FAQs

Bankruptcy is a legal process designed to help individuals and businesses reduce, restructure or eliminate debt. A bankruptcy case normally begins when the debtor files a petition with the Bankruptcy Court. A petition may be filed by an individual, by spouses together, or by a corporation or other entity. All bankruptcy cases are handled in federal courts under rules outlined in the United States Bankruptcy Code – 11 U.S.C. §§ 101-1532.

There are different types of bankruptcies, which are usually referred to by their Chapter in the United States Bankruptcy Code. For instance, individuals may file a Chapter 7 or a Chapter 13 bankruptcy, depending on the specifics of their situation. In like manner, businesses may file bankruptcy under Chapter 7 to liquidate or Chapter 11 to reorganize. Bankruptcy filings that involve parties from more than one country are filed under Chapter 15.

Potential debtors should also be aware that out-of-court agreements with creditors, certain types of consolidation or debt counseling services may provide an alternative to a bankruptcy filing.

Chapter 7 – entitled Liquidation, contemplates an orderly, court-supervised procedure by which a trustee takes over the assets of the debtor’s estate, reduces them to cash, and makes distributions to creditors, subject to the debtor’s right to retain certain exempt property and the rights of secured creditors. Because there is usually little or no non-exempt property in most Chapter 7 cases, there may not be an actual liquidation of the debtor’s assets. These cases are called “no-asset cases.” A creditor holding an unsecured claim will get a distribution from the bankruptcy estate only if the case is an “asset case” and the creditor files a proof of claim with the Bankruptcy Court.

In most Chapter 7 cases, if the debtor is an individual, he or she receives a “discharge” that releases him or her from personal liability for certain “dischargeable” debts. The debtor normally receives a “discharge” just a few months after the bankruptcy petition is filed. Amendments to the Bankruptcy Code enacted in to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 require the application of a “means test” to determine whether individual consumer debtors qualify for relief under Chapter 7. If such a debtor’s income is in excess of certain thresholds, the debtor may not be eligible for Chapter 7 relief. This does not apply, however, to an individual debtor who has business debts. An individual debtor is not required to take and pass the “means test” if over fifty percent of the debt involved is business related (e.g., non-consumer debt).

Moreover, if the debtor is a business entity, that entity might consider a Chapter 7 case if it can no longer stay in business or continue its normal business operations. The owners turn their business over to a Chapter 7 trustee for an orderly liquidation. The business stops operating, and the trustee liquidates its assets and pays what it can to its creditors in a priority determined by the Bankruptcy Code. This allows creditors to examine the assets available to them in a transparent manner and, in most matters, to discontinue permanently any collection actions against the business entity.

Chapter 11 – entitled Reorganization, ordinarily is used by commercial enterprises that desire to continue operating a business and repay creditors concurrently through a court-approved plan of reorganization. Upon filing, the debtor remains in control of its business operations as a “debtor-in-possession,” while working with its creditors to rehabilitate the company, under the supervision of the Bankruptcy Court. At the same time, the debtor usually has the “exclusive” right to file a plan of reorganization for the first 120 days after it files the case and must provide creditors with a disclosure statement containing “adequate information” to enable creditors to evaluate the plan. The Bankruptcy Court ultimately approves (confirms) or disapproves the plan being proposed. Under the confirmed plan, the debtor can reduce its debts by repaying a portion of its obligations and discharging others. The debtor can also terminate burdensome contracts and leases, recover assets and rescale its operations in order to return to profitability. Under Chapter 11, the debtor normally goes through a period of consolidation and emerges with a reduced debt load and a reorganized business.

Increasingly, struggling businesses are now opting to use Chapter 11 bankruptcy as a vehicle to sell substantially all of their assets. This is because under Chapter 11 debtors can sell their assets under uniquely buyer-friendly conditions. Specifically, the Chapter 11 debtor can sell its assets to a willing buyer “free and clear” of liens and encumbrances allowing that buyer to continue the debtor’s business without the burden of the previous debt.

Alternatively, Chapter 11 can also be used to allow for an orderly and controlled liquidation of a business. This alternative may provide certain benefits to both the debtor and creditors. Upon filing, debtors may have more control over the liquidation process as management remains in place and a trustee will not automatically be appointed. In like manner, unsecured creditors can form a creditors’ committee and have a voice in the bankruptcy process.

Moreover, in certain cases, Chapter 11 can be used by individuals or spouses who do not qualify for a Chapter 7 or a Chapter 13 bankruptcy. Most individuals who pursue bankruptcy protection under Chapter 11 are real estate owners, investors and professionals whose income is too high for a Chapter 7 or whose debts exceed the limitations of a Chapter 13.

Chapter 13 – entitled Adjustment of Debts of an Individual with Regular Income, is designed for an individual debtor with a regular source of income whose debts do not exceed certain dollar thresholds. In certain situations, Chapter 13 is preferable to Chapter 7 because it enables the debtor to keep a valuable asset – such as a house, and because it allows the debtor to propose a “plan” to repay all or part of the debt owed in installments over a period of time – usually three to five years. Chapter 13 is also used by debtors who do not qualify for Chapter 7 relief under the “means test.”

At a confirmation hearing, if the “plan” being proposed appears “feasible” and if the debtor complies with certain other requirements, the Bankruptcy Court will typically confirm the “plan,” and the debtor and creditors will be bound by its terms. Creditors have no say in the formulation of the “plan” other than to object to it, if appropriate, on the grounds that the “plan” does not comply with certain confirmation requirements of the Bankruptcy Code.

Chapter 13 is very different from Chapter 7 since the Chapter 13 debtor usually remains in possession of the property of the estate and makes payments to creditors, through the Chapter 13 trustee, based on the debtor’s anticipated income over the life of the “plan.” Unlike Chapter 7, the debtor does not receive an immediate “discharge” of debts. The debtor must complete the payments required under the “plan” before the discharge is received. The debtor is protected from lawsuits, garnishments and other creditor actions while the “plan” is in effect. The “discharge” is also somewhat broader (i.e., more debts are eliminated) under Chapter 13 than the “discharge” under Chapter 7.

Chapter 15 – entitled Ancillary and Other Cross-Border Cases, is the United States domestic adoption of the Model Law on Cross-Border Insolvency promulgated by the United Nations Commission on International Trade Law (“UNCITRAL”) in 1997. The purpose behind this Chapter, and the Model Law on which it is based, is to provide effective mechanisms for dealing with insolvency cases involving debtors, assets, claimants and other parties-in-interest involving more than one country.

Generally, a Chapter 15 case is ancillary to a primary proceeding brought in another country – typically the debtor’s home country. As an alternative, the debtor or a creditor may commence a full Chapter 7 or Chapter 11 case in the United States if the assets in the United States are sufficiently complex to merit a full-blown domestic bankruptcy case. In addition, under Chapter 15, a United States Court may authorize a bankruptcy trustee or other entity (including an examiner) to act in a foreign country on behalf of a United States bankruptcy estate.

Equally important, Chapter 15 gives “foreign creditors” the same rights as “domestic creditors” to commence and participate in United States bankruptcy cases, and “mandates nondiscriminatory” treatment for them. This Chapter also requires notice to “foreign creditors” concerning a United States bankruptcy case, including notice of the right to file claims.

To this date, the UNCITRAL Model Law has been adopted (with certain variations) in Mexico, Canada, Japan, Chile, Israel, the United Kingdom, Australia, South Korea, Colombia, Singapore, Greece, the British Virgin Islands and several other countries.

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