Bankruptcy. published by AAA Fair Credit Foundation

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1 Bankruptcy published by AAA Fair Credit Foundation

2 Bankruptcy 1. What is Bankruptcy? Chapters of Bankruptcy Understanding Bankruptcy Law Changes Is Bankruptcy Right for Me? Frequently Asked Questions Glossary of Bankruptcy Terms

3 1 Bankruptcy is a serious financial matter that carries with it serious consequences. While its purpose is to provide financial relief, it should not be viewed as an easy way out of a bad financial situation. If you are considering bankruptcy, always be sure to consult a financial professional and a qualified attorney before making your decision. 02

4 What is Bankruptcy? 1 Bankruptcy describes the financial status of an individual or firm that has been legally judged either to have debts that exceed assets or is otherwise unable to pay their bills. Formal bankruptcy may result in reorganization of debts and payments or it may require liquidation of assets and distribution of the proceeds to creditors whom the individual or firm owes money. Bankruptcy is hardly a new financial or economic concept. In fact, the earliest bankruptcy laws on record date all the way back to the 1500 s in England. During this time bankrupt individuals were considered criminals and punishments for the crime ranged from incarceration in debtors prisons to the death penalty. Bankruptcy laws in the United States first appeared in the early 1800 s, and although most of these early laws have been repealed, they were usually written in response to poor economic conditions. Today, bankruptcy law is much different. Instead of favoring one party over another (the debtor or the creditor), these laws emphasize the rehabilitation of the debtor while trying to provide the most equitable treatment for both parties. This is demonstrated by the different chapters of bankruptcy that classify businesses and individuals based on their unique financial situations. One of the main purposes of bankruptcy law is to give a person who is hopelessly burdened with debt, a fresh start by restructuring or wiping out their debts. W H AT I S B A N K R U P T C Y? 03

5 Chapters of Bankruptcy 2 C H A P T E R S O F? Chapter 7 Sometimes called a straight bankruptcy, Chapter 7 is a liquidation proceeding. This means individuals may eliminate (discharge) debts in exchange for giving up property that is not protected by exemption laws. This property is converted into cash proceeds which are then distributed amongst the individual s creditors. While most remaining debt is wiped out, there are debts that cannot be forgiven. Some of these include child support, taxes, and student loans. Chapter 11 This process is typically used for business bankruptcies and restructuring. It is not commonly used by individual consumers since it is far more complex and expensive to pursue. It allows businesses to reorganize themselves, giving them an opportunity to restructure debt and get out from under certain burdensome leases and contracts. Typically a business is allowed to continue operations while in Chapter 11 proceedings, although it does so under the supervision of the bankruptcy court and its appointees. Chapter 12 Chapter 12 is a reorganization plan closely modeled after Chapter 13 but designed specifically for family farms. The purpose of this legislation is to give family farmers, when facing bankruptcy, a chance to reorganize debts and keep their farms. Chapter 13 Also known as a reorganization bankruptcy, Chapter 13 bankruptcy is filed by individuals deemed to have the ability to pay off their debts over a period of three to five years. This type of bankruptcy appeals to individuals who have non-exempt property they want to keep. It is also only an option for individuals who have predictable income and whose income is sufficient to pay their reasonable expenses with some amount left over to pay off their debts. Creditors, under most circumstances, are not allowed to seek collections of these debts outside the bankruptcy proceedings. 04

6 Understanding Bankruptcy Law Changes 3 After eight years and three failed attempts, lobbyists finally pushed through the bankruptcy law reform changes supported by the credit card industry. Signed into law on April 20, 2005, the new law took effect 180 days later, on October 17, The new law, which marks the biggest change to bankruptcy law since 1978, prohibits some people from filing for bankruptcy altogether. And for those who manage to qualify for bankruptcy, it makes it harder to come up with manageable repayment plans and has fewer protections from collection efforts than the prior law. Overview of the Act The major intent of bankruptcy reform is to prevent abusive filings from individuals seeking to take the easy way out of repaying their debts. It requires that those who can afford to make some payments toward their debt actually make these payments, while still preserving their right to relief through the discharge of qualified remaining debt. U N D E R S TA N D I N G L A W C H A N G E S 05

