bankruptcy

Bankruptcy: An Introduction

An overview of the 2005 Bankruptcy Act and its basics is provided in this section.

LEARNING GOALS

  1. Understand the fundamentals of bankruptcy legislation in the United States.
  2. Learn the most important details of the legislation.

Bankruptcy Law’s Main Purpose

The rights of creditors and insolvent debtors who are unable to pay their obligations are governed by bankruptcy law. In a nutshell, bankruptcy is the process of seizing a debtor’s property and distributing it among his or her creditors. The phrase derives from the practice of Italian merchants in the 16th century, who did their business on market benches. Creditors literally “broke the merchant’s bench” if he didn’t pay his debts. As a result, rotta banco (broken bench) came to be used to describe someone who can no longer repay his debt.

Many individuals in both England and the United States regarded someone who went bankrupt as a terrible person during the Victorian era. This attitude was partly driven by the law, which treated an insolvent debtor as a criminal in England and the United States to a greater extent. From the second half of the 18th century until well into the 19th century, British insolvents were imprisoned; jail for insolvent debtors was phased out earlier in the United States. The creditor also got favorable treatment, as he or she could easily disrupt the financial affairs of a putative bankrupt with a simple filling.

Today, bankruptcy is seen in a different light. Bankruptcy is now associated with the financing system and serves to offer creditors an equal split of the bankrupt person’s assets while providing new hope to debtors who find themselves facing unsupportable financial obligations. Without such a statute, we may just assume that the level of economic activity would be far less than it is now; few people would be willing to risk being burdened with crushing debt for the rest of their lives. Bankruptcy offers the honest debtor a new beginning and a chance to clear up any disputes between creditors.

The History of the Bankruptcy System; Bankruptcy Court and Judges

Constitutional Basis

The states are not allowed to break a contract under the US Constitution. This implies that no state can directly give a debtor a way to discharge their obligations unless they have been completely paid. However, according to Article I, Section 8 of the US Constitution, Congress has the power to create a uniform bankruptcy law.

Bankruptcy Act

The bankruptcy code was first enacted by Congress in 1800, 1841, and 1867. Each of these laws only lasted a few years. In 1898, the Bankruptcy Act was passed by Congress along with the Chandler Act amendments in 1938. In 1978, Congress passed the Bankruptcy Reform Act, which was subsequently amended in 2005 by the current law, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). The topic of our chapter is covered in this legislation.

In 1900, bankruptcies averaged fewer than 20,000 per year. Even in 1935, when the United States was plunged into depression, bankruptcy actions in federal court rose just to 69,000. In the final years of World War II, registrations in this category peaked at 13,000. The figures show a big increase from 1950 forward. Before the 1978 changes, bankruptcy filings in court averaged 181,000 per year —reaching a high of 254,000 in 1975. In the 1980s, they reached a peak of nearly 450,000 filings each year and generally maintained that rate until just before the 2005 legislation took effect. The 2005 law—which was preceded by “large lobbying primarily by banks and credit card companies” —was intended to restore personal responsibility and integrity in the bankruptcy process, according to a CCH Bankruptcy Reform Act Briefing. The law’s critics argued that it was simply a means for the credit card industry to extort more money from customers before their debts were retired.

Bankruptcy Courts, Judges, and Fees

The US Bankruptcy Court for the Northern District of California, for example, is in San Francisco. It has two judges who were appointed by the US Courts of Appeal and are responsible for bankruptcy proceedings in that district. Unless both parties agree otherwise, bankruptcy judges are only permitted to hear bankruptcy issues (known as core proceedings). The bankruptcy trustees are government attorneys who have been designated by the US Attorney General. They have administrative tasks in managing the procedure.

The cost of initiating a bankruptcy petition is around $200, and the usual lawyer’s fee for simple cases is about $1,200–$1,400.

Bankruptcy Provisions Overview

The Bankruptcy Act of 2005 (BAPCPA) has six separate types of bankruptcy procedures. Each is described in its chapter of the legislation.

