What is the purpose of filing a personal bankruptcy?

There are two main purposes of bankruptcy. First is the give a debtor a fresh start financially by relieving some or all of the debt the debtor has. Second, it is intended to see that creditors are treated fairly in the process.

How does bankruptcy accomplish these purposes?

There are two different ways in which bankruptcy can provide for payments to creditors and a discharge for debtors-Chapter 7 and Chapter 13.

How does Chapter 7 work?

In a Chapter 7 bankruptcy, debtors give up certain property that they own at the time they file the bankruptcy case. This property is sold by a trustee, who uses the proceeds to pay creditors. The debtors receive their discharge shortly after the case is filed. In this way, Chapter 7 debtors are allowed to keep the money that they earn after filing the bankruptcy case, as well as most other property that they obtain after the filing.

What property do debtors have to give up in Chapter 7? What about tax refunds and lawsuits?

Debtors in Chapter 7 are required to give up "nonexempt" property that they own at the time of the filing; they are allowed to keep both "exempt" property that they own at the time of filing and any property that they receive a right to own after the bankruptcy filing. Exempt property is property that, according to the law, is necessary for the debtors' support and the support of their dependents. The law that determines what property is exempt varies from state to state. If all of a debtor's property is exempt, then the debtor does not have to give up any property in Chapter 7, but may still obtain a discharge.

As long a debtor has a right to payment at the time of the bankruptcy filing-from a tax refund, a lawsuit, or some other source-that right to payment is property that must be given to the Chapter 7 trustee unless it is exempt, even though the debtor has not yet received any money. Thus, a debtor may have to turn over a tax refund to the trustee that is received after the bankruptcy is filed, and a debtor may not be entitled to the settlement of a personal injury action that is entered into after the bankruptcy is filed.

If a debtor is behind in house or car payments, can Chapter 7 stop a foreclosure or repossession from taking place?

Whenever any bankruptcy case is filed, the creditors are stopped from taking action to collect the debts that were owed at the time of the bankruptcy. This feature of bankruptcy is called the "automatic stay." The automatic stay stops a foreclosure or repossession from going forward. However, no bankruptcy filing allows a debtor to keep property that is security for a loan without making payments on the loan. For example, debtors with home mortgages and car loans, cannot keep their homes and cars without making payments. As soon as the bankruptcy case is closed, the automatic stay terminates, and the creditor can proceed with foreclosure or repossession. Moreover, if the debtor is not current on payments, creditors may ask the court to terminate the automatic stay while the bankruptcy is still pending, and, in Chapter 7, creditors are usually able to terminate the automatic stay. In order to keep property that is security for a loan, a debtor often must enter into a "reaffirmation agreement" with the creditor who holds the lien on that property.

What is a reaffirmation agreement, and how does it work?

A reaffirmation agreement is an agreement by a debtor and a creditor about how to treat a particular debt that would otherwise be discharged in the debtor's bankruptcy. Usually, the debt is secured by collateral that the creditor could repossess or foreclose on. In the reaffirmation agreement, the debtor agrees to pay some or all of debt, usually, according to schedule. In exchange, the creditor agrees not to repossess or foreclose on collateral that secures the debt, as long as the debtor makes the agreed-upon payments. A valid reaffirmation agreement puts the debtor under a legal obligation to pay back the entire amount agreed upon, even if this is more than the value of the collateral that the debtor is keeping. So if the debtor defaults in the payments required under the reaffirmation agreement, the creditor can repossess or foreclose, and then seek a personal judgment against the debtor if the sale of the collateral does not satisfy the debt.

However, in order for a reaffirmation agreement to be valid, several requirements must be met, including the following: (1) the agreement has to be entered into before the debtor receives a discharge; (2) the agreement has to be filed with the court; (3) if the debtor is represented by an attorney, the attorney has to certify that it will not create a serious problem for the debtor; and (4) if the debtor is not represented by an attorney, the bankruptcy court has to make a finding that the reaffirmation agreement does not create a serious problem for the debtor. The agreement must be voluntary; no one can force either the debtor or a creditor to enter into a reaffirmation. Finally, debtors are given the right to change their minds: a debtor may cancel any reaffirmation agreement within 60 days after the agreement is filed with the court, or any time before discharge, whichever is later.