7 3 The Act has a number of provisions that strictly govern if and what type of bankruptcy an individual may file. The Act s most significant provisions include: a strict financial means test that makes it more difficult for debtors with incomes above their state s median state income level to file a liquidation bankruptcy under Chapter 7. The means test determines eligibility based on your income and essential living expenses. a requirement that all debtors must receive a briefing from an approved credit counseling agency at least six months before they can file their bankruptcy case. a requirement that debtors take an approved class on debt management techniques before they receive their bankruptcy discharge. a provision making it easier for a court to dismiss a bankruptcy case outright or to convert a Chapter 7 case to a Chapter 13 case. an attorney s signature on a bankruptcy petition certified that the attorney has performed a reasonable inquiry and has no knowledge that the information contained in the bankruptcy petition is incorrect. U N D E R S TA N D I N G L A W C H A N G E S 06

8 Is Bankruptcy Right for Me? 4 I S B A N K R U P T C Y R I G H T F O R M E? Choosing to file bankruptcy is not an easy decision. Remember, bankruptcy is not for everyone, so you should check out all your options before making your choice. Regardless of your ultimate decision, the best thing you can do now is be proactive. Take the initiative to evaluate your situation and seek out all your options now. After all, having a financial setback is nothing to be embarrassed about, but waiting to address it only exacerbates the problem. Use the following steps to help guide you in making the best choice for your personal financial situation: 1. Evaluate Your Current Financial Situation. Ask yourself a few of the following questions: a. are you frequently late in paying bills? b. Do you only pay the minimum amount due on credit card balances? c. Do you ever have trouble making even the minimum payments to your creditors? d. Do you lose sleep over how you will meet your monthly obligations? e. Have you experienced a significant decrease in wages? f. Have you experienced a life changing event such as divorce, loss of employment, medical emergency, or disability? Answering yes to some or all of these questions is a clear indication that you are in or on the brink of a financial disaster. Again, do not wait to take action evaluate your options and find a solution as quickly as possible. 2. Seek Out Professional Advice. Contact a qualified consumer credit counseling agency and ask for a free financial consultation. They will assist you in creating an overview of your personal finances, a monthly budget, and other advice pertaining to those items. They also will help you determine if you will benefit more from filing bankruptcy or if an alternate solution is best. 07

9 Always review the qualifications of the agency you contact before receiving any services. First, verify they are approved to provide the required pre-bankruptcy counseling so you do not have to repeat this step if you decide later that bankruptcy is your best option. A listing of approved agencies in your area may be found at approved.htm. Next, check the counseling agency s record with both the Better Business Bureau, and a national trade organization such as the American Association for Debt Management Organizations, www. aadmo.org. Having superior records in both areas is a good assurance that you will receive qualified, professional advice. 3. Consult a Licensed Bankruptcy Attorney. If, after you consult with a credit counseling agency, it is determined that you should file bankruptcy, ALWAYS get advice from a bankruptcy attorney. Consider interviewing with two different attorneys to ensure you receive the best service and advice. Again, conduct a background check on the attorney(s) you choose by verifying their license status with your state s Bar Association, reviewing a history of their firm with the Better Business Bureau, and checking to see if they belong to any other professional or trade associations such as the National Association of Consumer Bankruptcy Attorneys, I S B A N K R U P T C Y R I G H T F O R M E? Keep in mind that while non-profit consumer credit counseling agencies should provide you with a free consultation, some may charge you for the pre-bankruptcy counseling certification. Be sure to ask the agency you choose about their policies and fee structures. 08

