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What Happens to Most of Your Debts under Chapter 13 “Adjustment of Debts”?

In most Chapter 7 “straight bankruptcy” cases most debts are written off, so what happens to them in a Chapter 13 “adjustment of debts”?

 

The Advantages and Disadvantages of Chapter 13

Chapter 13 comes with many, many tools not available under Chapter 7. Many of these tools are helpful particularly if you have special debts or issues not deal with well in a Chapter 7 case—if you are behind on your mortgage, vehicle loan, or child support, if you owe income or property taxes, or if you have non-exempt (unprotected) assets you want to keep.

But these advantages come with what can be a significant disadvantage: you would usually have to pay something on your “general unsecured” debts—your run-of-the-mill ones without any collateral. That’s instead of paying nothing, as you likely would in a Chapter 7 case.

In some rare Chapter 13 cases you have to pay your “general unsecured” creditors in full—a so-called 100% plan. But on the other extreme, you may not have to pay those creditors anything—a 0% plan. Most of the time you have to pay them something, but often very little—only a few cents on the dollar.

How Much Do You Need to Pay Your “General Unsecured” Debts?

You must pay these debts whatever money is left over and available based on your budget after paying certain secured debts (home mortgage and vehicle arrearage, for example) and “priority” debts (recent income taxes, for example). So how much you have to pay on the debts that in a Chapter 7 case would be just discharged (written off without any payment) depends on your income, allowed expenses, and other debts, and sometimes also on the value of assets that you are trying to protect.

Here is a list of considerations in greater detail about how this works under Chapter 13.

1. Debts that are legally the same are treated the same. So, in a Chapter 13 plan all “general unsecured” debts are paid the same percent of the debt as are other “general unsecured” debts.

2. For any creditor to get paid anything out of what you are paying into a Chapter 13 plan, it has to file a “proof of claim”—stating the amount and nature of the debt—with the bankruptcy court, and do so by the stated deadline. If a creditor with a “general unsecured” debt does not file a “proof of claim” it will receive nothing through the plan. The debt will then be discharged at the end of the completed case.

3. If, as is often the case, other creditors do not file proofs of claim that usually, but not always, means more money available for the other creditors.

4. “0% plans” are those in which all of the money paid by the debtor into the plan is earmarked to pay secured and “priority” debts, plus trustee and attorney fees, leaving nothing for the “general unsecured” ones. Some bankruptcy courts frown on “0% plans,” either in general or especially when there does not seem to be good reason to be in a Chapter 13 case instead of a Chapter 7 one.

5. “100% plans” are those in which all of the “general unsecured” debts are paid in full through the plan. These happen mostly for two reasons. The debtors:

a. have enough disposable income (income minus allowed expenses) over the course of the case to pay off their debts in full; or

b. own more non-exempt assets which they are protecting through their Chapter 13 case than they have debts, requiring them to pay off their debts in full in order to keep those assets.

6. How much “general unsecured” debts are paid depends in part on how long the debtors are required to pay into their Chapter 13 case. Generally, if debtors’ pre-filing income is less than the published “median income” for their applicable state and family size, then they pay for 3 years into their plan. If their income is more than that amount, they must pay for 5 years instead.

7. Payments on “general unsecured” debts can also be affected by changes that happen during the case, such as income increases or decreases affecting the monthly plan payment amount, and unexpected tax refunds and employee bonuses paid into the plan.

8. Once the “general unsecured” debts are paid whatever the Chapter 13 plan provides for them (and the rest of the plan requirements are met), the remaining balances of those debts are discharged.

 

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What Happens to Most of Your Debts in Chapter 7 “Straight Bankruptcy”?

Your debts that are not secured by collateral and are not “priority” debts are discharged (written off) and paid nothing. Mostly.

 

In my blog post last week I introduced the three main categories of debts: “secured,” “priority,” and “general unsecured.”

