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Bankruptcy Basics - What You Should Know Before You File

Hundreds of years ago, a debtor who was unable to pay his debts was frequently thrown into debtor’s prison. Luckily, a debtor who has run into hard times no longer faces such harsh punishment in the United States. The United States Bankruptcy Code provides protection for individuals, couples and businesses that are unable to pay their debts. While each situation is unique, there are some bankruptcy basics that anyone who is considering filing for bankruptcy under the Bankruptcy Code should know.

 

Jurisdiction and Exemptions


Bankruptcy protection falls within the jurisdiction of the federal court system. This means that bankruptcy laws are the same in every state, with one major exception. Each individual state determines whether or not to allow debtors additional exemptions for property above and beyond those allowed under the federal rules. Your state of residency at the time of filing determines in which state you must file and, therefore, which exemptions apply. Your domicile for the preceding 180 days is generally used to determine your state of residency.


Chapters

The Bankruptcy Code is broken down into chapters under which a debtor must file for protection. Family farmers or fisherman may use a chapter 12 while anyone with a business may consider filing under chapter 11. Individuals, or couples, typically file under a chapter 7 or 13. A chapter 7 is often referred to as a “liquidation”. To file under chapter 7 you must pass the means test, a test which is basically used to determine whether your income falls under the median income for the area where you live. Under a chapter 7, all dischargeable debts will be forgiven and you will start again with a clean slate. A chapter 13 bankruptcy is known as a “reorganization” and is used by debtors with regular income above the means test standard or who have non-exempt assets they wish to protect. Under a chapter 13, the majority of your debts will be paid back over an extended period of time.


Automatic Stay

Regardless of the chapter under which you file, as soon as a petition for protection under the bankruptcy code is filed the court will enter an automatic stay. An automatic stay orders all creditors to immediately cease any collection efforts and prevents new creditors from initiating collection actions. The automatic stay remains in effect until the bankruptcy terminates or a creditor obtains a release from the automatic stay from the court.


Process

The bankruptcy process will differ somewhat depending on your personal situation and the chapter under which you file; however, there are some uniform procedures. A petition must be filed along with various schedules. A schedule of creditors is filed by all debtors. Income verification is also required of all debtors. A bankruptcy trustee is then assigned to the case. Approximately 45 days after filing, a meeting of creditors is scheduled in front of the trustee. This is the opportunity for creditors and the trustee to examine the debtor regarding debts and income. Although often just a formality, if a creditor believes a debtor is hiding income or assets, or obtained credit under fraudulent circumstances, the creditor may question the debtor accordingly. Creditors then have 60 days after the meeting of creditors to object to the bankruptcy. For a chapter 7 petition, the case is usually discharged after the 60 days have expired if no objections are filed. For a chapter 13 petition, a reorganization plan is also submitted to the court. The reorganization plan outlines how the debtor plans to pay back the debts over an extended period of time, usually three years. The bankruptcy is not actually discharged until successful completion of the reorganization plan. Any debts remaining after successful completion of the plan are also discharged under a chapter 13 petition.


Exemptions

Certain assets owned by the debtor may be exempt, meaning the bankruptcy court cannot use them to repay debts. Federal law allows for some exemptions while state laws may afford additional exemptions. A homestead exemption, for example, may allow you to retain the equity in your home up to a state defined limit. Most states also allow a personal property exemption. Under a chapter 7 petition, any assets owned by the debtor above the exemption limits can be seized by the trustee and sold to satisfy debts. Under a chapter 13 petition, most assets can be retained by the debtor, regardless of the value, as long as the reorganization plan is followed to completion.


Non-Dischargeable Debts

Most debts can be discharged by filing bankruptcy; however, there are certain debts that cannot. The most common debts that cannot be discharged, under most circumstances, are taxes, child support and student loans. In addition, debts that were incurred in contemplation of filing bankruptcy may also be rejected by the court. For example, if you charged a large amount on a credit card the month before you filed for bankruptcy, the court may not allow that debt.


Life after Bankruptcy

If your credit rating was poor before filing bankruptcy, you are typically in a better position as soon as the bankruptcy is discharged. A bankruptcy will, however, show on your credit report for ten years. Creditors view bankruptcy in many different ways. Some creditors consider the fact that if you recently filed for bankruptcy, you cannot file again for at least seven years, offering some protection to the creditor. Obtaining a car loan is often possible within a year after filing for bankruptcy, although you may pay a higher interest rate. A mortgage is likely to take longer after filing for bankruptcy. Keeping your credit report clean once you have received your discharge is the key after bankruptcy. With regular income and no derogatory credit, you may be able to obtain a mortgage in two to three years after filing for bankruptcy. Keep in mind, however, that there are a number of factors that go into credit decisions.


Alternatives to Bankruptcy

Before deciding to file for bankruptcy, explore all your other options first. Talk to your creditors to see if they are willing to work out a payment plan that can help you avoid bankruptcy. Credit counseling is another option. Many companies will help you by contacting your creditors on your behalf and trying to work out a plan that will allow you to pay off your debts without resorting to bankruptcy.


Legal Assistance

If bankruptcy appears to be your only option, seek legal assistance. Bankruptcy is complicated and very form intensive. Making a mistake could result in qualifying debts not being discharged. Some legal aid offices help with bankruptcy as do many private attorneys.