Bankruptcy was originally planned as a remedy for creditors — not debtors
Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay its creditors. Creditors may file a bankruptcy petition against a debtor ("involuntary bankruptcy") in an effort to recoup a portion of what they are owed or initiate a restructuring. In the majority of cases, however, bankruptcy is initiated by the debtor (a "voluntary bankruptcy" that is filed by the insolvent individual or organization).
History and Development of Bankruptcy
The concept and origin of bankruptcy law as it is now known in the United States originated in England. The first English bankruptcy law is generally agreed to have been enacted in 1542. (34 and 35, Henry VIII, c.4 (1542) England.)
Bankruptcy was originally planned as a remedy for creditors — not debtors. During the reign of King Henry VIII, bankruptcy law allowed a creditor to seize all of the assets of a trader who could not pay his debts. Additionally, on top of losing all of one's property, the unfortunate debtor also lost his freedom and was subject to imprisonment for failure to pay his debts. This left the family of the debtor in the position of having to pay the debts in order to obtain the release of the debtor. As time progressed, however, so did the rights of debtors in England. In the 1700s, for example, debtors were often released from prison and many fled to the United States to live. Many emigrated to Georgia and Texas, which became known as debtors’ colonies. Finally, by the early 1800s in England, debtors were often released from prison and their debts discharged. However, for many years, bankruptcy continued to be a remedy favoring creditors, involuntary in nature and largely penal in character. It was generally used only against traders.
Under the English system, collusive bankruptcy (agreed upon by creditor and debtor) was codified by the English Act of 1825. This also occurred when a trader filed a declaration of insolvency in the office of the Chancellor’s Secretary of Bankrupts which was then advertised. The advertised declaration supported a commission in bankruptcy to be issued. A law was thereafter enacted which declared that no commission grounded on this act of bankruptcy was to be “deemed invalid by reason of such declaration having been concerted or agreed upon between the bankrupt and any creditor or other person.” (6 Geo. IV, c.16, sections VI, VII (Eng.). Voluntary bankruptcy was not authorized until 1849. (12 and 13 Vict., c.106, section 93 (1849) (Eng.).
The subject of bankruptcy was given specific recognition upon the adoption of the United States Constitution in 1789. The United States Constitution says that Congress shall have power to establish “uniform laws on the subject of Bankruptcies” throughout the United States. U.S. CONST. I, section 8, Cl.4. Thus the law of bankruptcy, as enacted by Congress, is federal law. The first bankruptcy act enacted by Congress was in 1800. Bankruptcy Act of 1800, Ch. 6,2 Stat. 19. It was limited to traders and provided only for involuntary proceedings. Voluntary bankruptcy at that time was unknown.
Voluntary bankruptcy in the United States was established as an institution by the Acts of 1841 (Act of Aug. 19, 1841, section 1, 5 Stat. 440) and 1867 (Act of Mar. 2, 1867, section 11, 14 Stat. 521). From these early acts to the Bankruptcy Act of 1898, which established the modern concepts of debtor-creditor relations, to the Bankruptcy Act of 1938, widely known as the Chandler Act, and to subsequent acts, the scope of voluntary access to the bankruptcy system has been broadened and has made voluntary petitions more attractive to debtors.
The Bankruptcy Reform Act of 1978, commonly referred to as the Bankruptcy Code, constituted a major overhaul of the bankruptcy system. First of all, it covered cases filed after October 1, 1979. Second, the 1978 Act contained four titles: Title I was the amended Title 11 of the U.S. Code; Title II contained amendments to Title 28 of the U.S. Code and the Federal Rules of Evidence; Title III made the necessary changes in other federal legislation affected by the bankruptcy law changes; and Title IV provided for the repeal of pre-Code bankruptcy, the effective dates of portions of the new law, necessary savings provisions, interim housekeeping details, and the pilot program of the United States trustee.
Perhaps the most important changes to bankruptcy law under the 1978 Act, however, were to the courts themselves. The 1978 Act drastically altered the structure of the bankruptcy courts and conferred pervasive subject matter jurisdiction upon the judicial officers of the courts. The act granted the new courts jurisdiction over all “civil proceedings arising under title 11 or arising in or related to cases under title 11.” 28 U.S.C. §1471(b) (1976 ed. Supp.)
While the new courts were denominated adjuncts of the district court, they were in practice free standing courts. The expanded jurisdiction was to be exercised primarily by bankruptcy judges. The bankruptcy judge would continue to be an Article I judge, who was appointed for a set term.
