Bankruptcy

Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay their creditors. A declared state of bankruptcy can be requested by creditors in an effort to recoup a portion of what they are owed; however, in the overwhelming majority of cases, the bankruptcy is initiated by the bankrupt individual or organization.

Purpose

The primary purpose of the laws of bankruptcy are: (1) to give an honest debtor a "fresh start" in life by relieving the debtor of most debts, and (2) to repay creditors in an orderly manner to the extent that the debtor has the means available for payment.

Bankruptcy allows debtors to resolve debts through the division of non-exempt assets among creditors. Additionally the declaration of bankruptcy allows debtors to be discharged of most of the financial obligations, after their non-exempt assets are distributed, even if their debts have not been paid in full. During the pendency of a bankruptcy proceeding, the debtor is protected from extra-bankruptcy action by creditors by a legally imposed stay. The creditor will not be permitted to continue lawsuits, garnish wages, or contact the debtor by phone to demand payment.

History

In the Old Testament, Moses' Laws prescribed one "Holy Year" should take place every half a century, when all debts are eliminated among Jews and all debt-slaves are freed, due to the heavenly command.

In ancient Greece, bankruptcy did not exist. If a father owed (since only locally born adult males could be citizens, it was fathers who were legal owners of property) and he could not pay, his entire family of wife, children and servants were forced into "debt slavery", until the creditor recouped losses via their physical labour. Many city-states in ancient Greece limited debt slavery to a period of five years and debt slaves had protection of life and limb, which regular slaves (mostly war prisoners and people of color imported from the marauders) did not enjoy. However, servants of the debtor could be retained beyond that deadline by the creditor and were often forced to serve their new lord for a lifetime, usually under significantly harsher conditions.

The word bankruptcy is formed from the ancient Latin bancus (a bench or table), and ruptus (broken). A "bank" originally referred to a bench, which the first bankers had in the public places, in markets, fairs, etc. on which they tolled their money, wrote their bills of exchange, etc. Hence, when a banker failed, he broke his bank, to advertise to the public that the person to whom the bank belonged was no longer in a condition to continue his business. As this practice was very frequent in Italy, it is said the term bankrupt is derived from the Italian banco rotto, broken bench (see e.g. Ponte Vecchio). Others rather choose to deduce the word from the French banque, table, and route, vestigium, trace, by metaphor from the sign left in the ground, of a table once fastened to it and now gone. On this principle they trace the origin of bankrupts from the ancient Roman mensarii or argentarii, who had their tabernae or mensae in certain public places; and who, when they fled, or made off with the money that had been entrusted to them, left only the sign or shadow of their former station behind them.

Bankruptcy fraud

Bankruptcy fraud is a business crime of filing for bankruptcy with criminal intent, that is with the intention of evading payment for goods even though the buyer has funds that could be used to pay for them, or accepting payment for goods or services but not supplying them. Common types of bankruptcy fraud include petition mills, false oath, concealment of assets, and fraudulent conveyance. Multiple filings are not per se fraudulent; as with all things in the law, it depends on the circumstances. Bankruptcy fraud should be distinguished from strategic bankruptcy, which is not a criminal act (but may prejudice a judge against the filer if there is evidence that bankruptcy is being used strategically).

Bankruptcy in Canada

Bankruptcy in Canada is set out by federal law, in the Bankruptcy and Insolvency Act and is applicable to businesses and individuals. The office of the Superintendent of Bankruptcy, a federal agency, is responsible for ensuring that bankruptcies are administered in a fair and orderly manner. Trustees in bankruptcy administer bankruptcy estates.

Duties of trustees

Some of the duties of the trustee in bankruptcy are to:

Review the file for any fraudulent preferences or reviewable transactions
Chair meetings of creditors
Sell any non-exempt assets
Object to the bankrupt's discharge.

Creditors' meetings

Creditors become involved by attending creditors' meetings. The trustee calls the first meeting of creditors for the following purposes:

To consider the affairs of the bankrupt
To affirm the appointment of the trustee or substitute another in place thereof
To appoint inspectors
To give such directions to the trustee as the creditors may see fit with reference to the administration of the estate.

Consumer proposals - an alternative to personal bankruptcy

In Canada, a person can file a consumer proposal as an alternative to bankruptcy. A consumer proposal is a negotiated settlement between a debtor and their creditors.

