What Happens When I file a Bankruptcy?
In a Chapter 7:
Bankruptcy is a trade; it is an exchange. When one files a bankruptcy, one trades all non-exempt property for a discharge in debt. This means that the debtor loses all his or her non-exempt property. But the debtor keeps all exempt property. In Texas exempt property is generally a homestead, one car for each driver in the family, retirement, annuities, insurance policies and current wages. In other states, however, what one may keep in a bankruptcy is significantly different. See Bankruptcy in Other States.
The trade is initiated instantly upon filing. Upon filing a bankruptcy estate is created. That estate contains all of the assets of the debtor. So, immediately upon filing, the debtor transfers ownership of all of his assets to the bankruptcy estate. Later in the bankruptcy the exempt assets of the debtor return to him. The exempt assets are never really at risk because they are normally well defined.
Also upon filing a thing called an automatic stay comes into effect. That means that all collection efforts are automatically stayed (stopped) so the bankruptcy can go forward. The stay remains in effect until the discharge, and then then discharge prevents collection.
So what happens to these assets? If they are in this nebulous bankruptcy estate, where is it and who controls it? The bankruptcy trustee owns and controls the bankruptcy estate; he holds it in trust for the benefit of the creditors of the estate. It is the bankruptcy trustee's job to gather all of the assets of the estate and sell them and divide the money among the creditors. If the debtor is mistaken about what is exempt and what is non-exempt, he may have a confrontation with the trustee. The debtor who confronts a trustee normally loses. So, it is is very important to be very sure about what is exempt and what is non-exempt before filing.
While the trustee is gathering the assets of the estate the creditors (as well as the trustee) have a chance to object to the debtor's discharge or to his exemptions. An objection to a discharge of debt in any bankruptcy is very limited. That is, there are only a limited number of reasons that someone can object to a discharge. Some reasons for the denial of a discharge are false statement on bankruptcy papers, or stealing, or intentional harms or false financial statements.
Another reason for an objection to discharge is if the debtor makes too much money. Whether he does or does not can be complicated and depends on numerous factors. This is called the means test.
If no one objects, then the bankruptcy judge signs the discharge and the trustee distributes the assets of the estate and the case is closed.
In a Chapter 11:
A Chapter 11 bankruptcy is most often filed by corporations or partnerships, rather than individuals, and there is no exempt property for corporations or partnerships. So, when a business files a Chapter 11 all of its property and assets fall into the bankruptcy estate. However, the owner continues to operate the business and during the interim, no one can collect the previously existing debts.
The owner then uses the time that the bankruptcy gives him to reorganize. For instance, he may lay off some people, close a store, find a cheaper supplier, sell some equipment or whatever he can do do streamline his business. During this time he is paying no prior debts and he using the money to reorganize.
He then files a plan of reorganization that shows how he will continue to operate and use the extra money that he accumulates to make payments against the previously existing debts. Theoretically he has more money now because he does not have to pay all of his previously existing debts all at once. So, one type of a Chapter 11 plan is a payment plan where all or part of the previously existing debt is paid.
In a Chapter 13:
A Chapter 13 is the same as a Chapter 11, but it is for individuals, and the amount of the payments to the creditors is determined by the bankruptcy law.
A Chapter 13 is more structured and cheaper than a Chapter 11.
Knowing what will happen in advance is the most important piece of the bankruptcy puzzle.