Free Information on Bankruptcy Law Basics under the United States Bankruptcy Code
Many debtors, creditors, legal professionals, and others have heard of bankruptcy, but need more information to determine whether bankruptcy is the right option, and how to assert their rights after a bankruptcy is filed. This guide by an experienced bankruptcy attorney in California will assist in navigating the complex laws under the United States Bankruptcy Code. Remember that filing for bankruptcy has significant legal consequences that should only be undertaken in conjunction with the advice and counsel of an experienced bankruptcy lawyer.
1. What is Bankruptcy?
Bankruptcy is a legal proceeding filed in federal court in which an individual or a business requests relief from outstanding debts. It is a court order depicting how an insolvent (unable to meet the financial obligations of their lenders) individual or business plans to repay their creditors. Upon successful discharge, a debtor will no longer be liable for most debt obligations incurred prior to filing for bankruptcy. The most common forms of bankruptcy are Chapter 7 bankruptcy, Chapter 13 bankruptcy, and Chapter 11 bankruptcy. Essentially, bankruptcy is a legal tool that allows debtors to start fresh and learn from past financial mistakes.
A. History of Bankruptcy
The concept of bankruptcy is not new; in fact, records of debt forgiveness date back to ancient Hebrew society. The term “bankruptcy” is derived from medieval and Renaissance Italy. The Italian banca rotta translates to “broken bench,” which referred to Italian merchants who worked from a market stall or “bench.” If a merchant ran out of money and failed to pay his debts, his creditors would come and break his bench. This prevented the merchants from being able to work and visibly marked that they had failed to pay. The concept of discharging a debt did not appear in English bankruptcy law until the 1700s and the US did not pass a formal, uniform bankruptcy act until 1898. Finally, the Bankruptcy Reform Act of 1978 replaced this and became the basis for today’s United States Bankruptcy Code.
B. Involuntary Bankruptcy
Involuntary bankruptcy is relatively rare compared to voluntary bankruptcies. In an involuntary bankruptcy, a creditor brings a bankruptcy proceeding against a person or, more commonly, a business requesting that that person or business go into bankruptcy. Creditors may file an involuntary bankruptcy case against a debtor if they believe the debtor has the ability to pay but is refusing to do so for some reason. An involuntary bankruptcy proceeding can only be filed under Chapter 7 or Chapter 11 of the Bankruptcy Code and is only available to qualifying creditors who have a bona fide claim against the debtor.
C. Voluntary Bankruptcy
By far the most common form of bankruptcy is voluntary bankruptcy. Voluntary bankruptcy proceedings occur when a filer who is insolvent chooses to petition the court for bankruptcy. Filers can be either individuals or corporations who cannot pay off their debts. Voluntary bankruptcy can be an extremely useful tool to wipe the slate clean and start over.
D. What is Chapter 7 Bankruptcy?
Chapter 7 bankruptcy, also known as a liquidation bankruptcy, is the most common form of bankruptcy. In a Chapter 7 proceeding, a bankruptcy trustee, who is appointed by the United States Trustee Program to oversee a filer’s bankruptcy case, liquidates a filer’s nonexempt assets to pay creditors and any remaining debt is discharged. To be eligible to file for Chapter 7 bankruptcy, the debtor must pass a means test and cannot have a discharged Chapter 7 bankruptcy within the last 8 years.
E. What is Chapter 13 Bankruptcy?
Chapter 13 bankruptcy, also known as a wage earner’s plan, is a bankruptcy proceeding in which filers reorganize their finances and repay creditors under the supervision of the court. Filers are required to submit a previously agreed-upon monthly payment over a period of 3 – 5 years to a bankruptcy trustee, who then distributes it to the creditors. A trustee in a Chapter 13 bankruptcy is an impartial third party who helps a debtor restructure their debts and serves as a liaison between the debtor and the creditors. A Chapter 13 bankruptcy also allows homeowners to catch up on their mortgage payments and become current without losing their home.
