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What Is Bankruptcy?

Bankruptcy refers to the legal process in which a person's debts are discharged. What this means is that the debtor is no longer held liable for the repayment of specific debts, and their creditors may no longer collect or attempt to collect what they are owed.

The decision to file for bankruptcy is often one of the hardest choices that a person has to make in their lifetime. Poor planning can often make the process even harder. It goes without saying that filing for bankruptcy should be a last resort, and should only be done when all other methods of satisfying one's financial obligations have been exhausted. However, if your situation has become so severe that you are in danger of foreclosuregarnished wages or repossessions, or are facingdebts that you are in no position to pay, putting off the inevitable can have devastating consequences. Procrastination can cost you your car, your wages, and even your home. Filing your case in a timely fashion can spare you these losses.

  • If you are close to foreclosure on your home, declaring bankruptcy may stop this going forward and even create a payment structure that will help you pay off your arrears.
  • Bankruptcy may cause your car or other property to be given back to you if they have been repossessed by a creditor.
  • Large medical bills combined with a loss of employment, or on their own can create a nearly impossible financial hole to climb out of. Bankruptcy can help you in this situation and possibly reduce or even wipe away your medical bills.
  • Bankruptcy can stop harassing creditors from turning up on your doorstep, especially if they are being unfairly pushy or unreasonable or are fraudulently trying to take more than you owe.
  • If your utilities have been shut off, bankruptcy will help restore these so you do not have to live in darkness.
  • Although your student loans will not disappear, bankruptcy may help you to consolidate those debts and pay them off in a reasonable timeframe.
  • Bankruptcy will end wage garnishment, which means you will be able to afford life's necessities.   

You may have more than one of these issues overlapping in your life and bankruptcy may be the best and most logical way to start your financial life over.

To put it simply, bankruptcy is a federal court process which is designed to help consumers and businesses eliminate or repay debts under the protection of the bankruptcy court. Once bankruptcy proceedings are initiated, whether through Chapter 7 or Chapter 11, creditors cannot attempt to collect debt from the business until the bankruptcy process has ended.

Dischargeable vs. Nondischargeable Debts in Bankruptcy

There are two types of debt for bankruptcy purposes: dischargeable and non-dischargeable. A debtor is freed of the legal obligation to pay debts that are discharged in bankruptcy. Not all debts are dischargeable in bankruptcy, however.

Chapter 7 bankruptcy provides a debtor with the full discharge of debts that are legally allowed to be discharged. Basically in a Chapter 7 bankruptcy, the bankruptcy court takes control of all of the debtor's assets and liquidates them as necessary to pay off as much of the debt as possible. The debtor is no longer responsible for the unpaid balances that remain after liquidation of the assets. If there are not enough assets after liquidation to pay off all of the debts, the debts are discharged and the debtor is no longer obligated to pay them.

In a Chapter 13 bankruptcy, the court approves a plan to repay the debts to the greatest extent possible. The goal is to pay them off in full, but if some balances cannot be paid in full because the assets in the bankruptcy estate are inadequate, they can then be discharged.

Generally tax debt is priority debt in all chapters of bankruptcy. Tax debts are the first debts to be paid when assets are liquidated in Chapter 7. Only income tax debt can be discharged and even income tax debt can only be discharged in limited circumstances.

In a Chapter 13 bankruptcy, any tax debt incurred during the last three years cannot be discharged. It must be included and paid in full in Chapter 13 repayment plan. However, as in Chapter 7 bankruptcy, income tax debt can be discharged to a certain, very limited extent.

Are All Debts Discharged If I File for Bankruptcy?

Tax debt is a type of debt that is not dischargeable without limitation. Again, only income tax debt is dischargeable to some extent. Other types of tax debt, e.g. property tax debt, is not dischargeable. Other debts that are not dischargeable are as follows:

  • Federal, state and local taxes other than federal income taxes;
  • Customs duties;
  • Spousal support
  • Child support;
  • Student loans;
  • Secured debts;
  • Government imposed fines and penalties;
  • False statement debt incurred;
  • Restitution for fiduciary fraud such as embezzlement or larceny;
  • Punitive damage claims for acts found to be willful or malicious;
  • Debts not accounted for on court forms
  • Obligations arising from drunk driving incidents.

