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Bankruptcy

 

 

For big businesses -- and for everyday individuals, local governments, and even farms and fisheries -- bankruptcy can provide a way to tackle crushing debt. It’s a legal process that allows debtors to negotiate and repay money owed. For some, it’s a way to get out of debt entirely. It is recommended that attorneys be involved.

An automatic stay is a feature of bankruptcy law that goes into effect immediately upon filing a bankruptcy petition. It forces creditors to stop all collection actions against the debtor, such as foreclosures, repossessions, garnishments, and evictions, and gives the debtor time to sort things out and come up with a solution to its problems.

Types of Bankruptcy

Bankruptcy isn’t for $500 sitting on a credit card or for routine bills. It’s a solution for extreme debt that a company or individual is unable to repay. Specifically, it offers a lifeline when debtors start to face lawsuits, garnished wages, and pending evictions.

What the bankruptcy process actually looks like is determined by the type of filing a business or individual pursues.

The three most popular types are Chapter 7, Chapter 11, and Chapter 13, with names referring to specific sections of the US bankruptcy code. Each type of bankruptcy filing has its own process, although they share many of the same elements.

Chapter 7 is the most common for individuals. It is voluntary or involuntary, permits the debtor to liquidate assets in an orderly way. In Chapter 7, a trustee is appointed, who collects all nonexempt assets of the debtor, sells those assets, and distributes the proceeds to creditors. Individuals, partnerships, and corporations may file for Chapter 7 bankruptcy. Businesses usually file under Chapter 7 when they can't be run profitably, there is no chance of reorganizing, and the business wants to distribute its assets to creditors. There is no minimum or maximum debt limitation for Chapter 7, and the debtor need not be insolvent. If the debtor is an individual, he or she may be entitled to a "discharge" of debts. A debtor cannot dismiss a Chapter 7 case.

It’s possible that an individual could make too much money to be eligible for Chapter 7, however. In this case, they may turn to Chapter 13, which lets debtors work on a repayment plan over three- to five-year periods.

In Chapter 7, for example, debtors must first establish their filing eligibility. One requirement is that individuals may not make multiple filings too close together. Filers also must pass an income means test – essentially proving that their monthly income is below their state’s median.

Once a debtor has determined that they are eligible, the next step is to begin the paperwork associated with the filing. Most experts recommend that individuals hire a lawyer to help with these proceedings, as they can be complex.

After the paperwork has been turned in, the bankruptcy court verifies what a debtor has submitted, and filers will then go before the court for a meeting to review their claims.

In Chapter 7, filers will sell off assets like family heirlooms or investments to pay back what they owe. If they have debt on large purchases like furniture, they may need to return those items. Once this has been done, or if filers have no qualifying assets to sell, the court can “discharge” or erase the rest of the outstanding debt.

Chapter 11 is a popular option for businesses. It allows companies time to restructure their liabilities and come up with a repayment plan. Companies that have filed are able to remain operating while working through the court process.

It can be voluntary or involuntary, permits the debtor (usually a business) to restructure or reorganize its debt. A trustee is usually not appointed; the debtor is allowed to continue to manage its business. The debtor develops a "plan" outlining how its debts will be repaid. Usually, the plan does not involve "liquidating" assets; rather, a debtor plans on reorganizing its debts so that it can continue to operate, hopefully on a profitable basis.

Individuals, partnerships and corporations may file under Chapter 11. Businesses usually file under Chapter 11 when they are facing a cash flow shortage or temporary downturn in business. Upon confirmation, a Chapter 11 debtor receives a discharge of any debt that arose before confirmation. However, confirmation of a plan does not discharge an individual debtor from certain debts that are exceptions to discharge under the Bankruptcy Code. A debtor cannot dismiss a Chapter 11 case.

Chapter 13 can be used by individuals (including those engaged in business) to restructure or reorganize debt. A debtor "engaged in business" is someone who is self-employed and incurs trade credit in the production of income from that employment. The debtor may continue to operate his or her business in a Chapter 13 case. Partnerships and corporations may not file under Chapter 13.

The debtor proposes a plan that outlines how his or her debts will be repaid. The debtor must devote all of his or her disposable income to payments under the plan for three to five years. To qualify for Chapter 13, a debtor must have regular income; unsecured debts of less than $$336,900; and secured debts of less than $1,010,650. A trustee is appointed in a limited capacity. The debtor receives a discharge when he or she has completed all payments under the plan. Only a debtor may commence a Chapter 13 bankruptcy proceeding. Creditors may not commence an involuntary proceeding under Chapter 13. A debtor may dismiss a Chapter 13 case.

Consequences of Bankruptcy

Because a bankruptcy filing indicates that someone is unable to make payments on their debt, it can lower an individual’s credit score by as much as 200 points.
The process also doesn’t eliminate all debt. For instance, alimony and child support payments are not eligible for discharge. And, after the Chapter 7 or Chapter 13 process wraps up, debtors could still face foreclosure.

In corporate bankruptcies, common stockholders are the first to suffer. The process prioritizes all other creditors – so if you have stock in a company that files for Chapter 11, your investment is likely going to zero.

 

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