10 Frequently Asked Questions 5 FA Q 1. What debts are not discharged by bankruptcy? In general, liens (such as mortgages and security interests in cars) are nondischargeable as are some other types of obligations including: a. Federal, State, and Local Tax Claims b. Customs Duties c. Child or Spousal Support d. Most Student Loans e. Fines and Penalties from Government Agencies f. Fraud committed in a fiduciary capacity, such as embezzlement or larceny g. punitive damage claims for willful and malicious acts h. Debts not listed on the forms filed with the court i. Drunk driving obligations j. Debts incurred due to false statements made with intent to deceive 2. If I file Bankruptcy, Will it affect my Spouse? That depends on how you and your spouse divide and share your finances. If the debts listed in your bankruptcy proceeding are not joint accounts or co-signed by your spouse, then your bankruptcy will not affect your husband or wife in most cases. However, in community property states, either spouse can contract for a debt without the other spouse s signature on anything, and still obligate the marital community. There are a few exceptions to this rule such as the purchase or sale of real estate, that require both spouses to sign contracts, but the day to day debts such as credit cards do not require both spouses to sign. The community property states are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. A bankruptcy attorney will be able to tell you specifically which debts only apply to you and which will affect your spouse. 09

11 3. Can I Keep My Credit Cards? This decision ultimately resides with the credit card company. If you are discharging a credit card, they will cancel the card unless you reaffirm the debt. Even if you have a zero balance, the credit card company has the right to cancel your account with them. 4. If I File Bankruptcy, Can I Ever Get Credit Again? It is possible to get credit again after filing bankruptcy. Even though a bankruptcy filing stays on your credit report for ten years, it becomes less significant as time goes on. The truth is you are probably a better credit risk after emerging from bankruptcy than you were before. A number of banks now offer secured or pre-paid credit cards where a debtor puts a certain amount of money in an account at the bank that guarantees payment for any goods or services purchased with the card. Usually the credit limit is equal to the security amount deposited and may increase as the debtor proves his or her ability to pay the debt. Mortgage companies are also coming up with new products specifically for individuals with poor credit or past bankruptcies. Generally, someone may apply for a mortgage loan two years after a bankruptcy discharge. While the terms of these loans may not be as favorable, these financing options are comparable to terms received by others with similar financial profiles that have not filed bankruptcy. Additionally, your income stability and the size of your down payment are factors that will influence how much weight your bankruptcy filing carries in the loan approval process. 5. Can I be fired from my job for filing Bankruptcy? You cannot lose your job by filing bankruptcy. U.S.C. Sec. 525 prohibits any employer from discriminating against you because you filed bankruptcy. FA Q 10

12 6. What am I allowed to keep? The assets you are allowed to keep vary depending upon the state in which you reside and the type of bankruptcy you file. There may also be other limitations or exemptions that apply to you based on your personal financial situation. You should consult a bankruptcy attorney to find out how your state s property exemption laws might affect you. 7. Who will know about my bankruptcy? Bankruptcy proceedings are considered public information. Anyone may call the court to verify if you have filed bankruptcy or review the court s file of that proceeding. FA Q 11

13 Glossary of Bankruptcy Terms 6 B A N K R U P T C Y T E R M S Adversary Proceeding A lawsuit filed in bankruptcy court which is related to the debtor s bankruptcy case. Examples are complaints to determine whether or not a debt is dischargeable and complaints to determine the extent and validity of liens. Arrears The amount that is unpaid and overdue as of the date the bankruptcy case is filed. The word arrears is usually used when referring to back child support, back alimony owed, or the amount that is past due on mortgage payments (including interest and penalties). Assets Personal possessions of value including cash, real estate, vehicles and investments. Automatic Stay An injunction that stops lawsuits, foreclosure, garnishments and all collection activity against the debtor the exact date a bankruptcy petition is filed. Avoidance The Bankruptcy Code permits the debtor to eliminate (avoid) some kinds of liens that interfere with (or impair) an exemption claimed in the bankruptcy. Most judgment liens that have attached to the debtor s home can be avoided if the total of the liens (mortgages, judgment liens and statutory liens) is greater than the value of the property in which the exemption is claimed. This is sometimes called lien stripping. Avoidance Powers Rights given to the bankruptcy trustee or the debtor in possession to recover certain transfers of property such as preferences or fraudulent transfers or to void liens created before the commencement of a bankruptcy case. Bankruptcy Code Title 11 of the United States Code governs bankruptcy proceedings. Bankruptcy is a matter of federal law and is, with the exception of exemptions, the same in every state. When federal bankruptcy law conflicts with state law, federal law controls. Bankruptcy Estate The estate is all of the legal and equitable interests of the debtor as of the commencement of the case. From the estate, an individual debtor can claim certain property exempt; the balance of the estate is liquidated in a Chapter 7 to pay the administrative costs of the proceeding and the claims of creditors according to their priority. Collateral The property that is subject to a lien as payment of a debt or performance of a contract. A creditor with rights in collateral is a secured creditor and has additional protections in the Bankruptcy Code for the claim secured by collateral. 12

