an estate. The estate technically becomes the temporary legal owner of all of the debtor's property. The estate consists of all legal or equitable interests of the debtor in property as of the commencement of the case, including property owned or held by another person if the debtor has an interest in the property. Generally speaking, the debtor's creditors are paid from nonexempt property of the estate.

The primary role of a Chapter 7 trustee in an asset case is to liquidate the debtor's nonexempt assets in a manner that maximizes the return to the debtor's unsecured creditors. To accomplish this, the trustee attempts to liquidate the debtor's nonexempt property, that is, property that the debtor owns free and clear of liens and the debtor's property that has market value above the amount of any security interest or lien and any exemption that the debtor holds in the property. In addition, if the debtor is a business, the bankruptcy court may authorize the trustee to operate the debtor's business for a limited period of time, if such operation will benefit the creditors of the estate and enhance the liquidation of the estate.

  • Discharge

A discharge releases the debtor from personal liability for discharged debts and prevents the creditors owed those debts from taking any action against the debtor or his or her property to collect the debts. As a general rule, individual debtors receive a discharge in more than 99 percent of Chapter 7 cases. In most cases, unless a complaint has been filed objecting to the discharge or the debtor has filed a written waiver, the discharge will be granted to a Chapter 7 debtor relatively early in the case, that is, 60 to 90 days after the date set for the meeting of creditors. The lien is still valid even after a Chapter 7 discharge.

  • Denial of Discharge

The grounds for denying an individual debtor a discharge in a Chapter 7 case are very narrow. Grounds for denying a discharge to a Chapter 7 debtor include that (1) the debtor failed to keep or produce adequate books or financial records; (2) the debtor failed to explain satisfactorily any loss of assets; (3) the debtor committed a bankruptcy crime such as perjury; (4) the debtor failed to obey a lawful order of the bankruptcy court; or (5) the debtor fraudulently transferred, concealed, or destroyed property that would have become property of the estate.

In certain jurisdictions, secured creditors may retain some rights to seize their collateral, even after a discharge is granted. Depending on individual circumstances, a debtor wishing to keep possession of the collateral, such as an automobile, may find it advantageous to reaffirm the debt. A reaffirmation is an agreement between the debtor and the creditor that the debtor will pay all or a portion of the money owed, even though the debtor has filed bankruptcy. In return, the creditor promises that, as long as payments are made, the creditor will not repossess or take back the automobile or other property. Because there is a disagreement among the courts concerning whether a debtor whose debt is not in default may retain the property and pay under the original contract terms without reaffirming the debt, legal counsel should be consulted to ensure that the debtor's rights are protected and that any reaffirmation is in the debtor's best interest. A discharge under Chapter 7 does not discharge an individual debtor from certain specific types of debts listed in the Bankruptcy Code. The types of debts that are not discharged in a Chapter 7 case include (1) alimony and child maintenance and support obligations, (2) certain taxes, (3) debts for certain educational loans made or guaranteed by a governmental unit, (4) debts for willful and malicious injury inflicted by the debtor, (5) debts for death or personal injury caused by the debtor's operation of a motor vehicle while the debtor was intoxicated from alcohol or other substances, and (6) debts for criminal restitution orders.

To the extent that these types of debts are not fully paid in the Chapter 7 case, the debtor is still responsible for them after the bankruptcy case has concluded. Debts for money or property obtained by fraud, debts for willful and malicious injury inflicted by the debtor, and debts arising from a property settlement agreement incurred during or in connection with a divorce or separation––unless a former spouse timely files and prevails in an action to have such debts declared excepted from the discharge––are discharged. Once a discharge has been received, a debtor cannot file another case under Chapter 7 for six years.

While individuals may file a petition under Chapter 11, it is typically used to reorganize a business. Upon the filing of a voluntary petition for relief under Chapter 11, the debtor automatically assumes an additional identity as the "debtor in possession." The term refers to a debtor that keeps possession and control of his or her assets while undergoing a reorganization under Chapter 11, without the appointment of a case trustee. Generally, the debtor, as "debtor in possession," operates the business and performs many of the functions that a trustee performs in cases under other chapters.

  • How Chapter 11 Works

As with all other chapters, a Chapter 11 case commences when a bankruptcy petition is filed with the bankruptcy court. The voluntary petition will include standard information concerning the debtor and its assets and liabilities, and a request for relief.

A written disclosure statement and a plan of reorganization must be filed with the court. The disclosure statement is a document that must contain information concerning the assets, liabilities, and business affairs of the debtor sufficient to enable a creditor to make an informed judgment about the debtor's plan of reorganization. The contents of the plan must include a classification of claims and must specify how each class of claims will be treated under the plan. Creditors whose claims are impaired, that is, those whose contractual rights are to be modified or who will be paid less than the full value of their claims under the plan, vote on the plan by ballot. After the disclosure statement is approved and the ballots are collected and tallied, the bankruptcy court will conduct a confirmation hearing to determine whether to confirm the plan.

