Bankruptcy In Brief


Bankruptcy is governed by the federal law found at Title 11 of the United States Code. As federal law, it supercedes any conflicting state law by reason of the Supremacy Clause of the Constitution. With the exception of exemptions, it is the same from state to state.

Bankruptcy Basics

There are four kinds of bankruptcy proceedings. They are referred to by the chapter of the federal Bankruptcy Code that describes them.

Chapter 7 is the most common form of bankruptcy. It is a liquidation proceeding in which the debtor's non-exempt assets, if any , are sold by the Chapter 7 trustee and the proceeds distributed to creditors according to the priorities among creditors established in the Code. 

Chapter 7  is available to individuals, married couples, corporations and partnerships. Individual debtors get a discharge within 4-6 months of filing the case.  

If there are assets which are not exempt, the trustee takes control of those assets, sells them and pays creditors as much as the proceeds permit.  

Any wages the debtor earns after the case is begun are the debtor's, beyond the reach of creditors who had claims on the date of filing.

Chapter 11 is a reorganization proceeding, typically for corporations or partnerships. Individuals, especially those whose debts exceed the limits of Chapter 13, may file Chapter 11. In Chapter 11, the debtor usually remains in possession of his assets and continues to operate any business.  

The debtor proposes a plan of reorganization which, upon acceptance by a majority of the creditors, is confirmed by the court and binds both the debtor and the creditors to its terms of repayment. Plans can call for repayment out of future profits, sales of some or all of the assets, or a merger or recapitalization.

Chapter 12 is a simplified reorganization for family farmers, modeled after Chapter 13, where the debtor retains his property and pays creditors out of future income.

Chapter 13 is a repayment plan for individuals with regular income and unsecured debt less than $269,250 and secured debt less than $807,750. 

The debtor keeps his property and makes regular payments to the Chapter 13 trustee out of future income to pay creditors over the life of the plan (3-5 years).  

The level of repayment provided for in the Chapter 13 plan can range from 10% to 100% depending on the debtor's income and the make up of the debt.   

Certain debts that cannot be discharged in Chapter 7 can be discharged in Chapter 13. Chapter 13 also provides a mechanism for individuals to prevent foreclosures and repossessions, while catching up on their secured debts. 

The Law and its language

Bankruptcy is governed by the federal law found at Title 11 of the United States Code.  As federal law, it supercedes any conflicting state law by reason of the Supremacy Clause of the Constitution.  With the exception of exemptions, it is the same from state to state.

Before you file

Absent an emergency, it may pay to do some bankruptcy planning


What debt is dischargeable

If the bankruptcy is not going to be filed immediately, know what debt will survive the Chapter 7 filing in planning your financial life in the interim.

It may be to your advantage to maximize your payments to debts that are not going to be discharged (like taxes, secured debt, and family support) and cease paying dischargeable debts. If all of your debt is dischargeable, you may be able to accumulate cash by not making payments on existing debt.

Cash advances on credit cards aggregating over $1075 made within 60 days before the case is filed are presumed to be fraudulent and therefore non dischargeable. Any charges to credit cards after you decide to file bankruptcy, or even meet with a bankruptcy lawyer, are arguably non dischargeable because you didn't have an intent to pay the bill when you made the charge. If taxes are involved, know exactly which taxes are priority: that means knowing about extensions of time to file tax returns (for calculating the three year rule"); when a tax was assessed (the "240 day rule"); and when tardy tax returns were actually filed (the "two year rule") as well as any events that toll the running of the statute like offers in compromise.

Note that recent changes to the discharge provisions make loans used to pay non dischargeable federal taxes non dischargeable.

Maximizing exemptions

Exemptions: What can I keep if I file bankruptcy? The bankruptcy code allows each individual who files bankruptcy to keep basic assets deemed necessary for the debtor's "fresh start" after bankruptcy. That property is the debtor's "exempt property".

Debtors often worry that they will lose personal possessions and household goods when they file bankruptcy. Most Chapter 7 cases are no asset cases: that is, the debtors give up nothing to the trustee for the following reasons:

First, used household goods and personal effects have little resale value, and so do not represent a source of value to repay creditors. Second, the exemption systems permit debtors to retain the means of day to day living, free from the claims of their creditors. The point of bankruptcy is to get a fresh start and that is only possible if the debtor has something to start with.

Retirement savings, frequently the largest or second largest asset of most families, are not property of the estate. Since retirement plans are outside the estate, the debtor doesn't have to exempt them to keep them.

How do I calculate what's exempt?

The values in the exemption statutes refer to the present sale value of the item (not its purchase price or its replacement value).

The law looks only to the value of the debtor's share of the equity in an item if it is co owned. If an asset is subject to a mortgage or a lien, it is the value of the item after deducting the amount of the lien that is used to figure the exemption. Some liens can be avoided to create exempt equity.

Know what you are permitted to exempt from the claims of your creditors.

If you have significant non exempt assets, get good bankruptcy counsel about converting non exempt value into exempt value.

Courts are variable about what constitutes good bankruptcy planning and what is a scheme to "hinder, delay or defraud creditors". exemptions is traditionally permissible;hindering your creditors is grounds for denial of discharge. I submit that these are but two ends of a continuum and drawing any lines along that continuum is art, not science.

If your assets exceed the exemptions available in your state, get good bankruptcy counsel to evaluate the extent to which those assets can be consumed or converted to exempt assets within the tolerances of the local judges.

Having substantial non exempt assets may also suggest filing Chapter 13 rather than Chapter 7.

Denial of discharge

The debtor can be denied a discharge of all of his debts if the court finds, after trial, that the debtor committed certain acts deemed incompatible with the "honest but unfortunate debtor"

Acts that may result in denial of discharge include transferring, concealing or destroying assets or financial records; making a false oath on the schedules or under oath in the case; or failing to keep books and records from which the debtor's financial condition can be ascertained. The complete list is found at 11 U.S.C. 727.

Denial of discharge affects the debtor's liability to all creditors, whether or not the debtor committed some fraudulent act with respect to that creditor.

Denial of discharge doesn't stop the administration of the case, either.

The trustee proceeds to gather and liquidate the assets of the estate, so the debtor loses not only the non exempt assets but any chance of ever discharging the debts in bankruptcy.

Discharges are not denied lightly or easily. This is intended as a penalty for debtors who deliberately try unfairly or dishonestly to thwart their creditors.

Debtors who fully disclose their assets and their financial history should not worry about denial of discharge.

Anticipating avoidance actions

Debtors frequently want to protect creditors who are friends or family members from having to disgorge to the bankruptcy trustee payments made by the debtor or they may want to pay off a credit card so they can keep it after the bankruptcy.

Payments made, or liens perfected, within 90 days of the bankruptcy may be avoided by the trustee as preferences.

If the recipient of the transfer is an "insider", the look back period is 12 months."Insider" is defined in 11 U.S.C. 101 and includes family members, partners, corporations in which the debtor is a decision maker.