14 B A N K R U P T C Y T E R M S Confirmation The process by which the Bankruptcy Judge approves a plan of reorganization of a debtor in a Chapter 13 case. Conversion Cases under the Bankruptcy Code may be converted from one chapter to another chapter; for example, a Chapter 7 case may be converted to a case under Chapter 13 if the debtor is eligible for Chapter 13. Even though the Chapter of the Code that governs it changes, it remains the same case as originally filed. Credit Report A report outlining an individual s credit history, public records and credit worthiness. Creditor Any person or business that a debtor owes money to. Debtor Any person who is liable to another for money. Default Failure to make payments within a specified period of time as governed by the original contract. Delinquency Failure to make payments when payments are due. For most mortgages, payments are due on the first day of the month. Even though they may not charge a late fee for a number of days, the payment is still considered to be late and the loan delinquent. When a loan payment is more than 30 days late, most lenders report the late payment to one or more of the credit bureaus. Denial of Discharge Penalty for debtor misconduct with respect to the bankruptcy case or creditors as a whole. The grounds on which the debtor s discharge may be denied are found in 11 U.S.C When the debtor s discharge is denied, the debts that could have been discharged in that case cannot be discharged in any subsequent bankruptcy. The administration of the case, the liquidation of assets and the recovery of avoidable transfers continue for the benefit of creditors. Dischargeable Debts that can be eliminated in bankruptcy. Certain debts are not dischargeable; that is, they may not be discharged through bankruptcy or may only be discharged through Chapter 13. Family support and criminal restitution are examples of debts which cannot be discharged. Debts incurred by fraud can only be discharged in Chapter 13. Discharge The legal term for the order eliminating a debt through a bankruptcy case. When a debt is discharged, it is no longer legally enforceable against the debtor, though any lien that secures the debt may survive the bankruptcy case. 13

15 B A N K R U P T C Y T E R M S Equity Exempt Exemptions Fiduciary Fair Market Value Garnishment General Unsecured Claim Lien Liquidated A homeowner s financial interest in a property. Equity is the difference between the value of the property and the amount still owed on its mortgage and other liens. Property that is exempt is removed from the bankruptcy estate and is not available to liquidate for paying the claims of creditors. The debtor selects the property to be exempted from the statutory lists of exemptions available under the law of the state where they reside. The debtor gets to keep exempt property for use in making a fresh start after bankruptcy. Exemptions are the lists of the kinds and values of property that is legally beyond the reach of creditors or the bankruptcy trustee. What property may be exempted is determined by state and federal statutes, and varies from state to state. One who is entrusted with duties on behalf of another. The law requires the highest level of good faith, loyalty and diligence of a fiduciary, higher than the common duty of care that we all owe one another. For example, the debtor in possession in a Chapter 11 is a fiduciary for the creditors, owing loyalty to the creditors and not the shareholders of the debtor. The highest price that a buyer, willing but not compelled to buy would pay, and the lowest a seller, willing but not compelled to sell, would accept. A court-ordered method of debt collection in which a portion of a person s salary is paid to a creditor. The process by which a judgment creditor seizes money, which is owed to his judgment debtor, from a third party known as a garnishee. Creditor s claim without a priority for payment for which the creditor holds no security (or collateral). If the available funds in the estate extend to payment of unsecured claims, the claims are paid in proportion to the size of the claim relative to the total of claims in the class of unsecured claims. A charge upon real or personal property for the satisfaction of a debt or discharge of an obligation. Examples would include: judgments, taxes, mortgages, deeds of trust, etc. A debt that is for a known number of dollars is liquidated. An unliquidated debt is one where the debtor has liability, but the exact monetary measure of that liability is unknown.. 14