Many of these debts are not dischargeable for reasons of public policy.

What Is Bankruptcy Discharge?

Individuals and businesses petition for bankruptcy when they are unable to pay their debts and creditors threaten or take legal action to recover payment. In most cases, the debtor hopes to have his, her, or its debts discharged through bankruptcy.

Debt discharge means that the debtor is no longer legally obligated to pay back the debts. Creditors who have their claims discharged cannot legally collect their claims.

Which Debts Are Discharged?

With some exceptions, most unsecured debt is discharged. The most common debts which are discharged are:

  • Credit card bills
  • Utility bills
  • Medical bills
  • Attorney's fees
  • Personal and business loans
  • Deficiency balances
  • Civil court judgments
  • Taxes past a certain number of years
  • Past rent and other lease obligations

Generally, a debt is discharged during bankruptcy as long as the debt is not secured by property and the Bankruptcy Code does not explicitly make the debt non-dischargeable.

What Is the Difference between Secured and Unsecured Debt?

Secured debts are debts where the creditor claims a debtor's property if the debtor fails to pay back the creditor. The property that the creditor claims and that the debtor must surrender if the debtor doesn't pay the debt is known as collateral property. Secured debt includes debt secured by collateral, constructive trusts, and equitable liens.

Home mortgages are the most famous example of a secured debt. The homeowner, the debtor, promises to pay the bank, the creditor, the mortgage. If the homeowner fails to do so, the bank has the right to take back the house.

In contrast, unsecured debts are merely promises made by the debtor to pay back the creditor. The distinction is important because unsecured debt is subject to discharge while unsecured debt is not.

Which Unsecured Debts Cannot Be Discharged?

The Bankruptcy Code makes certain unsecured debt non-dischargeable. These debts include child support, certain taxes, and student loans (with some exceptions), among others.

In addition, the Bankruptcy Code denies debtors discharge if the debtor commits bankruptcy fraud. The debtor is also denied a discharge if the debtor filed for bankruptcy multiple times in eight years during a Chapter 7 bankruptcy or filed for bankruptcy multiple times in six years during a Chapter 12 or 13 bankruptcy.

When Is a Discharge Given?

Discharge is given at the end of the bankruptcy. In Chapter 7, discharge is given at the end of liquidation.

In Chapter 11, discharge is typically not given. The debtors who typically file for bankruptcy under Chapter 11 are corporations, who are not permitted to receive a discharge. However, Chapter 11 allows debtors to restructure their debts in a way that they might not have to repay their debts. The General Motors bankruptcy is the most famous example of this.

In Chapter 12 or Chapter 13, discharge is given upon completion at the end of the repayment plan. However, discharge can be granted even if the debtor fails to complete the plan. This only occurs if circumstances beyond the debtor's control cause the debtor to fail to complete the plan and modification of said plan is impracticable.

Objections to Bankruptcy Discharges

There are certain types of debt that may be discharged in a bankruptcy case. Once a debt is discharged, a creditor will no longer be allowed to call the debtor, garnish their wages, sue them in court, or do any other activity that would force them to pay a debt that has already been discharged or eliminated.

Under Chapter 7 bankruptcy, also known as consumer or liquidation bankruptcy, a debtor will be permitted to request a discharge of all of their debt that is legally allowed to be discharged. Thus, they will no longer be responsible for repaying those debts. Debt that is legally capable of being discharged by a bankruptcy court is called, “qualifying debt”.

Even when a specific debt is legally capable of being discharged, however, there are some cases where a creditor or bankruptcy trustee can object to the discharge of all or a particular debt. They can do this by either filing an adversary proceeding or a motion to make the debt or entire bankruptcy case nondischargeable. These procedures generally involve what are referred to as objections to bankruptcy discharges.

What Debts are Not Qualified to be Discharged in Bankruptcy?

There are some debts that are not eligible to be discharged in a bankruptcy case. According to the U.S. Bankruptcy Code, some types of debt that may not qualify to be discharged include:

  • Debt incurred in furtherance of a crime (e.g., embezzling funds while serving in a fiduciary capacity);
  • Debt associated with child support or alimony;
  • Student loan debts;
  • Debt that stems from neglecting to pay taxes (e.g., income tax debt); and/or
  • Debt racked up from unpaid HOA fees.

