Throughout my career, I have heard bankruptcy called a “fresh start,” a “lifeline,” and even “a gift from Congress” (the process was created by the U.S. Constitution way back in 1788, (Article 1, Section 8, Clause 4). There are many ways to describe it, but put simply, bankruptcy is a legal process that helps individuals, married couples, or companies obtain relief from debts that have become unmanageable.
What everyone agrees on is that, for someone facing seemingly insurmountable, unpayable debts, bankruptcy can offer financial relief, a way out from under crushing debt and a clear path forward. And, while I can’t promise it will be the easiest thing you will ever do, it is surprisingly less difficult than most people initially think, and I have never known anyone who has regretted filing for bankruptcy.
I often say that good lawyers, really, only sell two things – translation and peace of mind. Translation means the ability to properly make your case before a court, then to explain to you what the court or bankruptcy trustee says in a way that makes sense. In short, translation means the ability to easily switch between legalese and plain English. Peace of Mind simply means “My lawyer is handling the matter – Dave/Roemerman Law is on it and I feel good.” It does not guarantee a perfect result, but it should mean that you are confident you’re getting competent legal representation and that know where you stand in your legal proceeding.
This guide is intended to translate some of the complexities of the bankruptcy code into plain English. There is no way to cover everything in a short article, and it does not constitute legal advice, but I think it is a good place to get started if you are considering bankruptcy.
The bankruptcy process begins when a person/couple/company struggling with debt, known as the debtor, files a petition in one of 90 federal district courts. This is usually done where you live or where your business operates. The court will then give notice to all the people/companies to whom you owe money, known as your creditors, and call them to the table to settle your debts. The process is guided by the U.S. Bankruptcy Code (11 US Code Title 11), applying state property laws. This petition is filed under one of several available chapters of the bankruptcy code. You have probably heard of Chapter 7, Chapter 11, and Chapter 13, as those are the main chapters that most debtors file under.
While there are six available chapters, the three we are most concerned with here are Chapter 7, Chapter 11, and Chapter 13. All three are available to individual debtors/married couples, and Chapter 7 and Chapter 11 are also available for businesses. Each of these has its respective benefits and concerns to consider. This article gives a quick summary of each, but you can click on the links below to read more about each chapter.
A Chapter 7 filing is often called a “liquidation” or a “straight bankruptcy” filing. You must be eligible to file under Chapter 7, as measured by the Means Test. Under the Means Test, the bankruptcy code forbids you from filing under Chapter 7 if you make too much money. If you make less than the median household income for your state and your household size, you are automatically eligible for Chapter 7; if you make more than that, there is a formula that subtracts your allowable monthly expenses from your current monthly income (the average of your income over the past six months) to determine your monthly disposable income. This disposable monthly income number is then compared to the amount allowable under the bankruptcy code to determine whether you are eligible for Chapter 7, ineligible, or must dive further into whether you can pay at least 25% of your unsecured, non-priority debt.
If that sounds complicated, that’s because it can be complicated. In my opinion, the Means Test is one of the best reasons to seek the counsel of a good attorney before filing for bankruptcy. For what it’s worth, when it comes to personal filings, two of every three New York bankruptcies are Chapter 7 filings, with Chapter 13 making up the rest.
If you qualify, there are several appealing reasons to file under Chapter 7.
The downside to Chapter 7 is that the trustee or creditors may be able to seize and sell some of your larger assets to sell and pay a portion of your debts. That said, historically, well over 90% of Chapter 7 bankruptcy cases in New York are no distribution cases, meaning that the trustee does not seize and sell any assets, leaving no money to distribute to creditors. Additionally, some debts that are accounted for in a Chapter 13 plan, such as taxes and domestic support obligations, are not discharged in Chapter 7 and will simply survive the bankruptcy, meaning you will still owe them after your bankruptcy is complete.
A bankruptcy filing under Chapter 13, only available to individuals or couples, is often called a “debt reorganization” or “debt adjustment” and a debtor is required to pay back all, or part, of the debts owed, usually over a 3-to-5-year period. The Chapter 13 repayment plan – sometimes referred to as a wage-earner’s plan because it requires the debtor to have regular income in the future – must be approved, or confirmed, by the court, and your payments made over the scheduled period until the plan is completed. If your plan pays all of your outstanding debts, it is called a “100% plan.” If you cannot afford a 100% plan, you can pay all of your disposable income (another calculation) over the life of the plan and the outstanding balance will be discharged.