16 B A N K R U P T C Y T E R M S Perfection Personal Property Petition Preference Pre-petition Priority Priority Claims Proof of Claim When a secured creditor has taken the required steps to perfect his lien, the lien is senior to any liens that arise after perfection. A mortgage is perfected by recording it with the county recorder; a lien in personal property is perfected by filing a financing statement with the secretary of state. An unperfected lien is valid between the debtor and the secured creditor, but may be behind liens created later in time, but perfected earlier than the lien in question. An unperfected lien can be avoided by the trustee. Property that is not real property or affixed to real property, such as cars, stock, furniture, etc. The document that initiates a bankruptcy case. The filing of the petition constitutes an order for relief and institutes the automatic stay. Events are frequently described as pre-petition, happening before the bankruptcy petition was filed, and post petition, occurring after the bankruptcy. A transfer to a creditor in payment of an existing debt made within certain time periods before the commencement of the case. Preferences may be recovered by the trustee for the benefit of all creditors of the estate. Claims or events arising before the commencement of the bankruptcy case, that is, before the filing of the bankruptcy petition. Generally only pre-petition debts may be discharged in a bankruptcy proceeding. The Bankruptcy Code establishes the order in which claims are paid from the bankruptcy estate. All claims in a higher priority must be paid in full before claims with a lower priority receive anything. All claims with the same priority share pro rata. Claims are paid in this order: 1) costs of administration 2) priority claims and 3) general unsecured claims. Secured claims are paid from the proceeds of liquidating the collateral, which secured the claim. Certain debts, such as unpaid wages, spousal or child support, and taxes are elevated in the payment hierarchy under the Code. Priority claims must be paid in full before general unsecured claims are paid. Documents a creditor files that show how much money is owed to them by the debtor, together with all supporting evidence of such claim. There is usually a deadline in which to file a Proof of Claim. 15

17 B A N K R U P T C Y T E R M S Property of the Estate Reaffirm Relief from Stay Repossession Schedules Secured Debt Trustee Unsecured Debt The property that is not exempt and belongs to the bankruptcy estate. Property of the estate is usually sold by the trustee and the claims of creditors paid from the proceeds. The debtor can choose to reaffirm debts that would otherwise be discharged by the bankruptcy. Generally, when a debt is reaffirmed, the parties to the reaffirmed debt have the same rights and liabilities that each had prior to the bankruptcy filing: the debtor is obligated to pay and the creditor can sue or repossess if the debtor doesn t pay. A creditor can ask the judge to lift the automatic stay and permit some action against the debtor or the property of the estate. If the motion is granted, the moving party (but no one else) is free to take whatever action the court permits. Relief can be absolute, for example, permitting the creditor to foreclose on property, or limited, as for example, allowing the recordation of a notice of default. Once in default, as defined by the creditor in the security agreement, the creditor can: repossess the collateral by self-help (depending on state law) or with the aid of a court order, dispose of the collateral by public or private foreclosure sale, retain the collateral in satisfaction of the debt, terminate the debtor s right of redemption, add the costs of repossession and foreclosure to the unpaid balance of the debt, and pursue the debtor for any remaining unpaid balance or deficiency. The debtor must file the required lists of assets and liabilities to commence a bankruptcy case, collectively called the schedules. A secured debt is one where the creditor takes personal or real property as collateral. A creditor whose debt is secured has a right to take property to satisfy a debt in default. For example, most homes are burdened by a secured debt in the form of a mortgage. This means that the lender has the right to take the home if the borrower fails to make payments on the loan. A private individual or corporation appointed in bankruptcy filings who represents the interests of the creditors in the bankruptcy estate. A debt is unsecured if you have simply promised to pay a creditor a sum of money at a particular time, and you have not pledged any real or personal property as collateral for that debt. Generally, credit cards and medical bills are unsecured debts 16

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