A typical proposal would involve a debtor making monthly payments for a maximum of five years, with the funds distributed to their creditors. Even though most proposals call for payments of less than the full amount of the debt owing, in most cases the creditors will accept the deal, because if they don’t, the next alternative may be personal bankruptcy, where the creditors will get even less money.

The creditors have 45 days to accept or reject the consumer proposal. Once the proposal is accepted the debtor makes the payments to the Proposal Administrator each month, and the creditors are prevented from taking any further legal or collection action. If the proposal is rejected, the debtor may have no alternative but to declare personal bankruptcy.

A consumer proposal can only be made by a debtor with debts in excess of $5,000 to a maximum of $75,000 (not including the mortgage on their principal residence). If debts are greater than $75,000, the proposal must be filed under Division 1 of Part III of the Bankruptcy and Insolvency Act.

The assistance of a Proposal Administrator is required. A Proposal Administrator is generally a licensed trustee in bankruptcy, although the Superintendent of Bankruptcy may appoint other people to serve as administrators.

According to the Superintendent of Bankruptcy, in 2005 84,638 consumers filed a summary administration personal bankruptcy, and 16,554 individuals filed a consumer proposal. [1]

Student loans in bankruptcy

Prior to 1997, student loans were discharged in bankruptcy. In September 1997 the Bankruptcy & Insolvency Act was amended so that student loans were only discharged in a bankruptcy if they were more than two years old. In 1998 the rules were changed again, increasing the time period from two years to ten years. Under bankruptcy reform (see above) student loans will be automatically discharged after 7 years (or 5 years with court approval). A history of changes to the treatment of student loans in bankruptcy can be found at Student Loan Bankruptcy.

Bankruptcy in the United Kingdom

In the United Kingdom (UK), bankruptcy (in a strict legal sense) relates only to individuals and partnerships. Companies and other corporations enter into differently-named legal insolvency procedures: liquidation, administration and administrative receivership. However, the term 'bankruptcy' is often used (incorrectly) when referring to companies in the media and in general conversation. Bankruptcy in Scotland is referred to as Sequestration.

A Trustee in bankruptcy must be either an Official Receiver (a civil servant) or a licensed insolvency practitioner.

Following the introduction of the Enterprise Act 2002, a UK bankruptcy will now normally last no longer than 12 months and may be less, if the Official Receiver files in Court a certificate that his investigations are complete.

It is expected that the UK Government's liberalisation of the UK bankruptcy regime will increase the number of bankruptcy cases; initial Government statistics appear to bear this out. It remains to be seen whether the legislation will need reviewing if this remains the case.

There were 20,461 individual insolvencies in England and Wales in the fourth quarter of 2005 on a seasonally adjusted basis. This was an increase of 15.0% on the previous quarter and an increase of 36.8% on the same period a year ago.

This was made up of 13,501 bankruptcies, an increase of 15.9% on the previous quarter and an increase of 37.6% on the corresponding quarter of the previous year, and 6,960 Individual Voluntary Arrangements (IVA’s), an increase of 23.9% on the previous quarter and an increase of 117.1% on the corresponding quarter of the previous year.

Bankruptcy in the United States

Bankruptcy in the United States is a matter placed under Federal jurisdiction by the United States Constitution (in Article 1, Section 8), which allows Congress to enact "uniform laws on the subject of Bankruptcy throughout the United States." Its implementation, however, is found in statute law. The relevant statutes are incorporated within the Bankruptcy Code, located at Title 11 of the United States Code, and amplified by state law in the many places where Federal law either fails to speak or defers expressly to state law.

While bankruptcy cases are always filed in United States Bankruptcy Court (an adjunct to the U.S. District Courts), bankruptcy cases, particularly with respect to the validity of claims and exemptions, are often highly dependent upon State law. State law therefore plays a major role in many bankruptcy cases, and it is often quite unwise to generalize bankruptcy issues across state lines.

Bankruptcy chapters

There are six types of bankruptcy under the Bankruptcy Code, located at Title 11 of the United States Code:

Chapter 7 (a liquidation-style case for individuals or businesses),
Chapter 9 (Municipal bankruptcy)
Chapter 11 (a more complex rehabilitation-style case used primarily by business debtors, but sometimes by individuals with substantial debts and assets)
Chapter 12 (a payment plan or rehabilitation-style case for family farmers and fishermen)
Chapter 13 (a payment plan or rehabilitation-style case for individuals with a regular source of income)
Chapter 15 (ancillary and other cross-border cases)

The most common types of personal bankruptcy for individuals are Chapter 7 and Chapter 13.

