What exactly is bankruptcy?
Bankruptcy refers to a set of federal laws that relieves people from their legal obligation to repay some of their debts. This relief is called a “discharge” because bankruptcy debtors are discharged (i.e., released) from their legal duty to repay the debts they accrued prior to their bankruptcy.
Sometimes people confuse bankruptcy with debt consolidation, debt management, or other negotiated strategies. Bankruptcy is fundamentally different—it is not a negotiation. If a person is entitled to the relief under the law, they get it, whether the creditor wants to give it to them or not. At the end of the process the debtor gets a discharge from a federal court, which is enforceable in court against any creditor whose debt was discharged. This means that the debtor has no legal obligation to repay a debt that has been discharged in bankruptcy.
Will bankruptcy stop collection activities?
Yes. In addition to giving people a discharge from their debts, the other major benefit of a bankruptcy filing is that it gives debtors the benefit of the “automatic stay,” which immediately halts almost all collection activities, including collection calls, court actions, evictions, sheriffs’ sales, foreclosures, etc., the moment a person files bankruptcy. Depending on the type of debt, the automatic stay may not last the entire course of the bankruptcy, but even in cases where it doesn’t, the stay gives debtors time and space to catch their breath and potentially work out a negotiated solution.
What are the different “Chapters” of bankruptcy relief, and what do they mean?
Individuals can file a Chapter 7, 11, 12 or 13. Businesses can only file a Chapter 7 or 11. Each has specific eligibility criteria, and individuals can be eligible for more than one chapter.
What types of debts are generally not discharged in bankruptcy?
First, it is important to make a distinction between secured and unsecured debts. Unsecured debts are obligations where the creditor only has the right to seek repayment from the borrower personally. By contrast, secured creditors have the additional “security” provided in the loan documents (as with a car loan or mortgage) of the right to seize and sell the property securing the loan (the “collateral”).
As a general matter, most unsecured debts can be discharged in a bankruptcy, but there are exceptions. The major exceptions involve most (but not all) taxes, domestic support obligations (alimony, maintenance, support, etc.), and any debts incurred through fraud. In addition, student loans are not dischargeable unless repaying the loans would present an “undue hardship” (a high standard to meet). There are other types of debts that can’t be discharged, but these are the most common.
What about secured debts?
Though people can discharge their personal obligations on debts secured by property, secured creditors will typically (but not always, as described below) be able to retain their rights in the collateral in spite of a bankruptcy.
In order to demonstrate what this means as a practical matter, take a simple example of a person with a car loan who still owes $10,000, but the car is only worth $5,000. If he or she files Chapter 7 bankruptcy and stops making payments on the car, the financing company will be permitted to seize the car and sell it (after getting the bankruptcy court’s permission), but it will not be able to pursue the debtor for the deficiency, even though it will recover far less than the $10,000 it was owed. The deficiency is the unsecured (personal) portion of the debt, which gets discharged in the bankruptcy, while the value of the car (the collateral for the loan) is the secured portion. With certain important exceptions, a bankruptcy has no impact on the lender’s rights to the collateral, only its ability to collect money from the borrower.
This does not mean that bankruptcy is not a useful tool in dealing with secured debts. In a Chapter 7 debtors can remove some judicial liens (which are a type of secured debt) and some security interests given on property the borrower already owned (i.e., not situations where people agreed to the security interest as part of the loan they used to purchase the property). In a Chapter 13, debtors can use their Chapter 13 plan payments to catch up on missed mortgage and car payments and can even modify certain mortgages and car loans.
What property can I keep in a bankruptcy?
Individuals are allowed to keep certain property in a bankruptcy. This is called an “exemption” because it is property that is exempt from seizure and sale by creditors. In Massachusetts, some of the most common exemptions available to people include:
This is not an exhaustive list, so if you have property that you don’t see listed here, you should contact me. In addition, most of these exemption amounts can be doubled in a joint bankruptcy case (when both spouses file together), so you can protect twice as much jointly-owned property from your creditors.
What about the money I have in my retirement account?
I commonly hear from people who say they have already drained their 401(k) or IRA to pay their creditors. This is extremely bad news, as they almost certainly would have been able to protect these funds from their creditors. Under the bankruptcy laws people can protect the money they have in most of the common types of pension, retirement, profit-sharing, stock bonus plans, education savings plans for children and grandchildren, etc. In short, if you’re thinking of draining or borrowing from your retirement accounts to pay your debts, don’t do it.
What if I have property that I can’t exempt?