It is not wrong for the debtor to make payment to one creditor over another on genuine debts. It is the creditor, not the debtor, who stands to lose if the trustee elects to avoid a payment as a preference. If you want to provide for some creditors over others, you need to know whether that creditor is an insider and when the transfer is deemed made for purposes of the Bankruptcy Code.

The cost of filing suit to recover preferences from creditors usually limits trustee preference actions to transfers in the thousands of dollars.

The debtor can also reaffirm a debt after bankruptcy, as an alternative to paying the creditor's claim before bankruptcy or just pay the debt voluntarily after bankruptcy, without a formal reaffirmation.

Money on deposit vulnerable

If you bank or have investments at an institution to which you owe money, on a loan or a credit card, that institution probably has the right to take your money on deposit and off set it against your debt to them.

Thus, if you file bankruptcy owing a bundle on your Big Bank credit card, Big Bank can take the contents of your checking account at Big Bank on the day you file to pay the credit card bill.

So, good planning says "don't have your assets in institutions to which you owe money. "

Although the right of set off should not apply to funds deposited after the bankruptcy case is filed, the chances for bureaucratic snafus are ever present. Better safe than embroiled in telling a bank they violated the law.

We advise clients to open up new account before they file and move all of their cash, and automatic deposit instructions, to new banks.

Bankruptcy and the alternatives: weighing your options

Do you need to file bankruptcy?

Deciding to file bankruptcy can be a tough decision.  Almost everyone confronting the decision vacillates from "Fight" to "Flee":  struggle to pay the debts versus get relief from the constant pressure and start over.  

To decide, you need to know:

The alternatives :

Can you avoid bankruptcy on your own?

To explore non bankruptcy alternatives, create a budget for your realistic, monthly expenditures for current living,  including mortgage and car payments, but excluding all other existing debt service.  Try these nifty online budgeting tools to help.

With the money available each month after paying your current living expenses, can you pay off your existing debts at the current interest rates in 3 years? 

Forget minimum monthly payments: calculate what it really takes to pay off credit cards at credit card interest rates with this online tool . Can you reduce expenses, increase income, or sell assets to make that possible?

Think hard before resorting to liquidating IRA's or 401K plans to pay creditors:  these assets are generally protected from collection actions by creditors;  they are hard to replenish once spent; but most importantly, using retirement savings to pay creditors may create new debt in the form of income taxes and penalties for early withdrawal.  Your good intentions to repay creditors may just end up substituting Uncle Sam as creditor in place of your existing creditors.

Can you avoid bankruptcy with outside help:

If you can't pay off your debt within three years on the present terms, contact Consumer Credit Counselors , or a similar organization;  they can help you make a budget and  negotiate a repayment plan  that may include a reduced or even zero interest rate on your existing debt.  Creditors generally cease collection actions against those participating in CCC plans.  

These plans usually work best when the debt is primarily credit card debt.  CCC counselors sometimes exclude non dischargeable  tax debt from the plan, leaving the consumer paying unsecured, dischargeable credit card debt while non-dischargeable taxes go unpaid.  That approach seldom gets the debtor the relief needed.

Consider bankruptcy:

If these repayment alternatives are not feasible, consider bankruptcy.  

There is no magic formula that tells you whether bankruptcy is the best choice for you.  

In general, the older you are, the greater the number of people dependent on your income; the larger your debt; the smaller your cash reserves or retirement savings;  and the greater the amount of non dischargeable debt, the more likely that bankruptcy is appropriate for you. 

You don't need bankruptcy protection now if you have nothing that a creditor with a judgment could take from you:   that it, if everything you have is exempt under the law of your state, you have nothing to lose to a creditor and no need for bankruptcy protection now. 

On the other hand,  if your financial situation causes such stress that it interferes with your ability to work, parent, or sleep, perhaps you should consider bankruptcy as appropriate for your mental health rather than financial necessity.  

What debts can be discharged in bankruptcy?

The different kinds of bankruptcy are described at Bankruptcy Basics. The choice of chapter depends on many factors individual to your situation, and is one of the most important reasons to get good legal advice before filing.  Which chapter is best depends on the nature of your debt and the nature and value of your assets.

Chapter 7

Chapter 7 is the most frequently selected kind of bankruptcy for individuals.  The debtor receives a discharge of most unsecured debts within several months of filing the case.

If the debtor's income appears high enough to permit some repayment of debt, the trustee or the court may move to dismiss the case for "substantial abuse".  The theory is that to permit someone with the ability to repay to file Chapter 7 and avoid repayment abuses the bankruptcy system.

If your debt is mixed business and consumer it is important to know what the legal form of the business is.   Corporations and partnerships can file Chapter 7 and Chapter 11;  the choice depends on whether the business can be reorganized in Chapter 11 or will be liquidated in Chapter 7.  Sole proprietorships are treated for bankruptcy purposes as just one kind of asset of the individual who owns them;  thus the owner of a troubled business must file an individual bankruptcy, including all of his assets and liabilities, personal and business, to obtain bankruptcy court protection.

Chapter 13

Chapter 13 is frequently a better choice if you have debts that are not dischargeable in Chapter 7;  if you are in default on mortgages or car payments; if you have more property than can be exempted from creditors in Chapter 7; or  if you owe taxes   or other debts that are not dischargeable in Chapter 7.  

To be eligible for Chapter 13, you must have regular income and debts below a certain level.

Chapter 11

Chapter 11 bankruptcy is a form of reorganization available to individuals, corporations and partnerships.  It has no limits on the amount of debt, as Chapter 13 does.  It is the usual choice for large businesses seeking to restructure their debt.  The debtor usually remains in possession of its assets, and operates the business under the supervision of the court and for the benefit of creditors.

A Chapter 11 plan is confirmed only upon the affirmative votes of the creditors, who are divided into classes based on the characteristics of their claims, and whose votes are a function of the amount of their claim against the debtor.  

If the debtor can't get the votes to confirm a plan, the debtor can attempt to "cram down" a plan on creditors  and get the plan confirmed despite creditor opposition, by meeting certain statutory tests.

Chapter 11 is probably the most flexible of all the chapters, and as such,  it is the hardest to generalize about.  Its flexibility makes it generally more expensive to the debtor.  The rate of successful Chapter 11 reorganizations is depressingly low, sometimes estimated at 10% or less.

Chapter 7 bankruptcy

Chapter 7 bankruptcy is a liquidation proceeding in which the debtor's non-exempt assets if any, are sold by the Chapter 7 trustee and the proceeds distributed to creditors according to the priorities established in the Code.

In most consumer cases, all the assets are exempt, and therefore there are no assets to liquidate and there is no dividend to creditors. Chapter 7 is generally the simplest and quickest form of bankruptcy and is available to individuals, married couples, corporations and partnerships. 

Filing Chapter 7

The case is begun by filing the official petition, schedules and statement of financial affairs.  These forms prompt you to list all of your assets and all of your debts, along with some recent financial history.  The automatic stay goes into effect upon filing the petition, creating a legal barrier to collection actions by creditors.

