COMMON BANKRUPTCY MYTHS
Bankruptcy is an important decision that will impact your life in a number of ways. Make sure you are basing this decision on the facts, and not on bankruptcy rumors or myths.
1. Myth #1
Bankruptcy is a legal process governed by federal rules and procedures contained in the Bankruptcy Code and the Bankruptcy Rules. The primary purpose of bankruptcy law is to provide a debtor with a “fresh start” through which some debts can be paid, restructured or discharged. Bankruptcy also provides a way for creditors to be treated fairly and equitably. The debtor is the person who owes money, goods or services, and the creditor is the person to whom the money, goods or services is owed.
On April 20, 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act was enacted, with most provisions becoming effective on October 17, 2005. This new law provided the most substantial changes to bankruptcy law in many years.
A bankruptcy case begins when you (the debtor) pay a filing fee and file a petition with the bankruptcy court. Financial information, including a list of all assets and debts, must be provided. You must certify this information under penalty of perjury. Additionally, all debtors must now participate in consumer credit counseling with an approved nonprofit agency prior to filing a Chapter 7 or Chapter 13 bankruptcy petition. The law also requires that you provide the trustee with copies of your federal tax return for the most recent tax year ending prior to the filing of the petition, along with certain copies of pay stubs. This tax return and the pay stubs must be provided to the trustee seven days prior to the initial meeting of creditors (discussed below). Some trustees will require other financial documentation, as well.
As soon as the bankruptcy petition is filed, an “automatic stay” goes into effect. The “automatic stay” generally stops most debt-collection efforts against you, unless the bankruptcy court grants the creditor permission to pursue collection activities. The bankruptcy court, and in some cases a bankruptcy trustee, oversees the activities of a debtor until the court issues an order discharging the debts and the debtor’s case is concluded.
2. Myth #2
Almost any person who has a residence, business or property in the United States is eligible to be a debtor under the Bankruptcy Code. Individuals, solo proprietorships, partnerships, corporations and family farmers are eligible for bankruptcy relief. In rare cases, creditors may force someone into bankruptcy by filing an “involuntary petition” against a debtor.
Generally, there are no minimum financial or solvency requirements for the filing of a bankruptcy case by the debtor. However the new law imposes heightened eligibility requirements for filing a petition under Chapter 7. Specifically, a debtor must pass the “means test” provided by the new law, which compares your family’s current monthly income with the statewide median income. As a result, certain individuals may be required to proceed under Chapter 13 (where they must pay at least some portion of their debts) because they are not eligible to file a Chapter 7 petition. Note that certain debt restrictions or financial requirements apply in Chapter 12 or 13 bankruptcy cases.
3. Myth #3
In the early stage of a bankruptcy case, you must attend a meeting of creditors (also called a Section 341 meeting) at which you must provide information and answer questions under oath from the bankruptcy trustee, the United States Trustee or your creditors. The bankruptcy judge does not participate in such meetings. Although the meetings are not formal court hearings, testimony is taken under oath and you are subject to criminal penalties for perjury.
Bankruptcy courts are part of the federal judicial system, and federal bankruptcy judges decide most disputes that arise in bankruptcy cases. If any challenges are raised by creditors in your bankruptcy case, it may be necessary for you to testify in court. Many of the legal issues and procedures that arise in a typical individual case can be handled by an attorney without requiring the debtor’s attendance at bankruptcy court hearings.
4. Myth #4
In a Chapter 7 case, you will typically receive an order discharging most of your debts within 3-4 months. Chapter 13 usually requires payments over a 3-year to 5-year period before you will receive an order discharging your debts.
5. Myth #5
There are several different types of bankruptcy cases:
Chapter 7 — Liquidation
Chapter 11 — Reorganization (or liquidation)
Chapter 12 — Family Farmer and Fisherman Reorganization
Chapter 13 — Adjustments of Debts of Individual Regular Income
In a Chapter 7 liquidation case, sometimes referred to as “straight bankruptcy,” a trustee is appointed to collect and liquidate the debtor’s nonexempt assets (see below for an explanation of “nonexempt assets”) and to pay the proceeds to creditors in the order set forth in the Bankruptcy Code. Most Chapter 7 cases are “no asset” cases. This means that the debtor does not have sufficient nonexempt assets or sufficient income to make any distribution to unsecured creditors. Unsecured creditors are those who do not have a valid lien on collateral.
Chapter 11 is available to individuals and businesses that seek to reorganize their affairs or to liquidate in an orderly manner. In Chapter 11, the debtor remains in control of his or her property and operates as a “debtor in possession” subject to bankruptcy court supervision. In Chapter 11, the debtor is allowed a certain period of time within which to propose a plan of reorganization. The plan of reorganization sets the terms for payment of the debts. The terms of Chapter 11 plans vary, depending on the nature of the debt or the type of business the debtor operates, and creditors usually get to vote on the plan.
Chapter 12 allows family farmers and family fishermen with regular annual income to adjust their debts. Generally, the family farmer must have less than $3,544,525 in debts (50 percent of which must arise out of the farming operation) and at least 50 percent of the individual’s gross income must come from the farming operation. The aggregate debts of a family fisherman must not exceed $1,642,500 (80 percent of which must arise out of the commercial fishing operation) and at least 50 percent of the individual’s gross income must come from the fishing operation. A debtor under Chapter 12 must have regular and stable income that enables him or her to repay creditors under a long-term plan.
Chapter 13 is available to individuals with regular income who owe unsecured debts of less than $336,900 (unsecured debts are debts owed to creditors who do not have liens on any collateral) and secured debts of less than $1,010,650 (secured debts are debts subject to valid liens such as mortgages and car loans). By choosing Chapter 13, an individual debtor may avoid a Chapter 7 liquidation, stop home mortgage foreclosures, reinstate defaulted home mortgages and obtain a broader discharge of debts than is available in a Chapter 7 liquidation. In exchange, the debtor in a Chapter 13 case must repay unsecured creditors a portion of their claims from the debtor’s future income over a 3-year to 5-year period. Ordinarily, payments to unsecured creditors will be made by the Chapter 13 trustee according to the plan filed by the debtor and approved by the bankruptcy judge.
6. Myth #6
Bankruptcy can help a debtor in a number of ways. The filing of a bankruptcy case automatically stops most collection actions against you, such as garnishments, foreclosures and lawsuits, at least temporarily. This allows you to have a “breathing spell” during which you have the opportunity to put your finances in order and chart your financial future. While the bankruptcy case is pending, creditors cannot pursue most actions against debtors without bankruptcy court approval.
The ultimate goal of a bankruptcy filing is to obtain a discharge from certain debts that arose prior to the bankruptcy filing. Once the discharge is obtained, creditors cannot pursue collection efforts against the debtor, and those claims are permanently forgiven unless a lien remains in place or you “reaffirm” your obligation to the creditor (see below for a description of reaffirmation of debts). If a lien remains in place, the creditor can pursue the collateral securing the lien even after bankruptcy. If you reaffirm a debt, then the creditor can pursue you personally even after bankruptcy.
Bankruptcy also affords a debtor an opportunity to reject ongoing obligations under certain types of contracts, recover property or assets that were transferred or seized prior to the bankruptcy case, and remove certain kinds of liens.