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BANKRUPTCY: SAFE HAVEN OR PITFALL?

Sometimes even the most fiscally responsible individual or family falls into unmanageable financial circumstances. If you find yourself missing monthly mortgage payments, falling behind on credit card bills, or sacrificing your family's basic needs in order to ward off creditors, bankruptcy may be an option worth considering. Bankruptcy is not the best solution for everyone and does have credit and other repercussions that may last for some time after the bankruptcy is closed. It is important to consult an attorney with experience in bankruptcy matters as soon as possible if you are considering proceeding with this alternative.

All bankruptcy cases begin with the filing of a petition in bankruptcy court. Most cases are begun by the debtors themselves, often referred to as "voluntary" bankruptcy. These "voluntary" bankruptcies proceed automatically upon filing the petition. That is, the debtor's bankruptcy petition, once filed, constitutes an order for relief from debts that exist on the date of filing such that creditors who have filed or are about to file a lawsuit against the debtor must stop and have their debts settled in the bankruptcy case.

A person's creditors may also initiate a bankruptcy case by filing a petition in bankruptcy court, often referred to as "involuntary" bankruptcy. In "involuntary" bankruptcy, before going forward with the case, the court must decide whether there is a ground for bankruptcy. A common ground for "involuntary" bankruptcy is that the debtor is not paying debts as they become due.

Bankruptcy laws exist for the benefit of both creditors and debtors. Bankruptcy laws provide an orderly process for dividing the debtor's property and repaying each creditor as much as possible. On the other hand, bankruptcy laws also aim to give debtors a fresh start in rebuilding their financial lives.

The Federal Bankruptcy Code, the law that governs bankruptcy cases, is divided into several chapters. Chapter 7, often referred to as "liquidation," is available to both individuals and businesses. Chapter 13 (for individuals only and Chapter 11 (for businesses or individuals) are often thought of as rehabilitative bankruptcy. These types of bankruptcies are often referred to as "reorganization." Chapter 13 bankruptcies are appropriate for financially distressed individuals with some regular source of income. The individual can avoid losing assets by setting up a payment plan for creditors. A plan with payments that the individual can reasonably meet allows the individual to repay his/her debts and emerge from bankruptcy financially healthy.

Declaring bankruptcy is obviously a serious step, so you'll want to consider your alternatives carefully and get professional advice. The following discussion presents some of the differences between individual bankruptcies under Chapter 7 and Chapter 13 of the Bankruptcy Code.

Chapter 7 Bankruptcy - Available to Businesses and Individuals

  • Basic operation: A bankruptcy petition is filed with the court. A trustee is appointed to administer the bankruptcy. The debtor retains only exempt assets, such as some equity in a home, a certain value in a motor vehicle, a certain value in tools of his/her trade, personal items, pension benefits, and some cash. All non-exempt assets are sold and the money is split among creditors, according to the priorities established by the Bankruptcy court.
  • Limitations on availability: There are no monetary limitations. However, Chapter 7 bankruptcy is not available if the debtor has been discharged in bankruptcy within the past six years.
  • Effect on debts: With some exceptions, debts are discharged (cancelled) in the bankruptcy and the debtor's liability to creditors ends.
  • Effect on home: As long as any mortgage on the property is not in default, the debtor's home may be preserved under the homestead exemption. The homestead exemption is a certain value in real or personal property used by the debtor as a residence that is protected from the claims of creditors under the Bankruptcy Code.
  • Effect on automobile: The debtor's automobile may be taken by creditors unless the car is necessary for the debtor's work and arrangements are made to pay off the lien.
  • Effect on non-exempt assets. All non-exempt assets are sold.
  • Portion of debt repaid in bankruptcy: The portion of debt repaid in bankruptcy depends upon the value of the non-exempt assets sold to pay off debts.
  • Result at conclusion of bankruptcy proceedings: The bankruptcy court enters a discharge order, ending the enforceability of all debts except those debts that are non-dischargeable as specified by law. Non-dischargeable debts include taxes and child support.
  • Effect on credit: The bankruptcy may remain on your credit record for up to ten years, usually making it difficult to secure credit.

Chapter 13 Bankruptcy - Available to Individuals

  • Basic operation: A bankruptcy petition and a proposed payment plan is filed with the court. The payment plan makes payments over a maximum of three to five years. Payments are made from disposable income (the income left after allowing for necessities such as food and shelter). The debtor retains all assets.
  • Limitations on availability: There are caps on the amount of secured debt (e.g.. mortgage) and unsecured debt that a debtor may have outstanding in order to be eligible for re-organization bankruptcy. Consult your attorney for the dollar amounts of these caps. This type of bankruptcy can be used repeatedly.
  • Effect on debts: All or a portion of the debts are paid off over a period of time under a specific plan. Liability to creditors ends when the plan is successfully completed or the bankruptcy is converted to a Chapter 7, in which case the debts are discharged.
  • Effect on home: The debtor's home is preserved if the plan is successfully carried out. If the plan is not successfully carried out and if any mortgage on the property is not in default, the home may be preserved under the homestead exemption.
  • Effect on automobile: The debtor's automobile is preserved if the plan is successfully completed. If the plan is not successfully completed, it might be taken by creditors (unless arrangements are made to pay off the lien).
  • Effect on non-exempt assets: Non-exempt assets are not affected if the plan is carried out successfully. If the plan is not successfully completed, non-exempt assets can be sold to pay creditors, as in a Chapter 7 bankruptcy.
  • Portion of debt repaid in bankruptcy: The plan may allow payments for less than the actual value of the debts.
  • Result at conclusion of bankruptcy proceedings: The debtor will no longer be liable for most debts if plan is successfully completed.
  • Effect on credit: The bankruptcy may remain on the debtor's credit record for up to ten years. However, successful completion of the payment plan may make it easier for the debtor to secure new credit.
  • If you or someone you know is having financial difficulty, our office can help you determine if bankruptcy is your best option and provide you with the legal representation that you need.

The following agencies provide credit counseling that may help you avoid bankruptcy:

Consumer Credit Counseling Service (800) 966-3328
National Credit Counseling Services (888) 240-5522
Legal advice varies depending on the facts; for that reason, the information contained in this bulletin should not be acted on without consulting a lawyer.

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