The Bankruptcy Estate

Upon commencement of a bankruptcy, a bankruptcy estate is created. The bankruptcy estate (sometimes called "the estate") is a legal entity separate and distinct from the debtor, the creditors, or the trustee. Because the estate is not a real person, a trustee is appointed by the office of the U.S. Trustee to represent the estate and to make decisions on its behalf. It is not strictly correct to say that the trustee represents the creditors, though the creditors often benefit from actions by the trustee. With few exceptions, all the assets of the debtor transfer to the estate when the petition is filed. Exceptions to this rule include property to which the debtor holds only legal (as opposed to equitable) title. The estate also owns certain property acquired by the debtor within 180 days, including property received by inheritance or devise or as the result of a divorce judgment or a marital settlement agreement. In some circumstances, the trustee has the right to recover property transferred by the debtor or money paid by the debtor to a creditor before the case is filed.

Chapter 7

Chapter 7 personal bankruptcy is also known as straight bankruptcy or liquidation bankruptcy. Under Chapter 7, debtors are sometimes required to turn certain property that they owned when they filed their bankruptcy petition, over to the trustee. This property is sold, and the proceeds are used to pay the creditors. This process is called "administration" of the estate. However, in the vast majority of cases the debtor is allowed to keep most, if not all of his or her property. Debtors are required to file a schedule of exemptions in which they may elect to apply certain statutes, known as exemptions, to protect from the trustee and creditors, the equity they have in their property. Exemption statutes typically allow debtors to retain a portion or all of the equity they have in a given type of property like the homestead, a vehicle, household goods, and tools-of-trade. In most cases debtors have few if any assets with equity they cannot protect in this manner (non-exempt assets), and thus in most cases they do not lose anything to the trustee. The list of possible exempt assets differs slightly in each state. It is important to consult a personal bankruptcy attorney to determine what you can and cannot keep.

In most Chapter 7 cases the discharge is entered about 90 days after filing. The discharge is an order by the bankruptcy court that permanently forbids creditors from attempting almost any act to collect a debt owed by the debtor that existed at the time the case was filed. One example of an act not forbidden by the discharge is the sending of a home mortgage statement to the debtor even though the personal obligation to pay the mortgage has been discharged (see discussion of secured debts below).

The general rule is that all debts are discharged upon the entry of an order of discharge by the court. Unless a debt falls within one of very few exceptions to the general rule, it will be discharged. The court does not normally endeavor to determine which debts are discharged unless the debtor or a creditor files a law suit, known as an adversary proceeding, to determine dischargeability. This is typically left to the debtor and creditor to figure out whether a given debt has been discharged.

Some of the more common debts to be discharged in bankruptcy include credit cards, medical bills, personal loans, liability for negligence, and liability for breach of contract. In Chapter 7, exceptions to the general rule include most student loans, certain taxes, domestic support obligations (like child support and spousal support), fines and penalties owing to the government, and liability for personal injury arising from the operation of a motor vehicle by the debtor while intoxicated. Student loans can be discharged through bankruptcy by filing an adversary proceeding. Some debts will be discharged unless the creditor objects. These include debts arising from fraud, malicious injury to a person or property, and debts (other than support) arising from a judgment of divorce or a marital settlement agreement. Unscheduled debts (debts that are not listed by the debtor in the bankruptcy) are also sometimes not discharged. However, unscheduled debts are discharged as long as the creditor receives notice of the bankruptcy in time to file a proof of claim and in most Chapter 7 cases, it is never too late to file a proof of claim.