F. What is Chapter 11 Bankruptcy?
Chapter 11 bankruptcy is the most complex and usually the most expensive form of bankruptcy. Chapter 11 bankruptcy includes both individual and business bankruptcies by allowing such people and entities to restructure their affairs, debts, and assets. The debtor, called a debtor in possession, may continue to operate but must ask the court’s permission for certain business decisions. A business may choose to file for Chapter 11 bankruptcy if it needs time to restructure its debts and does not meet the qualifications for a Chapter 13 bankruptcy.
2. Steps for Filing for Bankruptcy in California
- Ensure that bankruptcy is the best option. The first step to filing for bankruptcy is to evaluate whether bankruptcy is truly the best option. Bankruptcy is not right in every situation, so we highly suggest you evaluate all possible alternatives and approach the decision to petition for bankruptcy carefully in consultation with a bankruptcy attorney.
- Evaluate your eligibility. For example, Chapter 7 bankruptcy requires passing the means test and Chapter 13 bankruptcy requires a steady income.
- Collect relevant documents. These may include a credit report, tax returns, pay stubs, bank statements, real estate valuations or appraisals, and any other documents related to assets, debts, or income.
- Take a credit counseling course. In both Chapter 7 and Chapter 13 bankruptcy proceedings, you will be required to take a court-approved credit counseling course before you can apply for bankruptcy. A certificate of completion of this course is required in order to submit your bankruptcy forms.
- Fill out bankruptcy forms. These forms can be extremely long and tedious, so many filers decide to hire a knowledgeable bankruptcy attorney to complete these forms. Be sure to print these forms (single sided) and sign them for the court.
- Get your filing fee in order. Depending on your circumstances, you may qualify to pay the fee in installments or for a fee waiver.
- File the paperwork with the court. At this time, you will receive the name of your appointed bankruptcy trustee, your 341 meeting information, and an automatic stay will be placed on your property.
- Mail documents to your trustee. Your trustee will request certain documents from you. If you do not send these documents, your bankruptcy case will not be discharged.
- Complete a Debtor Education Course. Although similar to the credit counseling course that was required to petition for bankruptcy, the debtor education course is different and required in order to receive a discharge.
- Attend your 341 Meeting, also known as your meeting of creditors. Here, you “shall appear and submit to examination under oath at the meeting of creditors” 11 U.S.C. § 343. Your trustee needs to verify your identity in this meeting, so be sure to bring a government issued ID and any other required paperwork. Creditors are welcome to attend this meeting as well, although it is very rare they will actually do so.
- Attend a confirmation hearing (Chapter 13 bankruptcy and Chapter 11 bankruptcy only). Unlike a 341 meeting, a confirmation hearing is a court proceeding in which you propose a plan to repay your debts. The judge must then confirm the plan for it to become effective.
- Get your discharge! A discharge in bankruptcy releases you from debts and liabilities that were incurred before you filed for bankruptcy. A discharge is like a fresh start – the ultimate goal of bankruptcy!
