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Introduction to Bankruptcy

Posted by attorney David Van Luu

Bankruptcy is one of many options for people in financial distress. Some consumers may improve their situation by directly negotiating with their creditors, while others may find help from a local financial counseling program or consumer credit counseling service to set up a debt repayment plan. For many others bankruptcy may be the only realistic option. This guide will explore the topic of bankruptcy. What is it? How can it be avoided? How does one file for bankruptcy?

I. Bankruptcy Defined

In short, bankruptcy is a legal process that allows people and businesses to obtain a fresh financial start when they are in such financial distress that they cannot realistically repay their debts. The fresh start is achieved by eliminating all or a portion of debts existing and/or by stretching out monthly payments under the supervision and protection of a court. The process is also designed to protect creditors, because general unsecured creditors will share equally in whatever payments the debtor may afford to make.

During the bankruptcy case, creditors generally cannot try to take action to collect their debts directly from the debtor. And after the conclusion of the case, these creditors cannot try to collect any discharged debts from the debtor. However, there is a list of exceptions of the debts that are not discharged (i.e., wiped out), such as certain taxes, student loans, domestic support obligations, fraudulently incurred debts, and DUI obligations. These exceptions will be discussed in a following legal guide.

II. Avoiding Bankruptcy

Making the decision to file for bankruptcy is a big one and should not be made without careful thought. A good first step is to sit down and honestly assess your financial situation by calculating your income level and comparing that figure to your debt level. Before making plans on your financial future, you need to have an understanding of the debts you owe and whether you can live within a strict budget. Many people can reduce their debt significantly simply by living within a self-imposed budget and spending money only on their "needs" rather than their "wants." By learning to take charge of their lives and spend only on the essentials many people may begin to reclaim their financial futures. For many, bankruptcy might be the only realistic option. But, you cannot make this decision until you have carefully examined your income and debt.

Even if you are unable to repay your debts now, there might be other options besides bankruptcy. For instance, your creditors may be willing to settle their claims for a smaller cash payment, or they might be willing to extend the terms of your loan and reduce the size of each payment. This would allow you to pay off the debt by making smaller payments over an extended period of time, and the creditor would reap the benefit of eventually receiving full payment. Additionally, you may find that you are "judgment proof" (meaning you have so little money and property that you couldn't pay a court judgment against you) and do not need to file for bankruptcy to protect your property and wages. If there's no point in creditors going after you in court, perhaps there is less reason for you to file for bankruptcy protection.

If you are behind on your payments you will want to call each creditor and ask for the collection department. Take down the name of the person you talk to, and then explain your intent to repay the account and your need to extend the monthly payments and/or reduce the dollar amount of each installment payment. You might also go to the collection department office to discuss your situation. Ask each creditor if they would agree to a voluntary repayment plan for your debts. In addition, you will want to ask them to reduce late fees and interests. The most important thing to remember is to get all agreements in writing before making any payment.

If you reach a settlement for a single payment, when the payment is made, be sure to indicate on the face and back of the check that the payment is "in full, final, and complete satisfaction" of your account, which you should also identify by number. However, never give creditors information that would enable them to directly access your checking account, and make sure you maintain control over the payment.

Sometimes negotiations will prove to be fruitless. Despite all of your attempts, some creditors might not be willing to give you more time to pay, unless they know what the other creditors are willing to do. Unless your debts are very large, it will be difficult for you to arrange for a meeting of your creditors and negotiate a reduction in your monthly payments or the amount of your debt. You can seek the help of a lawyer or debt consolidation company to negotiate an arrangement with your creditors. Your best bet may be to seek the help of a non-profit consumer credit counseling service. The repayment plans arranged through credit counseling centers enable you to make monthly payments that are then distributed by the program among creditors until all your debts are paid in full. Creditors usually prefer this kind of plan, since they will eventually get more of their money with this approach than they will in bankruptcy. Also, any payment received by the creditor will not be recoverable from them as a preference payment. Know that under a repayment plan of this sort that you may still have to pay interest charges on your debt. However, many creditors will waive or reduce interest charges and delinquency fees.

III. Filing for Bankruptcy

Filing for bankruptcy is a very personal and serious decision. The three primary causes of bankruptcy are loss of employment, large medical expenses, and divorce. Many people file when they have made all attempts to repay their debts, but do not see the light at the end of the tunnel. Such people and businesses may declare bankruptcy by filing a voluntary petition with the bankruptcy court, which seeks its protection and relief under the Bankruptcy Code. In addition to that request, the debtor must provide information about their assets, liabilities, income, expenses, and creditors. The debtor must completely and candidly disclose everything that is required on the bankruptcy petition. Often, debtors have a lawyer prepare and file the petition and other information for them, but some may choose to represent themselves. Whichever route one chooses, it must be stressed that it is important to the success of your case, and to avoid appearances of bankruptcy fraud, to be very thorough and disclose everything that is required on the petition. After filing, under court supervision, either one of the two results will follow: 1) your nonexempt assets will be sold, or 2) a three to five year repayment plan will be approved, or sometimes referred to as "confirmed" by the bankruptcy court. In both cases, the intent is to pay off as much of your debt as possible. Any unpaid debt will be discharged, unless the debt falls within one of the exceptions to discharge.

Understand that there are some restrictions on filing for Chapter 7 bankruptcy, but that these restrictions will not prevent you from being eligible for Chapter 13. Under the 2005 Bankruptcy Abuse and Consumers Protection Act (BAPCPA), an individual who earns more than the median income in his or her state may not be eligible to file a Chapter 7 case. Also, know that federal law protects your right to file for bankruptcy. For instance, you cannot contract away your right to file for bankruptcy. Also, you cannot be fired from your job solely because you filed for bankruptcy.

There are some advantages and disadvantages to filing for bankruptcy. By far the most important advantage is that debtors can obtain a virtually fresh financial start. Another big advantage is that any collection efforts by your creditors must stop immediately. As soon as your petition is filed, an automatic stay takes effect and, by law, most collection activities must cease. If a creditor continues to try to collect the debt the creditor may be cited for contempt of court or ordered to pay damages. On the other hand, the record of a Chapter 13 bankruptcy can remain on your credit report for up to twelve years, which is a long time in today's economic system. Moreover, once a bankruptcy petition is filed, there are strict time periods that must expire (two to eight years) before you can file another bankruptcy case and receive a discharge. If you have equity in your home or car, you may lose it, since that equity may be used to pay a dividend to your creditors' benefit, depending on state laws. In a Chapter 7 bankruptcy, you might also have to surrender some of your nonexempt personal property or your home to a bankruptcy trustee, which would similarly be liquidated/sold to pay a dividend to your creditors.

In closing, you should understand the pros and cons before resorting to bankruptcy as a means of solving your economic troubles. By doing so, you are making an informed and educated decision on the best course of action. But do not wait until the last minute to get help. The day before a foreclosure or court date may be too late to get good advice or to take advantage on non-bankruptcy options. Get advice when you find you cannot pay your monthly expenses in full for more than three months, or if you face a sudden large debt, such as a medical bill, for which you cannot make payment arrangements.

**The above statements are provided for general information purposes only and are not intended as legal advice or advice of any sort for a specific case or legal matter.**

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