Bankruptcy is a complex mixture of federal and state law, as well as judicial precedents and local rules and procedures. This comment provides a very limited and broad educational overview of a few of the many things that a generally-educated individual should know about bankruptcy. Always consult experienced legal, accounting, and financial professionals in all specific bankruptcy situations.
1. The history of debtor-creditor relations is long and complex. Under Roman law and the ancient laws of many nations, debt bondage or even enslavement could occur if a debt were unpaid. A payment of the debt provided redemption. Many modern U.S. states allow a redemption period if, for example, real estate is sold for delinquent property taxes. Forms of debt bondage still exist in the modern world. A complex public policy question involves balancing the encouragement of entrepreneurship and risk taking against the valid claims of unpaid creditors.
2. Article 1, Section 8, Clause 4 of the U.S. Constitution authorizes Congress to enact "uniform Laws on the subject of Bankruptcies throughout the United States." Congress occasionally enacted temporary bankruptcy laws. A permanent bankruptcy statute dates from 1898. There is historical support for the idea that this stature was designed to protect businesses. The business community in general has not hesitated to utilize bankruptcy as a financial restructuring or strategic tool. State debtors' prisons existed in the U.S. until the 1840s. Several U.S. Supreme Court decisions have found it be a violation of the Equal Protection Clause of the Fourteen Amendment to increase the amount of jail time for a prisoner who is financially unable to pay assessed fines or court costs.
3. Creditors are well-advised to secure co-signers, collateral, and/or liens. Collateral may be seized and sold, as repossessing an auto, when the debt is unpaid. These obligations involve a contract ("security agreement") between the creditor and debtor. A lien, in contrast, is a statutorily created claim against property that may be seized or sold to satisfy a debt. A traditional lending agreement as such may be unnecessary. A Mechanic's Lien secures payment for repairs and improvements to buildings and land (real estate). An Artisan's Lien secures payment for repairs and improvements to movable items (personal property), for example, auto repair. There are a surprisingly varied number of statutory liens. Consult an experienced professional to determine if a particular endeavor has potential statutory liens available and what procedures are required to successfully assert them.
4. In some situations both creditors and debtors may prefer a privately negotiated settlement of debts. These are faster, less expensive, may be creative, and avoid formal court administration. Discussion between the parties is advisable prior to formal bankruptcy procedures.
5. While in theory an individual may file for bankruptcy without legal and financial professional assistance, the law, forms, and procedures are quite complex. Even legal practitioners without bankruptcy experience would be wise to consult a bankruptcy specialist. There are both voluntarily and involuntary bankruptcies in modern U.S. law.
6. Filing for bankruptcy will typically temporarily stop ("automatic stay") most debt collection efforts including repossessions. It may be a race between repossession and a bankruptcy filing. However, a major exception to the automatic stay are domestic support obligations (alimony and child support, broadly speaking) that are untouched by bankruptcy. Violating the automatic stay may subject the creditor to a variety of monetary damages and attorneys' fees. A creditor may petition the Bankruptcy Court to lift (set aside) the automatic stay. The Court has considerable discretion in granting this petition "for cause." For example, if an auto otherwise subject to repossession is being severely damaged by the debtor in possession of it, then the Court might grant the lender the right to immediate repossess the auto.
7. Wage earners who earn above the median wage (based upon family size and dependents - "means test") for the geographic area in which they file for bankruptcy may not be able to do a liquidation bankruptcy in which many debts are immediately discharged (a Chapter 7 bankruptcy). The U.S. Trustee Program has this data at its Website. Instead, these debtors may be forced to create a Bankruptcy Court approved budget and make a specified monthly payment to the Bankruptcy Court for up to 60 months before a discharge of debts occurs (a Chapter 13 bankruptcy).
8. Businesses in financial distress that want to continue operating frequently choose a Chapter 11 bankruptcy. This allows the business to retain its assets and equipment and financially restructure with a "reorganization plan" that pays at least part of its debts, perhaps over five years. This is a detailed and complex process although there is a so-called "fast-track" procedure for small businesses whose debt does not exceed approximately $2.5 million and who do not own or manage real estate.
