Bankruptcy Law FAQ
- Alternatives to Chapter 7 Bankruptcy
- Before filing a bankruptcy petition, you should consider the following as practical alternatives:
Do nothing. In some cases, doing nothing is an appropriate alternative to bankruptcy. To collect on a debt, a creditor must usually sue you, obtain a judgment, and then try to collect on that judgment. A judgment creditor can try to collect on a judgment by garnishing your wages or your bank account. However, some people are “judgment proof,” that is, they don’t have any income or property to garnish, or their income is beyond a creditor’s reach because it is exempt, such as social security, unemployment benefits, or public assistance. As a result, creditors do not have any way of legally collecting their judgments. Bankruptcy is not necessary if you are “judgment proof.”
Negotiate. You or your attorney may be able to negotiate an agreement with your creditors. Such an agreement is commonly known as a “workout” agreement. A creditor may be willing to permit you to renegotiate repayment terms (like stretching out the number of months for repayment), or it may reduce the interest rate to lower your payment amount, and it may even be willing to “discount” or reduce the amount that you owe. Creditors are usually willing to negotiate if they believe that you are a viable bankruptcy candidate and they believe that they will receive more under the terms of the workout agreement than they would receive in a bankruptcy.
You may be able to take advantage of consumer protection laws to stop creditors who are harassing you (without having to file bankruptcy). An attorney practicing consumer law can help you determine what you may be able to do to stop creditor harassment.
Another alternative to Chapter 7 bankruptcy is to work with a credit counseling organization. The creditor counselor can negotiate a repayment schedule with your creditors. You usually make one monthly payment to the credit counseling organization, and then the credit counseling organization makes the payments to your creditors. There are many nonprofit credit-counseling organizations. The biggest is the National Foundation for Credit Counseling.
Of course, filing a Chapter 13 bankruptcy is also an alternative to filing a Chapter 7 bankruptcy. In a Chapter 13 bankruptcy, you propose a plan to pay your debts, usually over a period of three to five years. To file a Chapter 13 bankruptcy, you must have a regular income, and you must have enough disposable income to make your Chapter 13 payments. An experienced bankruptcy attorney can evaluate your financial condition and let you know whether Chapter 13 is a viable alternative for you.
- Things That Can Go Wrong in a Bankruptcy Case
- Although you may have a clear plan for what you want to accomplish by entering into bankruptcy, your creditors have rights too. Below are examples of some common
things that may happen in your bankruptcy proceeding that you may not expect.
A creditor or the trustee can object to a debtor’s general discharge if the debtor has committed a fraud on the court. For example, if the debtor has been dishonest, uncooperative, or has destroyed or hidden property of the estate the court may deny the debtor’s discharge altogether. If a debtor is denied a general discharge, the debtor does not receive the benefit of the bankruptcy. The debtor will remain liable for pre-petition debts, and all creditors are free to pursue the debtor to recover their claims. All in addition to the costs incurred in the abortive bankruptcy, and possible stigma.
A creditor can object to the discharge of a particular debt. In a Chapter 7 case, certain particular debts are not dischargeable under Section 523 of the Bankruptcy Code. Debts that are not dischargeable include:
- debts for certain taxes;
- debts arising from false pretenses, false representation, actual fraud, or false financial statements;
- debts for certain luxury goods and cash advances;
- debts that a debtor fails to list in the bankruptcy schedules;
- debts arising from fraud or defalcation, embezzlement, or larceny;
- debts for alimony and child support, and other obligations arising out of a divorce or separation;
- student loans;
- restitution orders;
- debts arising from willful and malicious injury;
- certain condominium or cooperative fees incurred after the filing of the bankruptcy;
- obligations arising from death or injury caused by the debtor’s DWI; and
- a few other, less commonly occurring, debts. When a debt is accepted from the debtor’s discharge, the debtor remains liable on the debt and the creditor is free to pursue the debtor to recover the claim.
A creditor (usually a secured creditor) can move for relief from the automatic stay. If the creditor obtains relief from the automatic stay, the creditor is free to pursue its state law remedies with respect to taking action against the property (like repossessing a car or foreclosing a mortgage). A creditor is entitled to relief for “cause.” Usually, cause means the creditor does not feel that it has adequate protection in its collateral. If a creditor wants relief from stay related to an act against property, the creditor must show that the debtor does not have equity in the property and that the property is not necessary to an effective reorganization.
