What Happens in Bankruptcy
Individuals or entities undergoing financial distress may be forced to consider bankruptcy. Bankruptcy is the legal status of an insolvent person or organization, that is, one who cannot repay the debts they owe to creditors. The principal focus of insolvency legislation and business debt restructuring practices is not on the elimination of insolvent entities but on remodeling the financial and organizational structure of debtors experiencing financial distress, so as to permit the rehabilitation and continuation of their business. The bankruptcy system generally endeavors to reward creditors who continue to extend financing to debtors and discourage creditors from accelerating their debt collection efforts.
Features of Bankruptcy in the United States
Bankruptcy cases are either voluntary or involuntary. In voluntary bankruptcy cases, which account for the overwhelming majority filed, debtors petition the bankruptcy court. In involuntary bankruptcy cases, creditors file the petition. Commencement of a bankruptcy case creates an estate. The estate consists of all property interests of the debtor at the time of case commencement, subject to certain exclusions and exemptions.
The United States District Courts have jurisdiction over bankruptcy matters; however, each district court may "refer" bankruptcy matters to the Bankruptcy Court. Most district courts have a standing "reference" order to that effect, so that all bankruptcy cases are handled by the Bankruptcy Court. The US Attorney General appoints trustees for each of the 21 geographical regions in the US. These trustees maintain and supervise a panel of private trustees for Chapter 7 bankruptcy cases. Furthermore, a US trustee may be heard on any issue in any bankruptcy case, except for filing a Chapter 11 plan of reorganization.
Automatic Stay
The Bankruptcy Code imposes an automatic stay at the moment a bankruptcy petition is filed. The automatic stay generally prohibits the commencement, enforcement, or appeal of actions and judgments against a debtor for the collection of a claim that arose prior to the filing of the bankruptcy petition. In other words, as soon as a petition is filed, a debtor is entitled to all the provisions of the Bankruptcy Code. The automatic stay also prohibits collection actions and proceedings directed toward property of the bankruptcy estate itself.
A secured creditor may be allowed to take the applicable collateral if the creditor first obtains permission from the court. The court must either grant permission or provide adequate protection to the secured creditor that the value of their collateral will not decrease during the stay.
Chapters of the Bankruptcy Code
Entities seeking relief under the Bankruptcy Code may file a petition for relief under a number of different chapters of the Code, depending on the circumstances. A case is typically referred to by the chapter under which the petition is filed.
Chapter 7: Liquidation
Liquidation under a Chapter 7 filing is the most common form of bankruptcy. Under Chapter 7, a trustee collects the non-exempt property of the debtor, sells it, and distributes the proceeds to the creditors. Because each state allows for debtors to keep essential property, most Chapter 7 cases are "no asset" cases - meaning that there are not sufficient non-exempt assets to fund a distribution to creditors.
Chapter 9: Reorganization for Municipalities
A Chapter 9 bankruptcy is available only to municipalities, and is a form of reorganization, not liquidation. Because municipalities are entities of state governments, the power of Congress to adjust debts through bankruptcy is limited. Municipalities' ability to re-write collective bargaining agreements is much greater than in a corporate Chapter 11 bankruptcy, and can trump state labor protections, allowing cities to renegotiate unsustainable pension or other benefits packages negotiated in flush times.
Chapter 9 Bankruptcy
Jefferson County, Alabama underwent Chapter 9 bankruptcy in 2009.
Chapters 11, 12 & 13: Reorganization
Bankruptcy under Chapter 11, 12, or 13 requires more complex reorganization, and involves allowing the debtor to keep some or all of his or her property and to use future earnings to pay off creditors. Individuals usually file Chapter 7 or Chapter 13. Chapter 12 is similar to Chapter 13, but it provides extra benefits to "family farmers" and "family fisherman" in certain situations. Chapter 12 generally has more generous terms for debtors than a comparable Chapter 13 case would have available.
Chapter 11 is commonly the form of re-organizational bankruptcy frequently entered into by businesses. Debtors may "emerge" from a Chapter 11 bankruptcy within a few months or several years, depending on the size and complexity of the bankruptcy. The Bankruptcy Code accomplishes this objective through the use of a bankruptcy plan. With some exceptions, the plan may be proposed by any party in interest. Interested creditors then vote for a plan.