The debtor must appear at the "first meeting of creditors" (also called the  § 341 meeting from the section of the Code that describes the meeting.)  The trustee can ask the debtor questions under oath about  assets and liabilities;   creditors can also question the debtor on those subjects, but seldom do.

If there are assets which are not exempt, the trustee takes control of those assets. From the sale of assets or the recovery of avoidable transfers, the trustee pays the expenses of the administration of the case, then distributes any remaining funds to creditors with allowed claims, according to the priority of the claims.   Any wages the debtor earns after the case is begun are the debtor's, beyond the reach of creditors who had dischargeable claims on the date of filing.

Generally, the only responsibilities the debtor has with respect to the bankruptcy after the 341 meeting is to cooperate with the trustee in providing any information requested by the trustee.

Getting to discharge

Creditors and the trustee have a 60 day period from the 341 meeting in which they may challenge the debtor's right to a discharge (Bankruptcy Code § 727) or the dischargeability of a particular debt (Bankruptcy Code § 523 (a) (2), (4), (6),and (15)) by  filing an adversary proceeding.  Unless  an action to deny the debtor a discharge is  filed, the order providing for the discharge of debts is issued by the court shortly after the 60 day period expires.  The filing of a contest to the discharge of one debt does not prevent or delay the entry of a discharge of the balance of the debtor's debts.

Discharge

Individual debtors get their discharge within 4-6 months of filing the case. The discharge affects dischargeable debts that existed at the commencement of the case. Corporations and partnerships don't get a bankruptcy discharge.

After the discharge

Certain debts survive a Chapter 7 bankruptcy because they are excepted from the discharge by law:  priority taxes, support, student loans, and liens  are among the kinds of debts not avoided in Chapter 7.  Any debts that were reaffirmed also survive the bankruptcy. 

Why Chapter 13?

Chapter 13  bankruptcy is a repayment plan that protects the debtor from collection action during the plan and discharges any unpaid balance of dischargeable  debts at the end of the plan. 

The discharge in Chapter 13 covers many debts that cannot be discharged in Chapter 7.  It is a powerful tool for debtors to regain control of their financial lives and to get a meaningful fresh start. 

Debtors choose to file a repayment plan under Chapter 13 when

  • they owe debts not dischargeable in Chapter 7 ( such as taxes, child support, fraud judgments)
  • they have liens that are larger than the value of the assets securing the debt
  • they have years of unfiled taxes
  • they are behind on car or house payments
  • their assets are worth more than the available exemptions

What's dischargeable in Chapter 7.

The Chapter 13 plan does not have to pay debts in full; it can provide for only fractional payment.  How much the plan has to pay to creditors is a function of the confirmation tests.   

The Bankruptcy Code does require that priority claims be paid in full.  The most frequently found priority claims are recent taxes and family support. 

The Chapter 13 discharge eliminates some debts that cannot be discharged in Chapter 7, like tax penalties and debts incurred by dishonesty.  

It permits the debtor time to pay debts that can't be discharged in either chapter, like recent taxes or back child support; to cure defaults on home mortgages; and to eliminate liens to the extent the lien is greater than the value of the asset. 

Who is eligible for Chapter 13?

To file Chapter 13, you must be 

  • an individual (no corporations or partnerships); 
  • have a regular income greater than your reasonable  living expenses; and
  • have liquidated, unsecured debts not exceeding $269, 250  and secured debts not exceeding $ 807,750. Telling if a debt is  secured.   

A liquidated debt is one where the amount the debtor owes is known, or capable of easy calculation.  For example,  a loan is a liquidated debt;  the damages owing in an auto accident are usually unliquidated until judgment is entered.

While you can only file Chapter 7 every 7 years, you can file a Chapter 13 bankruptcy even if you got a Chapter 7 discharge less than 7 years ago.  

A strategy frequently used is to file Chapter 7 to discharge those debts that are dischargeable, and file a subsequent Chapter 13 to repay those debts that were not discharged in Chapter 7.

How does Chapter 13 work?

Who makes the plan?

The debtor proposes a payment plan, based on how much money is available to pay debts after current living expenses are paid.  The plan is filed with the schedules commencing the case;  a copy of the plan or a summary of it is served on every creditor.  

The plan must be proposed in "good faith", a catch all term if there ever was one.

What does the plan provide?

The plan must also meet two other tests:

Best Interest of Creditors Test : the plan must give  unsecured creditors at least as much on their claim as they would have gotten if the debtor filed Chapter 7 ; and

Best Efforts Test :  all disposable income (the amount  left after payment of reasonable, current expenses) must be paid into the plan for at least 3 years.

The plan must also provide for payment in full of priority claims and generally provide for payment of the value of secured claims on cars, etc.,  in full over the life of the plan. Long term debt, like house mortgages,  need not be paid off in full in the plan, though the plan might cure any defaults on long term debt.

Payments can be the same over the life of the plan, they can start low and increase at intervals, or they can vary with the seasons. 

While plan must provide enough money to pay the priority claims (most commonly taxes and support) in full, payments to other creditors can be as little as 10 cents on the dollar.

Role of exemptions in Chapter 13

Role of the trustee: 

The trustee acts as the disbursing agent for the payments made into the plan. The trustee also reviews the plan and challenges those plans that don't, in the trustee's opinion, meet the tests for confirmable plans set out in the Bankruptcy Code. 

If the trustee and the debtor can't agree on the terms of the plan, a judge will decide if the plan can be confirmed.  

Once the plan is confirmed, the trustee pays creditors regularly from the payments made by the debtor. Generally, all debt existing at the beginning of the case must be paid through the trustee; current mortgage payments and some leases are among the  exceptions. 

Payments through the plan 

The debtor must make the first payment on the plan within 30 days of the filing of the plan and each month thereafter. Payments begin before the first meeting of creditors (the § 341 meeting) and continue even while objections to confirmation are pending. Payments must be made in certified funds, such as money orders or cashiers checks, or by voluntary wage deduction.

If you stop making plan payments, the trustee will ask that your case be dismissed.

Can creditors reject the plan?

Creditors' objections are limited in Chapter 13. They don't get to vote on whether they will accept the plan, as they do in Chapter 11. They can object only if they contend the plan does not meet the best interests of creditors test and the best efforts test, or if they contend the debtor has not proposed the plan in good faith.

A secured creditor can also object to the value that the plan places on the creditor's collateral. (The trustee can raise any objection that a creditor could raise). 

Objections to confirmation are usually resolved by negotiation between the debtor's counsel and the objecting party, usually by some sort of compromise. If the parties can't reach a compromise, the judge will decide the question.

The confirmed plan:   

Once the plan is confirmed, it binds all the parties: the creditors must accept the payments provided; the values given in the plan for the secured portion of claims are  fixed; and the debtor's payments over the life of the plan are fixed, unless the debtor's circumstances change and the plan is modified.

