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Sarah Delano Pavlik and Tom Pavlik write a monthly column on legal and business issues for the Springfield Business Journal.

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Last month I wrote about starting your own business. But what happens if your business is not successful, or you lose your job, or you have huge medical bills? If all else fails, you may need to file for bankruptcy.

Bankruptcies are administered by the United States Bankruptcy Courts. Bankruptcy is governed by federal law, however, your state of residency will determine your exempt property, that is, what property you are entitled to keep. Some states have very liberal exemptions. For example, Florida and Texas allow debtors to keep their homes regardless of value. That is one reason many people (O.J. Simpson, WorldCom executives, etc.) move to Florida and purchase large homes before filing for bankruptcy.

Illinois bankruptcy law is not particularly debtor friendly. Under Illinois law, a debtor may keep the following property:

  • Retirement plans and annuities;
  • Equity of $7,500 in a personal residence;
  • Equity of $1,200 in a car or other motor vehicle;
  • Equity of $750 in tools or books used in your occupation;
  • Necessary wearing apparel worth $350; and
  • Other personal property, including cash, worth $2,000.
If a husband and a wife file a joint bankruptcy petition, each spouse is entitled to claim these exemption amounts.

When filing for bankruptcy, you must decide what type of bankruptcy to file. Individuals can choose between a Chapter 7 bankruptcy and a Chapter 13 bankruptcy. (Farmers can also file a Chapter 12 bankruptcy.) The word "Chapter" refers to the chapter number in the Bankruptcy Code. Under a Chapter 7 bankruptcy, you will be required to liquidate your nonexempt property. The proceeds will be paid to your creditors, and remaining debts will be discharged. A Chapter 13 bankruptcy does not involve liquidation of your property and includes a payment plan for debts.

Generally, each person must file for bankruptcy separately, however, it is possible for a husband and wife to file a joint bankruptcy. In addition, either spouse can file alone. The determination of who files for bankruptcy will be determined by who is liable for the debts. Husbands and wives are not automatically liable for their spouse's debts, and each debt must be analyzed to determine liability. In addition to voluntarily filing for bankruptcy, a creditor can file to force you into bankruptcy involuntarily.

When you file for bankruptcy, the court will issue an automatic stay. That means that creditors must stop all collection efforts, and severe penalties can be imposed for violating the automatic stay. The court will appoint a trustee to handle your case. In a Chapter 7 case, the trustee will review your claims for exempt property and arrange for the liquidation of nonexempt property. During the bankruptcy proceeding, creditors may file claims with the court asserting that you are hiding assets or that you are not entitled to a discharge. If no objections are filed or if all objections are overruled, the court will issue an order of discharge.

One objection to bankruptcy is fraud. If you attempt to give your assets away to friends or family members before filing for bankruptcy, the court can deny you a discharge. You must disclose all such transfers to the court, and the court can declare the transfers void.

An order of discharge does not apply to certain debts. For example, most tax liabilities, student loans, alimony, child support and debts that are not disclosed to the court will not be discharged. In addition, certain creditors can request that their debts not be discharged, such as debts incurred by fraud, embezzlement or as a result of drunk driving or other criminal acts.

An order of discharge will not terminate liens on your property such as your home mortgage or a lien on your car. With permission of the court, these creditors can foreclose on the property during the bankruptcy proceeding.

An order of discharge will also not apply to any other party to a loan. For example, if your parents or a sibling co-signed on your car loan, they will still be liable on the loan even if your debt is discharged by the court. (A co-signer may be protected, however, if the debt is covered by a plan under Chapter 13.)

Unlike a Chapter 7 bankruptcy, in a Chapter 13 case, you are not required to liquidate your property. Instead, you file a plan with the court indicating how you will pay your creditors. A plan generally covers a three year period, but the plan can last as long as five years. Under the plan, you make regular payments to the trustee who in turn makes payments to your creditors. To be eligible for a Chapter 13 bankruptcy, you must meet certain income requirements and debt limitations.

Although bankruptcy may seem like an easy solution, you should carefully consider all of your options before filing. Bankruptcy can make it extremely difficult to obtain credit, particularly a home mortgage, for a number of years after the bankruptcy. In addition, your credit rating can affect your insurance rates, prospective employment and more. (Generally, however, your employer cannot discharge you or discriminate against you solely because you have filed a bankruptcy case.)

Congress is currently considering bankruptcy reform legislation that will make it more difficult to discharge debts in bankruptcy, particularly credit card debts. Therefore, if you are considering filing for bankruptcy, you may wish to do so sooner rather than later.
Posted in: September, 2002
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