Bankruptcy is a legal status for an individual or organization that is insolvent, or unable to pay their debts. Federal law regulates bankruptcy on a broad scale, but state law determines more specific issues like exemptions and the validity of claims. Modern insolvency legislation focuses on rehabilitation - renegotiating or eliminating debt to give individuals and businesses the opportunity to start fresh. Whereas previous laws would force bankrupt persons and entities to forfeit their assets, current laws aim to allow individuals to keep their homes,vehicles, businesses and other assets.

Insolvency laws in the US now reflect the importance of people and businesses maintaining their places in society and in the economy. The outcome: bankruptcy no longer means surrender -now it’s a strategy, one that almost 2 million people are using every year in the US.

Each state has at least one Federal Bankruptcy Court - Michigan has two: the Eastern and Western Districts. In most cases, the debtor themselves initiates the process by filing a petition for bankruptcy in their district. Although, in some rare cases, usually involving businesses, creditors can force a debtor into bankruptcy.

When an individual or organization files for bankruptcy, an injunction called an automatic stay prevents creditors from taking action to collect debts. This includes creditor harassment, wage garnishments, repossession and foreclosure and can even prevents interest and late fees from accumulating. Once the petition is filed, the court will notify all creditors of the automatic stay within a few weeks. However, the terms of

the automatic stay begin immediately upon filing the petition, so a debtor may choose to have their legal counsel notify their creditors sooner.

The Bankruptcy Code is under Title 11 of the United States Code and Chapters 7, 9, 11, 12, 13 and 15 define six types of bankruptcy. Chapters 9 and 15 deal with municipalities and international debts respectively. The remaining four types are for individuals and businesses, and make up the vast majority of filings in the US. These four can further be split into two groups: liquidation or elimination, Chapter 7; and rehabilitation or reorganization, Chapters 11, 12, and 13.

to stay current on their payments. After Chapter 7 bankruptcy, lien-holders maintain the right to collect on the property, but cannot hold the bankrupt individual responsible for those debts. This can be compared to switching from a termed lease to a month-to-month lease; the future liability of the individual is absolved and they may keep their property so long as they continue to pay for it. Should they stop making payments for any reason, the lien-holder will have the right to repossess or foreclose, but the debt holder will owe nothing.

There are some unsecured debts cannot be discharged as well. They include student loans, property taxes, child or spousal support, fines or restitution ordered by a court, and income tax debts less than 3 years old. The debts of corporations and partnerships cannot be discharged either. Once assets have been redistributed, the entity is legally dissolved while it’s debts still exist, theoretically.

So what can debts can be discharged? Credit cards, in-store lines of credit, medical bills, some private student loans, and other private loans. For most people struggling with debt, these types of debt are often the most burdensome, with high interest rates and minimum payments.

Chapter 7 is referred to as basic liquidation or straight bankruptcy and is the simplest, most common form of bankruptcy. Fundamentally, Chapter 7 calls for the liquidation, or sale, of a debtors assets, so that the funds acquired may be distributed to their creditors.

For individuals - including sole proprietors - certain assets are protected by property exemptions. Specific exemptions and value limitations vary from state-to-state, but generally include a home, vehicle, place of business, household items, retirement funds, and even some liquid savings. It is through redefining these exemptions that modern legislation is able to promote the rehabilitation of bankrupt persons and their businesses. Once all nonexempt assets, if any, are redistributed, most remaining debts will be discharged; meaning the bankrupt individual is no longer personally liable.

Some debts, however, cannot be discharged. Secured debts are debts that have a piece of property attached to then, like a car loan or mortgage. They are considered secured, since the property can be repossessed by the lender if the debt-holder fails

While in Chapter 11 bankruptcy, businesses are afforded a few mechanisms in order to promote profitability. Contracts, including labor, supply, and operating contracts as well as real estate leases, can be canceled or rejected, if doing so will improve financial conditions of the company and is likewise favorable for the creditors. Businesses in Chapter 11 are also able to offer lenders first priority on company revenues to obtain new financing, assuming that such debts would also benefit the company’s profitability.

Chapter 12 is a narrowly defined form of reorganizational bankruptcy that only family farmers and fishermen are eligible for. It is nearly identical to Chapter 13, except higher debt ceilings and more exemptions are allowed in order to account for their higher operational costs.

Chapter 13, the final form of reorganizational bankruptcy, is exclusively for individuals. To have a Chapter 13 plan confirmed, the debtor must be able to prove that each creditor will receive at least as much money as they would through Chapter 7 liquidation. Plans span a 3-5 year period and, like all reorganizational bankruptcies, must be approved by all creditors. Usually, debtors are able to keep their property and assets and their creditors end up with less than they were initially owed.

Reorganizational forms of bankruptcy are for individuals and businesses that are still earning income, but cannot afford their debts. In contrast to liquidation bankruptcy, debtors who file for reorganizational bankruptcy maintain control of their assets. When a petition for reorganizational bankruptcy is filed, or shortly thereafter, the debtor must submit a plan for repaying a portion of their debt within a period of time. Each creditor then has the opportunity to vote for or object the plan. Nonetheless, so long as the plan is fair and equitable to all creditors, objections can be overruled. In the end, the plan must be confirmed by the courts before it can be set into motion.

Chapter 11 is most often used by corporations and partnerships. Although, individuals are also eligible, Chapter 11 bankruptcy is commonly referred to as corporate bankruptcy. Here, debtors maintain the exclusive right to put forth their repayment plan for a period of time, after which creditors may also submit plans. Usually, the debtor retains control over the business operations, but the law does allow the court to appoint a trustee to operate the business. Either way, business operations are under the jurisdiction of the courts and subject to oversight until the debtors “emerge” from bankruptcy by completing their plan.

This is a highly unlikely scenario, since even the first mortgage is worth less than the value of the property. Instead, secondary lien-holders take the easy way out and completely forfeit their right to collect on any debts.

In the end, the homeowner is able to eliminate their second mortgage, along with any subsequent mortgages. They are able to share the burden of rapid property devaluation with their mortgage companies, who themselves are partly responsible for the financial imbalance.

Chapter 20 isn’t part of the Federal Bankruptcy Code - it’s a one-two-step for homeowners that have two or more mortgages and owe more on their first mortgage than their house is worth.

First, as discussed earlier, by filing Chapter 7 bankruptcy the homeowner is relieved of their personal liability for their mortgage, but the lien on the property remains.

Next, the homeowner files for Chapter 13 bankruptcy. Because the value of the property is severely deflated, lien-holders on the second mortgage (and any mortgage thereafter) would have to buy out the lien-holder of the first mortgage to lay any claim to their initial debt holdings.