The United States Trustee may decide that you have enough “disposable income” to repay some or all of your debts in a Chapter 13 bankruptcy, and file a motion to dismiss your Chapter 7 case for substantial abuse. You have disposable income if your monthly income exceeds your monthly expenses. (People with debts that are primarily business-related are not subject to this test.) To find substantial abuse, a judge must determine that your debts are primarily consumer debts, not business debts. Debtors in this situation may choose to convert their Chapter 7 case to a Chapter 13 case.
The Chapter 13 Trustee may object to confirmation of your Chapter 13 plan. One of the reasons the Trustee may object is that he or she believes you are not devoting all of your disposable income to payments under the plan. If you cannot confirm a Chapter 13 plan, your case will be dismissed, you will remain liable on your obligations, and your creditors will be free to pursue you to recover their claims.
If you are dishonest and defraud the court, you may be subject to criminal prosecution. You sign your bankruptcy petition under penalty of perjury. If you fail to disclose assets, hide assets, or lie about your financial condition, you may find yourself subject to large fines and jail time.
- Bankruptcy Dos & Don’ts
Do take bankruptcy seriously. It is a constitutional right, and courts take a very dim view of abuse of that right.
Do be honest and forthcoming on your bankruptcy petition. It is against the law to lie in bankruptcy proceedings. That means spill your guts out; you are sacrificing a small portion of your privacy to get a discharge of your debts. If you lie on your petition, or if you conceal assets, you could get in very serious trouble. The least that will happen is that your petition could be dismissed.
Do be honest and forthcoming with your attorney. Even if it is embarrassing, even if it makes you look like an idiot or a crook, it is better if your attorney knows. Giving your attorney insufficient information is like hiring a chauffeur and not telling him or her that your brakes don’t work. Anything that isn’t listed in your petition may not be discharged.
Do make yourself available to your attorney for discussions regarding the case, especially preparation of the petition and appearance at the meeting of creditors. It is not a waste of your time if it helps you to have an uneventful bankruptcy.
Do follow your attorney’s advice about how to behave in the meeting of creditors. Remember, he or she does this almost every day. Don’t be afraid to ask him or her if something is appropriate. It’s one of the things that you are paying your lawyer for. Your attorney will tell you what he or she wants from you if the Trustee or creditors ask you unexpected questions.
Do consider alternatives to bankruptcy. If you can pay your debts, there may be other things you can do. There are credit consultants and debt consolidators who may be able to help you get through this rough time in your life.
Do give your attorney EVERYTHING in your relevant financial files, again even if it is embarrassing or incriminating. If you have the document, the odds are someone else does too.
Don’t assume that bankruptcy will get rid of all your debts. Some tax liabilities are non-dischargeable (basically, all tax liability accrued in the three tax years prior to filing are non-dischargeable in most circumstances). Student loans are now non-dischargeable except in cases of extreme hardship.
Don’t talk to your creditors directly after you have filed for bankruptcy. Tell them to talk directly to your attorney. If you receive mail from them, forward it to your attorney immediately.
Don’t forget to consider saving some of your credit cards. If any of your credit cards have zero balances, you may be able to keep them. Some card providers may ask you to reaffirm your debt in return for keeping a card, and this is worth considering, especially if there is a small balance. Life can be a lot harder without a credit card. But it would be wise to consult with your attorney first if you do this.
Don’t keep a creditor off your petition for any reason. If you intend to pay them back, you can anyway.
Don’t run up a lot of bills immediately before you file. If you max out your credit cards or take out a loan before you file, the court could find your petition to be fraudulent and dismiss it, or except those debts from discharge.
Don’t unnecessarily spread the news that you have filed for bankruptcy. It is your business, and unfortunately there is still a stigma attached to bankruptcy. Your friends, and your employers, don’t have any right to know that you are in financial trouble.
- Important Consideration Before Your Company Files for Bankruptcy
- Is bankruptcy really necessary? You (or your attorney) may be able to negotiate an out-of-court solution or “workout” with your creditors.
