An Introduction to Bankruptcy

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Bankruptcy is a legal process that provides debt relief to consumers and companies who can not pay their debt. Bankruptcy Code was enacted by Congress in 1978 and has been amended several times since then. Bankruptcy procedure is governed by federal rules and local rules of each bankruptcy court. The U.S. is divided into 94 federal judicial districts each with their own court and federal judge. These courts handle bankruptcy matters as well as other federal cases.

There are six major types of bankruptcy – Chapter 7, Chapter 9, Chapter 11, Chapter 12, Chapter 13 and Chapter 15. Each of these has a different purpose and will be discussed in future blogs. Chapter 7 is also called liquidation. The individual’s property is sold to pay off debt. Chapter 13 or wager earner is when the court works out a repayment plan for part or all of the individual’s debt. Chapter 12 was designed for the family farmer or family fisherman.

The other three types of bankruptcy are for companies or commercial entities. Chapter 11 also known as reorganization allows a business to restructure so it can remain open. Chapter 9 covers municipalities. Chapter 15 was designed for ancillary and other cross-border cases.

The original intent of bankruptcy law was to provide individuals and companies a new start. Debts were forgiven and individuals were allowed to start over again. Once a bankruptcy petition is filed with the federal court, regardless of chapter type, creditors can no longer contact or harass the debtor over past due amounts. There are some types of debts – such as child support, alimony, student loans, tax liens, etc – that can not be discharged.

Lenders consider all types of bankruptcy to be serious derogatory credit. It is reported to the major credit bureaus and can stay on credit reports for up to ten years. After a bankruptcy it’s difficult to get credit. Lenders charge higher interest rates and sometimes penalties. Bankruptcy not only lowers your credit score but it sometimes prevents you from getting jobs, can increase your insurance premiums, and is a negative on background checks.

Filing bankruptcy does not mean someone is financially irresponsible. Statistics show that half of the individuals filing experience a serious health problem and two out of three lost a job. Divorce is also a strong contributing factor. Sometimes individuals experience all three at the same times. It is more difficult to put a number on financial mismanagement. This is definitely the cause of some bankruptcies, especially credit card debt that gets out of control.

Before 2005 the number of bankruptcy filings had been increasing every year. Some legislators were concerned that individuals did not try hard enough to pay their bills. After months of debate, in 2005 congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. It is now more difficult to do Chapter 7 liquidation, which is basically a full forgiveness of most debts. The biggest change is debtors are now required to get pre-filing credit counseling and post-filing financial education.

It’s too soon to measure if the Act of 2005 was successful. As consumers learned about the proposed changes they started to file bankruptcy. The total filings for 2005 were approximately four times higher than the year before. At the beginning of 2006 the numbers went down. But every quarter since then the numbers have steadily gone up. Experts contribute this to the mortgage crisis.

Sometimes a person gets in financial situations with no way out. Bankruptcy should be the last resort. If all possibilities are exhausted and there’s nothing you can do to recover, bankruptcy might be the best choice. I recommend filing on your own if this happens. If you can’t pay your bills and you don’t file bankruptcy, your creditors will force you into bankruptcy. It’s easier if you do this voluntarily.

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