What is Bankruptcy?

What is Bankruptcy?

In a nutshell, bankruptcy is the state in which a person or organization cannot repay the debts owed to others. Originally, bankruptcy law was the idea that the government could step in and confiscate all the property of a person and even jail the person so that all the person’s property can be sold to pay some of the debts owed by the debtor. They could also force the individual to work for the government to pay off the rest.

This notion of bankruptcy was a part of British law since the 1500’s and a power given only to the federal government in our Constitution. Fortunately, since we abolished slavery and debtor prisons, individuals are no longer jailed for bankruptcy to work off their debts (unless fraud was involved). Now, in the United States, this power is handled by the federal courts located within each state. Idaho has a U.S. District Court that covers the entire state and handles the bankruptcy cases that arise within the state (with multiple locations too). The current bankruptcy code provides an avenue for a debtor to seek relief from the weight of crushing debt. There are two paths followed by most bankruptcies.

1) Discharge of debt. This is also known as Chapter 7 bankruptcy. Here all property is taken into the bankruptcy and whatever the state feels is the minimum a person must have to live is given back to the person. How these needs are defined is different in each state. Usually you can keep your car, your home, and other things needed to live and work. Usually there is a maximum value for these items. I will discuss Idaho’s defined basics, called exemptions, at a later date. Obviously, organizations do not have this same protection because organizations do not really live and have basic needs. Everything extra above these needs will be sold or given back to the creditor by the court. The person is then given a clean slate, with their debts are wiped out. There are some exceptions to debt that can be removed, like child support, some taxes, and student loans. This wiping out of the debt is called discharge. After this bankruptcy is through, the person moves on without the debt behind him and is free from that point out. This is why it is called a fresh start.

Of course, some debts are attached to things, like a home or car. These debts typically stick to the item. For example, if you want to keep the car, you have to keep the debt (called ‘reaffirm’). Homes and cars are the most common instance where the debt will continue through bankruptcy.
It is not uncommon for a person to have only their basic needs and therefore no property is taken and most, if not all, the debts are discharged (again, there are exceptions).

2) Rehabilitation of debt. This is also known as a Chapter 13 bankruptcy. The difference between a Chapter 7 and a Chapter 13 bankruptcy is that Congress feels if a person makes a certain amount of money, they should not be outright discharged of their debts. Therefore, Congress wants people who make over a certain amount to repay some of their debts. This amount of income depends on the number of people in the family, where they live, and some other factors.

The idea behind a Chapter 13 is the person can pay their debts, or most of them, but just need a court’s help in organizing the creditors and forcing them to work together over a period of time to receive their payment. Even if the creditors do not get everything they want, these creditors are required to accept payment over time as the court requires. There is also a ranking system for these creditors to determine who gets paid first.

In Chapter 13, the debtor will retain ownership and possession of all their assets, but are required to set aside a certain portion of their income for repaying creditors for a period of three or five years. This plan is carried out and whatever was not paid by the end of the plan is discharged. The value of property owned and the income of the person determine whether it is three years or five.

It is probably appropriate to indicate that once a person is on this payment plan given by the court, it is very strictly held to. Failure to make the payments will cause the bankruptcy to be dismissed and creditors are free to pursue the remaining debt as the law allows.

3) I know I said there would be only two, but because it is commonly heard in the news, I thought I better put in a note about Chapter 11 bankruptcies. This is pretty much only for organizations (or persons who make over a half-million dollars a year) where creditors and the court work out repayment plans on a large scale. It works similarly to a Chapter 13 in many ways. There are some marked differences, but these are not important to mention as these effect very few individuals who file Chapter 11 bankruptcy.

4) Just because of the nature of our area, a note also for Chapter 12, the farmer bankruptcy. This works similarly to the Chapter 13 mentioned above, but is a special chapter just for farmers.
That is the basic idea of bankruptcy. Either a person has accumulated too much debt and cannot pay the debts, and rather than allowing the person to remain devastated, this person can be given a fresh start. Or a person makes enough money to pay debts but the creditors have all pounced at once or something else requires the intervention of a court to help the person get back into normal operating procedures.

As mentioned in Is Bankruptcy Morally Wrong?, usually persons who find themselves in over their head in debt are there with little or no fault of their own. Why not contact us to see if you qualify for bankruptcy and if it can help put your life back in order?