Guide to Bankruptcy
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Guide to Bankruptcy

Say the word bankruptcy, and your mind likely conjures up imagery of foreclosure, shuttered businesses, bad credit and overall financial ruin. The truth however, is that bankruptcy can be a viable, useful tool for regaining financial freedom. Keep reading to learn more about what exactly bankruptcy is, how it works and how you can make it work for you.

Bankruptcy: In a nutshell

In a nutshell, bankruptcy is simply the inability of an individual to secure additional monies from a bank or credit union. Declaring bankruptcy informs banks that the individual will no longer to be able to pay back owed debts if additional money is lent. People or companies who declare bankruptcy are not allowed to operate a bank account, until the bankruptcy status has officially been discharged.

There are two types of bankruptcy: voluntary and involuntary. Voluntary bankruptcy involves a debtor initiating his own declaration of bankruptcy, while involuntary bankruptcy occurs when a creditor files a petition against an individual or organization in an attempt to recoup some of the debts that are owed.

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A little bit of History!

Bankruptcy law goes back farther than you might imagine! In fact, the concept and origin of American-style bankruptcy is said to have been enacted in England in 1542, under the reign of King Henry VIII. Back then, the law allowed creditors to seize all the property and assets of a debtor, and even toss the debtor into prison, leaving his family to pay off the debts. As time went on however, debtors were granted more rights, and by the 18th and 19th centuries, they were released from prison and had their debts forgiven. Knowing what debtors used to go through certainly provides a new perspective when you consider what bankruptcy means in today's world!

How Bankruptcy Works

In the United States, bankruptcy is a matter placed under Federal Jurisdiction by the US Constitution. Bankruptcy cases are always technically filed in the US Bankruptcy Court, but these cases are often dependant on State law (especially with respect to the validity of clams and exemptions). Therefore, state law plays a significant role in many bankruptcy cases.

Typically today, a debtor declares bankruptcy to obtain release or relief from debt. This is accomplished through either a restructuring or a total discharge of the debts owed. Now, let's examine the different types of bankruptcy.

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Chapter-by-Chapter: Bankruptcy Types

Under the Bankruptcy Code, there are six types of Bankruptcy:

Chapter 7

Straight bankruptcy; refers to basic liquidation for individuals and businesses, and is considered to be the simplest and quickest form of bankruptcy.

Chapter 9

Municipal bankruptcy; refers to the federal mechanism for resolving municipal debts.

Chapter 11

Corporate Bankruptcy; refers to Rehabilitation or Reorganization, and is used generally by businesses (but sometimes by individuals who possess considerable assets and debts). This type of corporate financial restructuring typically allows companies to continue to function while the debts are paid off.

Chapter 12

Rehabilitation for fishermen and family farmers.

Chapter 13

Wage Earner Bankruptcy; refers to rehabilitation with a payment plan for individuals who possess a regular source of income - debtors adhere to a plan that allows them to pay off some or all of their debts.

Chapter 15

Ancillary and other international cases; provides another method for dealing with bankruptcy debtors and helps foreign debtors to eliminate their debts.

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How Bankruptcy Works

In the US today, 98% of all consumer bankruptcy filings are Chapter 7 cases, though individuals sometimes also use Chapter 13; businesses tend to file through either Chapter 7 or 11.

When it comes to Chapter 7, the debtor surrenders his non-exempt property to a bankruptcy trustee. The property is then liquidated and proceeds are distributed to the debtors unsecured creditors. This entitles the debtor to a discharge of at least some of the debt, but only if he isn't guilty of certain inappropriate behavior (such as concealing financial records). Furthermore, certain debts (student loans, child/spousal support, some taxes) will not be discharged even though other types of debts will be. Often, individuals who are experiencing this type of financial distress will only own exempt property (as in clothes, older cars, household items), and so they won't have to surrender any property at all during the bankruptcy (it's important to note that the amount of property that a debtor may exempt varies state to state). In most instances, the trustee sells off non-exempt property to pay off debts, but certain debts such as Social Security payments, unemployment compensation and certain values of equity in property, appliances, books and tools are protected; since these vary by state however, it's very important to consult with a bankruptcy attorney first to learn what you can expect. Finally, Chapter 7 Bankruptcy Relief is only available once in any given eight-year period.

In 2005, the Bankruptcy Code was amended to include the "means test" for eligibility. Debtors who fail this test for Chapter 7 eligibility have their case dismissed, and may have to convert the case over to Chapter 13.

