Bankruptcy Basics

Bankruptcy is the legal process in which a person or business that has become unable to pay its bills may have those debts canceled (called “discharged”) by a federal court, thereby relieving the individual or business from having to pay those debts. The purpose of bankruptcy is to allow one who has suffered financial hardship to receive a fresh start. Bankruptcy law is federal law and is thus drafted by Congress in accordance with Article I, Section 8 of the United States Constitution, which authorizes Congress to enact “uniform Laws on the subject of Bankruptcies....” Title 11 of the United States Code is where Congress wrote the bulk of the law regarding bankruptcy, and therefore Title 11 is commonly referred to as “the Bankruptcy Code.”

The Bankruptcy Code currently provides six different chapters under which a person or business may file a bankruptcy proceeding: Chapters 7, 9, 11, 12, 13, and 15.

Chapter 7 is available to individuals and to corporations, and is commonly known as “total bankruptcy” or “liquidation.” This is the most commonly-filed chapter of bankruptcy, and it is discussed in greater detail on the “Chapter 7 vs. Chapter 13” page of this website.

Chapter 9 is available only to municipalities, and is therefore a rarely-used chapter of bankruptcy.

Chapter 11 is utilized principally by businesses, and is often referred to as “business reorganization.” It is generally rather expensive and is usually only filed by sizable companies or by people who owe too much to file Chapter 13 and have too many assets or too much income to file Chapter 7.

Chapter 12 is available only to farmers or businesses engaged in farming or agricultural operations. This is a reorganization chapter similar to Chapter 13, but is only available to persons who derive around 80% or more of their income from agricultural operations.

Chapter 13 is available to individuals and sole proprietorship businesses, but not to corporations or partnerships. This chapter is commonly known as a “wage earner plan” or “individual reorganization.” This is the second most common form of bankruptcy, and is discussed in greater detail on the “Chapter 7 vs. Chapter 13” page.

Chapter 15 is used for cross-border cases, such as when the creditors of the person filing bankruptcy are located in a different country.

The first step one generally takes in filing for bankruptcy is to contact a bankruptcy attorney and set up a consultation. During the consultation, the attorney will ask questions and then advise the person to either file a bankruptcy or pursue some other course of action, as circumstances dictate. If the attorney recommends bankruptcy, then the attorney will explain the various chapters of bankruptcy that are available and which chapter he or she believes best suits the individual’s situation. Chapter 7 is generally over in about three to four months, and Chapter 13 usually lasts 36 to 60 months, during which time the person who filed bankruptcy (called the “debtor”) makes monthly payments to a bankruptcy trustee to pay back a portion of his or her debt, depending on what he or she can afford to pay (see the “Chapter 7 vs. Chapter 13” page for more detail). The attorney will also discuss which debts are “dischargeable” and which debts are “nondischargeable” by the bankruptcy case. In other words, not all debts may be canceled ("discharged") by bankruptcy, and some chapters of bankruptcy discharge certain types of debts that other chapters will not discharge. Generally speaking, debts which bankruptcy will NOT normally discharge include income taxes that are less than three years old or income taxes that are more than three years old if the returns were not filed accurately or on time (though this is really complex, ask your attorney), trust fund taxes (such as withholding taxes an employer was supposed to pay but didn’t), student loans, child support, alimony, injuries or damages caused by an accident in which alcohol or drugs were involved, criminal restitution, and certain other specifically-defined types of debt. Bankruptcy generally WILL discharge virtually every other kind of debt, including credit cards, medical bills, utility bills, collection judgments, personal loans, etc. Finally, the attorney will discuss the “exemptions” which apply to the individual’s bankruptcy case. An “exemption” is a certain dollar-value worth of real estate and personal property that a person who files bankruptcy may keep. All real estate and personal property which is “exempt” may be retained by the person filing bankruptcy, but all property which is not exempt may be sold by the bankruptcy trustee, with the proceeds of the sale being given to the creditors. Each State determines how much property a person may exempt (i.e. keep) when filing bankruptcy in that State, so how much real estate and personal property one may retain depends on the law of the particular State in which the person resides.

Questions one should remember to ask during a consultation include: (1) Are there any viable non-bankruptcy alternatives available? (such as deeds in lieu of foreclosure, short sales, debt settlement, credit counseling, reverse mortgages, etc) (2) What will happen to one’s property, including real estate and personal property, if one files bankruptcy? (i.e. is everything exempt or will you lose some asset?) (3) Is it best to file alone or with one’s spouse (if married)? (4) How much will the bankruptcy cost and what other fees may apply? (5) What debts will be discharged and what debts will still have to be paid when the bankruptcy is over?

If one decides to file bankruptcy, he or she will then provide information and documents to the attorney regarding all of his or her assets, debts, income, and expenses (among other things). The attorney will prepare the paperwork for the person’s review, which the individual will then sign. One should be sure to review all of the paperwork carefully, and ask any questions that one may have regarding the information contained in the paperwork. Thoroughness and accuracy are both very important. Also, if one does opt to file bankruptcy, that person must consult with an approved credit counseling agency either on the internet, by telephone, or in person for approximately 60 minutes and obtain a “certificate of credit counseling” from that agency, sometimes also called a “pre-bankruptcy certificate.” This certificate is valid for 180 days and must be obtained before the bankruptcy case is filed unless certain, rare exceptions are met, such as the debt is mostly commercial debt rather than consumer debt. There is also a second online course that has to be taken after the bankruptcy is filed, but that is discussed below. Click here for a select list of companies that provide counseling services for the Southern District of Indiana.

