What is Bankruptcy Litigation?

Brenda Scott

Bankruptcy is a legally declared state of financial insolvency, or the inability of a debtor to pay his bills. The primary purpose of bankruptcy is to help an individual or company get out from under debt and get a fresh start. Bankruptcy litigation refers to the legal process involved in obtaining debt relief through bankruptcy court.

Individuals who have a serious problem with debt may file for bankruptcy.
Individuals who have a serious problem with debt may file for bankruptcy.

In the United States, bankruptcy litigation can be initiated on the behalf of both individuals and businesses. Article 1 Section 8 of the Constitution directed Congress to create laws governing bankruptcy; as a result, all such cases are handled in federal courts, and not at the state level. Bankruptcy can be either voluntary, which is filed by the debtor, or involuntary, which is forced through a filing by the creditor.

Filing a bankruptcy petition in court declares a debtor's inability to pay his or her bills.
Filing a bankruptcy petition in court declares a debtor's inability to pay his or her bills.

There are three primary kinds of bankruptcy named after the applicable sections of the United States Code. Chapter 7 and Chapter 13 apply to individuals, while Chapter 11 generally is used by businesses. Chapter 7 bankruptcy litigation is called liquidation, a process which involves the selling of the debtor’s non-exempt assets, distributing the amount received to creditors, and canceling all remaining debts. In many cases, the debtor actually keeps most of his assets while having his debts relieved, though this does not apply to a mortgaged home. If the debtor wishes to keep his home, he will have to continue making the payments.

Chapter 13 bankruptcy litigation requires the debtor to submit a three to five year plan for debt repayment. This allows a person to keep his home and other assets, and requires creditors to reduce or eliminate interest on the debt. Chapter 11 bankruptcy litigation is mostly used by corporations and involves restructuring to allow the company to remain open and to pay off debt through future earnings. There are some debts which are not relieved through bankruptcy including; federal taxes, child support, alimony, most student loans and employee withholding taxes.

In Canada, bankruptcy litigation is only available to individuals and partnerships, and consists primarily of liquidation. The person must surrender the majority of his assets to the court, which directs the sell and distribution of proceeds to creditors. Debts which cannot be discharged in Canada through bankruptcy include student loans within ten years of graduation, fines, certain court awarded damages, child and spousal support and debts caused through fraud and theft. Unlike the US, however, Canada will discharge unpaid back taxes through the bankruptcy court.

In the UK, debt relief through bankruptcy litigation is rather easy to obtain, but bears some permanent consequences. In all countries, the bankruptcy will appear on a person’s credit rating for many years. The United Kingdom placed additional consequences by restricting anyone who has had a bankruptcy from participating in a number of occupations. Some of these include serving as a company director, director of a school or college, a Member of Parliament, an attorney, judge, estate agent, accountant or civil servant.

For some individuals, bankruptcy litigation offers an opportunity to get out from under staggering debt and to start over. The action should only be taken after all other alternatives have been pursued, however, because of the long-term negative consequences. Financial counseling, credit restructuring and debt consolidation are possible alternatives which can benefit both creditor and debtor.

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