Secured and priority debts tend to be the ones with issues worth talking about. Secured debts often have liens against your important property and possessions—your home, your car or your truck, maybe your furniture and appliances. Priority debts are ones that are usually not secured but are favored in various ways in the law. They include child and spousal support, certain taxes, and such.

It’s worth paying a lot of attention to secured and priority debts because they raise questions that are likely important to you. Such as, how does bankruptcy help you keep your car if you are behind on payments? If you file a Chapter 7 case do you have to keep paying on your furniture loan to keep your bedroom furniture, and if so how much? How can filing bankruptcy enable you to get and/or keep current on your child support? Will you be able to write off any of your overdue income taxes?

We will look into these questions and more about secured and priority debts in upcoming blog posts. And yet, you probably have more of the third category of debts, “general unsecured” ones, than either secured or priority debts. So first let’s look at what happens to your general unsecured debts, covering today what happens if you file a Chapter 7, and then in my next blog post what happens under Chapter 13.

General Unsecured Debts  

First a reminder from last week: general unsecured debts are those that don’t belong in the other two categories. They are unsecured in that they have no lien on any of your property or possessions. They are “general” simply in that they are not one of special “priority” debts that the law has selected for special favored treatment.

General unsecured debts include all sorts of obligations. Besides the most common ones like (most) credit cards and medical bills, they include personal loans without collateral, checking accounts with a negative balance, bounced checks, most payday loans, claims against you for property damage and personal injury, for breaches of contract—again, just about any way that you can owe money without collateral.

What Happens to Most General Unsecured Debts in Most Chapter 7 Cases

All these kinds of general unsecured debts are usually just legally, permanently written off—“discharged”—in a Chapter 7 bankruptcy case. That means that once they are discharged—usually about 3 months after your case is filed—the creditors can take absolutely no steps to collect those debts.

The only way those debts are paid anything is if either 1) the debt is NOT dischargeable or 2) it is paid (in part or in full) through an asset distribution in your Chapter 7 case.

 1) “Dischargeability”

A creditor can dispute your ability to get a discharge of your debt. Very few general unsecured debts are challenged and so they get discharged. In the rare case that the discharge of one of your debts is challenged, you may have to pay some or all of that particular debt. That depends on whether the creditor is able to establish that the facts fit within some quite narrow grounds. That would usually involving allegations of fraud, misrepresentation or other similar bad behavior on your part. If the creditor fails to establish the necessary grounds, the debt is discharged.

There are also some general unsecured debts that are not discharged unless you convince the court that they should be, such as student loans. The grounds for discharging student loans are quite difficult to establish.

2) Asset Distribution

If everything you own is exempt, or protected, then your Chapter 7 trustee will not take any of your assets from you. This is what usually happens—you’ll hear it referred to as a “no asset” case. But if the trustee DOES take possession of any of your assets for distribution to your creditors—an “asset case”— your “general unsecured creditors” may, but often don’t receive some of it. The trustee must first pay off any of your priority debts, as well as pay the trustee’s own fees and costs. The unsecured creditors get a pro rata share of the pool of whatever, if anything is left over.

Conclusion

In most Chapter 7 cases your general unsecured debts will all be discharged and most of the time will receive nothing from you. Rarely, a creditor may challenge the discharge of its debt. And if, again rarely, you have an “asset case,” the trustee may pay a part or—extremely rarely—all of the general unsecured debts, but only after paying all priority debts and his or her fees and costs.  

 

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If You File a Chapter 7 Bankruptcy with an Attorney You are Nearly Ten Times More Likely to Reach Your Goal of Writing Off Your Debts

Here’s some hard evidence on why it’s dangerous to file bankruptcy without an attorney.

 

As a bankruptcy attorney, I get many phone calls from people who have tried to file a bankruptcy by themselves and have gotten into trouble, sometimes serious trouble. I also run into similar horror stories about what happens when people file without an attorney when I attend “meetings of creditors”—the usually straightforward, usually short meeting with the bankruptcy trustee that everyone filing bankruptcy must attend. I’ve run into countless example of how dangerous it is to file bankruptcy without an attorney.

