Understanding Bankruptcy: The Basic Concepts
For many, bankruptcy is a confusing subject — and a daunting one. As with most issues involving the law, it can be hard to dig through all the legal jargon used. And when you’re feeling stressed about your finances, it can be even harder to understand the process.
We’re here to walk you through the bankruptcy process and understand what relief bankruptcy offers you as an individual. This post introduces some of the basic concepts of bankruptcy. If you are considering filing for bankruptcy in Arizona, contact us for a free consultation to find out how these basic concepts would apply to your individual situation.
Under United States law, individuals have the option of filing different types of bankruptcy when they are under the burden of too much debt. We’ll be discussing Chapters 7, 11, and 13 bankruptcy. We’ll spend the most time on Chapters 7 and 13 bankruptcy as those are most applicable to individuals like you.
Basic Concepts in Bankruptcy
First let’s look at some common terms used in bankruptcy. Once you file bankruptcy you are considered the “debtor.” Everyone you owe money to is a “creditor.” All the property that is dealt with during bankruptcy is called the bankruptcy “estate.” Under the law, you’re allowed to “exclude” some property from your estate, and you can claim an “exemption” for certain amounts and kinds of property.
Voluntary bankruptcy is a legal process initiated by the debtor. When you file a bankruptcy case, you are seeking relief from debt under the protections and requirements of the federal Bankruptcy Code. Bankruptcy cases are brought before the United States District Court, but they are generally referred to a special bankruptcy court for the district.
Chapter 7 bankruptcy is often referred to as “liquidation” or “straight bankruptcy.” In a Chapter 7 bankruptcy, anything you own that is included in the bankruptcy estate is converted to cash, which is then given to your creditors to settle your debt. At the end of Chapter 7 bankruptcy you receive what is called a “discharge.” A discharge means that you no longer have any personal responsibility to pay the debts included in the discharge.
In contrast to Chapter 7 bankruptcy, Chapter 11 or 13 bankruptcy is often referred to as a “reorganization” of your financial situation. Both Chapter 11 and Chapter 13 are available to individuals, but Chapter 11 is more commonly used by companies, while the requirements and rules under Chapter 13 usually make it more attractive for individuals.
If you ever read news about large companies reorganizing business finances through Chapter 11 bankruptcy, you may have seen that creditors have the right to vote on or approve of the companies proposed reorganization. Under Chapter 13 bankruptcy, the companies or individuals you owe money to don’t vote on or approve your proposed plan for paying back some of what you owe. And unlike Chapter 11, only you propose the plan for some or all of your debts. In Chapter 11, your creditors can also propose plans.
If you consider that Chapter 11 is most often used by large companies, it makes sense that creditors have the right to propose or vote on the plan to repay debt. Because very large sums of money that impact multiple companies are usually involved, creditors have a much larger stake in what happens in the bankruptcy.
In a Chapter 13 bankruptcy case, at the end of payment plan period you will receive a discharge, just as in Chapter 7 bankruptcy. This means you no longer have any personal responsibility to pay the debts included in the discharge.
An important point to remember is that when you owe money on a house or other property such as a car (secured loans), the mortgage company or bank can’t come after you personally if that loan was discharged in the bankruptcy. However, the company has a right to the property itself unless you pay the debt, which means that it can foreclose or repossess the property if you can’t make the payments.
Purposes of Bankruptcy
Bankruptcy is generally understood to have two purposes. The first purpose is to give individuals and companies the chance to get a fresh start when faced with financial problems. The second purpose is to give creditors an equal chance to recover what is owed to them by the debtor.
Individuals who file bankruptcy often have little property to be distributed to creditors. So the most important factor in consumer bankruptcy is usually to give individuals a new beginning. The idea behind this is to allow the individual to become productive and contribute positively to society.
The Supreme Court has described bankruptcy as giving “… to the honest but unfortunate debtor … 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, 244 (1934)).
Bankruptcy has also been described as a tool that “greases the wheels of a capitalist economy, offering a safety valve that somewhat tempers its harshness for those who do not fare well in free-market competition…. (It also) encourages risk-taking and expansion” (Consumer Bankruptcy Law and Practice, 2009). Thus, while bankruptcy might offer more to the individual debtor than to his creditors in the short term, in the long term it benefits the economy as a whole.
And creditors enjoy some direct benefits as well. Bankruptcy does offer them an equal opportunity to the assets owned by an individual or company. It also discourages (and stops) creditors from rushing in to foreclose or repossess property owned by the individual, leveling the field for all creditors.
Understanding the Bankruptcy Estate
We most often hear the word “estate” when someone dies and leaves property or money to family and friends. “Estate” is used in bankruptcy to describe all of the property that is handled by the court in a bankruptcy.
When you file bankruptcy, the estate is created. The estate consists of whatever property you own or have some legal right to, including property that is jointly owned. Certain property is exempted, which we will discuss next.
If you own property with another person, but only you file bankruptcy, it is only your portion of that property that is included in the estate, as a general rule. However, this can be a complicated issue. If you have jointly owned property it is best to set up a free consultation with one of our attorneys to discuss the specifics of your case.