The provisions of the 1978 Act came under scrutiny in the case of Northern Pipeline Co. v. Marathon Pipe Line Co., 458 U.S. 50, 102 S. Ct. 2858, 73 L. Ed.2d 598 [6 C.B.C.2d 785] (1982). In Marathon, the name by which this Supreme Court case is commonly referred, the Court held unconstitutional the broad grant of jurisdiction to bankruptcy judges because those judges were not appointed under and protected by the provisions of Article III of the Constitution. Under the United States Constitution, Article III judges hold their offices during good behavior (an appointment for life) and their salary cannot be cut during their continuance in office. Article I judges do not enjoy that kind of protection.
The jurisdictional challenge started when a creditor filed an adversary proceeding in bankruptcy court, which covered issues such as a breach of contract, warranty, and misrepresentation. The bankruptcy court denied the defendant’s motion to dismiss, which the defendant appealed to the District Court. The District Court held that 28 U.S.C. §1471 violated Article III of the United States Constitution because it delegated Article III powers to a non-Article III Court by its broad grant of jurisdiction to the bankruptcy courts. In a plurality opinion, the Supreme Court held that the broad grant of jurisdiction accorded bankruptcy courts by 28 U.S.C. '1471 was an unconstitutional delegation of Article III powers to a non-Article III Court. Similarly, Section 241(a) of the Bankruptcy Reform Act of 1978, by establishing the jurisdictional provisions set forth in 28 U.S.C. '1471 was unconstitutional. The Court stayed its judgment until October 4, 1982 to give “Congress an opportunity to reconstitute the bankruptcy courts or to adopt other valid means of adjudication, without impairing the interim administration of the bankruptcy laws.” Id. 458 U.S. at 89.
After the stay had expired, Congress still failed to act. Instead a model “Emergency Rule” was adopted as a local rule by the district courts. The purpose of the rule was to avoid the collapse of the bankruptcy system, and it was a temporary measure to provide for the orderly administration of bankruptcy cases and proceedings after the judgment in Marathon. The rule remained in effect until enactment of the 1984 legislation on July 10, 1984. Although the constitutionality of the “Emergency Rule” was under constant attack, the Supreme Court consistently denied certiorari.
In 1984 the legislature revised the Bankruptcy Code and implemented the Bankruptcy Amendments and Federal Judgeship Act of 1984. The observation has been made that most of these amendments were taken out of Justice Brennan’s opinion in Marathon. Title 28 U.S.C. ' 157(a) and (b)(1), which govern the jurisdiction of the bankruptcy court state in part:
(a) Each district court may provide that any or all cases under title 11 and any or all proceedings arising under title 11 or arising in or related to a case under title 11 shall be referred to the bankruptcy judges for the district.
(b) (1) Bankruptcy judges may hear and determine all cases under title 11 and all core proceedings arising under title 11, or arising in a case under title 11, referred under subsection (a) of this section, and may enter appropriate orders and judgments, subject to review under section 158 of this title.
Core proceedings as delineated by 28 U.S.C. §157, include but are not limited to:
(A) matters concerning the administration of the estate; (B) allowance or disallowance of claims against the estate or exemptions from property of the estate, and estimation of claims or interests for the purposes of confirming a plan under Chapter 11, 12, or 13 of title 11 but not the liquidation or estimation of contingent or unliquidated personal injury tort or wrongful death claims against the estate for purposes of distribution in a case under title 11; (C) counterclaims by the estate against persons filing claims against the estate; (D) orders in respect to obtaining credit; (E) orders to turn over property of the estate; (F) proceedings to determine, avoid, or recover preferences; (G) motions to terminate, annul, or modify the automatic stay; (H) proceedings to determine, avoid, or recover fraudulent conveyances; (I) determinations as to the dischargeability of particular debts; (J) objections to discharges; (K) determinations of the validity, extent or priority of liens; (L) confirmation of plans; (M) orders approving the use or
(lease) of property, including the use of cash collateral; (N) orders approving the sale of property other than property resulting from claims brought by the estate against persons who have not filed claims against the estate; and (O) other proceedings affecting the liquidation of the assets of the estate or the adjustment of the debtor-creditor or the equity security holder relationship, except personal injury, tort or wrongful death claims.
Thus, in effect, Congress granted jurisdiction to an Article III court, namely the district court, and then authorized (by 28 U.S.C. §157) that this jurisdiction could be delegated to the bankruptcy court. The district court was also authorized to withdraw in whole or in part, any case or proceeding referred under Section 157, on its motion or on timely motion of any party, for cause shown.