To understand how secured debts are treated differently in bankruptcy than unsecured debts, it is important to understand that there are two aspects to a secured debt. A secured debt includes the personal obligations (usually the obligation to pay and to keep the collateral insured) and the security interest. The security interest is what allows the creditor to take the collateral from the debtor if the debtor does not satisfy his or her personal obligations associated with the particular debt. The personal obligations are dischargeable according to the same rules that apply to unsecured debts. However, the security interest survives the discharge in most cases. This means that, while most car loans, home loans, and other secured debts are discharged, the creditor retains the right to take the collateral if the debtor doesn't pay. In many cases, the debtor will want to retain the collateral after the bankruptcy (e.g. keep a car to drive to and from work, to take kids to school, to buy groceries, and to perform a variety of other activities for which a car is crucial). The bankruptcy law authorizes the debtor to keep the collateral through one of two mechanisms: (1) the debtor can either purchase the collateral from the secured creditor (technically known as "redeeming" the collateral from the lien) by paying to the creditor, in one lump sum payment, the value of the collateral or the amount of the discharged debt, whichever is less, or (2) reaching an agreement with the creditor (technically known as a reaffirmation agreement) pursuant to which the debtor agrees to pay the creditor a negotiated amount over a defined period of time. Redeeming the collateral will typically be impractical because the debtor will not have sufficient funds to make a lump sum payment, but some lenders (sometimes referred to as redemption financiers) offer loans (typically at fairly high rates of interest) to debtors to enable them to redeem the collateral, after which the new lender will take a new lien on the collateral and the debtor must repay the new loan. Instead, the debtor may wish to negotiate a reaffirmation agreement with the original creditor, often on terms similar or identical to the original debt that has been discharged. The creditor will retain a lien on the collateral until the debtor completes payments under the reaffirmation agreement. If the debtor fails to make all of the payments, the creditor can then repossess the collateral, sell it, and sue the debtor for any difference between the amount still owing on the debt and the proceeds of the sale (known as a "deficiency"). Some courts might permit the debtor to keep the collateral without either redeeming the collateral or entering into a reaffirmation agreement if the debtor simply keeps paying the original debt and keeps the collateral insured. This alternative, sometimes known as "ride through" is superior to both redemption and reaffirmation. It is superior to redemption because the debtor need not come up with a lump sum payment to purchase the collateral from the creditor. It is superior to reaffirmation because if the debtor later discontinues payment, the debtor will not be liable for a deficiency following the secured creditor's repossession and sale of the collateral.

Under the new rules implemented as a result of the 2005 Bankruptcy Reform, it is now more difficult for people to qualify for Chapter 7 bankruptcy if their income over the preceding six months, multiplied by two, exceeds the median annual income of individuals who live in comparably sized households in the same state. These "above median" debtors are subject to a means test. Under the means, if an individual's monthly disposable income (income less expenses defined and permitted by the bankruptcy law) would permit the individual to repay a certain amount of debt to the individual's unsecured creditors, the bankruptcy court may find that the debtor's filing of a Chapter 7 case constitutes an abuse of the bankruptcy law and will then either dismiss the case (thus preventing the debtor from obtaining a Chapter 7 discharge) or, with the debtor's permission, convert the case to a Chapter 13 case. If an above median debtor's disposable income does not permit the individual to pay a certain amount of debt to the individual's income, the court typically will not find the filing of the case to be an abuse and the debtor can then obtain the Chapter 7 discharge.

Chapter 13

Chapter 13 bankruptcy is a reorganization plan for individuals. To qualify for Chapter 13, an individual must have secured debts under $807,750 and unsecured debts under $269,750. Under Chapter 13 the debtor keeps all of their property, but in return they make regular payments to a trustee, who distributes the payments to the creditors. Most Chapter 13 plans last for three to five years, and then the remaining unpaid and eligible debts are discharged. The types of debt that can be discharged under Chapter 13 was substantially scaled back by the 2005 reform amendments. Creditors may challenge a Chapter 13 plan but a plan can still be confirmed over their objection if the criteria for confirmation is otherwise met. A requirement for confirmation of a Chapter 13 plan is that unsecured creditors would receive at least as much as they would receive in a Chapter 7 liquidation.

Chapter 15

Chapter 15 incorporates the Model Law on Cross Border Insolvency drafted by the United Nations Commission on International Trade and Law. The law provides solutions to problems which arise in connection with cross-border bankruptcy, allowing US courts to issue subpoenas, orders to turn over assets, stays on pending actions, and orders of other types as circumstances dictate. The ancillary proceeding permitted under Chapter 15 is often a more efficient and less costly alternative to initiating an independent bankruptcy proceeding in the United States. It also avoids the conflicts which could arise between the jurisdictions involved in two independent bankruptcy proceedings initiated in connection with the same debtor.

Bibliography

Born Losers: A History of Failure in America, by Scott A. Sandage (Harvard University Press, 2005).

"Bankrupt your student loans and other discharge strategies," by Chuck Stewart, Ph.D., (Authorhouse, June 2006). ISBN 1-4259-2855-2

External links