In most instances, debt that falls under any of the categories in the above list are usually considered to be nondischargeable. This means that a creditor will not need to file an objection to any of them since they are already considered to be nondischargeable debt under the law.

Additionally, there are some debts that may traditionally be classified as dischargeable, but some condition is met that transforms them into nondischargeable debts. In such a case, a creditor may file an objection against those debts.

When May a Creditor File an Objection to Discharge?

Creditors, lenders, and/or appointed bankruptcy trustees are all parties who may file an objection to discharge a certain debt in a bankruptcy case. In most cases, however, it is usually a creditor who files such an objection. This may occur when a creditor wants to prevent a specific debt that is still owed to them by the debtor from being discharged.

The creditor may achieve this by alleging that the debtor made a false statement to obtain a loan or cash advance from them before filing for bankruptcy. If the bankruptcy trustee (i.e., the person tasked with overseeing the bankruptcy case and administering funds to a debtor's creditors) finds the creditor's claim to be true, then this could result in a denial of a debtor's request to discharge a certain debt.

In general, there are two primary types of objections that a creditor can make. A creditor may either file an objection to discharge one particular debt or they may file an objection to all of a debtor's discharge requests. Aside from alleging that a debtor made false statements, some other ways that a creditor may accomplish this is by claiming that the debtor:

  • Attempted to defraud the creditor;
  • Tried to abuse the U.S. bankruptcy system;
  • Failed to obey an order issued by the bankruptcy court;
  • Misrepresented, destroyed, or hid property and assets from the bankruptcy court; or
  • Committed perjury (i.e., lied under oath) by providing false statements on a loan application, to file a bankruptcy petition, or during the 341 meeting of the creditors.

It is important to note that committing bankruptcy fraud or any other crime related to a bankruptcy proceeding is a very serious offense that can lead to serious legal consequences, including a dismissal of a debtor's entire bankruptcy case, criminal fines, and imprisonment.

What are Some Common Creditor Objections to Bankruptcy Discharge?

There may be several reasons as to why a creditor may object to a certain bankruptcy discharge. In general, some of the most common creditor objections to discharge debts in a bankruptcy case may include:

  • If there are implications or evidence of misrepresentation, fraud, and/or abuse of the bankruptcy system. For example, if a debtor misrepresents the amount of funds in a bank account by temporarily transferring them to a relative to make it seem like they have less money than they owe, then this may constitute an instance of misrepresentation or fraud. In which case, the court will most likely deny a discharge and could potentially dismiss the entire case.
    • In addition, if it appears that a debtor tried to take advantage of the U.S. bankruptcy system in order to delay creditors or to avoid having to pay off certain debts, then the court will also likely deny a bankruptcy discharge. In extreme cases, such conduct can lead to the debtor also having to pay criminal fines or serve a prison sentence.
  • If a debtor purchases a large sum of luxury items with their credit card prior to filing a petition for Chapter 7 bankruptcy. For instance, if a debtor buys unnecessary luxury items, such as a watch, fine jewelry, expensive electronics, or book reservations with a five-star resort (i.e., items that are not considered to be essential needs), within 90 days before they file for bankruptcy, the debt will be presumed nondischargeable by a court.
    • The debtor will need to prove that these purchases were reasonably necessary to support either themselves or a dependent. As of April 2021, a debtor who buys luxury goods and/or services that amount to more than $675 within the 90-day period, should anticipate creditor objections and that this debt will not be discharged unless they can prove otherwise.
      • Additionally, any cash advances that a debtor receives that amounts to more than $950 after asking for an extended line of credit within 70 days before filing a petition for bankruptcy, will also be presumed to be nondischargeable debt.
  • If a debtor uses a credit card to pay off debts that traditionally are not eligible for bankruptcy discharge in a Chapter 7 case. For example, if a debtor used their credit card to pay down their student loans or HOA fees, then filed for bankruptcy to obtain a discharge of those debts that are now considered credit card debts, which would normally be either partially or fully dischargeable.

Does the Same Apply to a Business Bankruptcy?

