A fresh start. That’s what Pip wasn’t afforded in the Dickens novel, Great Expectations, as Dickensian England sent people to prison if they couldn’t pay their debts. By some estimates, more than half of English prisoners in the 18th and 19th century were imprisoned simply because of the inability to pay their debts.[1]
While debtors’ prison is a thing of the past, our society goes even further, allowing people saddled with unmanageable debt to get clean slates under certain conditions. The clean slate, of course, is known as bankruptcy.
We’ll be using the term “bankruptcy” in this course to mean cases filed under one of the chapters of Title 11 of the United States Code (the Bankruptcy Code).[2] A person or organization that files a bankruptcy action in federal court has “declared bankruptcy.” The person or company declaring bankruptcy is called the “debtor” and the person or company to whom a debt is owed is called the “creditor.”
Filing a bankruptcy creates a “bankruptcy estate,” which includes all legal or equitable interests of the debtor at the time of the bankruptcy filing, even if the property is held by another.[3]
Though the goal of bankruptcy law is to give the debtor a fresh start,[4] and people usually declare bankruptcy when their debt load overwhelms their ability to pay that debt, there may also be other reasons to file, as we’ll discuss a bit later.
Bankruptcy laws and regulations are complex. We’ll highlight the bankruptcy laws that are most relevant to most people and present them in an understandable way. Bankruptcy law allows the debtor to either eliminate a debt, which is called a “discharge” or “liquidation,” or to arrange to pay debts over time, which is called a “reorganization” or “rehabilitation.”[5]
Bankruptcy Statistics [6]
In the 12-year span from 2005 to 2017, about 12.8 million consumer bankruptcy petitions were filed in federal bankruptcy courts. Of those, 8.7 million (or 68 percent) were filed under Chapter 7 and 4.1 million (or 32 percent) were filed under Chapter 13.
Non-business filings (which means filings involving mainly consumer debt) constituted 97 percent of all Chapter 7 bankruptcies and 99 percent of all Chapter 13 bankruptcies. Business bankruptcies accounted for about 13 percent of all filings under all chapters.
Total numbers of bankruptcy case filings decreased every year from 2010 through 2017. However, bankruptcy filings by seniors aged 65 and over increased dramatically from 2013-2016 at a rate that was three times the rate in 1991[7].
History and Structure of U.S. Bankruptcy Law
Bankruptcy law is federal law, but the workings of a bankruptcy case may involve state laws as well. Bankruptcy law is authorized under the United States Constitution,[8] which empowers Congress to “establish . . . uniform laws on the subject of Bankruptcies throughout the United States.”
The idea and basic processes of bankruptcy law pre-date the founding of the country. Over the centuries, those laws have morphed into the bankruptcy laws of today, which tend to favor the debtor but also seek to balance the interests of the debtors, creditors and society.
Although bankruptcy laws were authorized when the Constitution was ratified, it was more than a decade later that they were first passed by Congress. The first bankruptcy statute, passed in 1800, heavily favored creditors, allowing only involuntary bankruptcies. It would be another few years before the shape of the debtor-oriented, voluntary bankruptcy laws that we currently have would begin to arise.[9]
Following a financial crisis in 1837, Congress passed the first federal bankruptcy statute that included voluntary bankruptcy. That law so heavily favored the debtor that it was repealed two years later. Still, it established the principle that federal district courts had bankruptcy jurisdiction that endures to this day. The next attempt at a federal bankruptcy statute was passed in 1867, but it was repealed in 1888.[10]
Finally, Congress passed the bankruptcy statute that would become permanent in 1898[11]. Since then, with numerous changes, there has been a consistent set of bankruptcy laws in the U.S. The two major changes to federal bankruptcy law were in 1978[12] and 2005,[13] though minor amendments to the law are routine.[14]
Bankruptcy law closely parallels American debtor-creditor law, but the two are separate legal fields. Debtor-creditor law, for example, includes regulations on debt collection, credit reporting and wage garnishment. While these are relevant in some bankruptcy proceedings, they can arise when no bankruptcy is filed or may be irrelevant even where there is a bankruptcy. Debtor-creditor law is the subject of other LawShelf courses.
