Bankruptcy law provides for the development of a plan that allows a debtor, who is unable to pay his creditors, to resolve his debts through the division of his assets among his creditors. This supervised division also allows the interests of all creditors to be treated with some measure of equality. Certain bankruptcy proceedings allow a debtor to stay in business using revenue that continues to be generated to resolve his debts. An additional purpose of bankruptcy law is to allow certain debtors to free themselves (to be discharged) of the financial obligations they have accumulated, after their assets are distributed, even if their debts have not been paid in full.
Bankruptcy law is federal statutory law contained in Congress passed the Bankruptcy Code under its Constitutional grant of authority to “establish. . . uniform laws on the subject of Bankruptcy throughout the United States.” See States may not regulate bankruptcy though they may pass laws that govern other aspects of the debtor-creditor relationship. A number of sections of Title 11 incorporate the debtor-creditor law of the individual states.
Bankruptcy proceedings are supervised by and litigated in the United States Bankruptcy Courts. These courts are a part of the District Courts of The United States. The United States Trustees were established by Congress to handle many of the supervisory and administrative duties of bankruptcy proceedings. Proceedings in bankruptcy courts are governed by the Bankruptcy Rules which were promulgated by the Supreme Court under the authority of Congress.
There are two basic types of Bankruptcy proceedings. A filing under Chapter 7 is called liquidation. It is the most common type of bankruptcy proceeding. Liquidation involves the appointment of a trustee who collects the non-exempt property of the debtor, sells it and distributes the proceeds to the creditors. Under Chapters 11, 12, and 13 a bankruptcy proceeding involves the rehabilitation of the debtor to allow him to use his future earnings to pay off his creditors. Under Chapter 7, 12, 13, and some 11 proceedings a trustee is appointed to supervise the assets of the debtor. A bankruptcy proceeding can either be entered into voluntarily by a debtor or initiated by his creditors. After a bankruptcy proceeding is filed, for the most part, creditors may not seek to collect their debts outside of the proceeding. The debtor is not allowed to transfer property that has been declared part of the estate subject to the proceedings. Furthermore, certain pre-proceeding transfers of property, secured interests, and liens may be delayed or invalidated. Various provisions of the Bankruptcy Code also establish the priority of creditors’ interests
BANKRUPTCY, legal proceeding in which a debtor declares his or her inability to pay consumer or business debts as they become due; debtors may seek a discharge from continuing personal liability for unsecured debts or they may attempt to reorganize financially by seeking an extended period of time in which to pay all or a proportion of their indebtedness.
Debtors who were unable to meet their financial obligations were harshly treated under the legal systems of most countries until relatively recent times. During one period in ancient Rome, creditors were entitled literally to divide a debtor’s body or to enslave debtors and their families. Under the laws of England in the reign (1603–25) of King James I, debtors who were unable satisfactorily to explain their inability to pay were placed in the public pillory. Debtors might be put to death if their failure to pay their creditors was due to fraudulent practices. Savage reprisals of this kind were eventually halted, but for many years British courts ruled that debtors who failed to pay a judgment against them were guilty of a breach of the peace and therefore subject to imprisonment. With the development of more sophisticated trade and commercial practices, steps were taken to ameliorate the condition of defaulting debtors. Since the late 19th century, bankruptcy legislation in the U.S. has evolved to permit persons who are unable to pay their unsecured debts to be discharged from that responsibility if they were willing to liquidate their nonexempt property for ratable distribution among unsecured creditors. Both the federal bankruptcy statute and state laws now allow a debtor to retain some exempt property in order to permit the debtor’s family to maintain a minimum standard of living. The states’ exemption laws vary widely in their generosity.
The U.S. Constitution empowers Congress “to establish. . . uniform laws on the subject of bankruptcies throughout the United States” (Article I, Section 8). This grant of power to Congress has been interpreted to preclude the states from including effective individual bankruptcy discharges in their laws. The current federal bankruptcy legislation is the Bankruptcy Reform Act of 1978, as amended in 1984 and 1986.
More than 90 percent of bankruptcy proceedings are voluntary. They are initiated by the debtor, who files a petition with the appropriate federal court. A bankruptcy trustee then collects and liquidates the debtor’s nonexempt property for the benefit of the unsecured creditors. Secured creditors are not affected by bankruptcy liquidations because they have taken collateral (such as a home mortgage) to ensure repayment of debts. Once distribution to unsecured creditors occurs, the court discharges the debtor unless that person’s prior behavior justifies denying the discharge or granting it with certain specific statutory exceptions. In order to limit or deny the discharge, the creditor must prove that the debtor has obtained credit by fraudulent practices or has engaged in other prohibited behavior. Creditors can file an involuntary bankruptcy petition against a debtor, alleging that the debtor is “generally not paying” debts, but this type of proceeding rarely occurs.
The Bankruptcy Code allows both consumer and business debtors to attempt financial reorganization instead of liquidation of nonexempt assets. A debtor who selects this alternative proposes a reorganization plan for consideration by the affected creditors and the court. For individuals who use Chapter 13 reorganization proceedings, a typical plan requires payments from the debtor’s future income. Businesses that wish to continue their operations, sometimes in a modified form, usually opt for Chapter 11 reorganization proceedings. Their proposals may combine payments from sales of some business assets with income from future business operations. Stockholder interests may be restructured in addition to modifying payment requirements for their secured and unsecured debts.
