By UpCounsel Corporate Attorney Chase Caldwell

In an episode of the comedy series The Office, Steve Carrell’s character, Michael Scott, makes a series of costly and poorly conceived financial decisions to maintain a relationship with his girlfriend. When they catch up to him, he tries escaping on a train and taking a second job as a late-night telemarketer to make ends meet, to no avail. Then, one of his employees tells him, “You just declare bankruptcy. All your problems go away.” After some deliberation, Scott walks out of his office and yells at the top of his lungs, “I declare BANKRUPTCY!” When another employee lets him know that you can’t just say the word bankruptcy and expect anything to happen, Scott responds, “I didn’t just say it. I declared it.”

If only. The realities of bankruptcy are far more complex, and while the relief that discharge can provide to both individual and business debtors may be the best or only option for some, the decision to file must weigh the value of that relief against the personal and professional consequences of accepting it.

For now, let’s assume that the soul searching has been done. The decision has been made, and it’s time to cross the Rubicon. But how? The U.S. Bankruptcy Code is divided into chapters, each of which deals with bankruptcy options for specific types of debtors. The most commonly invoked chapters, which are applicable to the vast majority of individuals and small businesses, are Chapters 7, 11, and 13. The remaining chapters deal with municipalities, specific situations involving farmers and fishermen, and very large corporations. The very brief synopsis below is limited to Chapters 7, 11, and 13, and is intended only as a starting point for determining the bankruptcy route that is right for you. For much more detailed information, you can explore the official bankruptcy forms and instructions available from the U.S. Courts. The different forms of bankruptcy vary in complexity, but it wise to obtain the assistance of a qualified attorney in any proceeding to make sure that you achieve the best possible result.

Chapter 7

When most people hear the word bankruptcy, it is a Chapter 7 or “straight bankruptcy” that comes to mind. Chapter 7 is a form of bankruptcy in which the debtor surrenders all of his or her “non-exempt property” for the payment of creditors in exchange for a discharge of unsecured debts, like credit cards and medical bills. Essentially, the property is sold by a trustee, and the proceeds are used to pay off as much debt as possible. Generally, the property sold does not cover the full amount of the debt, and the remainder of the debt is discharged, meaning that the debtor is not responsible for further payment.

For “secured debts,” which are debts for which there is collateral, the debtor either pays the debt or gives up the collateral property. Sometimes referred to as “liquidation” or “clean slate” bankruptcy, Chapter 7 is designed for debtors who are unable to pay their unsecured debts. In order to file Chapter 7, the debtor must meet a “means test” which measures ability to pay based on income and other calculations versus the amount of debt. The form for determining whether you meet the means test can be found at the link above.

Cons

  • The negative consequences are long-lasting. The record of your bankruptcy will stay on your record and credit report for up to 10 years, essentially ruining your credit for at least that period of time. It is worth noting that if you qualify for Chapter 7, you are likely facing a host of other issues with creditors such as collections, lawsuits, and repossessions that can have an equally if not more damaging effect on your credit. Taking the proactive step of handling your debts through bankruptcy may be looked upon more favorably by future lenders and creditors than a history of those black marks.
  • You are going to lose your property. There’s just no way around it. Any non-exempt property will have to be surrendered for the payment of all or some of your debts.
  • You will have to give up all your credit cards as part of the bankruptcy.
  • It will be nearly impossible to obtain a mortgage for a long period of time. Like the credit card situation, this is self-explanatory. Filing for bankruptcy is a bright red flag to future creditors and lenders.
  • If there is more trouble down the road, your options will be limited.You can only file Chapter 7 once in a six-year period. If you obtain Chapter 7 relief and another financial problem occurs within six years, you will not be eligible to deal with that problem through Chapter 7.
  • Some debts survive bankruptcy. Certain types of tax debt cannot be eliminated through bankruptcy. Bankruptcy will also not eliminate child support, alimony, or student loans.
  • It’s embarrassing. You will have to explain to both a judge and/or bankruptcy trustee what led you to having to file bankruptcy.

Pros

  • If you qualify for Chapter 7, the whole process from filing to completion generally takes only about 3-6 months.
  • States vary on what is or is not exempt from bankruptcy. Generally speaking, though you will be able to keep basic necessities and some states will expand exemptions to cover property that is not generally exempt, if you can demonstrate that you need it. For example, you generally might not get to keep your boat. But, if you are a charter boat captain and the boat is your livelihood, you may be able to hold onto it. Additionally, you can keep the wages you earn and the property you buy after filing. In other words, while you may have to surrender wages you had saved at the time you filed, your wages earned after filing will not be taken away.
  • Within 1-3 years, you may again be able to obtain credit cards, although the interest rates will be very high. There are now various types of cards with plans designed to help people build and re-establish credit.
  • Over time, with the re-establishment of a positive credit history, you may have more options, though it will not be easy. There are also lenders who specialize in mortgages to those with damaged credit, but the rates and restrictions may be heavy. Still, it’s possible.
  • You may be still be able to file a Chapter 13 bankruptcy, as discussed below. In theory, there is no limit on the number of times you can file for Chapter 13. The caveat is that each filing will impact your credit. Further, repeated filings may indicate to the Court that you are acting in bad faith or for fraudulent purposes.
  • Bankruptcy may prevent some creditors from from aggressively pursuing the debt. You may be able to obtain a court order that modifies or suspends alimony and child support based on your financial situation.
  • The judges and trustees have heard it all, and most of it is probably much worse than what they will hear from you. Judges and trustees are generally fair minded to those who are acting in good faith and ended up before them because of honest mistakes or unforeseeable circumstances.

