Articles

Bankrupt!

You may know someone who is in deep financial trouble. For people in that situation, there often seems to be no solution. A big black cloud of despair descends, and there seems to be no way out.

Consider the following fictional situation:

Steve and Wendy have been married for ten years, and have two children in grade school. Two years ago they bought their first home. Steve is a mechanic at a trucking company, and Wendy works part-time as a clothing sales clerk.

Steve and Wendy have always been responsible, but over the years their debts have steadily mounted up. Their current combined household income is $38,000 per year. They were leading a fairly normal life until last year, when Steve got sick.

Steve's illness was unanticipated, sudden, serious, and chronic. Steve ended up going on medical leave. His insurance pays for most, but not all, of his medical treatments. He does not have a disability issuance policy, and he has long ago run out of accumulated medical and vacation leave.

Prior to Steve's illness, Steve and Wendy had the usual consumer debts, maybe a little bit more. They were two years into a five-purchase contract on a car, and were also paying on a boat and home entertainment system. Their house was being purchased on a 30-year mortgage. They had several credit cards, and credit with some retail stores. Their total monthly payments on ordinary living expenses and consumer debts were pretty close to their combined income.

After Steve's illness, he missed more work than he could afford. As the debts piled up, the family began making purchases and small loans on their credit cards. A surprising amount of their medical bills were not paid by Steve's medical issuance. Before the family knew it they were over their heads in debt.

Steve eventually got back to work, but he had reduced hours at a lower paying job during his period of rehabilitation. Eventually, they began to receive past due notices, and realized that the total amount of their consumer debts exceeded their annual family income. There was no way they could pay their bills on time.

The mounting pressure caused by these debts, the ding notices, and telephone calls from collection agencies began to take a toll on their family life. Steve and Wendy began arguing frequently. Wendy began thinking about a divorce. Steve's work was affected by the stress, and he got a warning from his supervisor that he needed to change his attitude.

Fortunately, there is a perfectly legal and totally reasonable solution for Steve and Wendy through the laws of bankruptcy.

Bankruptcy has gotten a very bad name, mainly from a very few people who have abused the system. For the vast majority of people who file for bankruptcy, however, the laws were enacted specifically to help get a fresh start. A couple of centuries ago, if someone didn't pay his debts as they became due, it was a crime. No matter how poor you were, and no matter what the reason, if you didn't pay you went to jail. There were even special penal institutions called "Debtors' Prisons."

Bankruptcy laws took a different approach. The idea is that when people become overwhelmed by their debts, they should be able to discharge their debts, and start over again. For the people in the pressure cooker like Steve and Wendy, bankruptcy is truly a life saver.

There are two chapters under the bankruptcy statues which apply to most personal situations, chapters 7 and 13 of the federal bankruptcy code. Chapter 7, "Straight Bankruptcy", allows people to discharge their consumer debts. Some debts, like child support and taxes, cannot be discharged. The bankruptcy court appoints a trustee to oversee chapter 7 bankruptcies. The Trustee's job is to verify the income and assets declared by the Petitioner, identify any property which could be sold, and distribute the proceeds among the creditors. Certain categories of personal property can be exempted. Most people will be able to keep their clothing, furniture, and other personal items they need in order to maintain a household.

Some large items of personal property are totally exempt, such as retirement plans. A significant amount of equity in the family home can be exempted. Finally, there is a "Wild Card" exemption of up to $8,300 for most personal property.

Some large items of personal property, such as automobiles, may be partly exempt up to $2000. Equipment related to a trade or profession may also qualify for a separate exemption, such as phones and computers.

The Petitioner in a bankruptcy proceeding may also enter into side agreements with creditors who hold security interests. For example, some property like a car or house is purchased by a contract where the creditor keeps a security interest. The debtor can enter into a "Reaffirmation Agreement" with the creditor. Under such an agreement, the debtor "Reaffirms" the debt and allows the creditor to keep the security interest. If a reaffirmation agreement is not entered into, the creditor has the right to foreclose on the house, or repossess the car.

The procedure for bankruptcy is not nearly as expensive or time consuming as most people think. Many individual consumer bankruptcies can be completed with a visit to a lawyer for one or two hours, and two short hearings at the Bankruptcy Court.

For someone who files a Chapter 7 proceeding in Bankruptcy Court, the final result is a Declaration of Bankruptcy. All debts, except those which are reaffirmed, are discharged. The debtor has a fresh start.

Chapter 13 under the Bankruptcy Code is commonly known as the "wage earner" chapter. It covers any individual who has a regular income. Again, a trustee is appointed by the Bankruptcy Court, but the trustee basically only acts a distributing agent for the wages of the debtor. Payment of debts is set up over a 3 to 5 year period according to a schedule which basically amounts to a Court enforced budget.

Chapter 13 is relatively inexpensive and simple. The Court allows the debtor to control and posses even personal property which is not exempt by the Bankruptcy Laws. A Chapter 13 Case can be converted to a Chapter 7 Case at anytime.

Hopefully, you will never need to use either chapter 7 or 13. If you ever do, however, you will thank your lucky stars for these laws.