Living in Chapter 13:   

The restrictions on a debtor in Chapter 13 are few:

  •     make plan payments;
  •     don't incur significant new debt without court approval; and
  •     keep current insurance on any asset that is collateral for a debt.

The debtor can move or change jobs without restriction. Court approval may be needed in advance of getting a new car loan; incorporating a business that is an asset of the estate; or refinancing, selling or purchasing a home. Getting that approval can take 30-45 days.

Modifying the plan:  

Plans can be changed if there is an interruption of income, through job loss or ill health. Plan payments can be lowered or the percentage paid to creditors changed if the debtor's income or expenses in the future won't fund the plan as originally confirmed. 

The modified plan must meet the tests for plan confirmation. Sometimes, the amount of money to be paid into a plan must be increased, where the claims that are actually filed and allowed are greater than estimated at the beginning of the case.

The cost of Chapter 13:

Attorneys fees in Chapter 13 are usually paid in part before the case is filed, with the unpaid balance paid by the trustee from the payments the debtor makes into the plan. If the case is more complex or there are contests to confirmation or the allowance of a claim, the attorneys fees may exceed the initial fees set out at the beginning of the case. 

The court must consider requests for additional attorneys fees, and if the request is approved, the additional fees will be added to the debts paid through the plan.

The discharge: 

Discharge is the legal forgiveness of debts. The debts are discharged at the completion of the plan. When the discharge is entered, no creditor who had notice of  the bankruptcy can thereafter try to collect the debt from you personally unless the debt is one for a non dischargeable debt such as  criminal restitution or student loans that wasn't paid in full through the plan. 

While the discharge stays on your credit record for 10 years from the discharge, it becomes less and less significant in a creditor's decision to grant new credit with every year that passes.

Chapter 13 practice:

Chapter 13 varies widely from district to district depending on the custom and attitudes of the local trustees and judges about what is "reasonable" and in "good faith".  A successful  Chapter 13 case requires an experienced bankruptcy lawyer familiar with the prevailing judicial attitudes in the district and the myriad of unwritten local rules.

Bankruptcy relief analyzed by kind of debt

One way of organizing your search for information about bankruptcy is to look at the kinds of debts you owe and how those kinds of debts are treated in the various chapters of bankruptcy.

1.   Credit cards

Evaluating credit card discharge issues

Credit card issuers sometimes challenge the discharge of their debt in Chapter 7 by filing an adversary proceeding claiming that the debt was incurred by fraud and therefore should be excepted from the discharge.

This is sometimes called a non dischargeability action.

Credit card debt may be non dischargeable in bankruptcy under either of two legal theories:

  • The application submitted to get the card was fraudulent

  • The card was used fraudulently 11 U.S.C. 523(a)(2).

This issue arises only in Chapter 7 since, in Chapter 13, even debts tinged with fraud are dischargeable. More on choosing 13.

Hot buttons for card issuers

While each card issuer has a different practice about non dischargeability actions, each of the following circumstances probably increase the likelihood that the debt may be subject to challenge:

  • Increase in credit card usage shortly before filing

  • Newly issued card

  • Large cash advances in months before filing

  • Use of card for travel or vacations

  • Pattern of borrowing on one card to make payments on others

  • Exceeding credit limit

  • Using card when unemployed or without reasonable belief that the debt can be repaid

  • Large balance at filing

Generally, the longer the length of time between any particular use and the bankruptcy filing, the less likely the usage will trigger a challenge to dischargeability.

What options are available

If you are concerned about a challenge by a credit card issuer to the discharge of a particular debt, there are several strategies available:

  • Wait to file bankruptcy so as to put more time and/or more payments on the account between usage and filing.

  • Settle with any objecting creditor if and when they file a non dischargeability action

  • If non dischargeability actions are filed, convert the case to Chapter 13.

  • Contest the suit at trial: if you win, you may recover your attorney's fees incurred to defend the action.

  • File Chapter 13 where even debts that may have been incurred fraudulently are dischargeable.

2.   Taxes

Tax relief in bankruptcy

Bankruptcy can provide relief from the tax man. The automatic stay in bankruptcy stops even collection actions by taxing authorities, including garnishment and seizure. Some taxes and penalties are dischargeable; those that can't be discharged can be paid without interest in Chapter 13.

How much relief?

The precise measure of the relief available in bankruptcy depends on a number of factors including:

  • the kind of tax involved ,

  • the age of the tax,

  • whether a return was filed, and

  • the chapter of bankruptcy selected.

In general, unsecured income taxes that were first due more than three years before the bankruptcy is filed, for which a timely and non fraudulent return was filed, can be discharged in full in any chapter of bankruptcy.

Specific taxes: Recent taxes/Priority taxes:

Taxes first due within three years of the bankruptcy and taxes assessed within 240 days of the bankruptcy, or which are unassessed but assessable when the case is filed, are priority claims which are not subject to discharge. Priority taxes will survive a Chapter 7 discharge to the extent that the trustee does not have money in the estate to pay them. In Chapter 13, such taxes must be paid in full through the plan; penalties associated with those taxes, however, can be treated as a non priority claim and paid a fraction along with other unsecured claims. In Chapter 13, the tax does not continue to incur interest during the case; if the plan is completed, no post filing interest is due.

Unfiled returns/Unfiled tax returns:

When no return has been filed, or has been filed within two years of the bankruptcy, the taxes cannot be discharged in Chapter 7, but can be discharged in Chapter 13 if the tax was first due more than three years before the commencement of the bankruptcy case and was not assessed within 240 days of the filing.

A debtor can expect to have to prepare and file at least the returns for the priority tax years.

Filing a return constitutes an assessment of the tax. Filing a return on the eve of bankruptcy for a year long past could make a tax that is otherwise dischargeable in Chapter 13 into a priority for at least 240 days from assessment! Proceed with professional advice.

Be aware that this provision of the Bankruptcy Code, allowing non filing debtors to get back into the tax system through Chapter 13, is threatened in the pending changes to bankruptcy laws. See our two cents on the supposed reforms.

Trust fund taxes

Liability for trust fund taxes (the portion of an employee's wages that a employer withholds from the employee's check) is not dischargeable regardless of the age of the tax.

If you were an employer, or a "responsible person" for a corporation or partnership that did not pay withheld funds to the taxing authority, you may have personal liability for the taxes withheld.

Trust fund taxes or the penalty assessed against a responsible person can be paid through a Chapter 13 plan.

Distinguish the trust fund portion of the tax from the employer's portion of various taxes: the employer's portion of employment taxes can be discharged if it is not a priority tax or a trust fund tax.

Under the law of some states, sales taxes are also trust fund taxes. In other states they are excise taxes. Excise taxes become dischargeable with time; trust fund taxes do not.

Tax penalties

The treatment of unsecured tax penalties in bankruptcy is linked to the dischargeability of the tax to which they are related.

