Illinois Bankruptcy Law: individual

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Illinois Law

Illinois Bankruptcy Law: Individual

Bankruptcy Law: Individual

Bankruptcy Law: Individual

If a person falls behind in paying off debts and it appears that the person will not be able to make payments as they come due, it is better to take action rather than let one's financial situation deteriorate. For many people, the answer to financial problems is to declare bankruptcy, a legal proceeding in federal court that allows a person to be released from the obligation of paying some or all debts.

It is often said that bankruptcy gives a debtor a fresh start, but filing bankruptcy is not a panacea for all financial problems because it is not painless. Declaring bankruptcy can seriously damage a person's credit rating, making it difficult to establish credit or take out loans. Many people can work themselves out of even very serious debt without ever going near a bankruptcy court, so declaring bankruptcy should not be an automatic first step for someone experiencing financial problems.

The Bankruptcy Code

Bankruptcy law is federal law. The United States Constitution grants to the federal government the exclusive right to make bankruptcy laws. Pursuant to this authority, the federal government created the Bankruptcy Code, Bankruptcy Rules of Procedure, and a system of Bankruptcy courts to handle bankruptcies throughout the country. This is not to say that bankruptcy law is uniform throughout the nation, however. Although the federal government has final authority to make all bankruptcy laws, in some instances the Bankruptcy Code grants to individual states the power to deviate from federal rules in limited circumstances. For instance, the bankruptcy code allows a debtor to keep certain assets, known as exempt assets, that creditors cannot reach to satisfy a debt. The bankruptcy code gives states the authority to expand the categories of exempt assets if they choose. Thus, the amount of assets beyond the reach of creditors differs depending upon the state where the debtor files for bankruptcy.

The Bankruptcy Code creates different categories of bankruptcy, known as chapters, appropriate for different debtors. The two most common forms of consumer bankruptcy are Chapter 7 and Chapter 13.

Chapter 7

The vast majority of bankruptcy cases are Chapter 7 cases. Chapter 7 is often called liquidation bankruptcy. Chapter 7 is commonly used by individuals who want to walk away from their debt simply, but it may also be used by businesses that want to terminate their operations and liquidate their assets. When a debtor files Chapter 7, the bankruptcy court appoints a person to administer the case. This person is called the trustee. The debtor turns over some or all debts and assets to the trustee. The trustee then liquidates the property by selling it off and dividing the resulting cash among the creditors.

Under Illinois law, a person who files for Chapter 7 bankruptcy is permitted to retain up to $7,500 of equity in the person's residence; up to $1,200 in equity in the person's car; up to $2,000 in personal property such as cash and furniture; all necessary clothing, books and family pictures; up to $750 in implements, professional books or tools of the trade; and all professionally prescribed health aids for the person or one of the person's family members. These assets are called exempt assets. A person filing for bankruptcy must properly request these exempt assets in a bankruptcy case.

Step 1: Petition and Schedules

A Chapter 7 case begins when the debtor files a petition with the bankruptcy court. Any individual, partnership, or corporation can file Chapter 7 regardless of the amount of debt or whether the debtor is solvent or insolvent. The petition should be filed with the court serving the area where the debtor lives or where the debtor's principal place of business or assets are located.

Along with the petition, or shortly thereafter, the debtor files with the court several schedules listing current income and expenditures, a statement of financial affairs, all executor contracts, existing or potential lawsuits by or against the debtor, and any recent transfers of assets. If a debtor does not reveal a debt in these schedules, the bankruptcy court cannot discharge or cancel that debt. Any debt omitted from these schedules is called a non-scheduled debt and is not affected by the bankruptcy.

Step 2: Stay

Filing the petition automatically stops (stays) all of the listed creditors from trying to collect the money owed them. The stay arises automatically, without any judicial action, although the court usually does notify creditors of the filing of the petition. The stay is effective from the time of filing, even if the creditors do not receive notice until much later. As long as the stay is in effect, creditors cannot generally start or continue actions against the debtor to collect on the debt. Lawsuits, garnishment actions, even telephone calls to the debtor must cease.