3. Bankruptcy Requirements
Pursuant to the United States Bankruptcy Code, the following are debtor requirements for bankruptcy:
A. Chapter 7 Bankruptcy Requirements
Of all the types of bankruptcy, Chapter 7 has the most stringent requirements because it offers the most relief. Unlike other forms of bankruptcy, Chapter 7 provides for unsecured debt, such as credit card debt or medical bills, to be wiped completely. This makes Chapter 7 an attractive option for many filers so they can start anew. To file for Chapter 7 bankruptcy, the filer must:
- Be an individual, partnership, or corporation as defined by 11 U.S.C. §§ 101(41), 109(b)
- Beware: only an individual can receive a discharge in a Chapter 7 bankruptcy. Business entities may choose to file for Chapter 7 bankruptcy to place the burden of liquidating assets and paying creditors on the trustee, but keep in mind that they cannot receive a Chapter 7 debt discharge. 11 U.S.C. § 727(a)(1)
- Not have filed for Chapter 7 bankruptcy within the last 8 years 11 U.S.C. § 727(a)(8)
- Not have filed for Chapter 13 bankruptcy within the last 6 years 11 U.S.C. § 727(a)(9)
- Wait 181 days to file if the filer previously attempted to file for bankruptcy but had the petition dismissed for failure to appear in court, failure to comply with the court’s orders, or the filer voluntarily dismissed the case 11 U.S.C. §§ 109(g), 362(d) and (e)
- Take an approved credit counseling course within 180 days of filing for bankruptcy 11 U.S.C. §§ 109, 111
- Not trying to defraud creditors 11 U.S.C. § 110
- If the filer’s monthly income is above the state median, they must also pass the means test (see below)
B. Chapter 7 Bankruptcy Means Test
The means test is a device used by the courts as laid out in 11 U.S.C. § 707(b)(1) to limit the use of Chapter 7 bankruptcies to those who are unable to pay their debts. The higher your disposable monthly income (total income minus certain monthly expenses), the less likely you are to qualify for Chapter 7 bankruptcy. The logic behind this is that those with higher disposable monthly incomes should be able to pay back debt. The means test is broken down into several parts. First, is your income more than the median income for the same size household in California? The Federal Court’s Official Form 122A-1 can help you determine this. If you are under the median, you can petition for Chapter 7 bankruptcy. If you are over the median, you must determine if you have enough disposable income to pay off some of your debts. Official Form 122A-2 can help you find out if your disposable income qualifies or eliminates you from filing for Chapter 7 bankruptcy. If you do, the case may be converted to Chapter 13 bankruptcy or dismissed.
i. Exceptions to the Means Test
There are exceptions to the means test for non-consumer debtors . If your debts are not primarily consumer debts (i.e. your debt mostly consists of business debt), this qualifies as an exception to the means test. Additionally, if you are a disabled veteran who incurred debts mostly while on active duty or while performing a homeland defense activity or if you are a Reservist or member of the National Guard called to active duty before filing your case these can qualify as exceptions to the means test. See Official Form 122A-1Supp for these exceptions.
C. Chapter 13 Bankruptcy Requirements
The requirements for a Chapter 13 bankruptcy are similar to those of a Chapter 7 bankruptcy, but instead proof that you will be able to repay creditors is required. To file a Chapter 13 bankruptcy, a filer must:
- Be an individual (including self-employed) 11 U.S.C. § 109(e)
- Develop a plan to pay creditors in installments over the course of 3-5 years and have sufficient income to repay creditors as laid out in their monthly payment plan 11 U.S.C. § 1322(d)
- As of April 2019, have unsecured debts less than $419,275 and secured debts less than $1,257,850 11 U.S.C. § 109(e)
- Provide proof that you filed state and federal income tax returns for the last 4 years 11 U.S.C. § 1308
- Wait 181 days to file if the filer previously attempted to file for bankruptcy but had the petition dismissed for failure to appear, failure to comply, or the filer voluntarily dismissed the case 11 U.S.C. §§ 109(g), 362(d) and (e)
- Take an approved credit counseling course within 180 days of filing for bankruptcy 11 U.S.C. §§ 109, 111
D. Can I choose which type of bankruptcy to file? How do I choose?
Filing for the correct type of bankruptcy to fit your unique financial situation is arguably as important as deciding whether or not to file for bankruptcy in the first place. Remember that there are eligibility requirements for each type of bankruptcy and that filing for the wrong type of bankruptcy can have various negative consequences, such as case dismissal, restriction from filing another bankruptcy petition, and a decreased length for an automatic stay on following bankruptcy filings. Review your situation carefully, preferably with an experienced bankruptcy attorney, and be sure to include all pertinent documents in your evaluation. Refer to the chart below for a brief comparison between Chapter 7 bankruptcy, Chapter 13 bankruptcy, and Chapter 11 bankruptcy that should be used in consultation with a bankruptcy attorney. Note that the cost references the amount paid to the court. Of course, a bankruptcy attorney will cost you more.
