REG Chapter 7 Part 2: Bankruptcy and Insolvency

Explain the rights of the debtors and the creditors in bankruptcy and insolvency

Welcome back to the second installment of chapter 7 where I will discuss the ins and outs of bankruptcy and insolvency. This will be a meaty subject so hang tight. Here are today’s learning outcomes:

  • Explain the rights of the debtors and the creditors in bankruptcy and insolvency.
  • Summarize the rules related to the different types of bankruptcy.
  • Explain discharge of indebtedness in bankruptcy.
  • Identify the rights of the debtors and the creditors in bankruptcy and insolvency given a specific scenario.
  • Identify the type of bankruptcy described in a specific scenario.

Types of Bankruptcy

There are 5 types of bankruptcy:

Chapter 7 – Complete liquidation, which is the most aggressive form of bankruptcy.

  • Person or Business can voluntarily petition for bankruptcy or a debtor can force them involuntarily into bankruptcy.
  • Must prove they don’t have the means to pay the debt by taking a “means” test. Takes the total income and reduces it by allowable expenses (food, housing, other reasonable living expenses) to determine if the debtor has the means to pay back the debt.
  • Trustee is appointed
  • Banks, Railroads, and Domestic Insurance companies can’t file for chapter 7 bankruptcy.

Chapter 9 – Protect financially distressed municipalities (cities, counties, townships and school districts) from creditors.

  • Voluntary petition.
  • Creates a plan for the municipalities to pay back its creditors.

Chapter 11 – Reorganization of debt, not total discharge like chapter 7.

  • Voluntary or involuntary petition (can choose to file chapter 11 or be forced to file chapter 11).
  • Allows companies to restructure debt and potentially discharge other debt.
  • No trustee required.
  • Court approves reorganization of debt.

Chapter 13 – Reduction or adjustment of debt for individuals.

  • Voluntary petition only.
  • Trustee required.
  • individuals only (no businesses)
  • Creates a payment plan for the debtor to pay the creditor
  • Court approves plan

Rights/Duties During Liquidation

In the case of total liquidation there are debts that have priority over other debt:

  • Wages owed to employees.
  • Contributions to employee benefit plans.
  • Alimony.
  • Income taxes withheld from employees and other taxes imposed.

After these preferred debts are paid then secured debt and unsecured debt will be paid. Any money left over in the bankruptcy after property has been liquidated will be returned to the debtor.

There are also protections for debtors as well in regards to total liquidation but they only apply to individuals:

  • Reasonable protection for personal residence under certain dollar limits.
  • Debtors interest in motor vehicles.
  • Reasonable protection of furniture and household appliances.
  • Exceptions for personal medical aids.
  • Protection of income received from government benefits and pensions.

Discharge of Indebtedness

Discharge of indebtedness relieves the debtor from further liability. In most cases, discharge of indebtedness will be considered taxable income unless the discharge was associated with a bankruptcy. The following are examples of debt not dischargeable under any circumstance:

  • Alimony
  • Child support
  • Student loans
  • Fines or penalties

Key Takeaways

  • Know the different types of bankruptcies.
  • Know which debts have priority in liquidation.
  • Know the protections individuals have in bankruptcy (housing, vehicles, furniture, and income from government programs).
  • Know the debts that cannot be discharged in bankruptcy.

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