The bankruptcy code is the formal name for the bankruptcy law (as opposed to case law that interprets it). The following are the types of bankruptcies:

  • Chapter 7, Liquidation: The liquidation proceeding is available to all debtors, except railroads, insurance corporations, most banks and credit unions, and homestead associations. 11 United States Code Section 109(b). Liquidation is a type of “straight” bankruptcy procedure. A Chapter 11 reorganization is a form of bankruptcy in which the debtor’s nonexempt assets are sold for cash and given to creditors, thus relieving the insolvent person or firm from any further responsibility for the debt. The majority of bankruptcies, about 70%, are filed as Chapter 7.
  • Chapter 9, Adjustment of debts of a municipality: A Chapter 9 bankruptcy protects a municipality’s assets from being seized by third parties or other creditors who are owed money. 11 United States Code, Section 109(c). (The legislation does not imply that a town, city, or county will go out of business due to insolvency.)
  • Chapter 11, Reorganization: The Bankruptcy Code permits unsecured creditors to claim a percentage of the debtor’s property. This includes any person who might file Chapter 7, as well as railroads. It is the method by which a financially distressed firm may continue to operate while its financial problems are resolved.
  • Chapter 12, The settlement of family farmers’ or fisherman’s obligations. 11 United States Code, Section 109(f). Because there is a low debt ceiling under Chapter 13 for many family farmers, their cases are frequently difficult and expensive. As a result, Congress created Chapter 12 to alleviate these problems.
  • Chapter 13, Individuals with a regular income can claim an exemption from the debt cancellation program. Individuals (no corporations or partnerships) owing less than $1.3 million in total debt are eligible for this category.11 US Code Section 109(e). A repayment plan, often referred to as a composition or an extension, may be established by someone with a steady income who wants to file for bankruptcy.
  • Chapter 15, Other than that, this edited adaptation of the Model Law on Cross-Border Insolvency specifically covers other cross-border and ancillary proceedings. The United Nations Model Law on Cross-Border Insolvency promotes international cooperation among nations involved in cross-border situations and fosters legal certainty for trade and investment. “The term “ancillary” refers to the prospect that a US debtor may have assets or duties in a foreign country; those non-US elements of the case are “ancillary.”

The BAPCPA has three chapters that outline the rules for each litigation. Chapter 1, “General Provisions,” specifies who is qualified for bankruptcy relief under the legislation. Chapter 3, “Case Management,” describes the authorities and procedures for starting bankruptcy cases. Chapter 5, “Creditors, the Debtor, and the Estate,” explores the debtor’s assets—his or her property. The debtor is not permitted to take any legal action in bankruptcy court against the trustee because he or she has no right to do so. The trustee’s appointment papers state that the trustee may “avoid” (invalidate) transactions between the debtor and third parties seeking to remove property from an estate under Bankruptcy Code section 524(c).

To demonstrate how these procedure chapters (especially Chapters 3 and 5) are applicable, we’ll focus on one of the most typical procedures: liquidation (Chapter 7). The majority of bankruptcy law’s ideas discussed above also apply to other types of proceedings. However, certain principles differ, and we conclude the chapter by noting some of the particularities of two other significant proceedings—Chapter 13 and Chapter 11.

KEY TAKEAWAY

The goal of bankruptcy law is to provide a fresh start and negotiate creditor disputes. The most recent modifications to the legislation were made in 2005. Bankruptcy law assists six types of debtors, as follows: (1) Chapter 7, straight bankruptcy—liquidation—is used by most debtors (except banks and railroads).; (2) Chapter 9 applies to municipalities.; (Chapter 11 is a bankruptcy procedure that allows businesses to restructure their debts and reorganize.; (4) Chapter 12 applies to farmers; (5) Chapter 13 is for wage earners, and Cross-border bankruptcies are governed by Chapter 15. The bankruptcy code contains numerous chapters that cover bankruptcy proceedings in further detail.

Author: Katy Lawyer

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