As noted above, Chapter 13 Bankruptcy relief is only available to individuals who exhibit regular income, and whose debts don't exceed the limits of what Chapter 13 is designed to accommodate. Under this chapter, the debtor proposes a repayment plan for paying back some or all of the debt within three to five years. If the debtors monthly income exceeds the state's median income number, the plan will be set for three years, unless the courts determines cause for extending the plan. For income levels less than the state median, a five-year repayment plan is generally put in place. Regardless of the financial situation, an individual filing Chapter 13 Bankruptcy cannot exceed the five-year limitation. And unlike with Chapter 7, the debtor gets to retain ALL his property, exempt or otherwise, under Chapter 13.

Under Chapter 11, the debtor retains control and ownership of its assets throughout the bankruptcy relief plan. Re-termed a debtor in possession (DIP), the company (or individual) continues to run day-to-day operations of the business, while working with the Bankruptcy Court and creditors to negotiate and complete a plan of repayment. Before a plan is enacted, creditors are allowed to vote on the proposal. Once the plan is approved and confirmed, the DIP can continue to operate and pay off debts under the terms of the plan; however, if a majority of creditors don't approve the plan, additional requirements may be imposed by the bankruptcy court in order to push the plan through.

Regardless of the type of Bankruptcy a corporation or individual chooses to enroll in, and important feature in each filing is the Automatic Stay. This means that right at the request for bankruptcy protection, all lawsuits, foreclosures, repossessions, attachments, evictions, utility shutoffs and debt collection harassment's cease immediately.

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What else is out there?

Bankruptcy has historically gotten a bad rap - in truth, it's often a viable, helpful tool to regain financial freedom. However, it is by no means the only route to taking control of your finances. Here's some information on alternatives worth exploring:

Take No Action

A "judgment" must be obtained by a creditor to garnish wages or take property from a debtor. However, if a debtor has no income and no property, they are deemed "judgment-proof," meaning a judgment would have no effect on their financial situation. When enough time passes (seven years being the typical time frame), debt is removed from the debtors credit history. Therefore, for an individual with no income and no property, the "Take No Action" option maybe be the correct approach.

Self Money Management

This option is fairly self-explanatory. Debt is generated when one spends more than one's income allows him to pay off. Therefore, analyzing one's budget and cutting own expenditures so that there is enough income to sustain day-to-day needs and pay off existing debts is a potential option for coming out from under debt. Sometime's it's as simple as taking public transportation, eating out less, and eliminating upper-tier telephone, internet and TV options.

Negotiating with Creditors

When one files for bankruptcy, creditors often risk losing everything that is owed to them. Therefore, they are usually very happen to negotiate the terms of an individuals debt if it means keeping that person out of bankruptcy. Negotiation is typically a viable option if the debtor has sufficient income or assets that can be liquidated and then applied against the outstanding debt. Plus, negotiation often gives the debtor extra time to rebuild their personal finances.

Debt Consolidation

Sometimes, the biggest problem for debtors is overwhelming interest rates, which are often impossible to climb out from under. When this is the case, debt consolidation allows the debtor to borrow from a lender (in most cases a bank), at a low rate of interest, enough funds to repay high-interest debts (such as credit cards). Plus, in doing, so, debtors cut many monthly payments down to just one creditor, which simplifies budget planning.

Debt Restructuring

Restructuring debt is becoming a reality across the globe today, as private and public companies - and even entire countries - face financial distress. The end result is a reduction and renegotiation of delinquent debts, which in turn restores the debtor's cash flow so that operations can continue. Debt restructuring is usually less expensive and preferable to bankruptcy, and usually involves a reduction in owed debt and an extension of payment terms.

Formal Proposal to Creditors

While technically a Chapter under the Bankruptcy Code, a Chapter 13 Wage Earner Plan is a good alternative to explore when a debtor can't recover from debt through personal budgeting, debt consolidation or negotiation. Chapter 13 allows an individual up to five years, through a structured program, to repay debts to creditors, without incurring the more stringent conditions of Chapters 7 or 13.

So Now What?

If you're reading this, maybe you're currently in a state of financial distress. Or perhaps someone has recommended exploring bankruptcy and you're looking for more information and to get acquainted with what bankruptcy is all about. The good news is that you're not alone. According to the American Bankruptcy Institute, during the first half of 2010, there were over 750,000 consumer bankruptcy filings. On this site, you can learn more about how bankruptcy works, the filing process and what to expect while you work to get your budget back in order. Take the first step today towards financial freedom!

To review debt relief alternatives to bankruptcy in California and to get a free debt relief analysis, along with a free savings estimate, simply answer a few online questions. It's free and there's no obligation.

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