How to File Bankruptcy

The current economic crisis has taken its toll on individuals, as more than 1.4 million personal bankruptcies were filed in 2009. Also smarting from the high unemployment, weak consumer confidence and tight credit of the current economy are small business owners, who also filed record numbers of bankruptcies last year.

Hit by a perfect storm of local high unemployment, which stifles consumer activity, and higher operating costs derived from increased gasoline and other prices, many small businesses are struggling with escalating debts they’re unable to pay. Many small businesses took out loans in the pre-recession environment with high rates that weren’t believed to be a problem at the time because of the booming economy. Others are running up credit card and other debt to stay alive. Neither situation is sustainable in the current economic environment.

If your small business is on the verge of becoming insolvent, bankruptcy may be an appropriate means for you to discharge the business’ debts and protect your personal assets. Determining whether bankruptcy is an option for your business, and which form of bankruptcy to pursue is essential for small business owners seeking to resolve their debts and put their financial house in order.

Sole proprietorship, partnership or corporation?

Partnerships and corporations have more options in bankruptcies. Because these businesses are separate entities from their owners with their own assets and liabilities, the owners’ personal assets are usually safe in business bankruptcies. Chapter 11 and Chapter 7 bankruptcy are usually the most appropriate forms of bankruptcy for these businesses.

Chapter 7, 11 and 13

Chapter 11 bankruptcy is a reorganization of debt that business owners can use to restructure their debts in a way to make payment easier or to buy time. Chapter 11 allows businesses a variety of useful tools to help get its house in order. A business in Chapter 11 can get loans on favorable terms by agreeing to give new lenders the first crack at the business’ earnings. The business is also protected against litigation to recover debts while under Chapter 11.

Chapter 13 bankruptcy resembles Chapter 11, but is more appropriate for very small partnerships or sole proprietorship businesses. In a Chapter 13 bankruptcy, the business can continue to operate while income beyond certain amounts is applied to the business’ debts over a three to five year period. After this period, if repayment is made, the remainder of the debtors obligations are discharged.

How do you know?

As the housing and unemployment crisises continue to take their toll upon the American family, it’s no surprise that more and more people are turning to bankruptcy protection as a means of getting out from under snowballing debts. More than 1.4 million people filed bankruptcy in the U.S. last year, and even more are expected to in 2011.

Although it can provide a way for consumers to discharge crippling medical, credit card and other debts, bankruptcy has some pretty harsh consequences. For starters, it sits on the consumer’s credit record for almost a decade, negatively impacting consumers’ chances of getting a car or home loan and receiving favorable terms on loans that they can get.

On average, borrowers with a bankruptcy on their credit history get loans at interest rates that are several points higher than those of borrowers who have a clean credit history. Also, while bankruptcy alone can’t bar you from a job, if it dings your credit history bad enough it can be a detriment in getting employed by employers who check credit histories as part of their background check process. Also, if you’re not careful in calculating your exemptions in a Chapter 7 bankruptcy, you could end up losing property you thought you could keep.

The bottom line is that bankruptcy is a last resort and shouldn’t be entered into lightly. There are several alternatives to bankruptcy anyone considering this measure should be aware of and take advantage of if these options are applicable to their situation. Prior to any bankruptcy filing, the law requires that individual filers meet with a credit counselor at their own expense. During this meeting, the counselor will likely discuss options with the individual such as:

Debt consolidation:  High minimum payments on multiple debts may eat away at individual’s monthly income, and their ability to retire debt in a timely fashion. By consolidating debts, consumers can get the amount of money they must spend on debt service each month down to a more manageable level, and could also possibly obtain a more attractive interest rate.

Out of court settlement: Many creditors will accept an out of court settlement on debts for amounts far less than the amount of the debt. Creditors do this because the cost of pursuing debts in court from people who likely don’t have the money to pay it anyway often exceeds the amount of the debt. You can negotiate a debt settlement on your own, or hire firms devoted to this type of work to handle it for you.

A debt settlement program may help you resolve your debts, but it will likely have a negative impact on your credit history and rating. This impact will not be as severe however as a bankruptcy.

Negotiate: In the current climate of mass defaults, creditors are willing to cut deals in order to collect some of what they’re owed. Contact your credit card company and other debtors and see if they’re willing to make concessions on minimum monthly payments and interest rates. You might be surprised by what you hear.

Just pay it: The truth is that you incurred the debts you’re being dunned for, and it’s your responsibility to pay them. With the help of a credit counselor, or a money manager, you may be able to learn how to reduce your monthly expenses enough to where you can cover your debts without having to go through bankruptcy. Eliminating unnecessary entertainment and other expenses for 6 to 24 months may help you knock down your debt and develop better money management habits.

While many people get into financial trouble through no fault of their own, many others find themselves facing bankruptcy because they lived beyond their means. Doing basic money management drills such as setting a budget and taking advantage of coupons and various other money saving options can help you get back on your financial feet.