Chapter 13

Because Chapter 11 deals with business bankruptcies, we’ll skip it for now and stick with the second primary option available to individuals, Chapter 13. While many of the pros and cons of a Chapter 13 overlap with those of a Chapter 7, the eligibility requirements, purpose, and mechanics of a Chapter 13 are very different. Rather than liquidating assets in exchange for the elimination of nearly all debt, a Chapter 13 seeks to restructure the debt or eliminate part of it in order to create a situation in which the debtor can pay back the remainder of the debt over time (3-5 years) on a payment plan established during the proceeding. This type of bankruptcy is geared toward those who have disposable income, and may be in possession of property, such as a home, that they want to retain. Such debtors will generally not qualify for Chapter 7.

Establishing the payment plan can be a complicated process, and it is very difficult to succeed in a Chapter 13 without the aid of a qualified attorney. The debtor and his or her counsel must present a plan to the judge and the trustee, which sets forth any property that the debtor wishes to surrender to the creditors and proposes a payment plan as to which creditors are to be paid what amounts. The creditors are entitled to object to the plan at a creditor’s meeting, also called a 341 conference. Obviously, every creditor’s goal is to obtain the best possible result (the most money) in satisfaction of his or her interest. There may be complex arguments between creditors over who should be paid what and when. The creditors may also negotiate with the debtors over the proposed plan. While the proceeding may go much more smoothly if the creditors are all on board at the time the plan is presented to the judge, the judge can approve the plan over the objection of the creditors. At the most basic level, the judge will generally be concerned with whether the creditors are being treated fairly, which may not mean equally, but generally whether each creditor is receiving at least as much as he or she would if the debtor had filed Chapter 7.

Cons

  • The process can be lengthy. The paperwork and procedure are more complex, and take longer than a Chapter 7. Additionally, the payment plan may extend out for up to five years./li>
  • The negative consequences are long-lasting.
    The record of your bankruptcy will stay on your record and credit report for up to 10 years, essentially ruining your credit for at least that period of time.
  • Your finances are going to be under a microscope. The payments on your Chapter 13 plan have to come from disposable income (i.e. what is left after you pay for the necessities of food, shelter, etc.). Because of this, the trustee will be keeping an eye on your finances to make sure that you are complying. Additionally, what used to be your disposable income will now be tied up for the duration of the payment plan.
  • You will have to give up all your credit cards as part of the bankruptcy.
  • It will be nearly impossible to obtain a mortgage for a long period of time. Like the credit card situation, this is self-explanatory. Filing for bankruptcy is a bright red flag to future creditors and lenders.
  • If there is more trouble down the road, your options will be limited. You cannot file for Chapter 7 if you have filed for Chapter 13 in the past 6 years.
  • Some debts survive bankruptcy. Certain types of tax debt cannot be eliminated through bankruptcy. Bankruptcy will also not eliminate child support, alimony, or student loans. You may also be required to pay back mortgage liens, which survive.
  • It’s embarrassing. You will have to explain to both a judge and/or bankruptcy trustee what led you to having to file bankruptcy.

Pros

  • Over that time, you may be able to satisfy your debts through partial repayments, and spreading out the cost over time can substantially lower the installment payments on many debts.
  • It is worth noting that if you qualify for Chapter 13, you are likely facing a host of other issues with creditors such as collections, lawsuits, and repossessions that can have an equally if not more damaging effect on your credit. Taking the proactive step of handling your debts through bankruptcy may be looked upon more favorably by future lenders and creditors than a history of those black marks.
  • Unlike a Chapter 7, as long as you are making payments, you get to keep the property you are making the payments toward. Additionally, after you successfully complete the payment plan, the creditors cannot seek additional payment for the property that you have kept.
  • Within 1-3 years, you may again be able to obtain credit cards, although the interest rates will be very high. There are now various types of cards with plans designed to help people build and re-establish credit.
  • Over time, with the re-establishment of a positive credit history, you may have more options, though it will not be easy. There are also lenders who specialize in mortgages to those with damaged credit, but the rates and restrictions may be heavy. Still, it’s possible.
  • You may be still be able to file another Chapter 13 bankruptcy. In theory, there is no limit on the number of times you can file for Chapter 13. The caveat is that each filing will impact your credit. Further, repeated filings may indicate to the Court that you are acting in bad faith or for fraudulent purposes.However, you cannot file a Chapter 13 if either a Chapter 13 or Chapter 11 proceeding has been dismissed because you violated a court order or requested dismissal after a creditor asked for relief from the automatic stay.*
  • Bankruptcy may prevent some creditors from from aggressively pursuing the debt. You may be able to obtain a court order that modifies or suspends alimony and child support based on your financial situation.
  • The judges and trustees have heard it all, and most of it is probably much worse than what they will hear from you. Judges and trustees are generally fair minded to those who are acting in good faith and ended up before them because of honest mistakes or unforeseeable circumstances.

