What Is Bankruptcy and Why Are We Here?
Bankruptcy is a legal process that takes place within the federal court system. The purpose is to help people and businesses that are insolvent get relief from impossible-to-pay debts. Bankruptcy is meant to be a last resort. When a debtor has tried everything to make money to continue to pay debts and maintain their business or basic living standard, and failed, the debtor can turn to the bankruptcy court for protection from creditors and to unwind their financial situation.
People and entities can file for bankruptcy protection, meaning, human beings and corporate entities like corporations, limited liability companies, and every other entity that various state laws allow. We will distinguish between consumer bankruptcy, cases where the debtor is a person (with or without their small business), and business bankruptcy, cases filed by corporate entities. We will deal only with consumer bankruptcy.
The two most common types of consumer bankruptcy are Chapter 7 and Chapter 13. This refers to Title 11, Chapter 7 and Chapter 13 of the Code. It’s written as 11 U.S.C. § 700, et seq., or 11 U.S.C. § 1300, et seq. on the various bankruptcy forms you’ll see. Chapter 7 is personal liquidation of assets. Chapter 13 is personal reorganization. Chapter 7 also covers certain small businesses below a financial threshold that are liquidating. As a business owner, you will often see a personal Chapter 7, either just with an individual customer or coupled with the debtor’s small business.
• Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)
The BAPCPA was an overhaul of existing bankruptcy laws. It had two purposes: (1) to give debtors additional protection from creditors, freeing them from debts that were previously nondischargeable, and (2) to all but require debtors to give up their home in the event of a bankruptcy. The BAPCPA was and remains controversial. The hope was to make a system that was fairer to both debtors and creditors. Some feel that creditors got the bulk of the benefit. The heavy standards on debtors to keep their homes were a boon to the lending industry.
• THE MOST IMPORTANT RULE FOR CREDITORS
I put this at the head of the book for a reason. In my opinion, it is the first, and the most important, law every bankruptcy creditor needs to know. Once the bankruptcy case is filed (not when you’re notified, when it’s actually filed) an automatic stay goes into effect. This means that the creditor can take NO ACTION to collect an outstanding debt that was incurred prior to the case being filed (11 U.S.C. § 362(a)). “No action” includes essentially everything imaginable: no phone calls, no bills, no demand letters, no seizure, and definitely no filing a lawsuit. If a lawsuit is already pending in the state or federal court, the lawsuit is frozen in place until the bankruptcy case is resolved. Violating the automatic stay carries hefty financial penalties, sometimes tens of thousands of dollars for wanton creditors (11. U.S.C. § 362(k)). See, for example, Hubbard v. Fleet Mortgage Co., 810 F.2d 779 (8th Cir. 1987), upholding a fine of over $7,000 in damages, plus attorney’s fees, plus cancellation of the mortgage, in contempt action against a creditor for violation of the automatic stay. So beware.