4. How Bankruptcy Works
A. Automatic Stay: Can Creditors Collect After Bankruptcy is Filed?
Pursuant to 11 U.S.C. § 362, an automatic stay is issued upon the filing of the bankruptcy. An automatic stay is a temporary injunction preventing creditors from pursuing debts. The minute a bankruptcy petition is filed, the automatic stay begins. It will likely last through the entire bankruptcy but depends on whether the collection activity is directed toward the debtor or the property. It is also worth noting that an automatic stay will cease if the bankruptcy case is dismissed. The automatic stay halts creditors from starting pursuing court proceedings against the debtor, foreclosing on a debtor’s home, creating or enforcing a lien against the debtor’s property, and attempting to repossess collateral (such as a vehicle). It also temporarily prevents utility disconnections and evictions. An automatic stay requires creditors to halt collections unless the creditor is granted relief from the stay. The automatic stay will end in a shorter time for repeat bankruptcy filing. Note: an automatic stay cannot protect against certain tax debts, child support, alimony, and loans from pensions.
B. Who Are Bankruptcy Trustees?
A bankruptcy trustee is an impartial third party who is appointed by the US Trustee Program to oversee the bankruptcy estate (that is, the debtor’s non-exempt property). A trustee in a Chapter 7 bankruptcy case will be in charge of liquidating the bankruptcy estate, including gathering the debtor’s property, selling the bankruptcy estate’s property, and distributing the proceeds to creditors. By contrast, a trustee in a Chapter 13 bankruptcy case is in charge of reviewing the payment plan, receiving payments from the debtor, and distributing these payments to the creditors.
C. How Long Does the Bankruptcy Process Take?
Chapter 7: Chapter 7 bankruptcy case usually lasts between 2 and 5 months from initial credit counseling course to discharge for the vast majority of cases, notably the no-asset cases. It may take longer depending on if you need to provide more documents, the bankruptcy trustee has to sell your property, or if you are involved in a bankruptcy-related lawsuit.
Chapter 13: Because Chapter 13 bankruptcy requires repayment over time, it will take significantly longer than a Chapter 7 bankruptcy. Typically, a Chapter 13 bankruptcy takes 60 months. It is possible to repay debts earlier if you propose a 100% plan. A 100% plan requires that the filer pays all unsecured debts (such as credit card bills or medical bills) in full and leave only long term debts to be paid, such as mortgages or student loans.
Chapter 11: Chapter 11 bankruptcies usually last between 6 months and 2 years, but due to the complicated nature of these filings, it is not uncommon for them to last even longer.
D. What Happens After you File for Bankruptcy?
Immediately upon filing for bankruptcy, the automatic stay begins. Creditors cannot call or try to collect payment for debts and wage garnishments stop.
Next, filers will likely see a drop in their credit score. Between a 100 and 200 point drop is to be expected after filing for bankruptcy. On the bright side, they can immediately start improving their credit score once the bankruptcy case is discharged. Many filers already have low scores due to missed payments, so elimination of credit card debt because of a bankruptcy discharge puts them in a much better position to pay off their credit cards. Many debtors are able to rebuild their credit within 1-2 years of receiving a discharge. Keep in mind that a Chapter 7 bankruptcy will stay on a credit report for up to 10 years after filing and a Chapter 13 bankruptcy will remain on a credit report for up to 7 years after filing.
Finally, they will need to prepare bankruptcy paperwork and attend a credit counseling course. Once this is complete, they can file for bankruptcy.
E. How Much Does it Cost to File for Bankruptcy?
All bankruptcy filings require the filer to attend initial credit counseling meeting. The counseling fee is usually around $50, but may be waived if the filer’s income is low enough. Debtor education courses are also required later on in the bankruptcy process and cost between $50 – $100.
The filing fee is $335 for a Chapter 7 bankruptcy, $310 for Chapter 13 bankruptcy, and $1,717 for a Chapter 11 bankruptcy. Of course, attorneys will charge fees for their time on top of this amount.
