Bankruptcy laws are intended to give a fresh start to people who cannot pay their creditors. The concept of bankruptcy as a fresh start is fairly modern. Bankruptcy was originally viewed as a criminal act, a concept that is familiar to the readers of Charles Dickens, whose novels often emphasized the harshness of debtor’s prison. Under the current law of the United States, the failure to pay a debt is not a crime, and debtors cannot be imprisoned to coerce payment or to punish nonpayment of a debt.
Although the United States Constitution gives Congress the authority to create bankruptcy laws, the first federal law taking the modern view that bankruptcy should give debtors a fresh start was not passed until 1938. The current system did not come into existence until 1978. Although some states established their own bankruptcy laws before the modern Bankruptcy Code was enacted, almost all bankruptcy filings now take place in federal Bankruptcy Courts.
Bankruptcies can be either voluntary or involuntary. Most bankruptcies are voluntary. An involuntary bankruptcy occurs when creditors force a debtor into bankruptcy. Involuntary bankruptcies almost always affect businesses that are in severe debt. It is rare for an involuntary bankruptcy to be commenced against an individual debtor.
The Bankruptcy Code
The Bankruptcy Code is divided into several chapters. Some of those chapters define procedures that the Bankruptcy Court must follow. The Bankruptcy Code also establishes the powers and duties of the bankruptcy trustee, who is usually a lawyer appointed by Bankruptcy Court to administer bankruptcies. One chapter defines the "bankruptcy estate," the property of the debtor that a bankruptcy trustee can sell for the benefit of creditors.
Other chapters create the different kinds of bankruptcy that are available to debtors and establish the procedures that debtors and creditors must follow. Many of those provisions, like a form of bankruptcy that applies to railroads, are of little concern to the average debtor.
The most common forms of bankruptcy for individual debtors are found in chapters 7 and 13. A chapter 7 bankruptcy, often called a debt liquidation, wipes out most kinds of debt, although property in the bankruptcy estate can be sold to satisfy creditors. A chapter 13 bankruptcy, often called a debt repayment plan, allows debtors to keep their property while repaying at least a portion of their debt over a period of three to five years. The Bankruptcy Code defines an individual’s eligibility for either a chapter 7 or a chapter 13 bankruptcy.
Chapter 11 creates the other most common form of bankruptcy. A chapter 11 bankruptcy, often known as debt reorganization, is available to certain businesses that want to restructure their debt under court supervision. Businesses that cannot survive and are ready to liquidate their assets and wipe out their debt will often pursue a chapter 7 bankruptcy rather than a chapter 11 reorganization. Corporations and partnerships must use chapter 11 rather than chapter 13 because chapter 13 is available only to individuals who owe less than a specified amount of debt.
Recent Changes in the Law
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made several changes in bankruptcy law. If you filed a bankruptcy before 2005, you’ll find that many rules and procedures have changed. Before the law was amended, most debtors could choose to file a chapter 7 bankruptcy. Under the new law, only debtors who cannot afford to repay their debts under chapter 13 are allowed to file a chapter 7 bankruptcy. The new law also requires debtors to attend a credit counseling course before filing bankruptcy, and a debtor education class after filing. The new law also created a longer waiting period between chapter 7 filings and made a number of other technical changes to the Bankruptcy Code.