By this act, with few exceptions, such as the trial of personal injury and wrongful death claims and matters that require consideration of both Title 11 and organizations or activities affecting interstate commerce, the new bankruptcy courts were allowed to exercise all of the subject matter jurisdiction of the district courts. Thus, bankruptcy courts were enabled to hear cases such as the Marathon case.
The Bankruptcy Amendments and Federal Judgeship Act of 1984 in many ways resembled the Bankruptcy Act of 1898. Among other things, the law provided for the redesignation of separate units for bankruptcy judges under the district court system. Bankruptcy cases pending on or filed after July 10, 1984, are subject to most of the amendments relating to bankruptcy jurisdiction.
The Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act of 1986 made substantive changes relating to family farmers and established a permanent United States trustee system. The 1986 Act applies to cases filed since November 26, 1986.
The Bankruptcy Reform Act of 1994 is effective as to cases filed on or after October 22, 1994. The reform act and the case law interpreting its provisions have a great impact upon the mortgage banking industry and the servicer of mortgage loans. The changes effectuated by this act are discussed in the chapters that follow.
In ancient Greece, bankruptcy did not exist. If a man (since only locally born adult males could be citizens, all legal owners of property were men) owed and he could not pay, he and his entire household, whether wife, children or servants were forced into "debt slavery", until the creditor recouped losses via their physical labor. Many city-states in ancient Greece limited debt slavery to a period of five years and debt slaves had protection of life and limb, which regular slaves did not enjoy. However, servants of the debtor could be retained beyond that deadline by the creditor and were often forced to serve their new lord for a lifetime, usually under significantly harsher conditions.
The word bankruptcy is formed from the ancient Latin bancus (a bench or table), and ruptus (broken). A "bank" originally referred to a bench, which the first bankers had in the public places, in markets, fairs, etc. on which they tolled their money, wrote their bills of exchange, etc. Hence, when a banker failed, he broke his bank, to advertise to the public that the person to whom the bank belonged was no longer in a condition to continue his business. As this practice was very frequent in Italy, it is said the term bankrupt is derived from the Italian banco rotto, broken bank (see e.g. Ponte Vecchio). Others choose rather to derive the word from the French banque, "table", and route, "vestigium, trace", by metaphor from the sign left in the ground, of a table once fastened to it and now gone.
Philip II of Spain had to declare four state bankruptcies in 1557, 1560, 1575
and 1596. Spain became the first sovereign nation in history to declare
The characteristic discharge of debts was introduced to Anglo-American bankruptcy with the statute of 4 Anne ch. 17 in 1705, where the discharge of unpayable debts was offered as a reward to bankrupts who cooperated in the gathering of assets to pay what could be paid.
Bankruptcy is also documented in East Asia. According to al-Maqrizi, the Yassa of Genghis Khan contained a provision that mandated the death penalty for anyone who became bankrupt three times.
From A Religious Context
In the Torah, or Old Testament, every seventh year is decreed by Mosaic Law as a Sabbatical year wherein the release of all debts that are owed by members of the community is mandated, but not of "foreigners". The seventh Sabbatical year, or forty-ninth year, is then followed by another Sabbatical year known as the Year of Jubilee wherein the release of all debts is mandated, for fellow community members and foreigners alike, and the release of all debt-slaves is also mandated. The Year of Jubilee is announced in advance on the Day of Atonement, or the tenth day of the seventh Biblical month, in the forty-ninth year by the blowing of trumpets throughout the land of Israel.
In Islamic teaching, according to the Quran, an insolvent person should be allowed time to be able to pay out his debt. This is recorded in the Quran's second chapter (Sura Al-Baqara), Verse 280, which notes: "And if someone is in hardship, then let there be postponement until a time of ease. But if you give from your right as charity, then it is better for you, if you only knew."
Modern insolvency legislation and debt restructuring practices
The principal focus of modern insolvency legislation and business debt restructuring practices no longer rests on the elimination of insolvent entities but on the remodeling of the financial and organizational structure of debtors experiencing financial distress so as to permit the rehabilitation and continuation of their business.
Bankruptcy fraud is a crime. While difficult to generalize across jurisdictions, common criminal acts under bankruptcy statutes typically involve concealment of assets, concealment or destruction of documents, conflicts of interest, fraudulent claims, false statements or declarations, and fee fixing or redistribution arrangements. Falsifications on bankruptcy forms often constitute perjury. Multiple filings are not in and of themselves criminal, but they may violate provisions of bankruptcy law. In the U.S., bankruptcy fraud statutes are particularly focused on the mental state of particular actions.