If any of the requirements for a reaffirmation have not been complied with, the agreement may not be binding. In that event, the debtor would have no personal obligation to make payments under the agreement.

Can a Chapter 7 debtor make payments on a discharged debt without a reaffirmation agreement?

Yes. Even though a debt has been discharged, the debtor can still make a voluntary payment of the debt. This often happens, for example, with debts that are owed to family members or friends. But the key to this kind of payment is that it must be entirely voluntary; the debtor has no legal obligation to pay a discharged debt, and the creditors can take no action to pressure or persuade the debtor into making payments.

What can be done if a debtor falls behind in payments after obtaining a Chapter 7 discharge? Can another bankruptcy case be filed?

The discharge in a Chapter 7 case only covers the debts that were incurred before the case was filed. The bills that a debtor incurs after the case is filed are not discharged. The hope is that, after their old debts are canceled by the discharge, debtors will be able to pay their new obligations as they become due. But unexpected circumstances, such as illness or loss of employment, may again put debtors in a situation where they cannot pay their bills. In this situation, a debtor could file another Chapter 7 case, but there might not be a right to discharge. After a debtor receives a discharge in a Chapter 7 case, the debtor only has the right to receive a discharge in a later Chapter 7 case if the later case is filed at least six years after the first case was filed. However, even during this six year "waiting" period, debtors may still be able to obtain relief in Chapter 13.

Are all debts that were incurred before the bankruptcy discharged in Chapter 7?

No. There are a number of types of debts that are excepted from the discharge given in Chapter 7. Among the most common are debts for certain taxes, fraudulently incurred credit card debt, family support obligations (including child support and alimony), and most student loans. A debtor with debts of these kinds can still receive a discharge of other debts, but, after the bankruptcy the "excepted" debts will still be owing (less any payments made through the bankruptcy itself). Additionally, Chapter 7 debtors who engage in certain misconduct connected with the bankruptcy (like failing to disclose assets) may be denied a discharge entirely. However, many of the debts that are excepted from discharge in Chapter 7 (fraudulent credit card debt, for example) may be discharged through Chapter 13. Other types of debt (family support and student loans, for example) are excepted from discharge in Chapter 13 as well as Chapter 7.

How does Chapter 13 work? Who can file a Chapter 13 case?

Debtors in Chapter 13 keep all of their property, whether or not it is exempt, but they make regular payments on their debts out of the money that they earn after filing the bankruptcy case. These payments must be at least as much as would have been paid to creditors in a Chapter 7 case. The payments are made to a trustee, who distributes the payments to the creditors. The payments are made in regular installments, according to a plan that the debtor draws up (usually with the help of an attorney). The plans last either until the debts are paid in full or until the end of a three to five year period. The debtor receives a discharge at the end of the plan. Some kinds of debts that are not discharged in Chapter 7 cases-for example, debts arising from fraudulent use of a credit card-may be discharged in Chapter 13.

A Chapter 13 case can be filed by most consumer debtors. There are two principal requirements: First, the debtor must have regular income, although this need not be from a job-regular benefit payments or rental income would qualify. Second, the debtor must not have excessive debt. Chapter 13 is available only to debtors who do not owe more than $750,000 in secured debt (like home mortgages and auto loans), and more than $250,000 in unsecured debt (like most credit card debt).

If a debtor is behind in house or car payments, can Chapter 13 stop a foreclosure or repossession from taking place?

Yes. Unlike Chapter 7, where the debtor can usually stop a foreclosure or repossession only if the creditor agrees to a reaffirmation, a debtor in Chapter 13 can provide for car and mortgage payments in the Chapter 13 plan, and the creditor can be required to accept these payments instead of proceeding with foreclosure or repossession.

What can be done if a debtor falls behind in payments after filing a Chapter 13 case?