Filing fees may be paid in installments. 28 U.S.C. § 1930; and Fed. R. Bankr. P. 1006(b). Or, if the debtor’s income is less than 150% of the poverty level, the fee may be waived entirely pursuant to 28 U.S. Code § 1930. Failure to pay the court filing fee may result in a case dismissal. 11 U.S.C. § 707(a).
If you plan on hiring an attorney, there will also be attorney’s fees involved in your bankruptcy case. We highly recommend you hire a bankruptcy attorney instead of attempting to represent yourself pro se (without a lawyer). Without the knowledge of an experienced bankruptcy attorney, filers can lose income or property worth much more than attorney’s fees.
F. Debtor in Possession
A Debtor in Possession (DIP) is a person or corporation who has filed for Chapter 11 bankruptcy but still has property in which creditors have a legal claim, usually a lien or other security interest. A DIP may continue to do business but must ask the court for permission for certain business activities outside of the scope of regular business activities. Typically, a DIP is a transitional stage that allows the debtor to retain some value to their assets after bankruptcy. The assets are commonly part of the business and have a higher resale value together with the business than alone. DIP status also allows debtors to prevent liquidation or other sales that would under-value their assets.
G. Bankruptcy Dismissal
A bankruptcy dismissal closes a bankruptcy case before discharge. A debtor is still liable for all debts and the automatic stay is lost if a bankruptcy case is dismissed. Refer to our post on bankruptcy dismissal for a more comprehensive explanation of bankruptcy dismissal.
H. Bankruptcy Conversions
A bankruptcy conversion is a court-approved change from one chapter of bankruptcy to another chapter. Our blog post on bankruptcy conversions provides a more in depth explanation of bankruptcy conversions.
5. Debts in Bankruptcy
A. Unsecured Debt
Unsecured debt is a loan that is not backed by collateral; that is, a loan that is not backed by underlying assets. These loans usually have higher interest rates and are riskier to lenders if a borrower defaults on payment. Common examples of unsecured debt are credit card bills, medical bills, and utility bills.
B. Secured Debt
Unlike unsecured debt, secured debt is a loan that is backed by collateral. These loans are considered less risky because an asset backing this debt is a form of security. If a borrower defaults on the loan, the bank can repossess the collateral, sell it, and use the proceeds to pay back the debt. The two most common examples of secured debt are home mortgages and auto loans.
C. Rights of Unsecured vs. Secured Creditors
Similar to the above definitions, an unsecured creditor is a creditor or lender that issues a loan without obtaining specific assets or collateral and a secured creditor is a creditor or lender that issues credit that is backed by collateral. While a secured creditor can repossess assets to pay off a debt, an unsecured creditor may have to use litigation or bankruptcy proceedings to obtain repayment.
D. Judicial Liens
A judicial lien is created when a creditor records a judgment to the court asking the court to impose a lien on the debtor’s property. If the debtor has not satisfied the judgment, the judicial lien will remain on the property. In both Chapter 7 bankruptcy and Chapter 13 bankruptcy, a debtor may file a Motion to Avoid Judicial Lien. If this is granted by the court, the judgment creditor will no longer have a lien on your home. In a Chapter 7 bankruptcy, an Order Avoiding Judicial Lien will remove the debt completely. Even nondischargeable judgments can be removed if they impair an exemption in bankruptcy.
6. Property in Bankruptcy – What Happens to Property in Bankruptcy?
A. Liquidation – Chapter 7 (Sometimes Chapter 11)
A liquidation occurs in a Chapter 7 bankruptcy and sometimes a Chapter 11 bankruptcy when a bankruptcy trustee (or, in the case of a Chapter 11 bankruptcy, a debtor in possession) sells nonexempt assets to pay off creditors. Keep in mind that exempt property as defined by 11 U.S.C. § 522 will not be liquidated. The newly updated and increased California homestead exemption allows most Chapter 7 bankruptcy filers to keep their homes. For a complete list of exemptions in bankruptcy in California, refer to CCP § 704.
