Bankruptcy can be a very valuable step in helping individuals and businesses alike attain a financial “fresh start” from the burden of certain existing debts.

Bankruptcy helps in achieving this “fresh start” by discharging certain debts, or in other words, by releasing the debtor of personal liability for the debts and prohibiting creditors from taking action to collect on those debts against the debtor. Immediately upon the filing of a bankruptcy, an “automatic stay” prohibits creditors from taking any action to collect a debt from the debtor.   This means phone calls from bill collectors must stop, any action to foreclose a mortgage must stop, any lawsuits or threats of lawsuits stop while these matters are resolved in the bankruptcy.

Does bankruptcy sound right for you?   It may not be as simple as saying “yes”.  

In order to determine if bankruptcy is right for you, it is important first to determine if other non-bankruptcy alternatives are available.   For example, sometimes credit card debts and other obligations can be settled at a discount or a home mortgage lender may be willing to modify the mortgage.   Sometimes these remedies will grant sufficient relief making bankruptcy unnecessary.

If a bankruptcy is necessary to obtain debt relief and a fresh start, it must next be determined which type of bankruptcy is available or most appropriate under the circumstances. The different chapters of the Bankruptcy Code offer different types of relief and can have a very different impact on the debtor.   Each chapter has its own eligibility requirements that a debtor must meet to qualify for relief under that chapter.

Chapter 7

The most common and popular type of bankruptcy filing is a “liquidation” under Chapter 7 of the Bankruptcy Code. Chapter 7 bankruptcies are popular because they typically can be completed from start to finish in just a few months. However, under the amendments to the Bankruptcy Code enacted in 2005, individual consumer debtors must meet specific requirements imposed by a “means test” in order to qualify as a candidate for a Chapter 7.   In addition, there can be disadvantages to a Chapter 7 because certain types of debts are not discharged and the debtor may not be able to keep certain assets in a Chapter 7 bankruptcy.

Under a Chapter 7 filing, the court appointed trustee takes over the debtor’s nonexempt assets and reduces those assets to cash for distribution to the debtor’s creditors.   It is important to understand that filing Chapter 7 may result in the loss of property.   However, many Chapter 7 filings do not involve actual liquidation because there is little or no nonexempt property subject to sale by the trustee.   These cases are commonly referred to as “no asset” Chapter 7 cases.

For business owners seeking to continue business operations or debtors seeking to retain certain types of assets, Chapter 7 liquidation may not be the ideal bankruptcy filing.

Chapter 13

If a Chapter 7 is not a good fit, either because the debtor does not qualify under the “means test” or because the debtor needs to discharge certain types of debts or retain certain property, a Chapter 13 “individual reorganization” bankruptcy may be the answer. Under a Chapter 13 bankruptcy, the debtor must have a regular income, a portion of which is paid into a bankruptcy “plan” over a period of three to five years.   At the end of the plan term, if the debtor has complied with the requirements of the plan, a discharge is granted.   While this is a longer process, it can result in the discharge of certain debts and allow the debtor to retain certain assets that could not be accomplished in a Chapter 7.

While there are several benefits from filing under Chapter 13, one of the most significant is the opportunity for the individual to save their home from foreclosure.   An individual may effectively stop foreclosure proceedings and have the opportunity to cure any delinquency related to the mortgage over a period of time.   Debtors often file Chapter 13 petitions to modify secure debt.   It is imperative that during the entire Chapter 13 plan, all mortgage payments are made on time as they become due.

Another benefit to Chapter 13 is that it acts like a sort of consolidated loan by which all payments under the plan are paid to the Chapter 13 trustee, who thereafter distributes the payments to the various creditors under the plan.   This procedure eliminates the need for individual debtors to have any direct contact with their creditors while under the Chapter 13 plan.