Chapter 7

  • Penalties associated with priority (nondischargeable) taxes are not dischargeable;

  • Penalties related to dischargeable taxes are dischargeable,too.

Penalties associated with taxes arising more than three years before the bankruptcy are dischargeable, even if the tax to which it is linked isn't dischargeable.

Chapter 13

All unsecured penalties are dischargeable. Penalties can be paid at the same rate as non tax claims, usually a fraction on the dollar.

No new penalties accrue on prepetition taxes during the

Chapter 13 payment plan.

If a tax lien attaches to actual equity in assets, under the current law, the penalties are secured as well as the tax, even if they would be dischargeable if not secured.

Offers in compromise

An offer in compromise may be a better solution when the priority tax (recent taxes or trust fund taxes) is too large to pay off in a Chapter 13. The IRS is now also under direction to consider offers in compromise from those with pending bankruptcy cases.

In summary:

This is only a summary of the treatment of taxes in bankruptcy. The effect of recent tax assessments, offers in compromise, and amended returns have been omitted for simplicity. Be certain to bring these issues to the attention of any bankruptcy lawyer you consult.

3.   Student loans in bankruptcy

The borrower's bankruptcy options on student loans have shrunk to a very few. Changes to the Bankruptcy Code in late 1998 made student loans non dischargeable, regardless of the age of the loan, unless the borrower can establish substantial hardship.

Absent a showing of substantial hardship, the best that bankruptcy can do with respect to student loans may be to eliminate other debts that compete for the borrower's dollars, or to provide a measure of peace during a Chapter 13 plan. Some courts will permit debtors to separately classify student loans in Chapter 13 and pay them a greater percentage than other non secured debt.

It may also be possible to challenge either the enforceability or the accounting issues surrounding a student loan in bankruptcy.

Hardship discharge

Student loans are no longer dischargeable in bankruptcy just because they have been in pay status for the requisite time. The only way the loan can be modified or discharged is by proving that repayment of the loan will create a substantial hardship on the debtor/borrower and his family.

This standard is generally interpreted to mean that the debtor cannot maintain a minimally adequate standard of living and repay the loan. It usually requires a showing that the conditions that make repayment a hardship are unlikely to improve substantially.

Courts in some circuits will permit the judge to find that the debtor can repay a portion of the loan without hardship, and to discharge the balance of the loan.

Contesting the enforceability of the loan

Student loans are contracts like any other loan and are subject to challenge for fraud, etc. Also, students loans are not enforceable when the school has closed prior to the student completing his education. These challenges could be raised in a Chapter 13 proceeding and decided by a bankruptcy judge. In the usual Chapter 7, there is no dividend to creditors and thus no reason for the bankruptcy court to rule on the enforceability of a claim, outside of an adversary proceeding to obtain a hardship discharge.

Challenging the loan balance

A pervasive problem in student loans is the state of the lender's records: the loan has been transferred several times and it is not clear just what is owed and whether all the additional charges are in accordance with law.

Consider using an objection to the claim of the holder of a student loan in a Chapter 13 to get a judicial determination of the rights of the borrower: in bankruptcy, the burden of proof is on the creditor. Once a judge decides what is properly owed, principles of collateral estoppel should make the decision of the bankruptcy court binding on the lender even if the repayment period on the loan stretches beyond the end of the plan.

Living with student loans

There is some small comfort in the federal regulations which restrict the amount of a student/borrower's wages that can be garnished to repay a student loan to 10% of the borrower's take home pay. Of course, the lender also has the right to intercept tax refunds and apply them to the loan. In twenty years of practice, we have never seen a wage garnishment on a student loan.

Various agencies offer information on workouts and consolidation programs for troubled loans, including a program of repayment based on your income.

4.   Dealing with secured debts in Chapter 7

When a debt is secured, the creditor has rights in the security (or collateral) in addition to the rights against the debtor.   The debtor's personal liability may be discharged in Chapter 7 while lien rights in the collateral pass through bankruptcy unaffected unless they are avoided or stripped down.   When the lien cannot be avoided,  the debtor gets choices about how to provide for the creditor's rights in the collateral.

Long term secured debt like mortgages pass through the bankruptcy unaffected by the discharge.  Most creditors secured in real property are happy to continue receiving payments on the debt, so long as you are current.

You've got choices:         redeem,  reaffirm, or surrender

  • Redemption means that you pay the secured creditor the present value of the asset that is the collateral for the debt in a single cash payment.  Upon payment, the asset is yours, free of the secured debt and the balance of the debt is treated as an unsecured debt in the bankruptcy and discharged with your other debts.
  • Reaffirmation is an agreement to waive the discharge as to the reaffirmed debt and to pay it according to the terms of the original agreement.   The reaffirmed debt is legally enforceable if you breach (stop paying) later on, and the creditor retains the security interest in the asset until the debt is paid.
  • Surrendering the collateral renders the debt an unsecured debt in the bankruptcy.  The creditor can sell the asset to recover part of the claim.  Even if the asset isn't worth what was owed on it, the unpaid balance is discharged in the bankruptcy.
There's more:  the unwritten choice

The other option, not included in the bankruptcy code, is to do nothing with respect to the lien.  In some jurisdictions, such as California,  if you continue to make the payments on the debt secured by a car, for example, the creditor cannot repossess the car.  Law on this subject varies according to the differing holdings of the appeals courts.  Ask your lawyer about the law in your jurisdiction.

If the asset has a low value relative to the cost of repossessing it (such as used computers, major appliances, automobile tires) the debtor can simply decline to redeem, reaffirm or surrender and wait to see if the creditor will take action to recover the collateral after the bankruptcy.  In our experience, creditors threaten but do not pursue this kind of collateral after the bankruptcy.

Chapter 13 provides more options on secured debt

Lien stripping in bankruptcy

Liens can be stripped off of the debtor's assets in Chapter 11 or Chapter 13 when there is not enough equity in an asset, after deducting senior liens from the property's current market value, to secure the lien.

Section 506 of the Bankruptcy Code acknowledges that a lien is only a secured claim to the extent there is value to which it attaches. To the extent that the claim exceeds the value of the collateral, that portion of the claim is unsecured.

In Chapter 11 or Chapter 13, even voluntary liens, such as mortgages* and security interests, can be stripped down to the value of the collateral. Contrast that to lien avoidance pursuant to § 522, where only involuntary liens such as judgment liens or liens on household goods can be avoided if the property would otherwise be exempt.

Liens secured by vehicles

The most common application of lien stripping is the reduction of car loan liens to the present value of the car. Thus a lender holding a $12,000 claim secured by a car now worth $10,000 has a secured claim of $10,000 and a unsecured claim for $2,000. Two thousand dollars of the lien may be stripped off the asset (the car) in a reorganization. The plan must provide for payment in full of the secured portion of the debt; the unsecured portion can be paid little or nothing along with other unsecured claims.

