What is Bankruptcy?

     Bankruptcy is a legal process by which a person or persons receive financial relief by temporarily putting their affairs into the hands of a bankruptcy court.  In exchange for this temporary surrender of control, the bankruptcy court generally discharges much (indeed, sometimes all) of the person or persons’ debts.  Bankruptcy protection was enshrined by our founding fathers in the original United States Constitution, where it remains today.

     People who seek bankruptcy protection are debtors.  Entities who are owed money by the debtors are creditors.  There are two types of debts:  1) secured debts, in which the debtor gives a creditor an interest in some of the debtors’ property (called collateral) to guarantee repayment of the debt (a car loan or mortgage, for example); and 2) unsecured debts, in which the debtor has not provided collateral.

       The mechanics of the bankruptcy process are set forth in the Bankruptcy Code, a federal law passed by the Congress.  Consumers typically file one of three types of bankruptcies, each commonly referred to by the Bankruptcy Code chapter number in which it is found – Chapter 7 (straight/liquidation), Chapter 12 (farmer/fisherman reorganization), and Chapter 13 (personal reorganization).

     In a no asset Chapter 7 bankruptcy, debts are discharged, and the debtors keep all of their property.  Chapter 7 is far and away the most commonly filed bankruptcy chapter, making up over 80% of the bankruptcies filed in Vermont.  Chapter 12, in contrast, is used quite infrequently.  Chapter 12 allows farmers and fishermen to restructure their finances to avoid the repossession or foreclosure of collateral.  Chapter 13, like Chapter 12, also allows debtors to restructure their finances to avoid repossession or foreclosure, and is available to all individuals, not just farmers and fishermen.  Chapter 12, however, offers more protection for debtors than Chapter 13, and should be used over Chapter 13 whenever the debtors qualify.

     There are a number of similarities in these three bankruptcy chapters.  All bankruptcy proceedings, for example, are commenced with the filing of a bankruptcy petition, with schedules that detail the debtors’ assets, liabilities, income and expenses.  As soon as this petition is filed, creditors are prohibited from attempting, in any way, to collect their debt from the debtors (called the automatic stay), no matter what chapter relief is being sought under.  Similarly, in all bankruptcy proceedings a trustee is immediately appointed upon filing to represent the interests of the debtors’ unsecured creditors, and a few weeks later, a meeting (called a § 341 Meeting) is held at which the trustee is given an opportunity to question the debtors under oath.  Finally, in all chapters, the court discharges the debtors’ unsecured debts, with certain exceptions (child support and spousal support obligations, some tax debts, most student loans, and a few other types of debt).

     Other than these similarities, however, Chapters 7, 12, and 13  are each quite different, with separate rules regarding who can file, what property can be kept by the debtors, how secured debts are handled, and how long the bankruptcy lasts.

Chapter 7

• A Chapter 7 bankruptcy can be filed by individuals (a personal or consumer bankruptcy) or businesses (a business or nonconsumer bankruptcy). 
• Chapter 7 individual debtors keep all of their property that is exempt under the Bankruptcy Code.  Common examples of exempt property include clothes, cars, household furnishings, retirement accounts and the debtors’ primary residence (homestead).  If all of the debtors’ assets are exempt (called a no asset case), the debtors keep all of their property.
  
• With respect to exempt property that debtors have given a collateral interest in (such as a car with a loan or a house with a mortgage), Chapter 7 debtors may choose any one of the following options: 1) keep the property and continue payments on the underlying debt (under some circumstances, debtors execute a new agreement with the creditor, called a reaffirmation agreement); 2)  keep the property and pay the creditor a lump sum amount equal to the current replacement value of the property (called redemption); or 3) give the property back to the creditor (called surrender) with no additional liability (called a deficiency) incurred.
• The bankruptcy court discharges the debtors’ unsecured debts sixty days after the § 341 Meeting.  The court closes the Chapter 7 case shortly after the discharge is issued, approximately three months after the commencement of the case.

     Not everyone can or should file for Chapter 7 bankruptcy. For instance, if the debtors’ gross household income is too high (for example, more than $100,000 for a typical 3-person household), the debtors are forced by the Bankruptcy Code to file a Chapter 13 bankruptcy instead of a Chapter 7 (unless the debtors can convince the bankruptcy court that a Chapter 7 case is brought in good faith).  And if the debtors have property that they want to keep but can’t claim as exempt in a Chapter 7 proceeding, then Chapter 12 or 13 are better options.

Chapter 12

• A Chapter 12 bankruptcy can be filed by farmers or fishermen with regular (can be seasonal) annual income.  Chapter 12 debtors can be individuals or businesses.
• Chapter 12 debtors keep all of their property, whether exempt from the bankruptcy or not.
• A Chapter 12 bankruptcy includes a plan (called a Chapter 12 Plan) for the partial repayment of the debtors’ debts.  The Chapter 12 Plan is drafted by the debtors and confirmed by the bankruptcy court.  The amount that the debtors repay depends on: 1) the debtors’ disposable income; and 2) how much the debtors’ unsecured creditors would have received if the debtors had filed a Chapter 7 bankruptcy instead of a Chapter 12.
  
• With respect to property that debtors have given a collateral interest in, Chapter 12 debtors have the same options available to them as Chapter 7 debtors (reaffirmation, redemption, and surrender).  More importantly, however, Chapter 12 debtors have the additional option of keeping the collateral while at the same time lowering (called cramming down) certain debts to the current value of the collateral.  Secured debts that are subject to a Chapter 12 cram down include farm mortgages, boat loans, and some car loans.  Only Chapter 12 debtors have the power to cram down mortgage debt.
• In addition to the cram down power discussed above, Chapter 12 debtors are given the opportunity to make up (called curing) arrearages on secured debt so as to avoid the repossession or foreclosure of collateral. Chapter 12 debtors can include these past due amounts in their Chapter 12 Plan and make them up over time.
• The Chapter 12 Plan is based on monthly payments that are made for three to five years.  Once the debtors complete their Chapter 12 Plan payments, the bankruptcy court discharges the debtors’ unsecured debts.  The court closes the Chapter 12 case shortly after the discharge is issued, between three to five years after the commencement of the case.

Chapter 13

• A Chapter 13 bankruptcy can be filed by individuals.
• Chapter 13 debtors keep all of their property, whether exempt from the bankruptcy or not.
• A Chapter 13 bankruptcy includes a plan (called a Chapter 13 Plan) for the partial repayment of the debtors’ debts.  The Chapter 13 Plan is drafted by the debtors and confirmed by the bankruptcy court.  The amount that the debtors repay depends on: 1) the debtors’ disposable income; and 2) how much the debtors’ unsecured creditors would have received if the debtors had filed a Chapter 7 bankruptcy instead of a Chapter 13.
• With respect to property that debtors have given a collateral interest in, Chapter 13 debtors have the same options available to them as Chapter 7 debtors (reaffirmation, redemption, and surrender).  In addition, Chapter 13 debtors have the additional option of keeping the collateral while at the same time lowering (called cramming down) certain debts (such as car loans that are at least 2½ years old) to the value of the collateral.
• In addition to the cram down power discussed above, Chapter 13 debtors are given the opportunity to make up (called curing) arrearages on secured debt so as to avoid the repossession or foreclosure of collateral. Chapter 13 debtors can include these past due amounts in their Chapter 13 Plan and make them up over time.
• The Chapter 13 Plan is based on monthly payments that are made for three to five years.  Once the debtors complete their Chapter 13 Plan payments, the bankruptcy court discharges the debtors’ unsecured debts.  The court closes the Chapter 13 case shortly after the discharge is issued, between three to five years after the commencement of the case.