But I HAVE wondered whether anybody has actually investigated this question. Now somebody has, and we have some pretty solid evidence to back up what I have been witnessing anecdotally.

“The Do-It-Yourself Mirage: Complexity in the Bankruptcy System”

That is the title to a chapter in a book about bankruptcy called Broke: How Debt Bankrupts the Middle Class. This book is a series of articles about many important current issues in the field, with this one chapter focusing on cases filed by debtors not represented by attorneys (“pro se” filers).

The author of this chapter, Asst. Professor Angela K. Littwin of the University of Texas School of Law, analyzed data from the Consumer Bankruptcy Project, “the leading [ongoing] national study of consumer bankruptcy for nearly 30 years.” Her finding: “pro se filers were significantly more likely to have their cases dismissed than their represented counterparts.”

Very interestingly, she also learned from the data that

consumers with more education were significantly more likely than others to try filing for bankruptcy on their own, but that their education didn’t appear to help them navigate the process. Pro se debtors with college degrees fared no better than those who had never set foot inside a college classroom.

She concluded that after bankruptcy law was significantly amended back in 2005 in an effort to discourage as many people from filing, “bankruptcy has become so complex that even the most potentially sophisticated consumers are unable to file correctly.”

Ten Times More Likely to Get a Discharge of Your Debts

In a closely related study, Prof. Littwin stated that “17.6 percent of unrepresented [Chapter 7 “straight bankruptcy”] debtors had their cases dismissed or converted” into 3-to-5-year Chapter 13 “adjustment of debts” cases.  “In contrast, only 1.9 percent of debtors with lawyers met this fate.”  Even after controlling for other factors such as “education, race and ethnicity, income, age, homeownership, prior bankruptcy, whether the debtor had any nonminimal unencumbered assets at the time of the filing,” “represented debtors were almost ten times more likely to receive a discharge than their pro se counterparts.”

Prof. Littwin concluded that “filing pro se dramatically escalates the chance that a Chapter 7 bankruptcy will not provide a person with debt relief.”

 

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Business Disputes that Follow You Into Your Bankruptcy Case

A creditor can challenge the discharge of its debt in bankruptcy. This is not common, but is more so after a debtor closes a business.

 

Why Creditor Challenges Are More Common in Closed-Business Bankruptcies

For the following reasons, creditors tend to object more to the discharge of their debts in bankruptcy cases that are filed after the debtor has operated and closed a business:

  • The amount of debt owed, and thus the amount at stake, tends to be larger than in a conventional consumer case, making objection more tempting to the creditor.
  • In the business context some debtor-creditor relationships can be very personal, so when the business fails, these creditors take it personally. Consider debts between former business-partners who are blaming each other for the failure of the business, or between a business owner and the business’ primary investor who believes the owner drove the business into the ground, or between the contract buyer of a business and its seller in which the buyer feels that the seller misrepresented the profitability of the business. In these situations the aggrieved creditor is more personally motivated to fight the discharge of its debt.
  • The owners of businesses in trouble find themselves desperate to keep their businesses afloat. So they make questionable decisions which then expose them to objections about fraud and such once they file bankruptcy.
  • In the kinds of close creditor-debtor relationships mentioned above, the creditor often has hints about the business owner’s questionable behavior, and so is more likely to believe it has the legally necessary grounds to object.