- Do you need a lawyer? Although attorney representation is not required by the Bankruptcy Code, most businesses will be much better off hiring an experienced bankruptcy lawyer. The bankruptcy lawyer can help you make the best decision regarding whether to file for bankruptcy (and which chapter is best for your company) and can also guide your company through the process. This is especially true in Chapter 11 proceedings, which can be extremely complicated.
- Do you want to close your business or do you think you can operate on a profitable basis in the future? The type of bankruptcy your company files depends, in part, on the answer to this question.
- If you want to continue operating your company, do you have a realistic plan as to how your company will return to profitability?
- If you want to continue to operate your business, do you have the money to pay your bankruptcy attorney? Chapter 11 is expensive. Talk candidly with your attorney about the costs of filing a Chapter 11 case.
- If you want to continue operating your business, is existing management capable of operating the reorganized company? You may need to hire a “turn around” consultant to satisfy your creditors if they think that existing management is not competent.
- Are some or all of your company’s debts guaranteed by you or others? If so, a bankruptcy filing does usually not stop collection activities against the guarantor(s) or cosigner(s).
- Do you need immediate relief for a particular problem, such as foreclosure, repossession, garnishment, eviction or utility shut off?
- Are you willing to expose your company to the court, to creditors, and to some extent to the public, during the bankruptcy process? There is no privacy in a bankruptcy proceeding.
- Are you willing to comply with the many restrictions of operating a business in bankruptcy? Although you will be able to operate your business, you will be required to ask for court approval of anything that is not in the ordinary course of business.
- Company Bankruptcy What to Expect
- What you can expect when filing bankruptcy depends, in part, on what type of bankruptcy your company files. Here is an overview of what to expect under the three
chapters available to businesses.
The first step in each case is to consult with an experienced bankruptcy attorney. Complete the intake questionnaire and provide it to your attorney at (or better yet, prior to) your initial consultation, along with all relevant documents.
If you and your bankruptcy attorney decide that filing a bankruptcy is the best alternative for your company, your attorney will request that you complete some worksheets. Your attorney will use the worksheets, along with the other information you have provided, to complete the bankruptcy petition and schedules. The bankruptcy petition and schedules are key documents in a bankruptcy – the petition is what actually commences the case in court, and the schedules set forth the financial information on which your whole case is based.
When the schedules are complete, your attorney will have you review and sign them. Your attorney will then file the documents with the appropriate bankruptcy court. When the petition is filed, something called the “automatic stay” goes into effect immediately. That means that collection activities by your company’s creditors must stop. The filing of a bankruptcy case creates an “estate” consisting of all of the debtor’s nonexempt property.
Chapter 7 is “straight liquidation” – your company’s assets are, essentially, marshaled together and then divvied up between creditors according to a set of priorities laid out in the law. In a Chapter 7 case, a trustee is appointed to take possession of the property of the estate. Approximately twenty to forty days after filing the petition, you must attend the “first meeting of creditors,” also known as the “341 meeting” (named after the section of the Bankruptcy Code – section 341 – that provides for it). The trustee will ask you questions about your company’s assets and liabilities, and its income and expenses. Your creditors may also attend that meeting and ask you questions about your company’s financial condition. If your company does not have any assets, the bankruptcy case will end in about three or four months. If your company has assets, when your case ends will depend on how long it takes the trustee to gather your assets, sell them, and distribute the proceeds to your creditors. If the debtor is an individual, he or she automatically receives a “discharge” at the end of the case unless a creditor or the trustee objects.
Chapter 11 allows a company to restructure, according to a plan laid out in advance and agreed to by the parties and the court, and hopefully come out in the end as a solvent, going concern with a financial clean slate. If your company files under Chapter 11, your company becomes the “debtor in possession” with the right to retain the property of the estate and operate the business. Approximately twenty to forty days after filing the petition you must attend the “first meeting of creditors,” also known as the “341 meeting.” You will be asked questions about your company’s assets and liabilities, and its income and expenses. Your creditors may also attend that meeting and ask you questions about your company’s financial condition. The United States Trustee may appoint a “creditor’s committee” which usually consists of your company’s seven largest unsecured creditors. The creditor’s committee consults with the debtor, investigates the debtor’s conduct and financial condition, and participates in drafting the plan of reorganization. The debtor has the exclusive right to file a plan of reorganization for the first 120 days after filing. The debtor must also file a “disclosure statement” that contains financial information about the debtor and its business.
