What is Bankruptcy? An Introduction

You may have heard the term bankruptcy and wondered, what is bankruptcy?  Essentially, bankruptcy is the forgiveness of debts.  For consumers, there are two different varieties of bankruptcy, chapter 7 and chapter 13.  In a chapter 7 bankruptcy, the bankruptcy trustee liquidates your non-exempt assets and uses the proceeds from the sale to repay your creditors.   In a chapter 13 bankruptcy, you submit a repayment plan for your debts that outlines how you will pay your creditors in the next three to five years.  Under the plan, every month you pay the bankruptcy trustee directly and the trustee then distributes the funds to your creditors.  Strict compliance with your repayment plan is necessary.

History

The concept of bankruptcy can be traced back hundreds of years.  However, in the United States, the Bankruptcy Act of 1898 was the first legislation approved by Congress giving companies in distress an option of protection from their creditors.  The Bankruptcy Act of 1933 and 1934 was the next significant piece of bankruptcy legislation passed in the United States.  This Act was passed in response to the great depression.  Unfortunately, both Acts provided little relief for consumers.  However, in 1978, significant bankruptcy legislation was approved that gave consumers the same protections previously reserved solely for companies.  The Bankruptcy Act of 1978 made it much easier for both individuals and businesses to dissolve their debts or reorganize.  Since 1978, the number of bankruptcies filed each year has increased.  Congress responded by passing amendments to the Bankruptcy Code in 2005, creating the means test and redefining who may file for bankruptcy.   

Qualifying for Bankruptcy

To qualify for chapter 7 bankruptcy, you must pass the means test.  The means test considers the amount of income you make and compares your income to the median income in your state.  However, the means test considers factors other than your income.  For example, to determine if  you are eligible for bankruptcy, the means test calculates your monthly expenses.  The means test also calculates your disposable monthly income by deducting certain monthly expenses from your monthly income.  If you pass the means test, you qualify for chapter 7 bankruptcy.      

To qualify for chapter 13 bankruptcy, you must submit a repayment plan.  Your creditors will also be given notice of your repayment plan and they will have the opportunity to object to your plan.  Your repayment plan must be approved by your bankruptcy trustee.  If you manage to complete all necessary payments in the plan, you are given a full plan discharge.

Benefits of Bankruptcy

If you are eligible for bankruptcy and you have been trying to pay off your debts, but with little to no success, it may be time to consider filing for bankruptcy.  Bankruptcy eliminates most debts, like credit card debt and old taxes.  Bankruptcy allows you to get a fresh start, and begin building your credit again.  Bankruptcy also stops creditors’ harassing phone calls and letters. 

Disadvantages of Bankruptcy

There are disadvantages to filing for bankruptcy.  Bankruptcy does not eliminate all debts.  For example, student loans and child support payments are non-dischargeable debts.  These debts are not dischargeable because Congress feels elimination of these debts would violate public policy.  Another disadvantage of bankruptcy is its effect on your credit score.  A bankruptcy is a public record, and it can remain on your credit report for up to ten years.  However, consider that not filing for bankruptcy can leave unpaid debts on your credit report longer than a bankruptcy may appear.   

Getting Legal Help

If you have questions about what is bankruptcy, contact an experienced bankruptcy attorney in your area.  A bankruptcy attorney can help you decide if filing for bankruptcy is right for you.