Why to file under Chapter 13
As an example, say you have a $60,000 credit card balance with a 20% interest rate. That costs you roughly $12,000 a year (20% of $12,000), or $1,000 a month, just to make the interest payments. In a Chapter 13 repayment plan, no interest is charged, meaning your $1,000 a month payment, for 5 years (60 months) would cover the entire $60,000 balance. You have paid 100% of your debt. Without filing for bankruptcy, you would have paid $60,000 in interest ($12,000/year x 5 years) without making a dent in the $60,000 you owed in the first place. In other words, filing for bankruptcy still saves you a ton of money.
The downside to Chapter 13 is, of course, that you will be paying back a large portion of your debts over a few years, which is more expensive than a Chapter 7 filing and can lead to problems should you lose a job or have other financial hardships before completing your plan. This is where a lawyer can offer you peace of mind by helping you decide which chapter to utilize to give you the best post-bankruptcy situation possible.
A Chapter 11 is often called a “debt reorganization” (like Chapter 13) or a “debt restructuring” and is much more commonly used by businesses. Chapter 11 allows a company to cut costs, evaluate how to increase revenue, and look at ways to increase profitability. This is sometimes referred to as a “Chapter 13 for businesses.” Oftentimes, the debtor company stays in possession of its assets and continues to function. This is known as a debtor-in-possession (or “D-I-P”). Additionally, there is an early 2020 addition to the bankruptcy code, Chapter 11, Subchapter V.
Chapter 11, Subchapter V
Chapter 11, Subchapter V was created to be a cheaper, quicker, and easier Chapter 11 bankruptcy option for smaller businesses and individuals engaged in commercial activity; the debtor’s total debts must be less than $2,725,625 (in 2021).
Other Chapters of the Bankruptcy Code
Most of the proceedings in the above-mentioned chapters are governed by Chapters 1, 3, and 5 of the U.S. Bankruptcy Code. Additionally, debtors may file under Chapter 9 (municipalities), Chapter 12 (family farmer or fisherman), or Chapter 15 (cross-border bankruptcy, usually filed in another country, used to resolve issues in the U.S.). If you are an individual or small business looking to file, Chapters 1, 3, and 5 will impact your filing, but it is highly unlikely you would file under Chapters 9, 12, or 15.
For the purposes of this overview, we will stick to Chapters 7 and 13, the most common chapters under which individuals and couples file for bankruptcy.
The most important question in bankruptcy, probably the question you want answered, is “should I file?” While that is an individual question best answered by giving us a call and sharing your story, I can tell you the basic advantages of bankruptcy. Filing for bankruptcy offers debtors a unique solution to their problems that they cannot find elsewhere. As soon as you file, the automatic stay protects your assets from creditors. Additionally, filing for bankruptcy forces all your creditors to the table to resolve your issues, even if they were previously unwilling to negotiate with you.
Finally, bankruptcy can discharge debt, allowing you to walk away from tens or even hundreds of thousands of dollars in debt for a few thousand dollars in court and attorneys’ fees, tax-free.
Here is why bankruptcy is so helpful:
When someone files for bankruptcy, the automatic stay immediately protects their assets. It prevents creditors from touching the debtor’s assets until the court has determined the rights of everyone involved.
The stay kicks in as soon as the bankruptcy petition is filed and creditors are automatically stayed from taking further action. This automatic stay is an injunction that prohibits creditors from taking certain actions against the property of the debtor who just filed the bankruptcy petition. The protections of the automatic stay include:
In short, the automatic stay is one of the most powerful aspects of the bankruptcy code, protecting your assets against almost all collection efforts until the court rules on your case.
The U.S. Supreme Court once summarized bankruptcy very well, saying:
“One of the primary purposes of the bankruptcy act is to ‘relieve the honest debtor from the weight of oppressive indebtedness and permit him to start afresh free from the obligations and responsibilities consequent upon business misfortunes.’.
This purpose of the act has been again and again emphasized by the courts as being of public as well as private interest, in that it gives to the honest but unfortunate debtor who surrenders for distribution the property which he owns at the time of bankruptcy, a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.”