Tax liens

Tax liens can be stripped off in reorganization proceedings (Chapters 11 and 13) to the extent that the lien does not attach to equity in property. Tax liens can't be avoided on the grounds that they impair exemptions.

Avoiding liens that impair exemptions.

Tax liens after Chapter 7: The future of lien stripping Pending legislation in Congress severely limits lien stripping. A recent survey of Chapter 13 trustees determined that if the proposed law applied to current cases, 21% of the cases could not be confirmed and 45% of cases would suffer a reduction in the amounts otherwise paid to unsecured creditors.

5.   Lawsuits

Service of a lawsuit or impending trial often prompts defendants to consider bankruptcy.

Since the legal theories behind lawsuits can range from the simple collection action to a complex business tort case, there are no universal answers about whether the filing of a suit signals time to file bankruptcy.

Here are some things to consider.

  • Should I answer the complaint?
  • What happens if I do nothing?

  • Do I have to file bankruptcy before my creditor gets a judgment?
  • Will bankruptcy stop garnishment on a judgment against me?
  • Should I answer the complaint?

The law presumes that if you don't answer the complaint, you agree with the contention of the lawsuit. Consider answering the lawsuit if 1) you have a defense; or 2) you want to buy time to consider your options.

What happens if I do nothing?

If you do not file an answer, the plaintiff (the entity that brought the suit) can ask the court for entry of a judgment in the amount stated in the complaint. If no amount is stated, the plaintiff has to put on proof of the amount of damages; generally unless you answered the complaint, you cannot participate in the hearing to set the damages.

Once a judgment is entered, the plaintiff can obtain a lien on your assets and can use the services of the sheriff to levy on your bank accounts and garnish your wages. If all of your assets and income are exempt under the law of your state, you may be able to ignore the suit altogether.

Even after a creditor gets a judgment, you can negotiate with the creditor for the payment of the judgment. Since the creditor incurs expenses and delay in using legal processes to collect a judgment, you can sometimes negotiate a discount on the judgment for voluntary payment.

Do I have to file bankruptcy before my creditor gets a judgment?

In general a debt represented by a judgment is just as dischargeable as the same debt prior to entry of judgment. Note, however:

A judgment lien that attaches to assets is only avoidable if it impairs an exemption.

If the complaint alleged fraud or other grounds that would make a debt non dischargeable in bankruptcy, doing nothing may prevent you from later contesting the facts (i.e. you may be unable to get a bankruptcy court to hear your side of the fraud charge in a non dischargeability action).

In the case of debts that are unliquidated (uncertain in amount), a judgment will liquidate the debt: that may have the effect of increasing your debts beyond the eligibility requirements of

Chapter 13, with its "super discharge" and inexpensive reorganization possibilities.

Will bankruptcy stop garnishment on a judgment against me?

Bankruptcy will terminate garnishments as to wages earned after the filing of the bankruptcy.

Wages earned before the filing may be recoverable from the sheriff or the creditor if those wages would otherwise have been exempt.

The only possible exception concerns child support collections:

  • in such cases it depends on what chapter bankruptcy case is

  • selected and whether the support first came due before the commencement of the case, etc.

6.   Home Loans

Can I keep my house through bankruptcy?

An overriding concern for many contemplating bankruptcy is whether they will lose their house in the process. What happens to a house is a function of several issues, but, in general, if the equity in the house is exempt and you can keep making the payments, you can keep the house.

Equity is exempt

If there is no non exempt equity in your home (value over and above the sum of the unavoidable secured debts on the property exemption under applicable law cost of selling the house) the trustee won't attempt to sell the house to pay your creditors. If there is more than nominal non exempt equity, consider Chapter 13.

Almost without exception, the secured creditor wants you to keep the house and keep paying on the loan. The lender is not looking for an excuse to foreclose.

Secured debt survives

The bankruptcy discharge eliminates your personal liability for the mortgage, but it does not disturb the lien. Thus, the mortgage lender still has its rights in the property, including the right to foreclose if you breach the loan agreement.

But, just filing bankruptcy is not a breach of the agreement; failing to make the payments according to the loan agreement is a breach. So, make the payments, keep the house.

Is bankruptcy the solution?

The decision to file bankruptcy should not, in general, be driven by a single debt, but should be made after considering the total financial picture, the scope of relief that bankruptcy offers, and the non bankruptcy alternatives.

What debts can be discharged in bankruptcy?

The scope of the discharge is different in each chapter.  The Bankruptcy Code makes the Chapter 13 discharge more encompassing, to encourage individuals to use Chapter 13 to repay a portion of their debts.

Put most simply, most unsecured debt is dischargeable.  Most secured debt survives bankruptcy as a charge on the property to which it attaches unless a court order modifies the lien.

Chapter 7

Chapter 13


Not dischargeable in Chapter 7 are recent taxes;  family support;  student loans ;  drunk driving judgments;  criminal fines or restitution; or debts incurred by fraud or intentional wrongdoing.  

The complete list of non-dischargeable debts is found at 11 U.S.C. 523(a)  and is set out in table form  here at Discharge of debt in Chapter 7 

Everything else is dischargeable:  loans, credit card debts, judgments, medical bills, old income taxes.   More on treatment of different kinds of debt in bankruptcy.

Remember, liens and mortgages survive the bankruptcy:  the debtor personally has no further liability for the debt, but the lien (a charge on the asset that is the collateral)  survives as an interest in the asset.  In appropriate circumstances, liens can be avoided because they impair an exemption or because the lien doesn't really attach to any value in the collateral.

 


In Chapter 13, only family support, fines, student loans, and drunk driving judgments are non dischargeable.  

However, the Chapter 13 plan must provide for payment in full of priority taxes and past due support.

Debts incurred by fraud or intentional wrongdoing may be discharged if the debtor can demonstrate the plan is proposed in "good faith".  

What precisely is "good faith" occupies judges, lawyers and scholars and consumes lots of trees!

Discharge in Chapter 7 bankruptcy case

What debts are discharged in 

Chapter 7

dischargeable

possibly dischargeable

not dischargeable

  • Personal loans
  • Credit cards
  • Repossession deficiencies
  • Auto accident claims
  • Judgments
  • Business debts
  • Leases
  • Guaranties
  • Negligence claims 
  • Property settlements or division of debts in divorce
  • Willful and malicious injuries to others
  • Embezzlement
  • Debts incurred by fraud or dishonesty
  • Debts arising from breach of fiduciary duty

    A creditor contesting the discharge of these debts must take prompt action to contest the discharge of his claim.

 

  • Recent taxes
  • Trust fund taxes
  • Child or family support
  • Criminal fine or restitution
  • Auto accident claims involving intoxication
  • Debts not scheduled
  • Penalties payable to the government other than tax penalties
  • Student loans
  • Debts listed in prior bankruptcy where debtor was denied a discharge  

 

Small businesses and bankruptcy relief

Your business is in trouble: how do you determine if bankruptcy is necessary or helpful for your situation?

First, is the business a corporation, a partnership, or a proprietorship?