But Objections to Discharge Are Still Not Very Common

When former business owners hear that any creditor can raise objections to the discharge of its debt, they figure an objection would very likely be raised in their case. But in reality these objections occur much less frequently than might be expected, for the following reasons:

  • The legal grounds under which challenges to discharge must be raised are quite narrow. To be successful a creditor has to prove that the debtor engaged in rather egregious behavior, such as fraud in incurring the debt, embezzlement, larceny, fraud as a fiduciary, or intentional and malicious injury to property. These are not easy to prove, so creditors do not tend to try unless they have a strong case.
  • In his or her bankruptcy case the debtor publically files a set of papers containing quite extensive information about his or her finances, and does so under oath. The debtor is also subject to questioning by the creditors about that information and about anything else relevant to the discharge of his or her debts. If the information on the sworn documents or gleaned from any questioning reveals that the debtor truly has no assets worth pursuing, a rational creditor will often decide not to throw “good money after bad” by raising an objection.

Conclusion

In a closed-business bankruptcy case there are these two opposing tendencies. Challenges to discharge are more likely, especially by certain kinds of closely related creditors. But these challenges are still relatively rare because of the narrow legal grounds for them and the financial practicalities involved. A good bankruptcy attorney will advise you about this, will prepare your bankruptcy paperwork to discourage such challenges, and will help derail any such challenges if any are raised.   

 

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Why You Should or Should Not Worry about Creditors Objecting in Your Bankruptcy Case

FACT: In bankruptcy, creditors seldom fight the write-off of their debts. Why not? And when DO they tend to fight?

 

Debts That Creditors Must Object To

This blog post is NOT about the kinds of debts that simply can’t be discharged (legally written off), and don’t need the creditor to object for that to happen. Examples of those are child and spousal support obligations, recent income taxes debts, and criminal fines. Those survive bankruptcy without any effect on them.

Instead this is about ordinary debts and the ability of any creditor to raise certain limited kinds of objections to the discharge of its debt.

Your Fears

As you consider whether or not to file bankruptcy, you might be wondering whether doing so would be effective—whether you will succeed in discharging your debts so you no longer have to pay them. And you might also wonder whether it would be emotionally difficult—whether the creditors would give you a bad time and try to make you feel guilty for not paying your debts.

As indicated at the beginning of this blog post, creditors will very seldom raise objections to discharging their debts. So your bankruptcy case will likely result in the discharge of all the debts you expect to discharge, usually without even hearing from most or all of your creditors about it. So your bankruptcy will in most cases be effective and not contentious.

Why Objections Aren’t Usually Raised

But if creditors have a right to object, why don’t they do so? If they can make trouble for you, why don’t they?

Simply because doing so is very seldom worth their trouble.

Why not?

1. Creditors seldom have the factual basis on which to object.

The legal grounds for creditors to object to the discharge of their debts are quite narrow. They need to present evidence that you incurred the debt through fraud or misrepresentation, by theft or embezzlement, by your intentional injury to a person’s body or property, or through some other similar bad act. The biggest reason that creditors don’t raise objections to the discharge of their debts is that they seldom have grounds to do so.

2. It takes money for creditors to object, money they may well not recoup.

Creditors sometimes do have factual grounds to object, for example in relatively common situations such as bounced checks or the use of credit without the intent to repay (just before filing bankruptcy). But even in these situations, creditors often don’t object because they decide it’s not worth the risk that they would just spend more money on objecting without doing any good. They often don’t want to risk spending more money to pay for their staff and for attorney fees only to have the bankruptcy judge decide that the required grounds for objection have not been met.

3. The risk that the creditor would have to pay your attorney fees.

One of the reasons why sensible creditors decide not to object unless they are very confident that they have the grounds to do so is that they risk being ordered to pay your attorney’s fees for defending against their objection. That would happen if the judge decided that “the position of the creditor was not substantially justified.” So if creditors are not very confident of their argument, they could be dissuaded further by the risk of having to pay your costs fighting the objection.

So that’s why most creditors just write off the debt and you hear nothing from them during your bankruptcy case.