Debtors who have unexpected financial problems in a Chapter 13 case should immediately consult with their attorneys. It is often possible to deal with changed circumstances by amending the Chapter 13 plan. Also, it is sometimes possible to add to the plan debts that were incurred after the Chapter 13 case is filed, so that they will be discharged with other debts at the completion of the plan. Finally, even after the plan is completed and the debtor receives a discharge in Chapter 13, if unexpected circumstances arise that again make it impossible for the debtor to deal with new bills, the debtor may be able to file another bankruptcy case. There is never any "waiting period" before filing another Chapter 13 case, and if the debtor paid off at least 70% of the outstanding debt through the plan, there is generally no "waiting period" before obtaining a Chapter 7 discharge.

Do all creditors have to be listed on bankruptcy schedules?

Yes. All of the debts have to be scheduled, with the name and address of the creditors. This is so that they can receive notice of the bankruptcy, and get their fair share of any money that is paid to creditors. Sometimes debtors think that they should omit a creditor because they want to continue to pay the debt. This would violate the law, and it is unnecessary, because a debtor can always choose to pay a debt voluntarily, even though the debt has been discharged and there is no legal obligation to make payment. However, creditors are prohibited from taking any action to collect discharged debts.

What should a debtor do if a creditor does demand payment of a debt that is listed in the bankruptcy schedules?

If a creditor who is listed in the debtor's schedules attempts in any way to collect a scheduled debt, the debtor should inform the creditor that a bankruptcy case has been filed and request that the creditor stop the collection efforts. If the debtor is represented by an attorney, the debtor should give the attorney's name and telephone number to the creditor. If the debtor is not represented by an attorney, the debtor should give the creditor additional information about the case-the date of filing, the court in which the case was filed, and the case number. If improper collection action continues, the debtor should consult with an attorney to consider further action.

What should debtors do if they forgot to list a creditor in their bankruptcy schedules?

As soon as a debtor realizes that a creditor has been omitted, the debtor should notify his or her attorney with all of the information necessary to complete the schedule (the amount of the debt, the type and value of any collateral, and the name and address of the creditor). The attorney can then advise the debtor about what additional action, if any, is necessary. If an omitted creditor demands payment of the debt, the debtor should inform the creditor of the bankruptcy, as discussed above.

Does a bankruptcy case automatically remove liens-such as mortgages-against a debtor's property?

No. Liens can be placed on a debtor's property in many different ways. Some are by agreements, like mortgages and auto liens. Others are by operation of the law, like property tax liens on a debtor's home. And some liens are to enforce judgments that have been entered against the debtor. Certain liens can never be removed in a bankruptcy case except by paying the underlying indebtedness, and others can only be removed if special action is taken in the bankruptcy case. So, if a debtor has any question about liens on his or her property, these matters should be discussed with an attorney.

How does bankruptcy affect the debtor's credit rating?

Issuers of credit (like banks and credit card companies) are free to consider the fact of a bankruptcy filing in deciding whether to extend credit, and bankruptcy filings can be listed in credit reports for up to 10 years. Some issuers of credit may decide to extend credit regardless of a bankruptcy. Others may be willing to extend credit only after a number of years have passed, or until the bankruptcy filing is no longer on the credit report.

What can debtors do to re-establish their credit after filing bankruptcy?

In some jurisdictions there may be debtor education programs offered in connection with Chapter 13 cases that can help debtors re-establish credit. Where such programs are not available, debtors may be able to obtain a "secured" credit card, which requires that the debtor deposit funds with the credit card issuer. This provides the opportunity to show responsible use of credit, which is a major factor in any issuer's credit decisions. (Other major factors are length of employment and length of residency.)

How can debtors obtain a copy of their credit reports and correct any errors?

Whenever a debtor's application for credit is denied, the credit issuer is required to give the debtor, on request, a copy of any credit report that was used in making the decision. Otherwise, debtors can obtain their credit reports from the major credit bureaus. These bureaus will either provide a copy of the report without charge or sell a copy for a small fee. If there are errors in a report, such as an incorrect social security number or the listing of a debt that is not owed, the debtor should make a request for correction in writing to the bureau, enclosing copies of any documents that would establish the correct facts.