The plan of reorganization outlines how the debtor will deal with its creditors. The plan typically divides creditors into classes. Creditors vote on the plan of reorganization. Each class of creditors must accept the plan as it applies to that class. Usually, creditors that hold at least two-thirds in amount and more than one-half in number of the claims in a class must accept (vote yes to) the plan. However, if the court finds that the plan is “fair and equitable” and does not discriminate unfairly, the court may confirm (the legal shorthand for this is to “cram down”) the plan anyway. Plans may provide for payments to creditors over any reasonable period of time. Sometimes, payments on secured debts are extended over a period of twenty to thirty years.
Confirmation of the plan vests all property of the estate in the debtor and discharges all debts and liens that arose before the confirmation date except as provided for in the plan. The debtor has 180 days from the filing of the petition to obtain acceptance of the plan by creditors. Some plans (usually those that the debtor and creditors have mutually agreed to prior to filing) can be confirmed in two or three months. Usually, however, it takes between one and two years to confirm a plan.
Chapter 13 is for the adjustment of debts of an individual who has a regular income. A trustee is appointed in a Chapter 13 case, but does not take possession of the property of the estate. Approximately twenty to forty days after filing the petition, you must attend the “first meeting of creditors,” also known as the “341 meeting.” The trustee will ask you questions about your company’s assets and liabilities, and its income and expenses. Your creditors may also attend that meeting and ask you questions about your financial condition.
Individuals engaged in business and filing under Chapter 13 must file a plan within fifteen days of filing a bankruptcy petition. The plan must devote all of the debtor’s disposable income to payments under the plan for the next three to five years. The debtor must begin making payments under the plan within thirty days after the plan is filed. These payments are made not to the creditors but to the Chapter 13 trustee.
Creditors do not vote on the plan. If the plan complies with the requirements of the Bankruptcy Code, the court must confirm the plan. The confirmation hearing is usually held about four months after the case is filed. A discharge is granted when the debtor has completed all payments under the plan.
- The Pros and Cons of Declaring Bankruptcy
- There’s no question-whether or not to declare bankruptcy is a very hard decision. It affects your future credit, your reputation and your self-image. It can also
improve your short-term quality of life considerably, as the calls and letters stop. Here is a list of pros and cons to consider as you decide whether bankruptcy is the
correct option for you.
Most tax debt is non-dischargeable. Bankruptcy can make old tax liabilities (older than three years) go away. Bankruptcy will ruin your credit for some time to come. Missed debt payments, defaults, repossessions, and lawsuits will also hurt your credit, and may be more complicated to explain to a future lender than bankruptcy. Declaring bankruptcy now might make it harder to do later if something worse comes along. Declaring bankruptcy now can get you started sooner on rebuilding your credit, and you can almost certainly get a Chapter 13 plan
if there is another disaster before you are entitled to file another Chapter 7 case to liquidate your debts again.
Bankruptcy will not get rid of your student loan debt. Nothing will get rid of student loan debt, and at least bankruptcy will prevent your lenders from aggressive collection action. You will lose all your credit cards. Your credit cards probably got you in this mess to start with, so it’s hard to see that as a bad thing. Also, it may be possible to salvage one or two if your lawyer recommends it. Bankruptcy is an admission of defeat. Bankruptcy is facing reality, and it can also allow you to have a new start. Bankruptcy is an embarrassment. Harassing phone calls from creditors, dunning letters, repossessions, cancelled credit cards and declined charge authorizations, and lawsuits are all embarrassing. Your name will be in the paper and in court records once you file. Your name will also certainly be in court records, and may be in the papers, if you are sued to collect a debt. Bankruptcy will make it nearly impossible to get a mortgage, if you don’t already have one. There are lenders who specialize in lending to "bad risks," although that is an unfair characterization to make of someone who has taken a major step to solve financial difficulties. You may lose some of your luxury possessions. Most state exemptions allow you enough so that most things you own, particularly the things you need although not luxuries, will be exempt from bankruptcy, with plenty to spare. You will have to explain to a judge or trustee how you got into a financial. Both judges and trustees have heard far worse stories than yours.