Layout of Title 11
Title 11 of the U.S. Code is divided into several chapters that encompass the entirety of statutory bankruptcy law. These include several segments including the following. Chapter 1 one covers definitions and general provisions. Chapter 3 covers case administration, including the all-important “automatic stay” rules. Chapter 5 covers rules regarding the creditors, debtors and the bankruptcy estate. Chapter 7 covers “liquidation” bankruptcies in which the person will give up all non-exempt assets in exchange for a discharge or the business will give up all assets and stop operating. Chapter 9 covers bankruptcies for municipalities. Chapter 11 covers debt re-organizations, primarily for businesses. Chapter 12 is a special bankruptcy chapter for family farmers. Chapter 13 allows re-organization of debts for individuals with regular incomes.[15] This course will concentrate mainly on Chapters 3, 7, 11, and 13.
Jurisdiction
Bankruptcy, by definition, is a federal proceeding, and is governed by the federal Bankruptcy Code, which is Title 11 of the United States Code. The regulations under which bankruptcy law is administered are called the Federal Rules of Bankruptcy Procedure[16]. These regulations are separate from the Federal Rules of Civil Procedure, which govern other civil proceedings. In addition, each local bankruptcy court established its own set of rules.
State laws also come into play in many cases as the states have authority over laws concerning property and debtor-creditor relations[17]. Thus, bankruptcy law carves out state property exceptions that detail what property a debtor may keep while declaring bankruptcy. Exempt property varies by state, but there are several reference pages online that list all of them.[18] In addition, two other federal statutes affect rights and obligations in bankruptcy court: the Service Members Civil Relief Act[19], and the Securities Investor Protection Act of 1970[20].
Bankruptcy Courts
Bankruptcy court is not a statutorily separate court in the federal court system. Rather, it is a division of the federal district court, which is the trial-level federal court. Each federal judicial district in the country has a bankruptcy court, meaning that there are more than 90 bankruptcy courts across the country. Each bankruptcy court has its own clerk’s office. Bankruptcy courts may also operate in satellite district court offices in large districts.
Each bankruptcy court has one or more appointed bankruptcy judges. There are a total of 350 bankruptcy judges.[21] Unlike other federal judges, who are appointed for life, bankruptcy judges are appointed for fourteen-year terms.[22] Also unlike most other federal judges, bankruptcy judges are appointed by the district’s court of appeals rather than by the President.
The bankruptcy judge may decide any matter connected with a bankruptcy case, such as eligibility to file or whether a debtor should receive a discharge of debts. However, as a practical matter, most of bankruptcy legal and judicial work is administrative, and is overseen by a court-appointed trustee. It is a rare case that is actually heard at trial by a judge, so it is important to understand who these private trustees are.
Bankruptcy Trustees
Private bankruptcy court trustees are appointed in cases under Chapters 7, 12, 13 and sometimes 11. They are appointed and supervised by the United States Trustee’s Office. Trustees are private attorneys who are appointed from a list of attorneys who regularly practice in that court and whose primary law practice is devoted to this area of law. They are not government employees, but they are paid by the court, usually out of the bankruptcy estate.
Chapter 7 trustees are appointed to a panel and receive assignments through a blind rotation system, so they are sometimes called “panel trustees.” Chapter 7 trustees collect debtor assets, liquidate them under the bankruptcy code’s rules, and distribute the assets to the creditors and generally manage the case. The debtor may have as few as one meeting with the trustee, who will go over the case with the debtor and her attorney, and then send the paperwork to the judge to review and sign.
