Bankruptcy Law – Understanding the Basics

Bankruptcy law is a complex and confusing field. It is best left to a skilled attorney.


In a Chapter 7 bankruptcy, the debtor gets rid of most or all of his or her debts. Individual consumer debtors must pass a “means test” to qualify for this relief.

A firm facing financial difficulties may be worth more as a going concern than as a piecemeal collection of individual assets sold off to satisfy creditors. Chapter 11 is designed to preserve such a firm.

Chapter 7

In a Chapter 7 bankruptcy, the trustee takes over your assets, reduces them to cash and pays your creditors. You keep possessions that the law calls “exempt.” These include clothing, tools of your trade and a motor vehicle up to a certain value. The laws of the state where you live and federal law determine which items qualify as exempt.

If you file Chapter 7, you must pass a means test to prove that you can’t afford to repay what you owe. This requires a review of your debts, expenses and income. You also must undergo credit counseling before filing.

Chapter 7 allows you to get a fresh start by discharging most of your debt. This provides both temporary and permanent relief from creditors’ collection efforts. A few days after you file, an automatic stay bars most types of collection activity, including foreclosure, eviction and repossession. The only exceptions are actions for alimony, child support and criminal restitution. A trustee gathers your nonexempt property, sells it and distributes the proceeds to creditors. You are freed from personal liability for most of your debts after surrendering for distribution all but certain debts you cannot discharge, such as student loans and tax liens.

Chapter 9

Municipalities in financial distress can file for chapter 9 bankruptcy to negotiate a plan with creditors to repay their debts over time. It applies to cities, towns, counties, and “other political subdivisions or public agencies or instrumentalities of a state that are authorized by law to engage in governmental functions.” 11 U.S.C. SS 303(a). Unlike most bankruptcy cases, creditors and parties in interest cannot propose competing plans to resolve a municipality’s debts. This limitation stems from the Supreme Court’s decisions in Ashton and Bekins, which found that municipalities must remain in control of their governmental affairs during the course of a chapter 9.

The bankruptcy courts will carefully review whether a municipality is eligible to file for chapter 9 by considering the following requirements:

Chapter 11

In Chapter 11, business entities and individuals can restructure their debts by proposing a plan of reorganization voted on by creditors. In most cases, this involves selling company assets and distributing the proceeds to creditors.

A bankruptcy judge oversees a Chapter 11 case and must approve major decisions. A court may also appoint a trustee to take over the case if the debtor fails to meet its obligations.

Creditors are protected by a variety of laws, including the “avoiding” powers, which allow the debtor in possession or trustee to undo certain transfers of money or property made during a specified period before filing. In return for this power, the debtor in possession or trustee must provide creditors with a disclosure statement.

The debtor must file a disclosure statement within the exclusive window of 120 days after a case is filed. This is intended to discourage debtors from prolonging the bankruptcy process. The confirmation of a debtor’s plan discharges the debtor from most types of pre-petition debts, except those debts that would have been discharged in a liquidation proceeding under Chapter 7 or Chapter 13. 11 U.S.C. SS 1141(d).

Chapter 12

Unlike Chapter 7 bankruptcy, which is a liquidation process, Chapter 12 allows debtors to keep their property and continue operating their business. In a Chapter 12, the debtor, with help from creditors, creates a plan to repay some or all of their debts.

A debtor filing for Chapter 12 must appear at a meeting of creditors and answer questions about their petition and financial affairs. The court will also set up a trustee to work with the debtor and creditors.

The Chapter 12 debtor must file a proposed repayment plan within 90 days of filing the petition. This plan must pass a “best interests of the creditors test” that requires each creditor to receive at least as much money as they would get in a Chapter 7 liquidation proceeding. The plan must also cover the debtor’s living expenses and any amount owed for past-due alimony or child support.

Only family farmers are eligible for Chapter 12. Debtors must earn wages or have some other source of regular income, and must agree to pay part of their income to creditors. They must also file a budget and provide a detailed list of assets and liabilities.

Chapter 13

Chapter 13 is for individuals with regular income who wish to keep their property and repay debts over time, usually three to five years. It is often used to stop foreclosure or repossession and to catch up on missed mortgage or car payments. It can also help restructure and extend secured debt, like a car loan, to lower the monthly payment. This chapter can also protect co-signers on consumer debt.

A trustee is appointed to oversee a Chapter 13 case, and he or she will evaluate the proposed plan of repayment and distribute funds to creditors. Generally, priority debts such as recent taxes and family support will be paid in full, and secured creditors will receive at least the value of their collateral.

A chapter 13 case “automatically stays” most collection actions (except child support, spousal support, criminal restitution, and student loans). It also allows for the restructuring or extending of some debts such as car loans and mortgages to lower monthly payments. It can be converted to a Chapter 7 bankruptcy with the consent of the court.