Bankruptcy law is primarily federal law and varies little from state to state. The United States Constitution grants to Congress the power to establish uniform bankruptcy laws throughout the United States, which ensures uniformity in how bankruptcy proceedings are conducted, encourages interstate commerce and promotes national economic security. The individual states do, however, retain jurisdiction over certain debtor-creditor issues that are not addressed by or do not conflict with federal bankruptcy law such as which property remains exempt from creditors’ claims.
The most common forms of bankruptcy include:
Bankruptcy law provides two basic forms of relief: (1) liquidation and (2) rehabilitation, also known as reorganization.
Most bankruptcies filed in the United States involve liquidation, which is governed by Chapter 7 of the Bankruptcy Code. In a Chapter 7 liquidation case, a bankruptcy trustee collects the debtor’s non-exempt property and converts it into cash for the benefit of unsecured creditors. If the property is exempt or encumbered to the point of having no equity beyond the amount of the exemption, the trustee will abandon the asset. An abandonment means that the bankruptcy estate will not sell the asset or otherwise take an interest in the asset.
If there is equity available beyond the amount needed to satisfy liens and beyond the exemption claimed, the trustee distributes the resulting funds among the creditors in a particular order of priority described in the code. Not all creditors will receive the full amount owed through this process, and, in many cases, creditors will receive nothing. When liquidation and distribution are complete, the bankruptcy court may discharge any remaining debts of an individual debtor to the extent such debts are dischargeable. If the debtor is a corporation, it will more than likely not exist after liquidation and distribution of the corporation’s assets. Corporations do not receive a discharge in Chapter 7 bankruptcy. However, there can be strategic reasons for corporations to file for bankruptcy protection.
In a rehabilitation or reorganization, the option courts often prefer, creditors may be provided with a better opportunity to recoup what they are owed. Chapter 11 or Chapter 13 of the Bankruptcy Code governs this type of bankruptcy. Chapter 11 usually applies to individual debtors with excessive or complex debts, or to large commercial entities like corporations. Chapter 13 usually applies to individual consumers and to some small businesses with debts that fit within the boundaries of Chapter 13. (Farmers and municipalities may seek reorganization through the code’s special chapters, Chapters 12 and 9, respectively.) Reorganization provides a greater opportunity to retain assets if the debtor agrees to pay off debts according to a plan approved by the bankruptcy court. If the debtor fails to do so, however, the court may order liquidation.
Voluntary bankruptcy. In most instances, the bankruptcy case is filed by the debtor, which is considered a voluntary bankruptcy. Once the debtor files the bankruptcy petition, he or she is immediately entitled to relief from creditors through the bankruptcy procedure known as the automatic stay. The automatic stay freezes all debt collection activity and forces the creditors to allow the bankruptcy proceeding to determine how payment will be made.
Involuntary bankruptcy. Under Chapter 7 and Chapter 11, creditors, too, have the option of filing for relief against the debtor, which is known as an involuntary bankruptcy. Involuntary bankruptcies are allowed only when the requisite number of creditors with the requisite amount of debt seek to put the individual into bankruptcy against their will. The debtor has the right to file a response, after which the court determines whether the creditors are entitled to relief. If the court dismisses the involuntary bankruptcy filing, finding that it has no merit, the creditors may have to pay the debtor’s attorneys’ fees, damages for any losses the debtor experienced because of the filing, and even punitive damages to punish the creditors for the frivolous or abusive filing of a petition.
Read more about specific terms related to bankruptcy in our Bankruptcy Glossary.
Lawyers who practice bankruptcy law can help both debtors and creditors overcome obstacles to the repayment of debt. Their expertise often extends beyond bankruptcy to include debt repayment and collection options that can circumvent the need for a bankruptcy filing.