Bankruptcy fraud should be distinguished from strategic bankruptcy, which is not a criminal act, but may work against the filer.
All assets must be disclosed in bankruptcy schedules whether or not the debtor believes the asset has a net value. This is because once a bankruptcy petition is filed, it is for the creditors, not the debtor to decide whether a particular asset has value. The future ramifications of omitting assets from schedules can be quite serious for the offending debtor. A closed bankruptcy may be reopened by motion of a creditor or the U.S. trustee if a debtor attempts to later assert ownership of such an "unscheduled asset" after being discharged of all debt in the bankruptcy. The trustee may then seize the asset and liquidate it for the benefit of the (formerly discharged) creditors. Whether or not a concealment of such an asset should also be considered for prosecution as fraud and/or perjury would then be at the discretion of the judge and/or U.S. Trustee.
In individual countries
The Bankruptcy Act 1966 (Commonwealth) is the legislation that governs bankruptcy in Australia. Only individuals can become bankrupt; insolvent companies go into liquidation or administration (see administration (insolvency)). There are three "parts" of the act under which the vast majority of "acts of bankruptcy" fall. Part IV (Full Bankruptcy), Part IX Debt Agreements and Part X Personal Insolvency Agreements. Agreements refer specifically to arrangements between creditors and debtors, whereas Part IV relates to full bankruptcy and is generally synonymous with "bankruptcy".
A person or debtor can declare himself or herself bankrupt by lodging a debtor's petition with the Official Receiver, which is the Insolvency and Trustee Service Australia (ITSA). A person can also be made bankrupt after a creditor's petition results in the making of a sequestration order in the Federal Magistrates Court. To declare bankruptcy or for a creditors petition to be lodged, a minimum debt of $2,000 is required.
All bankrupts are required to lodge a Statement of Affairs document with ITSA, which includes important information about their assets and liabilities. A bankruptcy cannot be annulled until this document has been lodged.
Ordinarily, a Part IV bankruptcy lasts three years from the filing of the Statement of Affairs with ITSA. In the case of a debtor's petition, the Statement of Affairs is filed with the petition and the three year period commences immediately. However, in the case of a creditor's petition, the Statement of Affairs will rarely be filed on the same day the court order is made. If the bankrupt fails to lodge the document within a certain period of time, he or she can be prosecuted and fined.
A Bankruptcy Trustee (in most cases this is the Official Receiver) is appointed to deal with all matters regarding the administration of the bankrupt estate. The Trustee's job includes notifying creditors of the estate and dealing with creditor enquiries; ensuring that the bankrupt complies with his or her obligations under the Bankruptcy Act; investigating the bankrupt's financial affairs; realising funds to which the estate is entitled under the Bankruptcy Act and distributing dividends to creditors if sufficient funds become available.
For the duration of their bankruptcy, all bankrupts have certain restrictions placed upon them under the Act. For example, a bankrupt must obtain the permission of his or her trustee to travel overseas. Failure to do so may result in the bankrupt being stopped at the airport by the Australian Federal Police. Additionally, a bankrupt is required to provide his or her Trustee with details of income and assets. If the bankrupt does not comply with the Trustee's request to provide details of income, the Trustee may have grounds to lodge an Objection to Discharge, which has the effect of extending the bankruptcy for a further five years.
The realisation of funds usually comes from two main sources: the bankrupt's assets and the bankrupt's wages. There are certain assets that are protected, referred to as "protected assets". These include household furniture and appliances, tools of the trade and vehicles up to a certain value. All other assets of value will be sold. If a house or car is above a certain value, the bankrupt can buy the interest back from the estate in order to keep the asset. If the bankrupt does not do this, the interest vests in the estate and the trustee is able to take possession of the asset and sell it.
The bankrupt will have to pay income contributions if his or her income is above a certain threshold. The threshold is indexed biannually in March and September, and varies according to the number of dependents the bankrupt has. The income contributions liability is calculated by halving the amount of income that exceeds the threshold. If the bankrupt fails to pay the contributions due, the Trustee can issue a notice to garnishee the bankrupt's wages. If that is not possible, the Trustee may lodge an Objection to Discharge, effectively extending the bankruptcy for a further five years.
Bankruptcies can be annulled prior to the expiration of the normal three year period if all debts are paid out in full. Sometimes a bankrupt may be able to raise enough funds to make an Offer of Composition to creditors, which would have the effect of paying the creditors some of the money they are owed. If the creditors accept the offer, the bankruptcy can be annulled after the funds are received.