9. There are special provisions for statutorily defined family farmers and fishermen (Chapter 12). This provides a more streamlined process than the typical commercial bankruptcy. Among other features, the debtor must propose installment payments to the creditors over three to five years.
10. Unsecured (no collateral) creditors who receive an official notice of bankruptcy have a limited time (typically 90 days) in which to file an official "proof of claim" form with the Bankruptcy Court or lose their debt. While technically a secured creditor (with collateral, for example, a typical car purchase loan) does not have to file a proof of claim, it may be advisable to do so anyway. If the collateral sells for less than the outstanding debt balance, as often occurs, failure to file a proof of claim may forfeit the creditor's right to assert the debtor's personal obligation to pay the remaining balance. Consult a skilled professional.
11. Not all debts are discharged (wiped-out) in bankruptcy. Domestic support obligations (alimony and child support), some taxes, certain consumer debts for luxury goods and services, intentional torts (injuries), debts due to fraud, and student loans (unless repayment would cause an undue hardship) are a few examples of non-dischargeable debts. Note also that debts based upon tax fraud or unlawful tax evasions are not discharged.
12. If one spouse is engaged in a professional or business setting that carries a significant potential risk of litigation, then engage in financial planning with skilled legal and financial professionals well in advance of any lawsuit being filed. Another complex issue, requiring professional expertise, involves the extent to which property that is jointly owned by spouses may be subject to the bankruptcy filing by one spouse.
13. Divorce property issues require careful attention. Since a bankruptcy filing may follow a divorce, have a skilled legal professional structure the divorce obligations in a way that will minimize their being restructured or overturned by a Bankruptcy Court. This is complex.
14. A debtor may be allowed to keep some property in bankruptcy, but what items and in what dollar amounts may vary, depending upon the debtor's state of residency. Bankruptcy is broadly intended to provide a "fresh start." "Exempt property," what a debtor may keep, is determined by either a federal list or a state list. In some states a debtor may choose a more generous state exempt property list. Some states are legally more debtor-friendly than others. Texas and Florida, for example, have such a traditional reputation. Note that certain retirement accounts and pensions and educational savings accounts, appropriately created and held for a specified time, are exempt. The amount of homestead exemption for a principal residence may also vary. Consult experienced legal and financial professionals in order to plan in advance.
15. Individual debtors wanting to keep an asset, such as an automobile, that is subject to a "security agreement" (a contract that allows repossession for non-payment of debt) have to promptly "reaffirm" (agree to be bound by) the debt (in approximately 45 to 60 days) and begin making payments or surrender the asset to the creditor.
16. Most property that an individual acquires within 180 days after formally filing for bankruptcy ("after-acquired property") is includable as bankruptcy property and subject to sale or distribution to creditors. This property might be, for example, inheritances, life insurance death benefits, and divorce property settlements. Consult an experienced professional to financially plan.
17. Attempting to hide assets, destroy financial records, or in other ways refusing to cooperate with the Bankruptcy Court or Bankruptcy Trustee will have serious consequences. Not only may a bankruptcy discharge be denied, there may be a criminal law violation. Be forthcoming and honest.
18. Transferring assets by gift (without reasonably equivalent consideration) to friends or family members in advance of bankruptcy (typically two years) is not allowable as a "fraudulent transfer." It is a mistake to suppose that one need only transfer property ownership to family and friends in order to avoid creditors' claims.
19. Repaying prior to the bankruptcy filing only some creditors, such as loans by family members (up to one year prior to bankruptcy), are considered "preferential transfers" and these creditors may be compelled to return the payments to the Bankruptcy Court. Intent to defraud creditors is not required to trigger this provision. Not all payments may constitute a preference, the details of which are beyond the scope of this brief comment.
20. An individual is allowed a bankruptcy discharge of debts only once every 8 years. Interestingly, the Bible in Deuteronomy 15 mentions the cancellation of debts every 7 years. Many Bible passages mention debtors and creditors, indicating how ancient these issues are.
This comment provides a brief and incomplete educational overview of a complex topic and is not intended to provide legal advice. Always consult experienced legal, accounting, and financial professionals in all specific debtor-creditor and bankruptcy situations.