  • Adversary Proceedings

Under certain circumstances, the debtor in possession may institute a lawsuit, known as an adversary proceeding, to recover money or property for the estate. At times, a creditors' committee may be authorized by the bankruptcy court to pursue such actions against insiders (that is, officers and directors) of the debtor, if the plan provides for the committee to do so or if the debtor has refused a demand to do so. Creditors may also initiate adversary proceedings by filing complaints seeking various types of relief.

  • The Chapter 11 Discharge

The Bankruptcy Code specifies that the confirmation of a plan discharges or relieves the debtor from any debt that arose before the date of confirmation. There are, of course, exceptions to that general rule. Confirmation of a plan of reorganization may discharge any type of debtor––corporation, partnership, or individual––from most types of debts that arose before the confirmation of the plan. It does not, however, discharge an individual debtor from any debt that the bankruptcy court determines should not be discharged.

Chapter 13 is designed for individuals with regular income who want to pay their debts but are unable to do so in a timely manner. The purpose of Chapter 13 is to enable financially distressed individual debtors to propose and carry out a repayment plan under which creditors are paid over an extended period of time.

Under this chapter, debtors are permitted to repay creditors, in full or in part, in installments over a three- to five-year period, during which time creditors are prohibited from starting or continuing collection efforts. A plan providing for payments over more than three years must be for cause (a reason) and must be approved by the court. In no case may a plan provide for payments over a period longer than five years.

Any individual, even if self-employed or operating an unincorporated business, is eligible for Chapter 13 relief. Eligibility is contingent on the fact that the individual's unsecured and secured debts are between certain dollar amounts that are adjusted annually by statute. A corporation or partnership may not be a Chapter 13 debtor.

  • How Chapter 13 Works

A Chapter 13 case begins when a debtor files a petition with the bankruptcy court serving the area where the debtor has a residence. Unless the court orders otherwise, the debtor also shall file the following documents with the court: (1) schedules (lists) of assets and liabilities; (2) a schedule of current income and expenditures; (3) a schedule of unfulfilled contracts and unexpired leases; and (4) a statement of financial affairs.

To complete the petition, statement of financial affairs, and schedules, the debtor needs to compile certain information, including the following:

  1. A list of all creditors and the amounts and nature of their claims;
  2. The source, amount, and frequency of the debtor's income;
  3. A list of all of the debtor's property; and
  4. A detailed list of the debtor's monthly living expenses, that is, food, clothing, shelter, utilities, taxes, transportation, medicine, and so on.

Upon the filing of the petition, an impartial trustee is appointed to administer the case. The primary role of the Chapter 13 trustee is to serve as a disbursing agent, collecting payments from debtors due under the plan and, in turn, distributing these payments to creditors.

Furthermore, Chapter 13 contains a special automatic stay provision applicable to creditors. Specifically, after the commencement of a Chapter 13 case, unless the bankruptcy court authorizes otherwise, a creditor may not seek to collect a consumer debt from any individual who is liable with the debtor (that is, a cosigner on a note). Consumer debts are those incurred for consumer, as opposed to business, needs. The debtor must file a plan of repayment with the petition or within 15 days thereafter, unless extended by the court for cause. The Chapter 13 plan must, among other things, provide for the debtor to contribute that portion of his or her future income as is necessary to meet the terms of the plan.

Plans, which must be approved by the court, provide for payments of fixed amounts to the trustee on a regular basis, typically biweekly or monthly. The trustee then distributes the funds to creditors according to the terms of the plan, which typically offers creditors less than full payment on their claims.

The debtor must make regular payments to the trustee, which requires adjustment to living on a fixed budget for a prolonged period. Alternatively, a debtor may consent to the deduction of the plan payments, from the debtor's paycheck, to be sent directly to the Chapter 13 trustee. Experience has shown that this practice increases the likelihood that payments will be made on time and that the plan will be completed. In either case, failure to make the payments in accordance with the confirmed plan may result in dismissal of the case or its conversion to a liquidation case under Chapter 7 of the Bankruptcy Code. With certain exceptions, the debtor has the right to dismiss the Chapter 13 case at any time.

After the meeting of creditors is concluded, the bankruptcy judge must determine at a confirmation hearing whether the plan is feasible and should be approved. Creditors may object to confirmation of the plan based on various grounds that are set forth in the Bankruptcy Code. In that instance, the bankruptcy court will hear and rule on the objections.

  • The Chapter 13 Discharge

The Chapter 13 debtor is entitled to a discharge upon successful completion of all payments under the Chapter 13 plan. In return for the willingness of the Chapter 13 debtor to undergo the discipline of a repayment plan for three to five years, a broader discharge is available under Chapter 13 than in a Chapter 7 case. As a general rule, the debtor is discharged from all debts provided for by the plan or debts that are disallowed, except for the following: (1) certain long-term obligations (such as a home mortgage); (2) debts for alimony or child support; (3) debts for most government-funded or guaranteed educational loans or benefit over-payments; (4) debts arising from death or personal injury caused by driving while intoxicated or under the influence of drugs, which also refers to debts for restitution or a criminal fine included in a sentence on the debtor's conviction of a crime. To the extent that these types of debts are not fully paid under the Chapter 13 plan, the debtor will still be responsible for them after the bankruptcy case has concluded.