After the bankruptcy is annulled or the bankrupt has been automatically discharged, the bankrupt's credit report status will be shown as "discharged bankrupt" for some years. The number of years varies depending on the company issuing the report, but the report will eventually cease to record that information.
Certain limited information on Bankruptcy Law in Australia can be found at the ITSA web site.
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In Brazil, the Bankruptcy Law (11,101/05) disciplines the judicial or extrajudicial recuperation & Bankruptcy and is applicable only to private companies, except financial institution, credit cooperative, consortia, entity of supplementary schemes, society that operates health care plan, society of
capitalization and other entities legally treated as issues. It's also not applicable to public companies.
The law covers three legal proceedings. The first is the bankruptcy ("Falência"). The bankruptcy is the judicial liquidation procedure for an insolvent merchant that promotes the removal of the debtor of its activities, aiming preserve and optimize the productive use of assets, assets and productive resources, including intangible assets, of the company. The final goal of the bankruptcy is the liquidation of the assets of the company and payment of the debtors.
The second one in the Judicial Recuperation ("Recuperação Judicial"). Its goal is to allow the overcoming of the economic-financial crisis situation of the debtor, in order to allow the continuation of the source producer, the employment of workers and the interests of creditors, promoting, thus, the preservation of the company, its social function and stimulate the economic activity. It's a judiciary procedure required by the debtor who exercice its activities more than 2 years and have to be approval by the judge.
The Extrajudicial Recuperation ("Recuperação Extrajudicial") is a private negotiation that involves creditors and debtors and, as the judicial recuperation, also have to be approved by Judiciary power.
Main article: Bankruptcy in Canada
Bankruptcy in Canada is set out by federal law, in the Bankruptcy and Insolvency Act and is applicable to businesses and individuals. The office of the Superintendent of Bankruptcy, a federal agency, is responsible for ensuring that bankruptcies are administered in a fair and orderly manner. Trustees in bankruptcy administer bankruptcy estates.
Bankruptcy is filed when a person or a company becomes insolvent and cannot pay their debts as they become due.
Duties of trustees
Some of the duties of the trustee in bankruptcy are to:
- Review the file for any fraudulent preferences or reviewable transactions
- Chair meetings of creditors
- Sell any non-exempt assets
- Object to the bankrupt's discharge
- Distribute funds to creditors
Creditors become involved by attending creditors' meetings. The trustee calls the first meeting of creditors for the following purposes:
- To consider the affairs of the bankrupt
- To affirm the appointment of the trustee or substitute another in place thereof
- To appoint inspectors
- To give such directions to the trustee as the creditors may see fit with reference to the administration of the estate.
Consumer proposals in Canada
In Canada, a person can file a consumer proposal as an alternative to bankruptcy. A consumer proposal is a negotiated settlement between a debtor and their creditors.
A typical proposal would involve a debtor making monthly payments for a maximum of five years, with the funds distributed to their creditors. Even though most proposals call for payments of less than the full amount of the debt owing, in most cases, the creditors will accept the deal, because if they don’t, the next alternative may be personal bankruptcy, where the creditors will get even less money. The creditors have 45 days to accept or reject the consumer proposal. Once the proposal is accepted the debtor makes the payments to the Proposal Administrator each month (or as otherwise stipulated in their proposal), and the creditors are prevented from taking any further legal or collection action. If the proposal is rejected, the debtor is returned to his prior insolvent state and may have no alternative but to declare personal bankruptcy.
A consumer proposal can only be made by a debtor with debts to a maximum of $250,000 (not including the mortgage on their principal residence). If debts are greater than $250,000, the proposal must be filed under Division 1 of Part III of the Bankruptcy and Insolvency Act. The assistance of a Proposal Administrator is required. A Proposal Administrator is generally a licensed trustee in bankruptcy, although the Superintendent of Bankruptcy may appoint other people to serve as administrators.
In 2006, there were 98,450 personal insolvency filings in Canada: 79,218 bankruptcies and 19,232 consumer proposals.
The Dutch bankruptcy law is governed by the Dutch Bankruptcy Code ("Faillissementswet"). The code covers three separate legal proceedings. The first is the bankruptcy ("Faillissement"). The goal of the bankruptcy is the liquidation of the assets of the company. The bankruptcy applies to individuals and companies. The second legal proceeding in the Faillissementswet is the "Surseance". The Surseance only applies to companies. Its goal is to reach an agreement with the creditors of the company. The third proceeding is the "Schuldsanering". This proceeding is designed for individuals only.