Chapter 11

Chapter 11 is primarily associated with businesses, with small businesses making up the majority of filings. However, some individuals with high earning potential may also qualify. Actors and athletes who are swamped with debt but have the ability to earn large sums through things like royalties and endorsements are a good example – think Nicolas Cage and 50 Cent. The goal of Chapter 11, as opposed to Chapter 7, is to restructure the debt and often the operations of the business or individual in order to make the business or individual profitable so that debts can be fully or partially repaid while the business continues or the individual continues to make money.

This is achieved, whenever possible, through a reorganization plan. Creating the plan involves renegotiating contracts with creditors to either reduce or eliminate certain debts and then repaying those creditors in compliance with the respective agreements and the terms of the reorganization plan. Once the reorganization plan is approved, the debts are discharged, which basically means that they are replaced by the restructured debt set out in the plan.

This is not as easy as it sounds. Creditors in a Chapter 11 Bankruptcy are placed into categories. Secured creditors are placed in a variety of subclasses, and unsecured creditors are lumped together in a single class. There are often very complicated and technical arguments between two creditors as which of the debts has the highest priority in relation to the others. However, the judge has more discretion in a Chapter 11 case when it comes to approving a plan over the objection of the creditors.

*The “automatic stay” is major benefit of bankruptcy. If there is a lawsuit pending against you, such as a foreclosure, the automatic stay hits the pause button on the proceeding as long as the bankruptcy is pending. Under certain conditions, a creditor can ask for relief from the stay. This means that the creditor is asking the court to allow their lawsuit to proceed. This is common in foreclosure cases, the reason being that a mortgage survives bankruptcy.


Cons

  • The process is long, complicated, and expensive. Due to the nature of the creditors interests, and the interests of the business or individual debtor, as well as the fact that there is no limit on the amount of debt involved, the proceeding is complicated. It can take years to satisfy creditors under the reorganization plan and cost tens of thousands of dollars in legal fees.This may make Chapter 11 untenable for struggling small businesses.
  • You can’t put a fire out from inside the house. Trustees are generally not appointed in Chapter 11 cases except in small business proceedings and cases where there has been demonstrated fraud or gross mismanagement. The result is that that same executives who led the business into bankruptcy are often charged with getting it out. The problem here is self-evident. In many cases the folks that caused the problem aren’t capable of handling the solution.
  • The small business pitfall. For the reasons described above, many small businesses enter into a Chapter 11 only to have to convert to Chapter 7 and liquidate because of missteps in the process or the financial or leadership inability to manage the complexities of Chapter 11. Many of these companies would have been better off going straight into Chapter 7.

Pros

  • If successful, the business or individual emerges from the quagmire of the bankruptcy in a profitable state, which can offset these fees.
  • A change in management can help guide the business. The reduced oversight of Chapter 11 allows the company the opportunity to focus on profitability. In those situations where a trustee is appointed, the business is likely in need of a firm hand and can benefit from it.
  • There are experienced and qualified attorneys who specialize in this area of law, and businesses, particularly small businesses can seek counsel before making important decisions.

The Takeaway

The old saying goes, “If you’re going through hell, keep on going. You might get out before the devil knows you’re there.” Those facing bankruptcy are almost always caught in one of the many levels of financial hell that face both consumers and businesses, and the saying holds true. Stopping and doing nothing leaves debtors at the mercy of creditors, which is often no mercy at all. Bankruptcy relief can be a proactive step toward getting out of the pit before the really bad consequences occur. But, it is also true that doing the wrong “something” can be just as bad or worse than doing nothing. Some points in this article may be as clear as mud, which should make the most important one hit home even harder. The debtor considering bankruptcy should not pull a Michael Scott and charge into a complex process that he or she does not fully understand. It is critical to weigh the risks and benefits associated with filing, which should be done with the help of qualified counsel.

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About the author

Chase Caldwell

Chase Caldwell

Chase has a 7-year litigation and transaction background. He holds a J.D. from Nova Southeastern Univ., and an LL.M. in Business Transactions from the Univ. of Alabama. He is licensed to practice in all Florida state and Federal District Courts.

Chase has litigated over 1500 trial and appellate matters. He began at a civil litigation firm, and then became Regional Attorney Manager for a multi-state firm representing lenders in foreclosure proceedings. Most recently, prior to founding CMC Law Firm, he served as in-house counsel for a global telecom and tech company.

Chase provides representation to individuals and businesses in Florida on a variety of transactional and litigation matters.

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