Bankruptcy is the a legal procedure designed to protect a business or individual that cannot meet its financial obligations, as well as, protect creditors by ensuring each creditor is treated the same based on the type of debt they are owed. The process requires a debtor to prepare schedules listing all assets, debts, unexpired leases, executory contracts, and other types of liabilities.
Bankruptcies are governed by Title 11 of the U.S. Code, also known as the Bankruptcy Code, and are adjudicated by a system of Bankruptcy Courts. The Bankruptcy Courts are a part of the Federal Court System. These Bankruptcy Courts were created by Congress specifically to hear bankruptcy cases and controversies.
The debtor begins the process by filing a bankruptcy petition with the Clerk of the Bankruptcy Court in the Federal District where the debtor has lived or has had a principal place of business. The bankruptcy petition is a lengthy legal document that contains substantial information about a debtor’s financial situation prior to and at the time of filing. It is recommended that it be prepared with the assistance of an experienced bankruptcy attorney. Petitions that are incorrect or incomplete can have significant and serious consequences for the debtor.
The most common type of bankruptcy is Chapter 7. Chapter 7 bankruptcy is also called “straight” or “liquidation” bankruptcy. It is the simplest form of bankruptcy proceeding, and can be used by either individuals or businesses. In a Chapter 7, there is no repayment of debt plan. For individuals filing Chapter 7, nonexempt property is liquidated. However, it is not uncommon to have all of a debtor’s property be exempt and protected from liquidation. If filing as an individual, all debtor property becomes the property of the “bankruptcy estate.”
The bankruptcy Trustee can liquidate all nonexempt property in order to pay the unsecured creditors. Secured creditors are permitted to repossess the property upon which they have valid liens (such as a car). To the extent that their nonexempt property does not pay their unsecured, non-priority debts, the remaining debts (that are dischargeable) are discharged (meaning the debtor no longer has a legal obligation to pay the debt and cannot be collected against for it). There is no “exempt property” for businesses filing Chapter 7.
Two additional bankruptcy options: Chapter 11 and Chapter 13, will be discussed in future posts.