The Bankruptcy Code is a uniform federal law which is used to govern all bankruptcy-related cases. According to U.S. Constitution Article I, Section 8, Congress is authorized to enact “uniform Laws on the subject of Bankruptcies”. The “Bankruptcy Code” (title 11 of United States Code) was thus enacted by the Congress in 1978 and has undergone several amendments since then. The bankruptcy process proceedings are governed by the Bankruptcy Rules (Federal Rules of Bankruptcy Procedure) and local rules of each bankruptcy court. As per bankruptcy rules, a certain set of official forms are to be used in bankruptcy cases. Thus, both Bankruptcy Code and Local Bankruptcy Rules are used to conduct legal proceedings while dealing with debt issues of both individuals and businesses.
Each state of U.S. has one or more districts, with each judicial district having a bankruptcy court. According to Los Angeles based law firm Recovery Law Group, there are at present 90 bankruptcy districts across the country, each having their own clerk’s office. The United States bankruptcy judge has the decision making power over any federal bankruptcy case including whether a petitioner is eligible to file or if the debtor should be discharged of debts etc. Mostly the bankruptcy process is administrative in nature and is generally conducted away from the courthouse. Generally, the trustee appointed to oversee the case carries out the administrative process for bankruptcy cases filed under chapters 7, 12, 13 and sometimes even chapter 11.
More often than not, a debtor has very limited interaction with the bankruptcy judge. A chapter 7 debtor doesn’t appear in court unless an objection is raised in the case, whereas a chapter 13 debtor appears before the bankruptcy judge only at his repayment plan confirmation hearing. The only formal proceeding that a debtor must attend is the creditors meeting, usually held at the U.S. trustee’s office. Since section 341 of the Bankruptcy Code requires that the debtor attend a meeting where the creditors can question the debtor about property & debts, the meeting is called a “341 meeting”.
Bankruptcy laws had been enacted by the Congress (as per a 1934 decision) so that debtors could get a new financial start from their heavy debts. With these laws in place, an honest debtor can start afresh and make efforts for a brighter future free of the pressure of any pre-existing debt (Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934)). This is accomplished through bankruptcy discharge, whereby personal liabilities from specific debts are released and creditors are prohibited from ever taking action against the debtor regarding those debts. Various issues related to bankruptcy discharge like the timing of discharge, its scope (i.e. which debts are discharged and which aren’t), objections if any to the discharge and revocation of the discharge need to be clearly discussed. Apart from this, the debtor must be aware of any actions that they can take against creditors if they attempt to collect a discharged debt post the conclusion of the bankruptcy case.
Under the Bankruptcy Code, 6 basic kinds of bankruptcy cases are dealt with. These cases are generally named after the bankruptcy chapters under which they fall.
Chapter 7 (Liquidation) considers a court-supervised procedure for the debtor where a trustee (appointed by the court) takes control of the debtor’s estate and assets, reduces them to cash and distributes it to the creditors while allowing the debtor to retain some exempt property and the rights of secured creditors. Most of the time, there is little (or none) non-exempt property in most chapter 7 cases, actual liquidation of debtor’s assets may not take place. Such cases are termed as “no-asset cases”. Any creditor holding unsecured claim gets distribution from the bankruptcy estate only if it is an asset case and the creditor files a proof of claim in the bankruptcy court.
In case an individual files for bankruptcy under chapter 7, he/she can get a discharge from personal liabilities for certain dischargeable debts within a few months of filing the petition. As per amendments to the Bankruptcy Code under Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, a “means test” is used to determine if an individual consumer debtor qualifies for chapter 7 related relief. In case the debtor’s income is above some specified threshold, no relief under chapter 7 can be provided to him/her.
Chapter 9 (Adjustment of Debts of a Municipality) provides reorganization (similar to that under chapter 11) with the exception that only a “municipality” can file under chapter 9. Municipalities include villages, towns and cities, counties, taxing districts, school districts, and municipal utilities.
Chapter 11 (Reorganisation) is usually used by commercial establishments who wish to continue in operation, yet simultaneously repay their creditors through a court-approved reorganization plan. Chapter 11 debtor can file a plan for reorganization within the first 120 days of filing the case and should also provide creditors with disclosure statement having adequate information regarding creditors to evaluate the plan. The court puts its seal of approval or disapproval over the reorganization plan. Once approved, the debtor can reduce the debt by repaying some part of the debt while others are discharged. At the same time, the debtor can end burdensome contracts and leases, recover any assets and rescale the set-up to become profitable. During chapter 11 bankruptcy, the debtor can consolidate, reduce the debt and reorganize the business.
Chapter 12 (Adjustment of Debts of a Family Farmer or Fisherman with Regular Annual Income) can be used to provide debt relief to families of farmer and fishermen having a regular income. The process is similar to that of chapter 13; debtor proposes a plan to repay debts over a period of 3-5 years. A trustee is allocated under chapter 12 who ensures distribution of payment to creditors as per the confirmed plan. Chapter 12 allows the debtor (family farmer or fisherman) to continue their work while the plan is being carried out.
Chapter 13 (Adjustment of Debts of an Individual with Regular Income) is for individual debtors with a regular source of income. Those individuals who fail the means test and are thus ineligible for relief under chapter 7, can file for bankruptcy under chapter 13. This chapter is preferred over chapter 7 as it allows the debtor to keep a valuable asset like a house; allows the debtor to propose a repayment plan where within a 3-5 year time frame the creditors are paid. The court can approve or disapprove the repayment plan at the confirmation hearing depending whether it satisfies Bankruptcy Code’s requirements for confirmation or not.
Unlike chapter 7 bankruptcy, people filing under chapter 13 can remain in possession of property of the estate and also make payments to creditors (via bankruptcy trustee) depending upon the estimated income over the repayment plan time frame. However, the debtor’s debts are not immediately discharged (as in under chapter 7) but are done when the repayments are made as per the court-approved plan. The debtor is, however, protected from lawsuits and other creditor actions when the repayment plan is underplay. Moreover, more debts are removed in chapter 13 than those discharged under chapter 7.
Chapter 15 (Ancillary and Other Cross-Border Cases) provides an effective strategy to deal with cases involving cross-border insolvency. In this case, the debtor and/or its property is subject to laws on the U.S. and one or more foreign countries.
Bankruptcy Basics also provides an overview of the Service Member’s Civil Relief Act, which provides protection of members of the military against the entry of default judgments, while giving the court the ability to stay actions against any military debtor.
Description of liquidation proceedings under the Securities Investor Protection Act (“SIPA”) are also described in the Bankruptcy Basics. Despite the Bankruptcy Code providing a stockbroker liquidation proceedings, it is quite possible that a failing brokerage firm opts for a SIPA proceeding. The aim of SIPA is to return to investor’s securities and cash left with failed brokerages. Since its establishment in 1970 by the Congress, the Securities Investor Protection Corporation has protected investors who deposit bonds and stocks with brokerage firms by guaranteeing that every customer’s property is protected (up to $500,000 per customer).