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Bankruptcy Procedure

Filing Chapter 7 Bankruptcy

When declaring bankruptcy, the first step is mandatory credit counseling, followed by a financial inventory. The court then invokes an automatic stay. Depending on the type of bankruptcy, assets are liquidated, or the debtor makes payments. Then the debtor must complete a debtor education course. The last stage is the discharge of debt.

A bankruptcy liquidation (converting assets to cash) is handled through Chapter 7 of the Bankruptcy Code. Chapter 7 is straight bankruptcy, meaning the debtor is seeking full relief of the obligations owed to the creditor rather than a repayment plan or reorganization of debt. For instance, if a person has insufficient income to pay debts owed, they will most likely seek Chapter 7, which is a full relief of the debt, rather than Chapter 11, which is a repayment plan of the debt for business entities. Credit counseling is a required initial step in the petition for bankruptcy. Bankruptcy is handled in federal court, but exemption levels, the value of property that can be kept, can vary based on state law. Most exemptions are related to the homestead, which means the home and land that someone lives on.

Chapter 7 allows debtors to use their wealth or assets to repay creditors in proportion with the established exemption levels. Chapter 7 is called a liquidation chapter because the court will rule on selling all assets owned to help offset the outstanding debt. The arrangement includes feedback from the creditors and the individual filing for bankruptcy. For example, Mr. Jones owes over $75,000 in debt, including a car payment for his second car, credit cards, and a boat payment. The value of the car and boat is approximately $125,000, and he owes $50,000 total on both. The court would order the liquidation of the car as long as it is not his primary car, and the court would order the liquidation of the boat, which could offset the debt and leave money to help pay down the credit cards. This is an example of liquidation.

Another important step in the initial stages of bankruptcy is the financial inventory and review of cash flow (money coming in and going out), assets (property owned that has value), and liabilities (financial debt or obligation). This applies to individuals and business entities. For business entities, the court requires a full, updated balance sheet and income statement. Proof of claim is the document the creditor files with the court to verify the amount owed.

Once proceedings have begun, the court invokes an automatic stay, in which the court notifies creditors that they must stop collection efforts because a petition for bankruptcy has been filed. This reprieve allows debtors time to work with the court through the phases of bankruptcy.

The court appoints a bankruptcy trustee, who has authority over the property on behalf of the creditors and debtor. The trustee sets up a creditors' meeting to confirm the debts and establish priority, the order for who gets paid what, when, and how much. The next phase includes liquidating assets to repay creditors. Once the creditors are satisfied with the plan, the court approves it, and payments begin. Once payouts end as required in the agreement or plan, the debtor must attend an approved financial management educational course. The final step is the discharge, or cancellation, of the debt as approved by the court.

Chapter 7 Bankruptcy Timeline

Bankruptcy involves four steps allowing the court to hear from the debtor and from creditors before arriving at a resolution.

Chapter 11 and Chapter 13 Bankruptcy

A nonliquidating bankruptcy lets a debtor keep some assets, such as a house or car. Under a Chapter 11 or Chapter 13 bankruptcy, the debtor must follow a repayment plan.

A nonliquidating bankruptcy is one that is covered under Chapter 13 for individuals and Chapter 11 for business entities. This type of bankruptcy lets the debtor keep some assets, such as a car or a house, and puts the debtor on a repayment plan that lasts three to five years. Debtors have strict requirements under the reorganization and repayment plan and must make the monthly payments as outlined within the agreement after approval by the bankruptcy court.

A 2005 federal law brought about changes for bankruptcy that instituted a means test. Even if a debtor files under Chapter 7, the debtor may have to opt for Chapter 13, depending on the results of means tests. During these tests the court reviews income and ability to repay, along with the amount of debt. After the tests the debtor will either qualify for Chapter 7 or have the option of proceeding under Chapter 13. However, if a debtor first chooses Chapter 13, the court will follow that petition.

Business entities that want the relief of restructuring and reorganizing their debts under the Bankruptcy Code use Chapter 11. Unlike Chapter 7, Chapter 11 does not require a bankruptcy trustee. Instead, the debtor in possession acts as the trustee during the proceedings. The court appoints a creditors' committee to guard the interests of the creditors.

Many individuals and businesses want to reorganize and propose payment plans, as offered through Chapters 11 and 13. These chapters allow debtors to maintain certain assets instead of liquidating them, while paying the creditors through an approved repayment plan. Liquidation may still be the most viable option, depending on the current financial statement of the individual or business entity. If the reorganization and repayment does not bring the necessary relief to the debtor, Chapter 7 may be an option.