- Laws You Should Know Protecting Yourself From Creditors
- Several federal statutes control what creditors can do to collect debts from you. It may be that insisting on your rights under the law can solve your particular
problems, and that you can avoid bankruptcy.
The Fair Debt Collection Practices Act, 42 U.S.C. 1692c, gives you an impressive array of rights and protections against creditors. It provides:
Communication with the consumer generally
Without the prior consent of the consumer given directly to the debt collector or the express permission of a court of competent jurisdiction, a debt collector may not communicate with a consumer in connection with the collection of any debt –
- At any unusual time or place or a time or place known or which should be known to be inconvenient to the consumer. In the absence of knowledge of circumstances to the contrary, a debt collector shall assume that the convenient time for communicating with a consumer is after 8 o’clock antemeridian [a.m.] and before 9 o’clock postmeridian [p.m.], local time at the consumer’s location;
- if the debt collector knows the consumer is represented by an attorney with respect to such debt and has knowledge of, or can readily ascertain, such attorney’s name and address, unless the attorney fails to respond within a reasonable period of time to a communication from the debt collector or unless the attorney consents to direct communication with the consumer; or
- at the consumer’s place of employment if the debt collector knows or has reason to know that the consumer’s employer prohibits the consumer from receiving such communication.
Communication with third parties
Except as provided in section 1692b of this title, without the prior consent of the consumer given directly to the debt collector, or the express permission of a court of competent jurisdiction, or as reasonably necessary to effectuate a post judgment judicial remedy, a debt collector may not communicate, in connection with the collection of any debt, with any person other than the consumer, his attorney, a consumer reporting agency if otherwise permitted by law, the creditor, the attorney of the creditor, or the attorney of the debt collector.
If a consumer notifies a debt collector in writing that the consumer refuses to pay a debt or that the consumer wishes the debt collector to cease further communication with the consumer, the debt collector shall not communicate further with the consumer with respect to such debt, except –
- to advise the consumer that the debt collector’s further efforts are being terminated;
- to notify the consumer that the debt collector or creditor may invoke specified remedies which are ordinarily invoked by such debt collector or creditor; or
- where applicable, to notify the consumer that the debt collector or creditor intends to invoke a specified remedy. If such notice from the consumer is made by mail, notification shall be complete upon receipt.
For the purpose of this section, the term “consumer” includes the consumer’s spouse, parent (if the consumer is a minor), guardian, executor, or administrator. That is an awful lot of legal terminology, but it is always better to have the actual statute to quote when you talk to collection people. What it all means is that a creditor:
- Can’t call you early in the morning or late at night.
- Can’t call you at your job, if you tell the debt collector you can’t get collection calls at work.
- Can’t contact you directly if you have an attorney.
Note: The fact that a creditor can’t contact you directly if you have an attorney is a very good reason to get one. He or she can help you understand your rights, and may be able to negotiate a settlement or a payment plan with a creditor.
- Can’t contact other people about your debt.
- Can’t bother your family.
- Can’t contact you at all, if you tell them not to in writing.
Note: Now, what this last means is that they have to sue you to get a response, and most creditors are more than willing to do so. It doesn’t mean that you are off the hook!
- Communication with the consumer generally
- Bankruptcy Chronology Understanding the Steps in the Process
- Declaring bankruptcy can be a complicated legal process, but if you have an attorney, it may be relatively quick. Things generally happen in the same order in most
bankruptcies, so you can at least get a general idea of what’s likely to happen. It will also help to know some of the words and phrases that come up in a
Note: be warned-if you hide assets, or have committed fraud, or are trying to use bankruptcy in a wrongful way, it can be full of unpleasant surprises and frustrating delays.
The following chronology gives a general idea of how a bankruptcy filing proceeds. Your action may be different because of differences between local court rules, state laws, and rules of civil procedure. Your attorney can help you understand exactly how your case will fit with this chronology-remember, your attorney works for you, and should clearly explain every step of the legal process.