Trustees appointed to cases that are not liquidation bankruptcies (mainly, Chapter 11 and Chapter 13 cases) are called “standing trustees.” Their responsibilities are greater than those in Chapter 7 cases. Standing trustees evaluate the financial affairs of the debtors, make recommendations to the court regarding the reorganization plan and then administer the court-approved plan by overseeing the collections and payments mandated by the plan.[23]
Voluntary and Involuntary Cases
A bankruptcy can be filed either voluntarily or involuntarily. A voluntary case is one started by the debtor. An involuntary case is started by the creditor or creditors. The vast majority of cases are voluntary. [24] Involuntary cases may be where creditors have no other good way to collect debts from a recalcitrant debtor. There are numerous restrictions on involuntary bankruptcies, as they can only be filed under Chapter 7 or 11, and there are financial restrictions.[25]
Foreign Debtors
A foreign debtor can file for bankruptcy if the foreign entity has property located in the United States. They will be treated like any other entity filing under Title 11. These actions are independent of any foreign bankruptcy actions.[26]
Chapter 15[27] added to the Bankruptcy Code in 2005, allows the appointment of a representative of a foreign person or business engaged in a bankruptcy proceeding in another country. Once the representative is “recognized” by the court,”[28] the foreign entity comes under the jurisdiction of US bankruptcy laws, giving the debtor all the protections and other processes of the US bankruptcy system.[29]
Relief in Bankruptcy
Debtors in bankruptcy proceedings seek two objectives. The first is temporary – relief from paying debts while the case is in process. The “automatic stay” under Section 362 of the Code allows this temporary relief. The second is the permanent relief or restructuring of the debt at the end of the case, which is called the “discharge.”
The Automatic Stay
The voluntary filing of a bankruptcy action under Chapters 7, 11 and 13 automatically stops any lawsuits or collection actions against the debtor, the property of the debtor or the property of the estate.[30] This is called an “automatic stay.” The stay dates from the date of the filing, even if the creditors do not find out about the filing until later.
Bankruptcy courts also have injunctive power to grant stays in any case in which the automatic stay might not be available.[31]
The automatic stay applies to most collections actions, including:[32]
- The commencement or continuation of any civil litigation in a court, an administrative proceeding, or any other action whose cause arose before the bankruptcy petition was filed.
- The enforcement or collection of a judgment.
- Any act to obtain possession of any property of the debtor or the debtor’s estate.
- Creating, filing or foreclosing on a lien against the property of the debtor.
- Creating, filing or foreclosing on a lien against the debtor personally.
- Any collection actions, whether or not there has been litigation filed. This includes telephone calls from collectors.
- Collection through a debt setoff. A debt setoff occurs, for example, when money is taken from an income tax refund check to pay for a debt owed to the state or a bank to set off a fee owed to the bank.
- Federal or state tax collection actions, under certain circumstances.
Actions NOT covered by the automatic stay include:[33]
– criminal actions or proceedings against the debtor;
– SEC investigations and orders;
– any domestic relations court proceedings, including collecting child support, establishing paternity, and property division during a divorce; non-payment of child support, including withholding, suspending or restricting a driver’s license or any professional license, reporting overdue child support, intercepting tax refunds, and enforcing medical support obligations;
– any act by the bankruptcy trustee regarding the debtor’s property; and
– any property that has already been transferred out of the debtor’s estate,as in the case where the debtor made a fraudulent transfer to a friend or family member.
Debts that are “reaffirmed” also can be collected notwithstanding the automatic stay. A reaffirmed debt is one that the debtor voluntarily chooses to pay, even if there is no obligation to do so. These debts could include a mortgage (to keep a house or car) or a credit card debt (to keep the card).[34]
Filing a bankruptcy can stop an eviction, but not under all circumstances and potentially not for a very long time. While the stay applies to any eviction where the landlord has not yet secured a judgment, it does not apply to an eviction that has already been filed and served.
Even where applicable, the landlord can object to the stay and follow a formal process in the bankruptcy court that may allow the eviction to go forward. This process may be affected by state law. Some states, for instance, do allow a renter to pay back rent and “cure” the rent default.
The landlord can also continue or start an eviction if the reason for the eviction is illegal drug use.[35]
Filing a bankruptcy stays utility shutoffs for 20 days. There is also a process to try to extend that time.[36]
The automatic stay will stop wage garnishments. For Chapter 7 cases, this does not include child support, which will continue to be taken out of the debtor’s paycheck.[37] The stay will include child support in Chapter 11 and 13 cases since paying support will be a part of the reorganization plan. If wages are wrongly garnished, state law may allow a lawsuit against the employer to recover the money.