When Creditors Tend to Object

Creditors do object sometimes, often involving one of the following two situations:

1. Using leverage against you.

If a creditor thinks it has a sensible case against you, it could raise an objection knowing that you are not willing or able to pay a lot of attorney fees to fight it. The creditor knows that even if you have a good defense to its accusations so that you could well win if the matter went all the way to trial, it would cost you a lot to get to that point. So they raise the objection in hopes of inducing you to enter into a settlement quickly.

2. A Personal Grudge

If a creditor is very angry at you for some reason, he, she, or it might be looking for an excuse to harm you or cause you problems. Ex-spouses and ex-business partners are the most common creditors of this sort, but sometimes more conventional creditors find some reason to pick on you. Irrationality is unpredictable, so it sometime drives an objection even when there are little or no factual grounds for it.

The Creditors’ Firm Deadline to Object

Creditors have a very limited time to raise objections: their deadline is only 60 days after the Meeting of Creditors (so around 3 months after your bankruptcy case is filed).

So, talk with your attorney if you have any concerns along these lines. And then if whatever assurances he or she gives you doesn’t stop you from worrying about this, you’ll at least know that you won’t have long to worry before the creditors’ right to object expires. 

 

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What a Simple Chapter 13 Case Looks Like

The most common reason for a Chapter 13 “adjustment of debts” is if you have debts that can’t be written off in a “straight” Chapter 7 case.

 

When Chapter 7 Does Not Discharge Your Debts

My last blog post was about the discharge (legal write-off) of debts under Chapter 7. I concluded with the comment that if you have debts that Chapter 7 doesn’t discharge, Chapter 13 may be the way to go. It provides what is often the safest and most convenient method to deal with debts that you have to pay, while also discharging those debts that would be discharged under Chapter 7. The much longer time that Chapter 13 takes—3 to 5 years instead of as short as 3 to 4 months for most Chapter 7 cases—can be highly worthwhile under the right circumstances.

An Example

Let’s show you one example of the right circumstances. Imagine someone owing $7,000 in IRS debt for 2011 and 2012, $3,000 in back child support, $20,000 in credit cards, and $5,000 in medical bills. The person lost his or her job in late 2010 and used the situation to try to run a one-person business during 2011 and 2012. It made a little money but only barely enough to pay living expenses. There was absolutely no money available to set aside for income taxes. During that period the person also fell behind on child support payments. Then this person found a new job a few months ago that pays less than the one lost in 2010, but at least enough to pay ongoing taxes and support, in addition to living expenses. But the person’s budget leaves only about $400 to pay ALL debts, not nearly enough to pay the minimum amounts on the credit cards, much less anything towards the rest of the debts including the taxes and back support.

What Chapter 7 Would and Would NOT Accomplish

A regular Chapter 7 case would likely discharge the $20,000 in credit cards and the $5,000 in medical bills, but would leave owing the $7,000 to the IRS and the $3,000 in back support. Although discharging $25,000, the person would come out of bankruptcy still $10,000 in debt, owed to two creditors who can be extremely aggressive—the IRS and your ex-spouse or the local support enforcement agency.

Although the IRS might be willing to accept payments of $400 per month, there’s a good chance that your ex-spouse or the support enforcement agency would be able to garnish your wages for the back support, and that would negate any possible arrangement with the IRS. Plus the last thing this person would want at his or her new job is for the payroll office to get a garnishment order for back child support. A previously filed Chapter 7 case would have no power to stop that kind of garnishment.

What Chapter 13 Would Accomplish

In contrast Chapter 13 would be able to stop your ex-spouse or support agency from garnishing for back support—as well as from any action the IRS or any state taxing entity, or virtually any other creditor, could take.

So the person in our example would file a Chapter 13 case, start or continue paying any ongoing monthly child support payments, and would also be sure to have withheld an adequate amount for ongoing income taxes. Then his or her attorney would put together a plan to pay the Chapter 13 trustee $400 per month (based on what is available in his or her budget) for 36 months.