A person who files bankruptcy is referred to by the Bankruptcy Code as the “debtor,” and the persons and businesses to whom the debtor owes money, goods or services are the “creditors.” The debtor initiates his or her bankruptcy proceeding by filing a “bankruptcy petition,” also called a “voluntary petition,” with the United States Bankruptcy Court that presides over the district in which the debtor resides. It is possible in some circumstances for creditors to compel a bankruptcy on a debtor by filing an "involuntary petition," but this is reasonably uncommon.

Once the bankruptcy petition is filed, the Bankruptcy Court assigns a unique Bankruptcy Case Number to the bankruptcy petition and will appoint a “bankruptcy trustee,” also called simply a “trustee,” to oversee the debtor’s case. The job of the trustee is to ensure that both the debtor and the creditors are treated fairly, and if the trustee feels that some inequity is taking place or that the Bankruptcy Code is not being followed by either the debtor or a creditor, the trustee may refer these issues to the bankruptcy judge for resolution. The trustee’s job is also to handle the distribution of un-exempt assets. The Bankruptcy Case Number assigned to the case is formulated as follows: The first two numbers are the year the case was filed (though this can be misleading in the event of a deconsolidated case, which I won't go into here), the next 5 numbers are unique, the three letters are the initials of the judge assigned to the case, and the last number(s) are the bankruptcy chapter filed. For example, 20-01234-FJO-7 indicates the case was filed in 2020, Frank J. Otte (FJO) is the judge, and Chapter 7 was the bankruptcy chapter filed.

Immediately upon filing the bankruptcy petition, the debtor is protected by the “automatic stay” in most cases, which simply means that creditors are automatically ordered by the Bankruptcy Court to stop all collection attempts against the debtor. This means that creditors cannot call or bill the debtor, and can’t repossess a car, garnish wages, or foreclose on a home, once the bankruptcy petition is filed unless those creditors first get permission from the Bankruptcy Court to do so. If creditors do call, bill, or otherwise continue to harass the debtor after the petition is filed, debtors are generally advised to provide their Bankruptcy Case Number to the creditor and ask the creditor to call the debtor’s attorney for verification. If the creditor persists in harassing the debtor, the creditor may be punished by the Bankruptcy Court. The bankruptcy filing generally stops garnishments, lawsuits, foreclosures, and writs of attachment. In some cases, the automatic stay may only remain in effect for 30 days, or not go into effect at all, if the debtor has been involved in previous bankruptcy cases within the prior year (see your attorney for details).
As mentioned above, the debtor has to watch an approximately two-hour online video after their bankruptcy case is filed but before their case is over. Upon completing the video, sometimes called a “financial management course” or a “debtor education course,” the debtor will receive a certificate of completion that must be filed with the court prior to the case closing.
The Bankruptcy Code requires every debtor to attend a brief hearing regarding his or her bankruptcy case, and this hearing is called the “First Meeting of Creditors” or the “341 Hearing” (since section 341 of the Bankruptcy Code is the section which requires that this hearing be held). A week or so after the bankruptcy petition is filed with the Bankruptcy Court, the debtor will receive a letter from the Bankruptcy Court advising the debtor of the date, time, and location of the debtor’s First Meeting of Creditors. The hearing date is generally around five weeks after the date on which the bankruptcy petition was filed. 341 Hearings are now conducted electronically by Zoom in the Southern District of Indiana. It should be noted that the name “First Meeting of Creditors” is misleading for a couple of reasons: First, there is no “Second” Meeting of Creditors, and the First Meeting of Creditors is generally the only hearing that takes place in the typical bankruptcy case (though there are in some cases a second or third hearing (or more), and one should discuss this possibility with his or her attorney), and secondly, this hearing is hardly a “meeting of creditors” since creditors usually do not even attend at all. Typically, the hearing is comprised only of the trustee, the debtor, and the debtor’s attorney. Creditors have the right to appear at the hearing and ask the debtor questions if they wish, but they seldom do.

After the hearing is over, in a Chapter 7 case the debtor will normally receive an “Order of Discharge” in the mail about 60 to 70 days after the date of the hearing, which is the Bankruptcy Court’s order that the Chapter 7 debtor’s dischargeable debts are officially discharged. Upon receiving this Order of Discharge, the Chapter 7 bankruptcy case is basically over, though it may be held open for the completion of administrative tasks, such as disbursing funds to creditors, etc.

In a Chapter 13 case, after the hearing debtor will normally receive an “Order of Confirmation” in the mail about 30 to 60 days after the date of the hearing, which is the Bankruptcy Court’s order approving the debtor’s Chapter 13 Plan (see the “Chapter 7 vs. Chapter 13” page for more details). Once the Chapter 13 debtor makes all of the monthly payments required by the Chapter 13 Plan (which takes 36 to 60 months depending on the terms of each debtor's Chapter 13 Plan), then the Chapter 13 debtor will apply for discharge, and normally receive an Order of Discharge in the mail at which time the Chapter 13 bankruptcy case is over.

Chapter 7 is on one’s credit report for ten years, and Chapter 13 is typically on one’s credit report for seven years, though according to 15 U.S.C. §1681c(a)(1), a section in the Fair Credit Reporting Act, they can both be on the credit report for up to 10 years (see 15 U.S.C. §1681c). People usually see a significant improvement of their credit score within 12 months after filing bankruptcy. Often, a person who filed bankruptcy can get loans immediately after the bankruptcy, though interest rates may be impacted for up to a year (though our office has found some lenders willing to make car loans at fair interest rates shortly after bankruptcy). After a year, many people are back to normal interest rates, and after two years, often qualify for home loans and mortgages. Some books on credit repair can be found here. Bankruptcy is often one of the best tools at your disposal to improve your credit score.