- A bankruptcy case begins with a Petition. The Petition is a complex document, and includes characterization of debts. Typically, because the filing requirements
are so stringent, a lawyer will prepare this document, using detailed information that you will need to supply. In most cases, preparing and filing your Petition is
the hardest part of the process.
The Petition will be under Chapter 7 or Chapter 13 of the Bankruptcy Code. Chapter 7 discharges your debts; Chapter 13 allows you to pay most of them off over time. (There are other Chapters: Chapter 11 deals with business reorganization, and other Chapters deal with farms, railroads and municipalities.)
- When you file bankruptcy, federal law imposes an “automatic stay” which prevents your creditors from taking any action to collect debts against you, including
court judgments and tax debts, during the pendency of the bankruptcy. For instance, if you have been served with a lawsuit by one of your creditors to appear in
court over a debt, the bankruptcy filing will stop this lawsuit.
Depending on where you live, sometime between immediately and a month after you file, the Bankruptcy Court will send out a Notice of Filing and a Notice of Stay to your creditors. This Notice makes it illegal for your creditors to continue trying to collect from you, although they are free to contact your attorney. If you are contacted before the Notices go out, tell the creditor that you have filed and give them the Bankruptcy Court docket number. If you do not know the docket number, or the creditor asks more of you, or you do not feel confident dealing with the creditor, don’t hesitate to refer them to your attorney.
- Between four and six weeks after your filing, you will have to attend a “Meeting of Creditors” chaired by the Bankruptcy Trustee assigned to your case. Unless
there is a “red flag” that alerts the Trustee that your case is unusual, this will be a brief meeting. Generally, the Trustee will ask you a few form questions and a
few questions related to your business, and then will ask if there are any creditors present, with questions. Usually there will not be, although some credit card
providers attend many or most Meetings of Creditors.
If the Meeting of Creditors is uneventful, the process is probably over for you and your lawyer. If you are seeking a Chapter 7 Petition, you will receive a Notice of Discharge in about six weeks. If you are filing under Chapter 13, you and your attorney will have discussed a payment Plan, and you will receive Notice of Confirmation of the Plan in about the same time, and begin making payments.
- If the creditors have problems with your Petition, they have a certain amount of time to file an adversary proceeding. An adversary proceeding asks the Bankruptcy Court to refuse to discharge a certain debt for some particular reason. The most common reason is fraud, either giving rise to the debt (like if you got the money by stealing from your employer) or fraud in the bankruptcy (like lying about your assets). An adversary proceeding goes on like regular litigation, and it can take as long as regular litigation. Your discharge of these debts will be delayed until the adversary proceeding is resolved.
- If there are no problems with your Chapter 7 Petition, or once you have paid off your creditors under a Chapter 13 plan, or once any adversary proceedings are resolved, you will receive a Notice of Discharge. You may have to fill in forms to get a judgment removed from a judgment roll, but other than bookkeeping matters you have been given a fresh start.
- If you file under Chapter 13, your payment Plan will usually be on a timeline of three or five years.
It’s hard to say how long all these steps will take in your case. The entire process can take from as little as three months, to as long as five years. Bankruptcy is one of those rare areas where the process is faster in population centers. In Manhattan, you can receive a Chapter 7 discharge in about three months, whereas it takes about twice as long in rural Nevada. Adversary proceedings are as uncertain as any other litigation, although most Bankruptcy Courts are fairly vigilant about moving them through the system quickly.
- A bankruptcy case begins with a Petition. The Petition is a complex document, and includes characterization of debts. Typically, because the filing requirements are so stringent, a lawyer will prepare this document, using detailed information that you will need to supply. In most cases, preparing and filing your Petition is the hardest part of the process.
- Ten Common Pre-Bankruptcy Mistakes
- Pretending Nothing’s Wrong. Although optimism can be a wonderful trait, refusing to face up to financial challenges when your business is in trouble will do more harm than good.
- Keeping the Fat. It’s essential to look at expenses with a ruthless (and unselfish) eye when bankruptcy looms. That may mean giving up your prime parking spot, flying coach, or even laying off the brother-in-law that you hired as a favor to your little sister.
- Keeping Your Employees in the Dark. Although you don’t have to divulge every financial detail, it’s best to be straightforward when it comes to communicating with your employees. If they understand the full picture, they may be willing to accept short-term pay cuts or reductions in hours in the interest of long-term security.
