Bankruptcy is a legal tool designed to offer a "fresh start," so to speak, to those who cannot meet their financial obligations, while also protecting creditors by establishing an organized system to recover part of their money.
Bankruptcy is considered the measure of last resort for a debt problem that generally requires liquidating assets or signing a payment plan.
How does bankruptcy work?
When you file for bankruptcy, you are informing the judicial system that you cannot pay your debts. Being a legal process and not a program, it normally requires the debtor to file a petition before a bankruptcy court, and it is this court that supervises the process and decides how to handle your assets and financial obligations.
The court judge will be the one to decide whether part of the applicant's assets must be liquidated or if the debt can be restructured to satisfy as much of the obligation as possible.
Although the duration of the process varies depending on the type of bankruptcy, one could expect between 3 and 6 months for Chapter 7, between 3 and 5 years for Chapter 13, and from several months to several years for Chapter 11. Below we will discuss these 3 types of bankruptcy in more detail.
Automatic stay
Once the bankruptcy petition is filed, an automatic stay will go into effect, which will temporarily prevent creditors from initiating collection actions against the debtor, including lawsuits, foreclosures, or wage garnishments.
341(a) Meeting
Following the automatic stay, a trustee will be assigned to supervise the case, and approximately one month after the bankruptcy filing, the 341 meeting, also known as the meeting of creditors, will take place, where the debtor must declare their assets, income, and debts.
The purpose of the 341 meeting is to examine the debtor's financial situation and confirm the facts declared by them in the bankruptcy petition. The assigned trustee will determine if any of the assets must be sold in cases of liquidation (Chapter 7) or if a payment plan is needed in cases of reorganization (Chapter 13).
This meeting also aims to help the debtor understand the bankruptcy proceedings while allowing creditors and other interested parties to ask questions about their financial situation. It is mandatory for the debtor to attend the 341 meeting and answer questions under penalty of perjury; however, it is not mandatory for creditors to attend.
Discharge
At the end of the process, qualifying debts will be discharged, which means the debtor will no longer be legally responsible for them as long as they comply with the terms of the bankruptcy.
The discharge is a permanent order and prohibits the debtor's creditors from taking any type of collection action on the discharged debts.
It is important to consider that a valid "lien" or encumbrance that has not been voided in the bankruptcy proceeding will survive after the discharge. In other words, a secured debt that has been deemed unenforceable in the bankruptcy petition will remain the debtor's responsibility. Therefore, a secured creditor can enforce the lien to recover the secured property.
Can you apply on your own?
Yes, there is the option to file for bankruptcy without the help of an attorney. Representing yourself is called filing "pro se"; however, it is not recommended at all since bankruptcy law is complex, has long-term financial and legal repercussions, and a single mistake can significantly harm the case.
It is preferable to go through the process with the support of a specialized bankruptcy attorney who knows how to choose which type of bankruptcy to file and how to navigate the legal process, which we repeat, has long-term repercussions.
If you want to get more information about filing for bankruptcy on your own, start on the official US courts website uscourts.gov.
How much does it affect credit history?
A bankruptcy is a very negative credit event, considered by many lenders to be the worst possible.
The more accounts included in the bankruptcy filing, the greater the impact on the score. A person with a perfect credit history would experience a drastic drop in their score; on the other hand, a person with a negative history and a low score would experience only a slight drop.
Over time, the impact of a bankruptcy on credit diminishes, especially if you start building credit responsibly. However, the bankruptcy will continue to affect credit as long as it remains part of the credit report.
How long does it stay on credit?
The length of time a bankruptcy remains on your credit history depends on the type of bankruptcy. Generally, bankruptcies that discharge debts stay on the credit report longer.
For example, a Chapter 7 bankruptcy can remain on the credit report for up to 10 years from the date of the bankruptcy filing because the debts were discharged, while a Chapter 13 bankruptcy typically remains for 7 years since the debts were restructured and part of the debt ends up being paid.
Types of Bankruptcy
Being within the United States Bankruptcy Code, the types of Bankruptcy are referred to as “chapters” to facilitate identification and make reference to the legal provisions.
Chapter 7
Among the main types of bankruptcy is Chapter 7, which is liquidation bankruptcy.
Here, non-essential assets such as luxury properties or similar goods are sold to pay creditors, though assets like stocks and bonds can also be addressed. However, essential assets such as the primary home, furniture, and the primary vehicle are protected from being liquidated.
Unsecured debts, such as credit cards or medical bills, are typically discharged.
Chapter 11
Chapter 11, which is used mainly by businesses, allows restructuring debts without closing the business, providing the opportunity to create profitability plans, reduce costs, and find new ways to increase income.
Basically, the business continues to conduct its activities while working on a debt payment plan under the court's supervision. This plan may involve downsizing, renegotiating contracts, or selling assets.
Although it is an opportunity to stay afloat, the business cannot expand its operations, take on new debts, or sell assets not specified in the reorganization plan without court approval.
Chapter 13
Chapter 13, which is reorganization bankruptcy, allows you to keep your property (including non-essential property) and instead restructures debts into a payment plan that can last between 3 and 5 years in order to satisfy part of the debt that the creditors consider minimally sufficient and that is paid in a reasonable manner according to the debtor's income.
The last resort
People with low incomes typically qualify for Chapter 7, people with high incomes for Chapter 13; and Chapter 11, although it can be filed by individuals, is more common among businesses with severe difficulties.
A bankruptcy is the last resort to a debt problem, remaining as a negative mark on your credit for between 7 and 10 years, and depending on the type, if you have assets, they may have to be liquidated to pay off part of those debts.
There are two alternatives that should be considered before declaring bankruptcy. Personally, we would consider a Debt Management program since it does not leave a negative mark on your credit and the negative impact is only short-term. A Debt Settlement program could also be considered, although it is not one we would choose ourselves since, like bankruptcy, it leaves a negative mark on credit; it is an alternative if you do not want to go through the legal process of a bankruptcy.
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