There’s a classic scene in the television show, The Office, where Michael Scott, overwhelmed with debt, steps into the main office and says “I declare bankruptcy!” before finding out it doesn’t work that way. So, how does it work?
First of all, bankruptcy is federal law. With a few exceptions, filing bankruptcy is the same nationwide. From the simplest case to huge, corporate Chapter 11s, they all start with the same basic forms and the same basic premise. A bankruptcy petition is a complete statement of the financial situation of the person or business filing the petition informing the Court that the Debtor is insolvent, that he, she or it can’t pay the bills as they come due.
While bankruptcy has been around since the country began and is mentioned in Article I of the U. S. Constitution, the present laws were passed in 2005 as the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). BAPCPA went into effect because Congress became convinced by lobbyists for the credit card and banking industry* that bankruptcy debtors, particularly those with above average incomes and their attorneys were engaged in a massive effort to defraud the Courts. Because of that, the major effects of BAPCPA were to increase scrutiny on above average income debtors and to require everyone involved to document everything included in the bankruptcy petition. For that reason, I tell my clients that ninety percent of success in bankruptcy is making sure the petition is filed accurately and carefully.
So, what is success in bankruptcy? Ultimately, bankruptcy provides most filers with two types of relief. At the moment of filing, the Automatic Stay goes into effect, which operates like a giant legal umbrella, protecting debtors from their creditors. Other than the collection of ongoing child support and other domestic support obligations, virtually all efforts to get money or property from debtors are stopped by the filing of bankruptcy. Lawsuits, foreclosures, garnishments, harassing phone calls and collection letters must all stop from the moment the case is filed. The Automatic Stay is temporary relief that generally allows individual debtors, i.e. not corporations to be protected from their creditors until the case is administered and ultimately discharged.
While corporations generally do not get discharges, for individual debtors, the discharge is the point of bankruptcy. A discharge in bankruptcy means that any debt that could be discharged (there are exceptions like child support and most student loans) ceases to be collectable against the debtor forever. It legally ceases to exist, so there aren’t any tax consequences for forgiveness of debt.
Obviously, this is just a very general overview of the bankruptcy process, but bankruptcy can be quite complex and sometimes understanding the nuts and bolts helps.
*I’m a bankruptcy debtor’s attorney; you can’t expect me to be impartial about this subject.