Local Loan Co. v. Hunt, 292 U.S. 234 (1934), citing prior cases.
When a bankruptcy proceeding concludes, many debts are discharged against the debtor. This means that the debts are no longer owed by the debtor. You may hear someone say the debts are “forgiven,” but I caution against people using that term, as the IRS considers a forgiven debt (such as a lender saying “you don’t owe me/us anymore”) to be taxable income, whereas debt discharged in bankruptcy is usually not taxable. Thus, if you’re filing for bankruptcy, you should get comfortable with using the term “discharged” when it comes to what will happen to your debt in bankruptcy.
This is the “fresh start,” or “clean slate,” that people often speak of in bankruptcy. It is likely that you will have many debts entirely discharged (extinguished, no longer owed).
Some debts are not discharged and survive; oftentimes taxes, domestic support obligations (alimony/spousal support and child support), and student loan debts survive a bankruptcy filing. For the debts that are discharged – which often includes all credit card debt, medical debt, and deficiency debt (money still owed, after the sale of a foreclosed-upon house or a repossessed car) – you will no longer owe them, nor will you owe them in the future. They are gone forever, leaving you with a “fresh start” regarding your personal debts, a chance to begin anew.
Roemerman Law seeks to put its clients in a better place in their lives, not merely “help you file for bankruptcy.” One of the requirements to filing a bankruptcy in New York is that you take both a pre-filing and a post-filing course. We offer these through DebtorCC (Credit Counseling) and can save you money when you work with us.
More importantly, we enroll all our clients in the 720 Credit Score Program at no extra cost, allowing you to build your credit score after the bankruptcy. Repeat business is nice in most industries; in bankruptcy, we would rather you file once, get the fresh start, then build your credit and never have to file again.
Obviously, the answer to this question depends on what you’ve heard…however, I seem to talk to someone at least once a week who has heard terrible and completely untrue things about bankruptcy. In fact, the American Bankruptcy Institute, a collection of bankruptcy lawyers, has published a list of its Top 9 Bankruptcy Myths. Among these are the concept that married people must file jointly, that bankruptcy ruins your credit (both now and forever), and that filing is a shameful thing to do, reserved for a select and irresponsible few. As to that last one, absolutely nothing could be further than the truth. Let us set the record straight.
Since 1988, non-business bankruptcies have averaged well over 800,000 per year, according to the American Bankruptcy Institute’s statistics. In other words, millions of Americans have filed for bankruptcy. The idea that filing for bankruptcy is somehow a unique thing, based on personal shortcomings or failures, comes from people who know little about the bankruptcy system in the United States. If you are reading this and considering bankruptcy, know that you are not alone.
Further, the list of people who have gone bankrupt (personal or business) or become insolvent (unable to pay their debts) includes many household names:
Presidents (number of their presidency):
Thomas Jefferson (3), James Madison (4), James Monroe (5), Abraham Lincoln (16), Ulysses S. Grant (18), William McKinley (25), Harry Truman (33), and Donald Trump (45).
Business Tycoons with Their Name on the Company (industry):
Walt Disney (entertainment), Henry Ford (automobiles) – twice, J.C. Penney (retail), Milton Hershey (chocolate), and P.T. Barnum (circus).
Marvin Gaye, Burt Reynolds, Toni Braxton, Cindy Lauper, Red Foxx, Willie Nelson, Francis Ford Coppola, Lawrence Taylor, 50 Cent (Curtis Jackson), and Mike Tyson.
In short, plenty of famous, important, and successful people have utilized the advantages of bankruptcy (or sold off their assets in non-bankruptcy liquidations) and bounced back. You can, too.
The line on your credit report stating that you completed a bankruptcy will remain for 10 years (Chapter 7) or 7 years (Chapter 13), respectively. However, your credit score can begin to recover immediately, as credit is a function of many different factors. In fact, if a bankruptcy wipes out a large portion of the amount of money owed and stops you from missing payments (thus, improving your payment history), the bankruptcy can improve aspects of your credit score. Many people rehabilitate their credit after filing and, if they have learned how to manage their credit and what to do to improve their credit scores, they may even end up with excellent credit.