The stay lasts until the case is terminated (usually in a discharge) or the debt is dismissed or modified. However, the stay is only for 30 days if the debtor has had a prior bankruptcy case dismissed within the prior 30 days, and there is no stay at all if the debtor filed two or more cases that were dismissed in the prior year. In those cases, a stay must be requested by the debtor and may be granted or denied at the discretion of the judge.[38]
Lifting or Terminating the Stay
Any creditor can object to the automatic stay and try to begin or continue collection action. The objection can include filing a proof of claim with a motion for relief from the stay, filing a motion to ratify a foreclosure, or filing an objection to a Chapter 11 or 13 plan.[39] Objections can be either “for cause” (such as where the debtor has engaged in fraud) or where the creditor alleges “lack of adequate protection under the law.”[40]
The latter objection applies where the lien holder has secured interest in the debtor’s property. It can be used when the creditor claims that the property or the lienholder’s interest in the property will be permanently damaged unless the stay is lifted. For instance, the lienholder can claim that the stay is costing unrecoverable money by interfering with a sale of the building, or that the stay itself is devaluing the market value of the building.
The stay may be terminated under two common situations.[41] The first is when the debtor’s property is transferred to someone else. This could occur, for instance, when the trustee sells a mortgaged property, allowing the holder of the mortgage to enforce that agreement against the new owner of the property. The second is when the case ends.
Discharge
There are several ways in which a bankruptcy case can end. It can be voluntarily dismissed by the party that brought it. It can be terminated for cause by the court for fraud, for violating the rules or where the debtor has abused the process (like bringing an action with very little debt).
Most commonly, bankruptcy proceedings end in discharge, which means release of debts. We will be exploring what a “discharge” means for each chapter as we go through this course. We will also explore the various reasons that debtors and creditors do not always achieve their desired outcomes under the bankruptcy laws.
[1] “Debtors,” Victorian Crime & Punishment, http://vcp.e2bn.org/justice/page11365-debtors.html (last visited Aug. 17, 2018).
[2] “Chapter 11 – Bankruptcy Basics,” United States Courts, http://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics (last visited Aug. 17, 2018).
[3] The full definition of what comprises a bankruptcy estate is at 11 U.S. Code §541.
[4] “[I]t gives to the honest but unfortunate debtor…a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.” Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934).
[5] Chapter 11 – Bankruptcy Basics,” United States Courts, http://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics (last visited Aug. 17, 2018); “Bankruptcy Cases,” United States Courts, http://www.uscourts.gov/about-federal-courts/types-cases/bankruptcy-cases (last visited Aug. 17, 2018).
[6] “Just the Facts: Consumer Bankruptcy Filings, 2006-2017,” United States Courts, http://www.uscourts.gov/news/2018/03/07/just-facts-consumer-bankruptcy-filings-2006-2017 (last visited Aug. 17, 2018).
[7] Tara Siegel Bernard, “’Too Little Too Late’:Bankruptcy Booms Among Older Americans,” N.Y. Times, (Aug. 5, 2018).
[8] U.S.Const. art. I, §8, cl. 4.
[9] David Haynes, “History of Bankruptcy in the United States,” The Balance, (Apr. 29, 2018), https://www.thebalance.com/history-of-bankruptcy-in-the-united-states-316225.
[10] Id.
[11] This is known as the Bankruptcy Act of 1898.
[12] The Bankruptcy Reform Act of 1978, which brought the term “Bankruptcy Code” into effect and substantially increased the power of bankruptcy judges.
[13] The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, a radical set of changes to the law which included a “means test” to qualify for filing a Chapter 7 or 13 case and mandatory credit counseling.
[14] David Haynes, “History of Bankruptcy in the United States,” The Balance, (Apr. 29, 2018), https://www.thebalance.com/history-of-bankruptcy-in-the-united-states-316225.
[15] “Bankruptcy Basics,” United States Courts, http://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics (last visited Aug. 17, 2018).
[16] Codified by the United States Supreme Court pursuant to 28 U.S.C. § 2075. Often simply called the Bankruptcy Rules.
[17] See, for ex. Butner v. United States,440 U.S. 48, 52 (1979).