Step 3: Creditors Meeting

After the debtor files a Chapter 7 petition, the court appoints a trustee to administer the case and liquidate assets. The trustee usually calls a meeting of the debtor, the debtor's attorney, and the creditors. The debtor must attend this meeting. Creditors may attend in order to ask questions, and examine documents concerning the debtor's financial affairs and property. In most consumer bankruptcies, all of the debtor's assets are either exempt or subject to valid liens, so there are no assets for creditors to pursue. In these cases, known as "no asset" cases, it is likely that no creditors show up at the creditors meeting. If it appears that a case will have assets to pursue, creditors usually show up at this meeting to gather information about the case because they plan to ask the bankruptcy judge to declare some of the debts non-dischargeable, they plan to challenge the exempt status of some asset, or they plan to file claims.

Step 4: Claims

After the creditors meeting, the creditors can file a claim against the debtor with the court. If the case has non-exempt assets free of security interests, these will be used to satisfy valid claims.

Step 5: Liquidation, Discharge, and Reaffirmation

The trustee's primary role is to sell off the debtor's non-exempt assets in a way that maximizes the amount the creditors receive for their claims. Revenues from assets subject to security interests, such as property subject to a mortgage, is used to satisfy the debt on the particular asset. A Chapter 7 bankruptcy concludes when the trustee sells the debtor's property, distributes the cash to the creditors, and discharges the remaining debt. The discharge extinguishes the debtor's remaining personal liability on the debt. Certain items are non-dischargeable and thus unaffected by the bankruptcy. Non-dischargeable debts include:

Alimony and child support
Most tax obligations
Most student loans
Liability for damages resulting from willful or malicious acts

Creditors can ask the court to deny an individual debtor a discharge. The grounds for denial of discharge are extremely narrow and requests for denial are rarely granted. Grounds for denial include:

The debtor fails to adequately explain the loss of assets
The debtor perjured himself or herself or failed to obey lawful orders of the court
The debtor fraudulently transfers, conceals, or destroys property that should be in the estate

Because a secured creditor has rights that permit the creditor to seize pledged property, a debtor may want to reaffirm a debt even after it has been discharged if the debtor wants to keep the property. A reaffirmation is an agreement between the debtor and the secured creditor that the creditor will not exercise the creditor's right to take back the asset so long as the debtor makes payments.

A debtor must wait six years before the debtor can file for Chapter 7 again.

Chapter 13

Chapter 13 bankruptcy is often referred to as a "wage-earner plan," because it is generally used by people with stable incomes who want to repay at least some of their debts but are currently unable to do so. A debtor may file Chapter 13 bankruptcy if the debtor's financial crisis is temporary and the debtor expects income will grow enough in the next few years to pay off all debts. The main advantage to Chapter 13 is that the debtor is allowed to keep the debtor's property while a court-approved repayment plan is in effect. However, only an individual with less than $100,000 in unsecured debts and less than $350,000 in secured debts is eligible to file a Chapter 13 bankruptcy. Corporations and partnerships cannot file Chapter 13 bankruptcies, although this option is available to a small business operated by a sole proprietor. In addition, the debtor must have a job or prove to the court that the debtor has the ability to earn stable income.

Step 1: Petition

The petition required for a Chapter 13 bankruptcy is similar to that described above for Chapter 7. The debtor provides the court with the following:

Lists of all creditors, including the amount and nature of claims
The source, amount and frequency of debtor income
Lists of all property
Detailed descriptions of the debtor's monthly living expenses, including food, clothing, shelter, utilities, taxes, transportation, and medical care

Step 2: Stay

Filing a Chapter 13 petition automatically stays most actions against the debtor. So long as the stay is in effect, creditors generally cannot start or continue lawsuits or garnishment actions, or even phone the debtor demanding repayment. Chapter 13 also has a special stay provision that prohibits creditors from collecting consumer debt owed to the debtor by a third person.