Main article: Insolvency law of Switzerland
Under Swiss law, bankruptcy can be a consequence of insolvency. It is a court-ordered form of debt enforcement proceedings that applies, in general, to registered commercial entities only. In a bankruptcy, all assets of the debtor are liquidated under the administration of the creditors, although the law provides for debt restructuring options similar to those under Chapter 11 of the U.S. Bankruptcy code.
In Sweden, bankruptcy (Swedish: konkurs) is a process that can be done for companies and for private people. A creditor or the company itself can apply for bankruptcy. A person or a company in bankruptcy can not access its assets with some exceptions. It is common for companies in Sweden to reduce their debts through bankruptcy. The owner or a new owner starts a new company that buys the important assets including the name from the old company, which is left behind with its debts.
The formal bankruptcy process is rarely done for individuals. Creditors can claim money through the Enforcement Administration anyway, and people themselves don't benefit from it at all, because there are extra costs and the debts remain. People who are really insolvent can clean their debts with a process called debt cleaning (Swedish:skuldsanering). After an application they get a payment plan where they pay as much as they can for five years, and then all remaining debts are canceled. This process was introduced in 2006. Before that, all debts remained during the life of a person.
Main articles: Bankruptcy in the United Kingdom, Liquidation, and Administration (insolvency)
In the United Kingdom, bankruptcy (in a strict legal sense) relates only to individuals and partnerships. Companies and other corporations enter into differently-named legal insolvency procedures: liquidation and administration (administration order and administrative receivership). However, the term 'bankruptcy' is often used when referring to companies in the media and in general conversation. Bankruptcy in Scotland is referred to as sequestration.
A trustee in bankruptcy must be either an Official Receiver (a civil servant) or a licensed insolvency practitioner.
Current law in England and Wales derives in large part from the enactment of the Insolvency Act 1986. Following the introduction of the Enterprise Act 2002, a UK bankruptcy will now normally last no longer than 12 months and may be less, if the Official Receiver files in Court a certificate that his investigations are complete.
It was expected that the UK Government's liberalisation of the UK bankruptcy regime would increase the number of bankruptcy cases; The Insolvency Service statistics appear to bear this out -
UK Bankruptcy statistics
After the increase in 2005 and 2006 the figures have remained stable.
Bankruptcy and Pensions in the UK
The UK bankruptcy law was changed in May 2000, effective May 29, 2000. Debtors may now retain occupational pensions while in bankruptcy, except in rare cases.
Main article: Bankruptcy in the United States
Bankruptcy in the United States is a matter placed under Federal jurisdiction by the United States Constitution (in Article 1, Section 8, Clause 4), which allows Congress to enact "uniform laws on the subject of bankruptcies throughout the United States." The Congress has enacted statute law governing bankruptcy, primarily in the form of the Bankruptcy Code, located at Title 11 of the United States Code. Federal law is amplified by state law in some places where Federal law fails to speak or expressly defers to state law.
While bankruptcy cases are always filed in United States Bankruptcy Court (an adjunct to the U.S. District Courts), bankruptcy cases, particularly with respect to the validity of claims and exemptions, are often dependent upon State law. State law therefore plays a major role in many bankruptcy cases, and it is often not possible to generalize bankruptcy law across state lines.
Generally, a debtor declares bankruptcy to obtain relief from debt, and this is accomplished either through a discharge of the debt or through a restructuring of the debt. Generally, when a debtor files a voluntary petition, his or her bankruptcy case commences.
There are six types of bankruptcy under the Bankruptcy Code, located at Title 11 of the United States Code:
The most common types of personal bankruptcy for individuals are Chapter 7 and Chapter 13. As much as 65% of all U.S. consumer bankruptcy filings are Chapter 7 cases. Corporations and other business forms file under Chapters 7 or 11.
- Chapter 7: basic liquidation for individuals and businesses; also known as straight bankruptcy; it is the simplest and quickest form of bankruptcy available
- Chapter 9: municipal bankruptcy; a federal mechanism for the resolution of municipal debts
- Chapter 11: rehabilitation or reorganization, used primarily by business debtors, but sometimes by individuals with substantial debts and assets; known as corporate bankruptcy, it is a form of corporate financial reorganization which typically allows companies to continue to function while they follow debt repayment plans
- Chapter 12: rehabilitation for family farmers and fishermen;
- Chapter 13: rehabilitation with a payment plan for individuals with a regular source of income; enables individuals with regular income to develop a plan to repay all or part of their debts; also known as Wage Earner Bankruptcy
- Chapter 15: ancillary and other international cases; provides a mechanism for dealing with bankruptcy debtors and helps foreign debtors to clear debts.