[18] See, e.g., “Bankruptcy Exemptions by State,” NOLO, https://www.nolo.com/legal-encyclopedia/bankruptcy-exemptions-state (last visited Aug. 17, 2018).
[19] Servicemembers Civil Relief Act, Pub. L. 108-189, 117 Stat. 2835 (Dec. 19, 2003), codified at 50 U.S. Code § 3901-4043.
[20] Securities Investor Protection Act of 1970, Pub. L. 91-598, 84 Stat. 1636 (Dec. 20, 1970), codified at 15 U.S. Code § 78.
[21] “Bankruptcy Judgeships,” Federal Judicial Center, https://www.fjc.gov/history/judges/bankruptcy-judgeships (Aug. 17, 2018).
[22] 28 U.S. Code § 152.
[23] “Private Trustee Information,” The U.S. Dep’t. of Justice, (May 12, 2015), https://www.justice.gov/ust/private-trustee-information.
[24] As an example: in 2012, about 1.2 million bankruptcies were filed, but only about 1000 of them were involuntary (US government statistics). See “Table 7.2 – U.S. Bankruptcy Courts Judicial Facts and Figures (September 30, 2012),” United States Courts, (Sept. 30, 2012), http://www.uscourts.gov/statistics/table/72/judicial-facts-and-figures/2012/09/30.
[25]Nicholas Gebelt, “Involuntary Bankruptcy: What Is It, And Why Would Anyone File One?” Southern California Bankruptcy Law Blog, (Jan. 13, 2012),
[26] Peter Amend, “Foreign Debtors’ Access to U.S. Bankruptcy Courts: Expansion of ‘Property in the United States’ Definition in Chapter 15 Cases,” Orrick, (Dec. 1, 2015), https://blogs.orrick.com/distressed-download/2015/12/01/foreign-debtors-access-to-u-s-bankruptcy-courts-expansion-of-property-in-the-united-states-definition-in-chapter-15-cases/.
[27] Chapter 15 was modeled after a United Nations Commission on International Trade Law model code that has been adopted by several countries, including Canada, Mexico and Japan. See Megan R. O’Flynn, “The Scorecard so Far: Emerging Issues in Cross-Border Insolvencies Under Chapter 15of the U.S. Bankruptcy Code,” 32 N.W. J. Int’l. L. & Bus. 391, 391 (2012).
[28] 11 U.S. Code § 1517.
[29] 11 U.S. Code § 1519.
[30] 11 U.S. Code § 362.
[31] 11 U.S. Code § 105.
[32] 11 U.S. Code § 362.
[33] 11 U.S. Code § 362.
[34] “What Does it Mean to Reaffirm a Debt During Bankruptcy?,” Discreet Bankruptcy, http://www.discreetbk.com/what-does-it-mean-to-reaffirm-a-debt-during-bankruptcy/ (last visited Aug. 17, 2018).
[35] Carron Nicks, “Evictions and the Automatic Stay in Bankruptcy: Whether Filing for Bankruptcy Will Stop an Eviction Will Depend on Whether Your Landlord Has an Eviction Judgment,” NOLO, https://www.nolo.com/legal-encyclopedia/evictions-automatic-stay-bankruptcy.html (last visited Aug. 17, 2018).
[36]11 U.S. Code § 366.
[37] Kathleen Michon, “Using Chapter 7 Bankruptcy to Stop Wage Garnishment,” AllLaw, http://www.alllaw.com/articles/nolo/bankruptcy/chapter-7-stop-wage-garnishment.html (last visited Aug. 17, 2018).
[38] “Automatic Stay and Multiple Bankruptcy Filings” Riverside Bankruptcy Blog, (Sept. 1, 2015), http://www.socaladvocates.com/Bankruptcy-Blog/2015/September/Automatic-Stay-and-Multiple-Bankruptcy-Filings.aspx.
[39] Cara O’Neill, “When a Creditor Tries to Lift (Remove) the Automatic Stay,” NOLO, https://www.nolo.com/legal-encyclopedia/creditor-lift-remove-bankruptcy-automatic-stay.html (last visited Aug. 20, 2018).
[40] 11 U.S.C. § 362(d).
[41] 11U.S.C. § 362(c)(1) and (2).