- Deceiving Your Creditors. If you’re honest with your creditors, they may be willing to cut you some slack in order to maintain your business relationship. In addition, if you do end up filing bankruptcy, your fraud may come back to haunt you: in some cases, money obtained by fraudulent means must be repaid even if bankruptcy is filed.
- Laying Off Critical Personnel. Although it may seem like a good money-saving strategy to let go of highly paid workers, there’s no way your business can pull itself up by its bootstraps without your best people.
- Pledging Personal Property as Collateral. When there are no longer business assets that can serve as collateral for loans to keep your business afloat, it may be tempting to pledge your house, but if things don’t improve, you could then stand to lose not only your business but your family’s home, too.
- Dipping Into the Wrong Cookie Jar. It can also be tempting to dip into any ready source of cash in a crisis, but such impulses should be tempered. Some cash-starved businesspersons have been known to borrow from resources like payroll tax reserves with the intention of catching back up later and paying them back, but if that becomes impossible, the interest and IRS penalties, to say nothing of potential officer liability, will be worse than getting your fingers slapped by Mom.
- Letting Your Reserves Dwindle Down to Nothing. You should always have some cash on hand. Even if you do end up filing bankruptcy, you stand a much better chance of successfully reorganizing and making a go of it post-bankruptcy if you have some reserves.
- Being Disgraced by a Bankruptcy. Although going bankrupt should not be high on anyone’s to-do list, it is important to remember that filing bankruptcy is a respectable option when all other efforts to revive a business in financial crisis fail. Bankruptcy is a constitutionally provided vehicle to a fresh start, not a shameful disgrace.
- Going It Alone. In times of crisis, you need the strongest and smartest allies you can find. Your business or bankruptcy attorney can advise you on the most prudent courses of action to preserve your business and personal assets and protect your long-term financial interests. Even when money is tight-especially when money is tight-the counsel and support of an experienced lawyer are worth every penny.
- Common Bankruptcy Terms
The automatic stay is a feature of bankruptcy law that goes into effect immediately upon filing a bankruptcy petition. The automatic stay forces creditors to stop all collection actions (like foreclosures, repossessions, garnishments, and evictions) against the debtor, so that collection and distribution of assets can occur according to a fair and orderly method as specified in the Bankruptcy Code, rather than according to which creditors might be the quickest or most aggressive or have an “in” with the debtor.
A Chapter 7 bankruptcy permits the debtor to liquidate assets in an orderly way. In Chapter 7 (also known as “straight” bankruptcy), a trustee is appointed. The trustee collects all nonexempt assets of the debtor, sells those assets, and distributes the proceeds to creditors. There is no minimum or maximum debt limitation for Chapter 7, and the debtor doesn’t have to be insolvent. The goal of an individual debtor in a Chapter 7 case is to get a “discharge” of his or her debts.
A Chapter 11 bankruptcy permits the debtor to restructure or reorganize debt while carrying on, albeit in a significantly circumscribed way, their business and/or financial affairs. Individuals as well as businesses may use Chapter 11, but individuals who do so usually operate some kind of business. A trustee is usually not appointed in a Chapter 11 case. Rather, the debtor is allowed to continue to manage his or her business. Chapter 11 recognizes that there is often greater economic and/or social value in keeping a going concern going than in liquidating it, distributing what assets it has, terminating its commercial relationships, and letting its employees go.
The debtor develops a “plan” which outlines how his or her debts will be repaid. Usually, a debtor filing a Chapter 11 does not plan on “liquidating” assets, rather in most cases the debtor plans on reorganizing debts so that he or she can continue to operate, hopefully on a profitable basis. Individuals operating businesses usually file under Chapter 11 when they are facing a cash flow shortage or temporary downturn in business. Upon confirmation (court and creditor approval of its plan of reorganization), a Chapter 11 debtor receives a discharge of any debt that arose before confirmation.