Step 3: Plan

Within 15 working days of filing a Chapter 13 bankruptcy, the debtor presents a plan to the court that spells out how the debtor proposes to pay off debts over a three-year period or, by permission, over a five-year period. The plan must provide for the full payment of claims entitled to priority. For reasons of public policy, the Bankruptcy Code has several categories of unsecured claims that have priority over other unsecured claims, including:

Costs of administering the bankruptcy
Employees' wages, salaries, and commissions
Contributions to employee benefit plans
Deposits accepted by the debtor for personal items or services that the debtor did not deliver
Taxes

Step 4: Creditors Meeting

A creditors meeting is usually held about 20 to 40 days after the petition is filed. The debtor and trustee must attend the conference, but creditors have the option to attend. Trustee and creditors can question the debtor about financial affairs and terms of the plan. Any problems with the plan are usually solved during or shortly after this meeting.

Step 5: Confirmation Hearing

After the creditors meeting, the bankruptcy court determines at a bankruptcy hearing whether the plan is feasible and meets the standards for confirmation set by the bankruptcy code. Creditors are allowed to object to confirmation. The most common objections are that the debtor has not pledged sufficient disposable income to the plan or that the creditors receive less than they would if the debtors assets were liquidated in a Chapter 7 proceeding.

For most plans in Illinois, the Bankruptcy Court allows a five-year repayment plan. The court occasionally reduces the size of some of the dischargeable debts. During this five-year period, a portion of the debtor's paycheck goes to a court-appointed trustee who divides the money among the debtor's creditors.

If approved by the Bankruptcy Court, the plan prevents a debtor's creditors from garnishing wages or repossessing property.

Step 6: Discharge

A Chapter 13 debtor is entitled to a discharge if the debtor successfully completes all payments under an approved plan. The discharge releases the debtor from all debts provided for or disallowed under the plan. Creditors provided for under the plan may not start or continue actions against the debtor to collect a discharged obligation.

Advantages of Chapter 13 over Chapter 7

Filing a Chapter 13 bankruptcy has advantages over a Chapter 7 liquidation. Unlike a Chapter 7 bankruptcy, there is not a six-year waiting period before the debtor can file bankruptcy again. Thus, with only a few exceptions, the debtor can file a Chapter 7 bankruptcy at any time after filing Chapter 13 bankruptcy. This means that if the debtor is unable to make the payments specified in a Chapter 13 bankruptcy plan, the debtor can still act to discharge debts through a Chapter 7 liquidation.

The non-dischargeable debts under a Chapter 13 bankruptcy are generally the same as the non-dischargeable debts in a Chapter 7 bankruptcy. However, a Chapter 13 bankruptcy allows the debtor to discharge a few more types of debts than does a Chapter 7 bankruptcy.

If the debtor owns an unincorporated business, such as a freelance consulting business, the debtor can continue to own and operate the business under a Chapter 13 plan. Under a Chapter 7 liquidation, a Bankruptcy Court may order that such a business or its assets be sold. Also, the automatic stay of a Chapter 13 bankruptcy protects any co-signers of consumer debts, whereas Chapter 7 offers only very limited protection of others who may share the debtor's obligation.

Finally, certain homeowners may prefer a Chapter 13 bankruptcy, because in many instances it allows them to make up past payments on their mortgage. When someone falls behind in making mortgage payments or is in actual default, a lender quite often "accelerates" the payments. For a debtor in this situation, filing a Chapter 13 bankruptcy may allow the debtor to "decelerate" or reduce those monthly payments and may even reinstate the mortgage by wiping out a prior default. However, if saving a house is the primary reason for filing bankruptcy, the homeowner should talk through all the possibilities with an attorney, because the laws governing this area are extremely complicated and it is easy to make a costly misstep.

Conversion

The Bankruptcy Code allows a debtor to convert a Chapter 7 case to Chapter 13 or vice versa as long as the debtor meets the eligibility requirements of the new chapter and the case has not previously been converted from the new chapter. In other words, the debtor is not allowed to repeatedly convert the case from one chapter to another.