B. Reorganization – Chapters 11, 13
Unlike a liquidation, a trustee will not sell your nonexempt property under Chapter 11 or Chapter 13 bankruptcy. Instead, you will be required to pay off certain debts in full. Nonexempt assets must be paid by either disposable income or an amount equal to the value of the nonexempt assets (whichever is higher). This may dramatically increase monthly payments through your repayment plan.
C. What Happens to My Car and My Home?
Those who filed for Chapter 13 or Chapter 11 bankruptcy are able to keep their cars as long as they continue to make payments. However, in a Chapter 7 bankruptcy, it may be more difficult to keep a car. A document called a Statement of Intent is one of the many documents that will be filed among the bankruptcy paperwork. This form alerts the court what filers plan on doing with property that is securing a debt they owe, like a car with a loan that has not yet been paid off. They can chose to do one of three things with this property: reaffirm the debt, surrender the vehicle, or redeem the vehicle. Reaffirming the debt allows a filer to continue to make payments while remaining in possession of the vehicle. This debt is not discharged, and the lender retains the right to repossess the vehicle if there are any missed future payments. Surrendering a vehicle allows a filer to voluntarily surrender the car for repossession. This only occurs after the automatic stay has expired and is common with filers who have high car payments they can’t afford. Finally, a filer can redeem a vehicle by paying the lender the value of the car. This may be a good option if the vehicle is worth significantly less than the total outstanding debt.
Chapter 13 and Chapter 11 bankruptcy filers are usually protected from losing their homes as long as they follow the repayment plan. For Chapter 7 bankruptcy, filers should find out if their home is protected from being sold by a Chapter 7 trustee by calculating how much equity they can have in their house and still file for Chapter 7 bankruptcy. This calculation includes California’s recent increase to the homestead exemption, which allows many more filers to keep their homes. If your result is negative, your bankruptcy will likely be seen as a “no asset” bankruptcy and you will likely be able to keep your home. If the result is positive, this is the exposed equity that you may need to pay to the trustee to be able to keep your home.
There are also options available to help prevent a bankruptcy trustee from selling your house.
D. Will Bankruptcy Affect my 401k?
In short, no; bankruptcy will not affect your 401k. Retirement accounts including a 401k and other qualified Employee Retirement Income Security Act (ERISA) accounts are not typically included in the bankruptcy estate, and will therefore not be affected by a bankruptcy filing. Additionally, both federal and state laws provide exemptions that protect retirement accounts in bankruptcy. Unless you withdraw money from the retirement account or the account is fraudulent, retirement accounts are protected from creditors in a bankruptcy filing.
7. Bankruptcy Discharge
A bankruptcy discharge, also known as a discharge in bankruptcy, is a permanent court order releasing a debtor from personal liability for certain specified types of debts. That is, the debtor no longer has a legal obligation to pay off debts that are discharged. An individual can be granted a Chapter 7 bankruptcy discharge pursuant to 11 U.S.C. § 727. A business entity seeking a discharge must file for Chapter 11 bankruptcy and is subject to the limitations of 11 U.S.C. § 1141(d)(3). Refer to our guide on bankruptcy discharge for an in-depth look at the the bankruptcy discharge process. Note that certain debts may be declared nondischargeable under the Bankruptcy Code.
Contact an Experienced Bankruptcy Attorney in Los Angeles, Orange County, San Francisco, Riverside, San Diego, San Jose, Sacramento, Fresno, and Surrounding Areas in California
No two bankruptcy cases are the same; each bankruptcy case will bring with it a new set of challenges. Whether you a debtor, creditor, or other interested party, we highly recommend you consult a knowledgeable bankruptcy attorney to make the bankruptcy process as easy as possible. A bankruptcy attorney can help guide you through the complicated bankruptcy process and ensure the most favorable outcome in your case. Contact the bankruptcy attorneys at Talkov Law in California online or over the phone at (844) 4-TALKOV (825568) to schedule your free, 15 minute consultation.