What Is Bankruptcy?

••• US Bankruptcy Court, Washington D.C. Getty Images

Bankruptcy. Does the word send chills down your spine? That's the old stigma talking. The fact is, bankruptcy is a tool, a way to breathe life back into a company or bring financial stability and vitality to an individual or family.  

Bankruptcy is a federal legal process designed to give individuals and companies a "fresh start" from unmanageable debt. It can also be a way for companies to wind up business and liquidate assets in an orderly way.

Often the subject of fear and loathing, the bankruptcy system is crucial to the functioning of a modern economy. Bankruptcy not only removes the burden of excessive debt, but also helps to keep credit flowing in the economy. The Founding Fathers understood the need for a way to start over and provided in the U.S. Constitution for Congress's authority to establish the bankruptcy system. 

Bankruptcy Courts

The bankruptcy system is operated by the United States Bankruptcy Courts. The bankruptcy courts are subunits of the federal district court system. As a result, there is a bankruptcy court in each federal district of the United States. However, depending upon the population of a district, there may be multiple courthouses in different cities. Bankruptcy courts are supervised by bankruptcy judges that are appointed to 14-year terms by federal judicial committees.

Trustee

In the vast majority of bankruptcy cases, a trustee is automatically appointed when the case is filed.

The trustee administers the bankruptcy case by reviewing the documentation of the debtor (what we call he person who files a bankruptcy case). In a Chapter 7 case, the trustee will attempt to sell any non-exempt property to pay creditors. The trustee also has the obligation to be vigilant for fraudulent conduct and failure of the debtor to disclose information.

The trustee owes a fiduciary duty to the creditors of a debtor, and must collect as many assets as possible to pay creditors.

Goal of Bankruptcy

The desired outcome of most bankruptcy cases filed by individuals is a discharge. A discharge is an order from the bankruptcy court permanently prohibiting any creditor from attempting to collect a debt against you. The discharge is also known as a bankruptcy injunction. Although the discharge is permanent, it is not all inclusive. Some debts are not dischargeable. For example, most tax debts, child support, and spousal support cannot be discharged. As the bankruptcy discharge is a very powerful remedy, it is only given to honest debtors that disclose all of their property and debts.

Types of Bankruptcy

As of 2017 there are six bankruptcy chapters. This number is a surprise to many people because most individuals are only aware of Chapters 7, 11, and 13.  

Chapter 7 liquidation is by far the most common bankruptcy chapter. Chapter 7 liquidation is appropriate for individuals that cannot or do not wish to use Chapter 13's payment plan system. Individuals generally have to qualify to file a Chapter 7 case under a calculation called the means test.

 

Chapter 13 bankruptcy is the second most common chapter for individuals. Chapter 13 permits a debtor to repay at least a portion of debt over a period of three to five years. 

Chapter 11 bankruptcy is the third most common bankruptcy chapter. It is used by both individuals and businesses.to reorganize complex debt structures. 

Chapter 9 is used by municipalities and other political subdivisions like utility, hospital, airport, or school districts.

Chapter 12 is for family farmers and fisherman.

Chapter 15 is filed by foreign debtors who usually are companies with bankruptcy or receivership actions pending in other countries. 

Bankruptcy Fraud

As bankruptcy is a federal system codified by Congress into the United States Bankruptcy Code, bankruptcy fraud falls under the domain of the federal government.

Specifically, bankruptcy fraud, which includes false oaths, failure to disclose debts or assets, and other fraudulent conduct is a federal crime. Committing bankruptcy fraud can lead to you losing your discharge and could very well land you in jail.

Although the federal government keeps a watchful eye out for bankruptcy fraud, any creditor of a bankruptcy debtor can file a complaint against the debtor. The complaint may seek to deny the debtor a discharge for bankruptcy fraud. In addition, the complaint may seek a judgment by the bankruptcy court that the debt owed to the creditor is non-dischargeable in bankruptcy. A debt may be non-dischargeable under the bankruptcy laws or because the credit was obtained by fraudulent means. Bankruptcy is certainly not a safe haven for the unscrupulous debtor.