Corporations and partnerships are legal entities separate from their shareholders or partners. They can file Chapter 7 or Chapter 11 bankruptcy in their own right.

Partnership pitfall:

In a partnership's Chapter 7 case, the trustee can sue the general partners of the partnership if the partnership's assets are insufficient to pay all claims for the amount by which the partnership assets fall short of partnership debts. 11 U.S.C. 723. As a result, partners may be facing a suit by a well funded trustee suing for the benefit of all creditors of the partnership.

Get good advice before contemplating a partnership bankruptcy

Proprietorships are just an extension of the owner: they can't file bankruptcy alone: the proprietor must file bankruptcy, since the assets and the liabilities of the business are really just one form of assets of the proprietor. The individual owner may file Chapter 7, Chapter 11 or Chapter 13 (if the debt limits are met).

Should the business be reorganized or liquidated?

To answer this question, you have to know what has caused the problems the business now faces and what are the prospects for change:

  • Reorganization can't create a market; increase gross revenue, or make up for a poor fit between the skills available and the skills required to run the business.

  • Reorganization could free up cash from servicing the old debt to permit current operations; permit rejection of leases or contracts that are no longer advantageous (an expensive facility lease or improvident equipment purchase); or prevent the loss of vital assets or cash to creditor collection actions.

In between Chapter 7 liquidation and reorganization, a Chapter 13 or Chapter 11 could provide a breathing space for the owners to sell the business as a going concern or or its assets in something other than a fire sale. The resulting proceeds could pay taxes or unpaid salaries; sale of the business could provide ongoing jobs for the work force under new ownership. The bankruptcy could then be converted to Chapter 7 or dismissed if bankruptcy protection is no longer needed. The court will probably condition dismissal of the case on payment to creditors of the sale proceeds.

Possible pitfalls for management

What owners and officers need to know when business isn't going well and management is evaluating survival strategies and contingencies for closing, consider the following:
  • How much of the business debt is secured? The division of debt between secured and unsecured guides what reorganization can do for the business.

  • Is this debt secured? Hidden traps in proceeds from collateral Misuse of the the proceeds of a secured creditor's collateral can create a non dischargeable debt for the individuals involved.

  • Trust fund taxes are non dischargeable: When an employer deducts taxes and social security contributions from employee wages, the employer becomes a fiduciary for that money which belongs to the employee. "Loaning" the business the money due Uncle Sam from employees' paychecks makes the responsible corporate officers personally liable for the trust fund taxes not paid to the taxing authority. Sales taxes are trust fund taxes in some jurisdictions, as well.

Payments to insiders on old debts may be recoverable Repayments to relatives and business decision makers on their claims against the debtor can be recovered by the bankruptcy trustee under certain circumstances.

Does management have the resources and desire to engage in the reorganization process?

Bankruptcy reorganization in Chapter 11 requires significant time on the part of the owners and managers to comply with the requirements of the bankruptcy system.

The "bankruptcy bargain" is that, in exchange for the protection of the automatic stay and other bankruptcy protections, the debtor provides full disclosure of its financial condition to creditors and the court, both at the beginning of the case and on a monthly basis thereafter, and operates as a fiduciary for its creditors while the bankruptcy is ongoing.

Legal expenses are significant. Most reorganizations fail, usually for lack of a real plan to solve the problems.

Is the business one that the owners could start up again after a liquidation of the current business?

Businesses that require little capital, have few assets, or are really just extensions of the owner's skills and personality are ones that it may not pay to reorganize. The owners may be better off liquidating the business, in or out of bankruptcy, and starting over in a fresh entity.

This can be a complex issue and requires good professional advice to do correctly.

When Chapter 7 is best

A Chapter 7, whether for the individual or a corporation, may be the best choice when

  • the business has no future,

  • it has no substantial assets or qualities that cannot be reproduced,

    or

  • the debts are so overwhelming that restructuring them is not feasible.

Individuals can get a discharge of the dischargeable debts and a chance to start over. Corporations don't get discharges, but a Chapter 7 can provide an orderly liquidation under the direction of the trustee and at no expense to the debtor. Creditors are assured that they will be paid to the extent of the assets available and the priority of their claim. Former management is assured that the assets that are available go (after the expenses of the Chapter 7) to pay taxes for which the individuals may be liable.

Glossary of Bankruptcy Terms

Bankruptcy has its own language.  Here is a brief definition of those terms used in this site and in the Bankruptcy Code.

Adversary proceeding : A lawsuit filed in the bankruptcy court which is related to the debtor's bankruptcy case. Examples are complaints to determine the dischargeability of a debt and complaints to determine the extent and validity of liens.

Automatic stay : The injunction issued automatically upon the filing of a bankruptcy case which prohibits collection actions against the debtor, the debtor's property or the property of the estate.

Avoidance :   The Bankruptcy Code permits the debtor to eliminate (avoid) some kinds of liens that interfere with (or impair) an exemption   claimed in the bankruptcy.  Most judgment liens that have attached to the debtor's home can be avoided if the total of the liens (mortgages, judgment liens and statutory liens) is greater than the value of the property in which the exemption is claimed.  This is sometimes called "lien stripping."  For more, see Lien Avoidance and Lien Stripping .

Avoidance powers : Rights given to the bankruptcy trustee or the debtor in possession to recover certain transfers of property such as preferences or to void liens created before the commencement of a bankruptcy case. 

Bankruptcy Code . Title 11 of the United States Code  governs bankruptcy proceedings. Bankruptcy is a matter of federal law and is, with the exception of exemptions, the same in every state.  When federal bankruptcy law conflicts with state law, federal law controls.

Bankruptcy estate : The estate is all of the legal and equitable interests of the debtor as of the commencement of the case. From the estate, an individual debtor can claim certain property exempt; the balance of the estate is liquidated in a Chapter 7 to pay the administrative costs of the proceeding and the claims of creditors according to their priority.  More on the estate

Chapter 7 : The most common form of bankruptcy, a Chapter 7 case is a liquidation proceeding, available to individuals, married couples, partnerships and corporations. More in Bankruptcy Basics.

Chapter 11 : A reorganization proceeding in which the debtor may continue in business or in possession of its property as a fiduciary. A confirmed Chapter 11 plan provides for the manner in which the claims of creditors will be paid in whole or in part by the debtor.

Chapter 12 : A simplified reorganization plan for family farmers whose debts fall within certain limits.  Chapter 12 was not renewed when it expired this session of Congress.

Chapter 13 : A repayment plan for individuals with debts falling below statutory levels which provides for repayment of some or all of the debts out of future income over 3 to 5 years.  More in The Power of 13.

Collateral:   The property which is subject to a lien .  A  creditor with rights in collateral is a secured creditor and has additional protections in the Bankruptcy Code for the claim secured by collateral.  The measure of the secured claim is the value of the collateral available to secure the claim:  it is possible to have a lien on property that is subject to a senior lien or liens such that the security available to pay the claim is really without value to the junior creditors.   The rule with respect to liens is "First in time, first in right."   More on Secured Debts .