As described above, in most cases, you will be able to exempt most, if not all, of your property. In those cases where it looks like there will be non-exempt property, frequently we can find a way to keep your property by buying the non-exempt property back from the Chapter 7 trustee. In many cases, a friend or family member will provide the funds necessary so that you do not lose any non-exempt property. In those cases where there is no money available to buy back non-exempt property, you can always file a Chapter 13 and keep all of your property, so long as the creditors receive payments through the Chapter 13 plan equal to what they would have received if the non-exempt property had been sold in a Chapter 7.
The important thing to remember is that a bankruptcy can generally only increase the availability of property exemptions; so if you have property that is not exempt in bankruptcy, that means that it is also reachable by your creditors even if you never file for bankruptcy relief. Stated another way—if you’re being hounded by creditors, and you have non-exempt assets, you’re likely to lose them eventually anyway.
I’ve heard something about a “means test.” Do I make too much money to file bankruptcy?
You may have heard that when Congress changed the bankruptcy laws they imposed a “means test” that bars people who make too much money from filing bankruptcy. This is not true. It is true that in 2005 Congress changed the law and created what is commonly referred to as the means test, which was intended to force people who could afford it to enter into a repayment plan under Chapter 13, rather than have their debts discharged in a Chapter 7 without having made any payments. Despite the implementation of the so-called means test, most people are still eligible for Chapter 7.
Does my spouse have to file bankruptcy too?
In many cases it makes sense for both spouses to file for bankruptcy at the same time, but that is not always the case, and it is not uncommon for only one spouse to file. After reviewing your financial situation, I can recommend to you whether it is advisable for you and your spouse to file jointly.
Do I need an attorney?
Corporations must hire an attorney to file bankruptcy. Individuals are permitted to file without an attorney, but the bankruptcy court discourages it. As in all matters, an attorney’s most important role is maximizing your legal rights. In bankruptcy this means allowing you to keep the most property possible, and discharging the most debts possible—sometimes a relatively simple matter, but often requiring substantial time and skill.
However, more than anything, what I’ve heard from my clients is that they appreciate the peace of mind that comes with having someone there to tell them what to expect, what they need to do, and how it’s likely to turn out. The bankruptcy process is complex to the uninitiated. There are a number of procedural tricks and traps that, while not terribly difficult to navigate for an experienced attorney, would prove extremely burdensome and potentially disastrous for a debtor trying to represent him or herself. The primary value of having an attorney, in addition to knowing that your rights are being protected and maximized, is that you have someone to explain the process and a person to call when you have questions...which you will.
Will I be able to get credit after filing bankruptcy?
A bankruptcy can be reported on your credit reports for 10 years. While that sounds like a long time, if you’re already behind on your debts, your credit score is probably already substantially damaged. By filing a bankruptcy, you can eliminate many of your problem debts and free up cash.
Once you get back on your feet, you can reestablish your credit and use your new-found free cash to make timely payments, thereby improving your credit as the bankruptcy slowly works its way further back into your credit history (where it is weighted less heavily by the credit agencies).
In other words, if your credit score is already poor, a bankruptcy followed by a sustained period of on-time payments can give you a credit score that is higher than it would be if you perpetuated a cycle of non-payment indefinitely. Even if you are still current on your payments, but struggling to make them every month, concerns about your credit score should not necessarily cause you to reject bankruptcy as an option. As you probably already know, many credit card interest rates are so high that, barring a financial windfall, many debtors have no reasonable likelihood of ever catching up. Under these circumstances, it is frequently best to “rip off the Band-Aid” and start over, rather than spend thousands of dollars (and years) hopelessly treading water.
I don’t feel good about not paying my debts.
Bankruptcy is intended to give honest but unfortunate debtors a “fresh start” so that they can rebuild their credit, business and financial lives. Lawmakers recognize that having a vibrant, dynamic economy requires risk-taking and borrowing. In order to foster those risks, Congress enacted the Bankruptcy Code in part to ensure that debtors are not crushed under the weight of their debts. The bankruptcy laws recognize that you can’t get blood from a stone, and are designed to protect people who simply need a chance to start over with a clean slate.
Bankruptcy’s roots in our financial system go back to the beginning of our country. The Founding Fathers included a clause in the Constitution expressly authorizing Congress to pass the bankruptcy laws we have today. (Article I, section 8, clause iv: “The Congress shall have the Power...To establish...uniform Laws on the subject of Bankruptcies throughout the United States.”)
The bankruptcy laws represent the collective judgment of our democratically elected representatives in establishing what they believe to be the correct balance between the rights of debtors and creditors. When you file for bankruptcy, you’re doing no more than exercising the rights that all of us have and that Congress says you deserve.