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Article 1, Section 8 of the U.S. Constitution authorizes Congress to enact laws in the area of bankruptcies. Under this authority the Bankruptcy Code was enacted in 1978. It was subsequently codified as Title 11 of the United States Code and is the uniform federal law that governs all bankruptcy cases. In 2005 the Bankruptcy Abuse Prevention and Consumer Protection Act significantly changed bankruptcy procedures. Because this is federal law, states cannot govern bankruptcy proceedings, but they can enact laws and rules to clarify matters that the federal code does not address. The most common chapter of bankruptcy is Chapter 7, also known as straight bankruptcy. It involves liquidation, which means converting assets to cash. Chapter 13 is one type of reorganization, including an agreed-upon repayment plan, and is intended for individuals. Chapter 11 is the reorganization chapter for business entities.

At A Glance

  • Bankruptcy is the court process by which a debtor seeks protection from creditors. The debts may be restructured or discharged, depending on the type of bankruptcy filed. It is important to understand the impact and consequences of bankruptcy as an option to handle debt.
  • The purpose of bankruptcy is to give a debtor relief. Bankruptcy allows a clean slate for debtors, releasing them from debts they probably could not pay. Anyone may file for bankruptcy, but it is not a tool to defraud creditors.
  • A court may issue a discharge of indebtedness, which permanently removes the legal obligation to repay the creditors listed in the bankruptcy. The debtor will need to rebuild their credit rating.
  • 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 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.
  • Creditors have the right to share in the bankruptcy estate in order of priority that depends on their status as a secured or non-secured creditor. Creditors may inform the court of matters related to the bankruptcy, such as the debtor's plan, the liquidation of non-exempt assets, and payments from the estate. Creditors may also challenge the discharge rights of the debtor.
  • Creditors must cease collection and repossession actions as soon as the bankruptcy is filed. This protection generally extends to cosigners who are not in bankruptcy proceedings.