The bankruptcy estate includes not only tangible property but also the right to receive certain types of income. For example, if you own a rental property both the property itself and the rents you expect to receive from that property would be included in the bankruptcy estate. Similarly, if you filed an insurance claim for a car accident before you filed bankruptcy, and then receive the money after bankruptcy starts, that money would be included in the bankruptcy estate.
Most of the time, if you get property after filing bankruptcy this will not be included in the estate. But, there are exceptions to this when you get the property within 180 days after filing bankruptcy. If you inherit money or property with 180 days, this will be included in the bankruptcy estate. And if you get a divorce and receive a property settlement, or you receive life insurance proceeds within 180 days, these are included in the estate.
It is very important to reveal all of your property, assets, and expectations of income in your bankruptcy proceedings. Failure to do so may mean that your discharge will be revoked. A bankruptcy attorney can assist you in making sure that all of your appropriate property is included in the bankruptcy estate.
Property Not Included in the Estate
Consumer debtors often find that all or most of their property can be exempted from the bankruptcy estate. For example, the homestead exemption in Arizona protects up to $150,000 of the filer’s equity value in certain real property interests. Among the many other property exemptions are specific and detailed allowances for household furniture, furnishings, and appliances; food, fuel, and provisions; etc.
In general, all retirement plans are not included in the bankruptcy estate. Before the 2005 bankruptcy law changes, certain retirement plans were not included, but since 2005, most retirement plans are exempt from bankruptcy. If you have an IRA that has never been rolled over, this amount is capped at $1,095,000.
If you have started education savings accounts for your children, they are generally not included in the bankruptcy estate. There are some limitations on this. If you deposited money into an education savings plan within 1 year of your bankruptcy filing, those funds are included in the estate. And if a deposit was made within 1-2 years before filing bankruptcy then you can only exclude $5,475 per student/child.
In order to make sure that education savings accounts are not included in the bankruptcy estate, the money must be for a child, stepchild, grandchild, or stepgrandchild.
Tax refunds are generally included in the bankruptcy estate. It is important to consult with our attorneys to make sure that you chose the right time to file your bankruptcy when expecting a refund.
The Bankruptcy Trustee
For Chapter 7 and Chapter 13 bankruptcy cases, a “trustee” is appointed, whose role is to represent the interests of the unsecured creditors. The trustee is a party to the bankruptcy case, but does not have the power to resolve disputes. Rather, the trustee represents the creditors by filing or responding to issues, which are then resolved by the court.
The trustees are by no means out to get the debtor; they are required to follow certain rules laid out by bankruptcy law. A trustee is selected from a panel of private trustees established by the Executive Office of the US Trustee. After the date of filing, the trustee will send a letter to the debtor requesting certain documents. A hearing is assigned approximately six weeks after the date of filing; during those six weeks the trustee has time to figure out if there are any loose ends or questions they have for the debtor. The hearing is known as the “meeting of creditors” and is conducted by the trustee. In spite of its name, creditors rarely show up at the meeting.
Depending on the case, the trustee may be responsible for collecting the property included in the bankruptcy estate, liquidating nonexempt property, and distributing the proceeds to the creditors. The trustee may also be responsible for objecting to the exemption of property, to the discharge, and to transfers of property the debtor attempts to make during the bankruptcy case. These actions protect the rights of the creditors. While the role of the trustee is valid and important, it is also possible for a trustee to overstep their appropriate role by, for example, making unreasonable requests for information from the debtor.
The debtor is obligated by law to cooperate with the trustee, but not to do the trustee’s work for them. On the other hand, it is best not to unreasonably irritate the trustee. Trustees have some discretion, and this is why you do not want your trustee to dislike you. Although trustees are generally there to follow the law and will act professionally, if the trustee has no ill will against you, the trustee is likely to avoid expending too much energy in order to obtain small amounts of assets.
For instance, let’s say you have an expensive shoe collection. Under Arizona’s exemptions, you are permitted only $500 worth of clothing. Because your clothing is used, most people do not have anywhere near $500 worth. However, if you have designer shoes that are worth a great deal of money, they will not be considered exempt, and can be sold by the trustee to pay your creditors.
Most trustees will not do this, however, unless the assets are really significant, because of the hassle involved in marketing each pair of shoes and the relatively limited return. But if your trustee has grown to dislike you, he or she may be more interested in expending this energy. Whether he or she will do so will depend greatly on the personality of the trustee, and also on how you treat him or her. Do you lie, or act disrespectfully? It is important to be kind and professional with your trustee, for your own benefit. Dealing with the trustee can be complicated, and it is best to have a trusted attorney advise you.
The process of Arizona bankruptcy can be difficult and unique for each situation. If you are looking into filing for bankruptcy, it is in your best interest to consult with a competent Tucson bankruptcy attorney before taking any action. I am one of Tucson’s most prolific filers of bankruptcy petitions. That didn’t just happen by luck. My staff and I work hard to make sure our clients have a superior experience with our firm. If you are considering filing for bankruptcy in Arizona, contact us for a free consultation to find out how we can help.