Involuntary Bankruptcy

Unlike the types of situations described above, in which the debtor decides whether to file bankruptcy, in an involuntary bankruptcy creditors force the debtor into bankruptcy. Under certain conditions, creditors can petition the Bankruptcy Court to initiate a Chapter 7 or 11 (but not a Chapter 13) bankruptcy against a debtor. The court will only accept such a petition if it is signed by at least three creditors who are owed a total of at least $5,000 in unsecured debt. If a debtor has fewer than 12 unsecured creditors, however, just one unsecured creditor owed at least $5,000 can file an involuntary bankruptcy petition.

Involuntary bankruptcy is rare, but if someone does file a petition against a debtor in Bankruptcy Court, the debtor has an opportunity to file an answer to the petition and refute any charges made by creditors in the petition. If the judge sides with the debtor, the court dismisses the petition and can make the creditors pay reasonable attorney's fees and any money the debtor loses in defending the case. In addition, if the judge decides that the petition was filed in bad faith the court may also award the debtor punitive damages.

Effects of Declaring Bankruptcy

The old adage that it is better to know how to swim before jumping into deep water applies to anyone considering filing bankruptcy. Although under federal law it is illegal for an employer to discharge or discriminate against an employee who has filed a bankruptcy case, there are other potentially adverse effects of which to be aware.

Poor Credit Rating

Consumer laws allow credit agencies to list on reports of a person's credit history all of that person's bankruptcy filings in the preceding ten years. This means that mortgage companies, banks, credit card companies, landlords, employers, and all others who can legally obtain a copy of a person's credit report will know about that person's troubled financial past. Filing bankruptcy can make it difficult to obtain credit for those ten years.

According to the Illinois State Bar Association, while each case is different, some people find that obtaining future credit is easier if they file a Chapter 13 bankruptcy and attempt to repay some of their debts, rather than file a Chapter 7 bankruptcy and make no attempt to repay.

Creditor Scrutiny

One of the first events in a bankruptcy is a meeting between the debtor and all the debtor's creditors. At this meeting, the creditors and a court-appointed trustee are allowed to examine all of the debtor's financial records, such as bank statements and loan documents, and ask questions about how money has been spent. For anyone with anything unsavory or illegal to hide, such as gambling debts with a bookie, a bankruptcy proceeding can be incriminating.

Cost

Understandably, bankruptcy attorneys are very careful about a client's ability to pay legal bills. A bankruptcy attorney will usually collect enough money in advance from a near-bankrupt client to handle a typical bankruptcy filing. This may be more than some clients can pay, especially if there is any contest with creditors. In addition, the trustee in charge of a bankruptcy case is paid by commission, a percentage of the money that the trustee distributes to pay creditors.

Other Forms of Bankruptcy

There are three other kinds of bankruptcy filings that are not discussed more fully in this chapter because of their limited relevance to consumers. Knowing about them can help one better understand bankruptcy options.

Chapter 9

Chapter 9 is a very rare form of bankruptcy available only to municipalities.

Chapter 11

Chapter 11 is available for corporations, partnerships, and individuals but is mostly used by troubled corporations and partnerships. Chapter 11 allows the debtor to remain in operation while being sheltered from some of its debts.

Farm Bankruptcies

Chapter 12 is available only to family farmers and is designed to allow farmers to stay in business while attempting to pay off their debts. Chapter 12 offers several advantages over other bankruptcy chapters because it recognizes the seasonal nature of most agricultural income, the difficulty of predicting in advance how much a farmer will profit from a crop, and the fact that most farmers need much more credit than do most individuals. Chapter 12 was originally scheduled to be repealed on October 1, 1993, but the repeal date was pushed back to October 1, 1998.

Transfers to Avoid Losing an Asset in Bankruptcy

Some transfers that are valid outside the context of bankruptcy are invalid in bankruptcy. The Bankruptcy Code empowers a bankruptcy trustee to invalidate certain transfers made prior to a bankruptcy filing.