During that period of time neither the IRS, nor the support agency or ex-spouse, nor any other creditors would be able to take any action against the person or any of his or her assets as long as he or she complied with the Chapter 13 plan. That means that he or she kept up the $400 plan payments, and kept current on ongoing tax and support obligations (as provided for in the budget).

Over those three years the trustee would be paid $14,400 ($400 X 36 months), which would pay all the $3,000 in back support and the $7,000 in taxes—usually without any additional interest or penalties from the date of the filing of the Chapter 13 case. The Chapter 13 trustee would also get paid, usually about 5-to-10% of what is being paid into the plan, as would any attorney fees that weren’t paid to the attorney at the beginning of your case.  If there would be any money left over (little or none in this example), that would be divided pro rata among the credit card and medical debts. After the 36 months of payments, any remaining balances on those debts would be discharged. That would leave the person at the end of the Chapter 13 case owing nothing to anyone. The back taxes and support would have been paid off, and he or she would be current on any ongoing income taxes and child support.

So that’s what a simple Chapter 13 case would accomplish and would look like. 

 

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Discharge of Your Debts: THE Goal of Bankruptcy

Most debts are “discharged”—written off—in bankruptcy. But some may not be. Can we know in advance which will and will not be discharged?

 

 

Bankruptcy is about Discharge

The point of bankruptcy is to get you a fresh financial start through the legal discharge of your debts.

Both kinds of consumer bankruptcy—Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts”—can discharge debts. But most Chapter 13s tend to have other purposes as well, and the discharge usually occurs only 3 to 5 years after the case is filed.

In contrast, most Chapter 7 cases are filed for the single, or at least primary, purpose of discharging debts. Furthermore, in most Chapter 7 cases all debts that the debtors want to discharge are in fact discharged, and this happens within just three months or so after the case is filed.

This blog post focuses on Chapter 7 discharge of debts.

What Debts Get Discharged?

Is there a simple way of knowing what debts will and will not be discharged in a Chapter 7 case?

Yes and no.

We CAN give you a list of the categories of debts that can’t, or might not, be discharged (see below). But some of those categories are not always clear which situations they include and which they don’t. Sometimes whether a debt is discharged or not depends on whether the creditor challenges the discharge of the debt, on how hard it fights for this, and then on how a judge might rule.

Why Can’t It Be Simpler?

Laws in general are often not straightforward, both because life can get complicated and because laws are usually compromises between competing interests. Bankruptcy laws, and those about which debts can be discharged, are the result of a constant political tug of war between creditors and debtors over the last few centuries. There have been lots of compromises, which has resulted in a bunch of hair-splitting laws. 

To give some perspective, believe it or not the original bankruptcy laws in England—from which our bankruptcy laws came—did not include ANY discharge of debts. Bankruptcy was originally designed as a procedure to help creditors collect from debtors, not at all as a legal means of protecting debtors from creditors. So there was no perceived need for a discharge of debts—the creditors could just continue chasing their debtors after the bankruptcy procedure was done!

But Let’s Get Practical

The present reality is much more positive, and usually pretty straightforward:

#1:  All debts are discharged, EXCEPT those that fit within a specified exception.

#2:  There are quite a few of exceptions, and they may sound like they exclude many kinds of debts from being discharged. It may also seem like it’s hard to know if you will be able to discharge all your debts. But it’s almost always much easier than all that. As long as you are thorough and candid with your attorney, he or she will almost always be able to tell you whether you have any debts that will not, or may not, be discharged. Most of the time there are no surprises.

#3:  Some types of debts are never discharged. Examples are child or spousal support, criminal fines and fees, and withholding taxes.

#4:  Some other types of debts are never discharged, but only if the debt at issue fits certain conditions. An example is income tax, with the discharge of a particular tax debt depending on conditions like how long ago those taxes were due and when its tax return was received by the taxing authority.

#5:  Some debts are discharged, unless timely challenged by the creditor, followed by a judge’s ruling that the debt met certain conditions involving fraud, misrepresentation, larceny, embezzlement, or intentional injury to person or property.

