Bankruptcy occurs when an individual or organization legally declares an inability or impaired ability to pay their creditors. Bankruptcy can be initiated by either the bankrupt individual or organization. Creditors can also request that an individual or organization be placed in bankruptcy proceedings, in an effort to recoup part of what they are owed.

While bankruptcy cases are always filed in United States Bankruptcy Court (a federal court), bankruptcy cases are often highly dependent upon State law, since state law determines who a debtor must pay and what assets a debtor can keep.

The most common types of bankruptcy are identified by their “chapter” of the Bankruptcy Code,

Chapter 7 (a liquidation-style case for individuals or businesses),

Chapter 11 (a more complex rehabilitation-style case used primarily by business debtors, but sometimes by individuals with substantial debts and assets)

Chapter 12 (a payment plan or rehabilitation-style case for family farmers and fishermen)

Chapter 13 (a payment plan or rehabilitation-style case for individuals with a regular source of income)



Personal bankruptcy for individuals is usually Chapter 7 and Chapter 13.

The Bankruptcy Estate

When a person or organization files for bankruptcy, a bankruptcy estate is created. The bankruptcy estate (sometimes called "the estate") is a legal entity separate and distinct from the debtor, the creditors, or the trustee. Because the estate is not a real person, a trustee is appointed to represent the estate and to make decisions on its behalf. It is not strictly correct to say that the trustee represents the creditors, though the creditors often benefit from actions by the trustee. With few exceptions, all the assets of the debtor transfer to the estate when the petition is filed. But there are exceptions. Property received by inheritance, or as the result of a divorce judgment or a marital settlement agreement. In some circumstances, the trustee has the right to recover property transferred by the debtor to another person or money paid by the debtor to a creditor before the case is filed.

Chapter 7

Chapter 7 personal bankruptcy is also known as straight bankruptcy or liquidation bankruptcy. Under Chapter 7, debtors are sometimes required to turn certain property that they owned when they filed their bankruptcy petition over to the trustee. This property is sold, and the proceeds are used to pay the creditors. This process is called "administration" of the estate. However, in the vast majority of cases, the debtor is allowed to keep most, if not all of his or her property. Debtors file a document called a schedule of exemptions that allow them to protect the equity they have in their property from the trustee and creditors. Exemptions typically allow debtors to keep all or part of a given type of property like their home, vehicle, household goods, and tools-of-trade. In most cases, debtors have few if any assets with equity they cannot protect in this manner (non-exempt assets), and thus in most cases they do not lose anything to the trustee. The list of possible exempt assets differs slightly in each state, so it is important to consult a personal bankruptcy attorney to determine what you can and cannot keep.

Most Chapter 7 cases are discharged about 90 days after filing. Discharge is an order by the bankruptcy court that permanently forbids creditors from attempting to collect a debt owed by the debtor that existed at the time the case was filed. The general rule is that all debts are discharged upon the entry of an order of discharge by the court. Unless a debt falls within one of very few exceptions to the general rule, it will be discharged. Sometimes, when it is unclear whether a debt has been discharged by a bankruptcy, the debtor or a creditor files a lawsuit, known as an adversary proceeding, to determine dischargeability.

Some of the more common debts discharged in bankruptcy include credit cards, medical bills, personal loans, liability for negligence, and liability for breach of contract. In a Chapter 7 proceeding, exceptions to the general rule include most student loans, certain taxes, domestic support obligations (like child support and spousal support), fines and penalties owing to the government, and liability for personal injury arising from the operation of a motor vehicle by the debtor while intoxicated. Some debts will be discharged unless the creditor objects. These include debts arising from fraud, malicious injury to a person or property, and debts (other than support) arising from a judgment of divorce or a marital settlement agreement. Unscheduled debts (debts that are not listed by the debtor in the bankruptcy) are also sometimes not discharged. However, unscheduled debts are discharged as long as the creditor receives notice of the bankruptcy in time to file a proof of claim and in most Chapter 7 cases.

Secured and unsecured debts are treated differently in bankruptcy. A secured debt includes the personal obligations (usually the obligation to pay and to keep the collateral insured) and the security interest—the thing that the creditor can take as collateral for the debt, be it home, boat, car, etc. With secured debt, the personal obligation to pay is dischargeable according to the same rules that apply to unsecured debts. However, the security interest survives the discharge in most cases, which means that, while most car loans, home loans, and other secured debts are discharged, the creditor retains the right to take the collateral if the debtor doesn't pay. This may seem like a fine distinction upon first glance, but it becomes critical when the debtor decides after the discharge that the personal obligations are more burdensome than the collateral is worth. For instance, a debtor will be glad for his or her discharge if the car that is collateral for a secured debt gets stolen or wrecked and insurance will not pay off the amount due on the contract.

Under the new rules implemented as a result of the 2005 Bankruptcy Reform, it is now more difficult for people with an income exceeding the state median to qualify for Chapter 7 bankruptcy. These debtors are subject to a means test, and if their disposable income (income left over after paying their expenses) exceeds limits set by the government, the debtor is not entitled to a discharge in Chapter 7 and the debtor may elect to convert the case to a Chapter 13.

Here is a short review of bankruptcy after 2005. (http://www.uscourts.gov/bankruptcycourts/bankbasics04606.pdf)

Chapter 13

Chapter 13 bankruptcy is a reorganization plan for individuals. To qualify for Chapter 13 bankruptcy protection, an individual must have secured debts under $807,750 and unsecured debts under $269,750. The debtor keeps all of his property, but in return must make regular payments to a trustee, who distributes the payments to the creditors. Most Chapter 13 plans last for three to five years, and then the remaining unpaid and eligible debts are discharged. The kinds of debt that can be discharged under Chapter 13 was substantially scaled back by the 2005 reform amendments, so debtors will end up paying more creditors for longer periods than in previous years.

Creditors may challenge how much money they receive under a Chapter 13 plan, but a plan can still be confirmed over their objection, provided unsecured creditors would receive at least as much as they would receive in a Chapter 7 liquidation.

For more info: http://en.wikipedia.org/wiki/Bankruptcy_Code