Confirmation : The court order which makes the terms of the plan for repayment of debts in a Chapter 11, 12 or 13 binding. The terms of the confirmed plan replace the prepetition rights of the debtor and creditor.

Conversion : Cases under the Code may be converted from one chapter to another chapter; for example, a Chapter 7 case may be converted to a case under Chapter 13 if the debtor is eligible for Chapter 13.

Creditor :   The person or organization to whom the debtor owes money or has some other form of legal obligation.

Debtor:   The debtor is the entity ( person, partnership or corporation) who is liable for debts, and who is the subject of a bankruptcy case.

Debtor in Possession: In a Chapter 11 case, the debtor usually remains in possession of its assets and assumes the duties of a trustee.  The debtor in possession is a fiduciary for the creditors of the estate, and owes them the highest duty of care and loyalty.

Denial of discharge :   Penalty for debtor misconduct with respect to the bankruptcy case or creditors as a whole.  The grounds on which the debtor's discharge may be denied are found in 11 U.S.C. 727.  When the debtor's discharge is denied, the debts that could have been discharged in that case cannot be discharged in any subsequent bankruptcy.  The administration of the case, the liquidation of assets and the recovery of avoidable transfers, continues for the benefit of creditors.   More on denial of discharge.

Discharge : The legal elimination of debt through a bankruptcy case. When a debt is discharged, it is no longer legally enforceable against the debtor, though any lien which secures the debt may survive the bankruptcy case.

Dischargeable : Debts that can be discharged in bankruptcy.  Certain debts  are not dischargeable;  that it, they may not be discharged through bankruptcy or may only be discharged through Chapter 13. Family support and criminal restitution are examples of debts which cannot be discharged. Debts incurred by fraud can only be discharged in Chapter 13.  More on which debts can be discharged . Considerations in contesting discharge of a debt.

Dismissal : The termination of the case without either the entry of a discharge or a denial of discharge; the debtor and the creditors have the same rights  as they had before the bankruptcy  case was commenced.

Exempt:     Property that is exempt is removed from the bankruptcy estate and is not available to pay the claims of creditors.  The debtor selects the property to be exempted from the statutory lists of exemptions available under the law of his state.  The debtor gets to keep exempt property for use in making a fresh start after bankruptcy.  More on Exemptions.

Exemptions :   Exemptions are the lists of the kinds and values of property that is legally beyond the reach of creditors or the bankruptcy trustee.   What property may be exempted is determined by state and federal statutes, and varies from state to state. 

Fiduciary:   one who is entrusted with duties on behalf of another.  The law requires the highest level of good faith,  loyalty and diligence of a fiduciary, higher than the common duty of care that we all owe one another.

General, unsecured claim : Creditor's claim without a priority for payment for which the creditor holds no security (or collateral). If the available funds in the estate extend to payment of unsecured claims, the claims are paid in proportion to the size of the claim relative to the total of claims in the class of unsecured claims.


Lien : An interest in real or personal property which secured a debt; the lien may be voluntary, such as a mortgage in real property, or involuntary, such as a judgment lien or tax lien.

Liquidated:   A debt that is for a known number of dollars is liquidated.  An unliquidated debt is one where the debtor has liability, but the exact monetary measure of that liability is unknown.  Tort claims are usually unliquidated until a trial fixes the amount of the liability of the tort feasor.

Non dischargeable :   A debt that cannot be eliminated in bankruptcy.  Non dischargeable debts remain legally enforceable despite the bankruptcy discharge.  The Code's list of non dischargeable debts is found at 11 U.S.C. 523 .

Perfection:   When a secured creditor has taken the required steps to perfect his lien, the lien is senior to any liens that arise after perfection.  A mortgage is perfected by recording it with the county recorder;  a lien in personal property is perfected by filing a financing statement with the secretary of state.  An unperfected lien is valid between the debtor and the secured creditor, but may be behind liens created later in time, but perfected earlier than the lien in question.  An unperfected lien can be avoided by the trustee.


Personal property : Property that is not real property or affixed to real property, such as cars, stock, furniture, etc.

Petition : The document that initiates a bankruptcy case. The filing of the petition constitutes an order for relief and institutes the automatic stay .   Events are frequently described as "prepetition", happening before the bankruptcy petition was filed, and "post petition", after the bankruptcy.

Preference : A transfer to a creditor in payment of an existing debt made within certain time periods before the commencement of the case. Preferences may be recovered by the trustee for the benefit of all creditors of the estate.

Pre-petition : Claims or events arising before the commencement of the bankruptcy case, that is, before the filing of the bankruptcy petition.  Generally only pre petition debts may be discharged in a bankruptcy proceeding.

Priority :   The Bankruptcy Code establishes the order in which claims are paid from the bankruptcy estate.  All claims in a higher priority must be paid in full before claims with a lower priority receive anything.   All claims with the same priority share pro rata.  Claims are paid in this order:  1) costs of administration  2) priority claims and 3) general unsecured claims.  Secured claims are paid from the proceeds of liquidating the collateral which secured the claim.

Priority claims : Certain debts, such as unpaid wages, spousal or child support, and taxes are elevated in the payment hierarchy under the Code. Priority claims must be paid in full before general unsecured claims are paid.  Go to discussion of priority taxes .

Proof of claim : The form filed with the court establishing the creditor's claim against the debtor.

Property of the estate :   The property that is not exempt and belongs to the bankruptcy estate.  Property of the estate is usually sold by the trustee and the claims of creditors paid from the proceeds. 

Reaffirm :   The debtor can chose to reaffirm debts that would otherwise be discharged by the bankruptcy. Generally, when a debt is reaffirmed, the parties to the reaffirmed debt have the same rights and liabilities that each had prior to the bankruptcy filing: the debtor is obligated to pay and the creditor can sue or repossess if the debtor doesn't pay. 

Relief from stay :   A creditor can ask the judge to lift the automatic stay and permit some action against the debtor or the property of the estate.  If the motion is granted, the moving party (but no one else) is free to take whatever action the court permits.  Relief can be absolute, for example, permitting the creditor to foreclose on property, or limited, as for example, allowing the recordation of a notice of default. 

Schedules:   The debtor must file the required lists of assets and liabilities to commence a bankruptcy case, collectively called the schedules.

Secured debt:    A claim secured by a lien in the debtor's property by reason of  the debtor's agreement  or an involuntary lien such as a judgment or tax lien. The creditor's claim may be divided into a secured claim, to the extent of the value of the collateral, and an unsecured claim equal to the remainder of the total debt. Generally a secured claim must be perfected under applicable state law to be treated as a secured claim in the bankruptcy.

Unsecured :  A claim or debt is unsecured if there is no collateral that is security for the debt.  Most consumer debts are unsecured. 

Further definitions are found in Section 101 of the Bankruptcy Code.