Bankruptcy: An Overview

Bankruptcy is a legal process. The person filing for bankruptcy is called a debtor. The debtor files papers with the U.S. Bankruptcy Court (which is a federal court). By filing these papers, debtors are telling all creditors (the people, companies, or other entities that the debtor owes money to) that they are asking for relief from creditors. A debtor can be a person or a married couple, a company, or even a city.

In determining whether a person should file a bankruptcy, a lawyer should think about the worst-case scenario if the would-be debtor did not file a bankruptcy. The bankruptcy lawyer and potential debtor should discuss the matter.

The roots of bankruptcy are older than our country. The word “bankruptcy” comes from Latin words meaning “broken bench” (perhaps leading to the expression that a person is “broke”). The term "broken bench" shows that the concept of bankruptcy arose from business bankruptcy. A businessman or tradesman who goes out of business is no longer able to ply his trade from his workbench.

Personal bankruptcy also has a long, troubled history. In Europe and in the early history of the United States, people who could not pay back their debts went to debtor’s prison. Those were abolished in the U.S. in 1833. But bankruptcy still has a stigma. People feel ashamed about not paying back a debt that they agreed to pay and expected to pay, but now cannot pay.

Bankruptcy is in the U.S. Constitution, which says that “The Congress shall have power . . . To establish . . . uniform Laws on the subject of Bankruptcies throughout the United States.”  Bankruptcy laws are found in the Bankruptcy Code, which can be found at Title 11 of the U.S. Code, and in the Federal Rules of Bankruptcy Procedure (called the “Bankruptcy Rules”). The Bankruptcy Code tells you what to do, and the Bankruptcy Rules tell how to do it.

A good summary of bankruptcy law and procedure is available from the U.S. Bankruptcy Court here.

Every bankruptcy case has a judge. There are bankruptcy judges for each U.S. District Court. Texas has four U.S. districts: Northern, Southern, Eastern, and Western.

Bankruptcy judges sit in a separate court called the bankruptcy court. The only cases they work on are bankruptcy cases. The bankruptcy court is one level below the U.S. District Court, so if a bankruptcy judge’s order or ruling is appealed, the appeal goes to the U.S. District Court.

Every bankruptcy case has a trustee. The trustee is not a judge. The trustee’s duties depend on what type of bankruptcy the debtor has filed. In Chapter 11, 12, or 13, the debtor is reorganizing. Reorganizing means trying to pay back debts by making payments to creditors through an approved plan called a plan of reorganization (Chapter 11); a Chapter 12 plan; or Chapter 13 plan. In those chapters, the trustee evaluates the plan and recommends to the bankruptcy judge whether the plan should be “confirmed” (approved).

In Chapter 12 and Chapter 13, the trustee receives the debtor’s plan payments each month, and after taking a small fee, pays the remaining money to creditors according to the debtor’s confirmed plan.

In Chapter 7, debtors are liquidating, meaning that they tell creditors that they can’t pay them anymore. They let the trustee liquidate (sell, take) any nonexempt assets. However, a debtor is allowed to “exempt” (protect) most basic assets in order to get a fresh start after the bankruptcy is over. Therefore, most Chapter 7 cases end quickly as “no-asset” cases. In these, the trustee files a report with the bankruptcy court saying that there are no assets available to liquidate to repay creditors. A Chapter 7 trustee’s duties are laid out in 11 U.S.C. section 704.

If the debtor has nonexempt assets like a second house, or more cars than there are drivers in the debtor’s household, the trustee sells those nonexempt assets. After taking their fees, trustees pay the rest of the money to some or all creditors who have filed a document called a proof of claim with the bankruptcy court.

Discharge is when you have done everything you’re supposed to do and you are released, like when you are discharged from the hospital, or discharged from the military. Discharge in bankruptcy means that you have complied with whatever the law requires and a discharge order has been entered relieving you of some or all your debts. Discharge—whether from the military, the hospital, or a bankruptcy—is a good thing.

Dismissal is a bad thing. Because your bankruptcy case is a voluntary petition, you, as the debtor, are asking the court for relief from your creditors. When the case is dismissed, that means that you no longer have that relief or protection, and none of your unpaid debt was eliminated.

A bankruptcy case (petition) is filed by a debtor. The Bankruptcy Code defines “debtor” as the “person or municipality” in whose name the case is filed. The Bankruptcy Code says that the term “person” includes an “individual, partnership and corporation.”

If a debtor is judgment-proof, that usually means the debtor has no assets or income that a creditor can collect.

For instance, a credit card company could sue a debtor to collect credit card debt. That creditor might win the lawsuit. Winning means the creditor gets a court order saying that the debtor owes that creditor a certain amount of money. 

But that debtor might be judgment-proof. For example, all his income could come from Social Security, and kept in a bank account that doesn’t contain funds from any other sources. The debtor might rent, not own, an apartment. Also, the creditor could be a private entity, like a credit card company (rather than a government entity). The creditor can go to court and get a judgment. But the creditor won’t be able to do much, other than to call the debtor and send collection letters.  There is nothing to collect, or nothing the creditor would be allowed to collect.

You don’t have to have a lawyer. You might be able to make it through a Chapter 7 case by yourself. But filing a reorganization case under Chapter 11, 12, or 13 is tough—even with a lawyer.

As it says in the instructions for official bankruptcy forms, “It is extremely difficult to succeed in a Chapter 11, 12, or 13 case without an attorney.” Reorganization cases are hard to get off the ground and require years of maintenance. For instance, a Chapter 7 case lasts about three months. But if it gets confirmed (that is, successfully approved by the bankruptcy judge), a Chapter 13 case can last as long as five years.

Chapter 12 is a reorganization plan for farmers and fishermen—that is, people who make their living from farming or fishing. It is similar to Chapter 13.

Debtors with more than $394,725 in unsecured debt or $1,184,200 in secured debt cannot file under Chapter 13. They must file under Chapter 11.

Chapter 11 is more complicated than Chapter 13. It requires dividing your creditors into classes, then trying to get enough creditors to vote to confirm your reorganization plan. Both Chapter 7 and Chapter 11 can be used by people or companies.

Chapter 12 and Chapter 13 are only for individuals (a person or a married couple).