Individual debtors who have a regular income (including those engaged in business) can file a Chapter 13 bankruptcy to restructure or reorganize debt. A debtor “engaged in business” is someone who is self-employed and incurs trade credit in the production of income from that employment. A debtor engaged in business may continue to operate his or her business in a Chapter 13 case. Like a Chapter 11, the debtor proposes a plan that outlines how his or her debts will be repaid. The debtor must devote all of his or her disposable income to payments under the plan for three to five years. To qualify for Chapter 13, a debtor must have: a regular income; unsecured debts of less than $290,525; and secured debts of less than $871,550. A trustee is appointed in all Chapter 13 cases, but the trustee’s role is much more limited than in a Chapter 7 case. The small business debtor is allowed to continue his or her business. In Chapter 13 cases, a debtor receives a discharge when the debtor has completed all payments under the plan.
Generally, a discharge in bankruptcy means that an individual debtor’s obligations are erased or wiped out. When a discharge is granted, it protects the debtor from personal liability on the discharged debt. A discharge is only available to certain debtors and for certain debts, however. For example, debtors that are not individuals cannot receive a discharge in a Chapter 7 bankruptcy.
Individual debtors are entitled to keep certain assets free from the claims of creditors, under federal or state exemption laws. Typical exemptions are the homestead exemption (equity in the debtor’s personal residence), cash value of insurance policies, household goods and furnishings, clothing, wages, and tools used in the debtor’s job. Different states exempt different types of property and have different maximum dollar amounts. The amount of the exemption depends on whether federal or state exemptions are available and/or used.
A fraudulent transfer is a transfer made by a debtor with the intent or effect of reducing the assets available to creditors. For instance a debtor might attempt to repay a loan to a friend or family member when those funds ought rightfully to be divided between all the debtor’s creditors. Fraudulent transfer law exists both in and outside of bankruptcy. A trustee has the power to undo or nullify (“avoid”) transfers of the debtor made with actual intent to hinder, delay, or defraud creditors, and certain transfers for which the debtor did not receive a reasonably equivalent value in exchange for the transfer.
A preference is a payment received from a debtor by a creditor in the ninety days before the debtor’s bankruptcy filing. The trustee can recover such a payment if:
- the debtor made the payment within ninety days of filing bankruptcy;
- the payment was made to or for the benefit of a creditor on a pre-existing debt, and
- the debtor was insolvent when it made the payment.
There are various defenses to a preference action by the trustee, including that the payment was made in the ordinary course of the debtor’s business.
Relief from the automatic stay
Although the automatic stay prohibits collection of debts by a creditor – including secured creditors – a secured creditor can ask the bankruptcy court for “relief” from the automatic stay. There are three bases on which a creditor might be entitled to relief from the automatic stay. First, for “cause.” Usually cause exists where the creditor can establish that it otherwise would not have adequate protection. Second, if a creditor wants relief from stay related to an act against property, the creditor must show that the debtor does not have equity in the property and that the property is not necessary to an effective reorganization. Third, a creditor is entitled to relief if its claim is secured by “single asset real estate,” unless the debtor files a plan that is likely to be confirmed or the debtor makes monthly payments to the creditor equal to interest at current fair market value on the balance of the creditor’s interest in the real estate.
Actually there are several types of bankruptcy trustees:
The United States Trustee is responsible for oversight of the bankruptcy process as a whole. The United States Trustee’s duties are to maintain and supervise a panel of private trustees (usually, but not always, private attorneys) to serve in Chapter 7 cases, review fee applications filed in Chapter 11 cases, monitor plans and disclosure statements in Chapter 11 cases, monitor activities of creditors’ committees, monitor the progress of Chapter 11 cases, and assist the United States Attorney in criminal prosecutions.
The United States Trustee appoints the trustee in a Chapter 7 case from a panel of private trustees. A Chapter 7 trustee is responsible for representing the interests of the debtor’s estate and creditors as a whole.
In a Chapter 13 case, a “standing” trustee is appointed by the United States Trustee to conduct the duties of the United States Trustee in Chapter 13 cases.
In some cases, creditors may file a petition to force a debtor into bankruptcy against the debtor’s will, so to obtain some benefit from the distribution of the debtor’s assets or proceeds. To commence an involuntary Chapter 7 or a Chapter 11 case, the creditors must meet certain threshold requirements pertaining to their number and the amount of debt owed them by the debtor.
A debtor files a petition to commence a voluntary bankruptcy.