#6:  A few debts can’t be discharged in Chapter 7, BUT can be in Chapter 13. An example is an obligation arising out of a divorce other than support (which  can never be discharged).

The Bottom Line

#1: For most people the debts they want to discharge WILL be discharged. #2: An experienced bankruptcy attorney will usually be able to predict whether all of your debts will be discharged. #3: If you have debts that can’t be discharged, Chapter 13 is often a decent way to keep those under control. More about that in my next blog post about Chapter 13.

 

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Why Can’t a Creditor Chase You After Your Bankruptcy?

What makes it illegal for your creditor to pursue a discharged debt? What penalties may get awarded to you if a creditor breaks the law?

 

Chasing a Discharged Debt is a Violation of Federal Law

The Bankruptcy Code makes it perfectly clear that for a creditor to try to collect on a debt after it is discharged under either Chapter 7 “straight bankruptcy” or Chapter 13 “adjustment of debts” is illegal. Section 524 of the Bankruptcy Code is about the legal effect of a discharge of debt. Subsection (a)(2) of that section says that a discharge of debts in a bankruptcy “operates as an injunction against” any acts to collect debts included in that bankruptcy case. Acts explicitly stated as illegal include:

the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor.

In other words, the creditor can’t start or continue a lawsuit or any legal procedure against you, and can’t act in any other way to collect the debt.

What If a Creditor Violates This Injunction?

Nowhere in Section 524 of the Code does it say anything about what happens if a creditor violates the law by disregarding that injunction. The section does not clearly say what, if anything, the penalties are for a creditor caught doing so.

However, even though no penalties are specified in THAT section, there is a strong consensus among courts all over the country that bankruptcy courts can penalize creditors for violating the discharge injunction through another section of the Bankruptcy Code, Section 105, titled “Power of Court.” The idea is that the injunction against pursuing a discharged debt is a court order, and so a creditor violating it is in contempt of court. So the usual penalties for those who act in civil contempt of court apply.

Penalties Assessed Against Violating Creditors

These penalties for civil contempt can include “compensatory” damages and “punitive” damages.

Compensatory damages are intended to compensate you for harm you suffered because of the creditor’s violation of the injunction. These potentially include actual damages such as time lost from work or other financial losses, emotional distress caused by the illegal action against you, and attorney fees and costs you’ve incurred as a result.

Punitive damages are to punish the creditor for its illegal behavior. So the judge looks at how bad the creditor’s behavior was in determining whether punitive damages are appropriate and how much to award.

Conclusion

The vast majority of the time creditors in a bankruptcy case write the debts off their books and you never hear about those debts again. But even though it’s illegal for creditors to try to collect on a debt that’s been legally written off in bankruptcy, once in a while they do try. Some creditors don’t keep good records or simply aren’t all that serious about following the law.

So after you receive your bankruptcy discharge, if you hear from one of your old creditors trying to collect its debt contact your attorney right away.  This needs immediate attention. If the creditor’s behavior is particularly egregious, you and your attorney should discuss whether to strike back at the creditor for violating the law. There might possibly even be some money in it for you.

 

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U. S. Bankruptcy Laws Took Very Long to Get Off the Ground

The Constitution empowered Congress to “pass uniform laws on the subject of bankruptcies,” which then took more than 100 years to do so.