Fraudulent Conveyances

The Uniform Fraudulent Transfer Act is designed to remove any temptation a debtor may have to hide property, by giving it to a relative, for example, before declaring bankruptcy. Any transfer of the debtor's assets made within 90 days of filing bankruptcy, or one year if a relative or business associate is involved, is carefully scrutinized by the Bankruptcy Court. If the court determines that the debtor attempted to defraud creditors by selling property at a below-market price, the court can order that property or other assets be given over to the trustee. Anything sold at a reasonable market value before a bankruptcy filing cannot be recovered by the court under the rules of the Uniform Fraudulent Transfer Act.

Preferences

A preference occurs when a debtor treats one creditor more favorably than another. For instance, if a debtor with only $100 owes $100 each to creditors A and B and pays A completely, leaving nothing for B, then A has received a preference. Bankruptcy condemns preferences if the following conditions exist:

Transfer is for the benefit of a creditor
Transfer is made for debt owed prior to the initiation of bankruptcy
Debtor is insolvent at the time of transfer
Transfer is made 90 days before filing of the bankruptcy or one year before filing if made to an insider such as a relative or director of a corporate debtor

Creditors receiving preferences can be forced to return them to the debtor's estate.

Collection Agencies and the Law

Although not a part of Bankruptcy Code, laws regulating collection agencies are usually of concern to anyone experiencing financial difficulties. Both state and federal laws limit the kinds of activities that a collection agency can engage in as it tries to collect a debt. These laws only apply to third-party collection agencies and not to in-house collections. That is, if a creditor tries on its own to induce its delinquent accounts to pay their overdue bills it is not required to follow the laws governing collection agencies. But if a creditor turns collection matters over to a collection agency, the collection agency's employees must follow the rules. Laws regulating debt collection agencies are discussed more fully in the Consumer Protection Chapter.

Alternatives to Bankruptcy

Anyone in financial trouble has undoubtedly received many letters from creditors demanding payment on debts owed. Even a very demanding creditor may have a change of heart once a debtor mentions the possibility of filing bankruptcy, because creditors know that bankruptcy means that they may only get a fraction of what is owed them.

Anyone confident that existing financial problems are only temporary may want to consider asking major creditors to accept reduced payments for a short period or asking for a short delay in making payments. Provided that the debtor has not already given creditors reason to doubt the debtor's sincerity, e.g., by completely ignoring their letters or by consistently breaking promises, chances are good that creditors will agree to one of these plans.

As mentioned above, creditors know that bankruptcy means they will probably get just a small fraction of the total sum owed them. A creditor also knows that if it sues to collect its money, it must ask a judge to issue a court order to garnish the debtor's wages. This is time-consuming and costly. All these factors make it more likely that a creditor will agree to a repayment plan.

Many creditors can be understanding if approached with a reduced or delayed payment plan accurately spelling out the debtor's financial situation and showing that the debtor is trying to spread out meager resources in a way that tries to please everyone. A consumer credit counselor can help set up such a plan. Credit counselors can help to analyze and organize one's finances to set up a deferred or reduced payment plan.

In a typical case, a credit counselor devises a repayment plan that is then described in a form letter to be mailed to the debtor's major creditors. There are both advantages and disadvantages to using credit counselors, however. On the plus side, creditors who see that a debtor has taken the effort to consult with a credit advisor may be more likely to accept a repayment plan because seeing a credit counselor shows that the debtor is serious about getting out of debt. But credit counseling services also charge fees for their work, which may be more than an already-stressed budget can handle. However, there are some nonprofit agencies that offer credit counseling for a sliding-scale fee.

Resources

Office of Illinois Attorney General, Consumer Fraud Bureau, 500 South Second Street, Springfield, IL 62706, phone: (217) 782-1090 or 100 West Randolph Street, Chicago, IL 60601, phone: (312) 814-3000 or 1-800-252-8666. Free brochure Bankruptcy

Illinois State Bar Association, Illinois Bar Center, Springfield, IL 62701, phone: (217) 525-1760. Free brochure Bankruptcy for Individuals

Money Troubles: Legal Strategies to Cope with Your Debts, Robin Leonard, Nolo Press, Berkeley, CA, 1991.