In Chapter 7, a debtor surrenders his or her non-exempt property to a bankruptcy trustee who then liquidates the property and distributes the proceeds to the debtor's unsecured creditors. In exchange, the debtor is entitled to a discharge of some debt; however, the debtor will not be granted a discharge if he or she is guilty of certain types of inappropriate behavior (e.g. concealing records relating to financial condition) and certain debts (e.g. spousal and child support, student loans, some taxes) will not be discharged even though the debtor is generally discharged from his or her debt. Many individuals in financial distress own only exempt property (e.g. clothes, household goods, an older car) and will not have to surrender any property to the trustee. The amount of property that a debtor may exempt varies from state to state. Chapter 7 relief is available only once in any eight year period. Generally, the rights of secured creditors to their collateral continues even though their debt is discharged. For example, absent some arrangement by a debtor to surrender a car or "reaffirm" a debt, the creditor with a security interest in the debtor's car may repossess the car even if the debt to the creditor is discharged.
The 2005 amendments to the Bankruptcy Code introduced the "means test" for eligibility for chapter 7. An individual who fails the means test will have his or her chapter 7 case dismissed or may have to convert his or her case to a case under chapter 13.
Generally, a trustee will sell most of the debtor’s assets to pay off creditors. However, certain assets of the debtor are protected to some extent. For example, Social Security payments, unemployment compensation, and limited values of your equity in a home, car, or truck, household goods and appliances, trade tools, and books are protected. However, these exemptions vary from state to state. Therefore, it is advisable to consult an experienced bankruptcy attorney.
In Chapter 13, the debtor retains ownership and possession of all of his or her assets, but must devote some portion of his or her future income to repaying creditors, generally over a period of three to five years. The amount of payment and the period of the repayment plan depend upon a variety of factors, including the value of the debtor's property and the amount of a debtor's income and expenses. Secured creditors may be entitled to greater payment than unsecured creditors.
Relief under Chapter 13 is available only to individuals with regular income whose debts do not exceed prescribed limits. If you're an individual or a sole proprietor, you are allowed to file for a Chapter 13 bankruptcy to repay all or part of your debts. Under this chapter, you can propose a repayment plan in which to pay your creditors over three to five years. If your monthly income is less than the state's median income, your plan will be for three years unless the court finds "just cause" to extend the plan for a longer period. If your monthly income is greater than your state's median income, the plan must generally be for five years. A plan cannot exceed the five-year limitation.
In contrast to Chapter 7, the debtor in Chapter 13 may keep all of his or her property, whether or not exempt. If the plan appears feasible and if the debtor complies with all the other requirements, the bankruptcy court will typically confirm the plan and the debtor and creditors will be bound by its terms. Creditors have no say in the formulation of the plan other than to object to the plan, if appropriate, on the grounds that it does not comply with one of the Code's statutory requirements. Generally, the payments are made to a trustee who in turn disburses the funds in accordance with the terms of the confirmed plan.
When the debtor completes payments pursuant to the terms of the plan, the court will formally grant the debtor a discharge of the debts provided for in the plan. However, if the debtor fails to make the agreed upon payments or fails to seek or gain court approval of a modified plan, a bankruptcy court will often dismiss the case on the motion of the trustee. Pursuant to the dismissal, creditors will typically resume pursuit of state law remedies to the extent a debt remains unpaid.
In Chapter 11, the debtor retains ownership and control of its assets and is re-termed a debtor in possession ("DIP"). The debtor in possession runs the day to day operations of the business while creditors and the debtor work with the Bankruptcy Court in order to negotiate and complete a plan. Upon meeting certain requirements (e.g. fairness among creditors, priority of certain creditors) creditors are permitted to vote on the proposed plan. If a plan is confirmed the debtor will continue to operate and pay its debts under the terms of the confirmed plan. If a specified majority of creditors do not vote to confirm a plan, additional requirements may be imposed by the court in order to confirm the plan.