  • The United State of America started its existence without a national bankruptcy law, and in fact without the ability to have one. The Continental Congress established the United States with its founding constitution consisting of the “Articles of Confederation and Perpetual Union,” drafted in 1776-1777. Not ratified by the 13 states until 1781, the Articles of Confederation did not provide for a nationwide bankruptcy system.
  • The American Revolutionary War ended in 1782, the U.S. Constitution was drafted in 1787 and was ratified by the states in 1789.  It did allow for, yet did not of itself create a national bankruptcy law. It merely empowered Congress to “pass uniform laws on the subject of bankruptcies”.
  • The Constitution may have thus empowered Congress, but Congress did not do a very good job at this for nearly half our nation’s history. Three different times during the 1800s, a federal bankruptcy law was passed in direct reaction to a financial “panic.” But these federal laws were each repealed after the financial crises were over.
  • During the long periods when there was no nationwide law in effect, the states developed a patchwork of bankruptcy and debtor-creditor laws. But these local laws became more and more cumbersome as commerce became ever more interstate.
  • Finally, Congress passed the Bankruptcy Act of 1898. This is the first one that was not quickly repealed, and lasted 80 years.  This law was inspired by commercial creditors, to help in the collection of debts. However, it included the following very important debtor-friendly provisions: most debts became dischargeable, and creditors no longer had to be paid a certain minimum percentage of their debts.
  • This Bankruptcy Act of 1898 was amended many times, significantly in 1938 in reaction to the Great Depression. Among other things that 1938 amendment added the “chapter XIII” wage earners’ plans, the predecessor to today’s Chapter 13s.
  • The 1978 Bankruptcy Reform Act, the result of a decade of study and debate, gave us the Bankruptcy Code. It has been amended every few years since then, most significantly in 2005 with BAPCPA, the so–called Bankruptcy Abuse Prevention and Consumer Protection Act. 
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The Truly Amazing History of Bankruptcy Law

Debtors’ prisons? There’s that and a lot more to the very colorful history of bankruptcy law.

 

American bankruptcy law naturally grew out of the law of England during our colonial history. Pre-Revolutionary War bankruptcy laws were extremely different from current law.

  • The first bankruptcy law in England was enacted more than 450 years ago during the reign of Henry VIII. Debtors were called “offenders” under this first law, in effect seen as perpetrators of a property crime against their creditors. The purpose of this law, and as expanded during the following hundred and fifty years, was not to give relief to debtors. Rather it was to provide to creditors a more effective way to collect against their debtors.
  • Given this purpose, it is not surprising that this first law did not give debtors a discharge—a legal write-off—of their debts. In a bankruptcy the assets of the “offender” were seized, sold, and the proceeds distributed to creditors. And then the creditors could still continue pursuing the “offender” for any remaining balance owed.
  • A bankruptcy proceeding could only be started by creditors, not by debtors.  Creditors accused a debtor of an “act of bankruptcy,” such as physically hiding from creditors, or hiding assets by transferring them to someone else.  The current extremely seldom used “involuntary bankruptcy” is a remnant of this.
  • Strangely, only merchants could file bankruptcy. Why? Credit was seen as immoral, with only merchants being allowed to use credit, for whom it was seen as a necessary evil. As the only ones who had access to credit, only merchants had the capacity to become bankrupt.
  • For the following century and a half through the late 1600s, Parliament made the law even stronger for creditors, allowing bankruptcy “commissioners” to break into the homes of “offenders” to seize their assets, put them into pillories (structures with holes for head and hands used for public shaming), and even cut off their ears.
  • Finally in the early 1700s the discharge of debts was permitted for cooperative debtors, but only if the creditors consented!
  • Yet the law still provided for the death penalty for fraudulent debtors (although it was very seldom used).
  • Cooperative debtors received an allowance from their own assets, the very early beginnings of the current Chapter 13 “adjustment of debts.”

So this was the English bankruptcy law that was largely in effect at the time that the U.S. Constitution was adopted. That gives some perspective on what the framers may have had in mind with the Bankruptcy Clause of the U. S. Constitution. That Clause gave Congress power to “pass uniform laws on the subject of bankruptcies.” Fortunately the language is so open-ended that it gave bankruptcy laws the opportunity to evolve during the last two hundred fifty years into one infinitely both more compassionate and beneficial for the economy.

But this evolution during our national history was extremely rocky, until surprisingly recently. That is the topic of the next blog. 

 

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