Bankruptcy provides a legal framework for individuals and businesses to address overwhelming debt. The process either eliminates debt through discharge or reorganizes obligations to make them manageable. Federal law governs bankruptcy, creating uniform rules across all states.
Chapter 7 Liquidation
Chapter 7 is straight bankruptcy. A trustee liquidates non-exempt assets and distributes proceeds to creditors. The debtor receives a discharge of most remaining unsecured debts.
The means test determines eligibility. Debtors with income above the state median must pass a formula comparing income to expenses. Failing the means test requires filing under Chapter 13 instead.
Exempt property is protected from liquidation. Exemptions vary by state. Some states allow debtors to choose between state and federal exemptions. Common exemptions include homestead, vehicle, retirement accounts, and personal property.
Non-exempt assets are sold by the trustee. In practice, most Chapter 7 cases are no-asset cases because the debtor owns nothing beyond exempt property. The trustee files a no-asset report and creditors receive nothing.
Discharge eliminates personal liability on most unsecured debts. Credit card debt, medical bills, and personal loans are typically discharged. Certain debts survive bankruptcy.
Non-Dischargeable Debts
Student loans are not discharged absent undue hardship, a standard that is extremely difficult to meet. Recent developments suggest some loosening, but student loan discharge remains rare.
Recent taxes, typically those due within three years of filing, are not discharged. Older taxes may be dischargeable if they meet specific criteria.
Domestic support obligations including child support and alimony are never dischargeable. These debts survive bankruptcy in full.
Debts obtained by fraud, including false financial statements, are not discharged. Creditors must object and prove fraud during the bankruptcy case.
Intentional torts resulting in willful and malicious injury create non-dischargeable debts. The creditor must prove the required intent.
Fines and penalties owed to government units are generally not discharged. Criminal restitution survives bankruptcy.
Chapter 13 Reorganization
Chapter 13 allows individuals with regular income to reorganize debts through a three to five year payment plan. The debtor keeps assets while paying creditors from future income.
Plan length depends on income. Below-median debtors may propose three-year plans. Above-median debtors must propose five-year plans.
Disposable income determines plan payments. The debtor pays projected disposable income, defined as income minus allowed expenses. The means test expenses apply.
Secured debt treatment in Chapter 13 allows modification of some secured claims. Car loans can be crammed down to vehicle value if the loan is old enough. Mortgages on primary residences cannot be modified but arrears can be cured.
Priority debts including recent taxes and domestic support must be paid in full through the plan. The plan must provide for full payment of priority claims.
Discharge occurs upon completion of all plan payments. The discharge is broader than Chapter 7, covering some debts that would survive Chapter 7.
Chapter 11 Reorganization
Chapter 11 is complex reorganization primarily used by businesses but available to individuals with debts exceeding Chapter 13 limits.
Debtor in possession allows the business to continue operating under court supervision. Management stays in place unless a trustee is appointed for cause.
The plan of reorganization specifies how creditors will be treated. Creditors vote on the plan by class. Confirmation requires meeting statutory requirements including the best interests test and feasibility.
Creditor committees represent unsecured creditors in larger cases. The committee participates in negotiations and monitors the debtor’s operations.
Small business subchapter V streamlines Chapter 11 for businesses with debts below approximately $7.5 million. The process is faster and cheaper than traditional Chapter 11.
The Automatic Stay
Filing bankruptcy triggers the automatic stay, which immediately stops most collection activity. Lawsuits, garnishments, foreclosures, and creditor contact must cease.
Relief from stay can be obtained by creditors with cause. Secured creditors may obtain relief to foreclose on collateral. The debtor’s lack of equity and inability to reorganize support relief.
Violations of the stay can result in damages, attorney fees, and contempt sanctions. The stay has teeth against creditors who ignore it.
Repeat filers face limitations on the stay. A second case within one year receives only 30 days of stay protection absent court extension. A third case receives no automatic stay.
The Bankruptcy Estate
Filing creates the bankruptcy estate, which includes virtually all of the debtor’s property interests. The estate is administered by the trustee for creditors’ benefit.
Property of the estate includes real and personal property, causes of action, and rights to payment. Property acquired after filing generally is not estate property in Chapter 7 but is in Chapter 13.
Exemptions remove property from the estate for the debtor’s benefit. Proper exemption planning before filing preserves property. Improper planning can constitute fraud.
Avoiding powers allow the trustee to recover property transferred before bankruptcy. Preferences and fraudulent transfers can be set aside for the estate’s benefit.
Preferences and Fraudulent Transfers
Preference actions recover payments made to creditors within 90 days before filing, or one year for insiders. The creditor received more than it would have in a Chapter 7 liquidation.
Ordinary course defense protects payments made according to ordinary business terms. Regular payments on ongoing accounts are usually protected.
Fraudulent transfer actions reach back two years under bankruptcy law and longer under state law. Transfers for less than reasonably equivalent value when insolvent are avoidable.
Intent-based fraudulent transfer is harder to prove but reaches further. Badges of fraud include transfers to insiders, concealment, and transfers of substantially all assets.
For Service Members
Military service creates unique bankruptcy considerations that interact with SCRA protections and military career implications.
SCRA extends the automatic stay beyond the standard scope. Default judgments entered during military service can be reopened. The protections supplement bankruptcy’s automatic stay.
Means test income includes military allowances. BAH and BAS count as income for determining Chapter 7 eligibility. This can push service members over the state median, requiring Chapter 13 even for modest debts.
Security clearance implications of bankruptcy filing are significant but not automatic. Bankruptcy itself is not disqualifying. Financial irresponsibility that led to bankruptcy may be. How the bankruptcy is handled matters.
Deployment timing affects bankruptcy strategy. Filing before deployment may allow completion of required meetings and deadlines. Filing during deployment complicates required appearances.
Career impact varies by service branch and occupational specialty. Some positions require financial stability. Bankruptcy may trigger review but does not automatically end careers.
SCRA interest rate reductions can reduce the need for bankruptcy by making debts more manageable. A 6% cap on pre-service debt may provide sufficient relief without bankruptcy.
Continued service after filing ensures income for Chapter 13 plans. The military’s steady employment and housing benefits support plan feasibility.
A military attorney understands how bankruptcy interacts with SCRA, how military income affects the means test, and how filing affects security clearance and military career.
Disclaimer
This article is provided for general informational and educational purposes only. Nothing in this article constitutes legal advice, and no attorney-client relationship is formed by reading this content.
Bankruptcy law is complex and consequences are significant. The choice between chapters, exemption planning, treatment of secured and priority debts, and other strategic decisions require professional guidance. The information presented here may not reflect current law or apply to any specific situation.
Do not rely on this article to make legal decisions. Bankruptcy affects property, credit, and legal rights for years. Errors can result in loss of property, denial of discharge, or failure to address underlying financial problems.
If you are considering bankruptcy, consult with a qualified bankruptcy attorney who can evaluate your specific financial situation, explain your options, and guide you through the process.
The authors, publishers, and distributors of this content expressly disclaim any liability for actions taken or not taken based on this information. Reading this article does not create an attorney-client relationship with any person or entity.
For service members considering bankruptcy, the intersection of bankruptcy law with SCRA, military income treatment, and career implications requires counsel familiar with both bankruptcy and military-specific considerations.