Chapter 7 and Chapter 13 are the efficient bankruptcy chapters often used by most individuals. The chapters which almost always apply to consumer debtors are chapter 7, known as a "straight bankruptcy", and chapter 13, which involves an affordable plan of repayment. An important feature applicable to all types of bankruptcy filings is the automatic stay. The automatic stay means that the mere request for bankruptcy protection automatically stops and brings to a grinding halt most lawsuits, repossessions, foreclosures, evictions, garnishments, attachments, utility shut-offs, and debt collection harassment.
Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA)
Main article: Bankruptcy Abuse Prevention and Consumer Protection Act
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, 119 Stat. 23 (April 20, 2005) ("BAPCPA"), substantially amended the Bankruptcy Code. Many provisions of BAPCPA were forcefully advocated by consumer lenders and were just as forcefully opposed by many consumer advocates, bankruptcy academics, bankruptcy judges, and bankruptcy lawyers. The enactment of BAPCPA followed nearly eight years of debate in Congress. Most of the law's provisions became effective on October 17, 2005. Upon signing the bill, President Bush stated:
Under the new law, Americans who have the ability to pay will be required to pay back at least a portion of their debts. Those who fall behind their state's median income will not be required to pay back their debts. The new law will also make it more difficult for serial filers to abuse the most generous bankruptcy protections. Debtors seeking to erase all debts will now have to wait eight years from their last bankruptcy before they can file again. The law will also allow us to clamp down on bankruptcy mills that make their money by advising abusers on how to game the system.
Among its many changes to consumer bankruptcy law, BAPCPA enacted a "means test", which was intended to make it more difficult for a significant number of financially distressed individual debtors whose debts are primarily consumer debts to qualify for relief under Chapter 7 of the Bankruptcy Code. The "means test" is employed in cases where an individual with primarily consumer debts has more than the average annual income for a household of equivalent size, computed over a 180 day period prior to filing. If the individual must "take" the "means test", their average monthly income over this 180 day period is reduced by a series of allowances for living expenses and secured debt payments in a very complex calculation that may or may not accurately reflect that individual's actual monthly budget. If the results of the means test show no disposable income(or in some cases a very small amount) then the individual qualifies for Chapter 7 relief. If a debtor does not qualify for relief under Chapter 7 of the Bankruptcy Code, either because of the Means Test or because Chapter 7 does not provide a permanent solution to delinquent payments for secured debts, such as mortgages or vehicle loans, the debtor may still seek relief under Chapter 13 of the Code. A Chapter 13 plan often does not require repayment to general unsecured debts, such as credit cards or medical bills.
BAPCPA also requires individuals seeking bankruptcy relief to undertake credit
counseling with approved counseling agencies prior to filing a bankruptcy
petition and to undertake education in personal financial management from
approved agencies prior to being granted a discharge of debts under either
Chapter 7 or Chapter 13. Some studies of the operation of the credit counseling
requirement suggest that it provides little benefit to debtors who receive the
counseling because the only realistic option for many is to seek relief under
the Bankruptcy Code.
Europe in general
During 2004, the number of insolvencies reached all time highs in many European countries. In France, company insolvencies rose by more than 4%, in Austria by more than 10%, and in Greece by more than 20%. The increase in the number of insolvencies, however, does not indicate the total financial impact of insolvencies in each country because there is no indication of the size of each case. An increase in the number of bankruptcy cases does not necessarily entail an increase in bad debt write-off rates for the economy as a whole.
Bankruptcy statistics are also a trailing indicator. There is a time delay between financial difficulties and bankruptcy. In most cases, several months or even years pass between the financial problems and the start of bankruptcy proceedings. Legal, tax, and cultural issues may further distort bankruptcy figures, especially when comparing on an international basis. Two examples:
The insolvency numbers for private individuals also do not show the whole picture. Only a fraction of heavily indebted households will decide to file for insolvency. Two of the main reasons for this are the stigma of declaring themselves insolvent and the potential business disadvantage.
- In Austria, more than half of all potential bankruptcy proceedings in 2004 were not opened, due to insufficient funding.
- In Spain, it is not economically profitable to open insolvency/bankruptcy proceedings against certain types of businesses, and therefore the number of insolvencies is quite low. For comparison: In France, more than 40,000 insolvency proceedings were opened in 2004, but under 600 were opened in Spain. At the same time the average bad debt write-off rate in France was 1.3% compared to Spain with 2.6%.
- Bankruptcy alternatives
- Creditor's rights
- Debt consolidation
- Debt relief
- Debt restructuring
- Debtor in possession
- DIP Financing
- Distressed securities
- Financial distress
- Judicial estoppel
- Stalking Horse Agreement
- List of business failures
- Tools of trade
- Turnaround ADR