Business debts cannot be discharged in a Chapter 7 bankruptcy, unless the business is a sole proprietorship or a general partnership. So, for example, the following are the debts of the sole proprietor of a

business that could be discharged if the debtor files for Chapter 7 bankruptcy as an individual and not as a business:

  • Debts owed by a sole proprietor that are unsecured, e.g., debts to suppliers, consultants, and professionals such as accountants or lawyers;
  • Debts owed for leases and contracts entered into by the sole proprietor, such as leases for commercial property, residential property and equipment;
  • Debts for unpaid personal loans and promissory notes..

A corporation or partnership may only obtain a discharge of debts in a Chapter 11 bankruptcy subject to certain limitations described in bankruptcy law. If a business is organized as a corporation or limited liability company (LLC), only the business may be liable for paying business debts, so long as an individual did not co-sign or sign a personal guarantee for a loan or other obligation. If an individual did sign a personal guarantee or co-sign for a loan, that individual might file for bankruptcy of the business entity, which can be done under Chapter 7 or Chapter 11.

Otherwise, Chapter 11 generally offers the opportunity for businesses in financial straits to restructure and reorganize their existing debt load in order to continue business operations. In Chapter 11, a business can anticipate a four-month process as their debt is addressed with creditors. When the Chapter 11 bankruptcy plan is complete, the business emerges from the proceeding and continues operations. ‘

A business debtor can restructure its debt in Chapter 11 in any way that allows the company to remain in business, as long as the business, its creditors and the bankruptcy court agree on the strategy. So the reorganization plan might provide for:

  • extending or modifying payment terms
  • lowering interest rates
  • reducing or eliminating debt balances
  • selling assets, and
  • resolving other outstanding issues.

Once creditors agree, and the plan is confirmed, the debts identified in the plan are discharged. The discharge occurs at the time of confirmation of the plan and the confirmed plan becomes a new binding contract between the debtor and creditors. Tax debt is nondischargeable, of course.

Is It Possible to Protect Some Property from Bankruptcy?

Some property is exempt from bankruptcy. With certain limitations, basically a person's house, car and personal property, e.g. clothing and furniture, is exempt in bankruptcy.

When a person files for a Chapter 7 bankruptcy, a trustee is appointed whose job is to repay the person's creditors to the extent possible, given the debtor's assets. The person's assets and property become part of a bankruptcy estate, with a few exceptions. The trustee has the authority to sell property that is not exempt and use the proceeds to pay creditors according to their priority level.

The trustee assesses the debtor's equity in the property in determining whether to sell it. For example, if a person owes a lender $5,000 on their car and the car is worth $15,000, the trustee will have to pay the lender $5,000 of the $15,000, and the car will only be worth $10,000 to the trustee. If there is a vehicle exemption of $10,000, the trustee cannot sell the car to pay creditors. However, if the vehicle exemption is $3,000, the trustee may sell the car, repay the lender $5,000, pay the debtor $3,000 for the exemption, and use the remaining $7,000 to pay off creditors..

Most state systems and the federal system allow a debtor to keep some equity in their house, their vehicle, and their personal property. In some states, there is an unlimited homestead exemption, which allows a person to keep their home in its entirety. Usually, items of personal property and clothing are exempt and cannot be sold, unless they are unusually valuable.

In some cases, even though a person is unable to exempt an asset fully, the trustee may abandon it because the value is not much more than the exemption amount. Generally, it costs money to sell an asset, so it is only worth selling if enough money will be recovered from the sale to use for paying off creditors. If the trustee decides to abandon an item of property, the debtor is allowed to keep it.

Do I Need a Bankruptcy Lawyer?

Whether you are filing chapter 7, chapter 13, or Chapter 11, bankruptcy can be a complicated process. It is vital to know how the law regulates bankruptcy in your state, including what property exemptions you can claim. An experienced bankruptcy lawyer knows the ins-and-outs of filing for bankruptcy, and can recommend what chapter of bankruptcy is right for you. You are most likely to get the best possible outcome from your bankruptcy if you have an experienced bankruptcy lawyer representing your interests.

Call our office today at 212-994-7777 or complete the convenient online contact form to set up a consultation.