Of course, there are some cases when bankruptcy is the only feasible alternative. If you must declare bankruptcy, be smart. Get your documentation together, inventory your assets and your liabilities and hire a competent bankruptcy attorney. A botched bankruptcy can leave you in as bad or worse shape than you were in before you filed. Getting it right is imperative if you plan to get your finances back in order.

Bankruptcy doesn’t wave a magic wand and make your debts disappear. It’s a stress-fraught and time-consuming process that can sometimes be more trouble than it’s worth. If you can take advantage of a bankruptcy alternative to avoid filing for Chapter 7 or Chapter 9 bankruptcy, it is highly advisable that you do so to avoid the legal fees, paperwork and long term consequences of this last ditch proceeding.

The most recent major revision of the bankruptcy code was the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which effectively made it more difficult for individuals to file Chapter 7 bankruptcy, pushing them into Chapter 13 instead.

The BAPCPA was passed in response to a perceived increase in abuse of bankruptcy protection by consumers to wipe away credit card debt. The law was heavily promoted by the financial services industry, which claimed that many consumers were running up credit card and other unsecured debt just to walk away from them by filing Chapter 7 bankruptcy, under which most debts are erased after the liquidation of non-exempt assets.In most cases, these debtors assets were largely exempt from liquidation, making Chapter 7 an easy way for spendthrifts to run up big debts and then walk away from them scot-free.

Chapter 7 changes

Among the laws greatest impacts were its changes to Chapter 7 bankruptcy filings. In the past, debtors could file for Chapter 7 regardless of their income. Under BAPCPA, a means test was instituted to keep middle and upper income individuals from filing bankruptcy under Chapter 7. When an individual files for bankruptcy protection under Chapter 7, the court determines whether his or her income is above the state median income. If it is, the means test comes into play.

Under the means test, the court looks at the individual’s income and bills and determines the individual’s monthly disposable income. When making this judgment, the court takes into account family size, living expenses and some other factors.

For individuals who must submit to the means test, their monthly income is calculated and reduced by a set schedule of deductions set forth by the Internal Revenue Service.

These deductions include:

• Living expenses as defined under the IRS’s collection standards.
• Actual living expenses not covered by IRS standards, including health insurance, health savings account expenses and disability insurance.
• Expenses for protection from domestic or family violence.
• Expenses for nondependent family members care
• The expenses of administering a Chapter 13 repayment plan
• School expenses, up to $1,500 per year for minor children
• Home energy costs
• 1/60 of all secured debt that would come due within five years after the filing of a bankruptcy case
• Charitable donations
• 1/60th of priority debt

In general, if the individual is found to have a monthly disposable income of more than $183.50 after expenses, he or she is ineligible for Chapter 7 bankruptcy. If the individual doesn’t qualify for Chapter 7 bankruptcy, he or she must file for Chapter 13 protection. Under Chapter 13, the individual is placed in a repayment.

Waiting periods

Another change resulting from BAPCPA was an extended time period between bankruptcy filings. In the past, debtors had to wait six years between Chapter 7 bankruptcies. Now they must wait eight years.

Tougher homestead exemption requirements

Prior to the passage of BAPCPA, the amount of a debtor’s home equity protected from liquidation to settle debts was determined by state law. For instance, in Florida, your home is completely exempt from liquidation, while in other states only a part of its value is. Under the new law, if you haven’t lived in a state for more than two years, you’re only able to claim the home exemption available in the state where you previously resided. Also, if you bought your house less than 40 months ago, or if you’ve been found guilty of certain criminal acts, you can only exempt up to $125,000 of your home’s value, no matter what your state’s homestead exemption is.

Credit card debt

Under the new law, the courts take a closer look at individual’s credit card debt and are more likely to toss cases out on a presumption of fraud. The new law expands the court’s ability to presume fraud. BAPCA reduces the amount of money a debtor must spend for “luxury goods” before the presumption of fraud is invoked. The old limit was $1,225. The new limit is $500. Also the amount of money charged in cash advances to trigger a presumption of fraud has dropped from $1,225 to $750. Also, if a debtor charges any item worth more than $500 within 90 days of filing bankruptcy, the presumption that the debtor charged the debt with no intention of paying it will arise.

Retirement plans and consumer benefits

One positive benefit the law conferred upon individuals was increased protection for retirement plans. BAPCPA expanded the number of retirement plans exempt from liquidation in a bankruptcy.

Another provision of the new law that’s beneficial to consumers is its credit counseling requirement. Now debtors hoping to file Chapter 7 or 13 bankruptcy must undergo credit counseling at their own expense within 180 prior to filing. The credit counseling requirement helps debtors determine whether bankruptcy is right for them, and coaches them on better money habits they can follow after their bankruptcy proceedings.

Unintended consequences

Under the new law, attorneys are held liable for any false information they may file on behalf of their clients. This has led attorneys to be more diligent in verifying clients’ information, and has also led to an increase in attorney’s fees for bankruptcy filings.